On June 29, I posted a blog about dematerialization. I used the iPhone as an example of a technological improvement that enables increased output and resource conservation at the same time. I asked the readers of Cato@Liberty to tell me about additional gadgets and physical things (as opposed to services) that they no longer need thanks to their iPhones. Many have written and we have adapted our graphic accordingly. Please share it widely.
Oh no: I’ve gone and punched the 100-percent wasp’s nest again, and the wasps are responding predictably. Among them Joe Salerno stands out like a hornet among gall wasps, for Joe is an outstanding historian of monetary thought, and no mean monetary economist generally. Besides, you just can’t dislike the guy. Were I forced by a libel suit to defend my claim about 100-percent reservers constituting a “moronic cult,” he would probably be defense exhibit F, to be resorted to only if exhibits A through E all managed somehow to evade the process servers.
One reason why Joe woudn’t do my case much good, besides the fact that he doesn’t come across as a moron and is capable of charming jurors, is that he is not among those 100-percenters who insist that fractional reserve banking is fraud. On the contrary: he’d rather not talk about that, and goes so far to avoid doing so as to claim, at the end of his post, that the fraud argument is something I’m “fixated” on, as opposed to one that Rothbard himself and Salerno’s MI colleagues have repeatedly raised, as well as one that has been particularly influential in building popular opposition to fractional reserves. Just search “fractional reserves” and “fraud” on Google and you will see the vast harvest of misunderstanding that this Mises-Institute fractional-reserves = fraud campaign has yielded. Even Congressman Paul has been taken in.
So why doesn’t Joe want to talk about the fraud argument? My hunch, based in part on some past exchanges with Joe on the subject, is that he doesn’t want to talk about it because he himself doesn’t subscribe to it. But if that’s the case, instead of pretending that it hasn’t been a prominent and particularly influential component of his colleagues’ criticisms of fractional reserve banking, why does he not join myself and others in discrediting it? His criticism would, after all, go much further in debunking the absurd claim than my own or that of other non-MI insiders.
In any event, it is the fraud argument that I particularly have in mind when I speak of a moronic cult. What I mean by “moronic” is what everyone means by it. A “cult,” if you ask me, is a group that defines its members-in-good-standing as those who never publicly question certain core beliefs, where the core beliefs are in fact irrational or otherwise false. The last requirement is crucial, for otherwise the beliefs would not serve to distinguish loyal members from the great unwashed. You can’t, for instance, form a cult around the belief that 2 + 2 = 4 or that that the earth is a sphere. But you can form one around the claim that space aliens are about to save the chosen from Armageddon, or that a drug-addicted commie charlatan is really Mahatma Gandhi’s reincarnation, or that banknotes are really property titles.
Another sign of a cult is that, when publicly confronted with irrefutable evidence against their core claims, members respond, if they respond at all, by presenting modified versions of the claims designed, like so many planetary epicycles, to evade the original falsification, though only by erecting a different falsehood. Thus when the patent absurdity of their original fraud claim, to the effect that bankers were ripping-off their own depositors, was exposed (e.g., by pointing out that the “ripped off” depositors were receiving interest on their supposedly embezzled funds, and that were fraud really in play entrepreneurs ought to have been able to make a killing by exposing it while offering ironclad 100-percent alternatives), the “fraudists” (as I’ll call them to save space) responded with a new theory, to the effect that, rather than defrauding their own clients, bankers and clients together took part in a conspiracy to defraud the rest of the money-holding public, by reducing money’s equilibrium purchasing power. (Those conversant with welfare economics will recognize in this argument, among more obvious absurdities, a confusion of pecuniary and non-pecuniary externalities. In plain English, if by coming up with a new mousetrap, A reduces the market value of old-fashioned mousetraps owned by B and C, that effect is a “pecuniary” externality, and as such would generally not be considered evidence of a violation of B and C’s property rights.) Confronted by arguments to the effect that the difference between either demand deposits or demandable bank notes and time deposits is a difference not in kind but merely in degree, the fraudists reply by claiming, as Rothbard himself never did, that fractionally-backed time deposits are also fraudulent, and should therefore be banned as well. (Cf. Emerson on foolish consistency.) By hook or by crook, in short, the fraudists remain wedded to their core beliefs, shrinking from no argument or ground-shifting, however fatuous, that might appear to rescue them from otherwise damning criticisms, if only by exposing them to others equally if not more damning.
