Is a subway system the way to go?
After more than two decades of work, Almaty’s subway system is to open in December, reported Business New Europe. Will it prove worth the wait?
Perhaps not. In the United States, subways cost so much to build and run that they almost always lose money – even in crammed San Francisco, where Marlon Boarnet found that rush-hour traffic was nearly twice the normal capacity of the highways. In 1985, President Ronald Reagan said Miami could have saved money on its transit system by scotching it and buying a limo for each user. Metrorail, in Washington, D.C., was so expensive that the city could have bought a BMW for each daily passenger and saved money, wrote Tony Snow.
Mass transit is expensive, because not enough people use it to drive down its per-rider cost by much. The problem is not the fare. Offering mass transit for free could draw only a third more riders (judging from the American experience), because the demand to ride does not respond strongly to changes in the fare, concluded economists Gerald Kraft and Thomas Domencich. The problem is that people don’t want to walk to the station and wait for the train. Per hour, they value their walking and waiting time at as much as one and half times their wage. Their time within the vehicle – be it a car, bus or train – is valued at only half their wage, reported an urban economist, Arthur O’Sullivan. Mass transit consumes more time than the automobile in the journey from home to the vehicle, and from the vehicle to work. Because people value this time highly, they prefer driving to riding.
San Francisco’s subway system, BART, illustrates how mass transit can go wrong. The train speeds 80 miles per hour between stations spaced 2.5 miles apart. The rider spends little time on the train but must take a while to reach the station and wait for the vehicle. Since the rider values this time highly, he prefers to drive, albeit at only 40 miles per hour. Studies suggested that buses were cheaper than BART at all levels of traffic; and that the auto was cheaper than BART for traffic levels of up to 22,000 passengers per hour, noted Melvin Webber in his case study of the subway system. For a fourth of BART’s construction cost, San Francisco could have bought enough buses to carry all subway riders.
Even so, mass transit may decongest highways and thus save money – lots of it. Bangkok may lose a third of its output to congestion, estimated Japan’s international cooperation agency in 1990. In the United States, congestion may have accounted for .7 of a percent of the value of domestic output in 1994, estimated economists Richard Arnott and Kenneth Small. In Europe, congestion may claim 2 percent of GDP, calculated the transport directorate for the European Union. In Los Angeles, commuting takes so much time that the average household there is willing to take a pay cut in order to take a job that avoids congestion, found urban economists Edward Glaeser and Janet Kohlhase.
Cash or crash?
Suppose that transit helps us avoid just 1 percent of traffic accidents. Then, judging from Urban Institute estimates, cities in the United States would have saved $3.3 billion in 1989, nearly half of the total operating subsidy for public transit that year, said Janet Rothenberg Pack. Mass transit also helps us shorten the auto trip – a value that we can measure as the increase in the worth of a house that is nearer the work site and that thus avoids a longer commute. In addition, mass transit decongests alternate routes and reduces noise and pollution downtown. Finally, the riders themselves get something out of it. Pack figured that the total benefits of transit in Philadelphia exceeded the costs for each of the three years that she studied – 1981, 1982 and 1989. The largest benefits were the welfare gains to riders of transit and commuter rail. Estimates of the net benefits over the three years varied from $70.3 million to $140.3 million.
To justify the subsidy, the city can argue that the price of driving an automobile is too low, since it does not reflect the congestion imposed on other drivers; so the city must lower the price of transit to make it relatively attractive. But the subsidy also lowers the cost of travel; with low prices for both the car and the bus, we may get too much travel.
In recent years, fares from mass transit have covered less than 40 percent of costs. One problem is that transit systems pitch their fares low to attract riders. Since fare cuts attract relatively few riders in the short run, they reduce fare revenues. Moreover, transit systems must pay escalating labor costs. Wages have risen while the productivity of a worker –- the number of transit rides per employee – has dropped.
To save money, the city could contract out transit services to the lowest private bidder. Phoenix, Arizona, hired a taxi firm for dial-a-ride service on Sundays, at one-sixth of the cost of running buses.
Other possibilities include small buses, called jitneys, running to the station or to work; and buses picking up riders more often and at more stops. In Ottawa, a fleet of 850 buses accounted for more than 70% of all rush-hour trips to the downtown, reported the Transportation Research Board in the United States.
Rather than build subways or roads, the government could attack congestion directly, by taxing it. A study of California counties inferred that taxing congestion might prove more productive than building highways. Relieving congestion bore a strong, and positive, statistical relationship to output per worker across counties in the Seventies and Eighties. Constructing highways lacked this relationship. The author, Marlon Boarnet, concluded that taxing vehicles during rush hour would do more to increase output than would building roads. Relieving congestion helps workers get to their jobs quicker and thus produce more.
Building highways may fail to decongest roads by much, because it attracts new drivers, argued Small, an urban transportation economist. Taxing congestion, on the other hand, discourages all drivers. Moreover, it is a cheap measure for the government to undertake. One need only find a way to collect the toll – which may be fairly easy, with electronic monitoring. In New York, New Jersey and Pennsylvania, toll authorities equipped millions of cars with detection gadgets, so that drivers could pay their tolls monthly or with prepaid magnetic cards. The government can either return the money to taxpayers or use it to improve roads and transit. Small figured in 1993 that, in greater Los Angeles, a congestion fee of 15 cents per vehicle-mile during peak hours would raise nearly $3 billion a year.
In principle, the congestion tax should equal the cost that the motorist imposes on other drivers. It compels the motorist to weigh the true costs of his decision before deciding whether to drive. The tax is flexible. The government can experiment with the right tax to levy, raising it on the congested road until the road becomes slightly less congested than alternative routes, noted Small. It can charge a higher tax during peak hours, when the road is more jammed.
Governments are slowly adopting the congestion tax. Singapore has levied it since 1975; and, in 1992, France began taxing congestion on Sundays on its A1 highway into Paris, according to Small.
The case for a congestion tax is not unchallenged. Perhaps the time lost to congestion is not a true social cost, because the driver consents to bear it. Moreover, some congestion may be optimal, as a practical matter. In principle, one may maintain an even flow of traffic on the road; in practice, however, traffic ebbs and flows. If the road is not congested in its peak hour, then it may be underused at other times. In the Netherlands, highway use seemed optimal when 2 percent of each day’s traffic encountered congestion, reported The Economist. But even a little congestion can seem like too much of a good thing. -– Leon Taylor, tayloralmaty@gmail.com
Good reading
Alan Altshuler, editor. Current issues in transportation policy. Lexington, Mass.: LexingtonBooks. 1979.
Marlon G. Boarnet. Infrastructure services and the productivity of public capital: The case of streets and highways. National Tax Journal50 (1): 39-57. March 1997. Online. Reprinted in Wassmer (2000).
The Economist. Why motorists always outsmart planners, economists, and traffic engineers: The unbridgeable gap. May 9, 1998. Reprinted in Wassmer (2000). Reported the estimate of European congestion.
Matthew Edel and Jerome Rothenberg, editors. Readings in urban economics. New York: Macmillan. 1972.
Edward L. Glaeser and Janet E. Kohlhase. Cities, regions and the decline of transport costs. Harvard Institute of Economic Research Discussion Paper 2014. Online. 2003.
Gerald Kraft and Thomas A. Domencich. Free transit. In Edel and Rothenberg (1972).
Edwin Mills and Bruce Hamilton. Urban economics. Upper Saddle River, New Jersey: Prentice Hall. Fifth edition. 1997. Discusses urban transportation.
Arthur O’Sullivan. Urban economics. New York: McGraw-Hill. Seventh edition. 2009. Discusses mass transit.
Janet Rothenberg Pack. You ride, I’ll pay: Social benefits and transit subsidies. The Brookings Review 10(3). Summer 1992. Online. Reprinted in Wassmer (2000).
Kenneth A. Small. Urban traffic congestion: A new approach to the Gordian knot. Brookings Review 11: 6-11. Summer 1993. Online. Reprinted in Wassmer (2000).
Transportation Research Board, of the National Academy of Sciences. Case study of bus rapid transit in Ottawa. Online. Undated.
Robert W. Wassmer, editor. Readings in urban economics, Malden, Mass.: Blackwell. 2000.
Melvin E. Webber. The BART experience – what have we learned? In Altshuler (1979).
References
Clare Nuttall. Almaty metro nears end of line. Business New Europe. May 31, 2011. Online.
Friday, June 3, 2011
Friday, May 27, 2011
Let’s cut to the chase
Do tax cuts attract firms?
Since Kazakhstan gained independence in 1991, foreigners have invested more than $100 billion in its capacity to produce, said the country’s minister of economic development and trade, Kairat Kelimbetov. To stay on a roll, Kazakhstan is offering foreign firms some new subsidies -– even as it raises taxes on foreign firms already here. A 568-hectare industrial park in Almaty, next to the highway to Astana, would offer rail access and a terminal for containers. Not to be outdone, Astana is also developing an industrial park. Will such infrastructure subsidies attract enough firms to pay off?
Since 1960, statistical studies of this question in the United States have focused on cities and states, because of their avid competition for relocating firms. The results suggest that a city government can affect where the firm locates by spending wisely. Merely raising taxes may drive a firm away, especially if it can find a nearby local government with lower taxes. Within a city, a rise in taxes of 10 percent for one municipality may cause its business activity to drop by 10 to 30 percent, finds economist Timothy Bartik. Much depends on how the government spends the money. If it spends the additional tax revenues on providing more services, then the city economy may grow more rapidly. On the other hand, if it spends the money on programs that redistribute income, then the city economy may diminish.
Rather than raise taxes, the city may try to attract a firm by cutting them. For example, it may exempt new firms from paying property taxes for several years; or it may loan money to a developer, or guarantee a loan. Kyrgyzstan attracted a Coca-Cola plant to Bishkek in 1996 with a five-year tax break to take effect once the plant made a profit, reported The Washington Times. Evidently, Kyrgyzstan offered the tax break partly to offset the high transport costs in the country, perhaps stemming from the border that Uzbekistan closes periodically.
Some analysts fear that competitive tax-cutting may compel localities to “race to the bottom,” where all tax rates are too low to finance worthwhile programs. In 1995, John Anderson and Robert Wassmer studied the Detroit area, where localities vied keenly for jobs in the wake of the city’s loss of market share in the global automobile industry. They found that, as more cities offered tax breaks, the remaining ones joined the pack more quickly, as if they were afraid of losing firms to their neighbors. After 15 years, the likelihood of offering tax breaks diminished, perhaps because residents began to oppose them. Indeed, richer cities were less likely to offer breaks than poorer cities, perhaps because the rich opposed factory pollution.
To avoid getting mauled in tax competition, local governments try to identify the best types of tax cuts. Studying Detroit in 1994, Wassmer found that subsidies tailored to particular firms rarely succeeded, but much depended on the city’s traits. Property tax breaks could boost manufacturing value in an old city, although they failed in the average city.
