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Rampant corruption – not just the euro – has doomed Italy to stagnation

Rampant corruption – not just the euro – has doomed Italy to stagnation

So farewell then, Matteo Renzi! The resignation of the Italian Prime Minister after his heavy defeat in Sunday’s referendum on constitutional reform has created turmoil. Fears have been resurrected about the stability of the Italian banking system, and even the possibility of Italy leaving the euro has been raised.

But the problems of the Italian economy, along with the rest of the PIGS (Portugal, Greece and Spain), go much deeper. The long boom of the 1990s and 2000s in the Western economies ended in 2007. GDP began to fall in almost all Western economies during 2008. In the US, output is now some 10 per cent higher than it was at its previous peak in 2007. In the UK it is around 9 per cent up, and in Germany the increase is 8 per cent.

In Italy, GDP is still 8 per cent below its level of 2007. In Spain, the fall is 3 per cent, in Portugal 5 per cent, and the Greek economy is a staggering 26 per cent smaller than it was in 2007.

This is an exceptionally long period for output to remain below its previous peak level. By the early 1950s, for example, West Germany, which had been heavily bombed and overrun by foreign armies, had surpassed its previous peak level of output of the mid-1940s. So, too, had Japan, which had been attacked with nuclear weapons.

Why have the PIGS performed so spectacularly badly? A conventional reason, and one which has considerable force, is membership of the euro. The average growth rate since 2007 in the Eurozone member countries is negative: -1 per cent. In contrast, the average in Western economies which are not members of the Eurozone, such as Australia, the US and the UK, is a positive 10 per cent.

But there is an even more fundamental reason for the failure of the PIGS to recover, which goes to the heart of why Renzi wanted a radical reform of the constitution. Their societies are corrupt. The problems this creates can be plastered over in good times. But a major shock like the financial crisis opens the cracks.

Transparency International rates all countries on a scale of one to 10, with 10 being the most transparent and least corrupt. In 2007, most Western countries scored eight or more, the UK being 8.4. Spain was 6.7 and Portugal 6.5, which puts them at the level of Costa Rica. Italy registered 5.2 and Greece 4.6, down with the likes of Ghana.

Even after allowing for the effect of the euro, there is a strong negative correlation between the Transparency International scores of the Western economies and their GDP growth over the 2007-2016 period. Full technical details are in a paper I published in Economic Affairs in October. The more corrupt a society, the less able it has been to recover from the crisis.

The reforms proposed by Renzi were just the first step in what is needed to modernise the structure of Italy’s society and economy. Their failure means that Italy is doomed to stagnation.

Paul Ormerod 

As published in CITY AM on Wednesday 7th December 2016

Image: is licenced under CC BY 2.0

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Forget avoidance outrage: this is what we really think about tax

Forget avoidance outrage: this is what we really think about tax

Rather like a quantitative version of Hello! magazine, the Panama papers made headlines everywhere. Read all about the vast amount of money a particular celeb has got stashed away. Salivate, be titillated or be outraged, according to your fancy.

The story was covered heavily by the Guardian, the in-house newspaper of the metropolitan liberal elite. But the popular reaction was not quite what they were hoping for. Many people seem to regard the revelations contained in the Panama documents as just the way the ultra-rich and powerful are meant to behave. Rather like Conservative MPs and sex scandals, tax evasion and foreign dictators seem to go together quite naturally.

John McDonnell, the shadow chancellor, demanded an immediate and full public inquiry in the House of Commons. He could perhaps consult Yanis Varoufakis, one of his economic advisers, who of course was so successful in running the economy during his time as Greek finance minister.

Or the Left could more usefully ponder a fundamental principle in economic theory, the concept of so-called revealed preference. Economists attach relatively little value to surveys of opinion. This extends far beyond political opinion polls, though these serve to illustrate the point. In the 1980s, for example, survey after survey showed large majorities in favour of higher public spending financed by higher taxation. Yet the electorate consistently returned Margaret Thatcher to power when they had to make an actual decision.