So much for fraud and cults. What about the criticisms Salerno aims at me? He says that I’ve become a sort of “ ‘standing joke” among young students of Austrian economics. Perhaps I have become such among students who have been drinking too much MI kool-aid; but most of the comments and correspondence I get after doing one of my wasp-nest acts, itself mainly from students, suggests a rather different reaction. Unless I’m mistaken what Salerno is observing is evidence of a self-selection process that is, shall we say, not lighting-up Mises Institute seminars and forums with only the brightest of sparks. (I’ve no doubt that for the same reason any reference to “globe-ists” at Flat Earthers’ annual conventions is always good for a belly laugh.)
Turning to a (somewhat) more substantive criticism, Salerno tries his best to blacken me with the “Keynesian” brush by observing that I believe in money wage rigidities. Although the observation itself is perfectly true, the Keynesian tag is a calumny, and one that for once has Joe displaying a very faulty grasp of the history of economic thought. For as he ought to know, and as Auburn’s own Leland Yeager has gone to great pains to make clear in his usual, eloquent manner (see his essay “New Keynesians and Old Monetarists,” in The Fluttering Veil), Keynesians didn’t discover or invent the idea that wages may be inflexible, which was a commonplace long before the General Theory was published, and one that played and continues to play a central role in the writings of both “Old” and “Market” Monetarists. What’s more, if Axel Leijunhufvud is to be believed, Keynes himself based his own, peculiar arguments for expansionary monetary and fiscal policies not on the (then conventional) assumption that wages were sticky downward, but on his claim that, even if they weren’t sticky, full-employment could not be recovered by simply letting them adjust downward. (As Yeager points out the beliefs of “New” Keynesians in this respect resemble not those of Keynes himself but those of “old” Monetarists.) Finally, Rothbard, who before the advent of New Classical economics was almost unique in supposing that there was nothing to prevent wages from quickly moving to their new equilibrium values following an adverse demand shock, was never able to hold this view consistently. In America’s Great Depression, for example, he dishes it up in his early, theoretical chapters, only to go on to claim that Hoover contributed to the depression by resorting to policies that…kept wages from falling! Well, wage rigidities didn’t suddenly make their appearance during Hoover’s term, although he certainly made them worse, as did FDR to a still more destructive degree. Nor did they disappear when Truman took office. That wages did come down rapidly, along with other prices, following the post-WWI boom, thereby making for a short-lived bust of 1920–21, was partly due to the far less important role of labor unions in those days, and partly due to the fact that people had good reason to anticipate, and to therefore go along with, a post-war decline in equilibrium prices and wages.
The question whether wages are in fact rigid or not is, in any case, not one that can be settled by simply labeling the claim that they are rigid “Keynesian.” It is an empirical claim, and as such one that can be settled only by referring to empirical evidence. I happened so supply some such evidence in the course of a recent exchange with the Market Monetarists, in which I posted the following graph:
Here, it seems to me, is rather compelling evidence of wage stickiness, as indicated by the utter failure of hourly compensation to adjust downward in response to a massive collapse of spending–a collapse that presumably ought to have meant a corresponding re-alignment of other equilibrium nominal values. If what Joe calls the “Keynesian” view of things is correct, the failure of wages to adjust with spending should have been associated with a corresponding rise in unemployment; if on the other hand Joe’s own view is correct, there should be no close correlation between the “gap” between the series above and the rate of unemployment. I suppose my readers can guess which view squares most readily with the evidence, but here for good measure is the unemployment plot:
Don’t get me wrong: I know that one can also tell a story about labor mis-allocation and consequent structural (as opposed to ordinary cyclical) unemployment; moreover I believe that that story gets to part of the truth. But why make it the whole story? Why pretend that unemployment only did what it would have done even if nominal spending had never collapsed?