Rather than cut taxes, the city may issue bonds in order to buy land or machinery and lease it back to the firm at bargain rates. In Wassmer’s study, such industrial development bonds seemed to increase manufacturing value in new cities – and to increase employment in old ones. In an old city, the bonds may add a few jobs but not overcome the loss in value that’s due to aging capital. The new city is more likely to attract a high-tech firm, which may use the bonds mainly to buy machinery in place of workers.
Tips for TIFs
Incentives attract few retail firms, since these must locate near their markets to survive. Only a huge tax break could persuade a retailer to leave its old market for one less profitable. In Wassmer’s study, about the only incentive that worked was using the retailer’s tax payments to finance city projects that benefited it in particular, such as new roads to its site. This is “tax-increment financing” (TIF): The increment that the firm adds to the local tax base finances its own infrastructure.
This may sound like a good idea: The firm pays for services received, just like a customer in an ice cream store. Unfortunately, the city often will offer tax-increment financing only in a blighted area, hoping to redevelop it. But the area is blighted precisely because firms find it an expensive place in which to do business. The tax-increment financing thus induces firms to move from low-cost areas and into high-cost ones. That’s inefficient, since it reduces the amount that we can produce for a given cost. It’s like offering students a bribe if they will move from the quiet study areas of the library and into the concession room. They will study less.
Analyzing the Chicago area, Richard Dye and David Merriman found that communities adopting tax-increment financing grew more slowly, economically, as a result. Property values, measured by assessments, dropped by nearly a percentage point. The drop was not so severe for communities where the district offering tax-increment financing was larger compared to the entire community. When most of the city is in the district, then there are few opportunities to relocate a firm from the low-cost area outside the district. Hence relocations are less inefficient than in other cities.
Wassmer’s study of 25 cities in the Detroit area reached a similar conclusion. In 12 cases of a link between economic incentives and economic growth, the relationship was negative in seven: Cities that offered tax breaks grew more slowly. Wassmer suggested that slowly-growing cities are simply more likely to offer incentives to attract firms. Another possibility is that incentives persuade firms to move to the wrong areas.
Is it in the public interest for the city to offer tax breaks to try to create jobs? If markets work well, then every firm will locate where it maximizes profits. To offer a tax break may distort this decision, since the firm may impose costs on the jurisdiction that exceed the taxes that it pays. In Montgomery County, Maryland, an affluent suburb of Washington, D.C., Bartik found in 1989 that each new office job produced county revenues of $410 per year -– but required new highways that cost $347. This left little tax money to pay for sewers, water, police or fire safety. A tax break may better suit a city with a languishing economy and excess capacity, since the firm there would not congest roads and sewers.
Bartik argues that relocating jobs from areas of low unemployment to areas of high unemployment creates value. The jobless in an area of high unemployment will seek work more desperately, so they will value a job more highly. Also, relocating jobs from the growing economy will ease congestion of the infrastructure there – and it will make better use of the empty infrastructure in the sluggish economy.
Could markets (broadly defined) handle these matters? If the jobless in the stagnant economy seek work more desperately, then they will offer to work for lower wages. That will attract firms naturally. If the infrastructure is congested in the growing economy, then the government can raise its taxes. That will drive away firms that cannot pay for the costs that they impose on the city.
Almaty, Astana and Bishkek do vie for business. But the competition that most interests Kazakhstan's government is international: Can Astana woo firms that otherwise would go to China? In the global arena, tax cuts and infrastructural subsidies don't work so well, since the foreign firm must pay high transport costs to relocate in another country. (In principle, a government could overcome this barrier by offering to pay the firm's relocation costs, but it usually finds this too expensive to try.) But the basic question -- can public subsidies to firms increase the net value of production? -- still pertains.
–- Leon Taylor, tayloralmaty@gmail.com
Good reading
John E. Anderson and Robert W. Wassmer. The decision to ‘bid for business’: Municipal behavior in granting property tax abatements. Regional Science and Urban Economics 25: 739-757. 1995.
Timothy J. Bartik. Jobs, productivity, and local economic development: What implications does economic research have for the role of government? In Robert Wassmer, ed., Readings in urban economics: Issues and public policy.
Richard F. Dye and David F. Merriman. The effects of tax-increment financing on economic development. Journal of Urban Economics 47: 306-328. 2000.
Robert Wassmer. Can local incentives alter a metropolitan city’s economic development? Urban Studies 31: 1251-1278. 1994.
References
Kazinform. Industrial park of Astana city to attract private investors. Online. December 28, 2010.
Kazinform. Kazakhstan's policy in sphere of foreign direct investments attraction moves to non-oil & gas sector – Kelimbetov. Online. May 26, 2011.
Kazinform. Over the years of independence about USD 130 bln invested in Kazakhstan - A.Rau. Online. May 26, 2011.
The Washington Times. Why do business in Kyrgyzstan? Online at http://www.internationalspecialreports.com/ciscentralasia/99/kyrgyzstan/6.html. 1999.
Since Kazakhstan gained independence in 1991, foreigners have invested more than $100 billion in its capacity to produce, said the country’s minister of economic development and trade, Kairat Kelimbetov. To stay on a roll, Kazakhstan is offering foreign firms some new subsidies -– even as it raises taxes on foreign firms already here. A 568-hectare industrial park in Almaty, next to the highway to Astana, would offer rail access and a terminal for containers. Not to be outdone, Astana is also developing an industrial park. Will such infrastructure subsidies attract enough firms to pay off?
Since 1960, statistical studies of this question in the United States have focused on cities and states, because of their avid competition for relocating firms. The results suggest that a city government can affect where the firm locates by spending wisely. Merely raising taxes may drive a firm away, especially if it can find a nearby local government with lower taxes. Within a city, a rise in taxes of 10 percent for one municipality may cause its business activity to drop by 10 to 30 percent, finds economist Timothy Bartik. Much depends on how the government spends the money. If it spends the additional tax revenues on providing more services, then the city economy may grow more rapidly. On the other hand, if it spends the money on programs that redistribute income, then the city economy may diminish.
Rather than raise taxes, the city may try to attract a firm by cutting them. For example, it may exempt new firms from paying property taxes for several years; or it may loan money to a developer, or guarantee a loan. Kyrgyzstan attracted a Coca-Cola plant to Bishkek in 1996 with a five-year tax break to take effect once the plant made a profit, reported The Washington Times. Evidently, Kyrgyzstan offered the tax break partly to offset the high transport costs in the country, perhaps stemming from the border that Uzbekistan closes periodically.
Some analysts fear that competitive tax-cutting may compel localities to “race to the bottom,” where all tax rates are too low to finance worthwhile programs. In 1995, John Anderson and Robert Wassmer studied the Detroit area, where localities vied keenly for jobs in the wake of the city’s loss of market share in the global automobile industry. They found that, as more cities offered tax breaks, the remaining ones joined the pack more quickly, as if they were afraid of losing firms to their neighbors. After 15 years, the likelihood of offering tax breaks diminished, perhaps because residents began to oppose them. Indeed, richer cities were less likely to offer breaks than poorer cities, perhaps because the rich opposed factory pollution.
To avoid getting mauled in tax competition, local governments try to identify the best types of tax cuts. Studying Detroit in 1994, Wassmer found that subsidies tailored to particular firms rarely succeeded, but much depended on the city’s traits. Property tax breaks could boost manufacturing value in an old city, although they failed in the average city.
Rather than cut taxes, the city may issue bonds in order to buy land or machinery and lease it back to the firm at bargain rates. In Wassmer’s study, such industrial development bonds seemed to increase manufacturing value in new cities – and to increase employment in old ones. In an old city, the bonds may add a few jobs but not overcome the loss in value that’s due to aging capital. The new city is more likely to attract a high-tech firm, which may use the bonds mainly to buy machinery in place of workers.
Tips for TIFs
Incentives attract few retail firms, since these must locate near their markets to survive. Only a huge tax break could persuade a retailer to leave its old market for one less profitable. In Wassmer’s study, about the only incentive that worked was using the retailer’s tax payments to finance city projects that benefited it in particular, such as new roads to its site. This is “tax-increment financing” (TIF): The increment that the firm adds to the local tax base finances its own infrastructure.
This may sound like a good idea: The firm pays for services received, just like a customer in an ice cream store. Unfortunately, the city often will offer tax-increment financing only in a blighted area, hoping to redevelop it. But the area is blighted precisely because firms find it an expensive place in which to do business. The tax-increment financing thus induces firms to move from low-cost areas and into high-cost ones. That’s inefficient, since it reduces the amount that we can produce for a given cost. It’s like offering students a bribe if they will move from the quiet study areas of the library and into the concession room. They will study less.
Analyzing the Chicago area, Richard Dye and David Merriman found that communities adopting tax-increment financing grew more slowly, economically, as a result. Property values, measured by assessments, dropped by nearly a percentage point. The drop was not so severe for communities where the district offering tax-increment financing was larger compared to the entire community. When most of the city is in the district, then there are few opportunities to relocate a firm from the low-cost area outside the district. Hence relocations are less inefficient than in other cities.
Wassmer’s study of 25 cities in the Detroit area reached a similar conclusion. In 12 cases of a link between economic incentives and economic growth, the relationship was negative in seven: Cities that offered tax breaks grew more slowly. Wassmer suggested that slowly-growing cities are simply more likely to offer incentives to attract firms. Another possibility is that incentives persuade firms to move to the wrong areas.
Is it in the public interest for the city to offer tax breaks to try to create jobs? If markets work well, then every firm will locate where it maximizes profits. To offer a tax break may distort this decision, since the firm may impose costs on the jurisdiction that exceed the taxes that it pays. In Montgomery County, Maryland, an affluent suburb of Washington, D.C., Bartik found in 1989 that each new office job produced county revenues of $410 per year -– but required new highways that cost $347. This left little tax money to pay for sewers, water, police or fire safety. A tax break may better suit a city with a languishing economy and excess capacity, since the firm there would not congest roads and sewers.
Bartik argues that relocating jobs from areas of low unemployment to areas of high unemployment creates value. The jobless in an area of high unemployment will seek work more desperately, so they will value a job more highly. Also, relocating jobs from the growing economy will ease congestion of the infrastructure there – and it will make better use of the empty infrastructure in the sluggish economy.
Could markets (broadly defined) handle these matters? If the jobless in the stagnant economy seek work more desperately, then they will offer to work for lower wages. That will attract firms naturally. If the infrastructure is congested in the growing economy, then the government can raise its taxes. That will drive away firms that cannot pay for the costs that they impose on the city.
Almaty, Astana and Bishkek do vie for business. But the competition that most interests Kazakhstan's government is international: Can Astana woo firms that otherwise would go to China? In the global arena, tax cuts and infrastructural subsidies don't work so well, since the foreign firm must pay high transport costs to relocate in another country. (In principle, a government could overcome this barrier by offering to pay the firm's relocation costs, but it usually finds this too expensive to try.) But the basic question -- can public subsidies to firms increase the net value of production? -- still pertains.
