Does Central Asia need automatic stabilizers?
To smooth out fluctuations of income over time, a national government may rely on programs, called “automatic stabilizers,” that spend more in recessions and less in recoveries. For example, most nations pay benefits to the unemployed. This props up national spending -– and thus national income – in recessions, when unemployment rates are high. When the jobless have enough to put greens and soup on the table, they help preserve jobs at the grocery store.
On the other hand, when national spending and prices are too high, the stabilizers work in reverse. Unemployment compensation drops when few people are out of work, thus averting overspending.
Compared to the West, Central Asia has few automatic stabilizers. For example, Kazakhstan does not offer unemployment insurance to most workers. These benefits are aptly named; one can think of the taxpayer as paying “premiums” to the government in exchange for partial replacement of her wages lost during unemployment. But “the unemployment benefit scheme, to which [workers] previously contributed and earned the right to benefits, was abolished in their time of need,” remarked Martina Lubyova of the International Labour Organization in 2009. Now only the poorest of the jobless qualify for benefits.
In general, post-Soviet governments in this region cut back on social spending in the mid-Nineties, partly to qualify for Western loans. Because this spending usually goes to poorer households, it often acts as an automatic stabilizer. In 2002, welfare spending by the government of Kazakhstan amounted to 5.4% of the size of the economy (gross domestic product). Throughout Europe and Central Asia, the average ratio was 10.1%, noted the World Bank.
The lack of stabilizers in Central Asia may aggravate swings in its business cycles. For the period from 1998 through 2009, one measure of income volatility in the region was more than triple that for major economies in the West (see the Notes). In Central Asia, volatility was lowest in Kyrgyzstan and highest (by far) in Turkmenistan. Stabilizers are not the only factors in Central Asia’s volatility; the region depends on exports of such natural resources as oil, gas and gold, which oscillate wildly in their global prices. But this price volatility may strengthen the case for stabilizers.
Central Asia does share with the West some stabilizers that mitigate the business cycle indirectly. For example, when income falls in a recession, so do income tax payments. Unless the government spends all tax revenues on domestic output -– which is not the case in Kazakhstan -– then some part of tax payments leak out of the national economy. A fall in national income reduces this leak. In the United States, taxes absorb as much as 8% of an economic shock to gross domestic product, estimated economist Carl Walsh.
Stabilizers cannot eliminate economic downturns, but it can gentle them. The U.S. economy had few automatic stabilizers in the 1930s –- which is overlooked by paperback authors who predict another Great Depression just around the corner in America. In the Thirties, U.S. welfare was mainly left to the states and localities. Herbert Hoover had rejected a plan to provide federal welfare as “fascist and monopolistic.” By 1933, the states and localities were out of money, so Congress passed a New Deal bill to provide relief. Since then, the U.S. has never suffered unemployment rates as high as occurred in the early Thirties.
Automatic stabilizers may be more effective than discretionary policy, because they take effect right away, noted Nobel Laureate Joseph Stiglitz. In the U.S., carefully planning and carrying out a federal budget usually take the President and Congress at least 20 months. Kazakhstan may not need so much time, since the President dominates the Parliament, but automatic spending still would save time.
Automatic stabilizers can work only if the central bank tolerates them. When the central bank is intent upon tightening the money supply, then it can blunt the stimulus due to spending on unemployment insurance. In the Nineties, the Bank of Canada sometimes overrode the stabilizers to demonstrate its commitment to low inflation, noted David Dodge. In Central Asia, central banks are not as independent of national political leaders as is the Bank of Canada. -- Leon Taylor, tayloralmaty@gmail.com
Notes
To measure the volatility of a national economy, I gathered data on real gross domestic product per capita – in 2005 international dollars, using purchasing power parity – for the five post-Soviet nations of Central Asia, three major Western economies, and for Russia. The period studied was from 1998 (when the Russian ruble crashed) to 2009 (a year of global slowdown). I chose recessionary years for the endpoints to try to compute descriptive statistics over complete business cycles; but the strength of the slowdowns in those two years varies with the country. I measured volatility as the ratio of the sample standard deviation to the mean. It was 4.1% in France, 4.5% in Germany, 28% in Kazakhstan, 13% in Kyrgyzstan, 23.1% in Russia, 23.6% in Tajikistan, 41.5% in Turkmenistan, 5.1% in the United States, and 18.3% in Uzbekistan. All data are from the World Bank’s World Development Indicators.
