Corruption and bribes

The chart below shows the percentage of respondents in selected countries who willingly paid bribes to different service providers. The frequency of offering bribes for personal gains is strongly associated with the level of economic development. The highest percentage of paid bribes accures in those countries where the quality of institutions is very poor. The absence of judicial independence leads to the lack of trust, spread of uncertainty and costlier contract enforcement. In such conditions, corruption increases network and transaction costs. Thus corruption is a substitute for tax system. In terms of economic costs, corruption reduces economic growth by increasing the cost of transparent contractual relations. If corruption is persistent to a lesser extent, corrupt behaviour such as paying bribes is costlier since the probability of being caught is higher. Property rights and the rule of law together with judicial independence play an essential role in fighting corruption. Poorly defined property rights increase the risk of expropriation and therefore provide an incentive to pay bribes. Establishing a robust system of the rule of law is the best safeguard in tackling the persistence of corruption.

Source: The Economist (link)

Colonial legacy and economic development

In their newest study, Alexander Lee and Kenneth Schultz investigated the causes of widely divergent development outcomes in Northern and Southern Cameroon. After the independence in 1960, both parts of Cameroon attached a strong commitment to the culture of the respective colonizers. In spite of strong centralization policy, the economic divergence between both parts persisted.

As one of the most powerful colonial forces, France favored the policy principles of strongly centralized institutions which relied heavily on the administrative machinery of the state. Consequently, the French favored massive amounts of infrastructure investment. However, French colonial model led to the establishment of extractive states which lacked the rule of law and property rights as a foundation of economic development. In addition, the absence of clearly defined property rights resulted into the persistent power of political elites to extract political rents from natural resources while leaving behind a lot of forced labor and the lack of institutional autonomy. Consequently, development outcomes in the French part of Cameroon were significantly lower.

On the other hand, the British part of Cameroon enjoyed sizeable benefits from the exposure to British common law, Protestant religion, British education system, ideas of limited government and institutional autonomy which provided independent judicial system. Contrary to the French, British colonizers did not boost forced labor to a great extent since massive investment in infrastructure was not fostered. The authors of the new study tested the hypothesis of long-run influence of colonial legacy on contemporary development outcomes. Interestingly, the British part of Cameroon enjoys significantly better access to clean water than the French part as well as higher level of economic development. The evidence suggests that colonial origins importantly determine development outcomes. Concluding on Cameroon's experience, the evidence seems to support the notion that the economic outcomes from the British rule are superior to the outcomes generaded by French colonial rule.

Fertility, Earnings and Taxes

The persistence of low fertility rate is one of the many factors inhibiting the stability of public pension systems in developed world. From the 20th century onwards fertility rates have plummeted in all countries that belong to high-income group. The causes of this systematic drop in average fertility rates could be attributed to income affects of higher education and human capital as well es to greater perticipation of women in the labor market. The fertility rate used to stand above average in countries where the dominance of hierarchical religion has been present. Catholic countries such as Ireland, Portugal and Spain were known for extensive influence of religion on fertility decisions regarding the number of children. Thanks to greater use of contraceptive means, the fertility rates in those countries have stadely converged to the level of fertility in Protestant countries. In recent years, the fertility rate in Catholic countries has been ranked at the bottom in high-income country group.

In concidering the features behind lower fertility rate, the influence of taxation of labor supply has been neglected. In Catholic countries, the rate of female participation in the labor market was significantly lower than male labor perticipation rate. The spread of the welfare state in developed countries in the 20th century led to significant spikes in marginal tax rates on labor supply. For instance, 45 percent marginal tax rate implies that from each additional dollar earned, 45 cents go directly to the governement. The implication is that tax burden of labor supply nearing predatory levels does not encourage men and women to spend more time in the labor market. Consequently, the level of earnings decreases in the course of life cycle, further reducing the parental willingness to increase family size.

It is difficult to reverse the tax burden of labor earnings since the continuous growth of the welfare state amassed significant financial labilities of the government. To boost fertillity rate, it is essential to expand incentives to participate in the labor market, postpone labor market withdrawal and increase the family size. Without a prudent reduction of marginal tax rates and effective tax burden of labor supply, the Western world will experience decades of stagnating fertility rates whose negative impact on the stability of public finance could be difficult to reverse.

The Consequences of Lower Fertility Rate

One of the major challenges that modern world has to face is the reduction of fertility rate. Lower fertility rate leads to demographic imbalances. Demographic pressure on public finance will be enormous since the share of population above the age of 65 is expected to rise rapidly. Western world is undergoing a massive aging of the population. In the 20th and 21sth century, birth rates in Western countries have fallen considerably. Consequently, the share of population 65+ and old-age dependency ratio have increased extensively.

One of the most notable consequences of aging population is an enormous pressure on the long term sustainability of entitlement spending. If public pension and health care systems will not adjust to changes in fertility rate and labor market entry and exit age, an ageing population might easely undermine the ability of public finance to cope with the burden of old-age dependency.

The economic pressure of ageing population will inevitably require the adjustment of tax and spending policies. A growing share of dependent population implies that tax burden disporportionately falls on the working population. The growth of net financial liabilities and current effective tax burden strongly distorts labor supply decisions. Higher implicit tax rate during the working age might easily reduce the fertility rate and keep replacement rates below the demographic equilibrium level. Higher tax burden would then reduce the incentives for having children since the loss of consumption in the working age would stream into prospective periods. In addition, Western countries will have to tackle the issue of early retirement. Empirical evidence suggests that early retirement costs Western countries from 5 percent to 10 percent of the GDP each year.

The growing share of population 65+ leads to changing political landscape. Pension spending would be difficult to reverse if age-dependent population represented a significant share of the voting body. This might trigger the incidence of pensioners' parties in national parliaments which could substantially halt the prospects of pension reform. In any case, age-dependent population would be able to subordinate the preferences of political parties. That would diminsh any plausible possibility of a much needed pension reform.

