While reading prof. Mankiw's blog, I came across Andrei Schleifer's new working paper entitled The Age of Milton Friedman has drawn a linking line between an unparalelled progress of the last twenty years and free market economic policies.
The acceptance of free-market policies has been initiated by Ronald Reagan and Margaret Thatcher. The policies of both contained tax cuts, deregulation of the product markets, privatization of the industries and free trade. In the last quarter of the century, millions of lives have been lifted out of poverty. Normative economic analysis might explain this phenomena in a distinct feature. Some might possibly claim that greater government intervention through social security accounts and welfare state in some countries is the reason why poverty has largely been avoided. Despite a misleading utopia that populist politicians and social demagogues are using it, the truth is that a large disappearence of poverty has largely been a result of free-market policies that emphasized tax reform and deregulation.
Milton Friedman's intellectual mind has indeed inspired many leaders around the world to pursue free-market reform agenda. Margaret Thatcher succinctly fought the status quo set by the unions which resisted the deregulation of the labor market.
Ronald Reagan endorsed the most extensive tax reform in the U.S. history. Milton Friedman's intellectual radius also reached China that, despite being a communist country, implemented several pro-growth economic reforms that emphasized openness to the world. Surprise, surprise - China is today the fastest and most rapidly growing economy in the world. This achievment hasn't been an outcome of an enhenced government intervention but largely an outcome of economic reforms that communist China embraced under Deng Xiaoping. Those reforms lifted millions of poverty by allowing them to trade, invest and do business.
The age of free-market reforms brought an unimaginable improvement in the standard of living. Market liberalization brought competition into every walk of economic life. And competition, by no surprise, has brought welfare and value to consumer in terms of lower prices and improved product and service quality. Competitive mechanisms slashed top marginal tax rates, therefore bringing job growth and incentives to work, save and invest. The liberalization of the global trade slashed tariff rates and reduced both, transaction cost and the difficulty of a resource allocation in a productive use.
Territorial competition improved the quality of business locations around the world. The number of procedures to start a business has fallen down dramatically. And most importantly, fiscal competition has made spending fever much more restrictive, putting notable limits on government spending and consumption. The economic progress in transition economies such as Estonia, Slovakia and Czech Republic, has been made possible because of a commitment to reform, responsible leadership and an ambitious growth agenda. Indeed, Friedman's Free to Choose, Capitalism and Freedom and numerous intellectual debates contributed to the understanding that today's welfare and progress is an outcome of yesterday's reform and ideas.
Friday, February 22, 2008
Sunday, February 17, 2008
HUNGARY'S LOW GROWTH DISEASE
When studying and/or doing a job in macroeconomics, it is important to keep an eye on three key features: economic growth, inflation and unemployment. Macroeconomic analysis also emphasized the stability of macroeconomic aggregates such as GDP, public spending and budget consumption. An article Tax tinkering won't fix Hungary's growth problem published by The Guardian briefly outlined Hungary's macroeconomic turbulence in terms of low growth, high government spending and pretty high unemployment rate. Hungary's economy is facing significant macroeconomic problems. In third quarter of the year, Hungary's output grew by as little as one percent (link). In addition, fiscal issues accelerated the fragility of macroeconomic stability.
Tax reform: evidence from Sweden and Iceland
From previous decade onwards, tax reforms have become the guideline of macroeconomic policy. Significant tax cuts on labor supply, entrepreneurship and savings boosted the competitiveness and growth performance in those countries that implemented rigorous economic reforms. In Iceland, the combination of the lower government spending and tax cuts on personal and corporate income generated the Laffer Curve effect, when tax revenues were higher (in the share of the GDP) while tax rate on corporate income was lower (link). Sweden imposed substantial marginal tax cuts and tax revenues grew substantially in the share of the GDP (link).
Don't expect significant Laffer Curve effect in case if public spending is not reduced substantially
As a successful "case-study" of macroeconomic and microeconomic transformation into a market economy, Hungary (link) welcomed foreign investment by slashing the corporate tax rate to the lowest level in Europe, after Ireland and Cyprus. However, Hungary's policymakers decided to build a model of economic policy based on high government spending (link) and resumed budget deficit. The main source of the issue is not budget deficit itself, but the size of government spending in the share of the GDP. Including transfer payments and consumption, Hungary's government spending is extremely high. In recent year it equaled 49,5 percent of the GDP.
High marginal tax rates lead to tax evasion and underground economy
Hoping to restore revenue increases after imposing tax cuts on productive activity in the absence of lower government spending is hopeless nevertheless. Discretionary fiscal policy, high marginal and overall tax rates and highly volatile public finance besides high public expenditures are the main reasons why tax evasion occurs. Tax evasion is nothing else but the consequence of the fact that investors and individuals perceive the opportunity cost of high tax rates as significant. The usual effect of high and marginally progressive tax rates is that tax evasion accelerates the establishment of informal sector known as grey or underground economy. In Hungary, grey economy equals an estimated 17-18 percent of the GDP (link).
Hungary in regional competition
Slovakia (link), Hungary's neighbor went through a period of pro-growth economic and tax reforms. Tax rate on personal and corporate was slashed to flat 19 percent and government spending, including consumption and transfer payments, was reduced substantially. As a result, Slovakia became the Monaco on Danube, a high-growing Eastern European economy known as investment haven. A significant number of international companies such as Peugeot, Citroen and Volkswagen set their production establishments in Slovakia. Also, Slovakia's economy experienced a robust, non-inflationary output growth while Slovakia's macroeconomic institutions streamlined competitive, non-discretionary and stable macroeconomic policy based on expenditure cuts and growth agenda. Hungary has been losing its investment potential subject to abovementioned reasons. Recently, two companies - Audi AG and Servier - have taken alternative consideration of their operations location because of Hungary's statist tax system (link) and discretionary macroeconomic policy.
