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December 17, 2007

Economist's View - 4 new articles

Phelps: Innovative Thinking for European Business

Edmund Phelps reiterates his belief that Europe stifles innovation and dynamism, and that globalization may help to bring about positive change:

Innovative thinking for European business, by Edmund Phelps, Commentary, Financial Times: The great ideas about enterprise and society were all European. ... The thinking bore fruit. By the last decades of the 19th century, Europe's business was humming and productivity was growing at record speed – both powered by unprecedented innovation. ...

Yet European ideas hostile to capitalism also arose. In the 20th century, they shaped on the continent a system that was a giant step backward – a set of values and institutions that has been badly lacking in internal dynamism and stultifying, save when external opportunities lit the way.

At the core of this reaction were the tenets of corporatism: a tradition of "solidarism", originating with the corporazioni of ancient Rome and the medieval guilds, inspired the formation of industrial unions and employer confederations. These combines operate against entry of the outsider with an innovative idea for starting a new company and instill uncertainty even for incumbent enterprises.

A desire for order led to virtual unanimity being required among "stakeholders" and the "social partners" for a change to be allowed. ... An ethic of egalitarianism deterred the individual from deviating from his or her group... This could only have damped the entrepreneurial spirit.

A distaste for "money-grubbing" led many young people to prepare for the public sector or to manage the family business rather than start a new one. An attitude called "scientism" deriving from the rationalism of the French Enlightenment saw ... entrepreneurs and traders as worthless and held that rational economic policy demanded a co-ordinating role by the state – indicative planning and some key state enterprises.

The corporatist tenet that companies are arms of the state for the good of society was also inimical to dynamism. It caused owners and managers of a company to fear that oversize profits would make it a target of politicians. It led to a system of patronage... It also led to state protection of threatened companies through tax relief, tariffs and bars to competition. Whole industries were subsidised as "national treasures".

Making companies into a protected preserve led them to become social clubs in which only those with connections were let in. ... Flexibility and rapid response suffered. ...

Can the continent, with this legacy, regain high dynamism so as to lift its employment, productivity and spirits? ... Now it is said that the corporate sector has the power to transform itself... However, if the interests of owners and managers did not lift economic performance before, why should those interests raise performance now?

The general argument is that globalisation ... heightens pay-offs from better-performing economic structures. Moreover, the contact of continental companies with Anglo-American capitalism can make vivid to them some ways by which they can pull up performance.

For me, the key point is that globalisation has opened markets for the launch of continental European innovations – and these new markets have fast growth rates. This will create jobs and speed growth.

Time will tell how innovative the continental companies will become. Many companies may have to struggle in unreceptive domestic markets. Some managers may shun the risks... Finally, one wonders how large the gains can be without the revolution in workplace attitudes that high dynamism requires.

We may soon find out if his implicit air of superiority for the dynamism of the U.S. economy over Europe's is justified depending on whether we have a hard or soft landing as a result of the financial market crisis (and how it compares to Europe's response to similar problems).

I am going to make the counterargument to Phelps the lazy way - with your help (I hope). Suppose that you do accept that Europe has consciously chosen a different institutional structure that provides more social insurance, and that this has come at a cost (the size and even the existence of these costs is controversial). How would you defend the European system? Are the costs smaller than Phelps infers? What benefits would you point to, i.e. what does Europe have that the U.S. does not that more than makes up for any reduced innovation and dynamism?

Mr. Free Market Says Government Should Help

Greenspan says the government should bail out struggling homeowners:

Greenspan Says He Favors a Government Bailout for Homeowners, by Steve Matthews, Bloomberg: Former Federal Reserve Chairman Alan Greenspan said he favors spending U.S. government money to bail out mortgage borrowers who risk losing their homes because they can't make payments.

Greenspan, speaking on ABC's ''This Week'' program aired today, said cash bailouts, while creating a larger budget deficit, have the advantage of helping homeowners without distorting property prices or interest-rates on mortgages.

''Cash is available and we should use that in larger amounts, as is necessary, to solve the problems of the stress of this,'' Greenspan said. ''It's far less damaging to the economy to create a short-term fiscal problem, which we would, than to try to fix the prices of homes or interest rates. If you do that, it'll drag this process out indefinitely.''

Greenspan's suggested approach differs from that of Treasury Secretary Henry Paulson, who negotiated a freeze on the interest rates of some subprime mortgages without pledging any government money to help homeowners or banks.

The WSJ Economics blog has more. Greenspan is asked next if there needs to be a bias toward activism right now:

It depends what you mean by activism. If you mean doing something that works, absolutely. If you mean doing something just for the sake of perceptions, that's very costly. I don't know if [infusing cash] would work, but it would certainly help people — it would help their incomes; it would help their personal state, without affecting the structure of the way markets are behaving and the way adjustment process is going on. It's very critical that this thing reach a selling climax — if I may put it in other words, exhaust itself. It's only when the markets are perceived to have exhausted themselves on the downside that they turn. Trying to prevent them from going down just merely prolongs the agony.

