Archive for the ‘International Monetary Fund’ Category

In my speeches, I routinely argue that an aging population is one of the reasons why we need genuine entitlement reform.

A modest-sized welfare state may be feasible if a country has a “population pyramid,” I explain, Welfare State Wagon Cartoonsbut it’s a recipe for fiscal chaos when changing demographics result in fewer and fewer people pulling the wagon and more and more people riding in the wagon.

And if you somehow doubt that’s what is happening in America, check out this very sobering image showing that America’s population pyramid is turning into a population cylinder.

The bottom line is that demographics and entitlements will mean a Greek fiscal future for America and other nations.

To bolster my case (particularly for folks who might be skeptical of a libertarian message), I frequently cite pessimistic long-run fiscal data from international bureaucracies such as the IMF, BIS, and OECD.

I’m not a big fan of these organizations because they routinely endorse statist policies, but I figure skeptics will be more likely to listen to me if I point out that even left-leaning international bureaucracies agree the public sector is getting too large.

And now I have more evidence to cite. A new report from the International Monetary Fund explores “The Fiscal Consequences of Shrinking Populations.” Here’s what you need to know.

Declining fertility and increasing longevity will lead to a slower-growing, older world population. …For the world, the share of the population older than age 65 could increase from 12 percent today to 38 percent by 2100. …These developments would place public finances of countries under pressure, through two channels. First, spending on age-related programs (pensions and health) would rise. Without further reforms, these outlays would increase by 9 percentage points of GDP and 11 percentage points of GDP in more and less developed countries, respectively, between now and 2100. The fiscal consequences are potentially dire…large tax increases that could stymie economic growth.

Let’s now look at a couple of charts from the study.

The one of the left shows that one-third of developed nations already have negative population growth, and that number will jump to about 60 percent by 2050. And because that means fewer workers to support more old people, the chart on the right shows how the dependency ratio will worsen over time.

So what do these demographic changes mean for fiscal policy?

Well, if you live in a sensible jurisdiction such as Hong Kong or Singapore, there’s not much impact, even though birthrates are very low, because government is small and people basically are responsible for setting aside income for their retirement years.

And if live in a semi-sensible jurisdiction such as Australia or Chile, the impact is modest because personal retirement accounts preclude Social Security-type fiscal challenges.

But if you live just about anywhere else, in places where government somehow is supposed to provide pensions and health care, the situation is very grim.

Here’s another chart from the new IMF report. If you look at developed nations, you can see a big increase in the projected burden of government spending, mostly because of rising expenditures for health care.

At this stage, I can’t resist pointing out that this is one reason why the enactment of Obamacare was a spectacularly irresponsible decision.

But let’s not get sidetracked.

Returning to the IMF report, the authors contemplate possible policy responses.

They look at increased migration, but at best that’s a beggar-thy-neighbor approach. They look at increased labor force participation, which would be a very good development, but it’s hard to see that happening when nations have redistribution policies that discourage people from being in the workforce.

And the report is very skeptical about the prospects of government-induced increases in birthrates.

Boosting birth rates could slow down population aging and gradually reduce fiscal pressures. …However, a “birth rate” solution to aging is unlikely to work for most countries. The pronatalist policies seem to have only modest effects on the number of births, although they might affect the timing of births.

So that means the problem will need to be addressed through fiscal policy.

The IMF’s proposed solutions include some misguided policies, but I was surprisingly pleased by the recognition that steps were needed to limit the growth of government.

Regarding pensions, the IMF suggested higher retirement ages, which is a second-best option, while also suggesting private retirement savings, which is the ideal solution.

Reforming public pension systems can help offset the effects of aging. Raising retirement ages is an especially attractive option… For example, raising retirement ages over 2015–2100 by an additional five years (about 7 months per decade) beyond what is already legislated would reduce pension spending by about 2 percentage points of GDP by 2100 (relative to the baseline) in both the more and less developed countries. …increasing the role of private retirement saving schemes could be helpful in offsetting the potential decline in lifetime retirement income.

But if you recall from above, the biggest problem is rising health care costs.

And kudos to the IMF for supporting market-driven competition. Even more important, though, the international bureaucracy recognizes that the key is to limit the government’s health care spending to the growth of the private economy (sort of a a healthcare version of Mitchell’s Golden Rule).

…health care reform can be effective in containing the growth of public health spending. …There is past success in improving health outcomes without raising costs through promoting some degree of competition among insurers and service providers. …Containing the growing costs of health care would help reduce long-term fiscal risks. On average, health care costs are projected to increase faster than economic growth. …Assuming policies are able to keep the growth of health care costs per capita in line with GDP per capita, health care spending will increase at a slower rate, reflecting only demographics. Under this scenario, public health care spending pressures would be greatly subdued: by 2100, health spending would be reduced by 4½ percentage points of GDP in the more developed countries.

