Artificial states

The question of the artificial states has recently been brought up by the referendum in Southern Sudan on whether the southern part of the country should declare political independence from the northern part of the country. An article in New York Times (link) succintly discussed few notable fact-checked evidence of the increasing ethnic, political and economic North-South division within the country. As a single country, Sudan performed terribly in development outcomes. According to CIA World Factbook (link), the country suffers from high rates of extreme poverty and illiteracy. For instance, the official share of population below poverty line is estimated at 40 percent - almost twice the average of North African states. In addition to poor development outcomes, the country is plagued by significant political and ethnic fragmentation into largely Muslim, Arab-speaking north and predominantly Christain, English-speaking south. The political independence of South Sudan is the only contemporary evidence of the re-establishment of land borders alongside the ethnic division.

In the recent paper entitled Artificial States, Alberto Alesina, William Easterly and Janina Matuszeski presented two formal measures of artificial states. Aside from the measure of ethnic division, the authors constructed the measure of straightness of border lines. The hypothesis suggests that squiggly geographic border lines separate the states alongside the ethnic division. On the contrary, straight border lines suggest increase the probability of the emergence of artificial states plagued by ethnic and linguistic fractioning. The authors presented the empirical evidence, suggesting that fractional land borders are highly correlated with the GDP per capita. In addition, the share of ethnically partitioned population within the country is systematically decreasing the GDP per capita in cross-country comparison. The intuitive ideas behind the empirical evidence suggest that at the end of colonial period, colonizers that set straight borderlines between the emerging countries incured significant economic cost to newly formed African countries in terms of lost GDP. The evidence from Alesina-Easterly-Matuszeski study suggest that a 1 percentage point increase in the fraction of country's population belonging to groups partitioned by the border would decrease the GDP per capita by 1.3 percent. On the other hand, countries with squiggly geographic borderlines enjoy significantly higher GDP per capita.

The post-colonial period in Sudan was characterized by two civil wars which outbroke in 1972 and 1983. In 1956, Sudan gained the political independence from Great Britain. Contemporary borderlines were predominantly determined by the colonial authorities in African states prior to the wave of independence of many African nations. The emergence of the artificial states is rather a consequence of poor colonial policies than of high bargaining cost of ethnic groups within the country in setting country borderlines. Hence, the economic effects of colonial legacy can persist over time. Consider the evidence from Cameroon. The country was originally colonized by Germany. During the World War I, Northern Cameroon was occupied by Germany while the rest of the country was colonized by the French. Between 1916 and 1960, the country was a unique experiment of how the establishment of the institutional setting of European countries affects domestic development outcomes. A recent study by Alexander Lee and Kenneth Schultz (link) suggests that in the areas formerly occupied by the British enjoy higher levels of wealth and improved access to clean water while the rest of the rural country, after having been colonized by the French, suffers from significantly hindered access to clean water and worse provision of public goods. Even though the colonial patterns do not apply to urban areas, lessons from Cameroon suggest that the impact of post-independence public policies and colonial legacy on the level of wealth is of the same importance even when linguistic and ethnic fragmentation persists over time.

In spite of considerable degree of inefficiency, the persistence of inefficient and ethnically fragmented states is continuously marked by poor economic and development outcomes, often accompanied by civil-war conflicts such as military violence and genocide by the Sudanese army in Darfur. An interesting theory has been recently put forth by Daron Acemoglu, Davide Ticchi and Andrea Vindigni (link) who suggest that rich political elites seize state capture and democratic politics by expanding the size of bureaucracy. Hence, to gain political support, the coalition of elites chooses an inefficient structure and organization of the state.

The phenomenon of artificial states is not abridged to least-developed countries and developing world. Even in the group of advanced countries, several countries emerged despite a considerable degree of linguistic, ethnic and cultural fractioning within country borders. The evidence from Switzerland suggests that a continuous transition to a peaceful and stable democracy is possible. Amid highly fragmented linguistic and cultural characteristics such as four official languages and the persistence of GDP per capita divergence between high-income German cantons and low-income French cantons, Switzerland is characterized by envious political stability and economic performance. The genuine feature of federal political system is a consistent fiscal decentralization such as jurisdictional competition between units within the federalized structure in various areas such as taxation, regulation, health care etc. Hence, a decentralized fiscal structure and division of powers require a limited federal government and a high degree of autonomy within the federation. Thus, despite a multilingual population, the Swiss model of federalism is marked by political stability, peace and prosperity.

The phenomenon of artificial states in advanced countries is not confined to Switzerland itself. What distinguishes the Swiss model of federalism from centralist political systems in its neighboring countries is a high degree of political autonomy in Swiss cantons. Competition between jurisdictions within the federation nonetheless generates different economic outcomes. However, the outcomes generated by jurisdictional competition preclude adverse effects caused by either state capture of democratic politics or redistributive taxation between jurisdictions. In Switzerland, cantons with favorable public policies such as low tax rates on labor and capital, sound regulation and competitive provision of health care, have enjoyed persistently higher levels of wealth compared to cantons in the rest of the country. Of course, the coexistence of diverse ethnic and lingual groups within the single state requires common values, integrated into formal institutions.

