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Sakmongkol ak 47

Sunday, 7 December 2008

Tax Cutting and Deficit Financing our way to economic growth

apologies for the longish title.

When Lee Kuan Yew( LKY) is confronted with theory which did not work in practice, he chose the latter. LKY said- practice decided for him, in the implementation of policies. It was not the theory of capitalism, nor Milton Friedman that decided his policies. If there’s a golden thread in LKY’s approach, it is his constant striving to seek results, not in proving a theory right.

The other world leader that eschews theory and prefer practice was Deng Hsiao Peng. He is famous for the words- don’t care whether the cat is white or black, as long as it catches mice.

I know many writers have written on the blog saying, now is the age of Keynesianism. Alternatively its like saying, I told you, monetarism was wrong. We wouldn’t want to go into debates about the underlying rate of this and that. Or in the short run, the full effects of monetarism can only been known in the long run. Well, in the long run, we are all dead.

When we ask the government to spend, it does not matter whether to call that approach Keynesian approach. As long as it can get the economy going on. It does not mean that if the Keynesian approach doest work, we abandon it and adopt another. It is more important to constantly seek results.

Suppose we spend like mad, still the economy does not improve. That is perhaps due more to structural impediments. Labour and their skills don’t match. That’s structural unemployment. De Minimis has written an excellent introductory piece on that. Because of structural impediments, despite spending on them, labour productivity is not there. Our economy will still have much underutilized capacity as we have now, and are likely to have more in 2009 and 2010 . We will likely have over 8 percent of our workforce unemployed, 13 percent underemployed, millions of houses empty, factories idle, and office space unused). Government spending will bear fruits if the absorption capacity is there . whether government spending increases and enhances skills which make people have better income to apply .

Nor are supply-siders wrong in calling for say, income-tax cuts rather than government spending, claiming that people with more money in their pockets will get the economy moving again more readily than can government. It depends where the money is released is applied to.

Whether Keynes is irrelevant now or whether supply side economics is voodoo economics, the debates on them are better suited in the various economic journals. For me, which one works on the economy?

If we study the economic growth of certain countries in the world, we will observe some interesting points. When the U.S. emerged from World War II, it had the largest and best-functioning economy in the world. The other industrialized nations lay destroyed, and had to start rebuilding from scratch. Although the U.S. has remained the most prosperous nation in the world ever since, these other nations have been growing faster than the U.S. And they have been doing so with far higher tax rates! This would suggest that economic growth and tax cuts may not be related greatly as we would kike it to be.


Tax collections (percent GDP, 1991)

Country % GDP

Sweden                                53.2%
Denmark                               48.3
Norway                                  47.1
Netherlands                          47.0
Germany                               39.2
Finland                                  37.7
Canada                                 37.3
Japan                                    30.9
United States                29.8
The countries with higher taxes were growing faster than the US. 
Individual worker productivity, comparison of other nations to U.S. 
(U.S. = 100 percent)
Percent of U.S. individual worker productivity (U.S. = 100%) 
Country                                 1950s  1960s  1970s  1980s  1990
United States                      100%   100    100    100    100
Canada                                 77.1   80.1   84.2   92.8   95.5
Italy                                        30.8   43.9   66.4   80.9   85.5
France                                  36.8   46.0   61.7   80.1   85.3
Germany                               32.4   49.1   61.8   77.4   81.1
United Kingdom                   53.9   54.3   58.0   65.9   71.9
Japan                                    15.2   23.2   45.7   62.6   70.7

Holding worker productivity in the USA constant, from the above, we can see that labour productivity in countries with higher taxes than America has grown faster than in the US.

What all this shows is that growth is not absolutely correlated with tax cuts , and both liberals and conservatives have problems in trying to make a case. Far more serious factors affect growth, although, in truth, economists do know exactly what they are. Nobel laureate Robert Lucas, one of the world's most famous conservative economists, has spent over a decade looking for the secret to economic growth, and has not found it. Nobel-bound Paul Krugman, one of the world's most famous liberal economists, admits that the mystery of growth is "deep and poorly understood."

So what do we do? We spend to raise the aggregate demand yes. But we need to spend money more wisely. More on ways to enhance workers skills and raise productivity.


mekyam 7 December 2008 at 11:22  

tok sak,

a thought-provoking piece.

it goes hand in hand with de minimis latest on "Full employment and structural unemployment" [at for those interested.

walla,  7 December 2008 at 13:39  

The Nordic countries can afford higher tax regimes because their total factor productivities have been leveraged by technologies, particularly IT. They can therefore maintain their competitiveness at a higher level (see readings 2 & 1) which supports a higher standard of living and that itself is maintained for their location in an intra-open continental market where quality demand is a constant.