Interestingly, of all the options examined by the IMF, capping the growth of health care spending had the biggest positive impact on long-run government spending.

So what lessons can we learn?

Most important, the IMF study underscores the importance of the Medicaid reform and Medicare reform proposals that have been included in recent budgets on Capitol Hill.

In addition to making necessary structural changes, both of these reforms cap the annual growth of health care spending, which is precisely what the IMF report says will generate the largest savings.

So we’re actually in a very unusual situation. Some lawmakers want to do the right thing for the right reason at the right time.

But not all of them. Some politicians, either because of malice or ignorance, think we should do nothing, even though that will mean a very unpleasant future.

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When I wrote the other day that the Organization for Economic Cooperation and Development was the worst international bureaucracy, I must have caused some envy at the International Monetary Fund.

One can imagine the tax-free bureaucrats from the IMF, lounging at their lavish headquarters, muttering “Mitchell obviously hasn’t paid enough attention to our work.”

And they may be right. The IMF has published some new research on inequality and growth that merits our attention. I hoped it would be a good contribution to the discussion, but I was disappointed (albeit not overly surprised) to see that the authors put ideology over analysis.

Widening income inequality is the defining challenge of our time. …Equality, like fairness, is an important value.

Needless to say, they never explain why inequality is a more important challenge than anemic growth.

Moreover, they never differentiate between bad Greek-style inequality that is caused by cronyism and good Hong Kong-style inequality that is caused by some people getting richer faster than other people getting richer in a free market.

And they certainly don’t define “fairness” in an adequate fashion.

But let’s not get hung up on the rhetoric. The most newsworthy part of the study is that these IMF bureaucrats produced numbers ostensibly showing that growth improves if more income goes to those at the bottom 20 percent.

…we find an inverse relationship between the income share accruing to the rich (top 20 percent) and economic growth. If the income share of the top 20 percent increases by 1 percentage point, GDP growth is actually 0.08 percentage point lower in the following five years, suggesting that the benefits do not trickle down. Instead, a similar increase in the income share of the bottom 20 percent (the poor) is associated with 0.38 percentage point higher growth.

And this correlation leads them to make a very bold assertion.

…there does not need to be a stark efficiency-equity tradeoff. Redistribution through the tax and transfer system is found to be positively related to growth for most countries.

Followed by some policy suggestions for more class-warfare tax policy to finance additional redistribution.

…the redistributive role of fiscal policy could be reinforced by greater reliance on wealth and property taxes, more progressive income taxation… In addition, reducing tax expenditures that benefit high-income groups most and removing tax relief—such as reduced taxation of capital gains, stock options, and carried interest—would increase equity.

Those are some bold leaps in logic that the authors make. And we’ll look at some new, high-quality research on the efficiency-equity tradeoff below, but first let’s consider the IMF’s supposed empirical findings on growth and income.

Several questions spring to mind:

  • Did they cherry pick the data? Why look at the relationship between growth and income gains in the previous five years rather than one year, three yeas, or ten years?
  • Why do they assume the correlation they found in the five-year data somehow implies causation for future growth? Roosters crow before the sun comes up, after all, but they don’t cause sunrises.
  • Was there any attempt to look at other hypotheses? One thing that instantly came to my mind was the possibility that recessions often are preceded by easy-money policies that create asset bubbles. And since those asset bubbles tend to artificially enrich savers and investors with higher incomes, perhaps that explains the correlation in the IMF’s data.
  • Perhaps most important, why assume that faster income growth for the bottom 20 percent automatically means there should be more redistribution through the tax and transfer system? Maybe that income growth is the natural – and desirable – outcome of good Hong Kong-type policies?

There are all sorts of other questions that could and should be asked, but let’s now shift to the IMF’s bold assertion that their ostensible correlation somehow proves that there’s no tradeoff between growth (efficiency) and redistribution (equity).

Kevin Hassett of the American Enterprise Institute investigated the degree to which Arthur Okun was right about a tradeoff between growth and redistribution.

Forty years ago, the economist Arthur Okun wrote a seminal book with a self-explanatory title: Equality and Efficiency: The Big Tradeoff.  …Okun’s tradeoff seems to be forgotten by many on the left, who advocate expanded government spending at every turn… What is needed is some kind of controlled experiment.. When the financial crisis began, countries varied tremendously in the extent to which they redistributed income. Some, such as Ireland and Sweden, redistributed a lot; others, such as the U.S. and Switzerland, not so much. Now, seven years later, some countries have recovered smartly. Others have not. If we go back and sort countries by how much they redistributed before the crisis, how does the growth experience compare? …The vertical axis plots how much redistribution there was in each country in 2008. The horizontal axis plots the rate of per capita national-income growth that each country averaged during the four years between 2008 and 2012. In some sense, then, the chart asks the question, “To what extent does variation in the size of the welfare state in 2008 explain variation in how economies recovered from the crisis between 2008 and 2012?” …As one can see in the chart, …the data show a clear pattern: the heavy redistributors have done much worse.

