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[2118] Of less variance for democratic states versus autocracies

Just weeks ago, former Prime Minister Mahathir Mohamad contrasted the development of China and India. As reported, he praised the single-mindedness of the Chinese government in developing the country and ridiculed the Indian government for being far too democratic and not focusing enough on development. He went on to state that freedom hurts the economy.[1]

Art Harun, a columnist at The Malaysian Insider replied to this in his column[2] stating examples where democracies have been successful, contrary to the former Prime Minister’s assertion.[3] Zaidel Baharuddin, yet another The Malaysian Insider columnist jumped into the debate at his blog by defending the former Prime Minister, stating that “starving hard working farmers in India who has to fight drought and fertilizer prices don’t give a damn about freedom of speech or expression.”[4] Art Harun took the chance to reply to the point and various other comments too diverse to cite here[5] by arguing that economic prosperity does not have to be mutually exclusive with respect to freedom as well as adding that they are other factors that need to be considered in the determination of economic development, like leadership.[6]

Indeed but all those discussions are gradually veering off course from the point the former Prime Minister made, about how democracies perform poorly against less democratic states in terms of economic development.

This point is not necessarily true. If one wants to make that point, one cannot choose two data points and make a conclusion out of it. That is the logical fallacy of hasty generalization. A better way is to take all of democracies and all of authoritarian states and compare them.

There are prominent studies on this. One important study states that while the existence of democracy or dictatorship does not affect the mean growth rate of economic development, it does affect its variance. That means there are less consistency in economic growth under authoritarian regime compared to democracies. Adam Przeworski wrote an important paper on the issue:

Political regimes have no impact on the growth of total income when countries are observed across the entire spectrum of conditions. Contrary to widespread concerns, democracies do not reduce the rate of investment even in poor countries. It appears that when countries are poor there is little governments can do, so that it makes little difference for economic growth whether rulers are elected or hold power by force. In wealthier countries, patterns of growth are no longer the same. Dictatorships rely on the growth of labor force and on keeping wages low, while democracies pay higher wages, use labor more effectively, and benefit more from technical progress. But while growth under wealthier dictatorships is more labor-extensive and labor-exploitative than under wealthier democracies, so that functional distributions of income are different, the average rates of growth of total income are about the same.

Thus, we did not find a shred of evidence that democracy need be sacrificed on the altar of development. The few countries that developed spectacularly during the past fifty years were as likely to achieve this feat under democracy as under dictatorship. On the average, total incomes grew at almost identical rates under the two regimes. Moreover, per capita incomes grow faster in democracies. The reason is that democracies have lower rates of population growth. In spite of rapid diffusion of medical advances, death rates remain somewhat higher under dictatorship and life expectancies are much shorter. Population grows faster under dictatorships because they have higher birth rates, and the difference in birth rates is due to higher fertility, not to age structures of the population. [Democracy and Economic Development. Adam Przeworski. New York University. Retrieved on November 30 2009]

Almeida and Ferreira in 2002 probably made a more direct case:

Less-democratic countries do seem to have variable growth rates and policies than more democratic ones. This corroborates the conjecture of Sah (1991). Possible explanatoins for this fact can be found in Rodrik (1999a) and in Sah and Stiglitz (1991).

The evidence presented in this paper strongly supports Sah’s conjecture. The empirical results are unaffected by many robustness and specification checks. The results are not sensitive to specific time periods, to different democracy indicies, to different econometric procedures, or to model specification. The results hold even after controlling for many plausible determinants of growth rates and democracy indicies, including the usual variables from the empirical growth literature, time dummies and country-fixed effects, GDP, natural resource dependence, and OECD membership.

The greater stability of growth rates and policy measures among democratic countries adds to the existing list of desirable features of democracies, such as the positive correlations between democracy and per capita GDP levels, between democracy and primary schooling (Barro, 1999) and between wages and democracy indices (Rodrik, 1999b). Our evidence also corroborates the common view that some autocratic countries have had the most impressive growth experiences. However, since the worst experiences are also associated with autocratic countries, in an ex-ante sense, autocracy is no prescription for growth. [Democracy and the variability of economic performance. Heictor Almeida. Daniel Ferreira. Economics and Politics. Volume 14. November 2002]

Of note is the relationship between wages and democracy indices as reported by Rodrik. People in the Najib administration may well take that into account.

Anyway, at the Library of Economic and Liberty, economist Byran Caplan, who introduces Almeida and Ferreira, reproduces the following diagram to drive the point home:[7]

Some right reserved.

