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Archive for the ‘Convergence’ Category

In this clip from an interview with Chile’s Axel Kaiser, I discuss “Wagner’s Law” and the lessons to be learned from fiscal policy in Western Europe.

If you don’t want to watch the video, my discussion can be summarized in three sentences.

  • Yes, welfare states in Western Europe are comparatively rich by world standards.
  • But those  countries became rich when they had relatively small governments.
  • Adopting high taxes and big welfare states has since stunted their economic growth.

And here’s a fourth sentence that I should have mentioned.

  • They compensate for bad fiscal policy by having laissez-faire policies in other areas.

I expect that some people won’t accept my argument without some supporting evidence, so I’m going to share some charts.

We’ll start with this chart from Our World in Data. As you can see, nations in Western Europe has almost no welfare states prior to World War II. And it wasn’t until the 1960s and 1970s that big welfare states began to exist.

In other words, all the economic growth and industrial development that occurred in the 1800s and early 1900s took place when the fiscal burden of government was very small.

And if you want to see more charts to confirm this data, click here, here, and here.

Next we have a chart showing how the burden of government spending in the United States and Western Europe used to be similar, but then began to diverge after value-added taxes were adopted in the late 1960s and early 1970s.

Last but not least, let’s consider whether the expansion of the welfare state in Western Europe had negative economic consequences.

The answer is yes. This chart, prepared by Prof. Leszek Balcerowicz (former head of Poland’s central bank) shows that Western Europe was rapidly converging with the United States, but then began to lose ground after big welfare states were imposed (and also after improvements in American economic policy under Presidents Reagan and Clinton).

And if you want to see more charts to confirm this data, click here, here, here, and here.

P.S. Since I added a fourth sentence above, explaining that many European nation have good policies in other areas to compensate for bad fiscal policy, here’s a chart I prepared in 2018 showing how many European nations score very highly for economic freedom once fiscal policy is removed from the equation.

To see overall rankings of economic liberty, you can peruse the data from Economic Freedom of the World and the Index of Economic Freedom.

The bottom line is that Western European nations (with notable exceptions such as Italy, France, and Greece) get good scores, but would be far stronger if they had better fiscal policy.

And that’s the lesson that developing nations should learn.

P.P.S. As part of the interview, Axel and I also talked about California’s grim economic outlook.

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I’m currently in Tanzania as part of a speaking tour in Africa. My remarks today largely repeated the message I gave to an audience last week in Nigeria.

So I won’t bother sharing anything from my presentation. Instead, I want to highlight some numbers from a presentation by Professor Ken Schoolland.

He shared some data showing how the “Asian Tigers” grew far faster than major Latin American nations between 1950 and 2000.

These are very impressive examples of convergence (as the Asian Tigers caught up with Latin America) followed by divergence (as the Tigers then continued to grow much faster).

I’ll be adding this data to my “anti-convergence club.”

But I also noticed that Professor Schoolland was sharing some old data from 1995.

So I went to the Maddison website and created some new charts based on the latest-available data.

As you can see, the Latin American nations were richer in 1950, but they have not enjoyed fast growth in the past 70 years.

By contrast, the Asian Tigers have enjoyed spectacular growth since 1950.

So not only are these nations much more prosperous than nations in Latin America, in most cases they have even surpassed European countries and Singapore is now richer than the United States.

Since I’m writing about the success of the Asian Tigers, let’s address the myth that they became rich because of industrial policy.

Sam Gregg of the Acton Institute examined this controversy in an article for Law & Liberty.

…what about some of the East Asian Tiger countries? Aren’t they proof that, when devised and implemented by wise governments guided by even cleverer experts, industrial policy can work? …There is, however, a wealth of evidence indicating that these policies produced similarly pedestrian outcomes in these countries. As for the Tigers, what primarily took them from the status of economic backwaters to first-world economies was economic liberalization and especially trade openness… Even the most devoted industrial policy advocates hesitate to present two of the Tigers, Singapore and Hong Kong, as industrial policy successes. They do nevertheless regard South Korea and Taiwan’s postwar histories as demonstrating why industrial policy should play a major role.

Gregg takes a close look at what actually happened in South Korea.

Beginning in 1954 and until about 1963, Korea’s government focused upon import-substitution industrialization policies… however,…economic growth in Korea only began taking off between 1963 and 1973 following a decisive shift towards export-orientated development and trade openness. …Industrial policy assumed a larger place in Korea’s economy in the mid-1970s. …Korea’s turn towards industrial policy in this period does not appear to have produced spectacular results. Economic growth during this period—whether in terms of GDP, trade, employment, manufacturing output, or exports in goods and services—was actually lower than what had been realized in the 1960s. …These results may help explain why Korea’s drift towards industrial policy was reversed, beginning in the late-1970s. …The overall result was a return to high growth throughout Korea’s economy.