And here’s Kevin’s chart, and it clearly shows the redistribution-oriented nations had relatively slow growth (the top left of the chart).

The bottom line is that Kevin’s hypothesis and data are much more compelling that the junky analysis from the IMF.

But you don’t need to be an expert in economic jargon or statistical analysis to reach that conclusion.

Just look around the globe. The real-world evidence is so strong that only an international bureaucrat could miss it. The nations that follow the IMF’s advice, with lots of redistribution and class-warfare taxation, are the ones that languish.

After all, Greece, Italy, and France are not exactly role models.

While jurisdictions such as Hong Kong and Singapore routinely set the standard for growth.

And nations with medium-sized welfare states, such as Switzerland, Australia, and the United States, tend to fall in the middle. We out-perform Europe’s big-government economies, but we lag behind the small-government economies.

Let’s close by looking at some additional findings from the IMF study.

I was actually surprised to see that the bureaucrats admitted that inequality (more properly defined as some people getting richer faster than others get richer) was the natural result of positive economic developments.

We find that less-regulated labor markets, financial deepening, and technological progress largely explain the rise in market income inequality in our full sample over the last 30 years.

So why, then, is “inequality” a “defining challenge”?

Needless to say, the IMF never gives us a good answer.

I also was struck by this passage from the IMF study.

Figure 18 indicates that rising pre-tax income concentration at the top of the distribution in many advanced economies has also coincided with declining top marginal tax rates (from 59 percent in 1980 to 30 percent in 2009).

And here is the chart, which the IMF would like you to believe is evidence that lower tax rates have contributed to inequality (even though the bureaucrats already admitted that natural forces have led some to get richer faster than others).

Yet this chart simply shows that supply-siders were right. Reagan, Kemp, and other tax cutters argued that lower tax rates would lead rich people to earn – and declare – more taxable income.

And that’s exactly what happened!

Heck, I’ve already shared incredibly powerful data from the IRS on this occurring during the 1980s in the United States, so it’s no surprise it happened in other nations as well.

But I don’t want to be reflexively critical of the IMF. The study did have some useful data.

And there was even one very good recommendation for helping the poor by cutting back on misguided anti-money laundering laws.

Country experiences also suggest that policies such as granting exemptions from onerous documentation requirements, requiring banks to offer basic accounts, and allowing correspondent banking are useful in fostering inclusion.

Since I’ve written that anti-money laundering laws are ineffective at fighting crime while putting costly burdens on those with low incomes, I’m glad to see the IMF has reached the same conclusion.

And here’s a chart from the IMF study showing how poor people are less likely to have accounts at financial institutions.

By the way, the World Bank has produced some very good research on how the poor are hurt by inane anti-money laundering rules.

So kudos to some international bureaucracies for at least being sensible on that issue.

But speaking of international bureaucracies, I started this column by joking about the contest to see which one produced the worst research with the worst recommendations.

And while the IMF’s new inequality study definitely deserves to be mocked, I must say that it’s not nearly as bad as the drivel that was published by the OECD.

So our friends in Paris can rest on their laurels, confident that they do the best job of squandering American tax dollars.

P.S. Since I pointed out that the IMF inadvertently ratified one of the key tenets of supply-side economics, let’s remember that the IMF also confirmed one of the key reasons to oppose a value-added tax.

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When I first came to Washington back in the 1980s, there was near-universal support and enthusiasm for a balanced budget amendment among advocates of limited government.

The support is still there, I’m guessing, but the enthusiasm is not nearly as intense.

There are three reasons for this drop.

  1. Political reality – There is zero chance that a balanced budget amendment would get the necessary two-thirds vote in both the House and Senate. And if that happened, by some miracle, it’s highly unlikely that it would get the necessary support for ratification in three-fourths of state legislatures.
  2. Unfavorable evidence from the statesAccording to the National Conference of State Legislatures, every state other than Vermont has some sort of balanced budget requirement. Yet those rules don’t prevent states like California, Illinois, Connecticut, and New York from adopting bad fiscal policy.
  3. Favorable evidence for the alternative approach of spending restraint – While balanced budget rules don’t seem to work very well, policies that explicitly restrain spending work very well. The data from Switzerland, Hong Kong, and Colorado is particularly persuasive.

Advocates of a balanced budget amendment have some good responses to these points. They explain that it’s right to push good policy, regardless of the political situation. Since I’m a strong advocate for a flat tax even though it isn’t likely to happen, I can’t argue with this logic.

Regarding the last two points, advocates explain that older versions of a balanced budget requirement simply required a supermajority for more debt, but newer versions also include a supermajority requirement to raise taxes. This means – at least indirectly – that the amendment actually is a vehicle for spending restraint.