Autocracies are represented on the left side and democracies on the right side. Note the variances and the means.

Bottom line is, there is more risk to having an authoritarian regime than a democratic one, in terms of economic development. If one wants to be more certain about achieving success, democracy is one of the ingredients one must consider.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — Dr Mahathir singled out India as an Asian country that “made the mistake of being too democratic” and compared it unfavourably with China’s authoritarian regime.

“India, of course, will grow, but more slowly than China. It has the numbers but is not making use of them well.”

He expanded on the theme at a press conference later, saying that people “don’t understand the limits of democracy”.

“Democracy can be a hindrance to progress because you spend so much time politicking that you don’t have time to develop your country.

“In China, there’s not much politics. So, they can spend more time developing their country.

“In a democracy, everybody has a voice, everybody has a vote. But, in Malaysia, they sell their votes, which is not good at all.” [Dr M: A lot to learn from China. New Straits Times. November 17 2009]

[2] —[Enemies of the State. Art Harun. The Malaysian Insider. November 19 2009]

[3] — Yes. According to DrM, the Westerners are wrong for making democracy and freedom the cornerstone of progress. The British are so free they go on strike every other day. Well, who sent people to the moon in 1969? Which part of the world had an industrial revolution? Why have Russia, East Germany, Romania et al embraced democracy and freedom? From whom did we buy our Scorpene? Why Glasnost and Perestroika? So the people know the limits of freedom and how to behave themselves properly and in accordance with the Government’s code of behavioural acceptance?

And finally, according to Dr M, apart from China, Japan, South Korea and Taiwan will lead the Asian charge.

Which made me thinking, were Japan, South Korea and Taiwan governed by a benevolent absolutist government? Do the people in these countries know the limits of democracy? If so, to what extent? And who impose and define these limits on them? [Enemies of the State. Art Harun. November 19 2009]

[4] — I’m pretty sure, those starving hard working farmers in India who has to fight drought and fertilizer prices don’t give a damn about freedom of speech or expression. It is those comfortably well paid lawyers with some extra time on their hands who are more concerned about these things and write about it.

Meaning, [b]efore you talk about democracy perhaps it is wise to first elevate the people’s (rakyat) quality of living, because like the maslow’s hierarchy of needs there are more important things to fulfill before they get to the self actualization level. [Sinatra_Z – An Answer. Zaidel Baharuddin. November 20 2009]

[5] — Ahiruddin Attan for instance compared the more democratic Malaysia, which is behind the economic development curve with the less democratic Singapore, which is ahead:

I don’t think the Malaysian Insider would publish such a piece. Good try, though, Z. I do agree with you (and Dr M). We don’t need to look so far, just across the Causeway. We are way more democratic than Singapore, and look at how many of us idolize the Republic for its progress and wealth. Given the choice, however, I’d stay put here, Z. [Art Harun vs The Lipas Man. Ahiruddin Attan. November 20 2009]

[6] — My question is, why can’t we have them all? Especially in a democracy, where we elect our so called leaders to look after our well being as members of a State?

I think in this day and age, it is downright insulting — and not to mention, pathetic — for any leader to say to the people that I will give you food on your table in abundance but you would have to shut up, toe the line and do as I say, all the time and under all circumstances.

For a leader to lay the blame on the people which he or she ruled — for not understanding the limits of democracy — as a reason for his or her failure to achieve development and progress does not speak much of his or her leadership.

A comparison was made with Singapore in one of the comments. It was pointed out Singapore did not have much of a democracy and they progress well. But that does not prove that Singapore progressed well because it was less democratic.

 

Hasn’t it occurred to any of us that Singapore progressed because of the mentality and work ethics of its leaders? [Freedom lifts us up to where we belong. Art Harun. The Malaysian Insider. November 24 2009]

[7] —[Democracy, Dictatorship, and the Variance of Growth. Byran Caplan. Library of Economics and Liberty. October 2 2009]

Categories
Economics

[2117] Of contrasting elementary consumer welfare effect of income tax and GST

Since the latest fad in Malaysia is the goods and services tax, I thought I should share my limited knowledge on the matter. I am not an tax expert but I know my microeconomics and welfare analysis sufficiently enough to have an informed opinion on the matter.

Those that have done basic microeconomics will appreciate the tools of preference curve and budget constraint. These two tools are easy to work with and are crucial in understanding the effect of income tax and GST on consumer welfare.

