Topic: International Economics and Development

A Bumpy — but Hopeful — Road Ahead for Ukraine

Even when one tries to ignore the current developments in the East of the country, Ukraine is in a pickle. With one of the lowest incomes per capita among the transitional economies of Eastern Europe, rampant corruption, and quickly depleting foreign reserves, the country is overdue for a reform package in many areas, including fiscal and monetary policy, the judiciary system, bankruptcy law, energy policy, state ownership, to name just a few.

While there is no shortage of foreign experts offering their views on what policies Ukraine needs or does not need, the future of Ukraine is for Ukrainians to decide. Still, the outside world can help. The Cato Institute, for example, is teaming up with the Atlas Network and the Kyiv-based European Business Association this week, hosting an emergency conference on Ukrainian economy.

Instead of policy wonks from Washington, the conference convenes a stellar group of policymakers from the region, who have direct experience with reforms enhancing economic freedom. The speakers include Einars Repse, the former Prime Minister of Latvia, Ivan Miklos, author of Slovakia’s flat tax revolution, Kakha Bendukidze, who as Minister of the Economy was the driving force behind economic reforms in Georgia, Sven Otto Littorin, the former Minister for Employment of Sweden, who assisted with the liberalization of the country’s labor markets, Jan Vincent-Rostowski, until recently the Minister of Finance of Poland, as well as Cato’s very own Andrei Illarionov.

The conference website is here, and you can follow my live twitter feed at this link. Notwithstanding the pessimism of the daily news coming from that part of the world, the recent events in Ukraine have given its people and its leaders a unique window of opportunity to make a departure from the country’s post-Soviet legacy and to put in place institutions that will lead to economic opportunity, freedom, and shared prosperity.

A Fiscal Lesson from Germany

Germany isn’t exactly a fiscal role model.

Tax rates are too onerous and government spending consumes about 44 percent of economic output.

That’s even higher than it is in the United States, where politicians at the federal, state, and local levels divert about 39 percent of GDP into the public sector.

Germany also has too much red tape and government intervention, which helps to explain why it lags other European nations such as Denmark and Estonia in the Economic Freedom of the World rankings.

But I have (sort of) defended Germany a couple of times, at least on fiscal policy, explaining that the Germans didn’t squander much money on Keynesian spending schemes during the downturn and also explaining that Paul Krugman was wrong in his column on Germany and austerity.

Today, though, I’m going to give Germany some unambiguous praise.

If you look at last decade’s fiscal data, you’ll see that our Teutonic friends actually followed my Golden Rule on fiscal policy for a four-year period.

Here’s a chart, based on IMF numbers, showing total government spending in Germany from 2003-2007. As you can see, German policy makers basically froze spending.

German Fiscal Restraint

I realize that I’m a libertarian and that I shouldn’t be happy unless the burden of spending is being dramatically reduced, but we’re talking about the performance of European politicians, so I’m grading on a curve.

By that standard, limiting spending so it grows by an average of 0.18 percent is rather impressive. Interestingly, this period of fiscal discipline began when the Social Democrats were in power.

And because the economy’s productive sector was growing at a faster rate during this time, a bit more than 2 percent annually, the relative burden of government spending did fall.

The red line in this next chart shows that the public sector, measured as a share of economic output, fell from almost 49 percent of GDP to less than 44 percent of GDP.

German Spending+Deficit as % of GDP

It’s also worth noting that this four-year period of spending restraint also led to a balanced budget, as shown by the blue line.

In other words, by addressing the underlying problem of too much government, the German government automatically dealt with the symptom of red ink.

That’s the good news.

The bad news is that the German government wasn’t willing to sustain this modest degree of fiscal discipline. The Christian Democrats, who took office in mid-2005, allowed faster spending growth beginning in 2008. As I noted above, the budget increases haven’t been huge, but there’s been enough additional spending that Germany no longer is complying with the Golden Rule and the burden of the public sector is stuck at about 44 percent of GDP.

The moral of the story is that Germany shows that good things happen when spending is restrained, but long-run good performance requires long-run spending discipline.

That’s why I’m a fan of Switzerland’s spending cap. It’s called the “debt brake,” but it basically requires politicians to limit spending so that the budget doesn’t grow much faster than inflation plus population.

