Archives: December, 2011

European Central Bank Research Shows that Government Spending Undermines Economic Performance

Europe is in the midst of a fiscal crisis caused by too much government spending, yet many of the continent’s politicians want the European Central Bank to purchase the dodgy debt of reckless welfare states such as Spain, Italy, Greece, and Portugal in order to prop up these big government policies.

So it’s especially noteworthy that economists at the European Central Bank have just produced a study showing that government spending is unambiguously harmful to economic performance. Here is a brief description of the key findings.

…we analyse a wide set of 108 countries composed of both developed and emerging and developing countries, using a long time span running from 1970-2008, and employing different proxies for government size… Our results show a significant negative effect of the size of government on growth. …Interestingly, government consumption is consistently detrimental to output growth irrespective of the country sample considered (OECD, emerging and developing countries).

There are two very interesting takeaways from this new research. First, the evidence shows that the problem is government spending, and that problem exists regardless of whether the budget is financed by taxes or borrowing. Unfortunately, too many supposedly conservative policy makers fail to grasp this key distinction and mistakenly focus on the symptom (deficits) rather than the underlying disease (big government).

The second key takeaway is that Europe’s corrupt political elite is engaging in a classic case of Mitchell’s Law, which is when one bad government policy is used to justify another bad government policy. In this case, they undermined prosperity by recklessly increasing the burden of government spending, and they’re now using the resulting fiscal crisis as an excuse to promote inflationary monetary policy by the European Central Bank.

The ECB study, by contrast, shows that the only good answer is to reduce the burden of the public sector. Moreover, the research also has a discussion of the growth-maximizing size of government.

… economic progress is limited when government is zero percent of the economy (absence of rule of law, property rights, etc.), but also when it is closer to 100 percent (the law of diminishing returns operates in addition to, e.g., increased taxation required to finance the government’s growing burden – which has adverse effects on human economic behaviour, namely on consumption decisions).

This may sound familiar, because it’s a description of the Rahn Curve, which is sort of the spending version of the Laffer Curve. This video explains.

The key lesson in the video is that government is far too big in the United States and other industrialized nations, which is precisely what the scholars found in the European Central Bank study.

Another interesting finding in the study is that the quality and structure of government matters.

Growth in government size has negative effects on economic growth, but the negative effects are three times as great in non-democratic systems as in democratic systems. …the negative effect of government size on GDP per capita is stronger at lower levels of institutional quality, and ii) the positive effect of institutional quality on GDP per capita is stronger at smaller levels of government size.

The simple way of thinking about these results is that government spending doesn’t do as much damage in a nation such as Sweden as it does in a failed state such as Mexico.

Last but not least, the ECB study analyzes various budget process reforms. There’s a bit of jargon in this excerpt, but it basically shows that spending limits (presumably policies similar to Senator Corker’s CAP Act or Congressman Brady’s MAP Act) are far better than balanced budget rules.

…we use three indices constructed by the European Commission (overall rule index, expenditure rule index, and budget balance and debt rule index). …The former incorporates each index individually whereas the latter includes interacted terms between fiscal rules and government size proxies. Particularly under the total government expenditure and government spending specifications…we find statistically significant positive coefficients on the overall rule index and the expenditure rule index, meaning that having these fiscal numerical rules improves GDP growth for these set of EU countries.

This research is important because it shows that rules focusing on deficits and debt (such as requirements to balance the budget) are not as effective because politicians can use them as an excuse to raise taxes.

At the risk of citing myself again, the number one message from this new ECB research is that lawmakers - at the very least - need to follow Mitchell’s Golden Rule and make sure government spending grows slower than the private sector. Fortunately, that can happen, as shown in this video.

But my Golden Rule is just a minimum requirement. If politicians really want to do the right thing, they should copy the Baltic nations and implement genuine spending cuts rather than just reductions in the rate of growth in the burden of government.

Is the Problem in Italy and Greece a Lack of Demand?

Earlier this week Dean Baker took a shot at Robert Samuelson for claiming that the problems in Europe were because of the “runaway welfare” state. While I consider Baker to generally be quite thoughtful, I am not sure that comparing interest rates with levels of government spending really disproves Samuelson’s point. There is a lot that goes into differences in borrowing costs, especially across governments.  Setting aside the fact that banking and financial regulations distort the government debt markets, we should also see differences due to “willingness to pay” and not just “ability to pay.” All else equal in terms of budgets, I’d still charge more to lend to Greece than Sweden.

Baker attributes the real problems in Europe to “too little demand.”  Now I don’t know what the correct level of demand in any country is supposed to be, but for the level of problems we are witnessing in southern Europe, I’d suspect you’d need a pretty big hole in demand. If one buys into a standard Keynesian income-expenditure model of the economy, then a reasonable place to start looking would be final private consumption expenditures.