This doesn’t solve the political challenge, but it’s why advocates of limited government need to be completely unified in favor of tax-limitation language in a balanced budget amendment. And they may want to consider being more explicit that the real goal is to restrain spending so that government grows slower than the productive sector of the economy.

Interestingly, even the International Monetary Fund (which is normally a source of bad analysis) understands that spending limits work better than rules that focus on deficits and debt.

Here are some of the findings from a new IMF study that looks at the dismal performance of the European Union’s Stability and Growth Pact. The SGP supposedly limited deficits to 3 percent of GDP and debt to 60 percent of GDP, but the requirement failed largely because politicians couldn’t resist the temptation to spend more in years when revenue grew rapidly.

An analysis of stability programs during 1999–2007 suggests that actual expenditure growth in euro area countries often exceeded the planned pace, in particular when there were unanticipated revenue increases. Countries were simply unable to save the extra revenues and build up fiscal buffers. …This reveals an important asymmetry: governments were often unable to preserve revenue windfalls and faced difficulties in restraining their expenditure in response to revenue shortfalls when consolidation was needed. …The 3 percent of GDP nominal deficit ceiling did not prevent countries from spending their revenue windfalls in the mid-2000s. … Under the SGP, noncompliance has been the rule rather than the exception. …The drawbacks of the nominal deficit ceiling are particularly apparent when the economy is booming, as it is compatible with very large structural deficits.

The good news is that the SGP has been modified and now (at least theoretically) requires spending restraint.

The initial Pact only included three supranational rules… As of 2014, fiscal aggregates are tied by an intricate set of constraints…government spending (net of new revenue measures) is constrained to grow in line with trend GDP. …the expenditure growth ceiling may seem the most appealing. This indicator is tractable (directly constraining the budget), easy to communicate to the public, and conceptually sound… Based on simulations, Debrun and others (2008) show that an expenditure growth rule with a debt feedback ensures a better convergence towards the debt objective, while allowing greater flexibility in response to shocks. IMF (2012) demonstrates the good performance of the expenditure growth ceiling

This modified system presumably will lead to better (or less worse) policy in the future, though it’s unclear whether various nations will abide by the new EU rules.

One problem is that the overall system of fiscal rules has become rather complicated, as illustrated by this image from the IMF study.

Which brings us back to the third point above. If the goal is to restrain spending (and it should be), then why set up a complicated system that first and foremost is focused on red ink?

That’s why the Swiss Debt Brake is the right model for how to get spending under control. And this video explains why the objective should be spending restraint rather than deficit reduction.

And for those who fixate on red ink, it’s worth noting that if you deal with the underlying disease of too much government, you quickly solve the symptom of deficits.

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In early November of last year, I shared some remarkable data from a groundbreaking study published by the European Central Bank (ECB).

The study looking at public sector efficiency (PSE) in developed nations and found that “big governments spend a lot more and deliver considerably less.”

Later in the month, I wrote about a second ECB study that looked at a broader set of nations and further confirmed that smaller government produces better results.

The first ECB study clearly concluded that “small” government is more efficient and productive than either “medium” government or “big” government. Based on the second ECB study, we can conclude that it’s even better if government is…well, I guess we’ll have to use the term “smaller than small.”

Today, we can augment this research by looking at a new study from the International Monetary Fund.

The IMF’s new working paper on “Fiscal Decentralization and the Efficiency of Public Service Delivery” shows that it’s not only good to have small government, but that it’s also good to have decentralized government. Here are the main findings.

This paper analyzes the impacts of fiscal decentralization on the efficiency of public service delivery. …The paper’s findings suggest that fiscal decentralization can serve as a policy tool to improve performance… an adequate institutional environment is needed for decentralization to improve public service delivery. Such conditions include effective autonomy of local governments, strong accountability at various levels of institutions, good governance, and strong capacity at the local level. Moreover, a sufficient degree of expenditure decentralization seems necessary to obtain a positive outcome. And finally, decentralization of expenditure needs to be accompanied by sufficient decentralization of revenue to obtain favorable outcomes.

Here’s some explanation of why it’s better to have decisions made by sub-national governments.

Local governments possess better access to local preferences and, consequently, have an informational advantage over the central government in deciding which provision of goods and services would best satisfy citizens’ needs. …Local accountability is expected to put pressure on local authorities to continuously search for ways to produce and deliver better public service under limited resources, leading to “productive efficiency.” …Decentralization…encourages competition across local governments to improve public services; voters can use the performance of neighboring governments to make inferences about the competence or benevolence of their own local politicians… Fiscal decentralization may lead to a decrease in lobbying by interest groups.

I especially like the fact that the study recognized the valuable role of tax competition in limiting the greed of the political class.

The study also noted that genuine federalism leads to spending competition, though I get the impression that the authors seems to think this is a negative outcome.