–- Leon Taylor, tayloralmaty@gmail.com
Good reading
John E. Anderson and Robert W. Wassmer. The decision to ‘bid for business’: Municipal behavior in granting property tax abatements. Regional Science and Urban Economics 25: 739-757. 1995.
Timothy J. Bartik. Jobs, productivity, and local economic development: What implications does economic research have for the role of government? In Robert Wassmer, ed., Readings in urban economics: Issues and public policy.
Richard F. Dye and David F. Merriman. The effects of tax-increment financing on economic development. Journal of Urban Economics 47: 306-328. 2000.
Robert Wassmer. Can local incentives alter a metropolitan city’s economic development? Urban Studies 31: 1251-1278. 1994.
References
Kazinform. Industrial park of Astana city to attract private investors. Online. December 28, 2010.
Kazinform. Kazakhstan's policy in sphere of foreign direct investments attraction moves to non-oil & gas sector – Kelimbetov. Online. May 26, 2011.
Kazinform. Over the years of independence about USD 130 bln invested in Kazakhstan - A.Rau. Online. May 26, 2011.
The Washington Times. Why do business in Kyrgyzstan? Online at http://www.internationalspecialreports.com/ciscentralasia/99/kyrgyzstan/6.html. 1999.
Sunday, May 15, 2011
Bummer in the city
Why are the main cities of Central Asia so large?
In most countries, large cities grow more rapidly than small ones, noted economists Kenneth Rosen and Mitchel Resnick. Producing is cheaper in the bigger city because it has more suppliers. Selling is cheaper in the metropolis, too; it has more consumers.
In a developing country, the largest city is often much larger than you’d expect. One of five Mexicans lives in Mexico City; one of three Argentines, in Buenos Aires, according to economists Alberto Ades and Edward Glaesar. Nearly a tenth of all Kazakhstanis live in Almaty. Astana, which replaced Almaty as the capital city in 1997, also is growing rapidly. It accounts for 40% of all construction in Kazakhstan, reported Delovoy Kazakhstan last week. In addition, major cities dominate in Kyrgyzstan (where 16% of the population lives in Bishkek), Uzbekistan (8% in Tashkent), Tajikistan (10% in Dushanbe) and Turkmenistan (13% in Ashgabat), according to data from the World Bank.
Why? Maybe workers find large cities much more attractive than small ones. After all, cities pay higher wages. Urban firms save money by transporting goods cheaply to nearby consumers, and they wind up paying these savings to workers, since they must vie for their services. Moreover, prices are low in the city, since most producers locate there and compete for customers. Due to these two trends, a worker can afford to buy more goods in the city than elsewhere. That’s why he lives there.
But this reasoning points to a puzzle, identified by economists Raul Livas Elizondo and Paul Krugman, who is also a Nobel laureate and New York Times columnist. Normally, a firm would locate in a large city, since that’s where consumers and suppliers are. But in an economy open to international trade, those advantages of the metropolis disappear. Regardless of where it is in the nation, the firm can now import inputs and export output cheaply. In fact, it may avoid the big city, where land is costly. “Closed markets promote huge central metropolises, open markets discourage them.” On the other hand, a large city might emerge because it is cheaper to trade through one large port than two small ones. Roads, sewers and electrical grids are too expensive to duplicate.
To test whether the metropolis emerges because the country represses world trade, Ades and Glaeser studied the main cities of 85 countries (Kazakhstan wasn’t one of them). They found that trade related negatively to city size. Where trade comprised a small share of the nation’s economy, the nation’s main city tended to be large. But it was not clear whether the lack of trade caused large cities – or whether large cities caused a lack of trade because firms there found it cheaper to buy from suppliers nearby than from those abroad.
El Maximo, city slicker
Ades and Glaeser were more confident that dictatorships led to large capital cities. Nations with dictators had main cities that were nearly half again as large as the main cities in more democratic countries. The reason may be that the dictator finds the national population easier to control when much of it lives in the capital city, under his thumb. To attract migrants, he extracts payments from the hinterland and redistributes them in the capital city. People come to the big city because it offers subsidies and because it’s safer than the restive hinterland.
For example, to avoid uprisings, the Roman aristocracy gave away grain, which had been extracted from Egypt and Syria, to citizens of Rome, noted Ades and Glaesar. This policy attracted Italian migrants to Rome until the city had a million residents by 50 B.C.E., a third of them receiving grain. Rome also sponsored as many as 50 circuses a year. When Julius Caesar came to power, he reduced the amount of grain given away. The growth of Rome then slowed.
Over the 20th century, Mexico City drew rural migrants. Typically, they squatted on the land and chose a leader to protest against the leading political party, the Party of Institutional Revolution (the Spanish acronym is PRI). To avoid rebellion, the government would give the migrants land and basic infrastructure such as water supply. The migrants then switched to the PRI.
The sizes of Almaty and Astana aren’t due to a lack of world trade. Kazakhstan is an open economy; exports and imports come to as much as 90% of the total economy (measured as the value of production here, or gross domestic product). What the two metropolises do share in common – along with Tashkent, Ashgabat, Bishkek and Dushanbe -- is service as the nation’s capital city. -- Leon Taylor, tayloralmaty@gmail.com
Good reading
Alberto F. Ades and Edward L. Glaeser. Trade and circuses: Explaining urban giants. Quarterly Journal of Economics 110: 1. February 1995. Pages 195-227.
Raul Livas Elizondo and Paul Krugman. Trade policy and the Third World metropolis. Boston, Mass.: National Bureau of Economic Research. Working Paper #4238. December 1992.
O’Sullivan, Arthur. Urban economics. Sixth edition. Boston: McGraw-Hill. 2007. Chapter 4 analyzes city size.
Kenneth T. Rosen and Mitchel Resnick. The size distribution of cities: An examination of the Pareto law and primacy. Journal of Urban Economics 8:2. September 1980. Pages 165-186.
References
Julia Dubovytskyx. Astana pryvlekaet capital. Delovoy Kazakhstan. March 6, 2011. Page 1.
World Bank. World Development Indicators. www.worldbank.org. The population estimates used here are for 2009.
In most countries, large cities grow more rapidly than small ones, noted economists Kenneth Rosen and Mitchel Resnick. Producing is cheaper in the bigger city because it has more suppliers. Selling is cheaper in the metropolis, too; it has more consumers.
In a developing country, the largest city is often much larger than you’d expect. One of five Mexicans lives in Mexico City; one of three Argentines, in Buenos Aires, according to economists Alberto Ades and Edward Glaesar. Nearly a tenth of all Kazakhstanis live in Almaty. Astana, which replaced Almaty as the capital city in 1997, also is growing rapidly. It accounts for 40% of all construction in Kazakhstan, reported Delovoy Kazakhstan last week. In addition, major cities dominate in Kyrgyzstan (where 16% of the population lives in Bishkek), Uzbekistan (8% in Tashkent), Tajikistan (10% in Dushanbe) and Turkmenistan (13% in Ashgabat), according to data from the World Bank.
Why? Maybe workers find large cities much more attractive than small ones. After all, cities pay higher wages. Urban firms save money by transporting goods cheaply to nearby consumers, and they wind up paying these savings to workers, since they must vie for their services. Moreover, prices are low in the city, since most producers locate there and compete for customers. Due to these two trends, a worker can afford to buy more goods in the city than elsewhere. That’s why he lives there.
But this reasoning points to a puzzle, identified by economists Raul Livas Elizondo and Paul Krugman, who is also a Nobel laureate and New York Times columnist. Normally, a firm would locate in a large city, since that’s where consumers and suppliers are. But in an economy open to international trade, those advantages of the metropolis disappear. Regardless of where it is in the nation, the firm can now import inputs and export output cheaply. In fact, it may avoid the big city, where land is costly. “Closed markets promote huge central metropolises, open markets discourage them.” On the other hand, a large city might emerge because it is cheaper to trade through one large port than two small ones. Roads, sewers and electrical grids are too expensive to duplicate.
To test whether the metropolis emerges because the country represses world trade, Ades and Glaeser studied the main cities of 85 countries (Kazakhstan wasn’t one of them). They found that trade related negatively to city size. Where trade comprised a small share of the nation’s economy, the nation’s main city tended to be large. But it was not clear whether the lack of trade caused large cities – or whether large cities caused a lack of trade because firms there found it cheaper to buy from suppliers nearby than from those abroad.
El Maximo, city slicker
Ades and Glaeser were more confident that dictatorships led to large capital cities. Nations with dictators had main cities that were nearly half again as large as the main cities in more democratic countries. The reason may be that the dictator finds the national population easier to control when much of it lives in the capital city, under his thumb. To attract migrants, he extracts payments from the hinterland and redistributes them in the capital city. People come to the big city because it offers subsidies and because it’s safer than the restive hinterland.
For example, to avoid uprisings, the Roman aristocracy gave away grain, which had been extracted from Egypt and Syria, to citizens of Rome, noted Ades and Glaesar. This policy attracted Italian migrants to Rome until the city had a million residents by 50 B.C.E., a third of them receiving grain. Rome also sponsored as many as 50 circuses a year. When Julius Caesar came to power, he reduced the amount of grain given away. The growth of Rome then slowed.
Over the 20th century, Mexico City drew rural migrants. Typically, they squatted on the land and chose a leader to protest against the leading political party, the Party of Institutional Revolution (the Spanish acronym is PRI). To avoid rebellion, the government would give the migrants land and basic infrastructure such as water supply. The migrants then switched to the PRI.
The sizes of Almaty and Astana aren’t due to a lack of world trade. Kazakhstan is an open economy; exports and imports come to as much as 90% of the total economy (measured as the value of production here, or gross domestic product). What the two metropolises do share in common – along with Tashkent, Ashgabat, Bishkek and Dushanbe -- is service as the nation’s capital city. -- Leon Taylor, tayloralmaty@gmail.com
Good reading
Alberto F. Ades and Edward L. Glaeser. Trade and circuses: Explaining urban giants. Quarterly Journal of Economics 110: 1. February 1995. Pages 195-227.
Raul Livas Elizondo and Paul Krugman. Trade policy and the Third World metropolis. Boston, Mass.: National Bureau of Economic Research. Working Paper #4238. December 1992.
O’Sullivan, Arthur. Urban economics. Sixth edition. Boston: McGraw-Hill. 2007. Chapter 4 analyzes city size.
Kenneth T. Rosen and Mitchel Resnick. The size distribution of cities: An examination of the Pareto law and primacy. Journal of Urban Economics 8:2. September 1980. Pages 165-186.
References
Julia Dubovytskyx. Astana pryvlekaet capital. Delovoy Kazakhstan. March 6, 2011. Page 1.
World Bank. World Development Indicators. www.worldbank.org. The population estimates used here are for 2009.
Tuesday, May 10, 2011
Measure for measure
Is Kazakhstan's public debt a danger -- or merely mismeasured?