Reform or die slowly
In 2007, Hungary imposed the 3rd highest tax hike on labor supply in OECD. This could be a substantial incentive for tax evasion. Consequently, productivity growth would definitely stagnate. Timid initiatives to impose tax reform are completely useless unless government spending is cut radically. As a consequence, there would be much less pressure on budget deficit which is estimated to drop from 9,2 percent of the GDP to 4 percent of the GDP. However, deficit is often the wrong number. Also, social security contributions present a persistent barrier to employment and job growth. Long and generous unemployment periods do not create a job-seeking. Nonetheless, the combination of high unemployment and low growth is a deadly situation where the risk of stagnation is huge in case if substantial pro-growth reforms are not implemented. As an economy in transition, Hungary's macroeconomic policy will have to cut spending radically or it will quickly become the France of Eastern Europe (link).
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Tax reform: evidence from Sweden and Iceland
From previous decade onwards, tax reforms have become the guideline of macroeconomic policy. Significant tax cuts on labor supply, entrepreneurship and savings boosted the competitiveness and growth performance in those countries that implemented rigorous economic reforms. In Iceland, the combination of the lower government spending and tax cuts on personal and corporate income generated the Laffer Curve effect, when tax revenues were higher (in the share of the GDP) while tax rate on corporate income was lower (link). Sweden imposed substantial marginal tax cuts and tax revenues grew substantially in the share of the GDP (link).
Don't expect significant Laffer Curve effect in case if public spending is not reduced substantially
As a successful "case-study" of macroeconomic and microeconomic transformation into a market economy, Hungary (link) welcomed foreign investment by slashing the corporate tax rate to the lowest level in Europe, after Ireland and Cyprus. However, Hungary's policymakers decided to build a model of economic policy based on high government spending (link) and resumed budget deficit. The main source of the issue is not budget deficit itself, but the size of government spending in the share of the GDP. Including transfer payments and consumption, Hungary's government spending is extremely high. In recent year it equaled 49,5 percent of the GDP.
High marginal tax rates lead to tax evasion and underground economy
Hoping to restore revenue increases after imposing tax cuts on productive activity in the absence of lower government spending is hopeless nevertheless. Discretionary fiscal policy, high marginal and overall tax rates and highly volatile public finance besides high public expenditures are the main reasons why tax evasion occurs. Tax evasion is nothing else but the consequence of the fact that investors and individuals perceive the opportunity cost of high tax rates as significant. The usual effect of high and marginally progressive tax rates is that tax evasion accelerates the establishment of informal sector known as grey or underground economy. In Hungary, grey economy equals an estimated 17-18 percent of the GDP (link).
Hungary in regional competition
Slovakia (link), Hungary's neighbor went through a period of pro-growth economic and tax reforms. Tax rate on personal and corporate was slashed to flat 19 percent and government spending, including consumption and transfer payments, was reduced substantially. As a result, Slovakia became the Monaco on Danube, a high-growing Eastern European economy known as investment haven. A significant number of international companies such as Peugeot, Citroen and Volkswagen set their production establishments in Slovakia. Also, Slovakia's economy experienced a robust, non-inflationary output growth while Slovakia's macroeconomic institutions streamlined competitive, non-discretionary and stable macroeconomic policy based on expenditure cuts and growth agenda. Hungary has been losing its investment potential subject to abovementioned reasons. Recently, two companies - Audi AG and Servier - have taken alternative consideration of their operations location because of Hungary's statist tax system (link) and discretionary macroeconomic policy.
Reform or die slowly
In 2007, Hungary imposed the 3rd highest tax hike on labor supply in OECD. This could be a substantial incentive for tax evasion. Consequently, productivity growth would definitely stagnate. Timid initiatives to impose tax reform are completely useless unless government spending is cut radically. As a consequence, there would be much less pressure on budget deficit which is estimated to drop from 9,2 percent of the GDP to 4 percent of the GDP. However, deficit is often the wrong number. Also, social security contributions present a persistent barrier to employment and job growth. Long and generous unemployment periods do not create a job-seeking. Nonetheless, the combination of high unemployment and low growth is a deadly situation where the risk of stagnation is huge in case if substantial pro-growth reforms are not implemented. As an economy in transition, Hungary's macroeconomic policy will have to cut spending radically or it will quickly become the France of Eastern Europe (link).
Rok SPRUK is an economist.
Copyright 2008 by Rok SPRUK
Monday, February 11, 2008
MY READING LIST IN THESE DAYS
In previous days, there has been much less blogging on my blog due to study course and a growing list of obligations regarding studying and reading the required material. In Friday, there will be more blogging as I've already picked the selected writing and analytical topics. Here is what I read in these days:
Paul A. Samuelson, William D. Nordhaus: Economics, 16th edition,
Douglas G. Baird, Robert H. Gertner, Randal C. Picker: Game Theory and the Law,
Gordon Tullock: The Rent-Seeking Society
Gordon Tullock: Virginia Political Economy,
Gordon Tullock: Bureaucracy,
Gordon Tullock: The Calculus of Consent,
Ludwig von Mises: Human Action,
Richard Posner: Economic Analysis of Law
Paul A. Samuelson, William D. Nordhaus: Economics, 16th edition,
Douglas G. Baird, Robert H. Gertner, Randal C. Picker: Game Theory and the Law,
Gordon Tullock: The Rent-Seeking Society
Gordon Tullock: Virginia Political Economy,
Gordon Tullock: Bureaucracy,
Gordon Tullock: The Calculus of Consent,
Ludwig von Mises: Human Action,
Richard Posner: Economic Analysis of Law
Tuesday, February 05, 2008
THERE'S NO SUCH THING AS FREE LUNCH IN HEALTH-CARE
The U.K. Daily Telegraph reports on the persistent sentiments to limit and ration the access to health-care services for older people and individuals with different lifestyles. As Investor Business Daily succinctly commented, the denial of health-care services is more probable when government is in charge of it. In fact, government monopoly on health-care might explain some reasons for obesity and other particular man-made diseases simply because the individuals do not, in this case, bear full costs of reckless behavior and instead rely on government support.
GERMANY'S REGULATION AGENDA
As a response to subprime mortgage crisis, German government suggested further unilateral tightening of bank regulation as a step to prevent future risk volatility caused by external shocks such as recent subprime mortgage crisis (link).
INDIA'S OPENNESS TO FOREIGN INVESTMENT
The Economist Intelligence Unit has just published a brief article, outlining recent slewing of rules, some rigidity and entry barriers to foreign direct investment in certain sectors of the economy in India (link).