And here’s his analysis of what happened in Taiwan.

…the Kuomintang government adopted an import-substitution approach to trade characterized by high tariffs and import quotas. The Taiwan Production Board oversaw the extensive use of industrial policy, especially through preferential loan-treatment… In the mid-1950s, key Taiwanese officials and their American advisors recognized that Taiwan could not keep going down this path. Hence in the late-1950s, decisions were made that re-orientated Taiwan’s economy towards competition and trade openness by, among other things, liberalizing imports and foreign investment rules as well as beginning a process of steadily removing export controls and gradually giving more and more exporters what amounted to a free trade status. As in Korea’s case, growth in Taiwan took off. …the general direction of Taiwan’s economy from 1958 onwards was away from industrial policy and tariffs and towards increasing integration into global markets. Like Korea, Taiwan underwent a limited return to interventionist policies in the mid-1970s, but, again, like Korea, this did not last.

The bottom line is that South Korea and Taiwan are not as rich as Hong Kong and Singapore and one reason they are lagging is that their governments tried to pick winners and losers.

But both those nations largely have abandoned industrial policy, so at least they recognized their mistakes.

P.S. A big issue at the conference is whether the “China Model” should be emulated. I shared some data showing why that would be a big mistake.

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I don’t know whether to be amused or frustrated, but I can’t help but notice that folks on the left frequently argue that the United States needs to make government bigger in order to “catch up” or “shrink the gap” with Europe.

President Biden even has said that America is “falling behind” because the fiscal burden of government is lower than it is in other nations.

My response is always to point out that there is a gap between the United States and other developed nations, but that gap always shows that people in America are more prosperous, with far higher levels of consumption.

Heck, lower-income people in the United States often are better off than middle-class people in Europe.

And what’s especially remarkable is that the gap is growing rather than shrinking, even though convergence theory tells us Europe should be growing faster.

So why should we want to copy the policies of nations that have lower living standards?

Yet none of this information was included in a New York Times article about paid parental leave by Claire Cain Miller. Instead, the focus of the article is how the United States “lags” behind other nations.

Congress is now considering four weeks of paid family and medical leave… If the plan becomes law, the United States will no longer be one of six countries in the world — and the only rich country — without any form of national paid leave. But it would still be an outlier. Of the 185 countries that offer paid leave for new mothers, only one, Eswatini (once called Swaziland), offers fewer than four weeks. …Globally, the average paid maternity leave is 29 weeks, and the average paid paternity leave is 16 weeks… Besides the United States, the only other countries with no paid maternity leave are the Marshall Islands, Micronesia, Nauru, Palau, Papua New Guinea, Suriname and Tonga.

The bottom line is that our government does not provide some of the goodies provided by politicians in other nations, but we have a much stronger economy that produces much higher living standards.

And there’s lots of evidence that there’s more prosperity in the United States precisely because the welfare state is smaller and the tax burden is not as onerous.

I’ll close by acknowledging that there is a very legitimate Arther Okun-style argument to accept weaker growth in exchange for more handouts from government.

In the case of parental leave, I don’t find that argument persuasive (for reasons explained here, here, here, here, and here), but reasonable people can disagree.

What’s not reasonable, however, is whining that the United States “lags” other nations without acknowledging Okun’s tradeoff.

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Economists of all types agree with “convergence theory,” which is the notion that poor countries should grow faster than rich countries.

Though they are usually wise enough to also say “ceteris parisbus,” which means the theory applies if other variables are similar (the translation from Latin is “other things equal”).

I’m very interested in this theory because we can learn a lot when we look at nations that don’t have “equal” policies.

And the biggest lesson is that you have divergence rather than convergence if one nation follows good policies and the other one embraces statism.

Take a look, for instance, at what’s happened to per-capita economic output (GDP) since 1950 in Taiwan and Cuba.

The obvious takeaway from these numbers from the Maddison database is that Taiwan has enjoyed spectacular growth while Cuba has suffered decades of stagnation.

If this was a boxing match between capitalism and socialism, the refs would have stopped the fight several decades ago.

By the way, some folks on the left claim that Cuba’s economic misery is a result of the U.S. trade embargo.

