Tag: world bank

Doing Business Under Attack

The Doing Business project is among the World Bank’s most useful activities – both for scholars and, more importantly, for policymakers who are interested in pursuing pro-market reforms. It is disheartening to see that the review of the project, initiated last year by the Bank’s President Jim Yong Kim, has been hijacked by groups like Oxfam, Christian Aid or CAFOD, which are trying to erode the project’s analytical sharpness and destroy its role as a focal point for economic reformers in low- and mid-income countries. Perhaps they would like to see it scrapped altogether.

Marian Tupy and I are discussing the controversy, and offering arguments in favor of the Doing Business project in our article at Foreign Policy. Bottom line:

It is true that Doing Business is not an ideal metric of business environment: Nothing is. Yet over the past decade the survey has proven an extremely useful tool both for scholars and businesspeople who want to compare the ease of actually conducting business in different countries, and for policymakers trying to foster the development of the private sector. Unless someone comes up with a better alternative, discarding or watering down this metric is likely to lead to less well-informed choices about policy.

We may disagree about the relative importance of a good business environment for poor countries. Yet few would suggest that it should be simply ignored. It’s difficult to avoid the impression that Doing Business is currently coming under attack by groups with ulterior motives, groups who are inimical to a pro-market and pro-growth policy agenda. Given the extraordinary economic and human progress achieved in the last few decades through deliberate improvements to business environment, one hopes that the Doing Business project remains central to the World Bank’s portfolio of activities.

In World Bank’s New Tax Report Card, ‘High Effort’ Is a Very Bad Thing

Remember when you were a kid and your parents would either be happy or angry depending on whether your report card said you were trying hard or being a slacker? No matter whether your grades were good or bad, it helped to get an “A for Effort.”

But sometimes a high level of effort isn’t a good thing.

The World Bank has a new study that measures national tax burdens. But instead of using conventional measures, such as top tax rates or tax collections as a share of GDP, the international bureaucracy has developed an index that measures “tax effort” and “tax capacity” after adjusting for variables such as per-capita GDP, corruption, and demographics.

One goal of the study is to develop an apples-to-apples way of comparing tax burdens for nations at various levels of development. Poor nations, for instance, tend to have low levels of tax revenue even though they often have high tax rates. This is partly because of Laffer Curve reasons, but perhaps even more so because of corruption and incompetence. Rich nations, by contrast, usually have much greater ability to enforce their tax codes. So if you want to compare the tax system of Paraguay with the tax system of Sweden, you need to take these factors into account.

Here’s a description of how the authors addressed this issue.

Measuring taxation performance of countries is both theoretically and practically challenging. …tax economists have attempted to deal with this problem by applying an empirical approach to estimate the determinants of tax collection and identify the impact of such variables on each country’s taxable capacity. The development of a tax effort index, relating the actual tax revenues of a country to its estimated taxable capacity, provides us with a tempting measure which considers country specific fiscal, demographic, and institutional characteristics. …Tax effort is defined as an index of the ratio between the share of the actual tax collection in GDP and the taxable capacity.

This is a worthwhile project. There sometimes are big differences between nations and those should be part of the equation when comparing tax policies. Indeed, this is why my recent post on the rising burden of the value-added tax looked at data for nations at different levels of development.

But I’m irked by the World Bank study because it’s really measuring “tax onerousness.” I’m not even sure onerousness is a word, but I sure don’t like the term “tax effort” because it implies that a higher tax burden is a good thing. After all, we learned from our report cards that it’s good to demonstrate high effort and not be a slacker.

And just so you know I’m not just imagining things, the authors explicitly embrace the notion that bigger tax burdens are desirable. They assert (without any evidence, of course) that higher levels of tax promote “development” and that more money for politicians is “desirable.”

The international development community is increasingly recognizing the centrality of effective taxation to development. …higher tax revenues are important to lower the aid dependency in low-income countries. They also encourage good governance, strengthen state building and promote government accountability. …many developing countries experience a chronic gap between the actual and desirable levels of tax revenues. Taxation reforms are needed to close this gap.

