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Archive for August, 2018

With the possible exception of a few extreme environmentalists, everyone agrees that robust long-run growth is a key to a better society.

An unprecedented jump in growth, for instance, is what enabled the western world to escape poverty, resulting in the famous “hockey stick” of modern prosperity.

Maintaining growth is an ongoing challenge for developed countries, to be sure, and it’s also vitally important to help developing nations grow and prosper.

Which is why policymakers should focus on the policies that generate good outcomes.

Libek, a think tank in Serbia, has released a study on this topic. They start by pointing out that we now have some good measures of economic liberty in various nations.

…the Economic Freedom in the World Index in 1996 by the Fraser Institute…was the first methodological tool that measured intrusion in functioning of the market process by government entities, either directly through government intervention or indirectly though regulation and market institutions. A similar index, Index of Economic Freedom, produced by the Wall Street Journal and the Heritage Foundation soon followed… Since this very successful tool was invented, it has been widely employed in empirical studies…, the most important were concerning the role of economic freedom in fostering economic growth. …empirical studies mostly concluded that there is a significant connection between economic freedom and economic growth.

Since I’m always citing the Fraser Index and the Heritage Index, I agree that these are very helpful sources of data.

And lots of academics also use those numbers.

So Libek took a close look at this wealth of empirical research.

Libek conducted a metastudy regarding economic freedom in December 2017, with the aim to reexamine the connection between economic freedom and economic growth in published empirical studies. …Using Google scholar mechanism…92 studies…consider the connection between economic freedom and economic growth. Out of these, a predominant majority of 86 studies (93.5%) finds a positive correlation or connection between them, while only 6 studies (6.5%) have less positive results. …This metastudy shows that empirical studies have predominantly found that economic freedom is associated with higher economic growth rates, while there is only one study claim otherwise and results of other 5 are less conclusive. This high rate of concurrence between economists is highly unusual, given the fact that economist tend to often disagree even among theoretically more accepted topics. Therefore, it is conclusively shown that higher level of economic freedom, ceteris paribus, leads to higher economic growth.

The folks at Libek have a big incentive to care about these issues because Serbia is a reform laggard.

Here’s a chart comparing economic freedom in Serbia with other European regions.

And here is why economic reform is so vitally important for the people of Serbia.

Serbia remains one of the poorest countries in Europe, measured by GDP, with just 5 000 euros per capita. These low growth rates do not provide a possibility for development and closing the gap with more advanced European economies. …A study estimated future economic gains through higher economic freedom (Gwartney and Lawson 2004) reporting that 1-point increase in economic freedom (measured on a 1 to 10 scale) would increase long term rate of economic growth for 1.24% of GDP. Therefore, if Serbia would increase its score from the current 6.75 to 7.75 points – the approximately current level of Austria or Germany, Serbian long-term growth rate would increase from the envisaged 2% in 2017 (and estimated by the IMF to stand at 3.5% in 2018 and 2019) to 5.25% in 2020 and afterwards. This growth rate would enable a fast income convergence with other European countries, with GDP level per capita doubling in 14 years.

Amen. Serbia has the capacity to “converge,” but that won’t happen without economic liberalization.

For non-Serbians, the parts of the Libek report that will be of greatest interest deal with examples of nations that are out-performing their neighbors.

The importance of economic freedom is well shown by the most important case studies from different continents: Chile (South America), Singapore and Korea (East Asia), and Botswana (Africa). In all these prominent cases, economic freedom propelled these societies to a high and sustainable economic growth which led them to prosperity, compared to their neighbors.

The report specifically looks at the long-run data for countries that have sharply diverged from regional competitors.

Let’s start by comparing Chile with the rest of South America. As you can see, Chile’s dramatic economic liberalization led to far higher levels of national prosperity.

Now let’s compare Botswana to the rest of Sub-Saharan Africa.

I did something similar back in 2015 and also earlier this year, so this remarkable data is impressive but not surprising.

Last but not least, let’s compare Singapore and South Korea to their neighbors.

Once again, we see a compelling link between economic liberty and economic outcomes.

This is dramatically evident when comparing South Korea and North Korea, but you also see remarkable numbers when comparing Singapore with the United States.

