LOWER CORPORATE TAX RATE IN ONTARIO

Chris Edwards, an economist at the Cato Institute, reports that Tim Horton's (Canada's "Starbucks") is moving its headquarters to Ontario, as the provincial policymakers are cutting the federal-provincial corporate tax rate down to 25 percent (link). That is 15 percentage points lower than the federal corporate tax rate in the U.S.

GLOBAL ENABLING TRADE REPORT 2009

World Economic Forum recently published its annual report on enabling trade around the world (link).

The report estimated broader openness to trade after taking all indicators, regulatory and administrative factors into account. Notably, among these are the ease of market access, customs administration, difficulty of export and import procedures, quality of transport infrastructure, the availibility of transport services and the use of ICT. The report found a positive and moderate correlation between the GDP per capita and enabling trade index. Thus, it implies that countries with higher GDP per capita, on average, tend to be more trade-friendly.

There are, of course, some other factors, aside from GDP per capita, that affect broader openness to trade. The research by the WEF found that the customs regulations, quality of regulatory and business environment and the quality of transport infrastructure and services significantly explain country's openness to trade flows fairly well.

Countries with the highest Enabling Trade Index (ETI) are Singapore, Hong Kong, Switzerland, Denmark and Sweden, followed by Canada, Norway, Finland, Austria and the Netherlands. In spite of robust growth of trade volume before the economic crisis, Russia ranks 109th out of 121 countries in the report, accompanied by countries such as Syria and Nepal. This suggests that Russia's growth of trade volume before the crisis can be assigned to its factor-driven economic growth. WEF's report reveals that Russia's score poorly in terms of border administration, market access and the business environment while performing modestly in terms of quality of transport infrastructure. Index of Economic Freedom noted that Russia's trade freedom is inhibited by the inefficient arbitrary customs administration. The latter restrains trade and is a popular protectionist policy measure. The least trade-friendly countries, according to the report, are: Chad, Cote d'Ivoire, Venezuela, Zimbabwe and Nigeria.

CALIFORNIA'S DISMAL FISCAL LEGACY

At Bloomberg, Kevin Hassett wrote an article (link), discussing the shortcomings of California's fiscal crisis. According to the official estimates, California's annual budget deficit is likely to hit $26 billion. Dan Mitchell recently debated California's spending disease on CNBC (link). In addition, high government spending has deteriorated California's economic growth prospects. California has become a textbook case of gradual economic stagnation. Back in 1960, California's GDP per capita stood 24.5 percent above the U.S average. In 2008, it stood 7.4 percent above the U.S average. In recent decade, California has pursued an economic policy based largely on government's meddling into economic affairs.

The data from California's Department of Finance (link) reveal the outcome of economic mismanagement. In California, minimum wage has been growing steadily with a fascinating rate. In 1957, the minimum wage rate stood at $1.0 per hour. In 2008, the minimum wage rate was $8.0 per hour. That is 800 percent increase. In 2008, the minimum wage rate in California was 10.35 percent above the U.S average. The economics of minimum wage is simple: as unions set the minimum wage above the non-union rate, the employment drops and union members enjoy a wage premium and more employment protection. Larry Summers, the chairman of National Economic Council, nicely summarized how minimum wages, welfare payments and unemployment insurance spur long-term unemployment (link).

The macroeconomic outlook of California is not favorable. Seasonally-adjusted unemployment rate in May 2009 stood at 11.5 percent compared to 9.4 percent of the U.S average. Second, California's record-breaking budget deficit is largely a result of high tax burden and high government spending. In 2009, California's government spending is projected to reach $417.3 billion or almost 25 percent of California's gross state product (GSP). The share of government spending in the GSP is likely to climb higher when the 2009 GDP data will be released. Time-series data on fiscal policy (link) show that California's gross public debt in 2009 is set to hit $367.7 billion or 21.63 percent of state's gross product. A study conducted by Arthur Laffer & Moore Econometrics (link) showed that California's 10.3 percent top personal income tax rate is the second highest in the U.S, just behind the state of New York.

Not surprisingly, the overall employment grew only by 1.4 percent. In Texas, one of the most vibrant and highest-growing economies in the U.S, the overall employment grew by 2.9 percent. That is 107 percent difference. California's tax policy has also taxed dividends and capital gains by 10.3 percent tax rate, thus discouraging capital formation.

