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Posts Tagged ‘Competitiveness’

I’m in Shenyang, China, as part of the faculty for Northeastern University’s International Economics and Management program.

My primary role is to talk about the economics of fiscal policy, explaining the impact of both taxes and spending.

But regular readers already know my views on those issues, so let’s look instead at the vaunted Chinese Miracle.

And I don’t use “vaunted” in a sarcastic sense. Ever since China began to liberalize its economy in the late 1970s, economic growth has been very impressive. I don’t necessarily believe the statistics coming from the Chinese government, but it’s unquestionably true that there’s been spectacular progress.

The great mystery, though, is whether China will continue to enjoy rapid growth. In other words, will it actually converge with the United States (right now per-capita economic output in America is more than five times higher than it is in China)? Or will China, like many other developing/transition economies, hit a ceiling and then begin to stagnate.

I don’t pretend to know the future, but I can say with great confidence that the answer depends on the actions of the Chinese government.

The good news is that economic freedom jumped dramatically starting in 1980 according to Economic Freedom of the World. Thanks to good reforms, China’s score rose by more than 50 percent, climbing from 4.0 in 1980 to more than 6.0 in just a bit over two decades.

That’s a huge improvement, and it largely explains why prosperity has expanded and there’s been a record reduction in the grinding poverty and material deprivation that characterized the country.

But the bad news is that there hasn’t been much reform in the past 15 years. China’s economic freedom score has oscillated between 6.0 and 6.4 during that period.

Indeed, there have been financial bailouts and Keynesian-style “stimulus” schemes, so it’s possible that China is now going in the wrong direction.

Before digging into the details, let’s consider the economics of growth. I’ve written before that labor and capital are the two factors of production and that economic growth is a function of more labor, more capital, or learning to use existing labor and/or capital more productively.

One way to visualize this is with a production possibility curve. This is a tool in economics that often is used to illustrate tradeoffs and opportunity costs. If Robinson Crusoe is on a deserted island, what the best way for him to allocate his time to maximize the amount of fish he can catch and the number of coconuts he can collect? Or, for an entire society, what’s the “guns-vs-butter” tradeoff?

Here’s a chart I found online that illustrates the role of capital and labor and producing output. It’s a three-dimensional chart, which is helpful since it not only shows that there’s no output in the absence of capital and labor, but it also shows that an economy with just labor or just capital also won’t have much if any output. You produce a lot, by contrast, with labor and capital are mixed together.

But that’s just the beginning.

The above chart shows the amount of output that theoretically can be produced with given amounts of labor and capital. But what if there’s bad policy in a nation? Consider the difference, for example, between China’s plateaued economic freedom score and decent economic performance compared to Hong Kong’s great economic freedom score and great economic performance.

With that in mind, contemplate this two-dimensional image. With bad policy, either the economy only produces A when it can produce B (i.e., by using existing labor and capital more productively) or it produces B when it can produce C (i.e., by expanding the amount of labor and capital).

I suspect that China’s problem is mostly that bad policy interferes with the efficient allocation of labor and capital. In other words, there’s already a lot of labor and capital being deployed, but a significant amount is misallocated because of cronyism and other forms of intervention.

Now let’s move from theory to empirical details.

Here’s a close look at China’s reforms from Professor Li Yang, Vice President of the Chinese Academy of Social Sciences.

Over the past 35 years, China has achieved extraordinary economic performance thanks to the market-oriented reforms and opening-up….The GDP per capita also reached to $6075 in 2012, up from $205 in 1980… China’s economy experiences impressive changes in favor of marketization. In fact, as far back as 1996, 81% of the production materials, and 93% of retail sales, had already been traded according to the market pricing mechanism.

And here’s a chart showing the gradual expansion of market forces in China, presumably based on whether prices are determined by markets or by central planning.

We also have two charts showing the decline in genuine socialism (i.e., government ownership of the means of production).

The first chart shows that state-owned companies are becoming an ever-smaller share of the economy.

Even more impressive, there’s been a huge decline in the share of the population employed by state-owned firms.

This is good news, and it helps to explain why China is much richer today than it was 30 years ago.