Good reading
David A. Dodge. Untitled remarks. Economic Review. Fourth quarter 2002. www.kansascityfed.org.
Martina Lubyova. Labour market institutions and policies in the CIS: Post-transitional outcomes. Working paper 4. International Labour Organization. 2009. www.ilo.org
Joseph E. Stiglitz. The roaring Nineties. W.W. Norton. 2003.
Carl E. Walsh. The role of fiscal policy. Economic Letter. September 6, 2002. www.frbsf.org
World Bank. Dimensions of poverty in Kazakhstan. Report No. 30294-KZ, volume 1. Poverty Reduction and Economic Management Unit, Europe and Central Asia Region. 2004. www.worldbank.org The source of the estimates of the ratio of social spending to GDP.
References
World Bank. World Development Indicators. Various years. www.worldbank.org
Wednesday, June 29, 2011
Monday, June 27, 2011
Wheelers, dealers, and other public servants
If the government parties now, will it be hungover in the morning?
Central Asia is relying increasingly on presidents and legislators, not on the central banks, to guide the economy. In 2009, the governments of Kazakhstan and Kyrgyzstan stimulated their languishing economies by spending more than they collected in taxes. The resulting deficits amounted to 2% of the size of the economy (gross domestic product) in Kazakhstan and 1.4% in Kyrgyzstan, according to the World Bank. (Data were not available for Tajikistan, Turkmenistan and Uzbekistan.) Is this trend healthy?
Keynesians may sympathize. As an antidote to recession, they tend to favor fiscal policy to monetary. Tax cuts and government spending may create jobs when the economy is operating below capacity. On the other hand, printing money might not work. When people are scared, they might simply hide the new money rather than spend it. That other tool of monetary policy -– the interest rate -– might also fail. In principle, lower interest rates enable firms to borrow more money in order to expand. But in a depression, the interest rate is already low; the central bank can't push it much lower. If it is zero, then banks will see no point in loaning out more money, even if the central bank does provide it for a song. Welcome to the liquidity trap.
Even in normal times, firms don't pay much attention to the interest rate when contemplating their investment projects, according to Keynesians. True, they would profit by giving the green light to a project with a rate of return exceeding the interest rate. But firms don't always know what rate of return to expect. Executives base their investment decisions partly on "animal spirits" -- on their gut sense of where the economy is headed. They might pay high interest rates if they think that the economy is headed for a boom. And they might pass up a chance to build a factory at bargain-basement interest rates if they think that the economy is headed for a fall.
Even Keynesians would concede that monetary policy is not always impotent. Printing money doesn't always revive the economy, but destroying money seems a sure-fire way to cool it off for a while. We can't be sure that increasing the money supply will encourage investment, since the central bank can't force firms to borrow money. But reducing the money supply will discourage investment. Firms can't build factories if they can't borrow money to pay the builders. Loans are especially important to firms in Central Asia, which have not been operating long enough to build up war chests of cash (“retained earnings”). In the West, the Federal Reserve and the European Central Bank must worry that their attempts to ward off inflation may succeed all too well.
To Keynesians, government spending in a recession will raise output, not prices, because firms will not mark up their prices when demand is anemic. In the United States, prices were indeed stable during the 1950s -– but not in the 1960s. Economists then took more interest in inflation, noted a macroeconomist at the U.S. central bank, Marco Espinosa-Vega. Nobel laureate Milton Friedman argued that a temporary increase in the money supply can affect output in only the short run, by tricking workers into producing more; eventually, they will realize what has happened and will act accordingly. By spending more, the government just confiscates more of the economic pie for itself.
