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NO MAGIC WAND FOR PUBLIC DEBT, EXCEPT…

by Leonardo Baggiani December 15, 2021

written by Leonardo Baggiani

Public debt in the whole world keeps growing. As recently reported in “A Mountain of Debt: Navigating the Legacy of the Pandemic” and “The Aftermath of Debt Surges”, it is just the last “debt wave” in a long-established tendency. Yet, the rise has accelerated during the Covid-19 Pandemic: during 2020, public debt increased by 16 percentage points to 120% of GDP in the advanced economies, and by 13 percentage points to 97% of GDP globally. What are the possible ways out?

Economic growth would be the easy answer. Since growth has been sluggish for years, however, the current “consensus” (see Blanchard et al.) prescribes fiscal stimuli. These include loan/grant packages handed out by the richest countries to help the weakest. Yet, it does not seem that the appropriate expenditure/investment recipe has been found. Moreover, central banks are uncertain about how to solve the trade-off between accommodating policies and inflation. Finally, who will eventually pick up the tab? The only sure thing is that policymakers are ignoring expenditure cuts, and that the prospects about growth remain uncertain.

This explains the proposals about heavier taxation. However, raising extra funds by taxing incomes is politically difficult. First, in 2020, deficits rose from 2% to 9% of GDP on average, with one third of the rise due to a smaller tax base (GDP). Wealth taxes on the rich are certainly more attractive, but they would hardly boost revenues: there are not enough rich taxpayers around (in the top OECD countries, the average wealth tax amounts today to less than 1% GDP). Another option is privatising government assets on a massive scale. But it takes time, and past experiences suggest some scepticism.

In brief, price inflation and low interest rates seem the magic wand: they sustain nominal GDP and devaluate real debt, provided that central banks keep preventing interest rates from rising (thus ensure that real rates stay negative) and can stop inflation at the right moment. Certainly, a decade of missed inflation targets is not an encouraging precedent.

This is what we are observing today. However, the authorities can explore further lines of action. For example, they may trap savings in suitable debt instruments (e.g. via fiscal incentives), or resort to heavy regulation to manipulate bank rates and lending conditions. Quantitative Easing and capital-ratio rules are well-known instruments that encourage banks to buy and hold government bonds. Moreover, the presence of parameters relating to the environment and the so-called social responsibility effectively direct private funds to “appropriate expenditure/investment“ just identified by governments.

These policies are indeed ruining the prospects for growth. Yet, all warnings are being ignored, despite the weak response of growth after massive budgetary stimuli and soaring public debt. Indeed, default (payment suspension, haircut or any kind of restructuring) may be not too far away. Historically, the consequences of default are inflation and recession. Central banks would also pay a heavy price, though. The ECB holds about € 2.3 tn. By contrast, capital and reserves amount at about € 615 bn, just enough to cover the € 430 bn Italian treasuries in its drawers, should Italy default. As € 430 bn are just 16% of the total debt Italian outstanding, it is clear that Frankfurt cannot do much to bail out Rome.

The bottom line is that government spending will be revised, but not reduced. There is little room left for explicit tax rises, and it will be exploited. Inflation (and the inflation tax) will play the main role. It will take some time: ceteris paribus, a steady 4% inflation takes 7 years to devaluate debt by one third, and 10 years to halve it (a steady 6% inflation reduces the time to respectively 5 and 7 years). Economic growth would enhance its sustainability, while new budget deficits would counteract the inflationary effect. Of course, a new negative shock could also trigger a default. In other words, public debts will be paid either by the community (the inflation tax) or by bondholders.

So, what can we make of President Lagarde’s call to increase the supply of AAA-rated bonds as safe collaterals? Within the Eurozone, this need for “safe assets” has led to proposing the securitisation of government bonds to increase the supply of “safe assets” and limiting the consequences of defaults to specific categories of subscribers. As already argued, the ECB could indeed get rid of its government bonds by transforming them into structured products (the so-called ESBies). By doing so, it would channel risk to a specific corner of the market (professional speculators subscribing the riskiest tranche), have extra room to manipulate interest rates, and make defaults less painful. Given the alternatives, it remains a feasible scenario.

Photo by Fabian Kurz

December 15, 2021 0 comment

Highlights Online Articles

Italian Puzzles: will the announced tax cut be real?

by IREF December 8, 2021

written by IREF

Mario Draghi’s government is about to approve an eight-billion euro tax cut – about 1.5% of the estimated 2021 tax revenues. Is this a credible a promise or just an illusion?
The restrictions that followed Covid-19 have taken a heavy toll. Last year, GDP dropped about 9%, tax revenues decreased, and government expenditure soared. As a result, the budget deficit reached around 9.5% of GDP. The 2021 figure should be about the same. Of course, public debt has also risen and is expected to reach 150% of GDP by the end of this year (see Fig. 1).

Yet, Italy is not bankrupt. The European Central Bank came to the rescue by buying large quantities of Italian Government Bonds. In 2021, the ECB purchased bonds for a value of 159 billion euros (equivalent to about 95% of the expected public deficit), and further resources are being injected through the so-called Next Generation plan.

Of course, most parties are now focusing on how to share the Next-Generation pie and pander to their constituencies. Certainly, cutting tax pressure is one of the options that would make potential voters happy. Under such circumstances, is the announced tax cut realistic?

Lower taxes when the budget is unbalanced

Of course, lower taxation is sustainable only if expenditure is also lower. This requirement is particularly stringent when the budget is unbalanced. Yet, cutting expenditure is not what Italian politicians have in mind. Public opinion strongly opposes all plans in that direction, while politicians believe they can keep handing out all sorts of gifts, regardless of the fact that the budget deficit widens and corruption rises.