As for the collapse in spending itself, allowing that it reflected “the voluntary decisions of individuals to alter the amount of money they desire to hold,” it hardly follows that that made it harmless. On the contrary: the increased demand for money would, unless accompanied, and accompanied relatively swiftly, by a compensating decline in prices and wages, would necessarily imply a shortage of real money balances. By Walras’ Law that money shortage would have as its necessary counterpart a matching surplus (excess supply) of things-other-than-money, including goods and labor. In other words, it would mean recession and unemployment.
As for my seeing (“like any garden variety Keynesian”–ouch!) “fluctuations in aggregate demand as a market failure that must be offset by Fed policy”…well Joe, I’m afraid that’s really quite a howler, isn’t it? I might have expected it from some others of the anti-fractional reserve persuasion, but from you? Say it ain’t so Joe! Say that you haven’t forgotten that I’ve written a thing or two about how AD wouldn’t be so unstable were ours a free banking system. Say that you really do know the difference between a claim of market failure and one of government failure! Admit that when you suggest that I “want” the Fed to manage the money stock, it’s to score a cheap point against me in the hope of impressing gullible reader’s of The Bastiat Circle, and not because you really aren’t aware of my desire to see the Fed abolished, along with all other central banks. As for my betraying my cause by endorsing Fed activism as a second-best solution, if that seems so, it is only because it’s damn hard to point out that the Fed has screwed up without implying some “ideal” conduct that would have been better, which is surely not the same thing as imagining that the Fed can ever be expected to behave in such an ideal fashion. If that’s betraying my ideals, call me guilty.
Joe’s account of my ideas concerning how free banks evolve also bristles with misrepresentations. True, I say that eventually the banks might make do with very little monetary gold. But the transition to such a state of affairs would presumably be a very gradual one, and would proceed, not from some fictional 100-percent reserve starting point, but from that of established fractional-reserve ratios already in low double-digit (if not single digit) territory. So there’s no reason to assume that it would involve substantial, let alone “massive,” inflation. Neither is there any reason to suppose that bank money would “in effect become” fiat money. Nothing in the evolutionary process I describe points to a change in the status of note and deposit contracts as redeemable claims to standard money, and it is impossible to see how competing banks might convince their customers to voluntarily agree to any such change.
Fiction is also the word for Joe’s predictions concerning other likely consequences of a move to free banking. Like many of his MI colleagues and followers, he here speculates as if the possibility being contemplated were a perfectly hypothetical one, for which actual empirical evidence is lacking. But that’s just not so. Free banking has existed, not in some pristine version of course, but in approximations close enough to allow reasonable conclusions to be drawn about unregulated reserve ratios and such. So, did the most free of all banking systems, lacking central banks but also lacking any barriers to 100-percent reserve banking or subsidies to fractional reserve banks, exhibit the high reserve ratios to which Joe referred in testifying to Congress? Not at all. On the contrary, the freest systems, including Scotland’s (ca. 1750–1845) and Canada’s (ca. 1873–1914), had remarkably low reserve ratios. If 100-percent reserves are your thing, freedom in banking doesn’t appear like a good way to have them. Better to call out the anti-bank vigilante squads, or just have the law itself set things right (as the fraudists would presumably empower it to do).
Concerning Joe’s frenzied final paragraph, all I can say is that I hope he had himself a good stiff drink after writing it, and that he’s feeling a lot better now.
In an era of misinformation overload, it is disheartening to see the Washington Post perpetuating the ignorance surrounding the issue of outsourcing. To be sure, in addressing the topic in Tuesday’s paper, writers Tom Hamburger, Carol D. Leonnig, and Zachary A. Goldfarb were merely presenting the case of Obama’s critics “primarily on the political left,” who claim the president has failed to make good on his promises to curtail the “shipping of jobs overseas.” That conclusion may be accurate. But the article’s regurgitation of myths about outsourcing and trade, peddled by those who benefit from restricting it, gives readers a parochial perspective that leaves them confused and uninformed about the manifestations, causes, consequences, benefits, and costs of outsourcing.
Outsourcing is a politically-charged term for U.S. direct investment abroad. Although the large majority of that investment goes to rich countries, the Post article claims that “American jobs have been shifting to low-wage countries for years, and the trend has continued during Obama’s presidency.” While that may be factually true, the numbers are likely fairly small. Many more jobs have been lost to the adoption of more productive manufacturing techniques and new technologies that require less labor. And we, overall, are much wealthier for it.