Contrary to common perception, the artificial state may not be characterized exclusively by ethnic and linguistic fragmentation. To a large extent, Germany and Belgium could be classifed as artificial states. In Belgium, Flemmish-speaking north of the country consistently outperformed French-speaking south on various indicators and outcomes, including income per capita, international test scores and employment-to-population ratio. The political and linguistic division of Belgium into high-income Flemmish part and less developed French part reflects the essential dilemma of artificial states - should a single country with fragmented and heterogenous population be abandonded and whether ethnicity borders should represent country borderlines. In fact, linguistic fragmentation of Belgium to the extent that Flemmish and French part of the country adopted different administrative and education systems, led to persistent inability of two majorities to form a government. In 2007, The Economist opined that Belgium should cease to exist. The unification of Germany (Wiedervereinigung) integrated two parts of the country with vastly different institutional setting into a single political unity. However, Eastern and Western Germany were known for completely different political and economic system. The unification has incured many adverse effects. A significant difference in wage and price levels between East Germany and West Germany caused continuous migration of East German labor into West Germany, thus decreasing the productivity growth in East Germany. Consequently, the unification of the country led to the adoption of West Germany level of prices and wages in Eastern part of the new country. The artificial increase in price-wage level increased the unemployment rate in Eastern Germany to double-digit level, not least triggered brain-drain and capital flight. Hence, the unification of Germany as an artificial state resulted in persistent income per capita divergence between high-income West Germany and low-income East Germany. The unification of Germany into a single country should indeed never happen. In fact, adverse effects of the unification on East German productivity and wages would not lead to continuous increase in unemployment rate. If East Germany maintained a high degree of political autonomy, the transition to market economy would not be restrained by the adoption of West German price-wage level that could not be sustained by low productivity level in East Germany. To avoid the pitfalls of the artificial states, West and East Germany would be better off, had the countries never been reunified.

Recent national referendum in South Sudan on whether the southern part of the country should declare political independence from Sudan again pondered over the persistence of artificial states. The empirical evidence on poor development outcomes in several African countries suggests that borderlines, disregarding the ethnic distribution of the population within the country, are highly correlated with low income per capita. The unique solution of the artificial states is the adoption of political federalism. Under fiscal decentralization and limited government, federalism enables peaceful and prosperous existence of fragmented ethnic and linguistic structure in a single state. For instance, former Yugoslavia, known for highly fragmented ethnic, linguistic and economic disparities, ceased to exist not because federalism would not be a genuine political system but, ultimately, because of severe economic mismanagement, powerful and centralized government that disdained the principles of political autonomy and market economy, causing severe hyperinflation and the collapse of the federation that eventually resulted in a decade of civil wars and military violence. The evidence from Yugoslavia suggests that between 1950 and 1990, drastic economic divergence occured. The lesson suggests that the essential condition for the efficiency of federalism as a political system is high political autonomy and fiscal decentralization, both of which enable the competition between public policies.

Amid linguistic fragmentation, the competition between jurisidictions rewards competitive public policies by higher income per capita which ultimately boost the inception of public policies in less developed parts of the federation. Hence, without jurisdictional competition and political autonomy, ethnic and linguistic fragmention of the country may ultimately result in political instability which, in addition, generates poor economic outcomes.

FEDERAL DEBT IN THE US (1940-2009)

Source: Office of Budget and Management (2010)

LESSONS FROM CHILE

Hernan Buchi, former minister of finance in Chile, recently published a new book The Economic Transformation of Chile (link) where he outlined comprehensive economic reforms that boosted economic growth, lowered unemployment, reduced poverty and set the stage for more than two decades of robust growth and an economic turnaround which has been unprecendent in Latin America.

The books serves the reader with a menu of intriguing facts, curious statistics and precise analysis of how macroeconomic stability was achieved. Chile has been the leading nation in Latin America with the most stable and predictable inflation rate. Country's decent fiscal management and solid macroeconomic outlook were important cornerstones behind the invitation to the OECD.

According to Jose Pinera (link), Chile is expected to enter the club of developed nations in 2018, the first Latin American country ever. Chile pioneered the privatization of the pension system in early 1980s. Today, country's fully-funded pension system based on individual savings accounts is a model for the rest of the world (link) in overhauling unfunded pay-as-you-go social security systems.