Certainly, the Italian Tax System must be overhauled and the tax burden eased. However, there is not much room for maneuvering. Eight billion euros are a drop in the ocean and demands for tax cuts intensify. Trade unions and center-left parties ask for tax cuts on low to middle incomes workers and retirees. By contrast, right-wing parties (e.g., the Lega) argue that lighter corporate taxation should have priority.

Comprehensive reform of the fiscal system and tax cut

According to standard economic theory, an income tax should follow two principles. People with the same (or different) ability to pay should be treated equally (differently). Moreover, income taxation should not affect one’s position in the income ladder. The Italian tax system violates all these principles. Hence, people perceive the system as unjust and are encouraged to evade. Not surprisingly, some 50% of the Italian taxpayers pay no or very little income tax, while half of the income-tax revenues comes from the richest 20% of the population.

cumulative_share_of_population_and_cumulative_percentage_of_income_tax_payments_.png

Draghi’s reform

As mentioned earlier, an eight-billion tax cut is a drop in the ocean. Rather, the reform consists in reducing the marginal income tax (two or three percentage points) on those who make 15-50,000 euro, and increasing the burden (two marginal-tax points) on those making more than 50,000 euro. The eight-billion tax cut will not deliver the same advantage to all the taxpayers. According to the estimates, those with a yearly income around 50,000 euro will benefit from a 1,000 tax cut (on average), while the others have much less to celebrate (Fig. 3).

Indeed, one wonders whether such tax cuts will make a difference, and many believe that Draghi is missing an opportunity for deeper and more comprehensive reform.

December 8, 2021 0 comment

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The German real estate transfer tax: a race to the top

by Kalle Kappner December 1, 2021

written by Kalle Kappner

Since the 2006 reform, Germany’s federal states are free to set the tax rate concerning real estate transfers. Yet, decentralising tax power has not led to lower taxation. In fact, the opposite happened: since 2006, average tax levels for real estate have risen from 3.5% to 5.4%,: no state has ever decreased the tax rate, and except for Bavaria and Saxony, all states have increased the rate at least once.

Rising tax rates led to higher tax revenues, from €6.2 billion (0.26% of GDP) in 2006 to €16.1 billion (0.48% of GDP) in 2020. Among all of Germany’s taxes, the real estate transfer tax presents the largest percentage increase since 2004. Today, it is the states’ most important independent source of income.

This upward trend is due to Germany’s distorted fiscal equalisation scheme, through which the federal government redistributes tax revenues among the states and de facto weakens the effects of decentralisation. Put differently, Germany needs real tax decentralisation, and the real estate transfer tax should become part of the local property tax.

High economic costs

The real estate transfer tax has consequences. An international research overview by Ifo shows that higher real estate transfer tax rates generate a significant decrease in the number of transactions and in the average prices of real estate. In brief, the economic costs are significant. Germany is no exception. The rise of the real estate transaction tax rate by one percentage point over the last 15 years has led to 6% fewer transactions and 3% lower transaction prices on average. In general, every additional euro in tax revenue comes with a net welfare loss of 67 cents. Moreover, in districts where real estate prices tend to fall, higher tax rates prevent recovery – in prices and volumes. Price declines are more frequent for rental apartments.

Germany’s financial equalisation scheme

Since the 2006 reform, Brandenburg, North Rhine-Westphalia, Saarland, Schleswig-Holstein, and Thuringia have almost doubled the original tax rate and brought it to 6.5%. The rate is lower in the other states.
Tax competition is stifled by Germany’s financial equalisation scheme, following which funds are redistributed from high-revenue states to low-revenue states, but the parameters are set to discourage the states on the receiving side from lowering the tax rate in anticipation of compensation. In fact, there is a built-in incentive to raise the tax rate for all states, which serves neither the taxpayer nor the states.

Of course, the solution is not further centralisation. In the short run, the “tax race to the top” can be mitigated by simply leaving the transfer-tax revenue out of the equalisation scheme. In the longer run, the real estate transfer tax should be integrated into the local property tax, so as to make the local authorities more accountable for their tax strategies.

December 1, 2021 0 comment

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The (missing) link between temperature and economic growth

by David Stadelmann November 24, 2021

written by David Stadelmann

According to the recent report by the United Nations Intergovernmental Panel on Climate Change (IPCC), the global average temperature increase over the period 1850–1900 was about 1.1°C by the 2010s. Several countries in the world have seen increases in average temperatures approaching 2°C. From 1820 to 2016, gross domestic product (GDP) per capita in most of the Western world grew by about 25 times, and in the non-Western world by 13.5 times. This economic growth has been associated with enormous improvements in different indicators of human well-being, such as higher life expectancy, lower child mortality, and lower malnutrition.

The consequences of climate change may affect economic growth opportunities. The IPCC forecasts that average surface temperatures will be from 1.2°C to 3.0°C higher in the 2041–2060 period compared with the 1850–1900 period. The consequences of these temperature increases, such as rising sea levels, more frequent weather extremes, and shifts in plant habitats, are diverse and often expected to negatively impact nature. Global warming could also negatively affect human lives, for example, by jeopardizing food security or contributing to the spread of diseases, especially in the more vulnerable parts of the world. To what extent does climate change also affect human welfare? A recently published article in Economic Policy and a recent working paper by IREF take close look at the link between increases in temperature on the one hand and economic growth on the other.