But the great unknown is whether China will experience similar strong growth for the next 30 years.

Here’s more of Professor Yang’s optimistic analysis.

Another indispensable factor explaining China’s growth miracle is constant opening-up, which is equally guided by the principle of gradualism. Regarding the space structure, the markets successively opened up from the special economic zones, economic and technological development zones, coastal economic development zones, riparian regions, inland regions, and finally the whole China; regarding the industrial structure, from the advantaged manufacturing industry, to the less advantaged agriculture and service industries. In 2001, China’s entry into the WTO can be regarded as a milestone: China’s opening up transformed from selective policy measures to widespread and deep institutional arrangements.

The liberalization of trade is particularly impressive, as shown by the following chart from the study.

Makes me wonder what Donald Trump would adjust his protectionist China-bashing if he saw (and understood) this chart.

Anyhow, here are some passages from Professor Yang’s conclusion.

…market-oriented reforms constitute the most crucial factor to support China’s growth in the future. The key here is to properly deal with the relationship between government and markets. The latter will be expected to play the fundamental role in the allocation of economic resources. …China should make more effort to improve the efficiency of investment. …the government needs to reduce its intervention in the micro-level economic activities, promote deregulation and administrative decentralization, break up monopolies, and improve the efficiency of functioning.

I agree, particularly the part about boosting the efficiency of investment.

And that can only happen if China ends cronyism by letting capital be allocated by market forces rather than political connections.

Let’s close with two items.

First, one of the other faculty with me at the University in Shenyang is Ken Schoolland. In his presentation, he noted that there’s some real federalism in China. Provinces have considerable flexibility to engage in reform.

And it shouldn’t come as any surprise that the rapid growth in China has been concentrated in the areas that have moved the fastest and farthest in the direction of free markets.

Second, some experienced observers are a bit pessimistic about future Chinese economic developments. Derek Scissors of the American Enterprise Institute explains what needs to happen to boost future prosperity.

…the economy is in the process of stagnating. The only solution is a return to market-driven, politically difficult reform. Such reform must be focused primarily on rolling back the state sector. …Expanded individual or household land ownership in rural areas would be…helpful. …More individual land rights shrink the rural state. The critical step in revitalizing the economy is to shrink the urban state, and by a considerable amount. Such changes will of course be phased in over time but the sooner they start, the sooner economic performance improves. Shrinking the urban state sector would (i) finally address excess capacity; (ii) enable capital to be much more efficiently allocated; (iii) thereby slow or halt unproductive debt accumulation; and (iv)encourage innovation by enabling more competition. …In terms of capital allocation, formal interest rate liberalization was said to be a vital step. But it cannot be while the state controls most financial assets – the incentives for collusion among sister state financials are overwhelming.

Here’s Derek’s bottom line.

Want to know when China is going to thrive again – just check if the state sector is actually shrinking.

Amen.

What he’s basically describing are the policies that would dramatically improve China’s score from Economic Freedom of the World. And if China can ever climb as high as Hong Kong, then the sky’s the limit for growth and prosperity.

P.S. There are some signs that China’s leadership recognizes that a Reagan-style agenda is needed.

P.P.S. On the other hand, if China’s government takes the IMF’s advice, then prepare for economic decline and stagnation.

P.P.P.S. The most amusing economic news in recent years was when a senior Chinese official basically explained that the welfare state in Europe makes people lazy.

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The United States is laboring through the weakest economic recovery since the Great Depression.

Median household income is stagnant and labor-force participation is dismal.

Sounds awful, right?

Compared to the strong growth of the pro-market Reagan years and pro-market Clinton years, it is awful.

But maybe we should count our blessings

Here’s a chart from a presentation. by economists from the European Central Bank, and it shows how much the United States has grown since 1999 compared to Japan and euro nations.

We’ve enjoyed nearly twice as much growth as Europe and almost three times as much growth as Japan. Which is remarkable since those countries aren’t as rich as the United States and they should grow faster according to convergence theory.

So while it’s true that Obamanomics hasn’t been good for the United States, it’s apparently not as bad as Abenomics in Japan and Hollandenomics (and Renzinomics and Tsiprasnomics) in Europe.

