Wednesday, May 9, 2012

The Miracle of Growth

A common critique in Sweden is that the right-of-center government has cut welfare in order to reduce taxes for the affluent. Indeed taxes have been cut sharply. In 2006 when the current government took power taxes were on average 48.0% of GDP, while currently they are below 44.7% of GDP. This is twice the relative size of the total Bush tax cuts.


But this doesn’t mean we can assume spending is down. Because the economy has grown, spending per person is actually up, not down, even after adjusting for inflation.

Government spending in 2012 is projected to be 1788 billion kronor, up from 1500 billion kronor in 2006. After inflation and population growth this is still an increase in total welfare state spending since 2006. Welfare state spending in 2012 per person is 20% higher than it was 15 years ago in real terms. When the left talks about “cuts" they might mean “slower expansion than we prefer”.


A more difficult figure is output of the public sector, rather than spending (a measure of input). Perhaps government costs are going up faster than productivity, in which case more spending doesn’t translate into improved welfare. But then again government too probably has productive growth as a result of technological innovation, especially since half spending is just transfers and not effected by Baumol's cost Disease.

It is near impossible to determine if and to what extent the growth since 2006 was due to tax cuts. Even if it had nothing to do with tax rates, economic growth made it possible to cut Swedish taxes without cutting spending, a notion liberals often ridicule.

Saturday, May 5, 2012

Drill away the Trade Deficit

The debate about domestic drilling has focused on the effect on the price of oil. But even if American domestic energy production doesn’t reduce oil prices much, it will reduce net imports. Than at least the funds will not flow out of the country.


Following the crash, U.S manufacturing recovered some and the trade deficit declined, in part because the weak dollar made exports cheaper and in part due to a collapse in domestic demand. This reduced the massive U.S trade deficit. But the higher price of imported oil has eaten away some of these gains. Today, more than half the U.S trade deficit is due to net petroleum imports.

The trade deficit basically means each year Americans give away ownership of a piece of the U.S to foreign owners in order to finance more imports than foreigners bought stuff from you. At best those imports will be used for domestic investment (and even here the investment could have been financed by Americans), but mainly its used for consumption.

This is not a problem in the standard economic textbook model, just a source of mutual gain, so economists rarely discuss the trade deficit anymore. But in a more sophisticated framework financial market imperfections, government over-borrowing or a bubble in consumer spending may cause the country to under-save. In that case it may not be in the U.S best long run interest to have foreign rivals like China finance the spending binge with cheap capital, slowly taking control over much of the U.S economy.

The United States has massive amounts of gas and non-conventional oil, probably more than Saudi Arabia. Drilling is a straightforward, fool-proof way to reduce or even reverse the outward flow of capital.
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