The chart below shows final private consumption expenditures for Greece (dotted line = right axis) and Italy (solid line = left axis).  Yes, both had a pretty big drop at the end of 2008, but Italy seems to have been recovering steadily.  In fact, consumption today in Italy appears about 3% higher than at the previous peak.  Greece has not done so well, with consumption almost 5% below peak, but its still above the levels seen in 2007.  Neither of these charts has been adjusted for inflation or population, but if demand is unusually “weak” then we’d be seeing deflation, so if anything these numbers likely understate actual trends in consumption.

I’m not going to pretend that I’m an expert on either the Italian or Greek economy, or that this chart proves anything. It does, however, suggest to me that the problems in Greece and Italy are unlikely due to some sort of Keynesian liquidity trap where people just aren’t spending.

 

This Week in Government Failure

Over at Downsizing the Federal Government, we focused on the following issues this past week:

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U.S. Export Growth on Track, Thanks to China

The biz media are predictably hailing the small decline in the U.S. trade deficit in October as good news for the economy, but this morning’s monthly trade report from the U.S. Commerce Department is yet one more sign that the U.S. and global economies are struggling.

The media invariably focus on the difference between imports and exports, when the real measure of trade should be the sum of the two—whether total trade is growing or slowing. In October, the trade deficit declined from September only because U.S. imports of goods and services declined even more steeply than exports. How this is good news for the American economy is beyond me.

As I documented in a study earlier this year, imports and the trade deficit typically decline when the U.S. economy is on the ropes. That’s because a drop-off in domestic demand by consumers and businesses typically translates into a drop-off in demand for imported goods and services as well as those produced domestically. Far from boosting the economy, falling imports are one of the surest signs that the economy is down shifting.

U.S. exports also declined in October, in part because of slowing demand abroad. U.S. exports are still on track to double between 2009 and 2014, a goal of President Obama’s National Export Initiative, but the rate of growth year-over-year continues to slow.

China remains a bright spot in U.S. trade, despite the complaints of politicians in Washington. U.S. exports to China continue to grow more rapidly than exports to the rest of the world. Since China joined the World Trade Organization 10 years ago this month, U.S. exports of goods to China have grown five-fold, while they have not quite doubled to the rest of the world.

China is the only major market where U.S. exports have consistently grown above the 15 percent annual rate needed to double every five years. The compound growth rate of U.S. goods exports to China since its entry into the WTO has been 18.1 percent, compared to 6.8 percent to the rest of the world. China is now the third largest foreign market for U.S. goods. Yet a large contingent in Congress wants to slap tariffs on Chinese imports because of its currency practices that supposedly hinder U.S. exports.

In the business world, picking a needless trade fight with one of your best customers would be the height of folly. For many members of Congress, it has become an urgent item on their legislative agenda.

USPS Sends a Message to Congress

On Monday, the U.S. Postal Service filed its proposal to reduce service standards with the Postal Regulatory Commission (PRC). The USPS is seeking to cut costs by closing about half of its mail processing facilities, which would mean slower mail delivery. Given that the USPS is running on financial fumes and Congress is still trying to figure out how to kick the can down the road, management apparently decided that it had to act.

Sen. Tom Carper (D-DE), the chairman of the Senate subcommittee that oversees the USPS, acknowledges this in his statement on the proposal:

Although we’ve made some progress in moving postal reform bills forward in the House and Senate, we still have a lot of work that needs to be done in order to find a comprehensive solution to the Postal Service’s serious financial problems. In the absence of assistance from Congress and the Administration, the Postal Service has been forced to take matters into their own hands and try to modernize their business model with the limited tools and resources available to them. This situation is less than ideal. The few measures that the Postal Service can adopt on its own—such as closing distribution centers and slowing down first-class mail delivery times—to extend its survival and avoid insolvency will also potentially further erode its declining business.

Carper concluded his statement by making a pitch for bipartisan postal reform legislation that I recently panned.

The biggest obstacle standing in the way of the proposal is, of course, Congress. I would venture a guess that legislation will be introduced to stymie the plan—if it hasn’t already. After all, members of Congress have consistently fought USPS efforts to shutter post offices. Naturally, the postal employees unions aren’t happy and will make sure that policymakers know it.

Anticipating the pushback from policymakers and special interests, postal management sent a not-so-subtle message at the conclusion of the filing (bolded text is my emphasis):

The statutory scheme governing operation of the Postal Service permits the agency to make rational adaptations to market and fiscal realities, while still fulfilling its public service obligations. That scheme does not require that long-standing products, service features, and operational practices be maintained primarily for the purpose of preserving a tangible link to an iconic past, or to perpetuate a nostalgic image of the agency or its employees. It would be troubling for the future of the Postal Service if stakeholders responsible for its stewardship allowed their vision to be so clouded that, through omission or commission, they undermined or prevented significant adaptations that could help to preserve the long-term viability and relevance of the postal system. The needs of postal customers are changing. The circumstances affecting the Postal Service are dire. If the Postal Service is to remain viable and relevant, it must be permitted to implement operational and service changes consonant with such changing needs and dire circumstances.

I couldn’t have said it better myself—although I believe that privatization is the best way to “preserve the long-term viability and relevance of the postal system.”

