streda, apríla 11, 2007

Statism Aside: Government-Backed Economy Does Not Work

by Rok SPRUK

One of the greatest philosophers of all time, a Nobel Prize winning economist Friedrich August von Hayek once wrote that coercion implies the control of human life and inevitably leads to forced government intervention, redistribution of wealth and income and a reduced degree of personal liberties. Hence, Professor Hayek wrote that we shall never see a free society if government and the privileged few, mostly interest groups, would still exercise the means of coercion and control. There are several countries that went from rags to riches and became a global success stories. Ireland, once a third world country, became the second richest economy in Europe in less than a century. The »Irish miracle« of an economic supply-side powerhouse is also a proven case study of supply-side's success which is in principle based on Say's law which means that free exchange agreement is possible if one is able to sell before someone is able to buy. Critics of supply-side economic policy approach claim that Ireland sustained its economic model on the basis of natural circumstances and subsidies from European Structural Funds.

Thus, a lot of those critics propose the application of direct government subsidies and handouts to businesses to support growth and welfare while keeping a nearly confiscatory corporate tax wedge and steeply progressive taxation of marginal income. The tragedy of Airbus is a case study of the abovementioned tactics and strategy. Strong government interference, coercive role of trade union intervention, and ownership role resulted in the downfall of Airbus. Thinking about positive role of the government in the business sector is an illusionary servitude. When strategic managers develop a dynamic business model they consider several factors extending from information asymmetry, cost-benefit analysis, value-chain, risk management, innovative capacity to the ways of how to efficiently reach the targets wanted wheatear it be the combination of market share, business excellence and strong growth (star companies). In case of government handouts to businesses in the form of subsidies or ownership, strategic stakeholders undermine the previously mentioned areas as they mostly consider the political business goals (Airbus) though they are almost everywhere out of reach.

In Slovenia, the government intervention and handouts to businesses have a strong tradition marred by an explosive trade union demand pressures. When Slovenia gained independence, the level of economic freedom reached he lowest rate among transition countries. Even Belarus, the cradle of Soviet-style economy, had had a greater degree of economic freedom. The edifice for success in the range economic freedom is not very difficult to understand the establishment of the rule of law, sound protection of property rights and the privatization are several major components of economic freedom's invigoration in transition countries. In Slovenia, we had neither. The rule of law and the protection of private property rights have been accompanied by a corrupted judicial system while the privatization of state enterprises has been minor. Almost 90 percent of the big companies were left partially or wholly in government hands through the capital ownership of government funds, namely KAD and Sod. Thus, the private sector comprises only 65 percent of the GDP which is one the lowest rate of private sector economy/GDP among European countries. Sole government activities compose 35 percent of the GDP. In comparison with European competitors, Slovenian public sector is among the least efficient, taking input-output efficiency into account. According to Economic Freedom of the World (Fraser Institute), Slovenia has the second biggest public administration, after Sweden. An exponentially growing size of the public administration negatively affected the business environment. Obscene bureaucracy and a huge size of public administration externally distort decision-making in the private sector and, hence, increase the size of the compliance costs where extensive tax reports compose the major part. Historically, the government ownership of big companies caused the external pressures on economic policymakers. Slovenia is an economy largely dependent on international trade. Export presented 70 percent of the GDP in the early period of 2007. in 1991, the hyperinflation from Yugoslavia was inherited and policymakers decided to depreciate the currency several times in order to boost the export growth which resulted in a growing size of excess money supply leading to higher inflation. After the independence, the IMF recommended Slovenia to fix the exchange rate while the central bank didn't have enough currency reserves to fix the exchange rate. Instead, the central bank depreciated the exchange rate and conversely supported export sector at the expense of higher inflation and increased import prices.

The negative side-effects of government ownership of companies has been thoroughly experienced in the case of Slovenia. In 1991, when the economy launched the metamorphosis from Soviet-style to free-market economy, the human capital stock was marred by the lack of knowledge-intensive managerial company reform strategies and employee knowledge (that could be enriched by foreign direct investment) coupled with the edifice of economic nationalism. In this respect, the real sector was inefficient in meeting the global market competition and thus it undertook structural features in a direction of firing the employees with insufficient knowledge. The government intervened and offered those employees early retirement schemes instead of education. On other hand, the government initially complicated the laws surpassed by the parliament that regulated the foreign investment entry. Consequently, Slovenia has one of the lowest foreign investment penetration rates in the EU. In search of non-market utility many technologically redundant employees chose early retirement instead of going back to school. The fatal consequence of such features was the growth of »young pensioners« which has increased exponentially. Today, the age of retirement entry in Slovenia is the lowest in the EU which increases long-term demographic risk as the birth rate is minimal and flows of immigration heavily regulated.