In our case, we have all along been pitching on oil, commodities and brown goods manufacturing, with little to show in services value-add to command higher per capita earnings that will make higher tax payments easier to bear.

And while we have started with programs to raise our human capital, they have been more about basic training modules rather than ramp-up to meistership capabilities to which one can graft precision technologies.

A factor we have which is perhaps richer than others is social capital but that hasn't been tapped properly.

So i would say our situation is (a) we are late in trying to raise productivity from better human capital development, (b) developing manpower skills take years, (c) we don't have an abiding culture of developing the right trainers and infusing a culture of maintaining global standards, (d) we remain tied to basic materials and manufacturing, (e) we haven't developed blue ocean skills and approaches, and (f) we are still hung up about intra-socioeconomic malaise while the abiding solution that seems to repeat its calling on us every year is to grow the market and make our industries more investible.

Because these are long-term structural disconnects while the problems facing us from the crisis are requiring short-term next-month preparations, it may be good to think about reducing the income tax pressures not just on individuals but also for companies, in such big ways that the reduction will create some spending sentiment parallel to the reduction in bank interest rates.

When we look at our income demographics, you have poor and middling incomes in the rural places, and middle-class to crash-proof segment in the urban places. While the former may not benefit so much from tax reduction, the latter will and it is important they do because (i) the middle-class in particular are not doing as comfortable as their equivalent in the Nordic countries, adjusted for costs of living, (ii) many are living on credit, (iii) too many would have used an unhealthy part of their life savings, (iv) there's still a lot of price stickiness in things they need to live in the cities to say inflation is being contained well, and (v)if they keep quiet, business and investment decisions made in the cities will not be positive in the next year to two, in which case a lot of industries will be affected which in turn will exacerbate the structural unemployment situation which itself will be compounded by our workers repatriated back from overseas. The rural folks may be insulated for a while but soon enough much of even what they produce will not be able to find export markets in which case their incomes will come down, so that will also increase the pressure on the city folks who will need to send money home that they will soon not be having.

Reduction in tax will of course reduce the govt's development funds but what has the govt been using such funds for in past crises? Building infrastructure and schools are the main things. When even present facilities are going to underutilized, how will building more help increase productivity? The projects may help a bit in the rural areas but the bigger problems will be the urban poor and marginalized who have committed to mortgages and so on. Because city economies are more integrated, the downturn will hit them first and hardest and it will spread more widely in the cities. By token of reverse logic, paying less tax should enable each family to better keep their heads above water, even if lifestyles and spending patterns will have to change, depending on how tax reduction will be viewed by the wholesalers, brokers and retailers as opportunities to increase prices again. Whether that will be better contained will depend on people like Shahrir who need to come up with more novel and striking ways to prevent things like hoarding.

Any solution on productivity will take time to implement, even longer time to see results, but tax reduction, especially if you lop off ten percent or more, will certainly inject some much-needed confidence, and stave off the real effects of finding that recession has actually come in when everyone tries to deny it so.

As for postgrads working as cleaners, more may be expected to be doing so next year. We have seen this phenomenon before. They will be sharing the same working space with retirees who can't make ends meet with their pensions. There's no loss of honour from doing honest work. It is indeed a sign of the times that no one anywhere on this planet is exempt from harsh changes.

In other words, good times are paid by bad times. If we want to prove this wrong, we should have invested in the future by doing everything right from the very first day.

Late, but still has to be done.


de minimis 7 December 2008 at 17:27  


Another though-provoking piece. You are right to point out that the core priority is productivity.

Productivity is a value-laden expression, of course, because it is the measure of almost all that is important to the Malaysian economy. And, it starts with the quality of education and the responsiveness of available technical training (insufficient in Malaysia. Somehow overlooked in recent decades).

As for tax reduction, Scandinavian countries have, indeed, shown that high tax regimes can coincide with high productivity and innovation. But, as brother walla has stated, the Scandinavians have approached the issue of productivity and innovation from a different direction from developing countries.

For one thing, the quality of their education and their exposure to innovation is far ahead. Another thing is their higher wages.

In Malaysia's case, higher taxes are not commensurate with better living standards and quality of education. Our wages are depressed and, probably suppressed (this is a classic chicken-and-egg argument because many keep taking the view that wages need to be kept low because our labour skills are low and education standards are low). Moreover, our government has been marketing Malaysia as a low-cost jurisdiction.

I must thank mekyam for honouring me with an acknowledgment. Thanks to sak, of course, for tipping his hat in my humble direction.

Hafiz Noor Shams 9 December 2008 at 23:16  

I think the article mixed up the effects of short term growth and long term growth.

Tax cut as well as deficit spending are not really solutions to long term growth. It does help in a small way and the effect could be seen if its effect is controlled.

Long term growth, like what Solow demonstrated, is always the "a" out of the y = aKL. That's technology measured in terms of productivity.

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