ECONOMIC GROWTH AND TEMPERATURE

The economic performance of a country is a function of its factors of production and the efficiency of their use. Factors of production commonly include land, physical capital (e.g. machines), and human capital (e.g. a skilled labor force). Higher temperatures may adversely affect economic development by reducing the availability and productivity of these factors. This could occur, for example, through lower crop growth due to increased drought risk. In addition, there are a variety of other mechanisms that could contribute to a negative effect of higher temperatures on economic performance. For example, it is imaginable that climate change will exacerbate resource conflicts (e.g., over arable land), reducing investment and thus economic growth. However, in some countries and sectors also positive impacts are possible.

Several empirical research studies suggest that there is a relationship between temperature and economic development at the cross-country level. Typically, hotter countries are poorer when taking a snapshot of the world. Similarly, rising temperatures have been shown to have an unfavorable impact on national economic growth. Partly based on such studies, the IPCC cautions that climate change could pose a threat to future global economic development and consequently human living standards. In his Nobel Prize lecture, William D. Nordhaus also discusses links between climate change and economic impacts as well as consequences of climate-change policies on economic growth.

Existing empirical research examines the relationship predominantly at the national level, analyzing a country’s average temperature and per capita income. In addition to climatic conditions, many factors differ between countries that could have a lasting impact on economic development. For example, apart from a hotter climate, many African countries also suffer from a poor rule of law, a lack of economic freedoms, or ethnic conflicts caused, among other things, by arbitrary border demarcation of the former colonial rulers. If the past is any guide, it is reasonable to assume that factors such as economic policies, the rule of law, democracy, or human capital have more profoundly affected economic development than natural conditions in general or temperature in particular. A multitude of growth- and development-related factors vary across countries and cannot necessarily be adequately accounted for in comparative country studies, even if more sophisticated econometric techniques are employed. This raises the risk of a relevant bias when analyzing any potential impact of temperature on prosperity.

FROM THE COUNTRY TO THE REGIONAL LEVEL

The use of regional (i.e., sub-national) data on climatic and economic conditions can enrich existing country-level analyses. Analyzing regional data shows that there are considerable differences in climatic conditions within countries, just think of regions in Russia (Republic of Sakha vs. Krasnodar region) or the United States (Alaska vs. Arizona) as examples. Similar variations are observable concerning regional economic development: Some regions within countries are comparatively poor, while others are relatively rich. By specifically examining sub-national units within the same nation, all potential confounding factors that otherwise influence economic development over time at the national level can be excluded through econometric estimation techniques. This is precisely the methodological approach taken in two recent studies referenced above in Economic Policy and on the IREF website.

In the first study in Economic Policy, it is analyzed whether hotter regions within a nation are necessarily poorer. For a dataset of about 1,500 regions in 83 countries, there is no statistically robust relationship between temperature and per capita income at the sub-national level. This finding suggests that the relationship shown in part at the national level by the existing literature is not reflected in the same way at the sub-national level. Accordingly, at least parts of the relationship suggested at the national level may be a consequence of not adequately accounting for other growth- and development-related factors that differ within countries.

However, the study in Economic Policy does not directly allow to draw conclusions regarding the link between rising temperatures and economic growth. This can be problematic because climate change is a long-term phenomenon. Accordingly, it is possible that the negative economic effects of climate change might only become apparent over longer periods of time. Alternatively, economic growth may help to adapt to potential negative consequences of higher temperatures. To address such shortcomings, the working paper for IREF analyzes the effect of rising temperatures on regional economic development over longer time periods. At the same time, it also considers that certain country-specific factors can influence the adaptation of regions to rising temperatures.

The study shows that in the short-term there is no correlation between higher temperatures and economic growth, even when accounting for other regional variables. Thus, there is no positive or negative link between temperature increases in growth in the shorter run. Rising temperatures can have a negative impact on prosperity in the longer run. Further analyses show that the only regions affected by such negative long-term effects of rising temperatures are located in countries that do not allow sufficient adaptation possibilities to climate change. Country specific conditions such as high incomes, a strong democracy, and a strong rule of law help regions to adapt such that there is no link between temperatures and growth for regions in such countries even in the longer run. This finding is relevant because, a favorable economic and institutional environment is usually itself considered fundamental to economic growth. Put differently, higher incomes, democracy, an established rule of law, economic and political freedoms, etc. help to regions to grow and reduce or even cut any potential link between temperature and growth.

In summary, regarding comparative cross-country studies, the prevailing view is that high and rising temperatures may reduce growth and incomes. Looking at the sub-national level allows for a more nuanced picture and new insights. First, warmer regions are not necessarily poorer. Second, potential economic damage from higher temperatures may rather occur in the longer-term allowing time for adaptation. Third, and most importantly, the results suggest that economic and institutional factors can be strengthened to reduce or avoid the potential economic impacts of higher temperatures and foster economic growth at the same time. Thus, climate does not necessarily determine economic destiny.

Photo by Fabian Kurz

November 24, 2021 0 comment

Online Articles

Tunisia in trouble

by IREF November 11, 2021

written by IREF

On December 17, 2010, a young Tunisian by the name of Mohamed Bouazizi set himself on fire to protest against police harassment. His act triggered a wave of revolts across the Arab world as people rose against authoritarianism and poverty. The fall of Ben Ali’s regime in Tunisia after 23 years in power generated enormous expectations. People throughout the region hoped to end injustice and corruption, and start moving towards freedom, democracy and economic prosperity.