INTERVIEW WITH JOSE PINERA

POVERTY, INCENTIVES AND DEVELOPMENT

Daron Acemoglu wrote a marvelous article discussing the supportive role of incentives and institutions in global poverty reduction and economic development (link):

"If we know why nations are poor, the resulting question is what can we do to help them. Our ability to impose institutions from the outside is limited, as the recent U. S. experiences in Afghanistan and Iraq demonstrate. But we are not helpless, and in many instances, there is a lot to be done. Even the most repressed citizens of the world will stand up to tyrants when given the opportunity. We saw this recently in Iran and a few years ago in Ukraine during the Orange Revolution."

ECONOMIC COST AND BENEFITS OF GERMAN UNIFICATION

Yesterday, it has been 20 years since the fall of the Berlin wall and the eventual collapse of communist political and economic system in Central and Eastern Europe. However, there is still discussion about economic costs and benefits of German reunification (Wiedervereinigung). I've been motivated to open this debate by professor Becker's analysis (link) on the size of countries and by the recent article in Financial Times by the contributing German economist (link).

Economists in Germany and the rest of the world have long warned against the consequences of the unification of East and West Germany. After the unification, German central bank set the exchange rate at 1:1. Because East German workers' relative productivity level lagged far behind the West German level, East German workers migrated to West Germany in search of higher wages. When wage rates between West and East Germany were equalized in the absence of productivity catch-up in East Germany, the excess labor supply in the East led to high unemployment and slow changes in the economic structure. As the exchange rate was equalized and wages prevented from the natural adjustment to productivity growth, the unemployment soared as East German manufacturing sector couldn't employ labor anymore. The unemployed received massive transfer payments which, even more than a decade after the reunification, still present about 4 percent of total German income.

Today, the figures suggest that East German GDP per capita is roughly 70 percent of the Western German level and the unemployment rate exceeds 12 percent - more than twice the Western level. Low population density and high share of rural population are the main structural obstacle to higher productivity growth in the East. The majority of models in economic geography and urban economics suggests that agglomeration economies occur where population density is high. The latter yields significant advantages in terms of spillovers, search cost, factor mobility, know-how and economies of scale. Low population density is a major obstacle in attracting investment mostly because firms are not eager to locate at the periphery in the presence of high search costs and in the absence of high-skilled labor, agglomeration and linkages to economies of scale. In the U.S, for instance, Pittsburgh's industrial restructuring from resource-based steel industry into knowledge-intensive information technology, biotechnology and software development required agglomeration which combined high-skilled labor, human capital, access to regional and international markets as well as high population density.

In Germany, for example, Hamburg generated the highest GDP per capita (€51,000) among cities and Bavaria (Bayern) generated the highest GDP per capita (€36,000) among German states. Hamburg and Munich, as well as the linking cities located in their vacinity are among the most densely populated areas which enabled them to develop core industries, spillovers, know-how and dynamic knowledge externalities. There is an overwhelming evidence that differences in population density are a good source of growth difference between east and west Germany.

After the unification, German fiscal policymakers favored an expansive fiscal policy which directed federal expenditures into poorer regions of the East to boost the development of infrastructure. However, at an exchange rate 1:1, West German firms were reluctant to invest in East Germany mainly because of higher relative price of labor. As East German workers moved to the Western part of the country, west German firms hired eastern workers. As brain drain became widespread, the convergence of east German income per capita slowed.

East Germany were far better off, if the country remained independent. The reunification of Germany would yield singificant economic benefits, if the unification itself were based on close economic integration with the establishment of free trade area and free movement of capital, goods and labor. If East Germany remained independent and retained its own currency without the uncovered exchange rate realignment to to West German exchange rate parity, the relative price of East German labor wouldn't increase and thus the unemployment rate would be significantly lower than it has been ever since the reunification. Thus, West German firms would easily find attractive investments in East Germany. The process would dramatically reduce disparities in population density compared to the West. Under such scenario, East Germany's macroeconomic stabilization and institutional reforms would be a lot easier and the overall economic and political transition much less painful.

HOW FISCAL AND MONETARY POLICY LED TO THE GREAT DEPRESSION

In the recent edition of WSJ, Arthur Laffer highlighted (link) how mismanaged fiscal policy during Hoover and Roosevelt administration led and prolonged the Great depression, and how contractionary monetary policy let it happen.

HAPPY BIRTHDAY, MILTON

Milton Friedman died on November 16th 2006. July 31st remarks his birthday and an opportunity to reflect his profound legacy of economic thinking and ideas promoting individual liberty.

I first came across Friedman's ideas through one of his first research papers, Income from Independent Professional Service (link), coauthored with Simon Kuznets, wherein Friedman and Kuznets showed how shortage of physicians emerges from restrained labor supply and upward wage pressures. Together with Kuznets, Friedman applied statistical models to the analysis of income from professional services. The empirical results indicated that the regulation of professional services raises general income level for existing practitioners while, at the same time, reduces incentives for market entrants by raising fixed entry costs and compliance cost.