Just because voters dislike tax avoidance by global companies and the super-rich, it does not mean that they themselves want to pay any more tax. We saw this in the general election last year, where there was a decisive swing away from Ed Miliband’s Labour to the tax-cutting Conservatives in the marginal constituencies of England and Wales.

Economists believe that it is only by their actions that people reveal what their preferences really are. Faced with a hypothetical question, their answers are unreliable, so we observe what they genuinely think by the decisions they make. The Journal of Economic Perspectives had a symposium on this question in one of its 2012 issues. The discussions are technical, but the top MIT econometrician Jerry Hausman summed it up neatly when he wrote: “what people say is different to what they do”.

The plain fact is that we have data going back over 50 years on the total amount of tax which governments are able to levy on the British people. Regardless of who has been in power, no government has been able to lift the percentage of national income which goes in tax above the 38 per cent mark. This includes all taxes: income, capital, corporation and the rest.

Politicians have to understand the wishes of the electorate if they themselves want to stay in power. Gordon Brown might have doubled the size of the tax manual when he was in power, but the tax take was if anything slightly low when he was booted out in 2010, at 34.9 per cent of GDP.

For all the fine sentiments expressed in surveys and the outrage over tax dodging, the revealed preference of the British electorate is to keep taxes low.

As published in CITY AM on Wednesday 20th April 

Image: Taxes by Got Credit is licensed under CC BY 2.0

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FIFA, corruption and economic growth

FIFA, corruption and economic growth

The FIFA arrests have dominated both front and sports pages. We must await the outcomes of the trials before pronouncing on individuals.  But amongst soccer fans, the organisation is a byword for sleaze and corruption. England spent £21 million on the campaign to secure the 2018 World Cup. The height of our attempts to influence the delegates seems to have been the offer of a free breakfast with Prince William in Zurich. Little wonder that we only obtained one vote in addition to our own.

Economics has a great deal to say about corruption. Does it, for example, tend to increase or reduce the level of GDP per head in a country? The answer might seem obvious, but economic theorists are nothing if not imaginative. For example, in almost a caricature of rational choice theory, it has been argued that allowing government employees to solicit bribes provides them with an incentive to work harder. To be fair, however, the overwhelming consensus is that corruption is bad for the economy.

A key figure in the debate is Paolo Mauro, for over 20 years a senior economist at the IMF, and now a fellow of the Petersen Institute in Washington DC. His 1995 article in the Quarterly Journal of Economics has become the classic empirical investigation of the impacts of both bureaucracy and corruption on growth. He constructed a detailed data base across 67 countries, summarised in a bureaucratic efficiency index. This combined data on red tape, the independence of the judiciary, and corruption.

Mauro divided his sample into six different groups, depending upon the level of his index. There is a very strong correlation between membership of these groups, and whether or not a country has actively supported Sepp Blatter in FIFA. The African countries, for example, are almost all in the bottom two groups in terms of efficiency, and the top two are made up of Western Europe, America, Canada, Singapore and Japan.

The negative impact of corruption on growth is strong. The results of Mauro’s sophisticated statistical analysis are not straightforward to present. But, as an example, if Nigeria could somehow move from the most corrupt of his six groups to the third most corrupt, its economic growth rate would improve by as much as 1 per cent a year. If the country had done this over the whole period of its independence from the 1960s, income per head would be 65 per cent higher than it is now.

The problem of course is that a culture of bribery and corruption is self-reinforcing. In a corrupt society, it is in the collective interest to move to a much lower level of corruption. But it is not really in any individual’s interest to try and do so. If you take bribes, you will lose them. And if you expose bribes you will be ostracised, maybe even killed. This clash between the collective and the individual interest means that markets cannot solve the problem. I rarely praise the bureaucrats of the OECD in Paris, but their anti-bribery campaigns deserve support.

As published in City AM on Wednesday 3rd June 2015

Image: soccer_ball_2019 by Paul Sleet under license CC BY 2.0

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