Many scholars consider Tunisia the only success story amid the Arab countries involved in the 2011 uprisings because Tunisia seemed to be the only country that emerged as a democracy. However, in 2013 the interim coalition government led by the Islamist Ennahda Party came under accusation for being incompetent and power-hungry. The opposition’s fears were confirmed by the assassination of Chokri Belaid, a secular politician. The crisis escalated further in July 2013, when 65 members of the National Constituent Assembly momentarily walked out of the assembly when another opposition politician, Mohamed Brahmi, was assassinated.

On July 30, the Tunisian General Labour Union (UGTT) called for conference to resolve the crisis. Three other civil society groups, the Tunisian Order of Lawyers, the Tunisian Union of Industry, Trade, and Handicrafts (UTICA), and the Tunisian Human Rights League (LTDH), joined to form the National Dialogue Quartet. In December 2013, partly as a result of the Dialogue, a new government led by Mehdi Jomaa saw the light. The national dialogue helped place the country back on the pathway toward balance after the uprising in 2011.

Yet, the economic conditions of the country have hardly changed since the interest groups that had characterized the old regime successfully opposed all kinds of economic reform. Those who had hoped that democracy could make a difference are disappointed. Political participation fell from a high of 68 percent in the 2014 parliamentary elections to 42 percent in 2019.

Not surprisingly, therefore, in July 2021 tensions erupted. When the last government led by Prime Minister Hichem Mechichi enforced measures to deal with Covid-19, tens of thousands of Tunisians defied the lockdown and protested against Mechichi’s government and the political class in general. President Kais Saied suspended parliament, dismissed the prime minister, and announced he would temporarily rule by decree. In a word, democracy was put on hold.

Tunisia’s political crisis originates from a decade of economic failure

Indeed, despite the transition to partial democracy and significant advances in political and civil freedoms, endemic corruption and fragile enforcement of property rights are still inhibiting economic development and political stability. Some indicators, such as the Bertelsmann Stiftung Transformation Index (BTI)[[the Bertelsmann Stiftung Transformation Index (BTI) reports data from two years earlier. Thus, the 2020 report uses 2018’s data, and the political scene in Tunisia back then was not in a critical situation as it is today.]] describe Tunisia’s failure in the last decade.

As mentioned above, most Tunisians judge the revolution by considering economic performance, which has not improved. Since 2011, households’ incomes have fallen by a fifth; the Tunisian Dinar has lost half of its purchasing power; unemployment is currently at about 18%, with youth unemployment at more than 35%, up from 29% in 2010. Corruption persists, and the government budget deficit has now reached record levels at around 11%.

Tunisia is known for its active civil society. However, the government’s effort to please all major actors ended up slowing down economic transition. As a result, thousands of Tunisians left the country. Last year, at least 13,000 Tunisians risked their lives trying to reach Italy by boat. [[COVID-19 fallout drives Tunisians to Italy despite deportations – Migration, The New Humanitarian, Layli Foroudi, 1 September 2020]] Others simply committed suicide.[[Suicide by self-immolation in Tunisia: A 10 year study (2005-2014) – National Library of Medicine, National Center for Biotechnology Information (NCBI), by Mehdi Ben Khelil , Amine Zgarni , Malek Zaafrane, Youssef Chkribane, Meriem Gharbaoui , Hana Harzallah, Ahmed Banasr, Moncef Hamdoun, Nov 2016]]

The bottom line is that nowadays, more and more people start regretting Ben Ali’s “good old times”, when unemployment and tensions were lower, and they forget that those good old times featured extensive corruption and systematic violations of human rights. This climate of discontent towards the world of politics and disbelief in the democratic process explain why President Kais Said has been able to put democratic principles aside, take over the country and enforce a one-man rule regime.

Why did Tunisia fail?

In a sentence, political transition is not enough. Tunisians failed to develop free-market institutions. None of the two major parties Ennahda and Nidaa Tounes have engaged in significant economic reforms, enforced budgetary discipline, and reined in privileged interest groups. Nidaa Tounes has been torn by internecine tensions, while Ennahda has been suffering from bad reputation. In addition, both Ennahda and Nidaa Tounes needed money, and were not in a position to reject funds by interest groups. Of course, these offers came at a price.

Put differently, democratic rule requires much more than regular elections. It requires robust institutions and free-market oriented economic reforms, to reduce the role of the state and make room for private (unsubsidized) business.

November 11, 2021 0 comment

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Has Covid changed the backbone of the West?

by Luigi Curini November 3, 2021

written by Luigi Curini

This year and a half of pandemic has rekindled the debate about the relationship between individual freedom and its limits, especially when health is at stake. While in several countries governments seem to be reasonably cautious in this regard, Italy has adopted policies (i.e., the so called “green-pass”) that have no equal among Western democracies in terms of extension and invasiveness. Italian citizens cannot take a train, attend a university class or go to work without giving proof, possibly via a specific App in their smartphone, that they are vaccinated (or to be negative to a Covid-test taken in the last 72-hours). Despite the perplexity shown by some commentators, general support for the green-pass in Italy is rather high. About two Italians out of three believe that far from depriving them of liberty, the green pass actually enhances their liberty. Although this reaction may be surprising, it could perhaps be understandable, if such policies were thought as temporary. Some data, however, highlight a different and less optimistic scenario.

A survey conducted together with the Socio-Political Observatory of Hokuto at the end of July (and therefore before the adoption of the green pass by the Italian government) shows that a just a minority of the Italian population favors the idea of permanently extending some restrictive measures adopted to combat COVID-19, regardless of the risk linked to the pandemic. Yet, it is a significant minority: 31% would like to quarantine those entering the country from outside Europe; 28% would support measures that would allow only vaccinated individuals to travel abroad even in a post-COVID world; 26% would approve of mandatory mask indoors (as is currently the case in Italy); 22% would welcome future green-pass requirements for public events; and 18%are in favour of tracking of people who go to the restaurant. Just to give a benchmark, these percentages are lower than those reported by a similar survey published in the Economist for Great Britain. Still, they are far from negligible.