The lesson is not that nations need perfect policy (even Hong Kong has some statism). Instead, the message is that governments should strive to increase economic liberty – hopefully in big ways but even small reforms are helpful – so that there’s more “breathing room” for the economy’s productive sector.

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It’s no secret that I’m a critic of Trump’s protectionism. He doesn’t understand the benefits of trade, misinterprets trade data, and – to coin a phrase – he’s “making cronyism great again.”

But, as shown in this interview, even I’m shocked that he’s “blaming the victim” by going after Harley-Davidson.

I’m disappointed, though, that I only made part of the argument.

Harley-Davidson is being hurt by government because Trump’s steel and aluminum tariffs have raised the prices of inputs. But the company also is being hurt because other countries have responded to Trump’s protectionism with tariffs that will penalize the company.

Here’s some background on the story, as reported by CNN.

President Donald Trump said it’s “great” that consumers might boycott Harley-Davidson if it moves some motorcycle production overseas. …Trump’s remark came after the President hosted “Bikers for Trump” supporters at his golf club in Bedminister, New Jersey, over the weekend. …Tensions between the administration and Harley-Davidson have brewed for months. It started when Trump imposed hefty tariffs on steel and aluminum imports earlier this year in an effort to bolster domestic manufacturing. The European Union responded by pledging to raise tariffs on a list of goods that are imported from the United States, including Harley motorcycles. …Harley said it stands to lose as much as $100 million a year, and the company pledged to shift some of its production abroad so that it could avoid the added tariffs on motorcycles sold in the EU. …moving more production overseas was the “only sustainable option” in the face of a trade war.

Not that this is a sudden revelation.

The U.K.-based Financial Times reported back in June that the company was put in a bad position because Trump’s tariffs led to retaliatory tariffs from the European Union.

…Harley-Davidson announced it would move some manufacturing out of the US to avoid EU tariffs and Brussels prepared further retaliatory measures in case of new White House duties. The motorcycle maker is the first US manufacturer to scale down domestic production in response to the EU tariffs, which were imposed on Friday against $3.3bn in American imports as retaliation for US steel and aluminium duties.  Harley-Davidson’s decision illustrates why many pro-trade members of President Donald Trump’s own Republican party have raised concerns about the potential economic consequences of the multiple fronts he has opened in his trade offensive.

Kevin Williamson, writing for National Review, explained what’s really happening.

Harley-Davidson already operates facilities in Brazil, India, and Australia, and it has plans for a factory in Thailand. Avoiding protectionist measures drives some of that, but so do other factors, including proximity to customers — which is why Mercedes-Benz manufactures SUVs in the United States, where most of them are sold. Indians buy nearly 17 million motorcycles and scooters a year, and Harley-Davidson covets a larger share of that market. …its executives calculate that the Trump administration’s anti-trade policies will cost it as much as $100 million a year in the EU market alone. …What is Harley-Davidson supposed to do? Lose a few hundred million dollars while it waits for the Trump administration to get it right on trade? Because that day probably is not coming.

I’m not being a Trump basher, by the way. I noted in the interview that he’s also pushed through some policies that are good for both companies and competitiveness, such as targeted deregulation and lower tax rates.

But, as also noted in this Washington Post column, what’s frustrating is that the harm caused by Trump’s protectionism will offset the benefits of those good policies.

President Trump’s top economist defended the White House’s increasingly aggressive trade policies Tuesday, calling Harley-Davidson’s decision to move some operations overseas an exception to a broader trend of renewed corporate investment within the United States. Kevin Hassett, chairman of the Council of Economic Advisers, said foreign direct investment on American soil “has skyrocketed” in the year’s first quarter, a trend he attributed to a cut in the corporate tax rate that Trump signed into law last year. …Former White House economic adviser Gary Cohn, who resigned shortly after Trump  announced the tariffs, cautioned earlier this month that a trade war could wipe out the economic gains of the GOP tax law.

Let’s close by highlighting the oft-overlooked fact that the retaliatory tariffs against Harley-Davidson are not trivial.

Here are some excerpts from a Wall Street Journal editorial.