The paper was written in 1945 when orthodox Keynesian economic policies took a full-fledged march. Friedman's strong analytical rigour successfully challenged Keynesian economic establishment of that time. In Theory of the Consumption Function, Friedman showed how Keynesian theory of consumption fails to capture long-run behavior of households. In General Theory, Keynes postulated that household's consumption is determined by autonomous consumption and consumption induced by income. Since Keynes assumed that consumption is a linear function of income, higher income is ought to result in higher savings. Later on, Simon Kuznets showed that Keynesian consumption function suffers from empirical incosistencies. Even though it had been seemingly accurate in short-run cross-section data, it failed to predict household income pattern in time-series data over the long run. If Keynesian assumption was held true, the savings-to-income ratio would grow over time. On the contrary, the ratio remained constant over time in spite of relatively large income changes. Keynesian theory of consumption was further shook by new theories of consumption. Franco Modigliani, Nobel Laureate in Economics from 1985, challanged Keynesian consumption theory by introducing life-cycle hypothesis, showing how savings-to-income ratio changes over the entire lifetime, depending on household's life stage. Franco Modigliani and Richard Brumberg proposed the life-cycle income hypothesis with a more realistic assumption. He tested the following equation: C = aW + cY where a is marginal propensity to consume wealth (W), and c is marginal propensity to consume income (Y). The empirical results for the United States estimated the marginal propensity to consume from disposable income (c) at 0.7 and marginal prospensity to consume from wealth (a) at 0.06. The estimates were used to examine household consumption patterns. Thus, over the lifespan, as household's income went up by 1 percent, consumption expenditures wemt up by about 0.7 percent on average. Meanwhile, as household's wealth increased by 1 percent, the consumption expenditures grew by 0.6 percent on average.

The research by Modigliani and Brumberg in 1957 and Kuznets paved way for Friedman's Permanent Income Hypothesis. In a proposed hypothesis, Friedman argued againist Keynesian consumption theory. Its major inability is the weakness of prediction and the inconsistency in consumption patterns between short-run and long-run results. Contrary to Keynes, Friedman argued that disposable income arises from permanent and transitory income. Permanent income held by household was defined as household's preference for a stable consumption over the long run. Friedman showed that consumer's choices are made not by transitory income but by permanent income expectations. Thus, transitory changes in income have little effect on consumption behavior. The empirical assessment of permanent income hypothesis showed that households with lower income tend to have higher marginal propensity to consume. Friedman concluded that consumer's spending is not affected by static expectations but rather by real wealth such as physical assets and human capital assets. These determine consumer's earning ability and enable consumers to forecast their lifetime income.

When Friedman received a Nobel prize in economics back in 1976, the Nobel Commission entitled the award for "...his achievements in the fields of consumption analysis, monetary history and theory and for his demonstration of complexity of stabilization policies..." Back in 1963, Friedman and Schwarz wrote the Monetary History of the United States 1867-1960 where they examined the monetary trends in the United States since the end of the civil war.

Through an extensive empirical observation of money supply, monetary policy and business cycles they showed that monetary intervention by the Federal Reserve System, which was established in 1913, in an attempt to stabilize the short-term cyclical shock in the financial market resulted in the worst economic depression in world history. Fed's intervention reduced the broad money supply, destroying the depository base. The intervention led to the banking panic. Lending operations were disabled and the banking system suddenly went insolvent. When Federal Reserve cut the money supply by one-third in 1929, the ordinary recession turned into the depression in the light of deflationary shock. As the leading voice of the monetarist school, Friedman showed that inflation is a monetary phenomena resulting excessive growth of money supply relative to output growth.

Friedman's empirical research on monetary trends over time led to important conclusions. The most notable conclusions were that (1) short-run changes in money supply affect output while (2) long-run changes in money supply affect price level. Friedman's empirical work on monetary economics dropped the Keynesian myth of inflation caused by oil price increases or upward wage pressures. Friedman suggested that Fed should increase the quantity of money by a rate, ranging from 3 to 5 percent, determined in advanced. In a debate with Walter Heller, the chairman of Council of Economic Advisers to President Kennedy, Friedman argued that fiscal policy is an inefficient demand management tool in stabilizing economic fluctuations.

Milton Friedman was also a leading and indispensable libertarian voice throughout the world. Back in 1962, he published Capitalism and Freedom. The book spread the ideas of economic and individual liberty around the world. Friedman wrote that economic freedom is a neccesary condition for individual and political freedom. The ideas of ending all currency controls, removing barriers to trade, drastically cutting government spending, privatizing social security, introducing school vouchers and ending progressive income tax structure, spurred the creation of liberal freedom movements around the world.