Kazakhstan built its reputation among foreign investors on fiscal austerity. Now that the government is running deficits, will it lose investors? A major oil firm, ConocoPhillips, reportedly considers whether to leave. If this rumor is not just a strategic leak, then to what extent does Conoco’s itchiness result from doubts about the government’s self-discipline?
Kazakhstan’s debt is not the only one to matter to Kazakhstan. In the United States, the new Tea Party demands that Washington cut its annual deficit (the addition to debt), now a tenth of GDP. How would this affect our trade with the U.S.?
To the extent that it is measured, public debt in our neck of the woods appears modest compared to that of the United States, according to data from the World Bank. The share of government debt in the economy fell in Kazakhstan from 7% in 2005 to 6.3% in 2008, despite an incipient economic slowdown. (“Economy” refers to the value of domestic production, or gross domestic product). Russia pared its debt even more sharply, from 16.6% in 2005 to 6.5% in 2008. By comparison, the debt of the United State remained large and increasing, from 47.2% in 2005 to 54.6% in 2008. The World Bank reported no recent debt figures for Kyrgyzstan, Tajikistan, Turkmenistan or Uzbekistan.
But the history of the region’s debt is not reassuring. Earlier in the first decade of the 21st century, some ratios were disturbingly high: 99% for Kyrgyzstan and 80% for Tajikistan in 2001. Even in Russia and Kazakhstan, which subsequently brought down their debt ratios to manageable levels, the ratios were 41% in 2002 and 13% in 2003, respectively. (Even for this earlier time period, the World Bank reports no ratios for Turkmenistan and Uzbekistan.)
Perils of prudence
When the debt ratio is high, one may wish to think twice about adding to it. The ratio of the annual deficit to GDP was 7% in Tajikistan for 2004; and 1% in Kyrgyzstan for 2001, falling to 0 in 2008. (In the U.S., it was 3% in 2005 and 10.2% in 2009.) On the other hand, Kazakhstan had no deficit in 2004 and a 4.3% surplus in 2008; Russia racked up a 5% surplus in 2004 and 5.6% in 2008.
Kazakhstan and Russia may look prudent, but some reported data raise the possibility that they have defined the public debt to their advantage. Russia in 2008 had a debt of state-owned enterprises that amounted to 28% of GDP, although it reported a public-sector debt of only 6.5%, reported the business weekly Kursiv this March. In Kazakhstan, the corresponding figures were 9% and 6.3%. In China, the enterprise debt amounted to nearly a third of GDP.
We may misgauge debt in other ways as well. We should adjust our estimates for general trends in prices, since we want to know how much purchasing power that the government is diverting to its own purposes. For example, Kazakhstan’s nominal debt was $5.6 billion in 2007 and $8.4 billion in 2008, an increase of $2.8 billion, according to data from the World Bank. In 2008, the general rate of price increases (i.e., inflation) was 17% in Kazakhstan. Inflation thus accounts for .17*$2.8 billion = $470 million of the debt increase. The increase in real debt was $2.8 billion minus $470 million, or $2.33 billion.
Another problem with government’s usual accounting is its failure to consider the value of spending. When the government spends $10 million to build a road, it budgets an expense of $10 million. But in reality, financing roadwork is not like paying out $10 million for pensions. The new road is a public asset; it saves drivers valuable time. Rather than charge off the $10 million immediately, the government should do so over the life of the road – say, 20 years – as the annual loss of road value due partly to wear and tear (“depreciation”). Treating all new assets as cash expenses creates “budget bias” against adding capital, pointed out the watchdog agency of the U.S. Congress, the General Accounting Office.
“Capital budgeting” would account for gains as well as losses from new assets. When the government built its capitol at Astana, the expense normally would have increased its deficit and debt. Capital budgeting would credit the new office buildings as assets, offsetting construction costs. Another example is the bank bailout of 2009. Depending on the type of bank stock that the government acquired, in principle it could have collected dividends eventually -- and perhaps capital gains by selling the stock later at a higher price. In its accounts, should the government book the stock purchases as current expenses – or as financial investments?
Capital budgeting is not risk-free. We cannot determine the value of an asset by snapping our fingers. A U.S. economist, Robert Eisner, noted that asset values change “quite aside from current capital expenditures and depreciation. The changes may stem from alterations in income flows, absolute and relative prices of inputs and outputs both within the country and vis-à-vis other nations, technology, discount rates and risk.” If cash accounting creates a bias against new assets, capital budgeting creates a bias for them. The same government that gave itself a new capitol may be tempted to budget creatively in order to pile on the goodies. Even so, capital budgeting is worth a look, if only to remind us that not all deficits need be cardinal sins. – Leon Taylor, tayloralmaty@gmail.com
Notes
1. To measure the debt of the central government, the World Bank counts all contract obligations, including currency as well as loans. These liabilities are offset by “equity and financial derivatives held by the government.” Generally, the Bank measures the debt on the last day of the fiscal year.
2. The World Bank defines government surplus as “revenue (including grants) minus expense, minus net acquisition of nonfinancial assets.”
Good reading
N. Gregory Mankiw. Macroeconomics. New York: Worth Publishers. Seventh edition. 2001. Chapter 16, “Government debt and budget deficits,” clearly explains measurement problems.
Robert Eisner. Extended accounts for national income and product. Journal of Economic Literature 26:4. December 1988. Pages 1611-1684. Suggested improvements in national income accounting. The source of the Eisner quote above.
Robert Eisner. The misunderstood economy: What counts and how to count it. Harvard Business Press. 1995. Issues in national income accounting, written for the lay reader.
United States General Accounting Office. Budget issues: Capital budgeting for the federal government. Washington, D.C. July 1988. The “budget bias” quote is on page 1.
References
Silk Road Intelligencer. ConocoPhillips mulling exit from Kazakhstan – analyst. March 30, 2011. Online at www.silkroadintelligencer.com.
World Bank. World development indicators. Online at www.worldbank.org
Kazakhstan built its reputation among foreign investors on fiscal austerity. Now that the government is running deficits, will it lose investors? A major oil firm, ConocoPhillips, reportedly considers whether to leave. If this rumor is not just a strategic leak, then to what extent does Conoco’s itchiness result from doubts about the government’s self-discipline?
Kazakhstan’s debt is not the only one to matter to Kazakhstan. In the United States, the new Tea Party demands that Washington cut its annual deficit (the addition to debt), now a tenth of GDP. How would this affect our trade with the U.S.?
To the extent that it is measured, public debt in our neck of the woods appears modest compared to that of the United States, according to data from the World Bank. The share of government debt in the economy fell in Kazakhstan from 7% in 2005 to 6.3% in 2008, despite an incipient economic slowdown. (“Economy” refers to the value of domestic production, or gross domestic product). Russia pared its debt even more sharply, from 16.6% in 2005 to 6.5% in 2008. By comparison, the debt of the United State remained large and increasing, from 47.2% in 2005 to 54.6% in 2008. The World Bank reported no recent debt figures for Kyrgyzstan, Tajikistan, Turkmenistan or Uzbekistan.
But the history of the region’s debt is not reassuring. Earlier in the first decade of the 21st century, some ratios were disturbingly high: 99% for Kyrgyzstan and 80% for Tajikistan in 2001. Even in Russia and Kazakhstan, which subsequently brought down their debt ratios to manageable levels, the ratios were 41% in 2002 and 13% in 2003, respectively. (Even for this earlier time period, the World Bank reports no ratios for Turkmenistan and Uzbekistan.)
Perils of prudence
When the debt ratio is high, one may wish to think twice about adding to it. The ratio of the annual deficit to GDP was 7% in Tajikistan for 2004; and 1% in Kyrgyzstan for 2001, falling to 0 in 2008. (In the U.S., it was 3% in 2005 and 10.2% in 2009.) On the other hand, Kazakhstan had no deficit in 2004 and a 4.3% surplus in 2008; Russia racked up a 5% surplus in 2004 and 5.6% in 2008.
Kazakhstan and Russia may look prudent, but some reported data raise the possibility that they have defined the public debt to their advantage. Russia in 2008 had a debt of state-owned enterprises that amounted to 28% of GDP, although it reported a public-sector debt of only 6.5%, reported the business weekly Kursiv this March. In Kazakhstan, the corresponding figures were 9% and 6.3%. In China, the enterprise debt amounted to nearly a third of GDP.
We may misgauge debt in other ways as well. We should adjust our estimates for general trends in prices, since we want to know how much purchasing power that the government is diverting to its own purposes. For example, Kazakhstan’s nominal debt was $5.6 billion in 2007 and $8.4 billion in 2008, an increase of $2.8 billion, according to data from the World Bank. In 2008, the general rate of price increases (i.e., inflation) was 17% in Kazakhstan. Inflation thus accounts for .17*$2.8 billion = $470 million of the debt increase. The increase in real debt was $2.8 billion minus $470 million, or $2.33 billion.
Another problem with government’s usual accounting is its failure to consider the value of spending. When the government spends $10 million to build a road, it budgets an expense of $10 million. But in reality, financing roadwork is not like paying out $10 million for pensions. The new road is a public asset; it saves drivers valuable time. Rather than charge off the $10 million immediately, the government should do so over the life of the road – say, 20 years – as the annual loss of road value due partly to wear and tear (“depreciation”). Treating all new assets as cash expenses creates “budget bias” against adding capital, pointed out the watchdog agency of the U.S. Congress, the General Accounting Office.
“Capital budgeting” would account for gains as well as losses from new assets. When the government built its capitol at Astana, the expense normally would have increased its deficit and debt. Capital budgeting would credit the new office buildings as assets, offsetting construction costs. Another example is the bank bailout of 2009. Depending on the type of bank stock that the government acquired, in principle it could have collected dividends eventually -- and perhaps capital gains by selling the stock later at a higher price. In its accounts, should the government book the stock purchases as current expenses – or as financial investments?
Capital budgeting is not risk-free. We cannot determine the value of an asset by snapping our fingers. A U.S. economist, Robert Eisner, noted that asset values change “quite aside from current capital expenditures and depreciation. The changes may stem from alterations in income flows, absolute and relative prices of inputs and outputs both within the country and vis-à-vis other nations, technology, discount rates and risk.” If cash accounting creates a bias against new assets, capital budgeting creates a bias for them. The same government that gave itself a new capitol may be tempted to budget creatively in order to pile on the goodies. Even so, capital budgeting is worth a look, if only to remind us that not all deficits need be cardinal sins. – Leon Taylor, tayloralmaty@gmail.com
Notes
1. To measure the debt of the central government, the World Bank counts all contract obligations, including currency as well as loans. These liabilities are offset by “equity and financial derivatives held by the government.” Generally, the Bank measures the debt on the last day of the fiscal year.
2. The World Bank defines government surplus as “revenue (including grants) minus expense, minus net acquisition of nonfinancial assets.”