And that’s why Switzerland has enjoyed more than a decade of good policy.

To see other examples of nations that have enjoyed fiscal success with period of spending restrain, watch this video.

The Canadian example is particularly impressive.

Will Venezuela Be Next?

Last year, Nicholas Krus and I published a chapter, “World Hyperinflations”, in the Routledge Handbook of Major Events in Economic History. We documented 56 hyperinflations – cases in which monthly inflation rates exceeded 50% per month. Only seven of those hyperinflations have savaged Latin America (see the accompanying table).

At present, the world’s highest inflation resides in Latin America, namely in Venezuela. The Johns Hopkins – Cato Institute Troubled Currencies Project, which I direct, estimates that Venezuela’s implied annual inflation rate is 302%. Will Venezuela be the eighth country to join the Latin American Hall of Shame? Maybe. But, it has a long way to go.

The Hanke-Krus Hyperinflation Table
Latin American edition

Country Month With Highest Inflation Rate Highest Monthly Inflation Rate Equivalent Daily Inflation Rate Time Required for Prices to Double
1. Peru Aug. 1990 397% 5.49% 13.1 days
2. Nicaragua Mar. 1991 261% 4.37% 16.4 days
3. Argentina Jul. 1989 197% 3.69% 19.4 days
4. Bolivia Feb. 1985 183% 3.53% 20.3 days
5. Peru Sep. 1988 114% 2.57% 27.7 days
6. Chile Oct. 1973 87.6% 2.12% 33.5 days
7. Brazil Mar. 1990 82.4% 2.02% 35.1 days

Source: Steve H. Hanke and Nicholas Krus (2013), “World Hyperinflations”, in Randall Parker and Robert Whaples (eds.) Routledge Handbook of Major Events in Economic History, London: Routledge Publishing.

Bulgaria’s Currency Board versus Ukraine’s Chaos

When Communism inevitably and finally collapsed, Bulgaria’s economy was a basket case – behind almost all other communist basket cases, including Ukraine’s. Indeed, Bulgaria defaulted on its debt in 1990. By February 1991, Bulgaria had broken out in a bout of hyperinflation, with the inflation rate at 123% per month. And in February 1997, Bulgaria experienced the agonies of hyperinflation again, with the inflation rate reaching 242% per month. 

As he looked into the abyss, President Petar Stoyanov decided against taking the plunge and appointed me as his advisor in January 1997. I immediately prescribed a currency board system to put an end to Bulgaria’s malady, something I had laid out for Bulgaria back in 1991 (Steve H. Hanke and Kurt Schuler, Teeth for the Bulgarian Lev: A Currency Board Solution. Washington, D.C.: International Freedom Foundation, 1991.).

Bulgaria installed a currency board in July 1997. The lev was backed 100% by German marks and traded freely at a fixed rate of 1000 leva to 1 mark. Inflation and interest rates fell like stones. The economy stabilized, and the Bulgarians learned that, even though stability might not be everything, everything is nothing without stability. Discipline at last.

Yes, the main feature of a currency board is the fiscal and financial discipline that it provides. No more running to the central bank for a fiscal bailout. A currency board ties the hands of those meddlesome monetary authorities. And forget the silly theoretical and obscure arguments made by economists who don’t embrace fixed exchange rates. A currency board regime is all about discipline.

As we watch Ukraine melt down once again, we can see what could have been (and what could be) if Ukraine would have only embraced a system of discipline (read: currency board) – like Bulgaria did in 1997. The following table tells the tale:

Bulgaria versus Ukraine

Country

GDP per Capita (USD)

Fiscal Balances %GDP

Current Account Balances %GDP

General Govt. Gross Debt %GDP

Gross Borrowing Needs %GDP

Import Coverage Ratio (FX Reserves / Imports)

W.B. Ease of Doing Business 2014 Rank

Bulgaria

$7,623

-1.9%

1.5%

16.0%

2.6%

6.7

58

Ukraine

$4,011

-8.7%

-8.9%

42.8%

11.0%

1.9

112

Sources: Bulgarian National Bank, National Bank of Ukraine, J.P. Morgan (Emerging Markets Research), International Monetary Fund (IFS), World Bank (Doing Business). 