As one of the rarest voices around the world, Friedman proposed the negative income tax as an alternative to progressive income taxes. As the wealthy take advantage of various loopholes, exemptions and tax breaks, progressive income tax does not achieve its purpose but, contrary to expectations, it further increases the income inequality. The basic idea behind the negative income tax is that general allowance would be raised to guarantee the minimum income level while the income above basic exemption would be taxed at the flat rate. The books written by Milton Friedman truly revolutionized the world. Free to Choose, coauthored with Rose Friedman, introduced free-market ideas to the general public by popularizing cases for limited government, the rule of law, and various way to end government monopolies.

Friedman's ideas reached the arena of public policy in many countries. Although heavily criticized by the left-wing intellectuals, Friedman visited Chile and delivered a lecture in Santiago on economic freedom. He advocated deregulation, privatization and the case for floating exchange rate. Due to the decision of Chilean Ministry of Finance, the exchange rate was fixed to the U.S dollar as a cure to heel rampant inflation. Since the Central Bank of Chile hadn't reduce the money supply, dollar-denominated foreign loans deteriorated Chilean trade balance. The decision to fix the exchange rate in the absence of accomodative monetary policy, imports were inflated. Because exchange rate was not floating, the elimination of fixed exchange rate and a disinflationary policy of the central bank unavoidably resulted in a two-year recession.

However, nothing could be further from the truth than then assertion that free-market reforms destabilized Chilean economy. Output contraction is a natural consequence of disinflationary policy, following the reduction of money supply. After exchange rate controls were eliminated, and after the launch of the privatization of state-owned companies and the social security, deregulation and free trade, starting in 1985, Chilean economy grew at the robust rate. Industrial production increased and the unemployment went down. In the long run, Chile's GDP per capita has been the highest in the region with a vibrant economy facing stable institutions and an enviable Friedman's ideas influenced many leaders around the world.

His ideas inspired Margaret Thatcher to undertake the course of free-market reforms. Prior to the launch of fiscal and monetary policy reforms, the British economy was recognized as the sick man of Western Europe, facing high annual rates of inflation and unsuccessful Keynesian economic policy attempt to cure the ailing economy by boosting aggregate demand through government deficits. After Lady Thatcher slashed marginal tax rates, introduced deregulation, liberalized labor market and proposed the privatization of state-owned industries, the British economy thrived with economic growth rates reaching historic highs.

Milton Friedman left a wealthy legacy of free-market thinking and efforts to promote individual liberty, free economy and political freedom. The financial crisis of 2008/2009 that spurred the economic recession intiated the beginning of heavy government intervention. The pursuit of ideas in favor of individual liberty and economic freedom is the best weapon againist the growth of government and the welfare state. With an iron will of the classical liberal, he successfully battled the failures of the welfare state and government intervention. He surely is one of the greatest economists and thinkers of the time.

LESSONS FROM THE GREAT DEPRESSION

Here is a link to Christina Romer's speech about the lessons from the Great Depression and the economic recovery of 2009, presented yesterday at the Brookings Institution.

THE CURSE OF PUBLIC DEBT

John Steele Gordon wrote an article (link) about the history of U.S. national debt in the twilight of CBO's estimate of $1.2 trillion federal deficit before the stimulus package.

THE POTENTIAL OUTCOME OF OBAMANOMICS

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

LESSONS FROM MONETARY POLICY: 1930 AND 2007

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

KENNEDY TAX CUTS IN 1960s

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

THE MIRAGE OF SWEDEN'S WELFARE STATE

Today's edition of the Wall Street Journal includes an opinion (link) where the author describes how the costs of social engineering are strongly underestimated in Sweden which is considered a paradise and haven of the welfare state. Throughout the content of the article, several examples are cited to show how immigration benefits the well-being and how welfare state eroded wealth creation and stimulated the decline of entrepreneurship and growth.

The set of arguments for the welfare state often includes egalitarian reasoning that has hardly anything to do with economics except for the famous Lorenz curve, showing the size of the distribution of income and wealth across population quantiles whereby the empirical outcome represents the Gini index of inequality. However, there could hardly be found sufficient arguments in favor of welfare egalitarianism exercised by high tax rates on personal and corporate income and other notable sources of productive behavior.

AUSTRIA'S PROPELLING PATH TOWARDS PROSPERITY

The Economist has published four highly interesting reports on Austria's economic development (here, here, here and here). In addition, Economist Intelligence Unit provides some data on Austria's economic situation (here and here).

STREET SOCIALISM IS THE LAST SHELTER OF SCOUNDREL

Following the headlines of the international media, Slovenia is a fine land consisting of happy people, whose country's nobility is enriched by the fact that Slovenia is the wealthiest post-communist economy which recently entered the European Monetary Union, and a country enjoying the highest GDP per capita and standard of living in the Eastern Europe.

However, the reality is something completely different as I try to demonstrate in the words below.