Good reading
N. Gregory Mankiw. Macroeconomics. New York: Worth Publishers. Seventh edition. 2001. Chapter 16, “Government debt and budget deficits,” clearly explains measurement problems.
Robert Eisner. Extended accounts for national income and product. Journal of Economic Literature 26:4. December 1988. Pages 1611-1684. Suggested improvements in national income accounting. The source of the Eisner quote above.
Robert Eisner. The misunderstood economy: What counts and how to count it. Harvard Business Press. 1995. Issues in national income accounting, written for the lay reader.
United States General Accounting Office. Budget issues: Capital budgeting for the federal government. Washington, D.C. July 1988. The “budget bias” quote is on page 1.
References
Silk Road Intelligencer. ConocoPhillips mulling exit from Kazakhstan – analyst. March 30, 2011. Online at www.silkroadintelligencer.com.
World Bank. World development indicators. Online at www.worldbank.org
Wednesday, May 4, 2011
Comparing the impact of WTO accession of the member states of the customs union of Russia, Kazakhstan and Belarus on output, employment and monetary stability
By Dmitriy Belyanin
When the door to the WTO finally swings open, who will gain the most?
Introduction
All three members of the regional customs union -- Russia, Kazakhstan and Belarus -- have expressed their intention to join the World Trade Organization (WTO) once all legal procedures for forming the union have been settled. Due to economic differences among the three countries, the accession will affect each of them differently.
The WTO promotes trade among its members and forbids many of their trade barriers. The impact of accession on a country depends partly on whether it has much experience with markets. Of the three countries, Belarus has the most regulated economy, followed by Russia. Kazakhstan has the least. For this reason, I hypothesize that WTO accession will benefit Kazakhstan the most. The country partly overcame the drawbacks of trade liberalization and economic restructuring in the 1990s, when declines in its industrial production forced it to substitute imports for domestic output. Russia and Belarus too may benefit in the long run, but they are more likely than Kazakhstan to experience increases in unemployment, decreases in output, and instability in the exchange rate in the short run.
Impact on Output and Employment
WTO accession will enable exporters in Kazakhstan, Russia and Belarus to gain from increased export revenues, which will raise output and employment over time. The benefits of this increase will vary from country to country and will depend on the external environment.
With current estimated unemployment rates of 7.8% of the labor force in Kazakhstan and 7.5% in Russia, some workplaces may be created in sectors benefiting from oil revenue increases. During the late 2000s, both countries restricted exports of grain and oil products to hold down food prices. While they succeeded in doing so, they also hindered the creation of workplaces in the associated sectors. Potential jobs were also lost because consumers had less export income to spend on domestic goods. Many industries that could have developed in these countries did not.
On the other hand, Kazakhstan and Russia suffer from dependence on exports of raw materials, and eliminating export restrictions will divert even more resources into these already developed industries. Producers of import-competing industries will suffer from the removal of tariffs and import quotas, since their goods will have become cheaper than before the WTO accession.
The benefits of WTO accession for Belarus are much weaker than for the other two countries. Belarus had one of the lowest unemployment rates in the Commonwealth of Independent States (CIS) during the 2000s, and it continued to decline even during the global financial crisis, reaching 0.9% in 2010, according to estimates from the International Monetary Fund. Hence, the economy is already running at nearly full full employment. On the contrary, the removal of trade barriers and other forms of state support may expose the lack of competitiveness of Belarussian production. In the long run, however, Belarus, too, may benefit from new industries in place of the economy that it inherited from the Soviet Union, which had emphasized military production and heavy industry.
Exporters may also benefit from the removal of trade barriers by countries importing Belarussian goods.
Impact on Financial Systems
Joining the WTO will increase investment in many sectors of all three economies. Under freer trade, increases in oil prices will increase the attractiveness of securities markets for foreign investors. Bank deposits, of individuals and legal entities, may also increase. The growth of funds available for loans may reduce interest rates on deposits and loans. On the other hand, demand for credit would also increase, tending to increase interest rates.
WTO accession could create economic growth and thus develop capital markets, especially in Russia, which has MICEX, the largest stock exchange in Europe. Options and futures markets will develop as well, since there would be more exchange rate fluctuations to hedge against, due to removal of internal tariffs.
Freer trade would generate pressure for more flexibility in exchange rates. This pressure would grow as more trading partners enter the scene. Russia has allowed its currency to fluctuate since mid-2009, while Kazakhstan returned to a managed float this year. Such decisions reflect high oil prices, which enable exporters to lose less from domestic currency appreciation than would have occurred under lower oil prices. (In the short run, oil demand is not sensitive to price changes. So, when oil prices rise, oil revenues increase even though a few buyers balk at the price increase.) Allowing a more flexible exchange rate policy would enable the member states of the customs union to enjoy lower inflation, since central banks would no longer increase money supply so much in order to hold down the exchange rate. Nevertheless, exporters’ pressures on the central bank can make this effect negligible.
Belarus has a system of multiple exchange rates, so it will have to liberalize its currency exchange regime to enjoy the benefits of freer trade. Since it has been receiving oil and gas products from Russia at artificially low prices -- a prime factor in the country’s prosperity relative to the CIS -- conflicts of interest are likely.
Movement of goods and people may drive up transport costs as well as prices and land rents. On one hand, demand for real estate will increase. On the other hand, the commercial, industrial, and residential sectors will compete more vigorously for real estate. Unfortunately, the price increases of real estate can make housing unaffordable for the poor. Risk management will become more important, since avoiding a new crisis will become crucial.
Conflicts of Interest
Russia and Belarus have sparred over transfers of oil. Belarus depends heavily on imports of oil and gas from Russia, which has subsidized their prices. Since 2006, Russia has been rolling back its subsidies. A schedule of gradual price increases was agreed upon. Also, Gazprom – a giant energy firm owned by the Kremlin -- would gain a 50% stake in Belarussian Beltransgaz. New prices were supposed to take effect in 2011 but now have been delayed until 2014-2015.
The entry of Russia into the WTO would increase demand for Russian products, making them more expensive for Belarussian importers. This could trigger more negotiations by Belarus to receive oil and gas at prices below the EU market price. Economic growth in Belarus may be affected as well; some analysts argue that growth in the late 2000s might be attributed more to cheap oil and gas than to domestic factors.
Another risk associated with WTO entry relates to food security. Due to growth in food consumption in China and India, global food prices have been rising. To the extent that Russia and Belarus export food, freer trade may benefit food producers at the expense of their domestic consumers. In turn, consumers may push for more effective stabilization and welfare policies. At the same time, however, freer trade will lower prices of imported food.
Would a joint WTO accession be more beneficial than separate entries? A joint accession would push the three countries to coordinate their policies, but it would also slow down the accession. In June 2009, Vladimir Putin, prime minister of Russia, announced that the three states of the customs union would seek joint membership in the WTO. However, the WTO members disapproved, since it was unclear how the accession would work, other than that it would work more slowly. Hence, the three states have had to pursue separate membership. This approach, however, could enable smugglers in nations belonging to the WTO as well as to the customs union, to re-export foreign products to other member states illegally. Retaining high tariffs would discourage legal imports, reducing government revenues, as was the case for Kazakhstan when it re-exported imports from Kyrgyzstan, a WTO member. To prevent smuggling, strict customs regulations are vital.
Impact on Political Stability
Since WTO entry will benefit some interest groups at the expense of others, many leaders will seek to slow down accession until the worldwide political situation stabilizes. This is particularly true for Belarus, which loses as an importer from high world prices of oil and gas. On the other hand, Kazakhstan, which lacks strong opposition to the ruling regime, is unlikely to re-consider the terms of accession.
WTO accession can be unpopular amid economic instability resulting from high world prices of food and energy that force importers to consume less. A steep fall in oil prices may trigger devaluation in Kazakhstan and Russia. Previously, these countries would have had the option of increasing import tariffs and decreasing export taxes rather than devaluing their currencies. The WTO accession would restrain such protectionism. Devaluation is much less popular than protectionism and may result in protests.
In Belarus, Russia and Kazakhstan, political risks are high. Alexander Lukaschenka, President of Belarus, has been following a policy of authoritarian market socialism and has been criticized in the West. Protests followed the December 19 election in Belarus. Though these protests were suppressed, more may occur if the economy in Belarus destabilizes. Furthermore, WTO accession may inspire Belarussian citizens to demand more liberalization, economic and political, since the inflow of imports will increase the movement of people as well. (For example, workers in industries threatened by imports may seek jobs elsewhere.)
In Russia, political risks are evidenced by separatist movements in the Caucasus, an oil-rich region in southern Russia, as well as by the precedents of riots by activists. Political risks in Russia contribute to the already unfavorable business climate, which is apparent in Russia’s comparatively low rank on the Heritage Foundation Index of Economic Freedom.
Nursultan Nazarbayev has been in power in Kazakhstan since 1989. The opposition is too weak to revolt. Nevertheless, the future of Kazakhstan after Nazarbayev leaves office is uncertain. The absence of a clear successor is the single most important political risk and may affect the government’s bond ratings. However, as long as Nazarbayev stays in power, the country is unlikely to reverse its economic liberalization, which is substantial by CIS standards. Kazakhstan will most likely enter the World Trade Organization in two or three years.
Conclusions
Accession into the WTO will enable gains from increasing exports, such as growth in gross domestic product and new jobs. These benefits will be larger for Kazakhstan and Russia than for Belarus, which already has one of the lowest unemployment rates in the CIS. However, eliminating export restraints may slow economic diversification in Russia and Kazakhstan, since more resources will be diverted into already-developed industries.
WTO entry may accelerate financial development in all three countries. Securities markets may become more attractive, bank deposits may increase, and supply of and demand for loans will increase. More flexible exchange-rate policies will have to be implemented, and markets for derivative securities will have to develop. Freer trade will also increase real estate prices. Risk management may become crucial.
Conflicts of interest may arise between Belarus and Russia, since the former has been receiving oil and natural gas at artificially low prices from the latter. The prices of Russian-made products may increase, pressuring importers in Belarus of these products. Conflicts of interest may also arise between consumers and producers of food, since food export prices will increase.
WTO entry may be unpopular during periods of economic instability. The lack of opportunity to set export subsidies may make devaluations more common when commodity export prices decrease. These factors will aggravate political risks inherent in all three countries of the customs union.
Dmitriy Belyanin received an honors degree, as a Bachelor of Arts in Economics, from KIMEP in 2008. He received a Master’s of Business Administration degree from the Institute in 2010. He often writes and participates in conferences about finance and economics in Kazakhstan. He now assists research for the Bang College of Business.
When the door to the WTO finally swings open, who will gain the most?
Introduction
All three members of the regional customs union -- Russia, Kazakhstan and Belarus -- have expressed their intention to join the World Trade Organization (WTO) once all legal procedures for forming the union have been settled. Due to economic differences among the three countries, the accession will affect each of them differently.