If the authors of the study looked at economic history, they would understand that they have things backwards. “Effective taxation” doesn’t lead to “development.” It’s the other way around. The western world became rich when the burden of government was very small and most nations didn’t even have income tax regimes. It was only after nations because prosperous that politicians figured out how to extract significant shares of economic output.

But let’s set that aside and see which nations have the most and least onerous tax systems. Here’s a table from the report and it seems that Papua New Guinea has the world’s worst tax system and Bahrain has the best tax system. Among developed nations, New Zealand is the worst and Japan is the best. The United States (circled in red) gets a decent score. We’re not nearly as good as Switzerland and we’re slightly worse than Canada, but our politicians expend less “effort” than their counterparts in nations such as France, Italy, and Belgium.

By the way, I’m not endorsing either the methodology or the results. I like what the authors are trying to do (at least in terms of creating an apples-to-apples measure), but some of the results seem at odds with reality. New Zealand’s tax system isn’t great, but it certainly doesn’t seem as bad as the French tax code. And I have a hard time believing that Japan’s tax code is less onerous than the Swiss system.

The World Bank study also breaks down the data so that countries can be put into a matrix based on how much money they collect and how much “effort” they expend.

Here’s where the authors let their bias show. In their descriptions of the various boxes, they reflexively assume that higher tax collections are a good thing. Here is some of what they wrote in that section of the study.

The collection of taxes in this group of countries is currently low and lies below their respective taxable capacity. These countries have potential to succeed in deepening comprehensive tax policy and administration reforms focusing on revenue enhancement. …Botswana and Chile were originally in the low-effort, low-collection group, but they made it to the high-effort, high-collection group after recent improvements in revenue performance. …Although countries in this [high collection, low effort] group have already achieved a high tax collection, fiscally they still have the potential to implement reforms to reduce distortions and reach a higher level of efficiency of tax collection, since their tax effort index is low.

Very Orwellian, wouldn’t you say? We’re supposed to conclude that it’s bad if nations are “below their respective taxable capacity” because they can “succeed in deepening comprehensive tax policy” for purposes of “revenue enhancement.” Other nations, though, got gold stars because of “improvements in revenue performance.” And others were encouraged to try harder, even if they already collected a lot of revenue, in order to “reach of a higher level of efficiency of tax collection.”

But, to be fair, the study does include some semi-sensible comments acknowledging that there are limits to the greed of the political class. For all intents and purposes, the authors warn that there will be Laffer Curve effects if “high effort” nations seek to make their tax systems even more onerous.

Given that the level of tax intake in this group of countries is already high and stays above their respective taxable capacity, a further increase in tax revenue collection may lead to unintended economic distortions. …low-income countries with a low level of tax collection but high tax effort have less opportunity to increase tax revenues without possibly creating distortions or high compliance costs.

Just in case you’re not familiar with the lingo, “distortion” refers to the economic damage caused by high tax rates. This can be because high tax rates lead to a reduction in work, saving, investment, entrepreneurship, and other productive behaviors. Or it can be because high tax rates encourage people to make economically inefficient choices solely for tax planning purposes.

So the fact that the World Bank recognizes that taxes can hurt economic performance in at least some circumstances puts them ahead of the Congressional Budget Office and Joint Committee on Taxation. That’s damning with faint praise, to be sure, but I wanted to close on an upbeat note.

P.S. If you peruse the matrix, you’ll notice that New Zealand is considered a developing country. I’m sure that will be the source of amusement to my friends in Australia.

Data in New World Bank Report Shows that Large Public Sectors Reduce Economic Growth

When Ronald Reagan said that big government undermined the economy, some people dismissed his comments because of his philosophical belief in liberty.

And when I discuss my work on the economic impact of government spending, I often get the same reaction.

