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Interview with Guillermo Calvo
From the Richmond Fed, the focus is Latin America. Here is one insightful bit of many:
RF: What is your opinion of Hernando de Soto's The Other Path? What lessons can policymakers in Latin America take from that book?
Calvo: The main lesson is that regulations must be simplified as much as possible in order to encourage the development of the formal sector and, thus, most likely enhance the pace of technical progress. However, I am skeptical that a major overhaul of government regulations will have a major effect in the short or medium term. The reason is that the informal sector strongly relies on tax evasion and, unless you implement a major tax moratorium — accompanied by substantially lowered tax rates —firms are likely not to move to the formal sector, even if all the red tape is eliminated. Moreover, a moratorium is likely to have detrimental moral hazard implications.
Posted by Tyler Cowen on August 26, 2006 at 06:14 AM in Economics | Permalink
Comments
I'm confused. If the costs of complying with government regulations and paying taxes are reduced, at some point won't these costs be lower than the benefits of being in the formal sector and thus being able to take advantage of protection of property rights and contract enforcement? Or is there some sort of path dependency that makes businesses that start out in the informal sector less likely to switch even if seems to become worth it?
Posted by: Jacqueline at Aug 26, 2006 10:06:15 AM
The point is that the cost of paying taxes is very high, thus reducing the cost of govt. regulations will not have an impact. I'm not clear what he means when he says that a moral hazard prevents a tax moratorium though.
Posted by: Sameer Parekh at Aug 26, 2006 10:31:19 AM
the morald hazard is that they wont pay their tax debt because the will wait another amnesty.
Posted by: Salvador at Aug 26, 2006 2:05:34 PM
I would also recommend a recent article in the Economist on land titling experiments in Mexico and Argentina. Among the points discussed are that a stable job still remains key to aquiring credit in most developing countries and the difference b/w securing credit from public vs private banks. Also:
"[There are] two sides to collateral: enforcing the bank's right to repossess an asset is as important as recognising the owner's right to possess it. But titling programmes, they write, “unavoidably signal to lenders that a government prioritises housing for the poor, and hence is more likely to side with borrowers in enforcing credit contracts.” "
Link: http://www.economist.com/printedition/displayStory.cfm?story_id=7830209&fsrc=RSS
Posted by: PiensoBlog at Aug 26, 2006 5:11:44 PM
I'm with Jacq on this. There are benefits to operating a business in the sunshine (such as dispute resolution) that do not accrue to businesses that opperate underground (where dispute resolution often means breaking someone's kneecaps). At some point of regulation reduction (and de Soto demonstrates that "regulation" often means a checklist that extends the length of a hallway) there are benefits to stepping out and into the sunshine, even if you consider the cost of taxes. Instead of a tax moratorium, consider a permanent tax reduction along with the reduction in regulations. The larger tax base should offset the losses due to the rate reduction. Throw in a little crime reduction on the side (due to the reduction in broken kneecaps) and everyone is better off.
Posted by: Steve at Aug 26, 2006 7:39:29 PM
One big problem in most Latin America countries goes back to the Conquistadors: the white elite owns most of the land, at least on paper, but it allows the brown masses to squat on some of it to preserve social peace. The white elite doesn't want to formally give up its property rights in the land (would that encourage more theft?) and the brown masses don't want to move from the only homes they have. This isn't an insoluble problem, but it needs to be recognized as standing in the way of De Soto's solutions.
Posted by: Steve Sailer at Aug 26, 2006 9:43:19 PM
"The point is that the cost of paying taxes is very high, thus reducing the cost of govt. regulations will not have an impact."
I don't have my de Soto handy but I thought that he also advocated lowering tax rates because this would encourage more people to actually pay their taxes, thus bringing in enough new taxpayers into the system to offset the effect of the rate cuts on the tax revenue (sort of a Laffer curve of tax evasion)? Or am I thinking of someone else?
"the white elite owns most of the land, at least on paper, but it allows the brown masses to squat on some of it to preserve social peace."
I wish someone would/could do a cross-country study to see if there is a positive correlation between the level of inequality in the distribution of formal land ownership in a country and the popularity of communist/socialist ideology and candidates...
Posted by: Jacqueline at Aug 27, 2006 1:27:52 AM
This may be wrong, but I have a suspicion that at least
one motive for posting this quotation from Calvo is in
response to my remarks about taxation in Europe not necessarily
being associated with a bigger underground economy. Here
is Calvo saying that at least in Latin America it is the
big thing, the key thing, with reducing regulations and
so forth not so important.