The company considers the EU a “critical market,” and last year it sold nearly 40,000 bikes to European consumers. But in retaliation for Mr. Trump’s steel and aluminum tariffs, the European Union raised its tax on American-exported Harleys to 31% from 6%, effective last Friday. That amounts to a $2,200 tax on each motorcycle exported from the U.S. to the EU. …Harley said “the tremendous cost increase, if passed on to its dealers and retail customers, would have an immediate and lasting detrimental impact to its business in the region, reducing customer access to Harley-Davidson products and negatively impacting the sustainability of its dealers’ businesses.” Translation for Mr. Trump: Unlike real estate, cars and motorcycles are a global market.

All of which underscores the main point from the interview, Harley-Davidson is the victim.

I mentioned in the interview that some people think Trump is playing a clever game to force other countries to lower trade barriers. Since other nations generally have higher trade barriers than the United States, he’s right to have that as a goal. Assuming, of course, that really is his goal. I’m skeptical, but would love to be proved wrong.

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A few days ago, I shared some academic research investigating whether economic crises lead to more liberalization (Naomi Klein’s hypothesis) or more statism (Robert Higgs’ hypothesis).

Given the dismal long-run outlook for the United States and most other developed nations, this is not just a theoretical issue.

Well, the good news is that the evidence shows that economic turmoil appears to be associated with pro-market reforms. At least with regard to regulatory policy.

Today, I’m going to share more good news. We now have some empirical research from two Danish economists showing that voters like good policy.

Here’s what Niclas Berggren and Christian Bjørnskov wanted to ascertain in their research

Since the early 1980s a wave of liberalizing reforms has swept over the world. While the stated motivation for these reforms has usually been to increase economic efficiency, some critics have instead inferred ulterior motives…with the claim that many of the reforms have been undertaken during different crises so as to bypass potential opponents, suggests that people will dislike the reforms and even be less satisfied with democracy as such. We test this hypothesis empirically, using panel data from 30 European countries in the period 1993–2015. The dependent variable is the average satisfaction with democracy, while the reform measures are constructed as distinct changes in four policy areas: government size, the rule of law, openness and regulation. …We moreover include a set of control variables, capturing economic circumstances, political institutions and features of politics.

In other words, we’ve seen considerable liberalization over the past 20-plus years. Were voters happy or unhappy as a result?

Here’s a way of visualizing what they investigated.

For what it’s worth, I’ve argued that Reagan showed good policy is good politics.

And the good news is that this research reaches a similar conclusion. Here are their main results.

Our results indicate that while reforms of government size are not robustly related to satisfaction with democracy, reforms of the other three kinds are – and in a way that runs counter to the anti-liberalization claims. Reforms that reduce economic freedom are generally related to satisfaction with democracy in a negative way, while reforms that increase economic freedom are positively associated with satisfaction with democracy. Voters also react more negatively to left-wing governments introducing reforms that de-liberalize. …the hypothesis of a general negative reaction towards liberalizing reforms taking the form of reduced satisfaction with democracy does not stand up to empirical scrutiny, at least not in our European sample.

Wonky readers may want to spend some time with this table, which shows the results of the statistical analysis

I’ll close with a couple of specific observations from the research, all of which deal with whether some reforms are more popular than others.

The good news is that voters are most satisfied when there’s less protectionism.

It turns out that the most immediately important type of reform here is liberalizations that increase market openness, such as reductions in protectionism and removal of obstacles to capital movements.

(Methinks the folks in the White House may want to reconsider their protectionist policies. It seems people understand that trade wars cause blowback.)

The bad news is that voters don’t seem to get excited about reforms to restrain government spending, whereas other types of pro-market reforms are popular.

Reforms that involve government size are rarely statistically significant; reforms that involve the other three reform areas typically are.

Though voters sometimes aren’t happy when government gets bigger, so I guess that’s partial good news.

Crises only seem to matter when government size increases, and then they make the effect on satisfaction with democracy much more negative.

Perhaps this is evidence that people recognize Keynesian “stimulus” schemes aren’t a good idea? I hope that’s the right interpretation. Heck, maybe this is yet another reason to stop sending tax dollars to subsidize the OECD.

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In June 2017, I shared an image and made the bold claim that it told us everything we needed to know about government.