This is why it’s important that a growing number of establishment outfits are slowly but surely coming around to the same point of view.

This is remarkable. It’s beginning to look like the entire world has figured out that there’s an inverse relationship between big government and economic performance.

That’s an exaggeration, of course. There are still holdouts pushing for more statism in Pyongyang, Paris, Havana, and parts of Washington, DC.

But maybe they’ll be convinced by new research from the World Bank, which just produced a major report on the outlook for Europe. In chapter 7, the authors explain some of the ways that big government can undermine prosperity.

There are good reasons to suspect that big government is bad for growth. Taxation is perhaps the most obvious (Bergh and Henrekson 2010). Governments have to tax the private sector in order to spend, but taxes distort the allocation of resources in the economy. Producers and consumers change their behavior to reduce their tax payments. Hence certain activities that would have taken place without taxes, do not. Workers may work fewer hours, moderate their career plans, or show less interest in acquiring new skills. Enterprises may scale down production, reduce investments, or turn down opportunities to innovate. …Over time, big governments can also create sclerotic bureaucracies that crowd out private sector employment and lead to a dependency on public transfers and public wages. The larger the group of people reliant on public wages or benefits, the stronger the political demand for public programs and the higher the excess burden of taxes. Slowing the economy, such a trend could increase the share of the population relying on government transfers, leading to a vicious cycle (Alesina and Wacziarg 1998). Large public administrations can also give rise to organized interest groups keener on exploiting their powers for their own benefit rather than facilitating a prosperous private sector (Olson 1982).

In other words, government spending undermines growth, and the damage is magnified by a poorly designed tax policies.

The authors then put forth a theoretical hypothesis.

…economic models argue that the excess burden of tax increases disproportionately with the tax rate—in fact, roughly proportional to its tax rate squared (Auerbach 1985). Likewise, the scope for self-interested bureaucracies becomes larger as the government channels more resources. At the same time, the core functions of government, such as enforcing property rights, rule of law and economic openness, can be accomplished by small governments. All this suggests that as government gets bigger, it becomes more likely that the negative impact of government might dominate its positive impact. Ultimately, this issue has to be settled empirically. So what do the data say?

These are important insights, showing that class-warfare tax increases are especially destructive and that government spending undermines growth unless the public sector is limited to core functions.

Then the authors report their results.

Figure 7.9 groups annual observations in four categories according to the share of government spending in GDP during that year. Both samples show a negative relationship between government size and growth, though the reduction in growth as government becomes bigger is far more pronounced in Europe, particularly when government size exceeds 40 percent of GDP. …we provide new econometric evidence on the impact of government size on growth using a panel of advanced and emerging economies since 1995. As estimates can be biased due to problems of omitted variables, endogeneity, or measurement errors, it is necessary to rely on a broad range of estimators. …They suggest that a 10 percentage point increase in initial government spending as a share of GDP in Europe is associated with a reduction in annual real per capita GDP growth of around 0.6–0.9 percentage points a year (table A7.2). The estimates are roughly in line with those from panel regressions on advanced economies in the EU15 and OECD countries for periods from 1960 or 1970 to 1995 or 2005 (Bergh and Henrekson 2010 and 2011).

These results aren’t good news for Europe, but they also are a warning sign for the United States. The burden of government spending has jumped by about 8-percentage points of GDP since Bill Clinton left office, so this could be the explanation for why growth in America is so sluggish.

Last but not least, they report that social welfare spending does the most damage.

Governments are big in Europe mainly due to high social transfers, and big governments are a drag on growth. The question is whether this is because of high social transfers? The answer seems to be that it is. The regression results for Europe, using the same approach as outlined earlier, show a consistently negative effect of social transfers on growth, even though the coefficients vary in size and significance (table A7.4). The result is confirmed through BACE regressions. High social transfers might well be the negative link from government size to growth in Europe.