Allan Meltzer explains why Europe is lagging in an article for the Hoover Institution.

Europe has become the model for how democratic capitalism can give way to the welfare state. Following a surge of market-driven growth after World War II, there was a rise across the continent in income redistribution and regulations intended to protect workers and consumers, and to achieve “fairness.” From the 1960s onward, high tax rates and heavy regulations slowed economic growth. And many welfare state programs became roadblocks to economic progress by resisting reforms and prolonging the current European recession. …France and Italy are not as far along to disaster as Greece, but their welfare systems are also difficult to reduce to regain competitiveness. …Monetary policy cannot overcome real, structural problems. Spain and Ireland showed that EU members can restore growth most effectively by making…painful real changes… Sluggish growth will continue until EU officials adopt policies that encourage private investment.

It’s depressing to think that some American politicians want to copy European failure.

Some of the candidates in the 2016 presidential race offer more welfare state benefits as a remedy for current voter malaise. The promise is that the way to make everyone better off is by taxing high incomes and distributing more to others. That’s the route that many in Europe took. Instead of the promised happy outcome, much of Europe got slow growth and high unemployment and an ever greater need to restore competitiveness by reducing the expanded welfare state. …Prime Minister Thatcher often said, “The welfare state will end when they run out of YOUR money.” If she was right, the end for Europe is here. And the lesson for the United States is to adopt less costly policies before debt markets force the change. …the lesson for the United States is that we will not escape the problems of the welfare state.

Even the left-wing bureaucrats at the OECD sort of admit Europe is falling behind.

I’ve previously shared data from the OECD showing much higher living standards in the US than in Europe, and here are some excerpts from a recent report on global migration patterns for high-skilled workers.

…migrants to the EU are younger and less well educated than those in other OECD destinations. Of the total pool of highly-educated third-country migrants residing in EU and OECD countries, the EU hosts less than one-third (31%), while more than half (57%) are in North America. …most importantly, many labour migrants are not coming to the EU under programmes for skilled workers. …EU Member States covered by EU legal migration policies received annually less than 80 thousand highly qualified third country labour migrants. By comparison, Canada and Australia have annual admissions under their selective economic migration programmes for highly-qualified workers of 60 thousand each.

In the section on recommendations, you won’t be surprised to learn that the OECD failed to suggest pro-market reforms.

There’s boilerplate language about streamlining the process for high-skill immigrants, but nothing about the stifling tax burdens and expensive welfare states that cause European economies to be so stagnant and unappealing.

One very visible manifestation of inferior living standards in Europe is that people generally have very cramped housing conditions compared to the United States (even Americans in poverty have more living space than the average European).

And to make matters worse, air conditioning is the exception not the rule.

Amusingly, Europeans pretend to feel superior about their summertime misery, as reported by the Washington Post.

Whereas many Americans would probably never consider living or working in buildings without air conditioning, many Germans think that life without climate control is far superior. …many Europeans visiting the U.S. frequently complain about the “freezing cold” temperatures inside buses or hotels. …Europe thinks America’s love of air-conditioning is actually quite daft. …according to the Environmental Protection Agency, …demand for air-conditioning has only  increased over the past decades. …the United States consumes more energy for air conditioning than any other country. …Europeans are generally more used to warmer room temperatures because most of them grew up without any air-conditioning.

As one might expect, the issue is being used by climate alarmists.

Another factor that may explain Europe’s sniffy reaction toward American cooling is the continent’s climate change awareness. According to a 2014 survey, a majority of Europeans would welcome more action to stop global warming. Two thirds of all E.U. citizens said that economies should be transformed in an environmentally-friendly manner. Cooling uses much more energy than heating, which is why many Europeans prefer sweating for a few days… America’s air-conditioning addiction may also have another negative side effect: It will make it harder for the U.S. to ask other countries to continue to abstain from using it to save energy. …”If everyone were to adopt the U.S.’s air-conditioning lifestyle, energy use could rise tenfold by 2050,” Cox added, referring to the 87-percent ratio of households with air-conditioning in the United States.

