The View From 1776

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Tom Emerson, a professor at Carnegie Mellon University, emailed to me an op-ed page article appearing in the August 2, 2005, edition of the Wall Street Journal.  Tom noted that the writer, Nobel-Prize-winning economist Edward C. Prescot, did his research work at Carnegie Mellon.

The full article is reproduced below.  Its thrust is that individuals respond to economic incentives, most effectively to lower tax rates and reduced regulatory restrictions that provide scope for entrepreneurship.  Using Spain as an example, Professor Prescott’s statistics clearly demonstrate the effectiveness of such economic incentives.  From this he draws hope that all of Europe will eventually make an economic comeback.

Professor Prescott’s expectations may be correct.  He is, however, overlooking the poisonous effect on the souls of a people infected with the disease of socialism.  Aristotle noted that slavery is not simply a legal status; it is a state of mind that makes a slave unfit to participate in the political process.

Socialism is a form of slavery, or more accurately, a sort of neo-feudalism in which the individual has no rights independent of the figurative “piece of ground” to which the political state has assigned him.

Hilaire Belloc anticipated this in his 1912 book, “The Servile State.” He noted that, while the just-beginning socialist state in Great Britain was doing nice things for workers, it was at the price of their liberty to decide whether to work, when to work, or where to work.  Recipients of unemployment benefits, for example, had to report to employment offices and take whatever jobs were offered to them, or face punishment. 

Belloc’s prescience was confirmed after World War II.  Sir William Beveridge, one of the British Labour Party authors of socialized medicine and other welfare-state services after World War II, stated the necessity quite forthrightly. 

“…the State,” he wrote, “ in this field [attempting to guarantee full employment] is not wholly master of events so long as it desires to preserve the freedom of individuals……the State cannot undertake the responsibility for full employment without full powers.”

In other words, central planning necessary for imposition of socialism can not become effective without subordinating the rights of individuals to the goals of the planners.  That is simply a degree of servility.

Once acculturated to this mentality, a society can not reverse field. It would be like expecting rotten fruit to become fresh and sweet again.  It would be like taking a zoo animal back to the wild.  Uniform experience is that zoo animals accustomed to being fed and protected within their own private territories (cages) become completely disoriented, sicken and die (if not eaten shortly by predators) out in the native habitat of their wild kind.

Look at the actual history of Europe after the French abomination infected it in 1789.  Some countries, West Germany immediately after World War II for example, briefly flirted with free-market capitalism, but quickly moved back into the comforting arms of Big Brother.  Just as did Orwell’s protagonist, they discover that they really love Big Brother.

Take Mr. Prescott’s example of Spain.  Before the death of Generalissimo Franco, around 1965 the economy began opening up and young entrepreneurs appeared on the scene.  After Franco’s death came the socialists, and the economy again became moribund.  After recent free-market vitality, what did the Spaniards do?  They elected a socialist government to re-narcotize them. 

The life-destroying addiction of socialism is very hard to shake once it has penetrated the soul.

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August 2, 2005
The Wall Street Journal 

COMMENTARY
 
  
Even Europeans Will Respond to Incentives
By EDWARD C. PRESCOTT
August 2, 2005; Page A10

Medical metaphors are often used to describe an economy. We commonly hear reports of “healthy” and “strong” economies, or “sickly” and “weak” ones. In the case of Europe, with its multi-symptomatic condition, we even hear of a particular economic illness—the European Disease. This disease is marked by high tax rates, inflexible labor markets, over-regulation and resurgent protectionism, among other maladies. Prognosis? Not so good, we are told.

However, I am optimistic about Europe. Why? To paraphrase Herbert Stein’s famous maxim: The current situation is unsustainable, and what is unsustainable must end. But what, exactly, is unsustainable, and why am I optimistic that Europe’s current problems will give way to a new era of growth?
* * *
Let me begin to answer that question by recollecting an event that I was privileged to attend recently in Madrid. The occasion was the awarding of the prestigious Juan Lladó Prize, sponsored by the Instituto de Empresa and the José Ortega y Gasset Foundation, given annually to work undertaken by Spanish entrepreneurs in the field of cultural patronage and research. It struck me during the course of the evening that the event—with its celebration of entrepreneurism and its recognition of a lifetime of benefits that just one successful entrepreneur could bestow on a society—was representative of what the future could hold for European countries.