Teddy Roosevelt Is No Model for a President

Cato senior fellow Jim Powell, author of Bully Boy: The Truth about Theodore Roosevelt’s Legacy, writes at Forbes.com today that TR is a bad model for President Obama:

Theodore Roosevelt was the man who, in 1906, encouraged progressives to promote a federal income tax after it was struck down by the Supreme Court and given up for dead.  He declared that “too much cannot be said against the men of great wealth.”  He vowed to “punish certain malefactors of great wealth.”

Perhaps TR’s view was rooted in an earlier era when the greatest fortunes were made by providing luxuries for kings, like fine furniture, tapestries, porcelains and works of silver, gold and jewels.  Since the rise of industrial capitalism, however, the greatest fortunes generally have been made by serving millions of ordinary people.  One thinks of the Wrigley chewing gum fortune, the Heinz pickle fortune, the Havemeyer sugar fortune, the Shields shaving cream fortune, the Colgate toothpaste fortune, the Ford automobile fortune and, more recently, the Jobs Apple fortune.  TR inherited money from his family’s glass-importing and banking businesses, and maybe his hostility to capitalist wealth was driven by guilt.

Like Obama, TR was a passionate believer in big government – actually the first president to promote it since the Civil War.  He said, “I believe in power…I did greatly broaden the use of executive power…The biggest matters I managed without consultation with anyone, for when a matter is of capital importance, it is well to have it handled by one man only …I don’t think that any harm comes from the concentration of power in one man’s hands.”

Also like Obama, TR was almost entirely focused on politics – personalities, speeches, publicity and so on.  He seemed to be concerned about an economic issue only when it became a big problem, particularly if it was big enough to affect the next election.  There wasn’t much evidence of long-term thinking beyond the next election.  Certainly there was no evident awareness of unintended consequences.

Much more here.

Why Are American Tax Dollars Subsidizing a Paris-Based Bureaucracy so It Can Help the AFL-CIO Push Obama’s Class-Warfare Agenda?

To be blunt, I’m not a big fan of the Organization for Economic Cooperation and Development. But my animosity isn’t because OECD bureaucrats threatened to have me arrested and thrown in a Mexican jail.

Instead, I don’t like the Paris-based bureaucracy because it pushes a statist agenda of bigger government. This Center for Freedom and Prosperity study has all the gory details, revealing that OECD bureaucrats endorsed Obamacare, supported the failed stimulus, and are big advocates of a value-added tax for America.

And I am very upset that the OECD gets a giant $100 million-plus subsidy every year from American taxpayers. For all intents and purposes, we’re paying for a bunch of left-wing bureaucrats so they can recommend that the United States adopt that policies that have caused so much misery in Europe. And to add insult to injury, these socialist pencil pushers receive tax-free salaries.

And now, just when you thought things couldn’t get worse, the OECD has opened a new front in its battle against free markets. The bureaucrats from Paris have climbed into bed with the hard left at the AFL-CIO and are pushing a class-warfare agenda. Next Wednesday, the two organizations will be at the union’s headquarters for a panel on “Divided We Stand - Tackling Growing Inequality Now.”

Co-sponsoring a panel at the AFL-CIO’s offices, it should be noted, doesn’t necessarily make an organization guilty of left-wing activism and misuse of American tax dollars. But when you look at other information on the OECD’s website, it quickly becomes apparent that the Paris-based bureaucracy has launched a new project to promote class-warfare.

For instance, the OECD’s corruption-tainted Secretary-General spoke at the release of a new report on inequality and was favorable not only to higher income tax rates, but also expressed support for punitive and destructive wealth taxes.

Over the last two decades, there was a move away from highly progressive income tax rates and net wealth taxes in many countries. As top earners now have a greater capacity to pay taxes than before, some governments are re-examining their tax systems to ensure that wealthier individuals contribute their fair share of the tax burden. This aim can be achieved in several different ways. They include not only the possibility of raising marginal tax rates on the rich but also…reassessing the role of taxes on all forms of property and wealth.

And here’s some of what the OECD stated in its press release on income differences.

The OECD underlines the need for governments to review their tax systems to ensure that wealthier individuals contribute their fair share of the tax burden. This can be achieved by raising marginal tax rates on the rich.

Like Obama, the folks at the OECD like to talk about “fair share.” These passages sounds like they could have been taken from one of Obama’s hate-and-envy speeches on class warfare.

But the fact that a bunch of Europeans support Obama’s efforts to Europeanize America is not a surprise. The point of this post is that the OECD shouldn’t be using American tax dollars to promote Obama’s class-warfare agenda.

Here’s a video showing some of the other assaults against free markets by the OECD. This is why I’ve written that the $100 million-plus that American taxpayers send to Paris may be - on a per dollar basis - the most destructively wasteful part of the entire federal budget.

One last point is that the video was produced more than one year ago, which was not only before this new class-warfare campaign, but also before the OECD began promoting a global tax organization designed to undermine national sovereignty and promote higher taxes and bigger government.

In other words, the OECD is far more destructive and pernicious than you think.

And remember, all this is happening thanks to your tax dollars being sent to Paris to subsidize these anti-capitalism statists.