I’m much more tolerant of heat than the average American, so I probably could survive in a world without air conditioning.

But I hope that day never arrives and I continue to enjoy the full benefits of living in a first-world nation.

Let’s close with a fascinating map showing populations changes in Europe from 2001-2011. It’s in German, but all you need to know is that dark red means a 2-percent-plus increase in population while dark blue means a decline of at least 2 percent.

France and Ireland have population growth, as well as (to a lesser extent) Northern Italy and Poland.

But take a look at Portugal, Northwestern Spain, Eastern Germany, and the non-Polish portions of Eastern Europe. You’ll understand why I fret about demographic crisis in both Western Europe and Eastern Europe.

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What’s the best measure of the tax burden on the U.S. economy?

Is it the amount of money that we’re forced to surrender to the knaves in Washington (i.e., the difference between our pre-tax income and post-tax consumption)?

Or is it the loss of economic output caused by high tax rates, distorting preferences, and pervasive double taxation (i.e., policies that reduce our pre-tax income)?

The answer is both.

But even that’s not sufficient. There’s another very big part of the tax burden, which is the complexity caused by a 75,000-page tax code that imposes very high compliance costs on taxpayers. In other words, the tax (as measured by time, resources, and energy) we pay for the ostensible privilege of paying taxes.

And this compliance tax is enormous according to new research from the Tax Foundation. The report starts with some very sobering numbers.

…In 1955, the Internal Revenue Code stood at 409,000 words. Since then, it has grown to a total of 2.4 million words: almost six times as long as it was in 1955 and almost twice as long as in 1985. However, the tax statutes passed by Congress are only the tip of the iceberg when it comes to tax complexity. There are roughly 7.7 million words of tax regulations, promulgated by the IRS over the last century, which clarify how the U.S. tax statutes work in practice. On top of that, there are almost 60,000 pages of tax-related case law, which are indispensable for accountants and tax lawyers trying to figure out how much their clients actually owe.

It then measures the burden of this convoluted system for taxpayers.

According to the latest estimates from the Office of Information and Regulatory Affairs, Americans will spend more than 8.9 billion hours complying with IRS tax filing requirements in 2016. This is equal to nearly 4.3 million full-time workers doing nothing but tax return paperwork. …in dollar terms, the 8.9 billion hours needed to comply with the tax code computes to $409 billion each year in lost productivity, or greater than the gross product of 36 states… The cost of complying with U.S. business income taxes accounts for 36 percent of the total cost of the entire tax code, at $147 billion. Complying with the individual income tax costs another $99 billion annually.

The report provides data for 50 provisions of the tax code. In the interest of brevity, here are the 10-most expensive features of the internal revenue code.

The overall $147 billion compliance cost for businesses is enormous, particularly when you consider that corporate tax revenue for Uncle Sam this year is estimated to be $329 billion. So companies have a double-whammy of enduring the developed world’s highest corporate tax rate, and they have to spend lots of money for the pleasure of that punitive system.

Another part that grabbed my attention is “Form 4562” dealing with depreciation. If you care about good policy and stronger growth, businesses shouldn’t even have to depreciate. Instead, we should have a policy of “expensing,” which is simply the common-sense approach of recognizing costs in the year they occur. So firms are paying a $23 billion-plus tax for the privilege of a policy that already punishes them for investing. Amazing.

And don’t forget the death tax, which also makes the top-10 list. The Tax Foundation points out that the compliance cost basically doubles the burden of that horrible and unfair levy.

The estate and gift tax, which will only collect approximately $20 billion in federal revenues this year, has a compliance cost of $19.6 billion.

What a mess.

So what’s the answer?

Simply stated, we should rip up the entire internal revenue code and replace it with a simple and fair flat tax.

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Something doesn’t add up. People like me have been explaining that California is an example of policies to avoid. Depending on my mood, I’ll refer to the state as the France, Italy, or Greece of the United States.

But folks on the left are making the opposite argument.

A writer for the Huffington Post tells readers that California is proof that the blue-state model can work.