In a column for the Foundation for Economic Education, Emmanuel Rincón explains the real reason why these two jurisdictions are so wildly divergent.

…the Communist Party of Cuba has blamed the United States for Cuba’s misery and poverty, alluding to the “blockade” that the U.S. maintains against Cuba. However, …the rest of the world can trade freely with the island. …Taiwan’s economy is one of the most important in the world, with a poverty rate of 0.7%, as opposed to Cuba, which has one of the most depressed economies on the planet and 90% of its population living in poverty. What is the difference between the two islands? The economic and political model they applied in their nations. …Taiwan has the sixth freest economy according to the Index of Economic Freedom… While Taiwan took off with a capitalist model, Cuba remained anchored in the old revolutionary dogmas of Fidel Castro… With popular slogans such as redistribution of wealth, supposed aid to the poor, and socialism, Fidel Castro began to expropriate land and private companies to be managed by the state…today the GDP of the Caribbean island is five times less than that of Taiwan, and 90% of its population lives in poverty, while in the Asian island only 0.7% of its population is poor. It is definitely not the fault of the “blockade”, but of socialism.

To be sure, Cuba would be slightly less poor if there was unfettered trade with the United States, so maybe Taiwan would only be four and one-half times richer rather than five times richer in the absence of an embargo.

The moral of the story is that there’s no substitute for free markets and small government.

P.S. Though I appreciate the fact that our friends on the left are willing to extol the virtues of free trade, at least in this rare instance.

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Economists widely agree with the theory of “convergence,” which is the (mostly true) idea that poor nations should grow faster than rich nations.

This means that we can learn important lessons by looking at examples of “divergence,” and I provide 20 examples in this presentation.

The above video is an excerpt from a presentation I made earlier this week to a seminar organized by the New Economic School in the country of Georgia.

While it seems like I was making the same point, over and over again (and I was), I wanted the students to understand that the real-world evidence clearly shows that good policy is critical if less-developed nations want convergence.

And I also wanted them to realize that there are many examples of free market-oriented nations growing much faster than anti-market countries.

But, by contrast, there are not examples that go the other way.

I’ve challenged my leftist friends to cite one case study of a poor nation that became a rich nation with big government.

Or to cite a single example of an anti-market nation that has grown faster than a market-oriented country.

Especially when using decades of data, which means there’s no ability to cherry-pick the data and create a misleading impression.

Needless to say, I’m still waiting for them to give me an answer.

Here are the background stories from the examples of divergence in my presentation.

My last example showed important examples of convergence.

  • Example #20: United States vs. Hong Kong, Singapore, and Switzerland

And here are a few other examples of divergence that I didn’t include in my presentation.

Shifting back to convergence, my column on breaking out of the “middle income trap” also has very interesting data on how Hong Kong, Singapore, Ireland, and Taiwan have closed the gap with (or even exceeded) the United States.

I also recommend this column which looks at a wide range of nations that are converging with, diverging from, or staying flat compared with the United States, as well as this column showing how Ireland has caught up and surpassed other European nations.

The moral of the story is that there’s a very simple recipe showing how poor nations can become rich nations.

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In this clip from a recent interview with Gunther Fehlinger, I explore the connection between two very important important economic concepts: Convergence and Wagner’s Law.

Before launching into further discussion, let’s nail down two very important definitions.

  • Convergence is the notion that poor countries should grow faster than rich countries and eventually attain a similar level of prosperity.
  • Wagner’s Law is the seemingly paradoxical observation that richer nations tend to have larger fiscal burdens than poorer nations.

These two concepts deserve elaboration because many people either fail to recognize the implications or they draw the wrong conclusions.

For instance, convergence is a sensible theory, but the rate of convergence (or divergence!) is very dependent on the degree to which nations have good policy (or bad policy).

Moreover, Wagner’s Law shows that politicians figure out how to extract more money and fund bigger government once nations become rich, but some people reverse the causality and assert that big government somehow caused nations to become rich.

The key takeaway from these observations, as I explained in the interview, is that poor nations that want convergence need to copy the policies that rich nations had when they became rich (in the interview at about 0:56, I mistakenly said “were rich” rather than “became rich”).

And I’ve written many times to show that the rich nations of the western world made the leap to industrial prosperity in the 1800s and early 1900s – at a time when they had no welfare states and very low fiscal burdens (indeed most of them didn’t have any income taxes during that period).

Which gives me another excuse to re-issue my never-answered challenge: Please show me an example, from any point in world history, of a country became rich after adopting big government.

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