To make the contrast clear, we would have to make two assumptions in the spirit of comparative statics.

First, we would have to assume a situation where there is one tax and not the other. To have both at the same time and not mutually exclusive will necessarily make effort at observing the differences between the two harder than it should. Further, no other tax exists. In reality, of course, both could happen at the same time.

There is also the assumption that both taxes produce the same amount of revenue for the government. Again, in reality, that does not have to be. In fact, in reality, even if both types of tax theoretically produce the same amount of revenue for the tax man, issues like tax evasion are not accounted for. In this specific area, GST is better than income tax.

Before we begin, it is essential to note that any kind of taxation reduces welfare. But taxation exists for a variety of reasons that to go into it will necessarily veer off the topic we are interested in.

First off, the effect of income tax for consumer is reduced income. Say a consumer has a certain amount of income, a portion of it will be taxed. As a whole, the consumer could buy less quantity of an item — that is any item — the larger the tax size.

The effect of GST, which is a type of quantity tax (specifically, consumption tax but I prefer the term quantity tax because it is more general), is exactly the same as income tax if the GST is applied equally across all goods. By applied equally, I am referring to a situation where the opportunity cost of one item in terms of other items remain the same. An example involving a barter system is probably appropriate: y amount of butter could buy x amount of cheese, before and after tax. To put it in simpler terms but less precise, all items are taxed at the same rate.

The addendum is that the tax will only be paid if a purchase is made. The only way of not being taxed is by not spending. Whether that improves welfare depends on preference of consumer. If a consumer is really a large saver, he or she would probably be better off under GST than under income tax. However, for the majority of us, I would imagine not spending would make our welfare worse off.

If GST is not applied equally, it is possible for the consumer to be better off under GST scenario than under income tax scenario. Consumers could simply consume untaxed goods. With no income tax, quantity of untaxed goods consumers could purchase in terms of the taxed goods would likely increase. The consumers however would really have to love the untaxed goods for that to happen. If — still under unequal GST scenario — consumers prefer the taxed goods to untaxed goods, then consumers will be worse off under GST than under income tax. In microeconomics jargon, these refer to corner solutions.

Typical analysis offers this result however: income tax grants higher welfare to consumer compared to GST, in a situation when GST is applied unequally across goods. Reason is that income tax does not affect opportunity of goods purchased. Unequal GST does and that may force the consumer to move away from his or her optimum consumption under taxed scenario.

Categories
Economics

[2111] Of no robot, just manual labor

Sitting outside of a library trying to finish up my sandwich under a bright sunny sky, I smirked.

Two reasons.

One — less important than number two and not quite the reason why I am posting this up — is an action that reminds me of fiscal stimulus mentality.

At the university, which is a public school, a small army of workers was redoing the pavement. Before the work began, I could find nothing wrong with it. It was built quite well and pleasing to the eyes too. Yet, there went the works. Although I can never be certain if that effort was funded by Australian stimulus money without further information, I am inclined to believe it was related.

And now, the new pavement awaits me, which splendidly looks and functions exactly that it was before.

It has to be related with stimulus program. It simply has to be. Nonsensical project, public works, the recipe of stimulus project is all there.

Of more interesting is that no robot was involved in the process of redoing the pavement. You might think that I am joking but I assure you that I am only half joking. No robot. No fancy machine. Just plain manual laborers working under the sun.

Where am I getting at?

If you have been visiting this blog for a very long time, you will notice that I am particularly peeved with some groups of Malaysians who rile up against the country’s so-called addiction to cheap labor. They blame general low wages in Malaysia is caused by the availability of cheap labor from abroad. Furthermore, due to availability of cheap labor, companies in the countries continue to not move up the value chain or not employ better technology. If only there is no cheap labor, Malaysia would be supremely technologically advanced and Malaysians would be better paid, or so they argue.

Well, here in Australia, one of countries with the highest GDP per capita in the world, no robot still. Just manual labor.

I could imagine those anti-cheap labor people saying “construction is but one industry and there are other industries that will employ better technology if only the cost of labor is greater than the cost of capital.”

Maybe, but I smirked still. And I am smirking now too.

Categories
Economics

[2110] Of flawed institutions may be holding Malaysia back

Growth of six per cent of gross domestic product  per capita per year for the next eleven years. That, according to the Prime Minister, is the rate of growth that Malaysia requires in order for the country to achieve the much coveted developed status. There is no doubt economic growth is very much needed. Whether that rate is achievable is dependent on a number of factors and of them involves public institutions.[Erratum]

In the realm of growth, mainstream economic theory suggests that poorer countries can be expected to grow faster than richer countries and at some point, join the club of the rich. This phenomenon is called convergence and this is achieved through, largely technological progress and capital accumulation.