Monday, January 28, 2008
R&D, ENTREPRENEURIAL EDGE AND COMPETITIVENESS
Dani Rodrik recently published a post entitled How Ireland does it, where he cited an article from The New York Times about the competitive and growing entrepreneurship in Ireland. The article emphasized the combination of pro-growth economic policy, economic liberalization and tax cuts that empowered the growth of innovative and competitive entrepreneurship.
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
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
WHEN GOVERNMENT ANNOUNCES A STRIKE
In Slovenia, judicial branch of government recently announced a strike, claiming that judges are underpaid and demanding an initial wage increase. The first question to be asked is against whom the judicial branch of government is really demanding a strike? The announcement of the strike is a mark revealing the prevailing corruption in the judicial system, taking place throughtout the process of political transition from socialist system to the system based on market democracy. In Slovenia, generally speaking, private property rights are weakly protected, reflecting slow procedural operations, internal inefficiencies and signs of corruption in Slovenia's judicial system.
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)
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
PRO-GROWTH REFORMS IN GEORGIA
Wall Street Journal reported about an ambitious market liberalization and pro-growth economic and tax policy in Georgia (former Soviet state, not Georgia in the U.S). The agenda includes tax reform, privatization of state-owned enterprises, the liberalization of the investment rules and tapping the international capital markets.
IRELAND'S HIGH PERSONAL TAX RATES
Despite an attractive corporate tax scheme, Ireland suffers from punitive taxation of personal income. Indeed, throughout the years of pro-growth reforms that turned a lagging economy into a high-growing Celtic tiger, Irish policymakers reduced top personal income tax from 65 percent to 42 percent. Despite a significant reduction in top personal income tax rates, Ireland's personal tax regime remains quite unfavorable. Sunday Business Post recently reported how low-tax jurisdictions such as Portugal where no capital gains tax is charged, Bermuda, Monaco, Switzerland, Liechtenstein, Cayman Islands and British Virgin Islands attract successful individuals, tax exiles and lure direct investment.
Tuesday, January 22, 2008
ECONOMIC FREEDOM IN 2008
In a mutual cooperation, Heritage Foundation and Wall Street Journal issued a new 2008 Index of Economic Freedom (link). The index measures the level of economic freedom in the world, emphasizing the degree of economic liberty in each country. Some countries, such as Montenegro, Serbia and Iraq, remained unranked subject to incomplete information about the areas reflecting the level of economic freedom. By a methodological definition (link), the economic freedom is a material autonomy in relation to the state and organized groups. An individual is free who can secure and protect his human resources, labor and private property. Economic freedom involves several sub-levels such as freedom to invest, freedom to start a business, freedom to choose, freedom to trade, freedom from corruption, freedom from government, fiscal freedom and the protection of private property rights nevertheless. Higher the value of each component, higher the level of economic freedom.
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
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
TRADE UNIONS, WAGES AND INFLATION
Slovenia's labor market is known for an extensive regulation and barriers that hinder productivity growth. According to the latest Index of Economic Freedom, Slovenia's labor market is known as the most regulated and inflexible in the European region. High labor cost, regulated working schedule, and extensive taxation are hampering the capacity of productivity performance.
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
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
INDEX OF ECONOMIC FREEDOM 2008
Heritage Foundation and Wall Street Journal have recently released the newest 2008 Index of Economic Freedom (link).
Monday, January 14, 2008
THE VOICE OF CLASSICAL LIBERALISM
There is an important incoming change in the Slovenian political market. After almost two decades of political parties whose ideology has been based on collectivistic values, economic nationalism, market protectionism, government intervention and high taxes, a fresh new political party called Liberalci (Liberals) is arising. Party's program is based on the principles of limited government, low taxes and the rule of law. The party has already launch an ambitious and productive policy agenda which can be read here. The basis of the program are the ideas of classical liberalism such as individual liberty, economic and political freedom. The interview with Tomaž Štih, the founder of the party, can be read here and here. Mag, Slovenia's weekly politico-economic magazine has also written an interactive article about Slovenia's first classical liberal party. The article can be read here.
Sunday, January 13, 2008
NEW DEAL AND JOB GROWTH
Amity Shlaes, economic history senior fellow at the Council on Foreign Relations and the author of The Forgotten Man: A New History of the Great Depression, wrote an article about the period of New Deal policies. Her contention correctly assumes that New deal policies lenghtened the Great Depression and that public job creation undermines the strenghts of private sector in providing jobs and creating overall prosperity.
Source: Amity Shlaes: The New Deal Job Myth, AEI, Wednesday, January 2, 2008 (link)
Source: Amity Shlaes: The New Deal Job Myth, AEI, Wednesday, January 2, 2008 (link)
SUPPLY, DEMAND AND COMPETITIVE MARKETS
There is a detailed discussion over suddenly observed commodity price increases where food prices are exposed in particular. The Economist recently wrote about the future of food prices. Agreeably, the Economist correctly diagonosed that changing conditions of world supply and demand will inevitably result in higher consumer food prices as input and wholesale prices have increased substantially. What is the anatomy behind the price level? What features affect price dynamics? What is the driving wheel of price escalation? How firms take/make prices? What's the effect of elasticity? Why monopolies are bad and competition is good?
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
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
SARKOZY'S STATISM
French president Nicolas Sarkozy proposed a taxation on internet access and mobile phone use in order to prop up the funding of two public TV channels, free of advertising (link).
Monday, January 07, 2008
THE 2008 YOUNG ECONOMIST AWARD
The 2008 Young Economist Award goes to Raj Chetty of Berkeley. Raj Chetty has done extensive research on taxation, unemployment, social insurance and risk preferences. His notable spectrum of research includes "Dividend Taxes and Corporate Behavior: Evidence from the 2003 Dividend Tax Cut". The work has been published in Quarterly Journal of Economics together with Emmanuel Saez. Raj Chetty is also a faculty member at the National Bureau of Economic Research.
Source: The American (link)
Source: The American (link)
Sunday, January 06, 2008
ONE STEP CLOSER TO SOCIALISM IN SLOVAKIA
by Martin Rojko
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.