Being a student is a nice slice of lifetime. I do not pay attention to attending student parties and thus, I rather wisely invest my time into sitting at the library and studying the economic theory, policy and philosophy besides regular study courses. The fact is that the opportunity cost of attending parties is huge and it'd be completely irrational to neglect it or ignore it respectively. For example, Kobe Bryant understands his opportunity cost very well. He can, for instance, spent 2 hours mowing his lawn, having low overall return.

Contrary, he can record a TV commercial, earning $10,000 USD in two hours. His neighbor, Sally, might spent 2 hours working in McDonald's, earning $8 USD. Despite the fact that Kobe might mow the lawn faster than Sally, it'd be rational for Kobe to record a TV commercial while it'd be equally rational for Sally to mow the lawn, because of the opportunity cost.

Economically, my interest as a student is to finish the undergraduate study as soon as possible and get an overall return from the education. The opportunity cost of the education is, of course, my time. But in a broader perspective, higher earnings and human capital value is what shall count as a compensation for investing my time into the education, getting both: better education and better job opportunities.

As an economist, I strongly favor free choice; an ability to choose among the greatest possible set of alternatives in the course of human life. In fact, individual, economic and political liberty and individual responsibility to the fullest possible extent, is what has unlocked creative and talented entrepreneurial and intellectual minds to pursue intuitive and powerful ideas that shaped the economic future.

But I don't understand, why on earth, should the students jump on the streets, wear red suits, head old Soviet flags and shout in favor of the welfare state extensively. Slovenia's student organization, pensioners, public sector employees and trade unions claim that wage increases should be more robust subject to Slovenia's sound current economic shape and, on Saturday morning, they will march on the streets of Ljubljana and promote the spellings of socialism, social security and generous welfare services respectively. Slovenia's student organization says the following:

"An accessible education without scholarships for all, higher pensions and greater social justice. These are the ideas that will make everyone better off."

Over at the faculty field, I noticed a socialistic parole, saying: "Factories in the hands of workers, universities in the hands of the students!" added with Soviet-styled propaganda and typical communist star. This situation rather reminds on a retarded Soviet satelite grunged by Leninism and Marx's diallectical materialism. The origins of socialistic mentality in Slovenia are strong roots of collectivism. In this post, I explain why student protests against pro-growth tax and economic policy, school choice and competition in higher education, reform of the budget-funded health care system and social security reform are based on the false assumptions, myths and hostility against individual, economic and political liberty.

1. Population crisis in Slovenia is estimated to hit negative numbers. Aggregate labor supply is falling respectively and the number of retired persons is growing significantly. In Slovenia, when a person retired, the main slice his pension in financed through 1st pillar of pension fund which is funded directly through taxes on labor supply. The impact is clear: tax burden on labor supply is rising, public debt is growing respectively and fiscal outlays are expanded every year.

Consider the gross cost of an educated and intelligent worker in Slovenia, which an employer has to bear. Assume that monthly salary of the worker equals $3500 EUR in gross terms. The contribution rate to the retirement fund is 15,5 percent. Basic health care insurance deducts additional 6,36 percent. Personal income tax rates are composed into three brackets; 16 percent for the lowest quantile, 33 percent for the middle-income earners and 41 percent for the workers in high-income groups.

Obligated voluntary health insurance contribution rate is small compared to basic coverage rate of contribution, but it deducts the disposable income respectively. Additionally, employers have to pay the payroll tax and enhance the worker's income by compensating the costs of food and transport. In addition, an employer in Slovenia has to slice a contribution share to health care, social security and pension fund, at the expense of worker's productivity. Now, calculate the disposable income of the employee and see the tax wedge, squeezing his productivity after the hours he spends on the market.

2. Moderate tax cuts by the center-right government stimulated the growth of incomes by a narrow rate. Modest cuts in the labor taxation showed that tax cuts are self-financing, the unmistakeable notion of the Laffer Curve. Recently, the growth of economic activity in Slovenia reached historic highs. In 2007, the growth is estimated to reach 5,6 percent, which is quite uncompetitive compared to Eastern European economies. In 2006, Estonian economy grew by 7,9 percent, Latvia accounted 10 percent rate of output growth, Slovakia recently announced the data, revealing 9 percent annual growth rate.

By 2012, Slovenia's economic growth is estimated to diminish straight-forward to 3,6 percent respectively, reflecting weak structural advancement, age-dependency pressures and rapid increase in retirement activity. In 2006, the rate of inflation sparked up primarily due to higher food prices and intensive demand for food in Asian high-growing economies. Economically, inflation is a monetary phenomena arising from too much money, chasing too few goods. In a simple equilibrium, the result is the increase in overall price level. By January 2007, Slovenia entered the European Monetary Union, and after fixing the monetary emissions, the growth of money supply calmed down which normalized the inflation rate.

Subject to deteriorating exchange rate regime and periodically stimulated high inflation in the past, it will take time for Slovenian economy to adjust to new stream of monetary policy whereby the money supply is determined through interest rate setup by the ECB.