Unemployment rate and economic freedom

Does increasing economic freedom raise the unemployment rate? To answer the question, I collected data on the unemployment rate and Index of Economic Freedom in 2010. I randomly chose 26 countries from various income groups. In the sample are Hong Kong, New Zealand, Switzerland, Australia, Canada, U.S., Denmark, Chile, UK, Netherlands, Spain, Norway, Mexico, France, Turkey, Italy, Tunisia, Brazil, India, Indonesia, China, Russia, Syria, Bolivia, Venezuela and Zimbabwe. Based on the sample data, I estimated the rate of unemployment as a function of economic freedom as measured by the Heritage Foundation.

As it can be seen from the graph, economic freedom does affect the unemployment rate. In fact, the influence of economic freedom accounts for almost 37 percent of the variation in the unemployment rate. Partial regression coefficient suggests that a 1 point increase in the Index of Economic Freedom would reduce the rate of unemployment rate by 0.1452 percentage point. The coefficient is highly significant with p-value equal to 0.001. Thus, one could hardly blame greater economic freedom and labor market deregulation for the rise of the unemployment rate.

Economic Freedom and Unemployment Rate

Source: Index of Economic Freedom, 2010.

The Strength of Corruption

The Economist summarized the findings of the 2010 Corruption Perception Index. Corruption is still one of the main obstacles to prosperity and good governance. Many governments around the world are reluctant to tackle corruption because it is a rewarding political behavior abusing the quality of institutions. Nevertheless, persistent corruption causes high transaction costs of contract enforcement. Thereby it is creating wasteful allocation of resources. On the other hand, developed countries are not immune to corruption. The key to high quality institutions in developed world is to find the way how to eliminate the presence of legal corruption.

According to the Index, the perception of corruption in the world is the lowest in New Zealand, Denmark, Singapore and Sweden. Scandinavian countries still remain a benchmark for the nations around the world in adopting the best practices in fighting corruption. One of the main reasons is that these countries have adopted first-class institutions in formal and informal dimension. The highest perception of corruption was found in Somalia, Myanmar, Afghanistan and Iraq. It is time for undeveloped countries to recognize that corruption is the central drawback that keeps them poor and underprivileged; because it leads to economic stagnation, moral crises, wars and social unrest.

Source: The Economist, The usual suspect (link).

Obesity and employment

A very interesting estimate by the OECD shows that women with low level of education are far more likely than men to become obese.

WSJ posted an interesting article discussing the effect of weight on pay rates in Germany and the United States. The study found that employers treat women in a similar way than fashion industry does; by rewarding very thin women with higher pay. On the other hand, very thin men tend to get paid by $8,437 less than men with average weight. As men pack up their weight, their payroll goes up as well up to the point where they become obese. According to the study, pay-maximizing male weight is 207 pounds (93.89 kg). After that point, the loss of pay and productivity is higher for male than female. The study found that women who weigh 25 pounds (11.34 kg) less than the group norm, earned an average $15,572 more than women of normal weight. Another study found that direct and indirect cost of obesity for women is $4,879 which is about twice as much as for men ($2,646).

Overall, the obesity strongly reduces employment prospects and wage rates for both male and female. It also increases social risk such as exclusion and significantly lower mobility. Obese people find it more difficult to increase the payroll and employment status. This pattern is confirmed both at the theoretical and empirical level.

Does education increase employment?

The data supplied by the OECD indicate that going to college significantly increases the likelihood of employment. The graph shows the distribution of employment rates by educational level in 8 OECD countries. Employment rates are divided into two categories - secondary degree or less and tertiary degree. The gap in employment rate between the two categories is the widest in Slovak Republic, Italy and Germany. There is a general tendency across countries that the likelihood of employment increases with the level of education. In addition, the employment gap persists in observed countries. This empirical fact is consistent with human capital theory which predicts higher earnings and employment alongside the increasing level of education.

Source: OECD (2010)

Why Cuba's economic model failed

Fidel Castro, Cuba's long-standing dictator, recently confessed (link) to the American journalist that Cuba's communist political and economic model never worked. This is nonetheless a shocking statement revealing the actual awareness of the fundamental fallacies of the communist economic model. Cuba was long known for miserable social and economic indicators that were tried to be hidden by the ruling Communist party of Cuba. So, why is Cuban economic model destined to fail?

First, prior to the 1959 communist revolution, Cuba enjoyed the status of one of the wealthiest countries in Latin America, known for high level of judicial independence and strong protection of private property rights. Not surprisingly, before the revolution, Cuba recorded the highest stock market capitalization of any Latin American countries. The solid level of capital market development was a mere reflection of sound contract enforcement instituted by the judicial protection and the rule of law. When the revolution began, Cuba eliminated all private property rights by collectivization of land and by a complete nationalization of private enterprises. By that time, the very fundamentals of economic development were destroyed.

Second, Cuban communist leaders looked up to the Soviet Union as a role model of the socialist society. By the time of the revolution, Cuba followed the course of destructive economic policy. It began imposing price controls and the trade with the rest of the world, except for the socialist countries, was ended. In addition, civil and personal liberties vanished under the communist regime. Therefore, Cuban economic model resulted in food shortages, land depletion, massive immigration and frequent oil crises.

The collapse of the Cuban system was anticipated since every communist nation ended its Marxist economic experiment in the disastrous failure. For instance, Yugoslavia's socialist model resulted in the political disintegration of the country, record-breaking hyperinflation and a civil war. Cuba long praised its supposedly superior health care system which was said to outperform the quality of the American health care system. It is not difficult to infer that the majority of health indicators was manipulated by the government bureaucracy. Recently, Raul Castro decided to fire 500.000 government employees as an attempt to boost the growth of the struggling socialist economy (link).

The ultimate roots of Cuban economic failure lie in the belief of the power of the state to replace free price mechanism and free enterprise system as the coordinator of economic decisions of individuals and firms. The intention of Cuban revolutionary leaders to create "heaven on earth" resulted in probably the most significant economic and social stagnation in the 20th and 21st century. The case of Cuba reaffirmed the unprecendent failure and theoretical inconsistency of Marxist economic theory and policy. Cuban political and economic experiment once again showed that socialist political philosophy is based on false and misguided philosophical premises that completely misunderstood the meaning and nature of human liberty.