If California were an independent state, it would be the 8th largest economy in the world. However, tax and spending fine-tuning left a disastrous fiscal legacy of high public debt, deep budget deficits and stagnation of employment, productivity and income growth. To stabilize California's public finance and boost state's economic growth, the remedy of fiscal policy would include a drastic reduction of government spending, the ending of budget deficit and the creation of surplus. In addition, tax rates that penalize savings, work and investment should be slashed radically. It should not be neglected that entitlement spending is a hampering burden to the economy and is ought to be anchored by an official fiscal target. If California's public finances and fiscal policy continue the status quo, then, in a couple of years, California's economy will resemble France more closely than ever before.

4TH OF JULY 2009

"The ground of liberty is to be gained by inches, and we must be contented to secure what we can get from time to time and eternally press forward for what is yet to get. It takes time to persuade men to do even what is for their own good."

Thomas Jefferson

Happy Independence Day!

ECONOMIC GROWTH IN THE WORLD IN 2009

Source: Congressional Budget Office (link)

INTERVIEW WITH PAUL A. SAMUELSON

Conor Clarke has published a great interview with Paul A. Sameulson in two parts (here and here) discussing fiscal stimulus, Keynesian macroeconomics, behavioral economics and other issues as well.

LONG-TERM FEDERAL DEFICIT SPENDING

Source: CBO (link)

THE COST OF FREE TIME

This is what I chased in NYT (link):

IS ASIA THE NEW CENTER OF WORLD ECONOMY?

Gary Becker (link) and Richard Posner (link) discuss whether the gravity of world economy is moving from the US and the EU to emerging Asian economies.

Rapid economic growth and steady institutional transformation are the key drivers of Asia's economic rise in the global economy. While the United States and the EU will likely suffer from this year's recession and pursue a U-shaped recovery, India, China, Indonesia and Vietnam will continue to grow in 2009 with favorable midterm growth projections. Even minor short-run differences in economic growth can lead to a profound impact on long-run income per capita. For example, if China and India's long-run economic growth rate is about 5 percent, it would take 14 years to double its income per capita.

If the growth rate were 6 percent, which is more likely after taking the productivity shocks into account, it would take 12 years for income per capita to double. The medium-term forecasts by the IMF suggest that the U.S and Europe will grow between 2.5 and 3 percent. Similarly, that would take 29 years and 24 years to double the income per capita. The gap can be further estimated by the empirics of real convergence.

Rapid economic growth in Asian tigers will also induce their bargaining power in institutions such as WTO, IMF and World Bank. In particular, Asia's fast growing economies play a stronger role in world trade. Thus, the bargaining power of India and China in negotiating regional and multilateral trade agreements is growing. The central challenge, however, is whether Asian tigers will recognize that free trade promotes economic growth, welfare and peace. The rise of trade protectionism in the U.S (link) and Europe is a significant concern from a countervailing perspective. Even the area of climate change policy is a potential source of conflict between the US and the EU on one side and China and India on the other side.

Of course, I disagree with pessimistic arguments that the U.S will lose its leadership in innovation, technology and human capital. Indeed, top U.S universities will still remain world's top-notch sources of human capital and the U.S high-tech firms are unlikely to lose their world leadership. However, rapid economic growth in Asia will induce China, India, Indonesia and Vietnam to pursue free-market policies alongside economic, civil and political liberties to give up the authoritarian political climate. In fact, the transformation to free-market economy with independent economic and political institutions will, in the long run, determine the scope of Asia's economic rise in the world.

LABOR PROTECTIONISM IN THE U.S

Daniel Griswold, trade economist at CATO Institute, describes (link) how American labor unions oppose the free-trade agreement between the U.S and Columbia although the U.S International Trade Commission's estimates show that the free trade agreement between the two countries would boost U.S exports by about $1 billion annually. The AFL complains that Columbia is an unworthy of an agreement because of violence levied on union members (link). This may sound politically feasible, but the background is certainly much different from what AFL complains. In fact, Daniel Griswold showed that Columbian unions are as safe as American unions against political violence (link).

Recall the basics of international trade, H-O-S theorem (link) explains that international trade occurs because of the differences in relative factor abundance, i.e. differences between labor/capital ratio. Thus, a country with relative abundance in labor shall export labor-intensive products while the second country shall export capital-intensive products and services. Consequently, relative wages in labor-abundant country are lower compared to those in capital-abudant country. Why? Because in a more developed capital-abundant country, labor is scarce and, hence, relative wage is higher.