The WTO promotes trade among its members and forbids many of their trade barriers. The impact of accession on a country depends partly on whether it has much experience with markets. Of the three countries, Belarus has the most regulated economy, followed by Russia. Kazakhstan has the least. For this reason, I hypothesize that WTO accession will benefit Kazakhstan the most. The country partly overcame the drawbacks of trade liberalization and economic restructuring in the 1990s, when declines in its industrial production forced it to substitute imports for domestic output. Russia and Belarus too may benefit in the long run, but they are more likely than Kazakhstan to experience increases in unemployment, decreases in output, and instability in the exchange rate in the short run.
Impact on Output and Employment
WTO accession will enable exporters in Kazakhstan, Russia and Belarus to gain from increased export revenues, which will raise output and employment over time. The benefits of this increase will vary from country to country and will depend on the external environment.
With current estimated unemployment rates of 7.8% of the labor force in Kazakhstan and 7.5% in Russia, some workplaces may be created in sectors benefiting from oil revenue increases. During the late 2000s, both countries restricted exports of grain and oil products to hold down food prices. While they succeeded in doing so, they also hindered the creation of workplaces in the associated sectors. Potential jobs were also lost because consumers had less export income to spend on domestic goods. Many industries that could have developed in these countries did not.
On the other hand, Kazakhstan and Russia suffer from dependence on exports of raw materials, and eliminating export restrictions will divert even more resources into these already developed industries. Producers of import-competing industries will suffer from the removal of tariffs and import quotas, since their goods will have become cheaper than before the WTO accession.
The benefits of WTO accession for Belarus are much weaker than for the other two countries. Belarus had one of the lowest unemployment rates in the Commonwealth of Independent States (CIS) during the 2000s, and it continued to decline even during the global financial crisis, reaching 0.9% in 2010, according to estimates from the International Monetary Fund. Hence, the economy is already running at nearly full full employment. On the contrary, the removal of trade barriers and other forms of state support may expose the lack of competitiveness of Belarussian production. In the long run, however, Belarus, too, may benefit from new industries in place of the economy that it inherited from the Soviet Union, which had emphasized military production and heavy industry.
Exporters may also benefit from the removal of trade barriers by countries importing Belarussian goods.
Impact on Financial Systems
Joining the WTO will increase investment in many sectors of all three economies. Under freer trade, increases in oil prices will increase the attractiveness of securities markets for foreign investors. Bank deposits, of individuals and legal entities, may also increase. The growth of funds available for loans may reduce interest rates on deposits and loans. On the other hand, demand for credit would also increase, tending to increase interest rates.
WTO accession could create economic growth and thus develop capital markets, especially in Russia, which has MICEX, the largest stock exchange in Europe. Options and futures markets will develop as well, since there would be more exchange rate fluctuations to hedge against, due to removal of internal tariffs.
Freer trade would generate pressure for more flexibility in exchange rates. This pressure would grow as more trading partners enter the scene. Russia has allowed its currency to fluctuate since mid-2009, while Kazakhstan returned to a managed float this year. Such decisions reflect high oil prices, which enable exporters to lose less from domestic currency appreciation than would have occurred under lower oil prices. (In the short run, oil demand is not sensitive to price changes. So, when oil prices rise, oil revenues increase even though a few buyers balk at the price increase.) Allowing a more flexible exchange rate policy would enable the member states of the customs union to enjoy lower inflation, since central banks would no longer increase money supply so much in order to hold down the exchange rate. Nevertheless, exporters’ pressures on the central bank can make this effect negligible.
Belarus has a system of multiple exchange rates, so it will have to liberalize its currency exchange regime to enjoy the benefits of freer trade. Since it has been receiving oil and gas products from Russia at artificially low prices -- a prime factor in the country’s prosperity relative to the CIS -- conflicts of interest are likely.
Movement of goods and people may drive up transport costs as well as prices and land rents. On one hand, demand for real estate will increase. On the other hand, the commercial, industrial, and residential sectors will compete more vigorously for real estate. Unfortunately, the price increases of real estate can make housing unaffordable for the poor. Risk management will become more important, since avoiding a new crisis will become crucial.
Conflicts of Interest
Russia and Belarus have sparred over transfers of oil. Belarus depends heavily on imports of oil and gas from Russia, which has subsidized their prices. Since 2006, Russia has been rolling back its subsidies. A schedule of gradual price increases was agreed upon. Also, Gazprom – a giant energy firm owned by the Kremlin -- would gain a 50% stake in Belarussian Beltransgaz. New prices were supposed to take effect in 2011 but now have been delayed until 2014-2015.
The entry of Russia into the WTO would increase demand for Russian products, making them more expensive for Belarussian importers. This could trigger more negotiations by Belarus to receive oil and gas at prices below the EU market price. Economic growth in Belarus may be affected as well; some analysts argue that growth in the late 2000s might be attributed more to cheap oil and gas than to domestic factors.
Another risk associated with WTO entry relates to food security. Due to growth in food consumption in China and India, global food prices have been rising. To the extent that Russia and Belarus export food, freer trade may benefit food producers at the expense of their domestic consumers. In turn, consumers may push for more effective stabilization and welfare policies. At the same time, however, freer trade will lower prices of imported food.
Would a joint WTO accession be more beneficial than separate entries? A joint accession would push the three countries to coordinate their policies, but it would also slow down the accession. In June 2009, Vladimir Putin, prime minister of Russia, announced that the three states of the customs union would seek joint membership in the WTO. However, the WTO members disapproved, since it was unclear how the accession would work, other than that it would work more slowly. Hence, the three states have had to pursue separate membership. This approach, however, could enable smugglers in nations belonging to the WTO as well as to the customs union, to re-export foreign products to other member states illegally. Retaining high tariffs would discourage legal imports, reducing government revenues, as was the case for Kazakhstan when it re-exported imports from Kyrgyzstan, a WTO member. To prevent smuggling, strict customs regulations are vital.
Impact on Political Stability
Since WTO entry will benefit some interest groups at the expense of others, many leaders will seek to slow down accession until the worldwide political situation stabilizes. This is particularly true for Belarus, which loses as an importer from high world prices of oil and gas. On the other hand, Kazakhstan, which lacks strong opposition to the ruling regime, is unlikely to re-consider the terms of accession.
WTO accession can be unpopular amid economic instability resulting from high world prices of food and energy that force importers to consume less. A steep fall in oil prices may trigger devaluation in Kazakhstan and Russia. Previously, these countries would have had the option of increasing import tariffs and decreasing export taxes rather than devaluing their currencies. The WTO accession would restrain such protectionism. Devaluation is much less popular than protectionism and may result in protests.
In Belarus, Russia and Kazakhstan, political risks are high. Alexander Lukaschenka, President of Belarus, has been following a policy of authoritarian market socialism and has been criticized in the West. Protests followed the December 19 election in Belarus. Though these protests were suppressed, more may occur if the economy in Belarus destabilizes. Furthermore, WTO accession may inspire Belarussian citizens to demand more liberalization, economic and political, since the inflow of imports will increase the movement of people as well. (For example, workers in industries threatened by imports may seek jobs elsewhere.)
In Russia, political risks are evidenced by separatist movements in the Caucasus, an oil-rich region in southern Russia, as well as by the precedents of riots by activists. Political risks in Russia contribute to the already unfavorable business climate, which is apparent in Russia’s comparatively low rank on the Heritage Foundation Index of Economic Freedom.
Nursultan Nazarbayev has been in power in Kazakhstan since 1989. The opposition is too weak to revolt. Nevertheless, the future of Kazakhstan after Nazarbayev leaves office is uncertain. The absence of a clear successor is the single most important political risk and may affect the government’s bond ratings. However, as long as Nazarbayev stays in power, the country is unlikely to reverse its economic liberalization, which is substantial by CIS standards. Kazakhstan will most likely enter the World Trade Organization in two or three years.
Conclusions
Accession into the WTO will enable gains from increasing exports, such as growth in gross domestic product and new jobs. These benefits will be larger for Kazakhstan and Russia than for Belarus, which already has one of the lowest unemployment rates in the CIS. However, eliminating export restraints may slow economic diversification in Russia and Kazakhstan, since more resources will be diverted into already-developed industries.
WTO entry may accelerate financial development in all three countries. Securities markets may become more attractive, bank deposits may increase, and supply of and demand for loans will increase. More flexible exchange-rate policies will have to be implemented, and markets for derivative securities will have to develop. Freer trade will also increase real estate prices. Risk management may become crucial.
Conflicts of interest may arise between Belarus and Russia, since the former has been receiving oil and natural gas at artificially low prices from the latter. The prices of Russian-made products may increase, pressuring importers in Belarus of these products. Conflicts of interest may also arise between consumers and producers of food, since food export prices will increase.
WTO entry may be unpopular during periods of economic instability. The lack of opportunity to set export subsidies may make devaluations more common when commodity export prices decrease. These factors will aggravate political risks inherent in all three countries of the customs union.
Dmitriy Belyanin received an honors degree, as a Bachelor of Arts in Economics, from KIMEP in 2008. He received a Master’s of Business Administration degree from the Institute in 2010. He often writes and participates in conferences about finance and economics in Kazakhstan. He now assists research for the Bang College of Business.
Saturday, April 9, 2011
Seeing double (dividends, that is)
Can Central Asian governments do well by doing good?
The only certainties in life are debt and taxes – and the fact that abusing one will enable the government to avoid the other. Even if they don’t particularly want to protect the environment, governments in Central Asia may take an interest in pollution taxes because they raise funds disproportionally from foreign investors and consumers. In the past, Kyrgyzstan and Tajikistan have assumed large public debts as a share of gross domestic product -- 80% in Tajikistan and 99% in Kyrgyzstan in 2001, according to the most recent data available from the World Bank. Both countries have also run public deficits, again expressed as a share of gross domestic product -- 1% in Kyrgyzstan in 2001, and a phenomenal 7% in Tajikistan, in 2004, which was whittled to zero by 2008, according to the World Bank. Such governments may leap at an easy opportunity to reduce their obligations.
Might green taxes provide that opportunity? That remains to be seen. True, green taxes differ from the government’s normal means of raising money – taxing income, savings and consumption – that discourage some economic activity. A payroll tax lowers after-tax returns to the worker of another hour of labor, so it may dissuade him from offering that hour. Substituting pollution taxes for income taxes may raise as much money for the government and encourage work. Pollution taxes may yield a “double dividend.”
Some economists have speculated that tax revenues might increase. People might work more hours, generating output, sales and income – all of them taxable.
Green taxes are slow to catch on. Europe is relaxing its embrace of the double dividend. Its tax revenues from environmental taxes fell from 6.9% in 1995 to 6.4% in 2005, according to the European Environment Agency. However, to control carbon emissions that contribute to global warming, the European Union has adopted a scheme much like the green tax.
