Topic: International Economics and Development

Doing Business: If It Ain’t Broke, Don’t Fix It

By
Dalibor Rohac and Marian L. Tupy

A few weeks ago, we published a piece that defended World Bank’s Doing Business project against its critics. At the time, we didn’t know much about the politics behind the attack on the project – namely that the initiative to review Doing Business had come from China, which ranks relatively low in the ranking.

Perhaps unwittingly, the Chinese government has been assisted in its effort to shut the project down by a spectrum of organizations skeptical of markets, including CAFOD, Christian Aid, Oxfam, or Save the Children. Most recently, Christina Chang, a lead economic analyst at CAFOD appears to react to our article on FP’s Democracy Lab:

By lamenting the “uniquely democratic” debate around Doing Business, its self-appointed supporters are doing it a disservice. An independent review and a public debate are exactly what is needed.

That is not exactly a charitable way of identifying our position. We say explicitly that the project can be improved and are perfectly willing to entertain some of the specific suggestions Ms. Chang makes in her article, including the idea that the costs of corruption to businesses should be explicitly captured by the project, that the measure of access to credit could be improved, and that infrastructure-related constraints to doing business (such as access to electricity) could improve the project’s accuracy.

What bothers us, however, is that the critics of the project are also trying to undermine the key elements of the survey – namely the measures of taxation and labor market regulation. A large body of evidence shows that corporate taxation and labor market regulation have real costs to businesses – a fact Ms. Chang downplays by saying that these do not come up frequently in enterprise surveys in the developing world. While surveys may serve as a useful complement to the analysis of objective data on institutions, it is not sensible to use them as a basis for discarding specific elements of the Doing Business report – especially if independent evidence indicates that these elements matter.

Also, the goal of measuring taxation and labor market regulation as a cost to business has little to do with advancing an agenda of radical tax cuts or deregulation - although we would argue that such agenda would yield significant welfare gains in many countries around the world - instead, it has to do with an understanding of the relevant policy trade-offs.

The most serious flaw of Ms. Chang’s article lies in a confusion between the problems afflicting crony capitalism in the West and the development of private markets in emerging economies around the world:

The 2008 financial crisis highlighted long-standing reasons why the world needs to take a fresh look at how it does business. Unemployment has reached painful levels in many countries around the world. Multinational corporations use offshore jurisdictions to avoid billions in tax. Rampant inequality has become a hot-button issue.

For all these reasons, World Bank President Jim Yong Kim is right to conclude that the bank’s flagship Doing Business report needs a fresh look.

Let’s ignore the claim that inequality is on the rise, which is not true globally, and focus on the fact that Ms. Chang argued that the economic problems of the developed West somehow justify rethinking a project that has mostly informed policymaking in low- and mid-income countries. That would make sense if the policy recommendations that can be supported by the Doing Business project were also connected with the factors that have been driving economic problems of the West, such as unemployment, or the financial crisis of 2008. Yet Ms. Chang offers us no evidence for such claim.

If anything, one can argue that the unemployment in Western countries is associated with heavy labor market regulation, that the existence of offshore jurisdictions helps curb confiscatory tax regimes in the West, and that the crisis 2008 was driven by government involvement in financial and housing markets, or perhaps by a failure of monetary policy. In other words, Ms. Chang is guilty exactly of what we identified as the main problem of the current discussions about the Doing Business project – namely that she picks up on a failure of a particular type of crony capitalism in the West and uses it – disingenuously, one is tempted to say – to attack free markets around the world.

Topics: 
International Economics and Development

The Misery Index: A Look Back at Bulgaria’s Elections

By
Steve H. Hanke

With Bulgaria’s May 12th election fast approaching, it is useful to reflect on past elections and the resulting economic performance of each elected government. To do this, I have developed a Misery Index inspired by the late Prof. Arthur Okun, a distinguished economist who served as an adviser to U.S. President Lyndon Johnson.

The Misery Index measures the level of “misery” in the economy. My modified Misery Index is equal to the inflation rate, plus the bank lending rate, plus the unemployment rate, minus the annual percent change in GDP.

An increase in the Misery Index indicates that things are getting worse: misery is increasing. A decrease in the Misery Index indicates that things are improving: misery is decreasing. The accompanying chart shows the evolution of Bulgaria’s Misery Index over time.  

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The Socialist Party government of Prime Minister Zhan Videnov created hyperinflation and a lot of misery. The Misery Index under the Videnov government’s watch peaked at 2138 in the first quarter of 1997. That number isn’t shown on the accompanying chart—if it was, the chart would take up an entire page of Trud.

So, the chart starts in the second quarter of 1997, with the Kostov government. Shortly after Kostov took power, Bulgaria installed a Currency Board System, based on a draft Currency Board Law, which I authored at the request of President Petar Stoyanov. The Currency Board brought an end to Bulgaria’s hyperinflation, which peaked with a monthly inflation rate of 242%, in February 1997.