Author is a journalist of Slovak well-respected business weekly TREND and he runs a blog called „Private Property“ (vlastnictvo.blogspot.com)
Thursday, January 03, 2008
SLOVENIA: GERMANY OF THE BALKANS
By January 1, 2008, Slovenia took over the chairmanship of the EU presidency. In its latest article Slowenien: Deutsche vom Balkan, Der Spiegel described Slovenia as Germany of the Balkan region. Although the EU presidency would normally mean a final stage in leaving the Balkan region, such argument is very far away from the truth. My colleague Rado Pezdir once wrote a brilliant article on how unambitious Slovenian government really is in its intentions to discuss presumably relevant topics on behalf of EU presidency. Rado wrote:
"...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
"...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
SOUTH KOREA'S REFORM AGENDA
Lee Myung Bak, South Korea's newly elected president and former chief executive of Hyundai Construction and Engineering proposed a package of economic reforms such as tax cuts by cutting the corporate tax rate from 25 percent to 20 percent, fuel taxes by 10 percent, real estate tax, and public expenditure respectively. Korea's new president also pledged to privatize state-owned companies and remove the restrictions preventing industrial groups from owning banks.
Source: Yahoo News (link)
Source: Yahoo News (link)
ECONOMIC ANALYSIS OF CHINA'S INFLATION
Financial Times recently reported that Chinese central government's intention to curb the inflation aims at the introduction of a unique tax on exporters of grain. The report says that exporters of 57 types of grain will have to pay a temporary tax between 5 and 25 percent.
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
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
Monday, December 24, 2007
Saturday, December 22, 2007
FRANCE'S ECONOMY
The Economist published a brief outline about France's economy, showing what is actually behind disease of rachitic growth and status quo.
"In the late 1990s, France's economy grew faster than the European average, allowing the Socialist government to indulge in such goodies as the 35-hour work week. But the country's cherished social model has in recent years proved a strong disincentive to growth and to job creation. Unemployment is double that in Britain, and special public-sector pensions and rising health-care costs are straining the public finances.
Discontent with the economy—and the government’s handling of it—played a large part in France's rejection of the EU constitution. But, as usual in France, economic reforms smacking of libéralisme have met strong resistance: in the spring of 2006, after weeks of protests, the government dropped a proposed loosening of first-job contracts. Nicolas Sarkozy, elected president in May 2007, has promised reforms, although his first budget reduced neither public spending nor public debt, and his movement toward public-sector pension reforms provoked strikes."
Source: Economist, Finance & Economics Backgrounder (link)
"In the late 1990s, France's economy grew faster than the European average, allowing the Socialist government to indulge in such goodies as the 35-hour work week. But the country's cherished social model has in recent years proved a strong disincentive to growth and to job creation. Unemployment is double that in Britain, and special public-sector pensions and rising health-care costs are straining the public finances.
Discontent with the economy—and the government’s handling of it—played a large part in France's rejection of the EU constitution. But, as usual in France, economic reforms smacking of libéralisme have met strong resistance: in the spring of 2006, after weeks of protests, the government dropped a proposed loosening of first-job contracts. Nicolas Sarkozy, elected president in May 2007, has promised reforms, although his first budget reduced neither public spending nor public debt, and his movement toward public-sector pension reforms provoked strikes."
Source: Economist, Finance & Economics Backgrounder (link)
WILL THE LARGEST EUROPEAN ECONOMY RECOVER FROM A NON-REFORM DISEASE?
The Economist has recently published an article about the current state of Germany's economy. At this time, Germany faces persistent structural problems affect the dynamics of economic performance. The sub-prime mortgage mess has not been stretched to German market as less than 10 percent of German exports go to the United States and thus, German exposure to U.S slowdown is not huge. Germany's economic growth is estimated to fall from 2,6 percent in 2007 to 2 percent or less in 2008. What is actually behind a lingering growth performance? The growth of export performance is likely to decline, facing a drop from 8 percent in 2007 to 4,8 percent in 2009.
Among the economic issues, there was a significant surge of inflation which hit 3,1 percent annually in 2007 mostly due to higher food and energy prices. A detailed analysis of the demand conditions may reveal that the coefficients of price and income elasticity of demand have been quite inelastic, moving somewhere in the interval between 0 and 1. The suppliers know very well, that if demand is quite inelastic and consumer behavior quite monotonic, price increases could prop up their income. Germany's inflation rate may be transiotry as there are strongly supported expectations about the normalization of energy and food prices in the period to come.
Although consumer sentiments remained well-positioned, consumption-inflated spending may not boost the potentials of German economy on the way to recovery from low overall growth.
Germany's future and prosperity will crucially depend on the pace of economic reforms. The policy outcome of current government coalition is mixed. Labor-market reforms contributed one fifth to overall growth but there is a number of issues hampering the ability of German economy to operacompete successfully in a global environment. Bundesbank, German central bank, has shown that the contribution of labor to economic growth is likely a result of drawing unskilled workers into labor supply. Also, German government cut public spending and put limits on the growth of overall spending. Quite logically, the investment picked up an incentive and grew at a higher rate.
An impeding obstacle to Germany's prosperity is the attitude oriented against the economic reforms. The preference of economic justice over the need for tomorrow's change is a road to self-destruction. The consequence of such a misty combination of political and voting behavior is the lack of willingness and political courage to implement much-needed reforms. Steming away and streaming for status quo is what causes riots, dissatisfaction and an endless cycle of statist propaganda inflated by politicians, interest groups and the media.
Unemployment benefits, raising the minimum wage in public sector and similar policy implementation strongly discourage the economic performance from going to growth to searching for privileges from the state through various mechanism such as tax system, collective bargaining and public sector. In Germany's case, the raise of minimum wages in a state-controlled postal company, is nevertheless a sign of rent-seeking. If such collective demands are granted, the steps in the wrong direction will multiply. There is hardly any argument for the minimum wage. On demand side, minimum wage is a form of taxation that raises the overall cost of labor and increases the probability of being fired or unemploymed in the future. On supply side, the minimum wage reduces the productivity potentials and does not stimulate labor supply to spend more hours in the market.
Regulating job market will not boost job creation subject to external pressure on the allocation of labor resources and productivity of the labor supply. The pursuit of various form of unemployment insurance, which has flipped Germany into a mirage of structural unemployment, discourages laborers from seeking a job. It rather encourages seeking priviliges from the state and the lack of incentives to search job due to unfavorable working environment and the influence of trade unions on job growth and labor market.