Economists worry when the government borrows in order to spend. The competition with firms for loans forces up the interest rate, crowding out private investment. For example, the U.S. government mainly paid for the Civil War by borrowing money. The new federal debt claimed nearly one-sixth of the gross national product of the North –- large enough to crowd out all new investment during the war, wrote economic historians Jeremy Atack and Peter Passell.
Until recently, however, the bond markets didn’t worry about the deficit, perhaps because it does not claim as large a share of gross domestic product as it did in the Civil War -– or, for that matter, in the 1980s. You could argue that the U.S. deficit was not quite Brobdingnagian – not until recently, anyway.
But Americans really have foreign investors to thank, reported The New York Times. Asian central banks tried to weaken their currencies by selling them for dollars. (They want weaker currencies in order to boost exports.) To put their dollars to work, the central banks reinvested them in U.S. Treasury bonds, even when their rate of return was minuscule, according to The Wall Street Journal. (In May, net foreign assets for Kazakhstan were worth 10.7 trillion tenge, up by more than a third from the previous May, according to the National Bank of Kazakhstan.) Should the central banks stop buying dollars, the U. S. government would have trouble selling bonds. Bond prices would drop, and interest rates would rise. That would compound the difficulty of paying off Washington’s debt. And it would tend to raise interest rates paid by borrowers in Kazakhstan.
For an extreme example of what could happen in developing countries, let’s go to Argentina. A decade ago, the country’s mounting deficit convinced investors that they would never see their money again. They demanded higher interest rates before they would buy the country’s bonds. Over 2001, the interest rate on a 10-year bond rose by 20 percentage points to 35 percent, although the country had tried to reduce its deficit by raising income taxes, wrote Mark Spiegel. Argentina did not earn enough foreign currency from its exports to cover its interest payments, so the government eventually defaulted on its loans. Although Argentina became the second fastest-growing economy in the Western Hemisphere -– second only to oil-rich Venezuela –- it remained virtually the last place in the world in which investors would park their dollars, concluded a Federal Reserve economist, Ramon Moreno, in 2002.
The third-largest economy in the world, Japan’s, was in a similar predicament. Japan’s national debt amounts to 150 percent of its gross domestic product -– the highest ratio among leading industrial nations. In 2005, Moody’s ranked Japan’s bonds below those of Botswana. The fear was that Japan, having run deficits for 15 years, would simply keep issuing bonds, increasing the supply and forcing down the price, reported The New York Times. There was no point in speculating on the bond. The nuclear-power disaster at Fukushima this year has revived this economic problem.
The “in” crowd
Fortunately, the government can “crowd in” investment by paying off its debt. This enables savers to put their money instead into private investment. When the United States government paid off the Civil War debt, interest rates dropped, encouraging private investment and industrialization, concluded Atack and Passell.
The deficit might actually mean something if we could express the net cost of government to you over your lifetime. That’s the idea behind generational accounting. Due partly to the growing burdens of Medicare and Social Security, a 25-year-old male American could expect to pay nearly $200,000 more to government than he would receive in benefits, reported economists Roy Ruffin and Paul Gregory at the turn of the 21st century. On the other hand, the grandparents made out like bandits. Seventy-year-olds received over $50,000 more than they paid in taxes. And Uncle Sam was kinder to the 25-year-old female than to her male Significant Other; she could expect to pay only $90,000 more than she would receive. Women live longer than men, so they can expect to receive benefits for longer. They may also receive benefits as survivors of their husbands.
Kazakhstan is on a similar trajectory. For nearly 30 more years, the pension program will continue its transition from a pay-as-you-go system, in which current workers finance payments to current retirees, to fully-funded liabilities, in which each worker provides for her own eventual retirement. Future generations of workers will have to shift for themselves, unlike workers of 15 years ago.
