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Archive for October 4th, 2011

What nation is a role model for economic reformers?

I’ve certainly cited Hong Kong as an example, but I’ve also explained that we can learn lessons – at least on certain issues – from nations such as Sweden, Australia, Canada, and the Baltics.

Today, let’s talk about the curious case of Denmark, which is a rather schizophrenic nation (at least when it comes to public policy).

According to Economic Freedom of the World, it has the 15th-freest economy in the world, out of 141 nations that get graded. This is a relatively good score, but what makes Denmark rather interesting is that it is the combination of two things that normally don’t go together.

The first item is a free market, laissez-faire economy.

*  Denmark is the 5th best nation in the world for protecting property rights and maintaining a sound legal structure.

*  Denmark is the 11th best nation in the world for avoiding over-regulation of credit, labor, and business.

*  Denmark is the 24th best nation in the world for sound money.

*  Denmark is the 25th best nation in the world for freedom to trade across borders.

*  Because very few nations have consistently good scores in all these categories, Denmark ranks 4th among all nations when you combine these important measures of a free market economy, surpassed only by Hong Kong, Singapore, and New Zealand.

In other words, Denmark is about as laissez-faire as a nation can be, and it definitely ranks above the United States.

The second item is bad fiscal policy, featuring high tax rates and a bloated welfare state.

*  Denmark ranks 113th for fiscal policy in the Economic Freedom of the World report.

*  With a tax burden that amounts to more than 54 percent of GDP, it is second only to Norway as the highest-taxed developed nation in the world.

*  The burden of government spending is more than 58 percent of GDP, the highest of all industrialized nations.

*  Denmark impose the highest income tax rate in the developed work, a punitive rate of more than 59 percent.

*  Astoundingly, that top tax rate takes effect when income reaches about $45,000.

These factoids, which come from the OECD fiscal database and the OECD tax database, show that Denmark is about as statist as a nation can be.

So what can we learn from Denmark, especially given this Dr. Jekyll and Mr. Hyde approach to public policy? Probably a lot, but I want to focus on two lessons.

1. A nation with a big welfare state needs to compensate with ultra-free market policies in other areas if it wants economic growth. Denmark may not be enjoying strong economic performance, but it does reasonably well, particularly compared to some other European nations. The lesson to learn is that a nation that is screwing up on one policy – such as Denmark with fiscal policy – needs to be very careful not to allow mistakes in other areas.

2. An even more important lesson to understand is that Denmark waited until it became a rich nation before it adopted the welfare state. Indeed, this is the story of just about every North American and Western European nation. The burden of government spending didn’t explode until the 1960s. This is important because there is a relationship in the academic literature, known as Wagner’s Law, which revolves around the tendency for rich nations to have big governments. Some people naively conclude that this means big governments lead to more prosperity. But this puts the cart before the horse. Denmark and other western nations became rich first, and then government expanded.

This chart from two European economists shows that even as late as 1960, government spending in six major western nations averaged only about 25 percent of GDP. That’s far lower than the United States today (getting close to 40 percent) and much lower than the burden of the public sector in many European nations (in some cases more than 50 percent of GDP).

Most importantly, government spending consumed only about 10-12 percent of GDP prior to World War I, and this was the period when the western world was transforming from agricultural poverty to middle-class prosperity.

Unfortunately, the big expansion of the welfare state in the 1960s (which was made possible by the money maching known as the value-added tax) has slowed growth in western nations. The only silver lining to that dark cloud is that at least these nations became relatively rich before the burden of the public sector became too large.

This is why, whenever I’m speaking in a developing nation or a transition economy, I explain that they should copy nations such as Denmark and the United States. But they should copy our policies from 100 years ago, when we became rich countries. Copying our policies today, on the other hand, is a recipe for tepid growth in the short run and Greek-style fiscal chaos in the long run.

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Regular readers know that the two things that get me most excited are the Georgia Bulldogs and the fight against a bloated public sector that is ineffective in the best of circumstances and more often than not is a threat to our freedoms.

So you will not be surprised to know that I am delighted that former Georgia Bulldog star Fran Tarkenton (who also happened to play in the NFL) has a superb piece in the Wall Street Journal ripping apart the inherent inefficiency of government-run monopoly schools.

Here is the key passage.

Imagine the National Football League in an alternate reality. Each player’s salary is based on how long he’s been in the league. It’s about tenure, not talent. The same scale is used for every player, no matter whether he’s an All-Pro quarterback or the last man on the roster. For every year a player’s been in this NFL, he gets a bump in pay. The only difference between Tom Brady and the worst player in the league is a few years of step increases. And if a player makes it through his third season, he can never be cut from the roster until he chooses to retire, except in the most extreme cases of misconduct. Let’s face the truth about this alternate reality: The on-field product would steadily decline. Why bother playing harder or better and risk getting hurt? No matter how much money was poured into the league, it wouldn’t get better. In fact, in many ways the disincentive to play harder or to try to stand out would be even stronger with more money. Of course, a few wild-eyed reformers might suggest the whole system was broken and needed revamping to reward better results, but the players union would refuse to budge and then demonize the reform advocates: “They hate football. They hate the players. They hate the fans.” The only thing that might get done would be building bigger, more expensive stadiums and installing more state-of-the-art technology. But that just wouldn’t help.

This sounds absurd, of course, but Mr. Tarkenton goes on to explain that this is precisely how government schools operate.

If you haven’t figured it out yet, the NFL in this alternate reality is the real-life American public education system. Teachers’ salaries have no relation to whether teachers are actually good at their job—excellence isn’t rewarded, and neither is extra effort. Pay is almost solely determined by how many years they’ve been teaching. That’s it. After a teacher earns tenure, which is often essentially automatic, firing him or her becomes almost impossible, no matter how bad the performance might be. And if you criticize the system, you’re demonized for hating teachers and not believing in our nation’s children. Inflation-adjusted spending per student in the United States has nearly tripled since 1970. According to the Organization for Economic Cooperation and Development, we spend more per student than any nation except Switzerland, with only middling results to show for it.

Actually, I will disagree with the last sentence of this excerpt. We’re not even getting “middling results.” Here’s a chart from an earlier post showing that we’ve gotten more bureaucracy and more spending but no improvement over the past 40 years.

So what’s the solution to this mess? Well, since government is the problem, it stands to reason that competition and markets are the answer.

Sweden, Chile, and the Netherlands are just some of the countries that have seen good results after breaking up state-run education monopolies.

Watch this video to get more details.

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