The question is whether Germany will move out of the cage of low growth and discouraging structural picture. The answer is mix of particular sets of policy conditions and macroeconomic estimates. On macroeconomic level, inflation expectations remain favorable and consumer price index is expected to normalize subject to transitory shock on particular prices. On fiscal level, estimates suggest that more should be done to decrease public spending, cut taxes on productive behavior and reduce government size and consumption. Many futures answers to thequestion of where Germany will stand in the future, will depend on whether the polocymakers will give up the political payoffs emerged from rent-seeking and special interest groups.
Going in the reverse way, where political decision-making neglects economic costs, further makes it quite difficult for policymakers to implement long-range reforms regarding health-care, welfare state and labor market. In those areas, the presence of pressures from interest groups and trade unions will radically oppose the economic reforms to protect the benefits handed to special groups and priviliged from the state. There is no need to endure old-styled western European type of corporatist society where the interests of stakeholders are protected at first hand.
There is always a need for change in economic and structural terms, just as deregulation and openness created German economic miracle after the World War 2. Change is the engine of tomorrow's freedom and progress and an opportunity is rare, while a clever man will never let it go.
Rok SPRUK is an economist.
Copyright 2007 by Rok SPRUK
Among the economic issues, there was a significant surge of inflation which hit 3,1 percent annually in 2007 mostly due to higher food and energy prices. A detailed analysis of the demand conditions may reveal that the coefficients of price and income elasticity of demand have been quite inelastic, moving somewhere in the interval between 0 and 1. The suppliers know very well, that if demand is quite inelastic and consumer behavior quite monotonic, price increases could prop up their income. Germany's inflation rate may be transiotry as there are strongly supported expectations about the normalization of energy and food prices in the period to come.
Although consumer sentiments remained well-positioned, consumption-inflated spending may not boost the potentials of German economy on the way to recovery from low overall growth.
Germany's future and prosperity will crucially depend on the pace of economic reforms. The policy outcome of current government coalition is mixed. Labor-market reforms contributed one fifth to overall growth but there is a number of issues hampering the ability of German economy to operacompete successfully in a global environment. Bundesbank, German central bank, has shown that the contribution of labor to economic growth is likely a result of drawing unskilled workers into labor supply. Also, German government cut public spending and put limits on the growth of overall spending. Quite logically, the investment picked up an incentive and grew at a higher rate.
An impeding obstacle to Germany's prosperity is the attitude oriented against the economic reforms. The preference of economic justice over the need for tomorrow's change is a road to self-destruction. The consequence of such a misty combination of political and voting behavior is the lack of willingness and political courage to implement much-needed reforms. Steming away and streaming for status quo is what causes riots, dissatisfaction and an endless cycle of statist propaganda inflated by politicians, interest groups and the media.
Unemployment benefits, raising the minimum wage in public sector and similar policy implementation strongly discourage the economic performance from going to growth to searching for privileges from the state through various mechanism such as tax system, collective bargaining and public sector. In Germany's case, the raise of minimum wages in a state-controlled postal company, is nevertheless a sign of rent-seeking. If such collective demands are granted, the steps in the wrong direction will multiply. There is hardly any argument for the minimum wage. On demand side, minimum wage is a form of taxation that raises the overall cost of labor and increases the probability of being fired or unemploymed in the future. On supply side, the minimum wage reduces the productivity potentials and does not stimulate labor supply to spend more hours in the market.
Regulating job market will not boost job creation subject to external pressure on the allocation of labor resources and productivity of the labor supply. The pursuit of various form of unemployment insurance, which has flipped Germany into a mirage of structural unemployment, discourages laborers from seeking a job. It rather encourages seeking priviliges from the state and the lack of incentives to search job due to unfavorable working environment and the influence of trade unions on job growth and labor market.
The question is whether Germany will move out of the cage of low growth and discouraging structural picture. The answer is mix of particular sets of policy conditions and macroeconomic estimates. On macroeconomic level, inflation expectations remain favorable and consumer price index is expected to normalize subject to transitory shock on particular prices. On fiscal level, estimates suggest that more should be done to decrease public spending, cut taxes on productive behavior and reduce government size and consumption. Many futures answers to thequestion of where Germany will stand in the future, will depend on whether the polocymakers will give up the political payoffs emerged from rent-seeking and special interest groups.
Going in the reverse way, where political decision-making neglects economic costs, further makes it quite difficult for policymakers to implement long-range reforms regarding health-care, welfare state and labor market. In those areas, the presence of pressures from interest groups and trade unions will radically oppose the economic reforms to protect the benefits handed to special groups and priviliged from the state. There is no need to endure old-styled western European type of corporatist society where the interests of stakeholders are protected at first hand.
There is always a need for change in economic and structural terms, just as deregulation and openness created German economic miracle after the World War 2. Change is the engine of tomorrow's freedom and progress and an opportunity is rare, while a clever man will never let it go.
Rok SPRUK is an economist.
Copyright 2007 by Rok SPRUK
KENNETH ARROW ON CARBON EMISSIONS AND CLIMATE CHANGE
Kenneth Arrow, a Nobel laureate in Economics, discusses the state and future implications of climate change (link).
The benefits are the avoided damages, including both market damages and non-market damages that account for health and ecological impacts. Following a “business as usual” policy, by 2200, the losses in GNP have an expected value of 13.8%, but with a degree of uncertainty that makes the expected loss equivalent to a certain loss of about 20%. Since the base rate of economic growth (before calculating the climate change effect) was taken to be 1.3% per year, a loss of 20% in the year 2200 amounts to reducing the annual growth rate to 1.2%. In other words, the benefit of mitigating greenhouse gas emissions can be represented as the increase in the annual growth rate from today to 2200 from 1.2% to 1.3%.