Sustaining the unsustainable
If we can shift the burden of taxes to future generations, then we may spend too much today. That may help explain why the young bear a larger net burden than the old. It remains to be seen whether the young will pass on their spending to their progeny, too.
If the young perceive that they must pay higher taxes, then they may invest less in education and training, since they would take home a smaller share of the paycheck. The lack of education would strip our economy of growth. And that’s not the end of the story. Higher taxes might also discourage skilled immigrants from moving to the United States; and they might dissuade foreign investors from staking their wealth here, speculated The Financial Times.
Because the government must pay interest on the debt, we can expect it to grow at the rate of interest, unless we run up a surplus that diminishes it. The government cannot run deficits forever if the interest rate exceeds the rate of economic growth. Eventually, we would have to devote the entire economy to paying the interest. Even before interest payments overwhelm, foreigners may refuse to lend us money, for fear that we won’t pay it back. Adjusting for inflation, the annual interest rate at which the National Bank of Kazakhstan lends money, a benchmark for the economy, is roughly zero -- well below the national rate of economic growth, 7% or 8%. The government’s securities amount to 1.8 trillion tenge, according to the National Bank of Kazakhstan. Is cheap money addictive? – Leon Taylor, tayloralmaty@gmail.com
Good reading
Jeremy Atack and Peter Passell. A new economic view of American history. New York: W.W. Norton. Second edition. 1994.
Marco A. Espinosa-Vega. How powerful is monetary policy in the long run? Economic Review. Third quarter 1998.
Milton Friedman. The role of monetary policy. American Economic Review. March 1968. Pages 1-17.
Jagadeesh Gokhale. Tomorrow’s generation will foot the bill. The Financial Times. February 13, 2004. Page 13.
David Leonhardt. That big fat budget deficit. Yawn. The New York Times. February 8, 2004.
Ramon Moreno. Learning from Argentina’s crisis. Economic Letter. October 18, 2002.
Roy J. Ruffin and Paul R. Gregory. Principles of macroeconomics. Seventh edition. Addison-Wesley. 2000.
Michael R. Sesit. The hazard of currency reserves. The Wall Street Journal. February 11, 2004. Page C4.
Mark M. Spiegel. Argentina’s currency crisis: Lessons for Asia. Economic Letter. August 23, 2002.
Todd Zaun. After 100 years, Japanese will go abroad to sell bonds. The New York Times. January 15, 2005. Page B3.
References
World Bank. World Development Indicators. Online at http://data.worldbank.org/indicator
Central Asia is relying increasingly on presidents and legislators, not on the central banks, to guide the economy. In 2009, the governments of Kazakhstan and Kyrgyzstan stimulated their languishing economies by spending more than they collected in taxes. The resulting deficits amounted to 2% of the size of the economy (gross domestic product) in Kazakhstan and 1.4% in Kyrgyzstan, according to the World Bank. (Data were not available for Tajikistan, Turkmenistan and Uzbekistan.) Is this trend healthy?
Keynesians may sympathize. As an antidote to recession, they tend to favor fiscal policy to monetary. Tax cuts and government spending may create jobs when the economy is operating below capacity. On the other hand, printing money might not work. When people are scared, they might simply hide the new money rather than spend it. That other tool of monetary policy -– the interest rate -– might also fail. In principle, lower interest rates enable firms to borrow more money in order to expand. But in a depression, the interest rate is already low; the central bank can't push it much lower. If it is zero, then banks will see no point in loaning out more money, even if the central bank does provide it for a song. Welcome to the liquidity trap.