In July 2017, I shared a story and similarly asserted that it told us everything we needed to know about government.

In that grand tradition of rhetorical exaggeration, here’s a court case that tells us everything we need to know about government.

…a lawsuit arguing that Detroit students were being denied an education had been dismissed. …With the help of a public interest law firm, a handful of Detroit students charged in federal court that educational officials in Michigan — including Gov. Rick Snyder — denied them access to an education of any quality. …Student cannot be expected to learn when they are simply “warehoused for seven hours a day” in “an unsafe, degrading, and chaotic environment” that is a school “in name only.” …almost 99 percent of the students are unable to achieve proficiency in state-mandated subjects. Last year, the state moved for dismissal, arguing that the 14th Amendment contains no reference to literacy. …U.S. District Judge Stephen Murphy III agreed with the state. Literacy is important, the judge noted. But students enjoy no right to access to being taught literacy. All the state has to do is make sure schools run. If they are unable to educate their students, that’s a shame, but court rulings have not established that “access to literacy” is “a fundamental right.”

I’m not a lawyer, so maybe the judge made the right decision. Indeed, I suspect it probably was the right outcome since a decision in favor of the suit may have resulted in some sort of judicial mandate to squander more money on failed government schools. And we have lots of evidence that additional funding would mean throwing good money after bad.

But I still feel great sympathy for the students and their parents. They are stuck with rotten schools that cost a lot of money.

They have been betrayed by government incompetence. Both Thomas Sowell and Walter Williams have explained how the system is rigged to benefit teacher unions rather than kids.

And even though most of the victimized children are minorities, the NAACP sides with the unions. Shame. The failed government school monopoly serves the interests of insiders, not students.

The only solution is school choice, as explained in this video.

P.S. Needless to say, the federal government shouldn’t play a role. Bush’s no-bureaucrat-left-behind plan didn’t work, and neither did Obama’s Common Core boondoggle. The best thing that could happen in Washington would be the abolition of the Department of Education.

P.P.S. There’s a lot we could learn about school choice and private schooling from SwedenChile, India, Canada, and the Netherlands.

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Two months ago, I shared some data on private gun ownership in the United States and declared that those numbers generated “The Most Enjoyable Graph of 2018.”

Now I have something even better because it confirms my hypothesis about tax competition being the most effective way of constraining greedy politicians.

To set the stage, check out these excerpts from a heartwarming story in the Wall Street Journal.

Last year’s corporate tax cut is reducing U.S. tax collections, as expected. But that change is likely to ripple far beyond the country’s borders in the years ahead, shrinking other countries’ tax revenue… The U.S. tax law will reduce what other countries collect from multinational corporations by 1.6% to 13.5%… Companies will be more likely to put profits and real investment in the U.S. than they were before the U.S. lowered its corporate tax rate from 35% to 21%, according to the paper. That will leave fewer corporate profits for other countries to tax. And as that happens, other countries are likely to chase the U.S. by lowering their corporate tax rates, too, creating the potential for what critics have called a race to the bottom. …Mexico, Japan and the U.K. rank near the top of the paper’s list of countries likely to lose revenue… Corporate tax rates steadily declined over the past few decades as countries competed to attract investment.

Amen. This was one of my main arguments last year for the Trump tax plan. Lower tax rates in America will lead to lower taxes elsewhere.

For instance, look at what’s now happening in Germany.

Ever since Donald Trump last year unveiled deep tax cuts for companies in America, German industry has been wracked with fears over the economic fallout. …“In the long term, Germany cannot afford to have a higher tax burden than other countries,” warned Monika Wünnemann, a tax specialist at German business federation BDI. …the BDI urges Berlin to cut the overall tax burden, including corporate and trade levies, to a maximum 25 percent, compared to 26 percent in the US. …tax competition has clearly heated up within the European Union: France plans to reduce its top corporate rate to 25 percent by 2022 from 34 percent. The UK wants to cut its rate to 17 percent by 2021 from 20 percent today. If it fails to take action, Germany will be stuck with the heaviest corporate tax burden among industrialized countries.

Now let’s peruse a recent study from the International Monetary Fund.