The complete liberalization of trade between the U.S and Columbia would reward the relatively abundant factor in the U.S (capital) and reduce the real reward to less abundant factor (labor). Thus, in the short run, relative wages may decline. Note that the Columbian level of productivity is less than half of the U.S level. In the long run, however, relative wages shall not decline given a staggering difference in productivity between the U.S and Columbia.

As a interest group, AFL is protecting labor againist the short-run decline in relative wages. The hindrance of free trade, in fact, harms everyone. The U.S exporters would suffer the loss of one the key Latin American markets while the Columbian exporters wouldn't absorb the benefits of free trade. On the other hand, the greatest victims of protectionist trade policy are consumers. The consumers in the U.S would be denied the freedom of choice of Columbian imports while Columbian consumers would lose the variety of choices from the U.S at a lower price, following the abolition of tariff protection.

APPLYING ARROW'S IMPOSSIBILITY THEOREM

"For centuries philosophers, mathematicians, political scientists and economists have searched for the best method of voting. Fifty-eight years ago the economist Kenneth Arrow (later a Nobel laureate) decided to see whether any voting rule could avoid the problems we've illustrated. Fix them all at once, he found, and you get--a dictatorship. One voter calls the shots every time. Arrow's "impossibility theorem" demonstrates that no system of voting always gives the "right" result."

Source: John Mark Hansen, Allen R. Sanderson, The Olympics of Voting, Forbes, June 3, 2009 (link)

RUSSIA'S ECONOMIC CRISIS

As seen by The Economist (here and here):

"...a recent study by McKinsey, a consultancy. It looked into five sectors of the Russian economy and found that, although productivity has improved over the past decade, it is still only 26% of American levels. Bureaucracy and corruption are stifling it. It takes six times as long to obtain construction permits in Russia as in Sweden and, despite cheaper labour and land, the cost of building a distribution centre is a third more expensive than in London, according to McKinsey. When profit margins were 25%, construction firms could afford to pay off bureaucrats. Now they cannot..."

THE COST OF FISCAL STIMULUS

The Economist observes that a growing public debt and exploding fiscal deficit is the foremost macroeconomic enemy of the U.S economy (link). Interestingly, Douglas W. Elmendorf, the head of CBO delivered a brilliant testimony (link) on the state of the economy, emphasizing the interest rate spread, the macroeconomic effects of financial crisis and the deflationary outlook for 2010. Below is a time series and the long-term projection of the U.S public debt in the percentage share of the GDP under three scenarios.

Source: Congressional Budget Office (link)

U.S TRADE DEFICIT AND CHINA

Today, Bloomberg reported (link) that April's trade deficit in the U.S increased by 2.2 percent. The recession in major trading partner sharply reduced external demand for U.S exports. As trade deficit has continued to grow, the U.S experienced significant investment inflows due to Fed's and external demand for Treasury bonds by which Chinese central bank accumulated massive foreign currency reserves. Consequently, the U.S dollar depreciated against the yuan, pushing up trade deficit. In the last three months, the yuan appreciated by 0.3 percent. In spite of the recession, the Chinese economy is set to expand by 7.5 percent annually in 2009. Thus, it is hard to understand why some U.S politicians repeatedly say that the yuan is overvalued.

THE 2009 RECESSION AND ECONOMIC RECOVERY IN SLOVENIA

Earlier this morning I was informed by Bloomberg (link) that Slovenia officially entered the recession for the first time in the last 16 years. The information has not been surprising since major economic forecasts predicted a significant downturn in the light of deteriorating exports and investment. The data pointed out to a significant economic decline. Gross capital formation shrank by an astonishing 32.3 percent. On the other hand, private household consumption grew slightly by 0.1 percent while government spending grew by 3.8 percent.

The outbreak of the financial crisis led economic policymakers to pursue a robust fiscal stimulus to compensate the decline of investment and consumption spending. Before entering the EMU, Slovenia had to comply with Maastricht criteria, including anchoring the budget deficit at the maximum level of 3 percent of the GDP. This year, the budget deficit soared over 6 percent of the GDP, suggesting a growing pressure on public debt. Earlier this month, John Taylor, a professor of economics at Stanford, wrote a great article in FT discussing the hidden dangers of a growing government debt (link). When credit rating agencies downgraded the sovereign debt outlook for the United Kingdom from "stable" to "negative", it should be obvious to economic policymakers that fiscal stimulus failed the cost-benefit analysis and hardly consolidated the midterm economic outlook and recovery.

