Economy needs both Reform and Investment

LIVE TOGETHEROne way President Barack Obama can begin to put the IRS scandal behind him is by proposing a comprehensive tax reform. Beyond usual Washington theatrics, real problem is that the U.S. tax code is unbelievably complicated, clocking in around 74.000 pages, with all rulings, regulations and other material. The greater the complexity, broader bureaucrats’ powers to determine status of an individual, a corporation or association. A radically simplified tax code, even one that raised more revenue, would be good politics, good economics. (source: by Fareed Zakaria – The Washington Post – 23/05/2013)

U.S. tax code is at the heart of a system of institutionalized, legal corruption. Code is so vast because companies, industries and lobbying groups receive special preferences in return for campaign contributions, a cash-for-favors scheme Washington would denounce as crony capitalism in any Third World country. You can see the corruption at work in the fierce opposition to efforts to lower the corporate tax rate. After demanding this reduction for years, companies are now lobbying hard, and spending heavily, to retain their own special tax breaks, which is what drove rates up in the first place. Corruption aside, consider the economic costs of the gargantuan tax code. At 4 million words, it is multiple times larger than those of France and Germany. In 2010, Americans spent $168 billion to comply with the code. Last year taxpayers made 90 million calls to IRS toll-free telephone number asking for help.

In World Bank’s 2013 “Doing Business” report, the United States ranks a woeful 69th in the category of paying taxes. In Michael Porter’s survey of 10.000 graduates of the Harvard Business School, published in January 2012, the U.S. tax code was named the biggest drawback to doing business compared with other countries. The respondents recommended “simplifying the code” five times as often as they suggested “reducing taxes.” In our ongoing, spirited debate about austerity programs, the data are increasingly convincing that the Keynesians have been right. As someone who has long been advocating big investments in infrastructure, job-training and science, I’m delighted. But case against austerity is turning into the case against reform. Some of the most eloquent anti-austerity voices, including Paul Krugman in his influential blog, are dismissing the idea that there is any need for structural reforms, that these are effectively plans that will hurt workers and help greedy capitalists. But the record of past several decades shows that structural reforms, often induced by a crisis, have been a crucial path to growth. After the Asian economic crisis, the countries that opened up their economies grew strongly. Chile’s reforms in 1980s and 1990s set the stage for its long boom. Mexico’s reforms over past decade are paying off. One of the reasons that rich countries such as Canada, Germany and Sweden are doing so well these days is that, in the wake of their own economic crises in the 1990s, they undertook major, market-friendly reforms, and made their welfare states more sustainable. Changes in policy were relevant to countries’ subsequent success.

In Europe, countries such as Greece and Italy will not get sustained growth simply from stimulus spending and easy money. Most have rigid labor markets, high labor costs and inefficient and protected industries and guilds. Without change, these economies might get a temporary boost but will remain uncompetitive in a long run. Italy ranks 73rd on “Doing Business” survey, behind most emerging markets. In Greece’s vast state-owned industries, workers used to labor for 35 hours a week but were paid for 14 months a year and could retire with full pensions in their 50s. Did none of this have to change? Story of Japan’s stagnation over the last two decades is complicated. But some part of Japan’s failure to sustain growth was that it never reformed its protected industries, agriculture and retail chief among them. Between 1991 and 2008, Japanese government spent $6.3 trillion on construction, more than the total size of its economy. That’s why Prime Minister Shinzo Abe has been clear that to enable Japan to sustain its current revival, he wants to make the changes that his nation was unwilling to make in the last decade. It is true that many of the people urging austerity programs were also urging the countries to engage in structural reforms. But the two are not connected. Is it possible to be in favor of investment and reform. In fact, that’s exactly what United States needs to ensure the next generation of growth. 


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4 Responses to Economy needs both Reform and Investment

  1. In April, Germany’s central bank, the Bundesbank, was optimistic. Springtime would bring a rapid recovery from the winter blues and an increase in investment, it said. “Business activity expectations for the German economy have recovered quickly and strikingly in the last three months,” the Bundesbank wrote in its report. The bank’s optimism, however, may have been a touch premature. German exporters are becoming more pessimistic as the spring progresses. On Thursday, the Association of German Chambers of Commerce and Industry (DIHK) released the results of a survey showing that companies dependent on exports are much less optimistic than a short time ago. While 30 percent still expect overseas turnover to rise, one in eight believe it will fall. “Exports are likely to develop less dynamically in the coming months,” the DIHK writes in the report, which is based on survey of 25,000 companies. The new report comes at a time when many are forecasting an extended period of stagnation for the euro-zone economy. Last week, the European Union statistics office released growth numbers for the first quarter of this year indicating that nine of 17 member-states of the common currency zone are now in recession, with the zone as a whole shrinking by 0.2 percent in the first three months of this year. Germany’s economy, while showing growth, is hardy robust, expanding by a mere 0.1 percent from January to March. With several bloc economies mired in debt and economy malaise, the future is murky.

    Mark Carney, outgoing Bank of Canada governor, who is heading across the Atlantic to become head of the Bank of England on July 1, became the latest Cassandra earlier this week. In his final speech as Canadian central bank chief, Carney said of Europe: “Deep challenges persist in its financial system. Without sustained and significant reforms, a decade of stagnation threatens.” He added that: “Europe can draw lessons from Japan on the dangers of half measures.”