Blowing the whistle on penalties
A glance at figures for Central Asia suggests that some countries in the region may also profit by switching to green taxes. Kazakhstan relies heavily on taxing income, profits and capital gains. These sources accounted for nearly half of all its tax revenues, compared to 9 percent in Russia and 4 percent in Tajikistan, in 2004, according to data from the World Bank. Kazakhstan’s taxes may severely penalize work, production and saving.
Uzbekistan may also penalize savings severely. Like Kazakhstan, it taxed individuals in the top income bracket at 20% in 2004, substantially higher than Russia’s top marginal tax rate of 13%, according to the most recent data available from the World Bank. Taxing the top bracket may affect savings disproportionately: The rich save a larger share of their incomes than do the poor, since they can more easily afford material needs. (If subsistence requires $500 a year, then a household earning $500 a year can save nothing; but the household earning $50,000 a year is in happier straits.) Indeed, the top tax rate in Uzbekistan applied to an unusually large share of Uzbeks. The top tax in Kazakhstan fell on individuals earning more than $47,600 a year; in Uzbekistan, the minimum top income was $666, about a third of average income. These burdens may induce savings to flow out of Central Asia and into Russia. And the failure of three countries in Central Asia to provide recent basic data about their top tax rates is not encouraging.
I do not want to exaggerate the benefits to the region of adopting green taxes. With the possible exception of Kyrgyzstan, governments in Central Asia are relatively small to begin with. Their spending shares of the national economy range from 9% in Tajikistan in 2004 to 18% in Kyrgyzstan in 2005, according to World Bank data. (The statistic for Kyrgyzstan reflects ironically on the nation; in the early Nineties, it was supposedly the poster child in Central Asia for market reform.) By comparison, the public share of the economy in the United States – which has had one of the leanest governments in the West – was 16% in 2003. It is unlikely that additional reductions of the government’s role in the economy – by cutting taxes on income, profits and capital gains – can produce benefits comparable to those that arose from the region’s initial transition to market economies.
(Due to self-reporting, the statistics may understate a government’s actual expenditures on goods and services. On the other hand, the estimates of gross domestic product (the size of the economy) ignore the underground economy, which is probably substantial in Central Asia. The overall effect of the two understatements on a government’s share of GDP is uncertain.)
Another factor suggests that the region can gain only modestly from green taxes – the moderate impact of factor taxes on economic growth in other nations. (“Factors” are inputs used in production: Labor, capital, and natural resources.) For tax revenues, the United States relies almost entirely on income, profits and capital gains. Yet this did not prevent an economic expansion that lasted (save for brief recessions in 1991 and 2001) for more than two decades until the financial crisis of 2008.
All this notwithstanding, it may make sense to tax bads rather than goods, particularly when foreigners will pay the bill. -- Leon Taylor, tayloralmaty@gmail.com
Notes
1. The deficit expresses the government’s spending in the current year that it can’t cover with current revenues. The debt expresses the full amount owed; it sums all unpaid deficits to date. The deficit is like the spending that you charge this month to your credit card; the debt is like your total balance remaining to be paid.
2. The measure of government spending includes purchases of goods and services but not capital purchases for defense.
3. Parts of this post draw upon a newspaper article of mine written for the Caspian Digest in 2006.
References
European Environment Agency. EN 32. http://www.eea.europa.eu/data-and-maps/indicators/en32-energy-taxes-1/en32
World Bank. World development indicators. Various years. Online at www.worldbank.org
The only certainties in life are debt and taxes – and the fact that abusing one will enable the government to avoid the other. Even if they don’t particularly want to protect the environment, governments in Central Asia may take an interest in pollution taxes because they raise funds disproportionally from foreign investors and consumers. In the past, Kyrgyzstan and Tajikistan have assumed large public debts as a share of gross domestic product -- 80% in Tajikistan and 99% in Kyrgyzstan in 2001, according to the most recent data available from the World Bank. Both countries have also run public deficits, again expressed as a share of gross domestic product -- 1% in Kyrgyzstan in 2001, and a phenomenal 7% in Tajikistan, in 2004, which was whittled to zero by 2008, according to the World Bank. Such governments may leap at an easy opportunity to reduce their obligations.
Might green taxes provide that opportunity? That remains to be seen. True, green taxes differ from the government’s normal means of raising money – taxing income, savings and consumption – that discourage some economic activity. A payroll tax lowers after-tax returns to the worker of another hour of labor, so it may dissuade him from offering that hour. Substituting pollution taxes for income taxes may raise as much money for the government and encourage work. Pollution taxes may yield a “double dividend.”
Some economists have speculated that tax revenues might increase. People might work more hours, generating output, sales and income – all of them taxable.
Green taxes are slow to catch on. Europe is relaxing its embrace of the double dividend. Its tax revenues from environmental taxes fell from 6.9% in 1995 to 6.4% in 2005, according to the European Environment Agency. However, to control carbon emissions that contribute to global warming, the European Union has adopted a scheme much like the green tax.
Blowing the whistle on penalties
A glance at figures for Central Asia suggests that some countries in the region may also profit by switching to green taxes. Kazakhstan relies heavily on taxing income, profits and capital gains. These sources accounted for nearly half of all its tax revenues, compared to 9 percent in Russia and 4 percent in Tajikistan, in 2004, according to data from the World Bank. Kazakhstan’s taxes may severely penalize work, production and saving.
Uzbekistan may also penalize savings severely. Like Kazakhstan, it taxed individuals in the top income bracket at 20% in 2004, substantially higher than Russia’s top marginal tax rate of 13%, according to the most recent data available from the World Bank. Taxing the top bracket may affect savings disproportionately: The rich save a larger share of their incomes than do the poor, since they can more easily afford material needs. (If subsistence requires $500 a year, then a household earning $500 a year can save nothing; but the household earning $50,000 a year is in happier straits.) Indeed, the top tax rate in Uzbekistan applied to an unusually large share of Uzbeks. The top tax in Kazakhstan fell on individuals earning more than $47,600 a year; in Uzbekistan, the minimum top income was $666, about a third of average income. These burdens may induce savings to flow out of Central Asia and into Russia. And the failure of three countries in Central Asia to provide recent basic data about their top tax rates is not encouraging.
I do not want to exaggerate the benefits to the region of adopting green taxes. With the possible exception of Kyrgyzstan, governments in Central Asia are relatively small to begin with. Their spending shares of the national economy range from 9% in Tajikistan in 2004 to 18% in Kyrgyzstan in 2005, according to World Bank data. (The statistic for Kyrgyzstan reflects ironically on the nation; in the early Nineties, it was supposedly the poster child in Central Asia for market reform.) By comparison, the public share of the economy in the United States – which has had one of the leanest governments in the West – was 16% in 2003. It is unlikely that additional reductions of the government’s role in the economy – by cutting taxes on income, profits and capital gains – can produce benefits comparable to those that arose from the region’s initial transition to market economies.
(Due to self-reporting, the statistics may understate a government’s actual expenditures on goods and services. On the other hand, the estimates of gross domestic product (the size of the economy) ignore the underground economy, which is probably substantial in Central Asia. The overall effect of the two understatements on a government’s share of GDP is uncertain.)
Another factor suggests that the region can gain only modestly from green taxes – the moderate impact of factor taxes on economic growth in other nations. (“Factors” are inputs used in production: Labor, capital, and natural resources.) For tax revenues, the United States relies almost entirely on income, profits and capital gains. Yet this did not prevent an economic expansion that lasted (save for brief recessions in 1991 and 2001) for more than two decades until the financial crisis of 2008.
All this notwithstanding, it may make sense to tax bads rather than goods, particularly when foreigners will pay the bill. -- Leon Taylor, tayloralmaty@gmail.com
Notes
1. The deficit expresses the government’s spending in the current year that it can’t cover with current revenues. The debt expresses the full amount owed; it sums all unpaid deficits to date. The deficit is like the spending that you charge this month to your credit card; the debt is like your total balance remaining to be paid.
2. The measure of government spending includes purchases of goods and services but not capital purchases for defense.
3. Parts of this post draw upon a newspaper article of mine written for the Caspian Digest in 2006.
References
European Environment Agency. EN 32. http://www.eea.europa.eu/data-and-maps/indicators/en32-energy-taxes-1/en32
World Bank. World development indicators. Various years. Online at www.worldbank.org
Monday, April 4, 2011
The tax is always greener on the other side of the fence
Should Central Asia tax pollution or prohibit it?
You would not have expected economists to enthuse about taxes. But they prefer levies to fines when it comes to protecting the environment.
At present, most countries try to protect their environments by telling polluters to cut back emissions by the same percentage. Suppose that a government targets a 50% reduction in tons of sulfur dioxide (a by-product of generating electricity) released into the atmosphere. This, in fact, was the aim of the 1990 Clean Air Act in the United States.
The typical government would require each power plant to halve emissions by 50%. This strategy, “command-and-control,” ignores variations across firms in the cost of controlling pollution. Some firms can reduce pollution more cheaply than others, and so they should abate more: That way, we can cut emissions by a given amount at a lower cost. The saved money may be spent to create factories and jobs.
A tax on pollution (for example, $2,000 per ton of sulfur dioxide released into the air) would cut the total costs of controlling pollution, because it confronts each polluter with the same cost for emitting another ton. Firms that find pollution control expensive will prefer to pay the tax. Firms that find pollution control cheap will prefer to abate. Thus firms that can abate cheaply will abate the most. If the government wants more cleanup, then it can always raise the tax.
The government can tax pollution – or sell permits to potential polluters that can resell them if they wish. Both policies encourage abatement by the firms that can abate most cheaply. The abater avoids taxes – or resells its permits at profit to polluters that can’t afford to abate.
Defenders of command-and-control often claim that this strategy is simpler and fairer than the “green tax.” Simpler for whom? Certainly not for the managers of a power plant that must install an expensive electrostatic precipitator in order to halve emissions of sulfur dioxide. They may find it simpler just to pay the tax. If command-and-control is simpler for anyone, then it is for the post-Soviet regulator who is accustomed to direct controls.
Is command-and-control fairer than the green tax? It would seem fair to reward the firm that abates more than others -- or that abates more cheaply, since this releases resources for purposes that may benefit society. On both counts, the tax provides greater rewards than command-and-control, because it lets the firm decide how much pollution to eliminate -- thus encouraging abatement by firms that can abate most efficiently.
The most common argument against green taxes roots in a misunderstanding. Command-and-control is said to “prevent” pollution while the tax “permits” it. But a command to each firm to halve emissions of sulfur dioxide is also an implicit permission to pollute half as much as before. In principle, either the tax or command-and-control can achieve a feasible cut in pollution. The choice between the strategies should depend on how each would reach the targeted reduction, not on the target itself.
Our experience with green taxes
By cutting the cost of controlling pollution, green taxes can increase the size of the economy, by freeing up resources for new production. This alone may justify the taxes.