What about the dynamics of the business sector. The growth of productivity of export sector is growing too slowly and the business models are largely old-fashioned, not following the trends and challenges of innovative and growth-supporting strategies to absorb the competitive advantage of a small and open economy. Recent studies have shown that Slovenian labor productivity is in some cases six-times slower than the average EU15 labor productivity. The lack of productivity in wholly or partially government-owned industries emerges from the lack of sufficient capital and technology equipment brought by foreign direct investment such as greenfield or brownfield investment. The growth of productivity is usually hampered by government interference and employment regulation also on behalf of trade union pressures respectively.

Another reason why the performance of state-driven economy is miserable lies in the fact that the cooperation between the university system and business sector is linked very weakly. In Slovenia, there is a large monopolistic state university sector and no private university that could openly compete with government universities and find the incentives to link the bridge between the economy and university sector. In practice, disastrous consequences of monopolized regional universities are seen in a very low growth of services related to trademarks and patents. After postponing the industrial restructuring, Slovenian economy remained, after Poland, the second biggest share of industry in the GDP. Those industries (steel, leather) are facing a huge labor-cost competition from developing economies such as India and China. In advanced economies, enterprises such as Levi's completely abolished the industrial production on the native location and moved it to the countries with a largely smaller labor cost burden. Levi's, for example, focused on trademark development and design that bring the greatest output share per unit of product. On the road to economic growth, the investment in R&D is one of the foremost determinants of human capital creation but this also requires the adjustment of knowledge sector (universities and research institutes) to innovation flows. In other case, higher R&D spending is an »outlay in the black hole«. The fact that research and education quality of Slovenian university achieves a low international level is seen on the Shanghai Academic Ranking where none of Slovenian universities is among top 500 world academic institutions according to the number of highly cited articles (SCI), staff quality and several other factors determining the quality of academic environment. In Slovenia, there're only 3 highly cited scientific articles per 1000 inhabitants which is the third lowest ranking in Europe, only in front of Turkey and Portugal. The outcome of weak cooperation between the university-research sector and the economy is seen in the export structure of Slovenia's economy where the share of high-tech products is on the lower bottom-line among the EU economies. The education system from basic to secondary level is marred by government intervention. The system includes very unproductive education with no correlation with growth and dynamic challenge in a modern information society. According to OECD's Literacy in the Information Age, 80 percent of adult population in Slovenia is functionally illiterate, i.e. knowledge-fatigued to solve contemporary complex problems in a modern information society which also means not knowing how to calculate the savings for the old age.

The final impact of a statist influence in the economy is reflected in the aggregated level of international competitiveness pertaining to each economy. In recent years, Slovenia has dropped on nearly every scale measuring international competitiveness. IMD's World Competitiveness Scoreboard shows a very weak rule of institutions and law, a low performance of government policies, globally uncompetitive business sector and above all – a heavily regulated labor market. The rigidity of the labor market has also been displayed by the Index of Economic Freedom issued by Heritage Foundation in Cooperation with Wall-Street. Fraser Institute's Economic Freedom of the World ranked Slovenia in the group of authoritarian countries such as Tanzania and Uganda. The analysts at Fraser Institute exposed a growing size of public administration, a rigid labor market, state-dominated and highly concentrated banking and insurance sector. The latter is, of course, essential to capital formation and venture funds creation which improve the access of investors to capital and financial markets to sustain growth and entrepreneurial dynamics.

Despite the political rethorics, the command economy doesn't work as I have tried to demonstrate it above. If it worked, the economy of Soviet Union, Yugoslavia or North Korea would flourish. The major objection to free economy and private ownership of individual resources lies in the fact that the proponents of command economy and confiscatory taxation deny the prosperity and individual and economic freedom to successful people who accumulated the wealth from productive behavior – risk-taking, work and entrepreneurship.

Rok SPRUK is a classical liberal economist. His fields of work are macroeconomics, economic growth, tax reform, international economics and international competitiveness. In the area of business Rok is focused on strategic management, financial markets, business models and innovation. He lives in Slovenia where he studies economics and business. You can send Rok an email to or you can visit his blog entitled Capitalism & Freedom