Which factors are most highly correlated with some Italians’ willingness to make the limits to individual freedom inherited from the Covid months permanent? To answer this question, we produced a statistic that we call the “PROTECTION Index”. The index ranges between 0 to 8 – it is 0 when the respondent is against maintaining the restrictions reported in Figure 1, and 8 in the opposite case. The overall average of this index is 1.7, i.e., on average Italians are in favor of making almost 2 out of 8 restrictive measures permanent; the median value is however lower and equal to 0. In simple words, the data reveal the presence of a “protectionist” hard core in terms of restrictive measures, which would like to keep all or almost all of them. A minority of respondents, that’s true, but which in any case involves about 1 in 5 Italians.

Moreover, four socio-demographic factors seem to play an important role in this context: in general, the PROTECTION Index takes a higher value among highly-educated males, who live in large cities and aged between 45 and 54. This hardly matches the current narrative about the typical “populist” voter, the frequent scapegoat for the diseases of liberal democracies.

These figures shed light on the social credit system (SCS) recently introduced in China. Under this system, individuals, businesses, social organizations, and government agencies are assessed by considering their “trustworthiness”. SCS is not (yet) a single unified system since it includes diverse initiatives managed by local governments and commercial companies. Rather, the different SCS initiatives integrate various sources of data that justify privileges (e.g., tax reductions and easier access to governmental services) and sanctions (e.g., limited access to high-speed trains and financial services). The authorities use this carrot-and-stick system to direct citizens’ behavior, which the Chinese people seem to appreciate: according to one of the few analyses in this respect, almost half of respondents to a national survey (49%) indicated strong approval of SCSs.

In particular, the survey shows that Chinese citizens perceive SCSs not as an instrument of state surveillance, but as a tool to improve the quality of life, to close institutional and regulatory gaps, to enforce more honest and law-abiding behavior in society. More social trust is the final outcome. Indeed, the only strong reason that appears to erode public support for SCSs is “opacity”. In other words, Chinese citizens are not bothered to receive an official score by the government. They are worried only if such scores are perceived as biased. Interesting enough, respondents who approve of SCSs tend to be older, higher-income, male, more highly educated, and living in urban areas. This profile is exactly the same as the profile that characterizes supporters of more PROTECTION in the Italian case. Sadly, this is also the profile of those who have been historically considered the backbone and the ultimate watchdog of freedom in Western societies. Has this narrative become obsolete?

November 3, 2021 0 comment

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Shipping and Shopping: why you should buy your Christmas tree early

by IREF October 27, 2021

written by IREF

The IFO Institute (Munich) has just revised its forecast for the German economy. GDP is now expected to grow 2.5%. IFO’s previous prediction was 3.3% and the prediction the European Commission put forward last Summer was 3.6% (Fig.1). However, according to IFO the economy will rise 5.1% in 2022 and thus bring the country back where it was before the Covid-19 shock.

IFO economist Timo Wollmershäuser explains the delayed recovery by pointing out the unexpectedly slow comeback of the manufacturing sector: production actually fell 1.3% in the second quarter of 2021, despite buoyant demand. In particular, Wollmershäuser emphasizes that German companies suffer from their failure to obtain crucial intermediate goods, which are absorbed by other industries and countries, and the supply of which cannot be increased rapidly enough.

One wonders whether the supply difficulties are going to disappear soon – as the IFO Institute suggests – or whether these difficulties signal deeper global problems. In fact, the latter view seems more realistic.

Buy your Christmas tree right now!

Water is the leading transportation mode for international freight trade worldwide. For example, according to the U.S. Department of Transportation, as far as US international freight trade is concerned, in 2020 ships moved 40.2 percent of the value (over $1.5 trillion) and 69.9 percent of the weight (1.5 billion tons).

Due to the Covid-19 pandemics, ships are often obliged to quarantine for several days before they can dock. To make things worse, China adopted a zero tolerance approach toward Covid-19. This led to the closure of some of China’s biggest cargo ports due to coronavirus. The key terminal at Ningbo-Zhoushan was one of them. The longer inbound ships wait, the longer it takes before they move out again. Congestion characterises not only Chinese ports only, however. For example, Los Angeles, one of the top 25 U.S. international freight gateways, currently sees about 70 ships waiting on the inbound side.

Now, each ship is assigned a time window for docking. If the ship misses its window, it must wait until it obtains a new one. This creates uncertainty, and the situation is likely to deteriorate as Christmas approaches and demand for import intensifies. As Jami Warner, executive director of the American Christmas Tree Association said, «If I can give one piece of advice to consumers right now, it is to find and buy their Christmas tree early».

Shipping companies.

Not surprisingly, the cost of shipping has soared.[[The FBX is the leading international freight rate index, created in cooperation with the Baltic Exchange, and provides market rates for 40′ containers (called “forty-foot equivalent units” or FEUs). FBX calculations are based on aggregated and anonymous real-time business data from global freight carriers, freight forwarders, and shippers that use the WebCargo by Freightos freight rate management platform.]]