Spain's labor market reform

According to WSJ (link), Spain has finally implemented the broader reform of the labor market structure. Spain's 20 percent unemployment rate is the highest in the Euroarea. Traditionally, Spain was known for its notorious and heavily regulated labor market. The country used to maintain high levels of minimum wage and high cost of dismissal. The reform introduced by the Zapatero government removed the restrictions for dismissals on a fair basis and deregulated dismissal procedures on indefinite labor contracts. Dismissal cost has been decreased from 45 days to 33 days of salary per year worked.

The labor reform in Spain led to a lot of controversy among economists. Dani Rodrik (link), for instance, claims that labor market deregulation and fewer firing restrictions will further increase the unemployment rate since the major cause of it is the lack of labor demand. On the other hand, a handful of economists claim that Spain's persistent labor market rigidities are the major cause of country's high unemployment rate.

According to World Bank, redundancy cost in Spain averages 56 weeks of wages, more than twice the OECD level. During recessions, the decline in labor demand usually increases the unemployment rate and, therefore, hiring and firing restrictions do not exert the major influence on firm's decisions to employ additional units of labor. However, the persistence of strong labor market regulation imposes significant economic costs.

First, firms do not employ the optimum amount of labor. High redundancy cost and rigid dismissal procedures lead to either under-employment or over-employment of labor. Thus, firms shift the burden of high labor cost on higher prices, lower dividends and lower net wages.

Second, labor market regulation has broader implications. It eventually leads to more institutional rigidities and more pressure on higher wages by trade unions through collective bargaining. Consequently, wages become downward rigid. During the economic recovery, firms are therefore less motivated to employ new workers or extend the existing labor contracts.

As Spain finally recovered from the recession, the ongoing labor rigidity and even the increasing labor demand could not alleviate Spain's high unemployment rate. It would only put more pressure on Spain's government to increase government spending on unemployment schemes. Therefore, the reform of the labor law based on labor market flexibility is the most plausible alternative for Spain to boost employment and decrease the widening budget deficit that threatens country's economic recovery.

Should Bush tax cuts be extended?

According to WSJ (link), the majority of surveyed economists in the U.S. suggests that Obama administration should extend personal income tax cuts imposed under Bush administration between 2001 and 2003. Given the dismal effects of $787 billion stimulus, the U.S. economy would greatly benefit from tax cuts on earners in all income brackets. However, is the administration under president Obama willing to reverse the growing trend of government spending?

Critics of Bush tax cuts claim that reduction in personal income tax rates between 2001 and 2003 resulted in a disproportionate windfall gain to the wealthiest U.S. households while the families in the lower tail of income distribution received very low or zero gains from 2001-2003 tax cuts. What would happen if the Obama administration extended tax cuts for all taxpayers? Would the reduction of tax burden lead to stronger and faster U.S. economic recovery? To answer the question, it is essential to understand what actually happened with the U.S. economy when Bush tax cuts were implemented.

Between 2001 and 2003, Bush administration enacted a series of tax cuts aimed at boosting the recovery of the U.S. economy from the 2001 recesion. In this year, tax rate on income in the lowest bracket was reduced to 10 percent while top marginal tax rate was slashed to 35 percent from 39.6 percent. Tax rates were also reduced for middle-income earners. In 2002, the administration reduced tax burden on new business investment while in 2003 tax rates on dividends and capital gains was decreased. These measures were a part of broader $1.35 trillion tax cut program approved by the Congress over a ten year course.

However, tax cuts didn't pay for themselves as President Bush promised. The reason is the growth of federal government spending which increased by 2.5 percentage points of GDP between 2001 and 2008. During his term, President Bush signed the so called Medicare Part D plan which assured seniors additional drug prescription. The act created $8.4 trillion in unfunded obligations in present value terms. The CBO (Congressional Budget Office) estimated that extending Bush tax cuts would cost the U.S. Treasury $1.8 trillion in the following decade and would dramatically increase the federal budget deficit.

The war in Iraq was the major source of a growing public debt. Between 2001 and 2008 the federal public debt increased by 5.4 percentage points of GDP. Due to the growth of government spending, tax cuts led to a widening budget deficit. It should be noted that tax cuts were not the cause of the 2008-2009 budget deficit as critics often argue. An analysis by Center for Budget and Policy Priorities has shown that Bush tax cuts account for about 25 percent of the 2009 federal budget deficit.

If tax cuts are not accompanied by the reduction in government spending, the outcome is likely to result in either budget deficit or growing public debt. This is exactly what happened in the medium term with Bush tax cuts. A reduction in tax burden on personal income can result in higher tax revenue only if government spending is reduced. The U.S. budget outlook suggests a dismal fiscal future for America, marred by high public debt and a wide budget deficit that is unlikely to disappear before 2017. Bush tax cuts should be extended for earners in all income brackets, but only under a permanent reduction of government spending. Otherwise, any further tax cut would only add to the magnitude of federal budget deficit.

Natural resources and prosperity

Does natural resource abundance lead to more wealth and higher growth? This is an ample question of economic growth theory. In addition, many episodes of economic consequences of resource abundance suggest there is no single relationship between resources and growth. Many countries around the world are economically dependent on the supply of natural resources, especially in least developed and developing countries. In spite of significant amount of resources such as oil, coal, natural gas, gold and other commodities, many developing nations remain undeveloped and vastly dependent on foreign aid.

Countries such as Iran, Libya and Venezuela are among the largest oil-producing developing countries. In spite of vast supply of commodities, the data and experience do not suggest a positive impact of resources on economic growth. Prior to the 1979 Islamic revolution, Iran used to be one of the most developed countries in the Middle East. After 1979, Iran underwent an overhaul of its economic system and a beginning of large-scale state intervention in the economy. The theocratic government regime de facto suppressed private property rights and imposed strict government control over the economy. Even though Iran's oil reserves have been among the largest in the world, country's GDP per capita and structural indicators have stagnated since 1979.