Tax competition and declining corporate income tax (CIT) rates are not new phenomena. However, over the past 30 years, the United States has been an outlier in not reducing tax rates Combined with the worldwide system of taxation, this is widely regarded as having served as an anchor to world CIT rates. Now the United States has cut its rate by 14 percentage points to 26 percent (21 percent excluding state taxes), which is close to the OECD member average of 24 percent (Figure 1). Combined with the (partial) shift toward territoriality, this may intensify tax competition. …Given the combination of highly mobile capital and source-based corporate income taxation, pressures on tax systems are not surprising. …The most clear-cut, and possibly largest, spillovers are still likely to be caused by the cut in the tax rate. …Depending on parameter assumptions, we find that reform will lead to average revenue losses of between 1.5 and 13.5 percent of the MNE tax base. …The paper has also discussed the likely policy reactions of other countries. …tax rates elsewhere also fall (by on average around 4 percentage points based on tentative estimates).

And here’s the chart from the IMF report that sends a thrill up my leg.

As you can see, corporate tax rates have plunged by half since 1980.

And the reason this fills me with joy is two-fold. First, we get more growth, more jobs, and higher wages when corporate rates fall.

Second, I’m delighted because I know politicians hate to lower tax rates. Indeed, they’ve tasked the OECD with trying to block corporate tax competition (fortunately the bureaucrats haven’t been very successful).

And I could add a third reason. The IMF confesses that we have even more evidence of the Laffer Curve.

So far, despite falling tax rates, CIT revenues have held up relatively well.

Game, set, match.

I’m very irked by what Trump is doing on trade, government spending, and cronyism, but I give credit where credit is due. I suspect none of the other Republicans who ran in 2016 would have brought the federal corporate tax rate all the way down to 21 percent. And I’m immensely enjoying how politicians in other nations feel pressure to do likewise.

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I’ve been writing about the Laffer Curve for decades, making the simple point that there’s not a linear relationship between tax rates and tax revenue.

To help people understand, I ask them to imagine that they owned a restaurant and decided to double prices. Would they expect twice as much revenue?

Of course not, because people respond. Customers would go to other restaurants, or decide to eat at home. Depending on how customers reacted, the restaurant might even wind up with less revenue.

Well, that’s how the Laffer Curve works. When tax rates change, that alters incentives to engage in productive behavior (i.e., how much income they earn). In other words, to figure out tax revenue, you have to look at taxable income in addition to tax rates.

For some odd reason, this is a controversial issue.

My wayward buddy Bruce Bartlett posted a video on Facebook from Samantha Bee’s Full Frontal show. The goal was to mock the Laffer Curve, and here’s the part of the video featuring economists dismissing the concept as a “joke.”

Wow, that’s pretty damning. Economists from Stanford, Harvard, MIT, and the University of Chicago are on the other side of the issue.

Should I give up and retract all my writings and analysis?

Fortunately, that won’t be necessary since I have an unexpected ally. As shown in this excerpt from the video, Paul Krugman agrees with me about the Laffer Curve.

And Krugman’s not alone. Many other left-leaning economists also admit there is a Laffer Curve.

To be sure, as Krugman noted, there is considerable disagreement about the revenue-maximizing tax rate. Folks on the left often say tax rates could be 70 percent while folks on the right think the revenue-maximizing rate is much lower.

I have two thoughts about this debate. First, if the revenue-maximizing rate is 70 percent, then why did the IRS collect so much additional revenue from upper-income taxpayers when Reagan lowered the top rate from 70 percent to 28 percent?

Second, I don’t want to maximize revenue for government. That’s why I always make sure my depictions of the Laffer Curve show both the revenue-maximizing point and the growth-maximizing point. At the risk of stating the obvious, I prefer the growth-maximizing point.

The bottom line is that I think the revenue-maximizing point is probably closer to 30 percent, as shown in my chart. Especially in the long run.

But I wouldn’t care if the revenue-maximizing rate was actually 50 percent. Politicians should only collect the relatively small amount of revenue that is needed to finance the growth-maximizing level of government spending.

P.S. As tax rates get closer and closer to the revenue-maximizing point, that means an increasing amount of economic damage per dollar collected.

P.P.S. Paul Krugman is also right that value-added taxes are not good for exports.