Many factors contribute to California’s preeminence; one being its liberalism. Republicans don’t like to acknowledge California’s success. …The state’s job growth outpaced the nation’s in the first nine months of last year. California’s non-farm employment of 15.7 million people is at an all-time high. …California’s economy has thrived in spite of relatively high taxes and stringent regulations.

Meanwhile, a couple of columnists for the Washington Post are doing a victory dance based on recent California numbers.

…the…experiences of California…run counter to a popular view, particularly among conservative economists, that tax cuts tend to supercharge growth and tax increases chill it. California’s economy grew by 4.1 percent in 2015, according to new numbers from the Bureau of Economic Analysis, tying it with Oregon for the fastest state growth of the year. That was up from 3.1 percent growth for the Golden State in 2014, which was near the top of the national pack. …almost no one can say that raising taxes on the rich killed that recovery.

And let’s not forget that Paul Krugman attacked me two years ago for failing to acknowledge the supposed success story of job creation in California. I thought he made a very silly argument since the Golden State at that time had the 5th-highest unemployment rate in the nation.

But Krugman and the other statists cited above do have a semi-accurate point. There are some statistics showing that California has out-performed many other states over the past couple of years. Let’s look at the numbers. The St. Louis Federal Reserve Bank has a helpful website filled with all sorts of economic data, including figures from the Bureau of Economic Analysis on per-capita income in states.

I selected California for the obvious reason, but also Texas (since it’s often seen as the quintessential “red state”) and Kansas (which has become infamous for a big tax cut). And, lo and behold, if you look at what’s happened to per-capita income in those states, California has enjoyed the most growth.

Is this evidence that high taxes and a big welfare state are good for growth?

Hardly. California’s numbers only look decent because the state fell into a deep hole during the recession. And, generally speaking, a severe recession almost always is followed by good numbers, even if an economy is simply getting back to where it started.

So let’s expand on the above numbers and look at what’s happened not just over the past five years, but also since 2000 and 2005.

And if you look at California’s relative performance over a 10-year period or 15-year period, all of a sudden the Golden State looks a bit tarnished.

By the way, these numbers are not adjusted for either inflation or for cost of living. The former presumably doesn’t matter for our purposes since changing to inflation-adjusted dollars wouldn’t alter the rankings. Meanwhile, the data on cost of living would matter for comparative living standards (for instance, $46,745 in Texas probably buys more than $52,651 in California), but remember that we’re focusing on changes in per-capita income (i.e., which state is enjoying the most growth, regardless of starting point or how much money can buy in that state).

In any event, the numbers clearly show there’s more long-run growth in Texas and Kansas, and it’s long-run growth rates that really matter if you want more prosperity and higher living standards for people.

But let’s not stop there. Our left-wing friends frequently tell us that per-capita income numbers are sometimes a poor measure of overall prosperity since a few rich people can skew the average.

It’s better, they tell us, to look at median household income since that’s a measure of the well-being of ordinary people. And we can get those numbers (only through 2014, though adjusted for inflation) from the Census Bureau. What does this data show for Texas, California, and Kansas?

As you can see, California is in last place, regardless of whether the starting point is 2000, 2005, or 2010. In other words, California may have enjoyed some decent growth in recent years as it got a bit of a bounce from its deep recession, but it appears that the benefits of that growth have mostly gone to the Hollywood crowd and the Silicon Valley folks. I guess this is the left-wing version of “trickle down” economics.

Perhaps most interesting, the short-run numbers show that tax-cutting Kansas has a comfortable lead over tax-hiking California.

If that trend continues, then over time we can expect that the long-run numbers will begin to diverge as well.

Let’s close by looking at some analysis about those two states for those who want some additional perspective.

Victor David Hanson, a native Californian, has a pessimistic assessment of his state. Here’s some of what he wrote for Real Clear Politics.