Venezuela is a brilliant textbook example of how resource-abundant economy can stall as a consequence of socialist political dictatorship and unlimited constitutional power of the dictator. Libya is attributed with the largest supply of oil in Africa. Country's oil sector accounts for 95 percent of export earnings, 60 percent of public sector wages and 25 percent of GDP (link). Even though the country is the largest oil exporter in Africa and despite a GDP per capita in the rank of Russia and Lithuania, the unemployment rate is estimated at 30 percent which is the 21st highest unemployment rate in the world. In addition, Libya's business environment is marred by the lack of economic freedom resulted from high degree of corruption in public sector and judicial system. According to Heritage Index of Economic Freedom (link), Libya is the least free economy in North Africa and Middle East which is nonetheless unsurprising since in 1978 all private property rights for private businesses were eliminated.

Resource abundant countries also used to be expropriated by the colonizers in the age of colonization. Early colonizers of a vast majority of African resource-abundant countries did not focus on the permanent establishment of sound property rights and contract enforcement but solely on the extraction of natural resources. This created huge political instability and intense war conflicts on the African continent. On the other side, there are countries with abundant natural resources and high prosperity at the same time such as Norway and Canada. The political history of these countries suggests an entirely different institutional setting, based on the protection of private property and contract enforcement. Such a structure and origin of the legal system ensured low transaction costs and sound contract protection by the judicial system as the basis of economic development.

After centuries of socialist political and economic mismanagement, dictatorships in Africa and the Middle East resulted in the artificial wealth illusion demonstrated by relatively high GDP per capita and poor structural indicators such as high unemployment rate. Therefore, one should be cautious in examining the relationship between natural resources and economic growth in the longer run. Nevertheless, institutional, historical and political background of resource abundance should not be neglected.

The economic nonsense of corporate income tax

The share of corporate income tax in tax revenue has been growing in the last two decades in the majority of countries. Beginning in 1990s, policymakers in developed countries have trimmed corporate income tax rates in the hope of fewer distortions to saving and investment. As a consequence, tax revenues from this particular tax have increased as a share of the GDP. Surprisingly, leaders in corporate income tax reduction were high-tax European countries such as Sweden, Austria and Germany. Today, the lowest corporate income tax rates in developed world are found in European countries such as Cyprus and Ireland.

What is the economic feasibility of corporate income tax? In fiscal theory, the rationale for this particular tax lies in the existence of benefits from legal protection enjoyed by the corporations and private limited companies. Joseph Stiglitz has argued that this particular tax is a tax on entrepreneurship as it discourages new capital formation. Corporation's tax base depends on the amount of revenues minus expenditures for labor, materials and capital goods. The real paradox of corporate income tax is that it is preferable for the corporation to create new debt than to issue equity. In fact, the debt is considered as a deduction from corporation's tax base. Thus, it is difficult for start-ups to get the loan from the banks as the bank is not willing to take on the risk involved with the repayment of the loan since start-ups' success is uncertain. Therefore, the existence of corporate income tax hinders business investments and entrepreneurial activity in general.

The abolition of corporate income tax would be an important boost to capital formation and new business investment. In addition, many economic distortions would disappear. It should not be neglected that tax incidence in corporate income tax is not shifted to the corporation. The ultimate payers of this tax are workers, customers, suppliers and shareholders. The tax is shifted in lower wages, higher prices and lower dividends. At last, the tax also creates perverse incentives that discourage investment and, nevertheless, job creation.

Source: OECD Tax Database (link)

Benefits of immigration

The Economist wrote an interesting article on the significance of migration and important spillovers from immigration into developed countries. The economic crisis of the past year has slowed the flow of international migration. As the estimate from Migration Policy Institute suggests, the stock of illegal immigrants in America fell from 12.1 million in July 2008 to 11.9 million in the year after. It is important to emphasize the economic benefits of migration for developed and developing countries.

The migration to developed countries has resulted in higher employment and greater specialization in the labor market. Without the flow of migrants the structure of the labor market in developed countries would incentivize workers to take lower paid jobs which would result in lower incomes. As the developed countries opened their borders to immigrants from all over the world, young individuals were enabled to invest in human capital and by doing so increase their career prospects. As for developing countries, migrants increase the stock of human capital availible to the country of migrant's origin. Therefore, immigration from less developed countries should not be seen as a loss but as an immense opportunity to get the know-how and high skills through which the country of migrant's origin shall prosper. The widespread emergence of technologies such as Google's applications, Twitter, Facebook, Linkedin etc. has further enhanced the flow of knowledge and information to the countries of migrant's origin. It should not be neglected that economic catch-up, generated from technological imitation, is the only way for less developed countries to reach the income per capita of their richer peers.

The OECD published a report where it estimated that the inflow of migrants to rich countries fell by 6 percent in 2008, to 4.4 million. Five years before 2008, the inflow of migrants soared. The main benefit of immigration is more favorable demographic outlook since developed countries will experience sharp increases in the share of older population (65 years and over), replacement rate and fiscal burden of entitlement spending. The inflow of immigrants not only benefits the labor market but it also boosts incentives to work, save and invest since immigrants work longer hours and retire later than native population. Therefore, immigration should not be discarded but encouraged and promoted by national governments.

African economic development

Could the 2010 World Cup bring an end to decade-long economic stagnation and poverty persistence on the African continent? Political and social unrest in the great number of African countries has led to civil wars and consequently, African countries experienced little or no economic growth. Institutions such as World Bank have produced vast amounts of theoretical and empirical literature concerning African development agenda. African economic history is a history of colonization which serves as an efficient instrument for controlled experiments to test different theories of economic development and explain the true causes behind economic success and failure.

To be more percise, there is a limited amount of successful country studies that serve as a model of development to other African countries. In particular, legal origins of colonizers explain both initial economic conditions and long run economic performance. South Africa has been colonized by the Dutch and Great Britain. These two countries have exported their legal system based on the rule of law, robust property rights and liberal commercial code. The same happened in Mauritius, Gabon and Botswana. Incidentially, African countries abundant with natural resources were a quick target to European colonizers who focused their attention to the extraction of natural resources rather than on building a solid system of property rights protection and long term law enforcement. This hypothesis probably explains why countries situated near equator are deemed to long-run economic stagnation.