I don't understand how an infusion of cash to help struggling homeowners would leave the speed at which the housing market corrects unaffected. And maybe it shouldn't. The point of stabilization policy is to smooth business cycles, and it may be that smoothing the adjustment process over time, i.e. preventing a sudden drop through policy intervention, makes the bottom of the market higher higher than it was before. If so, then intervention does make the adjustment take longer, but it is not as severe. Greenspan also says "cash is available." From whom or from where? He's talking about creating a deficit through fiscal policy, so I'm guessing he means fiscal policy - broad based tax cuts in particular (though I've argued that increased spending works better than tax cuts for these problems) - not money directly given directly and solely to struggling homeowners, but its hard to tell from what he says. Atrios also comments.

links for 2007-12-16

How Will You Pay for That Free Lunch?

The CBO has this graph featured on its website:

Federal Spending (Percentage of gross domestic product)

The graph identifies the main source of the projected growth in our fiscal imbalance, health care costs (and it's mainly the growth in costs, not the baby boom retirement wave, though demographics do play a role). The CBO report says:

The rise in health care spending is the largest contributor to the growth projected for federal spending. Therefore, efforts to reduce overall government spending will require potentially painful actions to slow the rise of health care costs. There may be ways, however, in which policymakers can reduce costs without harming the health of Medicare and Medicaid beneficiaries. Changing those programs in ways that reduce the growth of costs—which will be difficult, in part because of the complexity of health policy choices—is ultimately the nation's central long-term challenge in setting federal fiscal policy.

Given the magnitude and importance of the budget problem, why are some politicians proposing tax cuts that will make the problem even worse?:

The Republicans' Expensive Tax Promise, by Tom Redburn, NY Times: For decades, ever since Ronald Reagan was elected in 1980, promising to cut taxes has been an essential element of every successful Republican campaign for the presidency. ...

But there is a crucial twist to the campaign this time around. All of the Republican candidates have pledged to extend President Bush's tax cuts from the early 1990s beyond their scheduled expiration in 2010. That promise, however, does not carry the same weight as in the past.

That's because, rather than delivering any additional benefit..., carrying out such a pledge would do nothing more than maintain the status quo. Nobody's taxes would be cut further... There's not as much political payoff in that.

And preventing anybody from being worse off is going to be incredibly costly. ... Simply to extend the Bush tax cuts indefinitely into the future and ... prevent the alternative minimum tax from imposing an increasingly heavy burden on tens of millions of middle-class and upper middle-class taxpayers would cost the government, over the next decade, roughly $2.5 trillion in revenues now expected under current law. And that's just the beginning.

Even without taking on any additional tasks, merely meeting the government's existing obligations — mostly to pay for the military and to keep up with the health care and retirement needs of the elderly — would send the budget deficit soaring... [graph]

"The combination of roughly constant revenues and significantly rising expenditures would quickly create an unstable fiscal situation," the budget office report notes...

How would the Republican candidates deal with this problem? Most say they would try to hold down spending — and cut taxes even more.

Indeed, ... Rudolph W. Giuliani, in a recent op-ed article in The Wall Street Journal, wrote that he was "committed to making the 2001 and 2003 tax cuts permanent, while aiming at still-lower marginal rates. We'll give the death tax the death penalty... We also need to reduce the corporate tax rate."

Fred D. Thompson recently unveiled his own tax proposal, which would ... allow taxpayers to choose between paying under the current system or opting for a "flat tax"... The simplified tax system would have just two rates: 10 percent and 25 percent.

The nonpartisan Tax Policy Center analyzed Mr. Thompson's overall proposal and found that it would "represent, by far, the largest tax cut in history...

Mr. Thompson predicted that the tax cut would largely pay for itself by stimulating economic growth and discouraging tax avoidance. If not, he suggested, any additional savings could be achieved by limiting Social Security benefits.

But the Tax Policy Center report found that ... the Treasury would recover no more than about $1 trillion over the decade, resulting in an overall revenue loss of $5 trillion to $6 trillion. The tax cuts would fall far short of paying for themselves. And nearly all the money, like the earlier rounds of tax cuts this decade, would flow to those at the top of the income ladder.

Meanwhile, Mike Huckabee has proposed yet a third alternative, endorsing the so-called "fair tax," which vows to replace all federal revenues — income taxes, payroll taxes for Social Security and Medicare, estate taxes, etc. — with a national sales tax on everything except education.

Proponents say that a sales tax rate of 23 percent on just about all goods and services would generate the same revenues as the current system, but tax experts ... say that it would effectively mean raising the cost of everything people buy by at least 30 percent.

And even if such a tax could be practically instituted, it would still not close the fiscal gap that is about to explode over the next few years.

"Campaigns bring out the Santa Claus in politicians," said Leonard Burman, director of the Tax Policy Center... "But the numbers just don't add up. By promising more tax cuts than we can afford, they are really misrepresenting the choices the nation faces." ...

[T]he Republican candidates, by vowing to extend President Bush's tax cuts, have left themselves with a far bigger fiscal gap to fill. So before the Republicans make any new tax promises, it might help if they first told voters how they plan to pay for the old ones.

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