3. There is no such thing as free education. In fact, somebody has to pay the equipment, rent and maintain the facilities, lecture rooms, provide the electricity and heating. In addition, somebody has to hire and pay the academic services. Somebody has to pay and provide computers, internet access and modern means of study. Saying that education is free is like claiming that you can go into the mall and take away some furniture without payment. There is a dozen of proofs that private sector education is competitive in terms of quality of the future graduates.

The best and most respected universities in the world are private ones. Eight Nobel-winning economists have come from Chicago University which is funded by private means as well as Stanford University. Investment in education provides the best interest in the future. The time you give up to consume, is the cost you have to bear to have greater returns and personal welfare in the future.

There is no such thing as free lunch, and the education has never been a free lunch. Scholarships, by empirical proof, improve the standards of education and provide opportunities for thousands of individuals to unlock knowledge potentials and empower the intuitive mind whether it be in entrepreneurship, design, economics, medicine, mathematics and everywhere else.

4. The essential to understanding complex phenomena in society is the economic literacy and education. Thus, Slovenes should know that despite the same length of working time as Austrian or German workers, the latter earn more because of higher productivity and technological progress which stimulates the productivity through effective individual management of creativity and knowledge. In addition, Slovenia is, as shown above, one of the most taxed countries in the world (link), thus giving investors a sign of avoidance as an investment location. Empirically and practically, labor supply is highly sensitive to tax rates, meaning that the labor supply is elastic, ceteris paribus.

It means, that the labor supply strongly responds to the marginal changes in taxation of income. As a result of higher taxes, gross labor cost in Slovenia is huge, discouraging job formation and denying the opportunities to thousands of intellectual and entrepreneurial minds to show their skills and talent. I wonder whether trade unions and its anti-growth intellectual leaders will bear full responsibility for the actions they presume as socially just. To say it again, social justice is a mirage and a trojan horse riddled by the totalitarian governments and supported by the individuals who deny economic and personal liberty to others. Those who deny the enforcement of economic and personal liberty as a property right to others, neither deserve it for themselves.

The demands of trade union such as full employment, high taxes on productive behavior, high wages, expanded income and profit redistribution, extensive welfare and social security services, would propel the stagnation of growth as well as the productivity potentials which is the main engine of growth in standard of living. Claims of egalitarian pursuit of redistribution, material and income equality, under which trade unions in Slovenia delegate the course of living order, can only be met under governments with totalitarian powers. Extensive unionism and its influence on structural and economic policy is perhaps the most powerful evidence that Slovenia is de facto the most socialist country in Europe.

5. At last, Slovenia's economic policy in the past 15 years is the most notable proof about the negative impacts of gradualism entailed into the course of public policy. Slovenia kept persistently the highest inflation among advanced countries in Eastern Europe. When the left-wing government took over the chairmanship in government, wages in public sector trimmed up enormously by 40 percent, creating an additional source of inflation pressures. The deadweight loss from economic depression was vast. Meanwhile, Slovenia's international competitors grew rapidly and thus a development was geared-up. In addition, the policy of early retirement enabled the formal retirement before the age of 50. In just one year, between 1992 and 1993, the number of retirees rolled-up by more than 100 percent.

Over the years, Slovenia's pension system, in terms of outlays, has been financed through budget and the first pillar of retirement insurance is estimated to be depleted in the medium run consequently because of the abovementioned reasons including early and beneficial retirement, high pensions and sky-rocketing continual spirals of wage increases in the public sector, adding a burden to high government spending.

6. In 1950, in terms of current prices, Slovenia's real GDP per capita was higher than Austria's which suffered war losses. From 1960 onwards, Austria's prosperity increased tremendously after Austrian early reformist government and its minister of finance Reinhard Kamitz adopted low taxes, imposed deregulation and liberalized trade and prices, while Slovenia's GDP growth started to trick towards relative stagnation. When Austria's technological development accelerated productivity growth, its standard of living grew tremendously, at the fastest pace in Western Europe.

When Austria enjoyed the fruits of market economy and remarkable output growth rate, Slovenian economy was mischiefed by socialist self-management which demolished the efficiency of entrepreneurial investment by wrongful decisions embraced by politicians, political entrepreneurs, workers and union leaders, who knew neither risk nor ambitious agenda, as there was no private means of production under socialism.

Finally, when Slovenia gained independence from communism, Austria's economy advanced the output growth while "the wealthiest ex-communist country" slid into depression while its central bank tacitly led the policy of high inflation through deteriorating exchange rate. Thus, the hourly output per average Austrian worker is higher relative to the output of Slovenia's worker per hour, because of higher productivity, greater innovative and entrepreurial capacity, and succinctly utilized gains from hours spent in the market.

