Topic: International Economics and Development

Once Again, Pope Francis

This is not the first time I’ve commented on the socioeconomic ideas of the current Pontiff of the Catholic Church. However, Time’s newly named Person of the Year Pope Francis unfortunately insists once again on statist ideas that go against an open society based on free markets.

No doubt this has a clear moral dimension given that the tradition of classical liberalism (and its modern advocacy) is based on mutual respect and the allocation of property rights as moral support of its philosophical, legal and economic proposals. Hence Adam Smith’s first book in 1759 was titled The Theory of Moral Sentiments – a concern held by the leading exponents of that noble tradition.

I do not want to repeat here arguments that I’ve already stated in my previous pieces. Rather, I will restrict my comments to the most salient socioeconomic aspects of the Pope’s new document.

Progress on the Laffer Curve*

The title of this piece has an asterisk because, unfortunately, we’re not talking about progress on the Laffer Curve in the United States.

Instead, we’re discussing today how lawmakers in other nations are beginning to recognize that it’s absurdly inaccurate to predict the revenue impact of changes in tax rates without also trying to measure what happens to taxable income (if you want a short tutorial on the Laffer Curve, click here).

But I’m a firm believer that policies in other nations (for better or worse) are a very persuasive form of real-world evidence. Simply stated, if you’re trying to convince a politician that a certain policy is worth pursuing, you’ll have a much greater chance of success if you can point to tangible examples of how it has been successful.

That’s why I cite Hong Kong and Singapore as examples of why free markets and small government are the best recipe for prosperity. It’s also why I use nations such as New Zealand, Canada, and Estonia when arguing for a lower burden of government spending.

And it’s why I’m quite encouraged that even the squishy Tory-Liberal coalition government in the United Kingdom has begun to acknowledge that the Laffer Curve should be part of the analysis when making major changes in taxation.

UK Laffer CurveI don’t know whether that’s because they learned a lesson from the disastrous failure of Gordon Brown’s class-warfare tax hike, or whether they feel they should do something good to compensate for bad tax policies they’re pursuing in other areas, but I’m not going to quibble when politicians finally begin to move in the right direction.

 

The Wall Street Journal opines that this is a very worthwhile development.

Chancellor of the Exchequer George Osborne has cut Britain’s corporate tax rate to 22% from 28% since taking office in 2010, with a further cut to 20% due in 2015. On paper, these tax cuts were predicted to “cost” Her Majesty’s Treasury some £7.8 billion a year when fully phased in. But Mr. Osborne asked his department to figure out how much additional revenue would be generated by the higher investment, wages and productivity made possible by leaving that money in private hands.

By the way, I can’t resist a bit of nit-picking at this point. The increases in investment, wages, and productivity all occur because the marginal corporate tax rate is reduced, not because more money is in private hands.

I’m all in favor of leaving more money in private hands, but you get more growth when you change relative prices to make productive behavior more rewarding. And this happens when you reduce the tax code’s penalty on work compared to leisure and when you lower the tax on saving and investment compared to consumption.

Another Misguided Plan to Burden America with a Value-Added Tax

It’s no secret that I dislike the value-added tax.

But this isn’t because of its design. The VAT, after all, would be (presumably) a single-rate, consumption-based system, just like the flat tax and national sales tax. And that’s a much less destructive way of raising revenue compared to America’s corrupt and punitive internal revenue code.

But not all roads lead to Rome. Proponents of the flat tax and sales tax want to replace the income tax. That would be a very positive step.

Advocates of the VAT, by contrast, want to keep the income tax and give politicians another big source of revenue. That’s a catastrophically bad idea.

To understand what I mean, let’s look at a Bloomberg column by Al Hunt. He starts with a look at the political appetite for reform.

There is broad consensus that the U.S. tax system is inefficient, inequitable and hopelessly complex. …a 1986-style tax reform – broadening the base and lowering the rates – isn’t politically achievable today. …the conservative dream of starving government by slashing taxes and the liberal idea of paying for new initiatives by closing loopholes for the rich are nonstarters.

I agree with everything in those excerpts.

So does this mean Al Hunt and I are on the same wavelength?