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Topics: 
Cato Publications, Finance, Banking & Monetary Policy, Foreign Policy and National Security, International Economics and Development

Dollarize Argentina Now

By
Steve H. Hanke

Argentina is once again wrestling with its long-time enemy, inflation. Now, it appears history may soon repeat itself, as Argentina teeters on the verge of another currency crisis. As of Tuesday morning, the black-market exchange rate for Argentine pesos (ARS) to the U.S. dollar (USD) hit 9.87, meaning the peso’s value now sits 47.3% below the official exchange rate. This yields an implied annual inflation rate of 98.3%. For now, the effects of this elevated inflation rate are being subdued somewhat by Argentina’s massive price control regime. But these price controls are not sustainable in the long term. Indeed, the short-term “lying prices” only distort the economic reality, ultimately leading to scarcity. There is, however, a simple solution to Argentina’s monetary problems: dollarization. I have advocated dollarization in Argentina for over two decades, well before the blow up of their so-called “currency board.” To put the record straight, Argentina did not have a true currency board from 1991 to 2002. Rather, as I anticipated in 1991, the “convertibility system” acted more like a central bank than a currency board. This pegged exchange rate system was bound to fail—and fail, it did. The 2001-02 Argentine Crisis could have easily been avoided if the country had simply dollarized. Argentina had more than sufficient foreign assets to dollarize their economy even late into 2001. But the Argentine government, through a series of policy blunders, ended up “floating” the currency. Not surprisingly, Argentina is now back to where it was in the late 1980s. So, how can Argentina dollarize? In short, the Banco Central de la Republica Argentina (BCRA) would take all of the assets and liabilities on its balance sheet denominated in foreign currency and convert them to U.S. dollars. The Central Bank would then exchange these dollars for all the pesos in circulation (monetary base), at a fixed exchange rate. By my calculation, the BCRA would need at least $56.36 billion to dollarize at the official exchange rate (as of April 23, 2013).

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Topics: 
Finance, Banking & Monetary Policy, International Economics and Development

Regulator to the World? Not the SEC…

By
Louise C. Bennetts

I don’t often commend regulators, but for those interested in preserving national sovereignty, new SEC chairwomen, Mary Jo White, is off to a good start if yesterday’s New York Times’ editorial is anything to go by. The Times criticized White for approving new SEC derivatives regulations that defer oversight of foreign security-based swap transactions, including those relating to the foreign subsidiaries of U.S. banks, to foreign regulators. The Times also derided White for approving rules that were “weaker” than the similar rules released by the Commodity Futures Trading Association.

Like the CFTC, the Times’ editorial board has clearly not heard of the concept of international comity, which it seems to confuse with “weakness”. In particular, it is not clear why the Times believes that unelected U.S. regulators should have the right to be self-appointed derivatives tsars to the rest of the world. The Times also appears to have overlooked the recent letter, signed by the finance ministers of nine of the United States’ largest trading partners and addressed to their U.S. counterpart Jack Lew. The letter was a thinly-veiled attack on the CFTC’s so called “extra-territorial” application of its cross-border swap rules and noted that an approach “in which jurisdictions require that their own domestic regulatory rules be applied to their firms’ derivatives transactions taking place in broadly equivalent regulatory regimes abroad is not sustainable.”

Of course, the Times does raise one important point: that it is undesirable to have two agencies releasing different rules on what amounts to the same topic. But the arbitrary distinction in the oversight of security-based swaps (regulated by the SEC) and OTC derivatives (regulated by the CFTC) is just one of Dodd-Frank’s many design flaws. Moreover, the SEC is under no obligation, pursuant to Dodd-Frank or otherwise, to follow the CFTC’s approach just because the CFTC released its regulations first. Especially as those regulations have proven to be so contentious (and not just with U.S. banks who legitimately fear being shut of international derivatives markets, but, more importantly, the foreign regulators on whom the U.S. may have to rely in a crisis).

It has become an unwelcome trend for U.S. regulatory agencies to overreach their jurisdictional and geographical boundaries. This began with the IRS’ FATCA implementation and has continued in the financial regulatory space. That White does not wish to follow her CFTC counterpart, Gary Gensler, down the rabbit hole and alienate the U.S.’s trading partners and allies is commendable, even if the Times is disappointed.

Topics: 
Finance, Banking & Monetary Policy, International Economics and Development, Regulatory Studies

Huge Value-Added Tax Increases in Europe Show Why Washington Politicians Should Never Be Given a New Source of Tax Revenue

By
Daniel J. Mitchell

The most important, powerful, and relevant argument against the value-added tax in the short run is that we can balance the budget in just five years by capping spending so it grows at the rate of inflation, a very modest level of fiscal restraint.