Prepared by Prof. Steve H. Hanke, The Johns Hopkins University.

The Missing Data in Krugman’s German Austerity Narrative

There’s an ongoing debate about Keynesian economics, stimulus spending, and various versions of fiscal austerity, and regular readers know I do everything possible to explain that you can promote added prosperity by reducing the burden of government spending.

Simply stated, we get more jobs, output, and growth when resources are allocated by competitive markets. But when resources are allocated by political forces, cronyism and pork cause inefficiency and waste.

That’s why statist nations languish and market-oriented countries flourish.

Paul Krugman has a different perspective on these issues, which is hardly a revelation. But I am surprised that he often times doesn’t get the numbers quite right when he delves into specific case studies.

He claimed that spending cuts caused an Estonian economic downturn in 2008, but the government’s budget actually skyrocketed by 18 percent that year.

He complained about a “government pullback” in the United Kingdom even though the data show that government spending was climbing faster than inflation.

He even claimed that Hollande’s election in France was a revolt against austerity, notwithstanding the fact that the burden of government spending rose during the Sarkozy years.

My colleague Alan Reynolds pointed out that Krugman mischaracterized the supposed austerity in the PIIGS nations such as Portugal, Ireland, Italy, Greece, and Spain.

We have another example to add to the list.

He now wants us to believe that Germany has been a good Keynesian nation.

The Arrest of “Chapo” Guzmán: Did We Just Win the War on Drugs?

The arrest on Saturday of Joaquín “El Chapo” Guzmán, leader of the Sinaloa Cartel, is no small feat. He was perhaps the world’s most wanted man, and his capture certainly represents a major political victory for Mexico and its president Enrique Peña Nieto. But just like the killing of Pablo Escobar in 1993 didn’t end the war on drugs, the downfall of Joaquín Guzmán won’t put an end to drug trafficking in the Americas.

As leader of Mexico’s largest criminal organization, “Chapo” was the central figure in the breakout of drug violence in that country. In 1992, Guzmán decided to invade the turf of the Arellano Félix brothers in Tijuana. Years later he also declared war on the Juárez and Gulf cartels, thus unleashing years of unprecedented bloodshed in northern Mexico. Eventually he would succeed in controlling most of the lucrative routes, and his organization would become responsible for nearly half of all illegal drugs coming into the United States.  

His power relied not solely on plomo (lead) but also plata (money). Some years ago, high-ranking officials at Mexico’s Attorney General’s Office were arrested for receiving bribes from the Sinaloa cartel. The sums were staggering: between $150,000 and $450,000 per month. Guzmán’s organization was also actively engaged in buying the support of policemen. According to the Secretariat of Public Security, every year the cartels spend approximately $1.2 billion dollars bribing 165,000 cops all over Mexico (just as a comparison, the Merida Initiative, Washington’s aid package to Mexico and Central America to fight organized crime, totals $1.6 billion).

Without a doubt, Guzmán’s capture is a huge success for Enrique Peña Nieto. In the last seven months, the leaders of Mexico’s top three drug cartels (Zetas, Gulf and Sinaloa) were arrested without a single shot being fired. So, are we on the verge of wining the war on drugs? That all depends on what the ultimate goal is. Is it taking down drug kingpins or stopping the flow of drugs into the United States? If it’s the latter, the war is far from over. A report from the Office of Intelligence and Operations Coordination of the U.S. Custom and Border Protection agency looked at drug seizure data from January 2009 to January 2010 and matched it with the arrests or deaths of drug operatives (11 druglords in total). It found that “there is no perceptible pattern that correlates either a decrease or increase in drug seizures due to the removal of key DTO [drug trafficking organization] personnel.”

The latest National Drug Threat Assessment report from the Justice Department indicates that while cocaine availability has been declining since 2007, that of marijuana, heroine and methamphetamine is on the rise. In the case of cocaine, the fall in availability hasn’t produced a sharp increase in its street price, as the graph below shows:

We shouldn’t expect a major decline in the flow of drugs into the United States, just as such didn’t occur after Pablo Escobar, then the leader of the powerful Medellín cartel, was killed in December 1993.