Even in normal times, firms don't pay much attention to the interest rate when contemplating their investment projects, according to Keynesians. True, they would profit by giving the green light to a project with a rate of return exceeding the interest rate. But firms don't always know what rate of return to expect. Executives base their investment decisions partly on "animal spirits" -- on their gut sense of where the economy is headed. They might pay high interest rates if they think that the economy is headed for a boom. And they might pass up a chance to build a factory at bargain-basement interest rates if they think that the economy is headed for a fall.
Even Keynesians would concede that monetary policy is not always impotent. Printing money doesn't always revive the economy, but destroying money seems a sure-fire way to cool it off for a while. We can't be sure that increasing the money supply will encourage investment, since the central bank can't force firms to borrow money. But reducing the money supply will discourage investment. Firms can't build factories if they can't borrow money to pay the builders. Loans are especially important to firms in Central Asia, which have not been operating long enough to build up war chests of cash (“retained earnings”). In the West, the Federal Reserve and the European Central Bank must worry that their attempts to ward off inflation may succeed all too well.
To Keynesians, government spending in a recession will raise output, not prices, because firms will not mark up their prices when demand is anemic. In the United States, prices were indeed stable during the 1950s -– but not in the 1960s. Economists then took more interest in inflation, noted a macroeconomist at the U.S. central bank, Marco Espinosa-Vega. Nobel laureate Milton Friedman argued that a temporary increase in the money supply can affect output in only the short run, by tricking workers into producing more; eventually, they will realize what has happened and will act accordingly. By spending more, the government just confiscates more of the economic pie for itself.
Economists worry when the government borrows in order to spend. The competition with firms for loans forces up the interest rate, crowding out private investment. For example, the U.S. government mainly paid for the Civil War by borrowing money. The new federal debt claimed nearly one-sixth of the gross national product of the North –- large enough to crowd out all new investment during the war, wrote economic historians Jeremy Atack and Peter Passell.
Until recently, however, the bond markets didn’t worry about the deficit, perhaps because it does not claim as large a share of gross domestic product as it did in the Civil War -– or, for that matter, in the 1980s. You could argue that the U.S. deficit was not quite Brobdingnagian – not until recently, anyway.
But Americans really have foreign investors to thank, reported The New York Times. Asian central banks tried to weaken their currencies by selling them for dollars. (They want weaker currencies in order to boost exports.) To put their dollars to work, the central banks reinvested them in U.S. Treasury bonds, even when their rate of return was minuscule, according to The Wall Street Journal. (In May, net foreign assets for Kazakhstan were worth 10.7 trillion tenge, up by more than a third from the previous May, according to the National Bank of Kazakhstan.) Should the central banks stop buying dollars, the U. S. government would have trouble selling bonds. Bond prices would drop, and interest rates would rise. That would compound the difficulty of paying off Washington’s debt. And it would tend to raise interest rates paid by borrowers in Kazakhstan.
For an extreme example of what could happen in developing countries, let’s go to Argentina. A decade ago, the country’s mounting deficit convinced investors that they would never see their money again. They demanded higher interest rates before they would buy the country’s bonds. Over 2001, the interest rate on a 10-year bond rose by 20 percentage points to 35 percent, although the country had tried to reduce its deficit by raising income taxes, wrote Mark Spiegel. Argentina did not earn enough foreign currency from its exports to cover its interest payments, so the government eventually defaulted on its loans. Although Argentina became the second fastest-growing economy in the Western Hemisphere -– second only to oil-rich Venezuela –- it remained virtually the last place in the world in which investors would park their dollars, concluded a Federal Reserve economist, Ramon Moreno, in 2002.
The third-largest economy in the world, Japan’s, was in a similar predicament. Japan’s national debt amounts to 150 percent of its gross domestic product -– the highest ratio among leading industrial nations. In 2005, Moody’s ranked Japan’s bonds below those of Botswana. The fear was that Japan, having run deficits for 15 years, would simply keep issuing bonds, increasing the supply and forcing down the price, reported The New York Times. There was no point in speculating on the bond. The nuclear-power disaster at Fukushima this year has revived this economic problem.