The benefits are the avoided damages, including both market damages and non-market damages that account for health and ecological impacts. Following a “business as usual” policy, by 2200, the losses in GNP have an expected value of 13.8%, but with a degree of uncertainty that makes the expected loss equivalent to a certain loss of about 20%. Since the base rate of economic growth (before calculating the climate change effect) was taken to be 1.3% per year, a loss of 20% in the year 2200 amounts to reducing the annual growth rate to 1.2%. In other words, the benefit of mitigating greenhouse gas emissions can be represented as the increase in the annual growth rate from today to 2200 from 1.2% to 1.3%.
Source: Kenneth Arrow, The Case for Mitigating Greenhouse Gas Emissions, Project Syndicate, The Economists' Voice, 2007 (link)
Thursday, December 20, 2007
JOHNNY MUNKHAMMAR: GUIDE TO REFORM
In a thorough, understandable and comprehensively written book “Guide to Reform” Johnny Munkhammar addresses some fundamental issues and perspectives about the need to implement long-term economic and structural reforms. The content of the book is divided into several chapters. Each of them reflects key areas of economic reform and each of them highlights the essentials on the road to prosperity through today’s change towards tomorrow’s benefit. In this brief review, I shall highlight the main premises drawn upon the economic reform. As an economist, I will attempt to make essential conclusions regarding author’s groundbreaking book.
The first question is whether economic reform is good. The author of the book has concluded that the main purpose of the economic reform is to pursue economic freedom and guideline the course of public policy instituted upon the ideas that brought nations an unparalleled increase in prosperity. Such conclusion is relevant and supported by countless empirical evidence. The general parameters that reflect the quality of macroeconomic and business framework are crucial to essential conditions regarding growth performance and increases in standards of living. What distinguished sound business environment and macroeconomic picture from restrictive and risky type of macroeconomic framework is the extent of coercion and government involvement into business affairs and personal lives. There is a positive correlation between high real GDP per capita and high level of economic liberty. Nations that have pursued economic freedom and the principles of limited government have observed what could (in German) be described as “Wirtschaftswunder”, an economic miracle.
Let’s start with a methodological, theoretical and empirical grounds and arguments for structural change and major long-range reforms. The author of the book supported the arguments with a significant and incredible amount of economic and political literature. As for an economist, the quest for economic reforms is fairly simple. The economist is interested about the outcome of the reforms and how to design a theoretical framework after data collection, data analysis and after relevant and empirically-tested conclusion are finalized. Throughout the course of the book, the author used a series of graphs and charts to show the how economic activity and standards of living grow together with fundamental economic reforms regarding welfare state, labor market, business environment, health care system, education system and structural performance.
The author succinctly shows how reforms implemented in recent years and decade worked tremendously well in countries that have adopted them. From the theoretical point of view, it depends which side of the economy is taken into the analytical account. The experience such as stagflation has shown that Keynesian economic perception about the real economy was wrong. John Maynard Keynes believed that the economic performance can be restored by the acceleration of aggregate demand. Keynesians also believed that government intervention and a significant monetary expansion can boost the growth performance. However, if newly printed money is injected into the economy, the inevitable consequence is higher inflation which negatively affects the ability of the economy to operate at the optimal capacity regarding long-term sustainability of economic growth. The main consequence of high inflation is a deep negative shock on price behavior resulting from the overweight money funds chasing too few goods.
Thus, there is a paradox given the fact that money injection into the economy inevitably reduces consumer purchasing power. On the other side, the neoclassical growth theory supports the view that the essential condition for long-term growth is the quality of growth engines such as human capital, low tax burden, investment, and productive behavior in general. At the end of 1970s, stagflation, rising inflation and unemployment, indicated the collapse of the Keynesian politico-economic doctrine. From a theoretical perspective, productivity growth is the essential condition for the increase of living standards. Any kind of particular burden that hampers productivity growth also reduces the potentiality of higher living standards and general welfare.
Throughout the book, the author underpins the classical essence of economic success: good governance, limited government, low taxes, sound monetary and macroeconomic framework, low regulation, privatization of public services and competitive product markets, including labor market. In moving towards the solutions and proposals suggested by Johnny Munkhammar in the book deserves an analytical outline of the policy areas that impede economic growth and increase risk of low growth, weak economic performance and an overall decline.
The author suggests radical cuts in public expenditure. The proposal is relevant since reductions in public spending boost growth and productive behavior. In fact, low tax rates on labor supply, savings, investment and entrepreneurship positively correlate with economic growth. The evidence has shown that tax cuts do not reduce revenues following the Laffer curve statement, saying that tax revenue is higher when tax rates are low. The author makes a strong point for privatization and cutting-edge competition in policy innovation. He says that “different reasons may exist for selling publicly owned activities, for example increasing competition, improving management or increasing citizens’ ownership… Competition brings innovation, variety, improvements and lower costs. Increased competition is necessary in publicly provided services and this can be achieved by several methods”.
The author has put a significant amount of effort in the analysis and key policy solutions pertaining to the areas that hinder the evolutionary process of sustainable economic growth. Among the most vital reforms are labor market reforms, product market deregulation, tax cuts, the introduction of competition and private initiative in health-care and education system under sound capital and financial markets, solid infrastructure and the reform of the business environment. He also lists a growing list of nations that implemented productive reform solutions;
The main problem in implementing the economic reforms is not that politicians are unaware of the economic reforms but the fact that their political support is subject to special interests emerging from rent-seeking patterns of behavior placed in societies where the weakness of institutions enables interest groups to gain privileges from the state, codified into the law and made permanent. Powerful stakeholders in the corporativist model of society will thus resist change at any cost. Such case is the collective bargaining which distorts the competitive equilibrium in the labor market at the cost of lower productivity growth and slower structural adjustment to economic change and globalization. Special interest groups possessing a degree of coercion and political influence will inevitably refuse reform proposals and mobilize its force to do everything possible to prevent the implementation of economic reforms by the means of fear and propaganda.
The author suggests a strategic set of combinations of political decision-making, game theory and tactical methods that could reduce the opposition to economic reforms and structural advancement. As an important feature, the author also makes strong point on the continuum of economic reforms as the main policy asset that reformist politicians should embrace. True, there will always be those who oppose economic reforms everywhere but, as Harold Wilson said, “those who reject change are the architects of tomorrow’s decay.”
The book is not only a great source of inspiration but also a great educational material that provides important data, information and answers to some of the greatest tasks of tomorrow’s challenge.