Put differently, the world badly needs more containers and expanded infrastructures. This explains why large corporations, among which IKEA and Woolmart, are planning to set up their own fleets.
As Sergio Spinosa – managing director of the X-Press Feeders, the world’s largest independent common carrier in Asia, Middle East, Central America and Europe – told IREF, there are no signs that the current situation can be settled before spring 2023. Hence, inflationary pressures are very likely to intensify and growth may slow down further, even in Germany.

October 27, 2021 0 comment

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Fully funded pension systems: Chile, Sweden and Poland show the way

by Translation by Anna-Maria Kohnke October 20, 2021

written by Translation by Anna-Maria Kohnke

In many countries, pay-as-you-go pension systems are under increasing pressure due to demographic changes. This explains why more and more opinion makers recommend switching to a funded system on top of the current voluntary schemes. During the transition period, however, the existing unfunded pension entitlements would still have to be paid out, while employees already start building a capital stock. This is commonly known as the ‘double burden’, and explains why resistance to change remains significant.

It may thus be useful to consider what happened in countries that experienced transition in relatively recent times by resorting to debt (Chile), accumulated surplus (Sweden), and privatisation gains (Poland).

Funded pension plans – an international trend

Although some countries have encouraged funded voluntary additional insurance while keeping pay-as-you-go schemes in place, numerous countries in Latin America, Eastern Europe, and Asia have been more ambitious, and moved towards fully funded systems. Chile began in 1981, and in 2008 30 countries had funded public pension schemes. Sweden, Poland and the UK were among them.

By and large, there are three ways of funding the additional cost of moving from unfunded to funded pension schemes. First, existing claims within the pay-as-you-go scheme can be cut, so as to reduce the amount of contributions. The resources made available are then devoted to building the stock of capital. Second, governments can resort to higher taxation or higher indebtedness. Third, one-off resources can be generated by privatisation programmes. Aside from the funding sources, the speed of transition also affects how costs are distributed among individuals and generations.

Chile: the debt-funded transition

Reform content. Chile engaged in pension reform in 1981. The pre-1981 unfunded scheme was replaced by a system of individual accounts into which all employees were required to pay 10% (today: 12.4%) of their salaries. Until 2008, participation was voluntary for the self-employed. These accounts are managed by private, regulated, and freely selectable investment trusts. The accumulated assets are usually paid out on a monthly basis upon reaching pension age. After 2008, the system also offers a tax-funded guaranteed minimum pension for those unable to accumulate enough capital.

Transition costs. Citizens who had already accumulated claims within the unfunded system in 1981 were given the choice whether to switch to a funded scheme or remain in the pay-as-you-go scheme. The cost of transforming one’s implicit credit into real capital was covered by the government budget. Of course, the state kept funding the pensions of those who remained in the pay-as-you-go-system. In 1981, the implicit government debt due to the unfunded system amounted to about 100% of GDP. This burden is expected to go to zero in 2045.

Funding and responses. The Chilean government planned to fund the initial transition costs through privatisation gains and budgetary rigour. However, since 1982, the annual costs of transition – 5% of GDP — are funded predominantly through government debt. Despite some weaknesses – relatively high administrative costs, concentration of the insurance industry, low returns during the financial crisis and relatively low pension levels – Chile’s pension reform inspired similar approaches in Peru (1993), Columbia and Argentina (1994), Uruguay (1996), Bolivia and Mexico (1997) and El Salvador (1998).

Sweden: funding thanks to the budget surpluses collected over the previous decades

Reform content. Sweden reformed its pension system between 1994 and 1999. The pay-as-you-go system in place since 1913 was transformed into the first Notional Defined Contributions system (NDC) globally, to which employees pay 16% of their wages. While the NDC operates almost like the traditional unfunded system, claims now depend on the wage rate, interest rates and life expectancy. Sweden also established a funded pillar based on 2.5% of the employees’ wages. The individual accounts can be administrated through private investment trusts of one’s own choice. The Swedish government also provides a default portfolio.

Transition costs. Transition arrangements apply to citizens born between 1938 and 1954: their pensions are paid partly through the previous pay-as-you-go scheme and partly through the NDC scheme. The implicit government debt outstanding in the mid-Nineties was 210% of GDP, and the state funded the ‘double burden’ through the so-called “buffer fund”.

Funding and responses. The ‘buffer fund’ is responsible for the 3% difference between pension contributions and pension payments. The Swedish model is characterised by a consensus-oriented process, low administrative costs and a successful mix of basic coverage and private competition. It is often considered exemplary.

Poland: privatisation gains and reform dismantling

Reform content. Inspired by Chile and Sweden, Poland’s government initiated a profound transformation of the pension system in 1999. Like in Sweden, public pensions now consist of a pay-as-you-go component, NDC-oriented elements, and a funded pillar. The latter was initially fed by 7.3% of pre-tax earnings, while 12.2% went into the NDC scheme. As a result, the level of contributions (19.5%) remained the same. However, due to the weak performance of the funded public scheme and the rapidly growing government debt, in 2011 the funded pillar was reduced to 2.3%. It has grown slightly in recent times, but the Polish government continues to put more emphasis on a mix of public pay-as-you-go and voluntary private provisions.

Transition costs. When the reform was initiated, the implicit government debt resulting from the pay-as-you-go system amounted to about 220% of GDP. However, the mixed components that characterise the Polish context ensure that a much lower percentage will become explicit.

