Gayle Allard and the ever-interesting Peter Lindert write:
How have labor market institutions and welfare-state transfers affected
jobs and productivity in Western Europe, relative to industrialized
Pacific Rim countries? Orthodox criticisms of European government
institutions are right in some cases and wrong in others. Protectionist
labor-market policies such as employee protection laws seem to have
become more costly since about 1980, not through overall employment
effects, but through the net human-capital cost of protecting senior
male workers at the expense of women and youth. Product-market
regulations in core sectors may also have reduced GDP, though here the
evidence is less robust. By contrast, high general tax levels have shed
the negative influence they might have had in the 1960s and 1970s.
Similarly, other institutions closer to the core of the welfare state
have caused no net harm to European jobs and growth. The welfare
state’s tax-based social transfers and coordinated wage bargaining have
not harmed either employment or GDP. Even unemployment benefits do not
have robustly negative effects.
These are underexplored but not easy to explore questions; here is the paper.
I would feel better if Ireland were removed from the data set, since a booming economy can afford many sins. After this adjustment, coordinated bargaining wouldn’t look as good. And when we calculate average productivity, should not the unemployed count for "zero productivity," or even negative, in the appropriate measure? I believe that tax rates matter, but only at particular thresholds.
I also would like to argue the following: "Don’t think we can pick and choose the egalitarian interventions which turn up as the very best in econometric studies. We are unlikely to know in advance which policies are the least harmful and politics is even less likely to turn those proposals into legislation."
But would I be committing The Libertarian Vice?
I don’t trust the tax result at all and thus have my doubts on the rest of the paper. On taxes, Prescott’s results make a lot more sense.
http://www.marginalrevolution.com/marginalrevolution/2003/10/why_dont_the_fr.html
I suspect that in industrialize democracies, policies that are clearly bad for the majority of people are abandon over time so the differences between countries end up being small, and therefore hard to measure. I know that some EU countries have much higher taxes than the US, but if you factor in what we pay for health insurance, the difference is not much. The fact that the US has a growing populations and work force, and Europe does not means we are much more focused on job creation.
Rhadamanthus– how could that exist? The big difference could be found in the differences in the tax systems. In Europe the tax system is set up to tax consumption much more then income then in the US. As a consequence there generally is less tax on capital in Europe. Moreover, the welfare system is much more a shift of income between middle and lower income groups and other middle and lower income groups than in the US.
I have not looked into it to any great extent, but I keep wondering if the slow down in Western Europe over recent years hasn’t been largely a conquence of the opening up of Eastern Europe to the world market system. Because wages are much lower in Eastern Europe but productivity is not all that much lower we have seen a major shift of investment that would have previously been in Western Europe to Eastern Europe. This has to have had a significant impact of slowing Western European growth that had little or nothing to do with the welfare system.
Does anyone have any studies that have looked at this issue?
Alex and Rhadamanthus,
While many have strong priors here, such as that “markets
always work better than governments,” a sentiment I know
widely accepted on this blog, this is in fact an empirical
issue that turns out to be quite complicated. One can
certainly quibble about details of the study in question
here, but many of its findings have shown up in other places.
The bottom line seems to be that certain kinds of interventions
are more harmful than others. Direct regulation of prices and
markets seems to be more serious culprits here than some others,
and is I would argue, very much of the problem in Germany, where
businesses face an array of silly regulations, rather than taxes
per se.
The obvious examples are Nordic countries. They are in
fact doing quite well on many measures, employment, inflation,
real per capita income (Sweden less so, but Norway just
surpassed the US, granted partly due to high oil prices),
and so forth. If one goes and looks at some of the indexes
on “competitiveness” and “friendliness to business” and
“corruption,” one finds these countries doing very well,
in some cases ahead of the US (certainly on corruption,
they have the lowest, with Finland best of all). Norway
has some of the simplest rules in the world for starting
a new business or establishing property rights. These
things turn out to be very important, unsurprisingly, and
most libertarians have no idea how good these countries
are in these areas. There is little state ownership and
never has been, and essentially no central or command
planning, never has been, in contrast with some other
western European countries.
Their high taxes are where they come off looking bad on
these various indexes, but given that people get some
services they desire, such as much higher quality (and
less expensive) medical care than one can get in the US,
people are not so displeased. Certainly the results on
taxes can be disputed, but we have all these Grover
Norquist types here in the US simply spouting as dogma
that tax increases are always bad and so forth, often
with little to no evidence.
Let me note for the US three examples, two recent, one
further back. During the governorship of Mark Warner
in VA, he raised taxes (a couple of years ago). His
opponents in the legislature made all kinds of doom
and gloom predictions of what would happen. But Forbes
just listed VA as far and away the best state in the US
to do business. So much for that forecast.
Then we have the Clinton tax increase of the early 90s,
not voted for by a single Republican in Congress. Again,
there were all kinds of forecasts that this would plunge
the country into recession, some of these forecasts quite
perfervid. You all know that this was followed by a major
boom that resulted in a full-blown stock market bubble.
So much for that forecast.
Then we can go back further. I shall simply note that from
around 1940 until 1964, or so, the top marginal income tax
rate in the US was over 90%. Now there is no way I would
support returning to that. However, the hard fact is that
the US GDP grew more rapidly during that period than it has
in the last 24 years, when the top marginal income tax rate
was never above 50% at the federal level. If someone wants
to point out that other factors may be involved, I fully
agree. But this case is simply a reminder that it is very
easy to wildly exaggerate the negative incentive effects of
high taxes.
Frankly, there is lots of evidence that tax complexity and
uncertainty is more important and damaging than simply high
taxes. Bush should have gone seriously for tax simplification,
as Reagan did in 1986 (not enough to suit me then, but better
than now). As it is, well, we all know what he has gone for,
and it is not much to write home about, unless you are a big
believer/follower of Grover Norquist and his allies.
To illustrate my point, here are the ten world’s worst countries for the Difficulty in Hiring Index according to the World Bank:
Mauritania: 100
Congo, Dem. Rep.: 100
Niger: 100
Morocco: 100
Congo, Rep.: 89
Central African Republic: 89
Sierra Leone: 89
Mozambique: 83
Burkina Faso: 83
France: 78 (ok, they are tied with 9 other countries including Greece)
The Chieftain of Seir,
This is indeed a big issue, but one that is difficult to deal
with because there are many estimates and no agreed upon numbers.
A lot of people studying this, such as Friedrich Schneider and
Dominik Enste or Edward Feige, argue that higher tax rates lead
to more underground economic activity. There certainly are some
good a priori reasons to expect this.
However, it turns out not necessarily to be the case. Again,
the Nordic economies exemplify the problem. They have the highest
tax rates around pretty much, but have among the lowest rates of
underground economic activity, according to most studies. There
appears to be a very strong correlation between corruption and
underground activity, and they are low on corruption also. This
may have to do with social capital and trust, and people not being
alienated from the system, thus willing to work at above-ground
jobs and paying taxes, even when their tax rates are high.
Rhadamanthus,
When you take the viewpoint that libertarian theory trumps all findings to the contrary then you certainly can’t find that productivity wasn’t harmed. However, if you test the theory, as the author of the paper has done, then you can find surprising results. Your question is: If libertarian theory is correct, how can these findings be true? You are free to have this view, but try reading the paper before questioning how strongly the author can assert his findings.
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