Fiscal decentralization can also obstruct the redistribution role of the central government.

For what it’s worth (and based on previous academic research), I agree that decentralization makes it harder for government to be profligate.

But that’s a good thing. I want to “obstruct” economically destructive redistribution.

Now let’s look at the specific finding from the study.

…expenditure decentralization seems to improve the efficiency of public service delivery in advanced economies… To quantify this effect, one could say that a 5 percent increase in fiscal decentralization would lead to 2.9 percentage points of efficiency gains in public service delivery. …about one third of public expenditure would need to be shifted to the local authorities to obtain positive outcomes from fiscal decentralization.

Though it’s worth emphasizing that decentralization works when the sub-national levels of government are completely responsible for raising and spending their own money.

Revenue decentralization shows positive and statistically significant impacts on public service delivery for advanced economies and emerging economies and developing countries. …These findings might imply the need to accompany expenditure decentralization with sufficient revenue decentralization to ensure improvement of performance.

I’ve already argued that federalism is good politics and good policy.

Now we have evidence that it’s good government.

And who would have guessed that the normally statist IMF would be the bearer of this good news.

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For the people of China, there’s good news and bad news.

The good news, as illustrated by the chart, is that economic freedom has increased dramatically since 1980. This liberalization has lifted hundreds of millions from abject poverty.

The bad news is that China still has a long way to go if it wants to become a rich, market-oriented nation. Notwithstanding big gains since 1980, it still ranks in the lower-third of nations for economic freedom.

Yes, there’s been impressive growth, but it started from a very low level. As a result, per-capita economic output is still just a fraction of American levels.

So let’s examine what’s needed to boost Chinese prosperity.

If you look at the Fraser Institute’s Economic Freedom of the World, there are five major policy categories. As you can see from this table, China’s weakest category is “size of government.” I’ve circled the most relevant data point.

The bottom line is that China could – and should – boost its overall ranking by improving its size-of-government score. And that means reducing the burden of government spending and lowering tax rates.

With this in mind, I was very interested to see that the International Monetary Fund just published a study entitled, “China: How Can Revenue Reforms Contribute to Inclusive and Sustainable Growth.”

Did this mean the IMF was recommending pro-growth tax reform? After reading the following sentence, I was hopeful.

We highlight tax policies that can facilitate economic transition to high income status, promote fiscal sustainability and make growth more inclusive.

After all, surely you make the “transition to high income status” with low tax rates rather than high tax rates, right?

Moreover, the study also acknowledged that China’s tax burden already is fairly substantial.

Tax revenue has accounted for about 22 percent of GDP in 2013…the overall tax burden is similar to the tax-to-GDP ratio for other Asian economies such as Australia, Japan, and Korea.

So what did the IMF recommend? A flat tax? Elimination of certain taxes? Reductions in double taxation? Lowering the overall tax burden?


The bureaucrats actually want China to become more like France and Greece.

I’m not joking. The IMF study actually wants people to believe that making the income tax more punitive will somehow boost prosperity.

Increasing the de facto progressivity of the individual income tax would promote more inclusive growth.

Amazingly, the IMF wants more “progressivity” even though the folks in the top 20 percent are the only ones who pay any income tax under the current system.

…around 80 percent of urban wage earners are not subject to the individual income tax because of the high basic personal allowance.

But a more punitive income tax is just the beginning. The IMF wants further tax hikes.

Broadening the base and unifying rates would increase VAT revenue considerably. …tax based on fossil fuel carbon emission rates can be introduced. …the current levies on local air pollutants such as SO2 and NOX emissions and small particulates could be significantly increased.

What’s especially discouraging is that the IMF explicitly wants a higher tax burden to finance an increase in the burden of government spending.

According to the proposed reform scenario, China could potentially aim to increase public expenditures by around 1 percent of GDP for education, 2‒3 percent of GDP for health care, and another 3–4 percent of GDP to fully finance the basic old-age pension and to gradually meet the legacy costs of current obligations. These would add up to additional social expenditures of around 7‒8 percent of GDP by 2030… The size of additional social spending is large but affordable as part of a package of fiscal reforms.

Indeed, the study explicitly says China should become more like the failed European welfare states that dominate the OECD.

Compared to OECD economies, China has considerable scope to increase the redistributive role of fiscal policy. …These revenue reforms serve as a key part of a package of reforms to boost social spending.

You won’t be surprised to learn, by the way, that the study contains zero evidence (because there isn’t any) to back up the assertion that a more punitive tax system will lead to more growth. Likewise, there’s zero evidence (because there isn’t any) to support the claim that a higher burden of government spending will boost prosperity.

No wonder the IMF is sometimes referred to as the Dr. Kevorkian of the global economy.

P.S. If you want to learn lessons from East Asia, look at the strong performance of Hong Kong, Taiwan, Singapore, and South Korea, all of which provide very impressive examples of sustained growth enabled by small government and free markets.