Funding and responses. Initially, the ‘double burden’ was supposed to be funded entirely through privatisations. Indeed, until 2010, roughly two thirds of the transition costs were paid this way. However, the Polish government did not expect any substantial revenue from privatisation in later years. To prevent debt from spiralling, therefore, the government decided to dismantle the funded pillar of the public system. A similar path was followed by Estonia, Latvia and Lithuania (2009), and also by other Eastern European countries. The bottom line is that the Polish experiment was not a success story: the Polish authorities overestimated the revenues from privatisation, ran into significant operational problems, and met high administrative costs. Moreover, they allowed access to only 14 private pension trusts. Heavy regulation regarding investments did the rest.

Learning from experience: gradual transition, competition, transparency

The experiences of Chile, Sweden and Poland offer three lessons. First, it is clear that gradual transition is a must. The partial failure of the Polish reform was due to the steep rise in public debt generated by the ill-timed programme. The success of Chile’s shock therapy approach can be traced back to Pinochet’s dictatorship and relatively low levels of contributions and coverage; these features are uncommon in the European environment.

Second, access to capital markets should not be constrained. Sweden’s citizens can invest their assets in over 100 competing pension trusts, including five public trusts which offer attractive and simple financial products. In Chile and Poland, the spectrum of public and private trusts is significantly narrower, which leads to high administrative costs and low returns.

Third, Chile, Sweden and Poland illustrate that a sound plan for funding the transition must be in place upon initiating the reforms. To prevent later backpedalling like in Poland, transition costs and funding sources should be calculated as transparently as possible. As opposed to Sweden, most European countries cannot count on previously accumulated surpluses. Hence, reforms must necessarily rely on government debt, possibly supplemented by the revenues generated by extensive privatisation programmes.

October 20, 2021 0 comment

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Morocco’s Tax policy: The urgent need for tax system reform

by IREF September 29, 2021

written by IREF

Morocco is one of the most dynamic economies in the African continent. It has a remarkable reputation in the region for opening its economy, privatization, and increasing the role of the private sector. However, Moroccan governments have consistently neglected to reform the tax system and thus encourage risk-taking, investment and entrepreneurship.
Similar to the developing countries with little or no energy resources, taxation is the main contributor to the Moroccan state budget. The Moroccan tax system is affected by a set of imbalances and problems that regard both the structure and the burden of taxation. Despite some reforms in the 1990s, the tax system is still characterized by heavy pressure and inefficient bureaucracy, even compared to other developing countries. In 1999, 2013, and 2019 the government organized three National Conferences with a view to modernizing and simplifying the tax system. Nothing came out of them.

What’s wrong with the Moroccan tax system?
All tax systems should respect some basic principles. The burden should be distributed widely and no group or industry should be favored over another. In Morocco, these principles are not respected. Morocco’s tax base is relatively tight and skewed. There is a significant gap between the potential tax base and actual tax collection. For example, 80% of VAT is paid only by 1.6% of the companies (the others evade or avoid VAT), 80% of corporate tax is paid by 0.8% of the taxpayers, and only 46% of companies submit their corporate tax return. Of these, only 33% show taxable profits. [[The Ministry of Economy, Finance and Administration Reform. Mr. Mohamed Benchaaboun, Minister of Economy and Finance, stated on Thursday, May 2nd, 2019, in Rabat https://www.finances.gov.ma/en/Pages/detail-actualite.aspx?fiche=4882]] This is the result of a system that features high tax rates, plenty of tax exemptions, and thus encourages evasion and avoidance.

The personal income tax is calculated based on the following progressive scale:

In regard to corporate taxes, the Moroccan Tax Code considers all revenues and capital gains generated in Morocco subject to Moroccan taxation.

A higher Corporate Tax rate of 37% applies to credit institutions, insurance companies.

Compared to other countries in the Maghreb region, the Moroccan personal income tax rates are the highest in the region. The 31% corporate tax rate is also the highest in the region, and the same is true for VAT (20%), which is the highest in Africa.

According to the OECD Revenue Statistics Africa 2020 report, the Moroccan average total tax rate on corporate profits is around 49.3%. Only 15 African countries (out of 53) do worse. This rate is high by African standards and also higher than the world average (40%). Total tax pressure is also heavy: the 2018 tax-to-GDP ratio was 27.8%, while the average for Africa is 16.5% and 23.1% for Latin America and the Caribbean. [[OECD REPORT – Revenue Statistics in Africa 2020 report (1990-2018), Tax revenue trends, 2010 -2018]] The upshot is that Moroccan growth suffers: according to a recent study that covers the past 46 years, a one percent increase in the overall Tax-to-GDP ratio slows down growth by 0.12 point. [[The Tax Burden and Economic Growth in Morocco: Empirical Analysis, Mohamed Karim, Mohamed Bouzahzah, Othmane Erguigue, December 2020, Journal of Economics and Public Finance 7(1):p1]]

Morocco’s tax policy is a source of distortions and public finance problems

The Moroccan tax code is also associated with privileges for those with the right connections. [[In 2016 alone, 407 tax exemptions regarded agriculture and fishing, food industries, real estate, or financial intermediation. “Morocco: Selected Issues,” IMF Country Report No. 18/76, November 2017, p.7]] As a result, a full of a range of exemptions distorts business decisions. For example, the standard VAT rate (20%) rate drops to 14% for transport and solar energy, to 10% for gas, banking and financial services and catering (10%), to 7% for water and animal fodder (7%). Some goods and services are actually exempt, especially in the agricultural sector. As a result, resources are diverted from much needed projects and efforts are devoted to acquiring privileges.

