In yesterday’s post, we examined the claim, made by Pope Benedict in Caritas in Veritate 25, that globalization has led countries to deregulate their labor markets, which in turn has led to cuts in social spending. It turned out that the Pope’s first claim (that globalization led to deregulation) was consistent with the data, whereas his second claim (deregulation led to cuts in social spending) was not. Countries with freer labor markets tend, on average, to devote a greater percentage of GDP to social spending than do countries where labor markets are highly regulated (and, since countries with freer labor markets tend to be richer as well, the increase is even larger in absolute terms).
In addition to speaking of labor market deregulation, Caritas in Veritate also makes reference to countries adopting “favorable fiscal regimes” as a part of global competition, and suggests that this also has led to a decline in social spending. Evaluating these claims is a bit more difficult than evaluating the Pope’s claims about labor markets, because it is not entirely clear what the Pope has in mind when he speaks of “favorable fiscal regimes.”
One possibility is that the Pope is thinking here primarily about taxes, and that adopting a “favorable fiscal regime” consists in lowering taxes, particularly taxes on business, in order to attract foreign investment.
The connection between taxes and spending is a lot more obvious than the connection between spending and labor market regulation, as government spending generally must be paid for by taxes. So almost by definition there is going to be a connection between the level of taxes in a country and the level of spending.
On the other hand, it turns out that countries with low taxes (represented by the Index of Economic Freedom’s Fiscal Freedom category) actually attract less foreign direct investment than do countries with higher taxes:
This might sound mysterious, but it’s really not. Richer countries tend to collect more in tax revenue than poor countries (both in absolute terms and as a percentage of GDP) because they can afford to do so. Taxes, then, turn out to be progressive not only within many countries (where individuals with higher incomes pay a higher tax rate) but also within countries as well. Thus, if one would like to see social spending in a country increased, one of the best things you can do would be to increase the wealth of the country.
It’s possible that when speaking of “favorable fiscal regimes,” the Pope had in mind not lower taxes, but a different kind of deregulation. Many countries, for example, place restrictions on foreign businesses doing business in their country. They may limit the ability of capital to move in and out of the country, or place special taxes on imports or exports, or otherwise regulate business in such a way that operating in the country becomes less desirable.
There are two categories in the Index of Economic Freedom that seem to capture this sort of idea. The first is Investment Freedom, e.g. the ability of foreign businesses to operate in a country without special penalties being attached to their doing so. The second is Trade Freedom, which measures the ability of foreigners to buy and sell with the inhabitants of a country without their products being subject to special taxation.
Both Investment Freedom and Trade Freedom are correlated with foreign direct investment, though the association is not huge:
In other words, countries that adopt freer trade and investment policies tend, on average, to spend more on social programs as a percentage of GDP than do countries that adopt protectionist policies. As with labor market deregulation, then, the claim that “favorable fiscal regimes” are responsible for cuts in social spending does not appear to fit the facts of the case.