The basket of California state taxes — sales, income and gasoline — rates among the highest in the U.S. Yet California roads and K-12 education rank near the bottom. …One in three American welfare recipients resides in California. Almost a quarter of the state population lives below or near the poverty line. …the state’s gas and electricity prices are among the nation’s highest. …Current state-funded pension programs are not sustainable. California depends on a tiny elite class for about half of its income tax revenue. Yet many of these wealthy taxpayers are fleeing the 40-million-person state, angry over paying 12 percent of their income for lousy public services. …Connecticut and Alabama combined in one state. A house in Menlo Park may sell for more than $1,000 a square foot. In Madera three hours away, the cost is about one-tenth of that. In response, state government practices escapism, haggling over transgendered restroom issues and the aquatic environment of a 3-inch baitfish rather than dealing with a sinking state.

The bottom line is that he fears the trend line for his state is moving in the wrong direction.

John Hood takes a look at why the Kansas tax cuts have resulted in budget turmoil, while tax cuts in has state of North Carolina haven’t caused much controversy.

How did Kansas and North Carolina end up in such different conditions? For one thing, while the two states both enacted major tax cuts, they weren’t structured the same way. Kansas punched a large hole in its income-tax base by excluding self-employment income. North Carolina briefly created a version of this exclusion in the immediate aftermath of the Great Recession, but then wisely eliminated it in favor of applying a low, uniform tax rate on a broad base of personal income. In Kansas, lawmakers also allowed themselves to be bamboozled by some out-of-state tax “experts” claiming that cutting income taxes would generate so much new investment, entrepreneurship, and population growth that the revenue loss to the state would be substantially offset. This can actually be true, of course — in the very long run, counted in decades. In the short run of state budgeting, however, policymakers are better off making far more conservative assumptions about revenue feedbacks. …Our state policymakers didn’t just reduce and reform taxes. They also controlled expenditures. Since the enactment of the 2013 tax changes, their authorized budgets have never pushed spending growth above the combined rates of inflation and population growth. Actual spending, in fact, has often come in below even these budgeted amounts.

John’s message is that pro-growth tax cuts don’t generate overnight miracles. Lawmakers have to be prudent when calculating Laffer Curve feedback. And they also should make sure there is concomitant restraint on the spending side of the budget.

The bottom line is that the Kansas tax cuts are good for the state’s economy, but they might not be sustainable unless politicians don’t quickly make reforms to cap spending.

P.S. Closing with some California-specific humor, this Chuck Asay cartoon speculates on how future archaeologists will view California. This Michael Ramirez cartoon looks at the impact of the state’s class-warfare tax policy. And this joke about Texas, California, and a coyote is among my most-viewed blog posts.

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Programs about the improbable success of Chile and Estonia already have aired on nationwide TV, and those were joined last weekend by a show about the “sensible nation” of Switzerland.

Here’s the 28-minute program.

When I first watched the program, I was slightly irked that there was very little discussion of the role of fiscal policy and the importance of spending restraint and competitive tax rates.

Moreover, there was no direct mention of Switzerland’s very successful spending cap, even though the “debt brake” has generated superb results.

Indeed, Switzerland is the only nation from Europe or North America that gets high scores from Economic Freedom of the World for both fiscal policy and rule of law (a notable achievement since Wagner’s Law tells us that it is very difficult to stop government from expanding once the private sector generates a lot of wealth that can be redistributed).

But I confess I’m biased about the importance of tax and spending issues.

And as I thought about what I had seen, I realized that the program’s focus on federalism and decentralization made sense.

Yes, Switzerland has a modest-sized government. And, yes, the debt brake has been a huge success. But those good outcomes are in part the result of a system where most government still takes place at the local (commune) or state (canton) level.

In other words, Switzerland generally still has the type of system America’s Founding Fathers envisioned, with a small central government.

I’ve already pointed out that the level of redistribution in Switzerland is relatively low because of its decentralized model.

But there’s another feature of federalism that’s worth celebrating. As Nassim Nicholas Taleb (of “Black Swan” fame) has pointed out, decentralized systems are much more stable and successful since there’s far less risk of a mistaken policy being imposed on a one-size-fits-all basis.

And countless scholars, including many Nobel Prize recipients, have explained that small, competing nations were a key reason why Europe became a rich continent in the first place.

Sadly, most Europeans have forgotten this lesson and have created the EU superstate in Brussels (which helps to explain why I’m delighted that the United Kingdom voted to escape that sinking ship).