The room was filled with entrepreneurs, both young and old, who were driven by ambition and persuaded by incentives to take the chances on which a vibrant economy is based. And it is more than passing coincidence that such an event would draw such a crowd in Madrid, because Spain’s economy is one of the shining stars of the European Community, and its example gives hope to those countries still struggling under the yoke of misguided policies.

Spain offers a good case for European optimism. Like many of its continental neighbors, Spain was afflicted with declining labor force participation through the mid-1990s. Let’s pause here to look at some facts. From 1993-96, the average hours worked (per working age person, per week) in Spain was 16.5. This compares with 17.5 hours in France and 19.3 in Germany. Clearly, Spain wasn’t working.

Then, in 1998, Spain flattened its tax rate in a manner similar to the U.S. tax reforms of 1986. Coupled with labor market reforms of the previous year, Spain’s labor force participation increased about 21% in the period 2000-2003, to 20 hours per week, exceeding that of Germany (18.3) and France (17.8). Correspondingly, this increase in labor participation led to increased tax revenues. (Incidentally, Spain, France and Germany all had slightly higher labor force participation rates than the U.S. in the early 1970s, when European tax rates were more in line with those in the U.S.)

I’ve made this point about tax rates before on these pages but it bears repeating because it reflects a fundamental economic insight that gets to the heart of policy making: People respond to incentives. You don’t make economic policy for nations, you make it for people. And it’s the responses of those people, when aggregated, that give us those data that we all love to analyze.

So, why did the European labor supply decrease by a third from the early 1970s to the mid-1990s? Because the marginal effective tax rate was increased to 60% from 40%. People chose to work less than before. Consequently, tax revenues fell. You can’t raise revenues by taxing people beyond their willingness to pay. And you can’t expect an economy to grow when people don’t have the incentive to work, or when entrepreneurs lack the incentive to take a chance.

European countries, in other words, were approaching a point of unsustainability. Spain had reached such a point, and even though there is still progress to be made, its subsequent policy correction has worked wonders. Of course, Spain is not alone in its transformation: Britain paved the way with its earlier reforms and has since reaped the rewards from gains in labor supply, the Netherlands has also instituted important labor market reforms that have paid dividends, and some Eastern European countries are benefiting from tax reforms. It’s time that the rest of Europe pay close attention to the examples of their perimeter neighbors.

Another reason for optimism is that Europe has already devised a solution to one of its thornier problems, namely, how to integrate its economies in a competitive manner that protects the property rights of other members within a country’s borders. The European Union has essentially solved this problem.

With the foundation provided by its economic union, and with the examples of its newly thriving members, the groundwork is essentially laid for an economic transformation of the whole continent, including France and Germany. I am especially hopeful about Germany because, frankly, it is in worse shape and it cannot continue under the current scenario for much longer. Germany will have to act, and I expect this transformation to occur within five to 10 years. There are indications that German political leaders are moving toward more flexible labor markets; tax reform will likely follow. A shift in policy by Europe’s largest economy—with its strong leadership role—will go a long way toward moving the whole EU toward an economic renewal.

Those European countries who are growing slower than they could or who are, indeed, losing ground, are reaching a breaking point. They cannot sustain their current path. They must, to return to our medical metaphor, take their medicine. For some, the remedy may not taste very good going down, but this short-run discomfort will quickly give way to the rejuvenated energy of its citizens and the long-run vigor of its economy. Europe has tried other prescriptions and those have failed; it’s time to cure the European Disease by reviving the health of its people.

Mr. Prescott, a winner of the 2004 Nobel Prize for Economics, is senior monetary adviser at the Federal Reserve Bank of Minneapolis and professor of economics at the W.P. Carey School of Business at Arizona State University.
 

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