Copyright 2007 by Rok SPRUK
Tuesday, December 18, 2007
BULGARIA IS NOW AN OFFICIAL MEMBER OF FLAT TAX CLUB
Sofia News Agency reports that Bulgarian lawmakers passed flat tax reform. Bulgaria is now an official member of the flat tax club.
OBWALDEN APPROVES 1,8 PERCENT FLAT INCOME TAX RATE
Obwalden is a Swiss canton situated in central Switzerland. SwissInfo reports that Obwalden has recently become the first Swiss canton to adopt 1,8 percent flat income tax rate on all categories. In December 2005, Obwalden decided to slash the corporate tax rate to 6,6 percent. The canton also decided to impose degressive tax system which was later declared as unconstitutional. In the first six months of this year, the canton saw an astonishing 230 percent growth of company registration. In addition, 90,7 percent of voters approved changes in tax regime.
THE ECONOMIC PERFORMANCE OF ICELAND IN 2008
The IMF estimated that Iceland's economy could slid into a mild recession in 2008. Meanwhile the rate of inflation is estimated to reach 3,3 percent (link).
The empirical data has shown that Iceland experienced one of the highest coefficients of fiscal revenue elasticity, whether it is measured in terms or relative changes in private consumption or in terms of effective real exchange rate. On the other hand, rigorous tax reform in previous decade returned a soaring growth of fiscal revenue which reflects the broad range of revenue elasticity as well as the effects of tax cuts on supply side of the economy and fiscal parameters.
Read also:
Anthony Arnett: Toward a Robust Fiscal Framework for Iceland; Motivation and Practical Suggestion, IMF Working Paper 07235, International Monetary Fund, 2007 (link)
The empirical data has shown that Iceland experienced one of the highest coefficients of fiscal revenue elasticity, whether it is measured in terms or relative changes in private consumption or in terms of effective real exchange rate. On the other hand, rigorous tax reform in previous decade returned a soaring growth of fiscal revenue which reflects the broad range of revenue elasticity as well as the effects of tax cuts on supply side of the economy and fiscal parameters.
Read also:
Anthony Arnett: Toward a Robust Fiscal Framework for Iceland; Motivation and Practical Suggestion, IMF Working Paper 07235, International Monetary Fund, 2007 (link)
Sunday, December 16, 2007
ARE GROWTH AND SIZE OF CHINA'S ECONOMY OVER-ESTIMATED?
The Economist recently published an article discussing the size and growth of China's economy (link)
Friday, December 14, 2007
ECONOMICS, DEMOCRACY AND PUBLIC POLICY
Wednesday, December 12, 2007
ALAN GREENSPAN ON MORTGAGE CRISIS
In OpinionJournal, Alan Greenspan places an emphasis on the roots of mortgage crisis. He concludes that numerous price bubbles cannot be safely by policy initiatives.
Overnight, financial risk surged the price of risk, thus pushing the interest rates on various assets compared to relatively riskless U.S. Treasure Securities.
Global economic growth increased steeply and the level of risk suddenly became underminded which led to overnight speculations and mispricing of secured sub-prime mortgages. Thus, a crisis was a well-known accident waiting to happen sooner or later.
Source: Alan Greenspan, The Roots of the Mortgage Crisis, Opinion Journal, Wednesday, December 12, 2007 (link)
Overnight, financial risk surged the price of risk, thus pushing the interest rates on various assets compared to relatively riskless U.S. Treasure Securities.
Global economic growth increased steeply and the level of risk suddenly became underminded which led to overnight speculations and mispricing of secured sub-prime mortgages. Thus, a crisis was a well-known accident waiting to happen sooner or later.
Source: Alan Greenspan, The Roots of the Mortgage Crisis, Opinion Journal, Wednesday, December 12, 2007 (link)
Monday, December 10, 2007
INTERVIEW WITH JOHN NASH, THE 1994 NOBEL LAUREATE IN ECONOMICS
PBS has published an interview with dr. John Nash of Princeton University. John Nash received a Nobel prize in economics in 1994 for pioneering the equilibrium analysis of non-cooperative games. The interview can be read and seen as a video here.
On Discovering Math
"I was in grade school. I would be doing arithmetic, and I found myself working with larger numbers than other students would be using. I would have several digits, and they would have maybe two or three digits. I would do multiplication and basic operation, but with larger numbers. Later on in adolescence, I got some practice in using a calculator machine, where you could multiply and add, subtract and divide really large numbers like 10 digits."
John Nash
On Discovering Math
"I was in grade school. I would be doing arithmetic, and I found myself working with larger numbers than other students would be using. I would have several digits, and they would have maybe two or three digits. I would do multiplication and basic operation, but with larger numbers. Later on in adolescence, I got some practice in using a calculator machine, where you could multiply and add, subtract and divide really large numbers like 10 digits."
John Nash
Sunday, December 09, 2007
OECD CUTS GROWTH FORECAST
The OECD questions whether financial shocks and housing market turmoil will push the growth rate to the slowest in five years (link)
Wednesday, December 05, 2007
SWEDEN, FREE-MARKET ECONOMY AND WELFARE STATE
At LewRockwell.com, Nima Sanandaji wrote an article about the well-known Swedish system (link). The author emphasized Sweden's unparalelled increase in prosperity between 1890 and 1970 and a lingering economic performance from 1970s onwards. In 1970, Sweden was the fourth wealthiest country in the world. After 1970, the Swedish system turned into troubles, having left a painful effect which ended in early 1990s when Swedish economy slid into a disastrous recession.
To browse the posts on this blog about Sweden, click here.
To browse the posts on this blog about Sweden, click here.
Monday, December 03, 2007
FALLING U.S. DOLLAR
The Economist has published a sound analysis of a falling U.S. dollar (link).
An interesting article brought up a couple of issues to be discussed. First, dollar crisis would be disastrous. The U.S economy is now expecting a recession. Even if it looms, the financial markets would force FED to raise the rates, slowing the recovery from recession. Consequently, euro would probably soar to new record-highs.
A major slice of global traded is accounted in dollars and most central banks hold the majority of foreign reserves in dollars. The tightness of euro has handed a chance of switching from one currency to another, pushing the value of U.S. dollar downward. However, different gueses about the possible worst-case scenario are nothing else but pure fears.