Not exactly. I think we have to wait until 2017 to have any hope of tax reform (even then, only if we’re very lucky), whereas Hunt thinks the current logjam can be broken by adopting a VAT and modifying the income tax. More specifically, he’s talking about a proposal from a Columbia University Law Professor that would impose a 12.9 percent VAT while simultaneously creating a much bigger family allowance (sometimes referred to as the zero-bracket amount) so that millions of additional Americans no longer have to pay income tax.

Liberalish Rather than Liberal: A Kuwaiti Grades the Gulf Kingdom

Kuwait City, Kuwait—“I read your blog post,” Dr. Anood Al-Sharikh told me when we met. “Kuwait isn’t really liberal, but more liberalish, don’t you think?”

She’s right, though in the Middle East even liberalish is a major advance over ugly authoritarian systems like the Saudi theocracy. Kuwait hosts many traditionalists and Islamists who live conservatively, but there is space for most everyone. Many women, like Al-Sharikh hold professional jobs, travel the world, and dress fashionably.

Moreover, politics is freer than elsewhere in the Gulf. Kuwait is ruled by an emir who appoints government ministers, but an elected National Assembly can challenge government ministers and force a cabinet’s resignation. On Tuesday I sat through some the “grilling” of the health minister, a liberal royal who I met last year when he was working in the prime minister’s office. Animated legislators vigorously challenged his performance as well as the arguments of their colleagues while pushing a no confidence motion.

Still, the government clearly has the upper hand, aided by problems elsewhere in the Gulf. A year ago, Kuwait was host to multiple demonstrations by an angry opposition which ranged from secular liberal to Islamist. Today “things have calmed down,” noted Waleed Moubarak of Alghanim Industries. That’s positive, in his view, since you “can only sustain so much political drama.”

But more happened than people being worn out. The authorities “sucked the wind out of” the opposition movement, noted Al-Sharikh. The “government struck back effectively” in a notably illiberal fashion, jailing some people and using its various forms of influence. It even pressed Islamist clerics to issue fatwas against the opposition. Moreover, she asked, “how can anyone in Kuwait be against the government,” which offers jobs, provides homes, pays for education, and more.

Internal contradictions hobbled the opposition: by allying with Islamists, the liberals were effectively promoting a political agenda that included imposing dress codes, closing churches, executing blasphemers, and enshrining sharia as the fount of law. Equally important, the collapse of the Arab Spring had a sobering effect. A bank analyst told me “the public was fed up, it saw chaos in Egypt, violence in Syria, and said that is not for us. People decided there was more to lose than to gain if they went down that particular route.”

In fact, Kuwait well demonstrates the tensions between a democratic polity and liberal society. Thus the “liberalish” country’s fascinating paradox: today, at least, Kuwait’s hereditary emir might be more likely than an elected parliament to encourage development of a free society.

Iran: From Hyperinflation to Stability?

With the announcement on Saturday night that Iran and the P5+1 group reached a tentative deal over the Iranian nuclear program, the Iranian rial appreciated 3.45% against the dollar on the black market. The rial jumped from 30000 IRR/USD on Saturday November 23rd to 29000 IRR/USD on Sunday November 24th. A daily appreciation of this magnitude is rare. In fact, it has occurred fewer than ten times since the beginning of 2013. Indeed, this indicates that the diplomatic breakthrough is having a positive effect on Iranian expectations.

Over a year ago, I uncovered the fact that Iran experienced a period of hyperinflation (in early October 2012), when its monthly inflation rate peaked at 62%. Since then, I have been actively monitoring and reporting on the IRR/USD black market exchange rates and calculating implied inflation rates for the country.

Since Hassan Rouhani took office, on August 3rd, Iranian expectations about the economy have turned less negative. Thus far, it appears Rouhani has been successful in ending the long period of economic volatility that has plagued Iran, since the US imposed sanctions in 2010. This has been reflected in the black-market IRR/USD exchange rate, which

There are three main factors at work here. The first is a concerted effort by the Rouhani administration and the central bank to curb Iran’s inflation. This stands in stark contrast to the previous regime, whose strategy was to simply deny that inflation was a problem.

The second is that that Iran’s economy has proved remarkably “elastic” – meaning that the country has ultimately adapted to the sanctions regime and has found ways to keep its economy afloat in spite of them.