7. Tomorrow, the streets in Ljubljana will shout and scream again, reflecting the misery of sub-Alpine socialism, which has always known nothing else but envy, misery, lies and deception. I will rather spend my time studying and reading Friedrich August von Hayek's The Constitution of Liberty, Greg Mankiw's Principles of Economics, Imre Lakatos's Proofs and Refutations, Karl Popper's Logic of the Scientific Discovery, James Buchanan's Demand and Supply for Public Goods, Kenneth J. Arrow's Social Choice and Individual Values and Wilhelm Roepke's Economics of Free Society.

Rok SPRUK is an economist

Copyright 2007 by Rok SPRUK

SWEDISH MODEL IS LIKE A COIN: BOTH SIDES CONSIDERED

Assar Lindbeck shows how Swedish politico-economic model has two sides of the coin.

BELARUSSIAN STATE ECONOMICS

At Economy.by, a Belarussian student explains how Belarussian State University's professor lectures economics to third-year students. During the lectures on Economics of enterprise professor Bainev tells the third-year students of economics faculty that Russians are the superior race, saying that:

"...Russians are the superior race, and the rest of the world in whole, and americans and europeans particularly, are the absolute morons and animals. He insists in a tough way on the fact that the market economy - is an absolute evil with which we should promtly fight. He says that we shouldn’t think about ourselves and our relatives, and should act only in the interests of nation and her the very best child - President of Belarus. He adds that the USSR was the best time, when people were absolutely happy. He alleged that we should do everything to reunite three main countires in the world - Ukraine, Belarus and Russia with a strong leader who will control people’s life."

Source: Lectures in BSU, Economy.by (link)

HALL OF FAME

Here is how I voted for the favorite free-market economist, journalist, business leader and think tank leader on the Free-Market Hall of Fame:

Favorite academic economist (past): Milton Friedman
Favorite academic economist (present): Gregory Mankiw
Favorite writer and journalist (past): Ayn Rand
Favorite writer and journalist (present): John Stossel
Favorite business leader and entrepreneur (past): Andrew Carneige
Favorite business leader and entrepreneur (present): Charles Koch
Favorite freedom organization and think-thank (past): Leonard Read
Favorite freedom organization and think-thank (present): Edward Crane III.
Favorite government official (past): Thomas Jefferson
Favorite government official (present): Vaclav Klaus
Hall of Shame (past): Karl Marx
Hall of Shame (present): Hugo Chavez

SHOULD BELGIUM BE ABOLISHED?

Sometimes it is right for a country to recognise that its job is done. This is one of the previous headlines in the Economist (link)

The question set in the article "Time to call it a day" is whether Belgium should no longer exist mainly because of the fractions between French-speaking Wallons and Dutch-speaking Flemings. The latest elections thus reflected the revealed political preference of the voters, prefering to vote upon the lines of linguistic roots. In sum, the result was the inability to form the government. The tension heated up as Flemish parliament inevitably considered the declaration of independence. There is a popular quote saying that Belgians have nothing in common except for the king, the football team and some bears. A very delicious chocolate could be added onto that list.

Economically, Brussels could harldy be recognized as a high-tech, free-enterprise powerhouse of Europe. Instead, it gains its strength as a bureaucratic center of Europe, as a city known as a center of government intervention and infamous European-styled central planning and extensive government structure and income redistribution headlined by the European Commission and European Parliament. In spite of the fact that at the end of the World War 2, Belgium was economically far more developed than Ireland, in terms of standard of living as well as in terms of fundamental macroeconomic indicators such as GDP growth and the share of capital formation in the GDP. In 1980, Belgium had a GDP per capita of $9478,99 USD in current prices while Ireland had a GDP per capita of $5746,20 USD. In 2004, after Ireland's supply-side feedback, Ireland's GDP per capita increased five-fold compared to 1980, after inflation adjustment. In contrast, Belgium's GDP increased three-fold between the same period, also after adjusting the GDP per capita with inflation (link).

In the long run, the macroeconomic forecast regarding Belgium is subject to severe structural risk such as ageing population and therefore age-dependency on public retirement schemes and contribution-funded public health care services financed through budget outlays, grabbing a growing portion of the GDP. By 2012, the real GDP growth is estimated to slide down to 0,9 percent (link).

Generally speaking, the splitting-up of Belgium into two separate units could dramatically reduce compliance costs since political decision-making and the ability to fight with long-term demographic pressures originally emerged from labor supply squeeze, and also to fight the disease of onerous government spending and high tax burden. In fact, the benefits of Belgium's abolishment accomplish more openness to individual liberty and the ability to impose the decision-making with fewer painful cost proportions, not just re-assesing the cradle of welfare dependency which has indeed punished the Belgium's international competitiveness compared to high-growing tigers such as Ireland.

Read also:
Libertarec, Time to change Brussels' regime or time to leave (Cas za menjavo rezima v Bruslju ali cas za odhod)