So the moral of the story, from both the video about Switzerland and from all the other evidence in the world, is that federalism is good policy.

Let’s close with an interesting example of Swiss federalism in action. The canton of Zug is known for being a low-tax haven in a country famous for having a reasonable tax regime. Well, the town of Zug is on the cutting edge of digital money.

…the town council has hopes Zug’s trend as a financial tech hub continues  — having embraced the new identity with this legislative move. …As the pilot program is first implemented it will initially allow payments up to 200 Francs, and possibly introducing the ability to pay larger amounts later in the future. …analysis will ultimately determine whether or not the town council will continue allowing Bitcoin payments for municipal services. …Bitcoiners will be taking notice of this small town, and it already has the added benefit of being located in Switzerland  —  which is known for its business friendly environment and relatively small regulatory burden. …In fact, Switzerland’s business environment and relatively free-market economy even helped to convince the Bitcoin wallet and exchange, Xapo, to relocate to Switzerland last year. …the town of Zug itself also provides its citizens with a relatively hands-off approach to the local economy. The Swiss town of  Zug showcases one of the lowest tax rates in the world. This combination of a hands-off approach by the government and large tax benefits has made the small town into a successful economic hub where global trade flourishes.

Wow, this says a lot about the quality of governance in Switzerland that a nation that doesn’t need Bitcoin (unlike, say, Greece or Argentina) nonetheless welcomes it as a competing currency.

Yet another reason why Switzerland is one of the world’s best nations.

P.S. Today’s column is about Switzerland, but I can’t resist pointing out that Hong Kong and Singapore both score highly for rule of law and small government. And Chile deserves honorable mention as well. For what it’s worth, the Princess of the Levant’s home country of Lebanon apparently has the world’s small fiscal burden, but the low score for rule of law suggests that the real story is that the government is simply too incompetent to collect and redistribute money.

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Communism is an evil system. Freedom is squashed and people are merely cogs in a system where government exercises total control over the economy and destroys the lives of ordinary people.

It also erodes the social capital of a people, telling them that individual initiative and success are somehow exploitative and evil.

So when such a system ultimately collapses after being in place for decades, one would not expect a fast rebound. After all, it’s presumably difficult to restore the characteristics of a free society such as a work ethic, personal responsibility, and a spirit of entrepreneurship.

This is why Estonia is such an improbable success. It was under the heel of Soviet communism from World War II until the early 1990s.

Yet as illustrated by this television program about Estonia, which recently aired across the country, there’s been a remarkable recovery and renaissance in this small Baltic republic.

The program mostly focuses on the entrepreneurial success of Estonia, so I want to augment the policy discussion.

There are five big reasons why Estonia is a role model for post-communist societies.

First, Estonia is a leader in the global flat tax revolution. It has a simple and fair system with a relatively reasonable rate of 20 percent.

Second, the flat tax rate has been continuously lowered from the original 26 percent rate when the system was adopted in the early 1990s.

Third, the business tax system is remarkably benign with a rate of 20 percent that is imposed only on dividends.

Fourth, the combination of these factors helps give Estonia the most attractive tax system of all OECD nations according to the Tax Foundation.

Estonia currently has the most competitive tax code in the OECD. Its top score is driven by…positive features of its tax code. First, it has a 20 percent tax rate on corporate income that is only applied to distributed profits. Second, it has a flat 20 percent tax on individual income that does not apply to personal dividend income.

Fifth, there are other pro-market policies. Estonia is ranked #22 in Economic Freedom of the World, putting it in the “most free” category. That’s only six spots behind the United States.

But good policy is not the same as perfect policy.

So while there’s much to admire about Estonia, here are five things about the country that could be improved.

First, the burden of government spending is excessive in Estonia. According to the most recent OECD figures (see annex table 25), 38.5 percent of economic output is diverted to the state, leading to substantial misallocation of labor and capital.

Second, like other nations in the former Soviet Bloc, there’s a demographic challenge. The welfare state may be modest by European standards, but in the long run it is very unaffordable in part because of a fertility rate of 1.59, which ranks 183 out of 224 jurisdictions.