Policymakers in less developed African countries should realize the drawbacks of political instabillity and potential conflicts. Without strong institutional foundations of economic performance such as a clear committment to establish a sound system of property rights protection, foreign aid will help little and produce no net gain for African countries. This reaffirms the basic postulate of economics: Incentives matter. Everything else is a commentary.

The impact of crisis on employment

In recent days, Greek public sector workers have launched protests against government austersity measures which include a cutback in minimum wages, public pensions, an increase in effective retirement age and a cut in entitlements. An interesting question is how the crisis affected employment outlook across the world. The OECD recently presented a brief overview of unemployment dynamics in member states (link).

The countries, least affected by the crisis in terms of unemployment surge, are the ones with strong and flexible institutional foundations of the labor market such as the flexibility of wages, the ease of firing and hiring, tax wedge and the linkage between productivity and wage rates. These countries are, for instance, Austria, The Netherlands, Korea and Norway. The surge in unemployment has been the most significant in countries such as Spain, Ireland, U.S. and Iceland where the banking and financial crisis have torn real income and employment by heavy spillover of financial shock into the real sector. It is important to emphasize that long-term employment outlook in OECD countries will be determined by wage flexibility and regulatory environment which is essential and conducive to job creation besides economic growth and unit labor costs.

Taxing soda drinks and fast food

In the U.S., average Body Mass Index (BMI) for men is 26, one point above the critical level. Given widespread growth of childhood obesity, policymakers in Washington have pondered the idea of levying a tax on soda drinks and fast food. The consumption of these products has negative impact on bystanders. Moreover, due to obesity, insurance premiums and costs of health care are rising. Each year, childhood obesity raises insurance premiums by $147 billion. In addition, childhood obesity is likely to become the major source of future growth of Medicare costs. Although the obesity pattern is the strongest and most significant in the U.S., Europe is not immune to widespread childhood obesity. The highest percentage of overweight children in Europe was found in Spain, Greece, Germany and in the UK. In general, obesity rates in Europe are catching up the U.S. level.

Academic studies have shown that the major factor of obesity among children and adults is excess availibility and low prices of soda drinks and fast food. In addition, large exposure of vending machines in schools also contributes to obesity through the consumption of candies and other high-calory products. For instance, an interesting study has examined the effect of vending machines on body weight. It showed that people with direct access to vending machines in schools and workplace gained cca. 3 kg more than those without access to vending machines. Therefore, is a tax on soda drinks and fast food a viable way to contain the growth of obesity?

Greg Mankiw has presented the economic point of view in NY Times (link). Generally speaking, the demand for soda drinks and fast food is price elastic, which means that a 1 percent decrease in the price of soda drinks would increase soda drink consumption by more than 1 percent. If government policymakers introduced a tax on soda drinks (fast food included), the burden of the tax would shift entirely on consumers who would pay the eventual cost of health care arising from obesity as a consequence of excessive consumption of soda drinks and fast food. That is why such a tax is feasible. There is no reason why the society should bear the burden of obesity through higher tax burden and rising cost of health care delivery. This is the most obvious evidence how society pays for private action that should be tackled by individuals themselves.

US health expenditures

The US has the highest percentage of health expenditure in OECD countries. The finding is surprising given the fact that the role of government in US health care delivery is among the smallest in the world. However, health insurance in the US is conducted through insurance companies and not directly between the patient and health-care provider. Such interaction creates the third party payer problem. Much of the health insurance in the US is provided through employer mandates. Such a scheme entitles employers to buy health insurance on behalf of employees via insurance company. The scheme, due to the lack of direct payment, creates the so called moral hazard, giving employees incentives not to provide themselves with full insurance coverage. Average American spends $7.250 on health per year, which is more than two and half times the average expenditure in the OECD ($3.000).

The US health-care reform should focus on deregulation of health insurance market across the country. The provision of free interstate health insurance market would force insurance companies to cut predatory premiums and end insurance denials to their customers. In addition, health-care reform should encourage out-of-pocket payments given the fact that these payments are strongly correlated with overall health conditions. Switzerland enjoys one of the highest life expectancies in the world alongside very high out-of-pocket payments for health care. The US should move in the direction of elimination of employer provided health insurance. This step would gradually reduce the size of health expenditures and would also contribute to the reduction of the number of uninsured.

Health Expenditures in the OECD

Source: OECD (2010)

Children living in one-parent households

Evidence suggests that living in one-parent household increases the probability of child poverty. In the OECD, 85 percent of single-parent households are headed by women. The highest percentage of single-parent households prevails in English-speaking countries (US, UK, Canada and New Zealand). The highest proportion of children aged 14 or below and living in one-parent household was found in the US (25.8 percent), Estonia (24 percent), the UK (22.9 percent). The lowest proportion was found in Portugal (9.8 percent), Italy (9.2 percent) and Greece (7.4 percent). It seems that the proportion is closely related to the religious pattern of the society, meaning that more traditional societies emphasize long term marriage and matrimony stability. The issue deserves more attention as the childrens' wellbeing, earnings and state of health are, in a large part, determined in early childhood.

The proportion of children living in one-parent households

Source: OECD (2010)

Productivity gap between the US and OECD countries

I collected data from the OECD on GDP per hour worked in each country as a percentage of the US level. The highest level of GDP per hour was found in Luxemburg (140.4 percent of the US level), Norway (136 percent of the US level) and the Netherlands (100.4 percent of the US level). In these countries, the level of productivity is higher as the workers there work fewer hours per year than in the US, so it is no surprise that relative productivity is higher. The least-performing countries are Poland (37.9 percent of the US level), Mexico (33.6 percent of the US level), and Chile (28 percent of the US level). These countries are catching-up developed nations, so in spite of relatively high number of working hours per year their level of productivity is significantly lower.