    The DIHK on Thursday also lowered its own expectations for German economic growth, sinking its prognoses for the entire year from 0.7 percent to a paltry 0.3 percent. “The German recovery has been postponed,” said DIHK head Martin Wansleben in Berlin. In addition to concern about exports, Wansleben also noted the unusually cold late-winter weather in March. Some 41 percent of German companies that took part in the survey said that weak foreign demand was the primary risk facing their businesses. “The uncertainty hasn’t been this great since 2010,” the DIHK said. (source: Der Spiegel – 23/05/2013)

  2. You may have missed it, but the European Union held a summit this week. Taking in a nutritious working lunch, Europe’s prime ministers, presidents and chancellors devoted half of Wednesday to weighty issues of energy and taxation. Gone are the panic-stricken sessions of last year, dogged by talk of the euro’s imminent failure. Today, Europe’s leaders note, reform is under way across most of the euro zone and some southern European countries are regaining their competitiveness. The government-debt market is back in its box, where it belongs. And over the past year share prices are up by a quarter. Nobody could pretend that life is easy; Europeans understand that hard work and sacrifices lie ahead. But the worst of the crisis is now safely in the past. It is a reassuring tale, and those worn down by the Wagnerian proportions of the euro saga (who isn’t?) are eager to believe it. Unfortunately, the idea that the euro is yesterday’s problem is a dangerous figment. In reality, Europe’s leaders are sleepwalking through an economic wasteland.


    The euro-zone economy has just endured a sixth successive quarter of shrinking GDP. The malaise is spreading to core countries including Finland and the Netherlands, which both contracted in the first quarter.Retail sales are falling. Unemployment, above 12%, is a record—with more than one in four Spaniards out of work. In spite of savage spending cuts, government deficits are persistent and high. The sum of government, household and company debt is still excessive. Banks are undercapitalised and international lenders worry about their as-yet-unrecognised losses. Although official interest rates are low, firms in southern Europe are suffering a cruel credit crunch. All this is causing economic hardship today and eating away at the prospects for growth tomorrow. The euro zone may not be about to collapse, but the calm in Brussels is not so much a sign of convalescence as of decay. For everyone’s sake, Europe’s leaders must shake themselves out of their lethargy. They must grasp that if they do not act, the euro zone faces stagnation or break-up—possibly both (…..) Mr Draghi was right to buy the euro zone time. He was also right to furnish the ECB with the tools to tamp down speculation. The trouble is that the politicians are squandering the chance for orderly reform. Optimists say that everything will be just fine after Germany’s election, when its leaders will have a mandate for euro-zone reform. But German reluctance either to lead or to pay for the rest of Europe runs deeper than that. Besides, Mr Hollande’s woes mean that the Franco-German relationship, always central to the evolution of Europe, has seized up. And if euro-zone leaders stumble on? Like Japan, Europe will be under a shadow for years to come. The cost will be measured in disillusion, blighted communities and wasted lives.

    Unlike Japan, though, the euro zone is not cohesive. For as long as stagnation and recession tear at democracy, the euro zone risks a fatal popular rejection. If the sleepwalkers care about their currency and their people, they need to wake up.

  3. Everyone knows the stereotypes. Germans save for the future, while Spaniards spend everything they earn. So it’s not surprising that Germany has survived the recent crisis in decent shape, while Spain is a mess, with unemployment at roughly 27 percent. If only the Spaniards had been as thrifty as the Germans, this never would have happened, right? WRONG. The spending patterns of Spanish households did not cause the euro crisis, but were a response to the imbalances created by excess savings in Germany. Furthermore, these excess savings were not caused by the thriftiness of German households, but by policies that forced up German savings rates to levels that Europe could not absorb without creating serious imbalances (…..)

  4. With the euro crisis refusing to relent, the German government is backing away from its austerity mandates and planning to spend billions to stimulate ailing economies in Southern European. But can the program succeed? (…..) This is how the plan is supposed to work: First, the KfW would issue a so-called global loan to its Spanish sister bank, the ICO. These funds would then enable the Spanish development bank to offer lower-interest loans to domestic companies. As a result, Spanish companies would be able to benefit from low interest rates available in Germany. Under the plans, Germany could also invest in a €1.2 billion ($1.6 billion) venture capital fund that could be used to support new business activities. Madrid hopes that the program will generate a total of €3.2 billion in new investment. The agreements with Spain are intended to serve as a blueprint for similar aid to Portugal and possibly even Greece. How high the payments to these countries will be has yet to be determined. “It will be nothing to sneeze at,” say Finance Ministry officials. The German government envisions spending a total in the single-digit billions on the program. Schäuble plans to fill in the budget committee in the German parliament, the Bundestag, next week. This is necessary because the KfW is supposed to serve as an agent of the federal government rather than act on its own account. For this reason, the federal government will back up the KfW program with guarantees, which require parliamentary approval. In his letter to Rösler, Schäuble also suggests that Berlin should advocate an easing of the guidelines for aid to crisis-ridden countries. He notes that Germany already acquired valuable experience in this regard during the difficult post-reunification period when it was developing the areas that once belonged to communist East Germany. “I think the situation in some EU member states is certainly comparable to Germany’s situation at the time,” Schäuble writes, and he urges Rösler to promote the plan at the EU Competitiveness Council meeting on Wednesday. If Rösler is successful, some €800 million in funding could be released that was already made available for aid to Portugal but is still being blocked owing to competition-related concerns (…..)


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