Well, this is a matter I have actually studied and published
on (see some papers at http://cob.jmu.edu/rosserjb). Indeed,
I along with two coauthors was the first to argue in the context
of transition economies that there is a strong link between
inequality and the size of the underground economy, ceteris
paribus. This has been confirmed in broader global data sets,
including Latin American countries, where, of course, inequality
is extreme. This is now viewed as an obvious truism by many,
but were the first in 2000 in the Journal of Comparative
Economics to argue it for any data set. How this can affect
things has been described both in De Soto and in comments above
by Sailer and others about land ownership and Conquistadors and
all that.
Regarding regulations, these are often associated with rent
seeking and bribery by officials. Our studies show that the
strongest link of all, stronger than the inequality one, is
between corruption and underground economies. Part of that
is driven by this sort of rent-seeking bribery based on regs
by officials. So, the reduce-regs argument is strong, even
if it might not be ultimately sufficient.
The debate over taxation and underground economy has been
fierce. Standard lit, led by Schneider and Enste, has simply
argued that it is obvious that higher taxes lead to more
underground economy. A 2000 paper by Friedman et al in Journal
of Public Economics found just the opposite, that globally in
a multiple regression, lower taxes were associated with more
underground economy.
In papers on my website we have resolved this. Income distribution
is the missing variable not in either of the studies done by these
two sides. Putting that in makes taxation an insignificant variable
with no net effect on underground economy share. What is going on?
The obvious effect that higher taxes increase incentives to join
the underground economy is offset by the effect that more equality
tends to reduce informality, and higher tax rates are strongly
correlated with more equality, with, again, the Nordic economies
the poster boys, having very low corruption, low underground
economies, low inequality, and high tax rates.
Regarding Calvo and Latin America, they are just the opposite of
the Nordics on all this. Clearly it is very hard to do much
about wealth and income distributions. In that case, major
reductions of regulations and probably some tax reductions, but not
to zero, on these businesses are called for to get this informal
sector to go legal/formal/above-ground. I think the regulation
problem, so deeply entwined with corrupt rent seeking bribery,
is the bigger problem in most of these countries (there are a lot
of individual variations, of course). Hence the call to reduce
taxes to zero is probably overdone.
Posted by: Barkley Rosser at Aug 27, 2006 9:35:00 AM
Why is this shaping up to a guns vs butter debate? Reducing regulations and reducing businesses taxes need not be mutually exclusive.
Since they both seem highly desirable, I'm inclined to think that doing both at the same time would be healthy, although one needn't wait on one if the other is politically deadlocked. But if they were both done at the same time and the economy boomed (even a mini-boom will do) as a result, no one would know which was the cause of the effect, so there would be added power to overcome rent seeking behaviour.
I'm with Jacqueline here, people seem to not be thinking on the margin. If reducing regulations reduces the cost to doing business legally, then at the margin you'd have more and more informal market business owners going legit. Not all of them, and not all at once, but it would start happening. Unless of course one thinks that regulation costs aren't real costs....
Posted by: happyjuggler0 at Aug 27, 2006 4:46:57 PM
The white elite doesn't want to formally give up its property rights in the land (would that encourage more theft?) and the brown masses don't want to move from the only homes they have.
The first part of that quote is indeed a moral hazard and at the margin would invite additional squatting. But allowing squatting to continue is also a moral hazard that enourages more squatting.
I suggest granting property rights to established squatters a la De Soto. I also suggest that at the same time this is happening, that it be decreed that all new squatting will be credibly punished by law, and that the government follow through on this threat.
Posted by: happyjuggler0 at Aug 27, 2006 4:58:06 PM
happpyjuggler0,
This business of property rights runs up against the
wealth (land) distribution issue in Latin America.
These folks are squatting on some kind of owned property.
If it is privately owned there is a difficult problem.
If it is public, then giving out some kind of business
equivalent of "homesteading" becomes a lot easier.
It is worth keeping in mind that De Soto's analysis is
very Peru-centric. Conditions vary across Latin American
countries in many ways. Calvo may have a broader perspective
(I think he is from Brazil, although maybe Venezuela or
somewhere else), although I have disagreed with his hard
focus on "cut taxes first," even as that may be the most
doable thing in some cases. In any case, one needs to keep
in mind that important legal, institutional, social, economic,
political, and other details can vary widely across these
countries. Just think how the following compare with Peru,
not to mention each other: Mexico, Guatemala, Costa Rica,
Barbados, Cuba, Haiti, Brazil, Venezuela, Paraguay, Chile.
Posted by: Barkley Rosser at Aug 27, 2006 6:18:26 PM
I had an acquaintance in Chicago who began a fashion clothing business in order to launder money from his marijuana sales. He wound up devoting himself full-time to the funky bluejeans because it proved to be less hassle for the money.
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