The article attributes 450,000 U.S. job losses to imports from China between 2008 and 2010 – a figure plucked from an “economic model” at the Economic Policy Institute that has been criticized by everyone in Washington but Chuck Schumer and Sherrod Brown. That estimate is the product of simplistic, inaccurate assumptions equating the value of exports and imports to set numbers of jobs created and destroyed, respectively, as if there were a linear relationship between the variables and as if imports didn’t create any U.S. jobs in, say, port operations, logistics, warehousing, retailing, designing, engineering, manufacturing, lawyering, accounting, etc. But imports do support jobs up and down the supply chain. Yet, so blindly committed are EPI’s stalwarts to the proposition that imports kill U.S. jobs that they even suggest that the number of job losses would have been greater than 450,000 had the U.S. economic slowdown not reduced demand for imports. In that tortured logic, the economic slowdown saved or created U.S. jobs. But I digress.
Contrary to the misconceptions so often reinforced in the media, outsourcing is not the product of U.S. businesses chasing low wages or weak environmental and labor standards abroad. Businesses are concerned about the entire cost of production, from product conception to consumption. Foreign wages and standards are but a few of the numerous considerations that factor into the ultimate investment and production decision. Those critical considerations include: the quality and skills of the work force; access to ports, rail, and other infrastructure; proximity of production location to the next phase in the supply chain or to the final market; time-to-market; the size of nearby markets; the overall economic environment in the host country or region; the political climate; the risk of asset expropriation; the regulatory environment; taxes; and the dependability of the rule of law, to name some.
The imperative of business is not to maximize national employment, but to maximize profits. Business is thus concerned with minimizing total costs, not wages, and that is why those several factors are all among the crucial determinants of investment and production decisions. Locales with low wages and lax standards tend to be expensive places to produce all but the most rudimentary goods because, typically, those environments are associated with low labor productivity and other economic, political, and structural impediments to operating smooth, cost-effective supply chains. Most of those crucial considerations favor investment in rich countries over poor.
Indeed, if low wages and lax standards were the real draw, then U.S. investment outflows wouldn’t be so heavily concentrated in rich countries. According to statistics published by the Bureau of Economic Analysis, 75 percent of the $4.1 trillion stock of U.S. direct investment abroad at the end of 2011 was in Europe, Canada, Japan, Singapore, Australia, New Zealand, Taiwan, Korea, and Hong Kong (i.e., rich countries). In contrast, only 1.3 percent of total U.S. foreign direct investment stock is in China.
Likewise, if wages and lax standards were magnets for investment, we wouldn’t see the vast sums of foreign direct investment in the United States that we do, and the United States wouldn’t be the world’s most prolific manufacturing nation. At the end of 2010, foreign direct investment in the United States totaled over $2.3 trillion, one third of which was invested in U.S. manufacturing facilities. As the president and his critics (including candidate Romney) drone on about the ravages of “shipping jobs overseas,” they should take a moment to note that 5.3 million Americans work for U.S. subsidiaries of foreign companies (jobs “outsourced” from other countries). And they should note that Europe’s Airbus announced last week that it is making a $600 million investment in a 1000-worker aircraft assembly plant in Mobile, Alabama, just down the road from the $5 billion, 1800-worker steel production facility belonging to Germany’s Thyssen-Krupp, which is located within a few hours’ drive of a dozen mostly foreign nameplate auto producers, who employ tens of thousands more U.S. workers and generate economic activity supporting thousands more. These investments, jobs, and related activity are the products of foreign companies outsourcing.
Why do these foreign companies come to American shores to produce instead of producing at home and exporting? Because each company has determined that it makes sense from an aggregate comparative cost perspective. They’re not here because of low wages or lax enforcement of labor and environmental standards, but because all of the factors affecting cost that each company uniquely considers, weigh – in the aggregate – in favor of investing here. One very important factor for a growing number of companies is proximity to market. Shipping products long distances can be costly, particularly for time-sensitive products and parts. And having a productive presence in your largest or fastest growing market is a factor that carries significant weight. Exporting is not always the best way to serve foreign demand.