The most important, powerful, and relevant argument against the value-added tax in the long run is that more than 100 percent of America’s long-term fiscal problem is too much spending.

So why even consider giving politicians a new source of revenue such as the VAT, particularly since this hidden form of national sales tax helped cause the European fiscal crisis by facilitating a bigger welfare state?*

And now Europeans are doubling down on that failed approach, thus confirming that politicians will rarely make necessary spending reforms if they think more revenue can be squeezed from taxpayers.

Here’s a chart taken from the recent European Commission report on taxation trends in the EU. As you can see, the average VAT rate in Europe has jumped by nearly 2 percentage points in just five years.

VAT EU Increase

As I explained last week, European politicians also have been increasing income tax rates, so taxpayers are getting punished when they earn their income and they’re getting punished when they spend their income.

Which helps to explain why much of Europe is suffering from economic stagnation. Given the perverse incentives created by redistributionist fiscal policy, it makes more sense to climb in the wagon of government dependency.

For more information, here’s my video that describes the VAT and explains why it’s a bad idea.

The Value Added Tax: A Hidden New Tax to Finance Much Bigger Government

*The same thing is now happening in Japan.

P.S. I don’t know if you’ll want to laugh or cry, but the tax-free bureaucrats at the Organization for Economic Cooperation and Development actually argue that the VAT is good for jobs and growth.

Topics: 
General, Government and Politics, International Economics and Development, Tax and Budget Policy

Where Are the European Spending Cuts?

By
Daniel J. Mitchell

Paul Krugman recently tried to declare victory for Keynesian economics over so-called austerity, but all he really accomplished was to show that tax-financed government spending is bad for prosperity.

More specifically, he presented a decent case against the European-IMF version of “austerity,” which has produced big tax increases.

But what happens if nations adopt the libertarian approach, which means “austerity” is imposed on the government, rather than on taxpayers?

In the past, Krugman has also tried to argue that European nations have erred by cutting spending, but this has led to some embarrassing mistakes.

Now we have some additional evidence about the absence of spending austerity in Europe. A leading public finance economist from Ireland, Constantin Gurdgiev, reviewed the IMF data and had a hard time finding any spending cuts:

…in celebration of that great [May 1] socialist holiday, “In Spain, Portugal, Greece, Italy and France tens of thousands of people took to the streets to demand jobs and an end to years of belt-tightening”. Except, no one really asked them what did the mean by ‘belt-tightening’. …let’s check out expenditure side of Europe’s ‘savage austerity’ story… The picture hardly shows much of any ‘savage cuts’ anywhere in sight.

As seen in his chart, Constantin compared government spending burdens in 2012 to the average for the pre-recession period, thus allowing an accurate assessment of what’s happened to the size of the public sector over a multi-year period.

Austerity in Europe

Here are some of his conclusions from reviewing the data:

Of the three countries that experienced reductions in Government spending as % of GDP compared to the pre-crisis period, Germany posted a decline of 1.26 percentage points (from 46.261% of GDP average for 2003-2007 period to 45.005% for 2012), Malta posted a reduction of just 0.349 ppt and Sweden posted a reduction of 1.37 ppt.

No peripheral country - where protests are the loudest - or France et al have posted a reduction. In France, Government spending rose 3.44 ppt on pre-crisis level as % of GDP, in Greece by 4.76 ppt, in Ireland by 7.74 ppt, in Italy by 2.773 ppt, in Portugal by 0.562 ppt, and in Spain by 8.0 ppt.

Average Government spending in the sample in the pre-crisis period run at 44.36% of GDP and in 2012 this number was 48.05% of GDP. In other words: it went up, not down.

…All in, there is no ‘savage austerity’ in spending levels or as % of GDP.

I’ll add a few additional observations.

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Topics: 
General, Government and Politics, International Economics and Development, Tax and Budget Policy

New European Data: When Tax Competition Is Weakened, Politicians Respond by Increasing Tax Rates

By
Daniel J. Mitchell

I often argue that we need to preserve tax competition and tax havens in order to limit the greed of the political class.

Without some sort of external constraint, they will over-tax and over-spend, creating the kind of downward economic spiral already happening in some European nations.

Speaking of which, new evidence from Europe bolsters my case.

Back in 2009, facing pressure from the big G-20 nations, all of the world’s major low-tax jurisdictions - even Switzerland - acquiesced to the notion that human rights laws protecting financial privacy no longer would apply to foreign investors.

In other words, high-tax governments now have much greater ability to track - and tax - flight capital.

So how have they responded since that time? Well, look at this chart from the European Union’s new report on taxation trends. Tax rates have begun to increase, reversing a very positive trend (which began with the Reagan and Thatcher tax cuts, though this chart only shows data since 1995).

Top EU Tax Rates

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Topics: 
Government and Politics, International Economics and Development, Tax and Budget Policy

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