This theory has its shares of successes and failures. Japan, South Korean, Taiwan, Hong Kong and Singapore are proofs of the validity of this theory. To some extent, Malaysia and other so-called tiger economies that grew at magnificent rate in the 1980s and 1990s are proofs of how this growth theory may be true. Growth of China and India further lends credence to the theory.

Failure of this model comes in its incapability to explain why a majority of African countries and some others have yet to grow as fast as predicted by the model.

A number of explanations on why the theory fails to describe lack of further convergence and in fact, divergence among countries, have been put forth to supplement it. The one that I think is relevant for Malaysia at the moment is the stress on public institutions as one of the factors of growth.

When looking at countries that are failing to converge with richer countries, one of the noticeable factors is the lack of trustworthy institutions in these poor countries. The judiciary suffers from manipulation and is powerless to ensure application of rule of laws with equal weight to all of its citizens. With powerless judiciary and even meaningless enforcement system, abuse of power runs rampart. Individual rights, including rights to private property, meanwhile are frequently violated. A system that ensures smooth and peaceful transition of political power — which typically means free and fair elections — is largely absent.

Without trustworthy institutions, technological progress and capital accumulation are likely not to happen. Furthermore, the only likely source of economic growth — on aggregate and not in terms of per capita of course — is population growth.

None of such woefully inadequate institutions describes Malaysia thankfully. This Southeast Asian country certainly has much better institutions than countries that are still battling mass famine, witnessing extreme poverty and experiencing very unstable political environment that includes gunfights. Yet, it is not hard to hypothesize how the imperfection that scars public institutions in Malaysia is relevant in discussions involving economic growth.

While perhaps things have gotten slightly better, the general feeling in the past few years is that public institutions in Malaysia, be it the police, the courts or the civil service, do not command the confidence of many people. The separation of powers between the executive and the legislative arms of government, as seen in Perak for instance, is really non-existence. The V.K. Lingam case suggests that the separation between the executive and the judiciary is blurry. Even if that case is considered as a case of a lawyer that sounded like somebody, looked like somebody but it is not that somebody boasting and speaking only to himself and thus, of no consequence, the issues relating to the 1988 constitutional crisis still haunt Malaysia.

The flaws in Malaysian institutions put a natural limit in how much economic growth is possible. It would take more and more effort to maintain a certain rate of GDP per capita growth the higher the level of development of the country, given the level of institutional capacity of Malaysia. At some point, it becomes really expensive and hard to maintain that rate regardless how forceful the free market or the state runs the economic engine of growth, if the country’s institutions remain at a level not befitting of a developed country.

I suspect that this is the main reason why Malaysia is stuck in the so-called middle-income trap. Institutions matter. It may be imperfect institutions that prevent Malaysia from converging with richer countries like Singapore and South Korea or even western European countries, just as how really bad institutions prevent poor countries from moving forward at all.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

A version of this article was first published in The Malaysian Insider on November 10 2009

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

Erratum — I made a mistake by stating the Prime Minister said six per cent growth of GDP, instead of six per cent growth GDP per capita in the original article. I should not have relied on Bernama, which was sloppy in its reporting. It used growth of GDP and growth of GDP per capita as if the two concepts are synonymous and I simply relied on Bernama without corroborating it with the primary source, or by diversifying my sources:

PUTRAJAYA, Nov 9 (Bernama) — The government needs to redouble its efforts, identify new growth areas and ensure the nation maintains a six per cent annual Gross Domestic Product (GDP) growth from now to 2020 in order to achieve a developed status in 11 years, Datuk Seri Najib Tun Razak said here Monday. [Najib: Six Pct Annual GDP Growth Needed To Achieve Developed Nation Status. Bernama. November 9 2009]

Yet another article by Bernama

PUTRAJAYA: The government must redouble its efforts, identify new growth areas and ensure the nation maintains 6% annual GDP growth from now to 2020 in order to achieve a developed status in 11 years, said Datuk Seri Najib Razak.

The Prime Minister said on Monday, Nov 9 that measures to redouble the government’s efforts and identify new growth areas would be spelled out in the new economic model, expected to be launched by end of the year.