On the other hand, U.S. government bonds have fallen as investors haven't expected higher asset premiums. The dollar has peaked in 2002. Since then, consumption-induced borrowing has boosted current-account deficit. Recently, various incentives to import less and export more, have lifted the account deficit from 7 percent of the GDP to 5,5 percent.
The state of the U.S. currency is very much related to so called "cyclical divergence" between the U.S. and the economies in the rest of the world. Financial markets have prolonged the expectations about the interest rate cut. But, a weakening dollar is not a consequence of a single feature. A sizeable amount of assets have been stocked in the U.S. dollar, affected by credit-crunch mess. As growth prospects were weaker, the currency became cheaper. There is no doubt that a widening current-account deficit has left the dollar vunerable to external pressures.
In addition, rising oil prices and weak dollar has raised inflation expectations in gulf countries. Economically, those countries would have to let their currencies to rise to curb the inflation pressures and expectations. If their currency appreciate, other reserve currencies would arise. If the dollar-falling would continue to slide faster, the interest rate cut would have to be held back to prevent the decline in the value of dollar. True, there would be some trade-off pressures.
Speculations about the U.S currency situation are often overblown and there's little evidence, empirical and actual, that the dollar could slide deep into a chaotic slump. Yet, there is a question how long will dollar remain the world's leading currency (link).
An interesting article brought up a couple of issues to be discussed. First, dollar crisis would be disastrous. The U.S economy is now expecting a recession. Even if it looms, the financial markets would force FED to raise the rates, slowing the recovery from recession. Consequently, euro would probably soar to new record-highs.
A major slice of global traded is accounted in dollars and most central banks hold the majority of foreign reserves in dollars. The tightness of euro has handed a chance of switching from one currency to another, pushing the value of U.S. dollar downward. However, different gueses about the possible worst-case scenario are nothing else but pure fears.
On the other hand, U.S. government bonds have fallen as investors haven't expected higher asset premiums. The dollar has peaked in 2002. Since then, consumption-induced borrowing has boosted current-account deficit. Recently, various incentives to import less and export more, have lifted the account deficit from 7 percent of the GDP to 5,5 percent.
The state of the U.S. currency is very much related to so called "cyclical divergence" between the U.S. and the economies in the rest of the world. Financial markets have prolonged the expectations about the interest rate cut. But, a weakening dollar is not a consequence of a single feature. A sizeable amount of assets have been stocked in the U.S. dollar, affected by credit-crunch mess. As growth prospects were weaker, the currency became cheaper. There is no doubt that a widening current-account deficit has left the dollar vunerable to external pressures.
In addition, rising oil prices and weak dollar has raised inflation expectations in gulf countries. Economically, those countries would have to let their currencies to rise to curb the inflation pressures and expectations. If their currency appreciate, other reserve currencies would arise. If the dollar-falling would continue to slide faster, the interest rate cut would have to be held back to prevent the decline in the value of dollar. True, there would be some trade-off pressures.
Speculations about the U.S currency situation are often overblown and there's little evidence, empirical and actual, that the dollar could slide deep into a chaotic slump. Yet, there is a question how long will dollar remain the world's leading currency (link).
Saturday, December 01, 2007
PRIVATIZATION OF STATE ENTERPRISES: THE CASE OF SLOVENIA
Dr. Joze P. Damijan, the professor of economics at Vienna University of Economics and Business Administration, recently wrote an article about the need to accelerate the privatization of state enterprises in Slovenia. The article can be read here and here.
In Slovenia, 65 percent of the GDP is composed of private sector while public sector is extensive, accounting for about 35 percent of the GDP. There is a numerous empirical evidence in favor of privatization. In fact, the allocation of scarce resources is the key argument for privatization. Managers in state enterprises have different interests than private investors. That's why, private enterprises are more risk-taking in particular investment opportunities. Thus, as an empirical matter, private investors usuallly sustain higher rates of return on equity than managers in state companies.
In Slovenia, the government has been controlling the economy by extensive ownership participation in all major enterprises, ranging from insurance companies (Triglav), pharmaceutical industry (Krka), manufacturing sector (Gorenje) to retail industry (Mercator), banking sector (Nova Ljubljanska Banka, NKBM) and even telecommunication sector (Telekom Slovenije, Mobitel).
There is also a proof that sizeable state entrepreneurship reduces growth and distorts capital allocation nevertheless. In China, there is an average estimate that a decrease in state-owned enterprise share of industrial production increases real GDP growth by 1,14 percent (Phillips, Kunrong 2003).
In Slovenia, political and popular attitude toward the privatization is somehow negative. Yet, the privatzation is urgent. Some privatization is already taking place. Unfortunately, it is taking place very slowly and non-transparently. The withdrawl of government ownership of enterprises is essential to sound economic performance and economic liberty nevertheless.
In Slovenia, 65 percent of the GDP is composed of private sector while public sector is extensive, accounting for about 35 percent of the GDP. There is a numerous empirical evidence in favor of privatization. In fact, the allocation of scarce resources is the key argument for privatization. Managers in state enterprises have different interests than private investors. That's why, private enterprises are more risk-taking in particular investment opportunities. Thus, as an empirical matter, private investors usuallly sustain higher rates of return on equity than managers in state companies.
In Slovenia, the government has been controlling the economy by extensive ownership participation in all major enterprises, ranging from insurance companies (Triglav), pharmaceutical industry (Krka), manufacturing sector (Gorenje) to retail industry (Mercator), banking sector (Nova Ljubljanska Banka, NKBM) and even telecommunication sector (Telekom Slovenije, Mobitel).
There is also a proof that sizeable state entrepreneurship reduces growth and distorts capital allocation nevertheless. In China, there is an average estimate that a decrease in state-owned enterprise share of industrial production increases real GDP growth by 1,14 percent (Phillips, Kunrong 2003).
In Slovenia, political and popular attitude toward the privatization is somehow negative. Yet, the privatzation is urgent. Some privatization is already taking place. Unfortunately, it is taking place very slowly and non-transparently. The withdrawl of government ownership of enterprises is essential to sound economic performance and economic liberty nevertheless.
Subscribe to:
Posts (Atom)