In the long run, productivity is the only engine of economic growth and the wealth of nations. It is the only hope for less-developed and developing nations to catch the income per capita level of advanced countries. There are many obstacles to higher productivity in the labor market. First, many countries impose minimum wage laws, risking higher unemployment among less-skilled workers. Minimum wages increase labor costs and reduce overall employment. Second, the number of working hours is often restricted by trade union determination of labor contracts and entry requirements in many sectors. Third, some countries reduce labor supply incentives through higher hourly wages on extra working hours so that employers do not encourage employees to work longer hours. And fourth, high marginal tax rates discourage workers from longer work. A reduction in marginal tax rates, the abolition of minimum wages, deregulation of entry requirements and tax incentives for extra hours of work could significantly boost productivity growth and higher standards of living.

GDP per hour in OECD countries

Source: OECD (2010)

IMF Borrowing Crisis

The graph shows 10 largest borrowing arrangements by International Monetary Fund (IMF). Recent $140 billion rescue package for Greece is one of the largest cradit loan arrangements in the 21st century. The fund's contribution to Greece has surged the overall indebtedness of the Euroarea. During the financial crises IMF usually extended credit lines to the countries in trouble. Recently IMF extended borrowing arrangements to Latvia and Iceland. Before Greek rescue aid, IMF's contribution to Iceland's rescue package was one of the largest borrowing expansions ever given to such a small country. In the future, as emerging economies will further grow, IMF will have to be keen on the possibilities of systemic crises in these countries. The IMF should not extend the rescue loan to every country as this is not always effective in the end. The main purpose of the IMF is to help counties facing balance-of-payments crisis and not being the borrower of the last resort as in the case of Greece.

Source: The Economist

Italian Big Government

The figure from The Economist showes that the number of official cars on the streets in Italy is 6 times as much as in the average European country. The figure doesn't seem to reflect the terrible state of the Italian economy. In 2009, Italy's public debt grew up to 115.3 percent of the GDP. Given the worrying state of public finance, Italy's one of the riskiest countries in the Euroarea. It is a country of an enormous contrast between the developed North and the agrarian South. The country also has one of the largest shadow economies and widespread corruption perceptions in the developed world. Because of reginal income per capita disparity, Italy is a country of significant differences in youth and adult unemployment across the country. According to the OECD, Italy has one of the highest youth unemployment rates in the EU (26.3 percent). In the last year, youth unemployment rate in Italy grew by 5 percentage points. The proportion of youth in employment is 20 percentage points below the OECD average.

Source: The Economist

Mortgage crisis in the UK

Bank of England published a very interesting survey of household financial conditions in the UK. The following graph shows quarterly percentage changes in the house purchase and remortgaging dynamics in the UK between Q2:2007 and Q1:2010. As the graph indicates, there is an excess volatillity in the housing market as a result of loose monetary policy and unpredictable mortgaging changes. Housing markets reflect the instability of the UK economy.

House purchase and remortgaging dynamics in the UK

Source: Bank of England, 2010 (link)

Youth unemployment in OECD

Youth unemployment is one of the major macroeconomic problems in the OECD countries. High youth unemployment rates are a significant concern mainly because joblessness affects housing market, inflation outlook and demographic picture. Persistent unemployment rate means less purchasing power and a strong downward pressure on prices.

According to the latest data for 21 OECD coutries, the highest youth unemployment rates (15-24 years) in the fourth quarter in 2009 were in Spain (43.6 percent), Slovak Republic (31.9 percent), Ireland (29.1 percent) and Hungary (28.8 percent). The labor market outlook in Spain is very worrisome given the fact that almost half of the young population is jobless. Spain's youth unemployment is almost 4 times the youth unemployment rate in Germany (10.2 percent). The OECD forecast a growing unemployment rate until 2011, which means that current unemployment figures could get worse in the coming years. The lowest youth unemployment rates were found in Netherlands (7.6 percent), Norway (8.9 percent) and Korea (9.4 percent).

Youth Unemployment Rate in Q4:2009 in OECD

Source: OECD (2010)

The biggest difference between youth and adult unemployment rate was in Sweden where youth unemployment rate was 4.3 times higher than adult unemployment rate. Similar differences were found in Norway and Luxembourg (both 3.87). The smallest differences were found in Germany (1.42), Portugal (1.96) and Denmark (2.03).

Youth-to-Adult unemployment ratio in Q4:2009 in OECD

Source: OECD (2010)

How farm subsidies kill Europeans

Cardiovascular diseases (CVDs) are the main cause of deaths in the Europe, approximately 49 percent of all deaths, out of which 30 percent of all premature deaths before the age of 65. Cardiovascular diseases are estimated to cost the EU €169 billion every year.

Let take a look at the data. In Germany, 907 men and 237 women on average die prematurely each year before the age of 75 due to coronory heart diseases (CHD). In the UK, 479 men and 1453 women die each year due to premature death alone. The number of premature deaths is high in Mediterranean countries (Italy, Spain) as well. In Italy, 233 men and 826 women die because of the premature death (link).

"The school milk subsidy scheme introduced by the European Commission likewise means that a child drinking full-fat rather than skimmed milk will consume an additional 1.5 kg of saturated fat every year approximately 4 g per day. British children obtain 23% of their daily saturated fat intake from full-fat milk (link)."

To prevent premature deaths in Europe, European policymakers should impose a tax on the products causing significant health problems such as diabetes, obesity, lung cancer, incresing blood pressure, raising cholesterol etc., and by doing so save more lives. The EU Common Agicultural Policy (CAP) annual budget represents approximately €45 billion which represents 45 percent of the overall EU budget. Through subsidies and direct payments, CAP is a source of massive oversupply and overproduction of dairy products. These products are the main source of excessive butter and full-fat milk consumption which further leads to raising cholesterol, coronary heart diseases, incresed blood presure etc. The CAP has a deadly cost - human lives.

Taxing luxury yachts

The lawmakers in Florida have considered cutting the 6 percent boat registration tax. Florida already has one of the highest sales taxes in the US. Buying a $1 million boat will cost you $60.000 in sales tax. In nearby states such as North Carolina, yacht registration costs you $1.500 at most, whereas only $600 in Rhode Island and $500 in South Carolina. Even more attractive are Cayman Islands where you pay close to zero tax on yacht registration. Because of Florida's uncompatitive tax regime, 8 out of 10 boats in the state are registraed somewhere else, either in other costal states or abroad. The message is clear, raising taxes is tempting but in reality it leads either to tax evasion or capital escape. Higher tax rate lead to the opposite results of what the policymakers expected. Their decision costs Florida $120 million in lost revenue.