The third factor in the rial’s recent stability is an improvement in Iranian economic expectations. This is where the P5+1 talks come into play. Iranians recognized that easing of the sanctions regime would be a bargaining chip in any nuclear negotiations. In consequence, their economic expectations improved as the talks progressed. Indeed, Saturday’s announcement gave these expectations a shot in the arm.

In light of the rial’s recent stability, I have delisted the rial from my list of “Troubled Currencies,” as tracked by the Troubled Currencies Project. For starters, the rial no longer appears to be in trouble. And, on a technical note, implied inflation calculations are less reliable during sustained periods of exchange rate stability.

That said, we must continue to pay the most careful and anxious attention to the black-market IRR/USD exchange rate in the coming months. Like the P5+1 agreement, Rouhani’s economic progress in Iran is tentative and likely quite fragile. Since the black-market IRR/USD is one of the only objective prices in the Iranian economy – and perhaps the most important one of all – it will continue to serve as an important weather vane, as the diplomatic process continues, and as Iran’s economy gradually moves into a post-sanctions era. 

The Aftermath of Chile’s Election

Chile went to the polls yesterday in what was perhaps the most important presidential election since the return of democracy in 1990. Many foreign observers focused on the curiosity that the two leading candidates were both daughters of Air Force generals who chose opposing sides during the military coup that toppled socialist president Salvador Allende in 1973. But what is at stake in this election wasn’t Chile’s past, but its future.

Let’s first recapitulate where Chile stands today: Thanks to the free market reforms implemented since 1975 by the military government of Augusto Pinochet – that were subsequently deepened by the democratic center-left governments that ruled the country since 1990 – Chile can boast the following accomplishments:

  • It’s the freest economy in Latin America and it stands 11th in the world (ahead of the United States) in the Economic Freedom of the World report.
  • It has more than tripled its income per capita since 1990 to $19,100 (PPP), which is the highest in Latin America.
  • According to the IMF, by 2017 Chile will reach an income per capita of $23,800, which is the official threshold to become a developed country.
  • According to the UN Economic Commission on Latin America and the Caribbean (ECLAC), Chile has the most impressive poverty reduction record in Latin America in the last two decades. The poverty rate went down from 45% in the mid-1980s to 11% in 2011, the lowest in the region.
  • It has the strongest democratic institutions of Latin America according to the Rule of Law Index of the World Justice Project.
  • It’s the least corrupt country in Latin America according to Transparency International.
  • Along with Costa Rica and Uruguay, it has the best record in Latin America on political rights and civil liberties, according to Freedom House.
  • High income inequality, which has always been a sore in the eyes of many, has decreased in the last decade.

With such an impressive record, it’s quite puzzling that the leading candidate, former president Michelle Bachelet, is running again under a platform calling for changes that would significantly alter the Chilean model by increasing the role of the government in the economy. In particular, Bachelet is proposing free higher education to everyone, the abolition of for-profit private schools and universities, the introduction of a state-owned pension fund in the country’s private pension system, higher taxes on businesses and professionals, and even a new constitution.

Bans on Child Labor

Only a heartless libertarian could possibly object to bans on child labor, right? After all, no one wants to live in some Dickensian dystopia in which children toil endlessly under brutal conditions.

Unless, of course, bans harm, rather than help, both children and their families. And in a new working paper, economists Prashant Bharadwaj (UCSD), Leah Lakdawala (Michigan State), and Nicholas Li (Toronto), find just that.  They

… examine the consequences of India’s landmark legislation against child labor, the Child Labor (Prohibition and Regulation) Act of 1986. … [and] show that child wages decrease and child labor increases after the ban. These results are consistent with a theoretical model … in which families use child labor to reach subsistence constraints and where child wages decrease in response to bans, leading poor families to utilize more child labor. The increase in child labor comes at the expense of reduced school enrollment.

And it gets worse.  The authors

… also examine the effects of the ban at the household level. Using linked consumption and expenditure data, [they] find that along various margins of household expenditure, consumption, calorie intake and asset holdings, households are worse off after the ban.

Good intentions are just that; intentions, not results.  The law of unintended consequences should never be ignored.