But outsourcing has been stigmatized as a process whereby U.S. factories are disassembled rafter-by-rafter, machine-by-machine, bolt-by-bolt and then reassembled in some foreign location for the purpose of producing goods for sale back in the United States. There may be a few instances where that accurately depicts what took place, but it is simply inaccurate to generalize from those cases. According to the BEA research described in these two papers (Griswold and Slaughter), between 90 and 93 percent of U.S. outsourcing – investment abroad – is for the purpose of serving foreign demand. Only between 7 and 10 percent of that investment is for the purpose of making sales back to the United States.
In 2009, U.S. multinationals sold over $6 trillion worth of goods and services in the foreign countries in which they operate, which was nearly quadruple the value of all U.S. exports that year. Outsourcing helps make U.S. multinational corporations more competitive, and the profits they earn abroad (even if they’re not repatriated) underwrite investment and hiring by the parent companies in the United States. Typically, the U.S. companies that are investing abroad are the same companies that are investing in the United States for reasons that include the fact that U.S. MNC investment abroad tends to spur complementary investment and hiring in the U.S. parent operations.
The capacity to outsource also serves another crucial, underappreciated function: to safeguard against bad U.S. policy. Like tax competition, outsourcing provides alternatives for businesses, which help discipline sub-optimal or punitive government policy. Because of globalization and outsourcing, businesses can choose to produce and operate in other countries, where the economic and political environments may be more favorable. As more and more companies undertake these comparative aggregate cost-of-doing-business assessments, governments will have to think long and hard about their policies.
Governments are now competing with each other to attract the financial, physical, and human capital necessary to nourish high value-added, innovation-driven, 21st century economies. Restricting or taxing outsourcing as a means of trapping that investment wouldn’t be prudent. It would render U.S.businesses less competitive, and ultimately reduce employment, compensation, and economic activity. In this globalized economy, policymakers cannot compel investment, production, and hiring through threat or mandate without killing the golden goose. But they can incentive U.S.companies to return some operations stateside and foreign firms to invest more here by adopting and maintaining favorable policies.
According to the results of a survey of over 13,000 business executives worldwide published in the World Economic Forum’s Global Competitiveness Report 2011/12, there are 57 countries with less burdensome regulations than the United States. That same survey found that business executives are increasingly concerned about crony capitalism in the United States, ranking the U.S. 50th out of 142 economies in terms of the government’s ability to keep an arms-length relationship with the private sector. Then consider the fact that the United States has the highest corporate tax rate among all OECD countries. Add to that the prevalence of frivolous lawsuits, political uncertainty, out-of-control government spending, the dearth of skilled workers, uncertainty about the tax burden come 2013, and it starts to become clear why U.S. companies might consider investing and producing abroad. But policymakers can improve policy — in theory, at least.
It boils down to this. About 95 percent of the world’s consumers and workers live outside the United States. We live in a world where U.S. companies have much more competition on the supply side, much greater opportunity on the demand side, and far greater potential for tapping into a global division of labor (i.e., collaborating across borders in production) than 50, 20, even 5 years ago. After a very long slumber, the rest of the world has come on-line. We should embrace, not curse, that development.
In a globalized economy, outsourcing is a natural consequence of competition. And policy competition is the natural consequence of outsourcing. Let’s encourage this process.
The Washington establishment loves talking about the “distribution” of income and taxes. The CBO has issued a new report on the topic that will no doubt keep the discussion rolling on.
That said, the CBO report has some interesting statistics to consider. Most important are calculations of average federal tax rates, which are total federal taxes paid as a share of income. The chart shows average tax rates by quintiles, which each contain one fifth of U.S. households grouped by income level. The households at the top are hit with the largest burdens by far. Elsewhere, I’ve discussed who some of these high-earning households are and the damage done by nailing them with such high taxes. (For example, see here and here).