In fact, few governments impose pure green taxes. Gasoline taxes are common; in Europe, they have accounted for up to three-fourths of the price of gasoline, according to CNN/Money. But governments rarely design a gasoline tax simply to reduce air pollution from vehicles. Indeed, it would poorly suit that purpose, since each vehicle typically pays the same tax per gallon regardless of the amount of pollution that it emits. A more typical purpose of the tax is to raise road funds.
Successful green taxes are few and far between. In Japan, a tax on sulfur dioxide pays for a program that compensates victims of pollution, notes Tom Tietenberg. Since its purpose is to raise money rather than to control emissions, the tax is not necessarily set at a rate that would reduce pollution to the optimal level (i.e., the level at which the benefit of abating each ton of sulfur dioxide exceeds the cost of abating that ton). The Swedes have better luck with taxes on another air pollutant, nitrogen oxide. Since they want firms to abate, they set the tax high, Tietenberg writes. They also return the money to the polluters on the basis of their energy production. In effect, a firm is rewarded for polluting little per unit of energy. Swedish emissions of nitrogen oxide have fallen sharply. The Germans also tax pollution (in waste water) sensibly; the tax varies with the amount and toxicity of the pollution, according to Tietenberg.
Successful green taxes in developing countries are harder to identify. South Africa introduced a carbon tax last year, in part to try to limit emissions of greenhouse gases, according to People’s Daily Online. Indonesia and the Philippines have taxed the use of resources and the discharge of wastes. But developing nations competing for foreign investors may step away from green taxes. In 2005, Georgia’s parliament canceled taxes on air and water pollution that had taken effect in 1993. On the other hand, neighboring Armenia has introduced pollution taxes, according to Wikipedia.
Will poor countries adopt green taxes?
Conventional wisdom holds that developing nations are more likely to trade off environmental quality for economic growth than is the West, out of their greater relative difficulty in providing food and shelter. Thus developing nations are less likely than the West to adopt green taxes. They would rather have pollution than starvation. Statistics don’t always bear out this argument: The share of per capita income that is devoted to national government spending on environmental protection is higher in Kazakhstan than in the United States. Nevertheless, economists have amassed statistical evidence for a decade that jibes with the conventional wisdom, for the least developed countries. (Prominent among these studies is a 1995 paper by Grossman and Krueger.)
Studies of many nations at a given time find that, as one shifts attention from a very poor nation to a slightly richer one, pollution levels initially rise. They peak for a low-middle-income nation with an average annual income of $8,000 in the mid-Nineties – which was roughly true of Mexico. Then pollution levels fall for richer nations.
Here is a common explanation: Very poor nations will suffer increasing pollution levels as they industrialize; and, in rich nations, educated voters will increasingly compel the government to control pollution.
This economic “law” has been observed only for some air pollutants. And it has been observed mainly in studies in which one takes a statistical snapshot of many nations at a particular time; little evidence suggests that it holds true for any particular nation over time. Nevertheless, since the nations of Central Asia (except, possibly, for Kazakhstan) are unusually poor, they may tolerate rising levels of pollution for now, in exchange for higher incomes, rather than reduce pollution with green taxes. – Leon Taylor, tayloralmaty@gmail.com
Good reading
Gene M. Grossman and Alan B. Krueger. Economic growth and the environment. Quarterly Journal of Economics 110: 353-77. 1995.
Tom H. Tietenberg. Economic instruments for environmental regulation. Oxford Review of Economic Policy 6: 17-33. Reprinted in Robert N. Stavins, Economics of the environment: Selected readings, New York: W. W. Norton. Fifth edition. 2005.
Tom Tietenberg. Environmental and natural resource economics. Boston: Pearson. Seventh edition. 2006.
References
John Beghin, David Roland-Holst, and Domingo van der Mensbrugge. Trade and the environment in general equilibrium: Evidence from developing countries. Dordrecht, Netherlands: Kluwer Academic. 2002. A chapter discusses Indonesian taxes.
CNN/Money. Gas prices around the world. http://money.cnn.com/pf/features/lists/global_gasprices/
Alan Krupnick, Richard Morgenstern, Carolyn Fischer, Kevin Rolfe, Jose Logarta, and Bing Rufo. Air pollution control policy options for metro Manila. Washington, D.C.: Resources for the Future Discussion Paper 3-30. December 2003. http://www.rff.org/documents/RFF-DP-03-30.pdf
You would not have expected economists to enthuse about taxes. But they prefer levies to fines when it comes to protecting the environment.
At present, most countries try to protect their environments by telling polluters to cut back emissions by the same percentage. Suppose that a government targets a 50% reduction in tons of sulfur dioxide (a by-product of generating electricity) released into the atmosphere. This, in fact, was the aim of the 1990 Clean Air Act in the United States.
The typical government would require each power plant to halve emissions by 50%. This strategy, “command-and-control,” ignores variations across firms in the cost of controlling pollution. Some firms can reduce pollution more cheaply than others, and so they should abate more: That way, we can cut emissions by a given amount at a lower cost. The saved money may be spent to create factories and jobs.
A tax on pollution (for example, $2,000 per ton of sulfur dioxide released into the air) would cut the total costs of controlling pollution, because it confronts each polluter with the same cost for emitting another ton. Firms that find pollution control expensive will prefer to pay the tax. Firms that find pollution control cheap will prefer to abate. Thus firms that can abate cheaply will abate the most. If the government wants more cleanup, then it can always raise the tax.
The government can tax pollution – or sell permits to potential polluters that can resell them if they wish. Both policies encourage abatement by the firms that can abate most cheaply. The abater avoids taxes – or resells its permits at profit to polluters that can’t afford to abate.
Defenders of command-and-control often claim that this strategy is simpler and fairer than the “green tax.” Simpler for whom? Certainly not for the managers of a power plant that must install an expensive electrostatic precipitator in order to halve emissions of sulfur dioxide. They may find it simpler just to pay the tax. If command-and-control is simpler for anyone, then it is for the post-Soviet regulator who is accustomed to direct controls.
Is command-and-control fairer than the green tax? It would seem fair to reward the firm that abates more than others -- or that abates more cheaply, since this releases resources for purposes that may benefit society. On both counts, the tax provides greater rewards than command-and-control, because it lets the firm decide how much pollution to eliminate -- thus encouraging abatement by firms that can abate most efficiently.
The most common argument against green taxes roots in a misunderstanding. Command-and-control is said to “prevent” pollution while the tax “permits” it. But a command to each firm to halve emissions of sulfur dioxide is also an implicit permission to pollute half as much as before. In principle, either the tax or command-and-control can achieve a feasible cut in pollution. The choice between the strategies should depend on how each would reach the targeted reduction, not on the target itself.
Our experience with green taxes
By cutting the cost of controlling pollution, green taxes can increase the size of the economy, by freeing up resources for new production. This alone may justify the taxes.
In fact, few governments impose pure green taxes. Gasoline taxes are common; in Europe, they have accounted for up to three-fourths of the price of gasoline, according to CNN/Money. But governments rarely design a gasoline tax simply to reduce air pollution from vehicles. Indeed, it would poorly suit that purpose, since each vehicle typically pays the same tax per gallon regardless of the amount of pollution that it emits. A more typical purpose of the tax is to raise road funds.
Successful green taxes are few and far between. In Japan, a tax on sulfur dioxide pays for a program that compensates victims of pollution, notes Tom Tietenberg. Since its purpose is to raise money rather than to control emissions, the tax is not necessarily set at a rate that would reduce pollution to the optimal level (i.e., the level at which the benefit of abating each ton of sulfur dioxide exceeds the cost of abating that ton). The Swedes have better luck with taxes on another air pollutant, nitrogen oxide. Since they want firms to abate, they set the tax high, Tietenberg writes. They also return the money to the polluters on the basis of their energy production. In effect, a firm is rewarded for polluting little per unit of energy. Swedish emissions of nitrogen oxide have fallen sharply. The Germans also tax pollution (in waste water) sensibly; the tax varies with the amount and toxicity of the pollution, according to Tietenberg.
Successful green taxes in developing countries are harder to identify. South Africa introduced a carbon tax last year, in part to try to limit emissions of greenhouse gases, according to People’s Daily Online. Indonesia and the Philippines have taxed the use of resources and the discharge of wastes. But developing nations competing for foreign investors may step away from green taxes. In 2005, Georgia’s parliament canceled taxes on air and water pollution that had taken effect in 1993. On the other hand, neighboring Armenia has introduced pollution taxes, according to Wikipedia.
Will poor countries adopt green taxes?
Conventional wisdom holds that developing nations are more likely to trade off environmental quality for economic growth than is the West, out of their greater relative difficulty in providing food and shelter. Thus developing nations are less likely than the West to adopt green taxes. They would rather have pollution than starvation. Statistics don’t always bear out this argument: The share of per capita income that is devoted to national government spending on environmental protection is higher in Kazakhstan than in the United States. Nevertheless, economists have amassed statistical evidence for a decade that jibes with the conventional wisdom, for the least developed countries. (Prominent among these studies is a 1995 paper by Grossman and Krueger.)
Studies of many nations at a given time find that, as one shifts attention from a very poor nation to a slightly richer one, pollution levels initially rise. They peak for a low-middle-income nation with an average annual income of $8,000 in the mid-Nineties – which was roughly true of Mexico. Then pollution levels fall for richer nations.
Here is a common explanation: Very poor nations will suffer increasing pollution levels as they industrialize; and, in rich nations, educated voters will increasingly compel the government to control pollution.
This economic “law” has been observed only for some air pollutants. And it has been observed mainly in studies in which one takes a statistical snapshot of many nations at a particular time; little evidence suggests that it holds true for any particular nation over time. Nevertheless, since the nations of Central Asia (except, possibly, for Kazakhstan) are unusually poor, they may tolerate rising levels of pollution for now, in exchange for higher incomes, rather than reduce pollution with green taxes. – Leon Taylor, tayloralmaty@gmail.com
Good reading
Gene M. Grossman and Alan B. Krueger. Economic growth and the environment. Quarterly Journal of Economics 110: 353-77. 1995.
Tom H. Tietenberg. Economic instruments for environmental regulation. Oxford Review of Economic Policy 6: 17-33. Reprinted in Robert N. Stavins, Economics of the environment: Selected readings, New York: W. W. Norton. Fifth edition. 2005.
Tom Tietenberg. Environmental and natural resource economics. Boston: Pearson. Seventh edition. 2006.
References
John Beghin, David Roland-Holst, and Domingo van der Mensbrugge. Trade and the environment in general equilibrium: Evidence from developing countries. Dordrecht, Netherlands: Kluwer Academic. 2002. A chapter discusses Indonesian taxes.
CNN/Money. Gas prices around the world. http://money.cnn.com/pf/features/lists/global_gasprices/
Alan Krupnick, Richard Morgenstern, Carolyn Fischer, Kevin Rolfe, Jose Logarta, and Bing Rufo. Air pollution control policy options for metro Manila. Washington, D.C.: Resources for the Future Discussion Paper 3-30. December 2003. http://www.rff.org/documents/RFF-DP-03-30.pdf
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