Marginal Revolution: Which European interventions have been the real problems?

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Which European interventions have been the real problems?

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?

Posted by Tyler Cowen on August 25, 2006 at 07:02 AM in Economics | Permalink

Comments

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

Posted by: Alex Tabarrok at Aug 25, 2006 8:20:33 AM

The idea of letting "unemployed" counting for negative productivity is intruiging, because they live off the productive ones and limit their ability to save and purchase. One would have to collect data on the amount of redestribution in all European countries and the unemployement statistics.
However, how would one account for so-called "1 Euro" jobs, which are generated by government for short-term employment to boost moral. Is it covered productivity?
Is this in fact a Maximum Wage-law?

Posted by: Max at Aug 25, 2006 8:36:01 AM

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.

Posted by: joan at Aug 25, 2006 10:37:54 AM

Tyler and Alex,

How is it even possible that welfare state programs don't damage productivity to a significant degree? Just ceteris paribus it seems to me that markets tend to allocate goods and service to their most productive uses, whereas governments don't. So don't we have some prima facie reason (but not impossible to defeat reasons) to think that all programs like this will have some dampening effect?

I mean, it has to be said that when you spend more money on X, you tend to get more X. So if you move investment money (which is probably the effect of high income taxation) to social services money, don't you create a disincentive for more investment and an incentive for more poverty? And isn't there good prima facie reason to think that people, at least sometimes, follow those incentives?

So forgive me, but when the authors claim:

"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."

I am very skeptical. Shouldn't their statement be weaker? Or perhaps negated?

Another interesting question (which I would love for you two to blog on): Exactly what counterfactual scenario are the authors comparing the current situation to? Do economists have a view about how to compare real-life scenarios to counterfactual scenarios? What counterfactuals one picks seems exceedingly important to understanding one's data. But, counterfactual situations are so hard!

To me, if one argues that welfare-state wealth transfers have no effect on GDP, that means that *GDP WOULD BE NO HIGHER* if those programs did not exist. But how could that possibly be?!

Posted by: Rhadamanthus at Aug 25, 2006 11:02:57 AM

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?

Posted by: spencer at Aug 25, 2006 11:48:13 AM

Aehm, I don't know what you mean with "no effect", because effectively, someone with 3100 Euro per month salary, has a Tax-rate of 75%:

You end up with something around 900 EURO after taxes OO

And you think this is not negative? I also think that the amount of people leaving Germany has risen to an all-time high. It is the same in France. We only have a good productivity, because the recycling process of the government still works to transfer huge amounts from high earners to the poor.
We also have still a strict rule of government schools, which are (in contrast to the US) rather competitive and steam-lined on success and knowledge.
We still have a huge export, which is the result of the decades old family businesses in mechanical engineering.
We have been living on this substance for too long and I don't think this will last a lot longer.

Posted by: Max at Aug 25, 2006 1:27:13 PM

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.

Posted by: Barkley Rosser at Aug 25, 2006 4:37:43 PM

It has been my feeling for a while that labor restrictions are the worst. If you look at the World Bank "Doing Business In..." (http://www.doingbusiness.org/), you will see that many African countries with hunger problems have tighter labor market restrictions than the U.S. Insanity!

Posted by: Mr. Econotarian at Aug 25, 2006 5:03:55 PM

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)

Posted by: Mr. Econotarian at Aug 25, 2006 5:12:30 PM

I, being an ignoramus, hardly dare open my mouth in such a learned company. But I will dare a few small questions…

How can you make an accurate judgment on the effect of macro economic polices without taking into account the relative size of the black\grey markets in the various economies in question?

Speaking as someone who has worked in the trades, I can tell you that what the government mandates and what people actually do can be two different things. To put this in practical terms, let us say that some economist decided to study the economic effects of an OSHA safety regulation. Let us say that his study shows that the OSHA safety regulation has no negative economic effect. Let us suppose that this study is correct as far as it goes.

But let us also say that the study fails to look at whether anyone actually follows the regulation in question. Let us suppose that the actual facts of the matter are that no one follows that particular regulation. This raises the question; what is the use of the economist's study on the economic effects of that particular OSHA regulation?

Now correct me if I am wrong, but I have always been told that the black\grey markets in Europe are very large. In fact, I have read that black\grey markets form a larger percentage of actual economic activity in Europe than in America. Admittedly one has to wonder how you can accurately measure such things. But this still raises the question of how useful it is to compare official economic statistics in an effort to determine the effects of macro policy.

You might argue that if macro policy causes economic activity to move to the black\grey market that the loss of such activity will show up in the official statistics. But a quick thought experiment will show this not to necessarily be the case.

Let us say that some French dude wants to build a house. Let us say that French regulations get in his way. Let us say that bribes the authorities so that he can build his house without complying with the regulations. Now this house will show up in the statistics as legitimate economic activity. But what does it tell you about the actual effect of the regulation in question?

The whole reason people pay bribes is because it is less of a cost than complying with the regulations (all other things being equal). Thus by paying the bribe, less economic cost is afflicted by the regulation than would be the case if it was honestly applied.

Given all this, how can we be sure that actual economic cost of a particular macro economic policy is truly being reflected in comparison of various countries?

I guess that question was not so small. So for decency's sake, I will save the rest of my questions for some other time.

Posted by: The Chieftain of Seir at Aug 25, 2006 7:39:52 PM

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.

Posted by: Barkley Rosser at Aug 26, 2006 2:26:49 AM

Barkley Rosser,

I should have specified that I was thinking more along the lines of regulation and not taxes. I know that you can hardly throw a stone in a Republican convention without hitting someone who would use the Black\Grey market problem as justification for why lower taxes will bring in more revenue. But the Black\Grey market problem as it relates to the macro cost of regulation does not seem to get as much attention. At least, not in the publications that I read….

I was going to ask a question about how economists handle the comparison of the macro effect of taxes as well, but when I say the length of my first question I decided to skip it.

Posted by: The Chieftain of Seir at Aug 26, 2006 7:50:03 AM

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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