Recently, Donald Kohn, the vice president of the Fed expressed concerns about fiscal deficit regarding inflationary outlook (link). The reaction of the fiscal policy included a typical fine-tuning infusion of government spending which produced little effect. Of course, it should be noted that a rather drastic expansion of public debt is not only a consequence of an expansionary fiscal policy but also of significant bailout loans from IMF. IMF's $2.4 billion bailout loan raised Latvia's public debt from 9 percent to 15.2 percent of the GDP in 2008 (link). By 2010, it is estimated to go up to 46 percent (link) of the GDP. The explosion of public debt is a particular concern and an obvious consequence of economy's overheating. The IMF recently reported that overall bank credit to private sector settled at 95 percent of the GDP. Complementary, external indebtedness rose to 130 percent of the GDP (link). Clearly, Bank of Latvia failed to act as a lender of the last resort with unbuilt foreign reserves basis and a balance sheet that couldn't sustain the bailout of the financial sector.

Iceland, definitely one of the biggest victims of the financial crisis has recently been downgraded on sovereign debt by Moody. The assets by the outward-oriented banking sector, fuelled by a stunning interest rate differential and carry trading against uncovered interest parity, skipped the size of the economy by 900 percent. The Moody predicted that Icelandic public debt will reach 145.3 percent in 2009 and shall decline slowly and gradually.

On the annual basis, Slovenia's small and open economy declined by 8.3 percent which is one of the most significant declines in the EU after Baltic tigers and Ireland. The European Commission predicts 3.4 percent decline in output by 2009. Exports are expected to decline by 11.8 percent. Small and open economies are vulnerable to economic crises and external shocks, particularly because its trade-to-GDP ratio stands at 60 percent of the GDP and beyond.

This year's quite striking decline has much to do with Slovenia's main macroeconomic backbones. The inflation rate, which grew significantly during the 2007 economic expansion when GDP growth stood at 6.8 percent annually, has not increased. That is because Slovenia, as other EMU members, experiences the recessionary output gap and also because there were no inflationary shocks from the oil market. The third frontier of explanation for a deflating pressure on economic activity in Slovenia is that during the recession spillovers from the tradeable sector strongly affected domestic retail and service sector. In March 2009, the unemployment rate stood at 8.4 percent. The combination of a weak labor market and significant downturn of private consumption spending weakened the bargaining power of unions over wage determination, although wages in the public sector recently grew by double-digit rates (link). In May, the monthly rate of inflation reached 0.6 percent respectively (link). The industrial production, one of the keenest signals of economic activity, for instance, declined by 20 percent in March 2009 (link). The lack of productivity shocks such as restructuring and innovation further worsened the outlook of industrial production.

In a Keynesian spinning turn, Slovenian government pursued a dramatic fiscal expansion coupled with an easy money policy from the ECB's lowest baseline interest rate since early 2000s. In addition to horrible state of public finance, the government enforced a set of measures to protect the major banks from the failure. After the failure of Lehman brothers, it became obvious that the credit flow to state-owned companies for purposes of acquisitions and oligpolistic consolidation will inevitably decrease significantly as the banks' balance sheets were too soft and, of course, too small to secure loans to the real sector. Not surprisingly, the banks performed dismally at the stock market. SBI20, Slovenia's headline stock market index shrank by an astonishing 68 percent between 2008 and 2009 (link), suggesting that P/E ratios and earnings forecasts were mostly overvalued and distorted by the insider information and inadequate and unreliable signals.

The recent staff report by the IMF on Slovenia (link) suggested the immediate enforcement of structural reforms to boost economic recovery. The historical track record of macroeconomic and structural reforms is quite sluggish. During the financial and economic crisis of 2008/2009, the Slovenian government raised government spending and tax burden.

Additionally, it further regulated the labor market by preventing firings through wage guarantees to temporary unemployed whom employers are obligated to reemploy as the economic recovery goes further. Is this a reminder that a totalitarian political economy is still alive? Yes. It seems that economic policymakers ignored the overwhelming regulatory burden in the business environment (link), extremely regulated, inflexible and costly labor market (link), the lack of scale to develop sound capital and financial markets (link) (link), unfinished privatization, high tax wedge and the lack of judicial enforcement in defending the rule of law and the protection of property rights.