The “in” crowd
Fortunately, the government can “crowd in” investment by paying off its debt. This enables savers to put their money instead into private investment. When the United States government paid off the Civil War debt, interest rates dropped, encouraging private investment and industrialization, concluded Atack and Passell.
The deficit might actually mean something if we could express the net cost of government to you over your lifetime. That’s the idea behind generational accounting. Due partly to the growing burdens of Medicare and Social Security, a 25-year-old male American could expect to pay nearly $200,000 more to government than he would receive in benefits, reported economists Roy Ruffin and Paul Gregory at the turn of the 21st century. On the other hand, the grandparents made out like bandits. Seventy-year-olds received over $50,000 more than they paid in taxes. And Uncle Sam was kinder to the 25-year-old female than to her male Significant Other; she could expect to pay only $90,000 more than she would receive. Women live longer than men, so they can expect to receive benefits for longer. They may also receive benefits as survivors of their husbands.
Kazakhstan is on a similar trajectory. For nearly 30 more years, the pension program will continue its transition from a pay-as-you-go system, in which current workers finance payments to current retirees, to fully-funded liabilities, in which each worker provides for her own eventual retirement. Future generations of workers will have to shift for themselves, unlike workers of 15 years ago.
Sustaining the unsustainable
If we can shift the burden of taxes to future generations, then we may spend too much today. That may help explain why the young bear a larger net burden than the old. It remains to be seen whether the young will pass on their spending to their progeny, too.
If the young perceive that they must pay higher taxes, then they may invest less in education and training, since they would take home a smaller share of the paycheck. The lack of education would strip our economy of growth. And that’s not the end of the story. Higher taxes might also discourage skilled immigrants from moving to the United States; and they might dissuade foreign investors from staking their wealth here, speculated The Financial Times.
Because the government must pay interest on the debt, we can expect it to grow at the rate of interest, unless we run up a surplus that diminishes it. The government cannot run deficits forever if the interest rate exceeds the rate of economic growth. Eventually, we would have to devote the entire economy to paying the interest. Even before interest payments overwhelm, foreigners may refuse to lend us money, for fear that we won’t pay it back. Adjusting for inflation, the annual interest rate at which the National Bank of Kazakhstan lends money, a benchmark for the economy, is roughly zero -- well below the national rate of economic growth, 7% or 8%. The government’s securities amount to 1.8 trillion tenge, according to the National Bank of Kazakhstan. Is cheap money addictive? – Leon Taylor, tayloralmaty@gmail.com
Good reading
Jeremy Atack and Peter Passell. A new economic view of American history. New York: W.W. Norton. Second edition. 1994.
Marco A. Espinosa-Vega. How powerful is monetary policy in the long run? Economic Review. Third quarter 1998.
Milton Friedman. The role of monetary policy. American Economic Review. March 1968. Pages 1-17.
Jagadeesh Gokhale. Tomorrow’s generation will foot the bill. The Financial Times. February 13, 2004. Page 13.
David Leonhardt. That big fat budget deficit. Yawn. The New York Times. February 8, 2004.
Ramon Moreno. Learning from Argentina’s crisis. Economic Letter. October 18, 2002.
Roy J. Ruffin and Paul R. Gregory. Principles of macroeconomics. Seventh edition. Addison-Wesley. 2000.
Michael R. Sesit. The hazard of currency reserves. The Wall Street Journal. February 11, 2004. Page C4.
Mark M. Spiegel. Argentina’s currency crisis: Lessons for Asia. Economic Letter. August 23, 2002.
Todd Zaun. After 100 years, Japanese will go abroad to sell bonds. The New York Times. January 15, 2005. Page B3.
References
World Bank. World Development Indicators. Online at http://data.worldbank.org/indicator
Friday, June 3, 2011
Don’t take the A train
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.
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, 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-Ã -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-Ã -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.
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