“The new economic model would provide a clear guideline on what needs to be done and obviously information, communications and TECHNOLOGY [] [ICT] would play a greater role in this,” he said after chairing the 21st Multimedia Super Corridor (MSC) Malaysia Implementation Council Meeting. This was the first meeting to be chaired by Najib after becoming the prime minister. [Najib: GDP must grow 6% yearly to be developed nation in 2020. Bernama via The Edge. November 9 2009]

My apologies.

Nevertheless, the idea on institutions is still valid. Hence, the removal of the following paragraphs. They were originally placed between the first and the second paragraph of the corrected version:

Yet, as a measurement of success, growth of six per cent of GDP per year and the application of industrial policy to achieve that in many ways are unsatisfying.

First off, the proper metric should be growth of GDP per capita. Malaysians who care for their own welfare should be more interested in improving their average standard of living rather than seeing the economy simply growing on aggregate. While it is true that having a large economy on aggregate makes a country more influential in terms of international diplomacy even when the wide population themselves in generally is poor — observe China and India — GDP growth alone is not particularly meaningful in measuring average well-being of individual Malaysians. To make concrete out of words, consider the following simple example: growth rate of GDP on aggregate could grow at a rate lower than population growth rate to make change of rate of GDP per capita negative; in even simpler terms, the economy could grow on aggregate but each person on average could be worse-off.

If aggregate GDP growth rate is the measure of success, and if I were the Prime Minister, my industrial policy would include encouraging Malaysians to multiply like rabbits by any means necessary and adopt a very, very liberal immigration policy, one which would solve the problem illegal immigrants that the Rudd government in Australia faces. Never mind the Malthusian scenario that may come, this policy would hit six percent growth of aggregate GDP sooner rather than later and then boldly go where no man has gone.

But I am no prime minister and I am not that crazy. I do not accept the aggregate GDP growth rate as a good metric. On top of that, I am a libertarian: I do not like industrial policy because it calls upon central planning policy that essentially runs on the assumption that government knows best.

Notwithstanding criticism leveled at the concept of GDP itself…

Categories
Economics

[2107] Of if you want your bonus, you should lose your job first

CUEPACS, labor union for civil servants in Malaysia, given current environment of large fiscal deficit and economic uncertainty, has the audacity to demand for bonus.[1] The demand is not met, as evident by absence of such bonus in the proposed federal government budget tabled nearly two weeks ago. Today, the Prime Minister rightly admonished — admonished awfully understates the situation since the PM said demand is “morally wrong” — the union in the process.[2]

As a taxpayer staring at the possibility of higher tax in the future, that demand clearly is impossible to meet. The large fiscal deficit due to combination of structural and cyclical factors must be tackled and at the moment, I would probably be grudgingly willing to suffer increased taxes if government spending sees reduction at the same. I however would like to see those who fail to pay their taxes be brought to book first before having to suffer from a tax hike, although that is a different issue that I will not delve farther here.

Returning to my point, granting such bonus will only increase the likelihood of tax increase without a reduction of government size, which is already bloated.

You know what?

If they really want their bonus, I can be amenable to that but only on one condition: a lot of civil servants need to lose their job. This means badly performing civil servants have to go through the door. I will not mind having high quality and productive civil servants, which definitely will mean smaller workforce, being paid good bonus.

The union is a vote bank. That is probably why it has the audacity to do this. In this case, its audacity comes at the expense of taxpayers. That is intolerable.

Money does not grow on tree, mate.

Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved Mohd Hafiz Noor Shams. Some rights reserved

[1] — KUALA LUMPUR: Cuepacs wants the Government to pay the 1.2 million civil servants a two-month bonus this year.

It hopes the Government will include the bonus in Budget 2010 plus a similar incentive for 400,000 pensioners, said the umbrella body’s president Omar Osman. [Cuepacs seeks bonus of two months for govt staff. The Star. October 18 2009]

[2] — KUALA LUMPUR, Nov 4 — It is morally wrong to ask for bonuses while the country is still struggling to sail out of the economic downturn and people in the private sector are being retrenched, Prime Minister Datuk Seri Najib Razak said today.

”It’s morally wrong to ask for bonus when the economy has not recovered. I keep telling Cuepacs (president Omar Osman) that it cannot be just like a trade union, shout for bonus every time (there is budget) because you want to (remain) popular among your members,” he said. [Najib slams Cuepacs as ”˜immoral’ to demand bonus. Bernama. October 18 2009]