The consequences on the dynamics of violence in Mexico are yet to be seen. Sinaloa is the last major drug organization with a semi-pyramidal structure in that country, and it’s also the most professionally run. Two of “Chapo’s” top lieutenants, Juan José “El Azul” Esparragosa and Israel “El Mayo” Zambada remain at large. It’s likely that they already had in place a succession plan in case Guzmán was arrested. Some experts even speculate on a new generation of drug kingpins taking over Sinaloa. So it isn’t sure that the cartel will implode or disintegrate. Nor we should expect an outbreak of violence as other cartels try to move into Sinaloa territory. That didn’t happen when Miguel Ángel Treviño, leader of the Zetas, was arrested last July.

The arrest of “Chapo” Guzmán is being seen as a major triumph in the battle against organized crime in Mexico. But his capture doesn’t bring us any closer to victory in the war on drugs.

Save Elephants by Selling Ivory

For many people free markets seem cold and calculating.  Maybe it’s the best way to sell, say, automobiles and soap.  But we shouldn’t like the process.  And we certainly shouldn’t base our behavior on markets when basic concepts of right and wrong are at stake.

Of course, markets are no substitute for understanding what the good life is all about.  However, markets offer a powerful tool to reinforce underlying moral values.

One of the great tragedies of the modern age is the slaughter of elephants.  Ivory long has been a widely desired decorative material.

Unfortunately, these days most new ivory comes from poachers.  The killing of elephants has sparked a new form of prohibition, with steadily tighter controls over ivory sales. 

As I note in my new Freeman article:

As a result, elephants have turned into modern day bison—simultaneously owned by no one and more valuable dead than alive.  The result has been devastating for elephant populations in many African states, with upwards of 40,000 elephants being killed annually.

In fact, about the only advocates of the giant creatures are Westerners who see the animals in zoos or on carefully controlled safaris.  In contrast, struggling developing nations must manage wildlife reserves and deter poachers while facing what they see as far more pressing human needs. 

Worse is the situation facing villagers and farmers.  Residents of the industrialized West wax eloquent when talking of faraway elephants, but to locals the creatures are giant rats, threatening and destructive. 

Thus, despite much effort, activists and governments have not been able to stop the massacre of elephants.  Yet faced with the failure of prohibition, the usual suspects only propose more of the same. 

They are pushing countries to destroy existing ivory stockpiles, acquired from elephants which died naturally or were culled, as well as seized from poachers.  Groups also are pressing to ban even the sale of antique ivory, as if outlawing ancient objects could bring back long-dead elephants.  Even more improbable have even been proposals that Western nations deploy military

Without a change of tactics, elephants could disappear from some African countries.  Yet some in the West favor morality lectures rather than practical innovations. 

Moral suasion always is worth a try.  But what happens after preaching fails?

Use markets to reinforce the moral message.  Observed the international conference covering endangered species (CITES):  “provided that their full value (i.e. both intrinsic and extrinsic) is fully realized by the landholders involved, not only will elephants be conserved but so will the accompanying range of biodiversity existing on such land.” 

It’s not a jump into the unknown.  Before 1989 Botswana, Malawi, Namibia, South Africa, and Zimbabwe allowed legal sales.  The same countries generally enjoyed expanding elephant populations, in contrast to the shrinking herds evident elsewhere in Africa.

Even today, after closure of these ivory markets, some governments sell licenses to hunt elephants when the population exceeds the land’s capacity.  Where the money is shared locally, noted analyst Peter Fitzmaurice, “Damaged land and crop losses are not only being tolerated, but villages are doing their best to guard against poachers.”

More needs to be done.  Observed CITES:  “A legal trade in ivory, elephant hide and meat could change current disincentives to elephant conservation into incentives to landholders and countries to conserve them.” 

Some activists appear to believe that it simply is morally wrong to trade in animals, or at least elephants (speciesism lives!).  But markets have been used elsewhere to help save endangered species, such as vicunas, tigers, and crocodiles.

Why not elephants too?

The current system formally treats elephants as sacred, thereby leaving them for dead.  Markets would treat elephants as commercial, thereby keeping them alive. 

If asked, elephants likely would prefer the second policy.  So should we.