The last point in this passage needs to be emphasized. It is redistribution spending that does the greatest damage. In other words, it’s almost as if Obama (and his counterparts in places such as France and Greece) are trying to do the greatest possible damage to the economy.

In reality, of course, these politicians are simply trying to buy votes. But they need to understand that this shallow behavior imposes very high costs in terms of foregone growth.

To elaborate, this video discusses the Rahn Curve, which augments the data in the World Bank study.

As I argue in the video, even though most of the research shows that economic growth is maximized when government spending is about 20 percent of GDP, I think the real answer is that prosperity is maximized when the public sector consumes less than 10 percent of GDP.

But since government in the United States is now consuming more than 40 percent of GDP (about as much as Spain!), the first priority is to figure out some way of moving back in the right direction by restraining government so it grows slower than the private sector.

Freedom vs. Entitlements

A new World Bank working paper by Jean-Pierre Chauffour (author of the Cato book, The Power of Freedom: Uniting Human Rights and Development) finds that freedom is the root cause of development. In contrast to economic, political and civil freedoms, Chauffour finds that “beyond core functions of government… the expansion of the state to provide for various entitlements, including so-called economic, social and cultural rights, may not make people richer in the long run and may even make them poorer.”

Should We Break Up the Banks?

When it comes to banking policy, there are few people I respect more than Jonathan Macey and Arnold Kling; so when these two, independently, argue that we should be breaking up the largest banks, it is idea that merits consideration.  Yet I still have my doubts.

First, lets start with what we are fairly certain of.  There is a large empirical literature that suggest most US mega-banks are beyond their efficient size.  There is a good survey of the literature by former Fed Economist Allen Berger .  So, at a minimum, the academic literature suggests the largest banks are beyond a size that is justified by the social benefits.

However, there is also a small literature that suggests more concentrated banking systems are more stable, and less prone to crisis.  Some of this literature has grown out of research efforts by the World Bank.  While this literature is largely cross-country comparisons, recalling our own banking history gives several examples - the savings & loan crisis, the mass of small banks failures in the 1920s and 1930s, and current day Georgia - where lots of small bank failures have been associated with significant economic damage.  So, at minimum, there is some question of whether breaking up the largest banks would give us a more stable, less crisis-prone system.  In fact, there is considerable evidence to suggest that breaking up the banks would make our financial system more fragile.

To some extent, the debate over breaking up the large banks is about reducing political power.  The argument is that, because of their vast resources, these large banks unduly influence and capture our political system.  Undoubtedly, I believe the largest banks have substantial influence over both our legislative and regulatory systems.  However, so do smaller banks.  From my seven years as staff on the Senate Banking Committee, I would definitely argue that the Independent Community Banks Association (ICBA), as a group, has far more pull than does say Bank of America, as a single company.  One need only witness the various exemptions for small banks in the Dodd bill, for instance from the consumer protection bureau, to illustrate the lobbying power of small bankers.  One could also argue that the economic history of progressive era legislation, like the Sherman Act, is one of smaller, organized interests winning against larger sized firms.  Despite its appeal, the assertion that bigger is always better in politics is just an assertion.  Yet this is at heart an empirical argument, and perhaps one that can be tested.  Until then, I still have my doubts.

On What Planet Is Lindsey Graham a Free-Trader?

I’ve just started reading a new article by economists at the World Bank and the Peterson Insititute. The gist of the paper is that greenhouse gas emission targets will have little effect on “carbon leakage”, the apparently-largely-theoretical phenomenon whereby carbon-intensive industries move to less regulated jurisdictions in response to stringent emissions regulations in their original home.  So we can strike that off our list of worries.

The authors do reach the conclusion, though, that output of energy-intensive products will decline in response to emissions caps and the political temptation for “carbon tariffs” will be strong (see here why that is a bad idea). Basing the carbon tariffs on the carbon content of imports–as opposed to, say, the carbon content of domestic production displaced– will lead to significant falls in developing country exports. Music to protectionists’ ears, perhaps, but not exactly a recipe for international cooperation or global prosperity.