The coronavirus pandemic has caused a surge in public spending in Morocco, resulting in a fiscal deficit of 7.6 percent in 2020. In order to balance the budget tax increases in sight. In July 2021, a new law to increase the tax base, fight fraud, introduce a carbon tax was approved by the parliament. In addition, the government plans to pass a solidarity tax of 2.5 percent for companies with annual profits between 4 million dirhams (about 430,000 US dollars) to 40 million dirhams, and of 3.5 percent for companies with profits greater than 40 million dirhams. If the bill is approved, wage earners will also contribute with 1.5 percent of their monthly salaries.

The outlook for the future is thus far from encouraging. A heavier tax burden on households and companies is hardly the way of encouraging investments and encouraging growth.

September 29, 2021 0 comment

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Pay-as-you-go state pensions: What are German parties planning?

by Fabian Kurz September 15, 2021

written by Fabian Kurz

“Pensions are safe”, former German labour secretary Norbert Blüm promised during the 1986 electoral campaign. Thirty-five years later, the future of Germany’s public pension scheme plays an important role in political campaigns once again. This article considers what today’s main political parties are now offering to the German electorate.

The unfunded retirement plan

State pensions in Germany follow the pay-as-you-go system. That means that today’s pensions are funded directly by today’s working population. Although payments are made to the German pension system, these resources are spent immediately and will not be available when today’s worker retire.
The most important funding parameters in the pay-as-you-go pension schemes are the number of contributors and the number of receivers. The total amount of the pensions disbursed is largely determined by the age of retirement, by how much current retirees paid to the system during their working life and the criteria used to transform such payments into claims.
Of course, demography plays a crucial role. If younger generations get thinner, contributions drop and pensions suffer. This means that an aging population becomes source of trouble. Today, this is the certainly the case for Germany.

Parameter 1: Retirement age

According to the current legislation, retirement age will be gradually increased to 67 years, i.e. three years more than retirement age in 2019. This will affect pensions in two ways: workers will work (and contribute) for a longer period of time, and receivers will benefit for a shorter period. Currently, only one political party promises to lower the retirement age. All the other parties do not question the timing already approved (67 years), but in some cases would not deny the possibility of allowing early retirement with lower pensions.

The conservatives (CDU) favour a gradual increase in the retirement age. The social democrats (SPD) want to follow through with the rise already agreed (from 64 to 67 years), but oppose further increases, and plan to maintain the current possibilities of earlier retirement without cuts in the annual benefits. The liberals (FDP) demand a flexible retirement scheme similar to the Swedish model. This should enable employees to retire from the age of 60, but continued employment would be incentivised through higher pensions. The far right (AfD) follows a similar approach, and plead for flexible retirement age combined with financial incentives for longer employment. The Green Party wants to keep a general retirement age at 67 while making it easier to retire early or to work beyond this age. The Left is the only party that demands to reduce the retirement age to 65 or to allow retirement with a full pension after 40 years of employment.

Parameter 2: Increase number of payers

In the short term, the ratio between contributors and receivers does not depend only on the age of retirement. It can also be altered by changing the number of mandatory contributors. For example, self-employed people and civil servants can be included in mandatory state pension schemes, which is what the SPD, the Greens, and the Left Party demand. The number of payers can also be increased through immigration, like the Greens suggest. These measures cannot change the ratio permanently, however. In the end, the new contributors will also have their own pension claims in the future.

Parameter 3: The level of contributions

The level of contributions is the most obvious parameter to quickly fund higher pensions. In this light, the CDU and their allies (CSU) want to create an advisory board, the purpose of which is to make proposals to this effect. Although these parties do not make any concrete suggestions, they are inclined to letting contributors decide how much they want to pay (within limits). Similarly, the SPD argues for voluntary additional contributions within a PAYG framework.
The FDP wants to bring back the ‘catch-up factor’, a mechanism that would prevent further increases in contributions, while the Green Party, the Left and AfD want to increase budgetary transfers to support future pensions and reduce the burden on the contributors. In particular, the Left wants to abolish the Riester pensions (private pension schemes subsidised by the government) and use the resources thus made available to subsidise the state pensions.

Parameter 4: The pension rate

The current pension rate is 49.8%. This is the ratio between the average net amount received by pensioners after 45 years of contributions, and the average net income of employees. This rate will increase from 2021 to 2023, due to a new way of calculating the pension level and does not affect the present level of pension payments. From 2024 onwards, however, the ratio will decrease and follow a trend that started in 2009.

A lower pension rate does not necessarily imply that pensions decrease. If wages increase fast enough, then pensions will rise. This is what all parties in the Bundestag are hoping. Yet, the SPD and the Greens have made it clear that the pension rate should not fall below 48%. The FDP does not give concrete numbers but aims to increase the rate in the long run by introducing a stock-market related pension scheme. The Left demands an immediate increase to 53%. The AfD does not have any concrete suggestions.

Lack of ambition

The proposals for reform suggested by the various parties are not suprising. All parties want to prevent a reduction in the pension rate, and they all refrain from suggesting a further increase in the age of retirement or in the size of contributions.

proposals_of_the_parties_for_the_german_pay-as-you-go_statutory_pension_system.png

Yet, limiting the retirement age while keeping contributions constant will not be easy. An increase in the subsidies financed through taxation, as suggested by the Left, AfD, and the Greens, will not make the system more sustainable. It merely shifts the financial burden from contributors to taxpayers. Indeed, the Social Democrats, the Greens and Left demand an extension of the pay-as-you-go system to cover additional groups. But although this may temporarily help to raise the number of contributors, it does not improve the ratio of payers to receivers in the long run.

The truth is that no party dares to announce significant changes in the most important parameters of the unfunded system. Nonetheless, demographic changes and the resulting need for more pension resources will make significant adjustments inevitable.

September 15, 2021 0 comment

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