This is a clear evidence that higher tax rate does not lead to more revenue, as people and businesses easily move to more favorable tax destinations. To keep the citizens and businesses at home, you should build a more attractive business environment with lower tax rates and friendlier regulations (link).

Doing Business in OECD

Some of the issues that careful investor would consider when chosing the best country for doing business are the flexibility of the labor market, the nature of the tax system, the cost of starting a business, the protection of investors, contract enforcement, getting credit, etc. To investigate the issue, I collected data on doing business in 27 OECD countries from World Bank's Doing Business.

In the graph you can see the ranking of countries according to the ease of doing business. The best performing OECD country is New Zealand. New Zealand's business environment is known for low corruption perception, strong contract enforcement, low tax rates on labor and capital, not to mention flexible and non-distortionary business legislation. The second best performer is the US followed by Denmark and the UK. In spite of one of the highest fax rates in the world, Danish business environment is a benchmark for the rest of the world in two major policy fields. First, a flexible labor market and second, a robust sistem of legal protection of investors. Among the best performing countries are Anglo-Saxon countries and Nordic countries. These countries are known for relatively free business environment although Nordic countries are characterised by high tax burden and high government spending.

Countries of Continental Europe are ranked in the middle. Their business environment is unfortunately known for high tax burden, high government spending, rigid labor market and, nevertheless, strong governmant intervention. For example, the collective bargaining coverage of labor contracts in Austria and Germany is close to 100 percent which is a measure of strong union power.

The Ease of Doing Business in 27 OECD countries

Source: World Bank

The worst performers in the OECD are Mediterranean and Vishegrad countries (Czech Republic, Slovakia, Poland, Hungary). In addition to high taxes, big government and rigid labor market, Mediterranean countries suffer from a weak rule of law and costly contract enforcement which hinders investor protection and diverts investment from productive into shadow sector of the economy. It is not surprising that in these countries union strikes and shadow economy are widespread.

Days to start business in 27 OECD countries

Source: World Bank

In the upper graph, you can see the number of days necessary to start a business. The findings reflect the pattern of the ease of doing business. Countries with higher administrative burden have the longest procedures in starting a business. Spain and Continental European countries were ranked on top with the highest number of days in starting a business while Anglo-Saxon countries are admired for quick and flexible administrative procedures in starting a business.

Economic freedom and the wealth of nations

Today, I would like to present the impact of GDP per capita on economic freedom across the world in 2010. Economic freedom is a measure of country's freedom to invest, consume, work and produce in any way pleased. It is also a measure of state's protection of private property rights under the rule of law. In the graph, I compared the GDP per capita (PPP-adjusted) in international dollars and economic freedom score from Index of Economic Freedom. The index ranges from 0 to 100; where higher number indicates higher level of economic freedom.

As you can see, higher GDP per capita is associated with more economic freedom. I found that if GDP per capita increases by 1000 USD, economic freedom score, on average, improves by 0.6 percentage points, all other remaining constant. In addition, 48.03 percent of the variation in economic freedom is explained by the variability of GDP per capita.

Economic freedom is an essential determinant of economic development. The lack of institutions of private property, rule of law and contract enforcement is the main source of economic underdevelopment and contemporary stagnation in the third world.

It is not natural disasters and the lack of humanitarian aid that keeps Haiti poor but the absence of economic freedom which has lead to widespread corruption in judiciary, business and politics, and to the diversion of investment out of the country. Haiti's economic freedom index (50.8) is among lowest in the sample of 50 countries.

The least economically free countries are Venezuela (37.1), Libya (40.2), Belarus (48.7) and Russia (50.3). The best performing countries in economic freedom are Australia (82.6), New Zealand (82.1), Ireland (81.3) and Switzerland (81.1).

Economic freedom and GDP per capita in 50 countries

Source: Heritage Foundation, IMF (2010)

Corruption and economic welfare

I collected data on GDP per capita and Corruption Perceptions Index (CPI) for 50 countries in the year 2009, disregarding the level of GDP per capita. The sample consists of developed, developing and least developed coutries. I discovered significantly negative relationship between GDP per capita and perception of corruption. CPI ranges from 1 to 10. Higher index implies lower corruption perception.

Corruption and economic welfare across nations

Source: IMF (2010), Transparency International (2009), own estimate

In general, countries with higher GDP per capita have significantly lower corruption perception and better institutional governance as well as the rule of law. The main finding is that if GDP per capita increases by 1000 USD, Corruption Perceptions Index will, on average, increase by 0.2 index points, all other remaining constant. It means that the persistence of corruption drops when countries become wealthier. GDP per capita is a good predictor of corruption perception. In general, 74 percent of the variability of corruption perception in the sample is explained by GDP per capita variation.

The least corrupt countries in the sample are New Zealand (9.4), Denmark (9.3), Sweden (9.2) and Switzerland (9.0). The highest perception of corruption was found in Haiti (1.8), Venezuela (1.9), Russia (2.2) and Belarus (2.4).

As we can see, fighting corruption is an important policy measure of encouraging economic development on the road to prosperity.

Corruption eruption

The Economist wrote an interesting article about corruption where it discussed the problematics of corrupion and why does it exist. The answer is simple. The chances of being cought are small while the temptation of bribery is too high as benefits are so great. According to "When in Rome act like a Roman" argument, bribery is the price the you have to pay to enter the world's most difficult markets. Bribery can also speed up the bureaucratic procedures. On the other hand, tackling corruption can make your way a bit more difficult as in the case of IKEA when the company entered the Russian market and decided to fire managers who were paying bribes to local officials. Ethics is the only weapon that can overtake the corruption.