P.P.S. I was greatly amused when the head of China’s sovereign wealth fund mocked the Europeans for destructive welfare state policies.

P.P.P.S. Click here if you want some morbid humor about China’s pseudo-communist regime.

P.P.P.P.S. Though I give China credit for trimming at least one of the special privileges provided to government bureaucrats.

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It’s not very often that I applaud research from the International Monetary Fund.

That international bureaucracy has a bad track record of pushing for tax hikes and other policies to augment the size and power of government (which shouldn’t surprise us since the IMF’s lavishly compensated bureaucrats owe their sinecures to government and it wouldn’t make sense for them to bite the hands that feed them).

But every so often a blind squirrel finds an acorn. And that’s a good analogy to keep in mind as we review a new IMF report on the efficacy of “expenditure rules.”

The study is very neutral in its language. It describes expenditure rules and then looks at their impact. But the conclusions, at least for those of us who want to constrain government, show that these policies are very valuable.

In effect, this study confirms the desirability of my Golden Rule! Which is not why I expect from IMF research, to put it mildly.

Here are some excerpts from the IMF’s new Working Paper on expenditure rules.

In practice, expenditure rules typically take the form of a cap on nominal or real spending growth over the medium term (Figure 1). Expenditure rules are currently in place in 23 countries (11 in advanced and 12 in emerging economies).

Such rules vary, of course, is their scope and effectiveness.

Many of them apply only to parts of the budget. In some cases, governments don’t follow through on their commitments. And in other cases, the rules only apply for a few years.

Out of the 31 expenditure rules that have been introduced since 1985, 10 have already been abandoned either because the country has never complied with the rule or because fiscal consolidation was so successful that the government did not want to be restricted by the rule in good economic times. … In six of the 10 cases, the country did not comply with the rule in the year before giving it up. …In some countries, there was the perception that expenditure rules fulfilled their purpose. Following successful consolidations in Belgium, Canada, and the United States in the 1990s, these countries did not see the need to follow their national expenditure rules anymore.

But even though expenditure limits are less than perfect, they’re still effective – in part because they correctly put the focus on the disease of government spending rather than symptom of red ink.

Countries have complied with expenditure rules for more than two-third of the time. …expenditure rules have a better compliance record than budget balance and debt rules. …The higher compliance rate with expenditure rules is consistent with the fact that these rules are easy to monitor and that they immediately map into an enforceable mechanism—the annual budget itself. Besides, expenditure rules are most directly connected to instruments that the policymakers effectively control. By contrast, the budget balance, and even more so public debt, is more exposed to shocks, both positive and negative, out of the government’s control.

One of the main advantages of a spending cap is that politicians can’t go on a spending binge when the economy is growing and generating a lot of tax revenue.

One of the desirable features of expenditure rules compared to other rules is that they are not only binding in bad but also in good economic times. The compliance rate in good economic times, defined as years with a negative change in the output gap, is at 72 percent almost the same as in bad economic times at 68 percent. In contrast to other fiscal rules, countries also have incentives to break an expenditure rule in periods of high economic growth with increasing spending pressures. … two design features are in particular associated with higher compliance rates. …compliance is higher if the government directly controls the expenditure target. …Specific ceilings have the best performance record.

And the most important result is that expenditure limits are associated with a lower burden of government spending.

The results illustrate that countries with expenditure rules, in addition to other rules, exhibit on average higher primary balances (Table 2). Similarly, countries with expenditure rules also exhibit lower primary spending. …The data provide some evidence of possible implications for government size and efficiency. Event studies illustrate that the introduction of expenditure rules is indeed followed by smaller governments both in advanced and emerging countries (Figure 11a).

Here’s the relevant chart from the study.

And it’s also worth noting that expenditure rules lead to greater efficiency in spending.

…the public investment efficiency index of DablaNorris and others (2012) is higher in countries that do have expenditure rules in place compared to those that do not (Figure 11b). This could be due to investment projects being prioritized more carefully relative to the case where there is no binding constraint on spending

Needless to say, these results confirm the research from the European Central Bank showing that nations with smaller public sectors are more efficient and competent, with Singapore being a very powerful example.

One rather puzzling aspect of the IMF report is that there was virtually no mention of Switzerland’s spending cap, which is a role model of success.

Perhaps the researchers got confused because the policy is called a “debt brake,” but the practical effect of the Swiss rule is that there are annual expenditures limits.

So to augment the IMF analysis, here are some excerpts from a report prepared by the Swiss Federal Finance Administration.

The Swiss “debt brake” or “debt containment rule”…combines the stabilizing properties of an expenditure rule (because of the cyclical adjustment) with the effective debt-controlling properties of a balanced budget rule. …The amount of annual federal government expenditures has a cap, which is calculated as a function of revenues and the position of the economy in the business cycle. It is thus aimed at keeping total federal government expenditures relatively independent of cyclical variations.