I’m still digesting the substance of the paper, but I was struck by what I think is a pretty large oversight/mischaracterization in the second paragraph.  The authors refer to the “internationally-minded” Sen. John Kerry (true in the serves-on-the-foreign-relations-committee-and-speaks-French sense, I guess) and the “free-trade oriented” Senator Lindsey Graham (R, SC).

Huh? A cursory glance at Senator Graham’s record indicates that in no serious sense could he be deemed “free-trade oriented.” Senator Graham has voted to lower trade barriers less than half (43 percent) of the time and has taken only 20 percent of opportunities to cut subsidies. That puts him in the “interventionist/internationalist” camp. Maybe the authors didn’t know about the Center for Trade Policy Studies’ “Free Trade, Free Markets: Rating Congress” tool, but surely Senator Graham’s co-sponsorship of the notorious Schumer-Graham legislation, among other transgressions, should have tipped them off.

Rory Stewart on the Deep Confusion Underpinning Our Afghanistan Strategy

Rory Stewart has a terrific piece in the London Review of Books arguing that Beltway foreign-policy thinkers are “minimising differences between cultures, exaggerating our fears, aggrandising our ambitions, inflating a sense of moral obligations and power, and confusing our goals” when it comes to Afghanistan:

Policymakers perceive Afghanistan through the categories of counter-terrorism, counter-insurgency, state-building and economic development. These categories are so closely linked that you can put them in almost any sequence or combination. You need to defeat the Taliban to build a state and you need to build a state to defeat the Taliban. There cannot be security without development, or development without security. If you have the Taliban you have terrorists, if you don’t have development you have terrorists, and as Obama informed the New Yorker, ‘If you have ungoverned spaces, they become havens for terrorists.’

These connections are global: in Obama’s words, ‘our security and prosperity depend on the security and prosperity of others.’ Or, as a British foreign minister recently rephrased it, ‘our security depends on their development.’ Indeed, at times it seems that all these activities – building a state, defeating the Taliban, defeating al-Qaida and eliminating poverty – are the same activity. The new US army and marine corps counter-insurgency doctrine sounds like a World Bank policy document, replete with commitments to the rule of law, economic development, governance, state-building and human rights. In Obama’s words, ‘security and humanitarian concerns are all part of one project.’

This policy rests on misleading ideas about moral obligation, our capacity, the strength of our adversaries, the threat posed by Afghanistan, the relations between our different objectives, and the value of a state…

Stewart’s prognosis is at once dispiriting and fortifying.  On the one hand, “it is unlikely that we will be able to defeat the Taliban.”  More sharply, “30 years of investment might allow its army, police, civil service and economy to approach the levels of Pakistan.  But Osama bin Laden is in Pakistan, not Afghanistan.”  On the other, “the Taliban are very unlikely to take over Afghanistan as a whole.”  Why not?

It would require far fewer international troops and planes than we have today to make it very difficult for the Taliban to gather a conventional army as they did in 1996 and drive tanks and artillery up the main road to Kabul.

Even if – as seems most unlikely – the Taliban were to take the capital, it is not clear how much of a threat this would pose to US or European national security. Would they repeat their error of providing a safe haven to al-Qaida? And how safe would this safe haven be? They could give al-Qaida land for a camp but how would they defend it against predators or US special forces? And does al-Qaida still require large terrorist training camps to organise attacks? Could they not plan in Hamburg and train at flight schools in Florida; or meet in Bradford and build morale on an adventure training course in Wales?

So what on earth are we doing?  “No politician wants to be perceived to have underestimated, or failed to address, a terrorist threat; or to write off the ‘blood and treasure’ that we have sunk into Afghanistan; or to admit defeat. Americans are particularly unwilling to believe that problems are insoluble; Obama’s motto is not ‘no we can’t;’ soldiers are not trained to admit defeat or to say a mission is impossible.”