Ethical principles are the ones that can make people, firms and govermnents change the why they deal with the situations. Moreover, in the US, the Department of Justice is prosecuting far more cases than ever before. In 2001, only eight cases were prosecuted. Now there are 150 cases, which confirms that things are improving. As the likelihood of being cought is dramatically higher than few years ago, firms are not taking on more risk that before. That is why not so many firms tend to do their work in the corrupt way. Internet as well makes it easier to control firms' activities. Thus, it is easier to reach the information. There is still a lot to be done with the help of a watchful eye.

Arizona's immigration law

The Economist published an article discussing the new Arizona's immigration law. Russell Pearce, an Arizona's state senator, proposed the new immigration law that would allow policemen to question anyone who would look suspicious to show them an identity card or some kind of document. So in the state with overwhelmingly white population where half a million have Hispanic origins there would be no surprise, if you are constantly stopped and questioned by the police as you match the profile.

We shouldn't forget how the US was brought forth by millions of immigrants from all over the world who were all looking for a better start in life. It is sad to hear that even though Latinos make up to 30 percent of the populaton in Arizona, only 12 percent are electorated. We should not be so intolerant to newcomers as we were once in their shoes. On the other hand, I try to understand the fear and insecurity that natives experience on a daily basis. Nevertheless, they should find a better solution to resolve the problem. Not to make the same situation that African Americans had to face back in 1960s that could happen to Latin Americans today, the history should not be repeated. And that is why the government should play out the roll it has been given.

Tax and labor cost

I composed a graph from Eurostat's database on tax wedge in EU, US, Iceland, Norway and Switzerland in 2008. Tax wedge is a measure of overall tax burden of labor cost. It shows the share of taxed labor cost. It is striking to see that EU goverments take in almost half of what you earn. Tax wedge is the highest in Belgium (50.3 percent). Hopefully, it does not set an example to the rest of EU countries, as EU15 tax wedge is over 40 percent. After all, EU15 is known for high tax burden. As you can see from the graph, tax wedge is the highest in Continantal Europe. Germany, one of the biggest EU economies, scored second with 47.3 percent, next is Hungary (46.7 percent) followed by France (45.5 percent), Austria (44.4) and other countries. All countries that scored above 35 percent should implement some radical reforms and so became more competitive and attractive for doing business. One of the countries that achieved to reduce tax wedge the most is Cyprus (0.0 percent), second best is Malta with 17.9 percent, Iceland (23.7 percent), Switzerland (26.5 percent), USA (28 percent), Luxemburg (29.6 percent) and UK (29.7 percent).

Source: Eurostat

Soccer Power Index

Soccer Power Index is a statistical measure of team power in world soccer. It is an interesting tool to predict soccer match results. Countries are ranked on the basis of Fifa points and past performance. The scale contains 211 national teams.

World Cup 2010

Nate Silver published the statistical simulation of the 2010 World Cup. For each country, he calculated the probabilities of wining and advancing in the playoff round. Below is the list of both probabilities for each team in each group. As you can see, the results are very interesting.

Source: FiveThirtyEight

Foreign direct investment in China's manufacturing industry

The biggest foreign direct investor in China's manufacturing industy in 2005 was Hong Kong where a lot of multinational firms are located, mostly because Hong Kong is one of China's special administrative regions due to Hong Kong's high degree of political and economic autonomy. In fact, Hong Kong enjoys the status of the freest economy in the world. The second foreign direct investor is Latin America followed by South Korea and other countries.
Source: China Statistical Yearbook (2005)

Foreign auto producers in China

Here is a graph showing the distribution of US, European and Japanese auto producers across location in Chinese manufacturing centres. As can be seen in the graph, Shanghai is the most popular manufacturing destination for US and Eurorean auto producers, followed by Jiangsu and Hubei. The most atractive destinations for Japanese auto producers are Jiangsu, where more than 70 producers are located, the next one is Guangdong followed by Shanghai and Tianjin.

Source: European Commission (2009)

Tariffs and China's trade

In 2001 China became the 143rd member of World Trade Organization (WTO). Since then, the country boosted trade liberalization in all sectors. Till the 1st of July 2006 tariffs on imported vehicles were in the range from 70 to 80 percent, which is a prohibitive level. When becoming the member of WTO, tariffs on imported vehicles, on average, dropped to 25 percent. After China became the member of WTO, import quotas and domestic content requirements were eliminated. In addition, now there are no restrictions on distribution and financing by foreign companies. Here is a link to the working paper published by the European Commission.

International comparison of housing prices

The Economist collected quarterly data on housing prices between 2003 and 2009. It is interesting to see how housing markets in different countries were affected during that period. You can roll over the chart here.

UK's public debt crisis

Financial Times reports that UK goverment borrowing spiralled out of control and is the worst in Britain's postwar history. In the past financial year, government borrowed 163.4bn GBP. In 2010, public sector net debt is expected to rise up to 53.8 percent of national income, up from 44 percent last year. Britain is in serious public debt crisis. That is why it is in an urgent need of the rebirth of Thatcherism and Reaganomics.

Sugar's record price

Prices of sugar are not expected to fall due to higher usage of sugar. About 70 percent of manufactured food has sugar ingredient. World's collective tooth is getting sweeter. On one side developing countries are starting to enjoy the nicer things in life whereas on the other hand developed countries are seeking some comfort in a cookie jar. This year USDA (US Dept. of Agriculture) estimated that worldwide sugar comsumption will rise by 1.5m tons. Supply won't be able to sustain the demand, even though prices are not expected to drop. Because of the curent global situation on sugar market, bad weather, monsoons in India and Mexico have damaged sugar crops. Not even Brazil, the larger sugar producer can't help prices to drop as now half of sugar it produces is used to make ethanol. And that is all a very good news for American sugar producers.

Millions of poor Indians are considered criminal by tradition

The Economist wrote an interesting article about the lack of the rule of law in India. Law protects only high-ranking wealthy individuals. That is what millions of poor Indians experience each day, as many are imprisoned without sufficient evidence. The right to justice is one of the basic human rights. World leaders should encourage India to enforce laws that would give all people the right to file the complaint and be properly treated, despite their origin. Western nations should set an example of the rule of law for the developing world. Sadly, many developed nations underestimate the importance of robust system of law for economic development of third-world countries.