These structural and macroeconomic reforms would strengthen the midterm growth outlook and significantly boost the economic recovery. Nonetheless, these reforms would not inhibit the economic growth in the long-run. The IMF's World Economic Outlook predicts weak growth in 2010 and a consecutive recovery until 2014 when the economic activity is expected to increase by 3.5 percent. However, the economic growth in Eastern tigers is expected to go steadily beyond 4 percent by 2012. By 2012-2014, Estonia's economic growth is expected to set up between 4 and 4.5 percent. Nonetheless, Slovakia, which smoothly matured in macroeconomic stability by entering the EMU in 2008, is set to expand 5.2 percent in 2011 and experience moderate growth ranging between 4 and 4.5 percent until 2014. Even a minor difference in economic growth has a significant long-term effect.

If Estonia and Slovakia steadily experienced 4.5 percent economic growth rate, it would take 16 years to double its GDP per capita. On the other hand, if Slovenia steadily experienced 3.5 percent economic growth rate, its GDP per capita would double in about 21 years. In my workshop on real convergence, I estimated that Estonia and Slovakia shall catch-up with Slovenian level of the GDP in about 12 to 16 years. In 1991, the catch-up gap between Slovenia and Estonia was between 45 and 50 years respectively.

Thus, without bold and strong economic reforms, the future of Slovenia shall be nothing more than a story of a slowly-growing and gradually stagnating economy with close and unfortunate similarities to Italy and France rather than to Singapore or Australia.

RUSSIA'S MACROECONOMIC OUTLOOK

The WSJ reports that Russia's economy recorded nearly 10 percent output contraction in Q1:2009 (link). In spite of surging oil prices and strong increases in stock market index, the midterm macroeconomic outlook on Russia is not favorable in terms of economic growth, fiscal policy and macroeconomic recovery. While the local currency appreciated 0.3 percent against the U.S dollar (link), the slow recovery in the financial sector is likely to deteriorate the macroeconomic outlook. The main ailing problems of the financial sector remain high credit and liquidity risk as well as default risk. The central bank could possibly mitigate the shocks in the financial sector by building up foreign reserves to act as the lender of the last resort. However, Russia's persistent obstacle to macroeconomic stability is high inflation rate and dismal fiscal policy record. When the inflation rate is high, building foreign currency reserves may be risky, letting domestic currency overvalued. Reduction in public spending and tightening of the monetary policy to stabilize the inflation rate could essential pursue stable midterm outlook.

ECONOMIC CRISIS AND RECOVERY IN EASTERN EUROPE

The Economist has published an article about the economic slump and recovery in Eastern Europe (link).

INFLATION IN THE OECD

The WSJ reports (link):

"Consumer prices in the 30 members of the OECD rose 0.9% in the 12 months ended March 31, the lowest level since records began in 1971. The previous record low was the 1.3% rate of inflation recorded in January and February of this year. As recently as July 2008, the OECD inflation rate stood at an 11-year high of 4.8%. The OECD said energy prices in its 30 member countries dropped 11.8% in the 12 months to March, having fallen by 8.6% in the 12 months to the end of February. Food prices rose 4.5% in the same period, having risen 4.8% in the 12 months to the end of February."

Interestingly, Iceland and Ireland had the most extreme movements in consumer prices in recent year. Iceland, which has been severely hit by the crisis, experienced 15.2 percent inflation rate in recent year, partly as a result of rapid domestic currency depreciation after its banking sector collapsed. On the other hand, Ireland experienced a modest deflation (-2.6 percent) in recent year, mostly due to a significant reduction in investment demand. As the interest rate kept falling steadily (link), the risk of deflation emerged because lower interest rates on overnight loans failed to boost the investment activity and credit flows in the light of credit crunch, falling stock market indexes and grimmy data from the labor market. The OECD countries, indded, face the lowest inflation rate in the last 30 years and the deepest output contraction after the oil shocks shackled the world economy in 1970s and 1980s. Meanwhile, cutting interest rates further could bloat the liquidity trap, the consequences of which are well-known and painful in ther long-run perspective.

THE ECONOMIC CRISIS AND RECOVERY

Here's a speech delivered by CEA chair Christina Romerat Joint Economic Committee about the current economic situation and the outlook (link)

TWO INTERESTING READINGS

Earlier this morning, I came across the latest release of data on the distribution of federal taxes and household income, published by the CBO (link) and a fascinating lecture of Peter R. Orszag on the role of immigration in the U.S labor market (link).