Here’s a chart from the report.

And here are some of the real-world results.

The debt-to-GDP ratio of the Swiss federal Government has decreased since the implementation of the debt brake in 2003. …In the past, economic booms tended to contribute to an increase in spending. …This has not been the case since the implementation of the fiscal rule, and budget surpluses have become commonplace. … The introduction of the debt brake has changed the budget process in such a way that the target for expenditures is defined at the beginning of the process, which must not exceed the ceiling provided by the fiscal rule. It has thus become a top-down process.

The most important part of this excerpt is that the debt brake prevented big spending increases during the “boom” years when the economy was generating lots of revenue.

In effect, the grey-colored area of the graph isn’t just an “ideal representation.” It actually happened in the real world.

Though the most important and beneficial real-world consequence, which I shared back in 2013, is that the burden of government spending has declined relative to the economy’s productive sector.

This is a big reason why Switzerland is in such strong shape compared to most of its European neighbors.

And such a policy in the United States would have prevented the trillion-dollar deficits of Obama’s first term.

By the way, if you want to know why deficit numbers have been lower in recent years, it’s because we actually have been following my Golden Rule for a few years.

So maybe it’s time to add the United States to this list of nations that have made progress with spending restraint.

But the real issue, as noted in the IMF research, is sustainability. Yes, it’s good to have a few years of spending discipline, but the real key is some sort of permanent spending cap.

Which is why advocates of fiscal responsibility should focus on expenditure limits rather than balanced budget requirements.

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The International Monetary Fund isn’t my least-favorite international bureaucracy. That special honor belongs to the Organization for Economic Cooperation and Development, largely because of its efforts to undermine tax competition and protect the interests of the political class (it also tried to have me arrested, but I don’t hold that against them).

But the IMF deserves its share of disdain. It’s the Doctor Kevorkian of global economic policy, regularly advocating higher taxes and easy money even though that’s never been a recipe for national prosperity.

And it turns out that the IMF also is schizophrenic. The international bureaucracy’s latest big idea, garnering an entire chapter in the October World Economic Outlook, is that governments should spend more on infrastructure.

Barack Obama’s former chief economist supports the IMF scheme. Here some of what he wrote for the Washington Post.

…the IMF advocates substantially increased public infrastructure investment, and not just in the United States but in much of the world. It further asserts that under circumstances of high unemployment, like those prevailing in much of the industrialized world, the stimulative impact will be greater if this investment is paid for by borrowing… Why does the IMF reach these conclusions? …the infrastructure investment actually makes it possible to reduce burdens on future generations. …the IMF finds that a dollar of investment increases output by nearly $3. …in a time of economic shortfall and inadequate public investment, there is a free lunch to be had — a way that government can strengthen the economy and its own financial position.

Wow, That’s a rather aggressive claim. Governments spend $1 and the economy grows by $3.

Is Summers being accurate? What does the IMF study actually say?

It makes two big points.

The first point, which is reflected in the Summers oped, is that infrastructure spending can boost growth.

The study finds that increased public infrastructure investment raises output in the short term by boosting demand and in the long term by raising the economy’s productive capacity. In a sample of advanced economies, an increase of 1 percentage point of GDP in investment spending raises the level of output by about 0.4 percent in the same year and by 1.5 percent four years after the increase… In addition, the boost to GDP a country gets from increasing public infrastructure investment offsets the rise in debt, so that the public debt-to-GDP ratio does not rise… In other words, public infrastructure investment could pay for itself if done correctly.

But Summers neglected to give much attention to the caveats in the IMF study.

…the report cautions against just increasing infrastructure investment on any project. …The output effects are also bigger in countries with a high degree of public investment efficiency, where additional public investment spending is not wasted and is allocated to projects with high rates of return. …a key priority in economies with relatively low efficiency of public investment should be to raise the quality of infrastructure investment by improving the public investment process through, among others, better project appraisal, selection, execution, and rigorous cost-benefit analysis.

Perhaps the most important caveat, though, is that the study uses a “novel empirical strategy” to generate its results. That should raise a few alarm bells.

So is this why the IMF is schizophrenic?

Nope. Not even close.

If you want evidence of IMF schizophrenia, compare what you read above with the results from a study released by the IMF in August.

And this study focused on low-income countries, where you might expect to find the best results when looking at the impact of infrastructure spending.

So what did the author find?

On average the evidence shows only a weak positive association between investment spending and growth and only in the same year, as lagged impacts are not significant. Furthermore, there is little evidence of long term positive impacts. …The fact that the positive association is largely instantaneous argues for the importance of either reverse causality, as capital spending tends to be cut in slumps and increased in booms… In fact a slump in growth rather than a boom has followed many public capital drives of the past. Case studies indicate that public investment drives tend eventually to be financed by borrowing and have been plagued by poor analytics at the time investment projects were chosen, incentive problems and interest-group-infested investment choices. These observations suggest that the current public investment drives will be more likely to succeed if governments do not behave as in the past.