The annual Wiretap Report released by the Administrative Office of the U.S. Courts only captures the tiny tip of our vast electronic surveillance iceberg, but it does at least provide a lot of useful data about one type of government spying: Eavesdropping on phone calls in the course of criminal investigations. And so each year, the handful of journalists who keep an eye on this sort of thing dutifully report the bottom line number, and how much of an increase (usually) or decrease (very occasionally) it represents over the previous year’s number. But there’s an important qualifier: The number that makes it into the headlines is consistently 600–700 wiretap orders short, compared with the amended numbers quietly released years later. And the discrepancy between the headline number and the final estimate has been getting worse over time.
In 2001 and 2002, about 12 percent of the wiretap orders ultimately included in the official tally for those years were reported to the Administrative Office after their filing deadline—and therefore not included in the Wiretap Report for that year, or any of the press coverage surrounding it. By 2006 and 2007, fully 25 percent of wiretap authorizations weren’t counted in the report for that year. By 2008, it was more than 28 percent. While the headlines reported a 14 percent decline in wiretap orders for that year—to “only” 1,891—the current amended tally stands at 2,632. That’s a more modest 10 percent decline over the previous year’s amended number—and in fact it’s quite probably less than that, because future reports are likely to keep increasing the tally for those years, with the biggest amendments typically made to more recent years, further closing the gap.
The percentage of late-reported wiretap orders for 2009 and 2010 drops a bit—but almost certainly that’s because there are plenty that still haven’t been reported. The summary of supplemental reports from this year’s Wiretap Report, covering 2011, added dozens of late reports each year from 2006 and 2007; hundreds per year for 2008–2010. Extrapolating that trend forward, we can pretty confidently predict that this year’s estimate of 2,732 wiretap orders is a significant undercount, that the real figure is closer to 3,300 or 3,400, and that we won’t actually have a realistic estimate for another three or four years. All that, of course, assumes that the AOUSC does eventually get a reasonably complete accounting of wiretap orders—though when we’re seeing hundreds of late reports coming in two and three years after the statutory filing deadline, it doesn’t seem entirely unreasonable to suppose that some slip through the cracks entirely.
In any event, this is unfortunate for a couple reasons. As I suggest above, what gets prominently reported is almost always just the prior year’s number in the most recent report—which means the further off that number is from the ultimate estimate, the more distorted the picture the public gets. I informally queried a few journalists who write in this area, and found that even the very knowledgeable ones were unaware that the numbers were typically revised up by such a large number. Moreover, the deep-dive analysis in each year’s report is, unsurprisingly, focused on the previous year’s activity based on whatever data they have at the time. If they’re missing 28 percent of the data points, that analysis is less likely to represent reality faithfully. None of this is the fault of the AOUSC—they’ve got to work with whatever hundreds of judges and prosecutors manage to get them by their deadline—but it’s a big enough gap in the data that it deserves to be flagged in the press coverage of each year’s numbers.
In yesterday’s New York Times, Thomas Ricks penned an op-ed calling for the draft to be reinstituted. Ricks offers that under his plan for military conscription, libertarians who object could opt out provided they don’t partake of Uncle Sam’s other goodies such as federally subsidized mortgages, Medicare, and college loans. As a libertarian who objects to a draft, but who also received an NROTC scholarship in exchange for an active-duty commission, I think that Ricks is offering conscientious objectors a raw deal.
Those opting out, of course, could not refuse to pay the taxes that are used to fund government programs. That would be great for the government—compel people to pay for services that they will never use—but it is profoundly unfair, especially to young adults.
Mr. Ricks’s plan will certainly cost more money than our current all-volunteer force, especially in the near term. For example, we can expect tuition to skyrocket as soon as college administrators realize that the taxpayers are on the hook to pay for these new conscripts’ secondary education. The long-term savings that Ricks anticipates from changes to the military retirement are likely to prove equally elusive; past attempts to rein in costs for military retirees, including changes to eligibility rules, have repeatedly failed. There are sensible ideas for fixing the problem, but the politics are still really tough.
A draft is unlikely to save us money, but it will certainly abridge young people’s freedom. It is unfair to older adults, too, who would see their taxes rise. To add insult to injury, many older adults would see their tax dollars go to pay low-wage workers who would then be competing with them for jobs. Mr. Ricks thinks it’s outrageous that a 50-year old janitor earns $106,000 a year, plus overtime; the janitor would disagree. Others who would suddenly be forced to compete with a taxpayer-funded horde of 18-year olds include day care providers, nurses, and construction workers.
