Thursday, December 9, 2010

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)

Wednesday, December 8, 2010

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.

Monday, December 6, 2010

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.