Addendum: This post was updated on August 12 to add the clip of selected economists mocking the Laffer Curve.

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When I give speeches about modern welfare states, I’ll often cite grim data from the IMF, BIS, and OECD about the very depressing fiscal consequences of ever-expanding government.

And if I really want to worry an audience, I’ll augment those numbers by talking about the erosion of societal capital and explain it’s very hard to adopt necessary reforms once the work ethic and self-reliance have been replaced by a culture of dependency and entitlement.

I basically warn people that many western nations (including the United States) are doomed to suffer Greek-style fiscal collapse. Depending on the type of speech, this is where I sometimes share a slide suggesting that there are two possible outcomes once an economic crisis occurs.

  • Does a crisis caused by bad government lead to even more bad government, which is the pessimistic hypothesis in Robert Higgs’ classic, Crisis and Leviathan?
  • Or does an economic crisis force politicians to actually scale back the size and scope of government, which is the hypothesis in Naomi Klein’s The Rise of Disaster Capitalism.

I’ve generally sided with Higgs, though there obviously are cases – such as Chile – where bad statist policies were followed by sweeping economic liberalization.

But, based on new research from the International Monetary Fund, it may be that Klein has a stronger argument (which would be a depressing outcome for her, since she favors bigger government).

Here are some of the issues that the authors investigated.

Relying on a new database of major past labor and product market reforms in advanced countries, we test a large set of variables for robust correlation with reform in each area. …structural reforms are notoriously difficult to implement…one of the most prominent hypotheses put forward in the literature, namely that crisis induces reform… we attempt to minimize value judgements and measurement error by employing a newly constructed “narrative” dataset of major reforms in four areas namely product market regulation (PMR) in network industries, EPL for regular workers, EPL for temporary workers, and unemployment benefit systems. … The large welfare costs of economic or financial crisis can break the deadlock over welfare-enhancing measures that could not be adopted otherwise due to conflict over their distributional consequences.

In short, they wanted to find out whether bad economic news (as captured by data on “GDP growth, deep recession, unemployment, crisis”) leads to pro-market reforms.

The answer is yes.

Our main result supports some form of the crisis-induces-reform hypothesis across all four reform areas. High unemployment, recession and/or an open economic crisis tend to be associated with a greater likelihood of reform. The effect is economically significant. For example, an increase of 10 percentage points in unemployment (as seen in several European economies in the aftermath of the Great Recession) is associated with an increase in the probability to undertake a major EPL reform for regular contract of about 5 percentage points — that is, about twice the average probability in the sample.

Here’s a chart from the report showing a big spike in deregulation in late 1990s/early 2000s.

And here’s a chart showing nations that took steps to cut back on unemployment subsidies.

Keep in mind, by the way, that some nations (such as Austria) may not have reformed because they never adopted bad policies in the first place.

Kudos to Denmark for implementing so much reform. And Greece wins a Booby Prize for failing to adopt desperately needed reforms.

I was also happy to see some results that bolster my argument in favor of jurisdictional competition as a tool to encourage better policy.

We also find evidence that outside pressure increases the likelihood of reform in certain areas. Reforms are more likely when other countries also undertake them.

Interestingly, it doesn’t appear that ideology plays a major role.

…we do not find any evidence for an ideological bias—there is no robust difference between left- and right-of-center governments’ propensity to undertake reform. …In the context of labor and product market reforms, while a reforming right-of-center government may face the combined resistance of the leftwing electorate, trade unions and other civil society groups, a left-of-center government will be less likely to be accused of pushing through reforms on ideological grounds and may therefore be more likely to succeed.

My two cents is that ideology can play a role (think Reagan and Thatcher, for instance), but that there are plenty of instances of putative right-of-center politicians making government bigger (Nixon and Bush, to cite US examples) and several instances of supposed left-of-center politicians overseeing pro-market reforms (Bill Clinton being the obvious example from America).

I’ll close with a very important caveat. The IMF study looked at regulatory policy. There are no lessons to be learned from this research about whether crises produce better fiscal policy.

For what it’s worth, based on all the post-financial-crisis tax increases that were imposed in Europe, I suspect that the Higgs hypothesis is still very relevant.

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