Libertarians want minimal government, as Mr. Ricks claims, but his plan would dramatically expand government power, abridge individual liberty, and distort the labor market. Despite his claims that this will be beneficial to the economy, economists long ago concluded that the all-volunteer force is superior to conscription. Conscription is a superficially great deal for the government, but a net loss for the taxpayer and draftee in hidden costs, and lost freedom.
I am sympathetic to Mr. Ricks’s desire to avoid rushing headlong into other foolish wars. It is too easy for the United States to wage war and send resources—drones, special operations forces—to low-level conflicts. Congress has abdicated its responsibility to declare war and deficit spending kicks the monetary costs down the road. But the draft is not the answer. Instead, let’s begin our search for a solution by forcing the advocates for such wars to a higher standard of proof, and holding them accountable when their rosy predictions of quick success prove erroneous.
Last month, I exposed some major errors that Paul Krugman committed when he criticized Estonia for restraining the burden of government spending.
My analysis will be helpful since I am now in Estonia for a speech about economic reform, and I wrote a column that was published today by the nation’s main business newspaper.
But just in case you’re one of the few people in the world who isn’t fluent in the local language, the Mises Institute Estonia was kind enough to post an English version.
Here are some of the key points I made. I started by explaining one of Krugman’s main blunders.
Krugman’s biggest mistake is that he claimed that spending cuts caused the downturn, even though the recession began in 2008 when government spending was rapidly expanding. It wasn’t until 2009 that the burden of government spending was reduced, and that was when the economy began to grow again. In other words, Krugman’s Keynesian theory was completely wrong. The economy should have boomed in 2008 and suffered a recession beginning in 2009. Instead, the opposite has happened.
I then pointed out that Estonia’s long-run performance has been admirable.
…the nation’s long-run economic performance is quite exemplary. Economic output has doubled in just 15 years according to the International Monetary Fund. Over that entire period – including the recent downturn, it has enjoyed one of the fastest growth rates in Europe.
But I’m not a mindless cheerleader (though I might become one if any of the local women gave me the time of day), so I took the opportunity to identify areas where public policy needs improvement.
This doesn’t mean Estonia’s policy is perfect. Spending was reduced in 2009 and 2010, but now it is climbing again. This is unfortunate. Government spending consumes about 40 percent of GDP, which is a significant burden on the private sector.
Being a thoughtful guy, I then made suggestions for pro-growth changes.
Estonia should copy the Asian Tiger economies of Singapore and Hong Kong. These jurisdictions have maintained very high growth for decades in part because the burden of the public sector is only about 20 percent of GDP. …Estonia already has a flat tax, which is very important for competitiveness. The key goal should be to impose a spending cap, perhaps similar to Switzerland’s very successful “debt brake.” Under the Swiss system, government spending is not allowed to grow faster than population plus inflation. And since nominal GDP usually expands at a faster rate, this means that the relative burden of government spending shrinks over time. By slowly but surely reducing the amount of GDP diverted to fund government, this would enable policymakers to deal with the one area where Estonia’s tax system is very unfriendly. Social insurance taxes equal about one-fourth of the cost of hiring a worker, thus discouraging job creation and boosting the shadow economy.
And I elaborated on why reform of social insurance is not just a good idea, but should be viewed as an absolute necessity.
Reducing the heavy burden of social insurance taxes should be part of a big reform to modernize programs for healthcare and the elderly. A major long-term challenge for Estonia is that the population is expected to shrink. The World Bank and the United Nations both show that fertility rates are well below the “replacement rate,” meaning that there will be fewer workers in the future. That’s a very compelling reason why it is important to expand personal retirement accounts and allow the “pre-funding” of healthcare. It’s a simple matter of demographic reality.
In other words, Estonia doesn’t have a choice. If they don’t reform their entitlement programs, the burden of government spending will rise dramatically, which would mean a higher tax burden and/or substantial government debt.
We also need entitlement reform in the United States. Our demographics aren’t as bad as Estonia’s, but we all know — as I explained in my post about Cyprus — that bad things happen sooner or later if government spending grows faster than the economy’s productive sector.