Third, there was a very impressive burst of liberalization after escaping Soviet tyranny, but the commitment to economic reform has since stagnated. Estonia’s EFW score peaked at 7.90 in 2005, 9th-highest in the world, and is now down to 7.61, which puts Estonia in 22nd place.

Though it’s worth noting some of the erosion in economic liberty is the result of European Union rules that require trade barriers on non-EU products (which is the same reason why the UK may enjoy higher trade over time if it votes to leave the EU).

Fourth, the social insurance tax rate is a stifling 33 percent, driving a significant wedge between what an employer must pay and what an employee actually receives. The only mitigating factor is that a small portion of that money goes to a funded pension system (i.e., a partially privatized Social Security system).

Fifth, it is too cold and dark for much of the year. To be sure, that’s not a complaint about policy. But it’s one of the reasons why I recommend Australia for people seeking a haven from bad U.S. policy.

All things considered, Estonia deserves a lot of praise. The problems that remain are modest compared to the nation’s major achievements.

P.S. Lest I forget, one of the admirable things about Estonia was the way the government cut spending in response to the economic crisis at the end of last decade. And I’m talking genuine reductions in spending, not the make-believe we-didn’t-increase-spending-as-fast-as-we-planned “cuts” that often take place in Washington.

P.P.S. In a shocking display of either sloppiness or malice, Paul Krugman blamed Estonia’s 2008 recession on the spending cuts that took place in 2009.

In reality, Estonia’s relative spending discipline has paid dividends. The economy quickly recovered and is out-performing other European nations that chose either tax increases or Keynesian spending binges.

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At the risk of oversimplifying, libertarians want to minimize the level of government coercion is society. That’s why we favor both economic liberty and personal liberty. Simply stated, you should have the right to control your own life and make your own decisions so long as you’re not harming others or interfering with their rights.

That’s a philosophical or moral argument.

There’s also the utilitarian argument for liberty, and that largely revolves around the fact societies with more freedom tend to be considerably more prosperous than societies with lots of government.

I’ve repeatedly made this argument by comparing the economic performance of market-oriented jurisdictions and statist ones.

Let’s look at some new evidence. Based in Lausanne, Switzerland, the Institute for Management Development is a highly regarded educational institution that publishes an annual World Competitiveness Yearbook that basically measures whether a nation is a good place to do business.

So it’s not a measure of economic liberty, at least not directly. And the quality of governance matters for the IMD rankings (presumably based on something akin to the European Central Bank’s measure of “public sector efficiency“).

But you’ll notice a clear link between economic liberty and competitiveness.

Here are the top-10 nations. (you can look at the rankings for all nations by clicking here).

As you might suspect, there’s a strong correlation between the nations that are competitive and those that have smaller governments and free markets.

Indeed, three out of the top four jurisdictions (Hong Kong, Singapore, and Switzerland) rank in the top four for economic liberty according to Economic Freedom of the World.

And I’m happy to see that the United States also scores very highly, even if we only rank 17 out of 157 for economic freedom.

Indeed, every country in IMD’s top 10 other than Sweden is ranked in the top quartile of EFW.

You also probably won’t be surprised by the countries getting the worst scores from IMD.

Congratulations to Venezuela for being the world’s least competitive nation. Though that might be an overstatement since IMD only ranks 61 jurisdictions. If all the world’s countries were included, Venezuela presumably would beat out North Korea. And maybe a couple of other squalid outposts of statism, such as Cuba.

It’s also worth noting that Greece gets consistently bad scores. And I’m not surprised that Argentina is near the bottom as well (though it has improved since last year, so hopefully the new government will continue to move in the right direction).

By the way, it’s worth noting that economic freedom is a necessary but not sufficient condition for competitiveness. Jordan, for instance, ranks in the top 10 for economic freedom but gets a low score from IMD, presumably because the advantages of good policy don’t compensate for exogenous factors such as geopolitical risk and access to markets.

The moral of the story, though, is that free markets and small government are the recipe for more prosperity. And those policies are probably even more important for nations that face exogenous challenges.

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