Wow. Not only is the short-run effect a mirage based on causality, but the long-run impact is negative.

But the real clincher is the conclusion that “public investment” is productive only “if governments do not behave as in the past.”

In other words, we have to assume that politicians, interest groups, and bureaucrats will suddenly stop acting like politicians, interest groups, and bureaucrats.

Yeah, good luck with that.

But it’s not just a cranky libertarian like me who thinks it is foolish to expect good behavior from government.

Charles Lane, an editorial writer who focuses on economic issues for the left-leaning Washington Post, is similarly skeptical.

Writing about the IMF’s October pro-infrastructure study, he thinks it relies on sketchy assumptions.

The story is told of three professors — a chemist, a physicist and an economist — who find themselves shipwrecked with a large supply of canned food but no way to open the cans. The chemist proposes a solvent made from native plant oils. The physicist suggests climbing a tree to just the right height, then dropping the cans on some rocks below. “Guys, you’re making this too hard,” the economist interjects. “Assume we have a can opener.” Keep that old chestnut in mind as you evaluate the International Monetary Fund’s latest recommendation… A careful reading of the IMF report, however, reveals that this happy scenario hinges on at least two big “ifs.”

The first “if” deals with the Keynesian argument that government spending “stimulates” growth, which I don’t think merits serious consideration.

But feel free to click here, here, here, and here if you want to learn more about that issues.

So let’s instead focus on the second “if.”

The second, and more crucial, “if” is the IMF report’s acknowledgment that stimulative effects of infrastructure investment vary according to the efficiency with which borrowed dollars are spent: “If the efficiency of the public investment process is relatively low — so that project selection and execution are poor and only a fraction of the amount invested is converted into productive public capital stock — increased public investment leads to more limited long-term output gains.” That’s a huge caveat. Long-term costs and benefits of major infrastructure projects are devilishly difficult to measure precisely and always have been. …Today we have “bridges to nowhere,” as well as major projects plagued by cost overruns and delays all over the world — and not necessarily in places you think of as corrupt. Germany’s still unfinished Berlin Brandenburg airport is five years behind schedule and billions of dollars over budget, to name one example. Bent Flyvbjerg of Oxford’s Said Business School studied 258 major projects in 20 nations over 70 years and found average cost overruns of 44.7 percent for rail, 33.8 percent for bridges and tunnels and 20.4 percent for roads.

Amen. Governments are notorious for cost overruns and boondoggle spending.

It happens in the United States and it happens overseas.

It’s an inherent part of government, as Lane acknowledges.

In short, an essential condition for the IMF concept’s success — optimally efficient investment — is both difficult to define and, to the extent it can be defined, highly unrealistic. As Flyvbjerg explains, cost overruns and delays are normal, not exceptional, because of perverse incentives — specifically, project promoters have an interest in overstating benefits and understating risks. The better they can make the project look on paper, the more likely their plans are to get approved; yet, once approved, economic and logistical realities kick in, and costs start to mount. Flyvbjerg calls this tendency “survival of the unfittest.” …Governments that invest in infrastructure on the assumption it will pay for itself may find out that they’ve gone a bridge too far.

Or bridge to nowhere, for those who remember the infamous GOP earmark from last decade that would have spent millions of dollars to connect a sparsely inhabited Alaska island with the mainland – even though it already had a very satisfactory ferry service.

Let’s close with two observations.

First, why did the IMF flip-flop in such a short period of time? It does seem bizarre for a bureaucracy to publish an anti-infrastructure spending study in August and then put out a pro-infrastructure spending study two months later.

I don’t know the inside story on this schizophrenic behavior, but I assume that the August study was the result of a long-standing research project by one of the IMF’s professional economists (the IMF publishes dozens of such studies every year). By contrast, I’m guessing the October study was pushed by the political bosses at the IMF, who in turn were responding to pressure from member governments that wanted some sort of justification for more boondoggle spending.

In other words, the first study was apolitical and the second study wasn’t.

Not that this is unusual. I suspect many of the economists working at international bureaucracies are very competent. So when they’re allowed to do honest research, they produce results that pour cold water on big government. Indeed, that even happens at the OECD.

But when the political appointees get involved, they put their thumbs on the scale in order to generate results that will please the governments that underwrite their budgets.

My second observation is that there’s nothing necessarily wrong with the IMF’s theoretical assertions in the August study. Infrastructure spending can be useful and productive.

It’s an empirical question to decide whether a new road will be a net plus or a net minus. Or a new airport runway. Or subway system. Or port facilities.

My view, for what it’s worth, is that we’re far more likely to get the right answers to these empirical questions if infrastructure spending is handled by state and local governments. Or even the private sector.

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