Caritas in Veritate 25, By the Numbers II

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:

On the other hand, as with Labor Freedom, Investment Freedom and Trade Freedom are positively correlated with government social spending as a percentage of GDP:

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.

Advertisements

8 Responses to Caritas in Veritate 25, By the Numbers II

  1. Balthasar says:

    Well, the second claim (deregulation led to cuts in social spending) is certainly true in the case of the Republic of Ireland, where I live. Also in the UK now, after borrowing so much money over the last decade under the Labour Party in order to pump money into the economy just around the time of an approaching election and at the same time as continuing the deregulation begun under the Conservatives, they’re now having to dramatically cut social spending under the Con/Lib Government.

  2. Balthasar,

    So should one conclude from that that deregulation leads to cuts in social spending, or that overspending results in cuts in social spending?

    Blackadder,

    I’ve been enjoying these detailed posts of yours, which I think are a useful corrective to the approach to CST which considers it sufficient to cite a phrase from an encyclical to establish a factual trend in the real world.

  3. Balthasar says:

    Deregulation “eventually” leads to social spending cuts.

  4. Balthasar says:

    Let me put the point in a different way, deregulation absent human nature needn’t result in cuts in social spending; what the Pope is saying is that in the real world deregulation does one way or another lead to social spending cuts.

  5. Balthasar,

    I’m not sure how you could apply it as a general rule that “in the real world deregulation does one way or another lead to social spending cuts”. I know there are common examples in our country of how lack of regulation/oversight can lead to certain abuses, which in turn result in imbalences that result in some sort of “crash” — and it’s attractive at first glance to draw from this that lack of regulation will, given human nature, result in abuses that cause crashes, decrease tax funds, and thus result in less social services.

    However, the flip side has also been historically true in many cases in recent history. For instance, India and China have both significantly decreased their degree of regulation in the last two decades, resulting in a large amount of foreign investment and trade, which has in turn spurred the economy, increased government revenues, and resulted in a higher overall level of social spending (though still rather meagre by developed world standards.)

    Further, there are wide areas of “deregulation” which have been carried out in the US and Western Europe which have not resulted in market imbalances or collapses. We just don’t tend to talk about those very much, because things like state telecom monopolies are pretty generally not missed.

    What that would leave us with is “deregulation which causes problems causes problems”, but that’s something of a tautology.

  6. Tony says:

    What, precisely, is it about the “foreign” in foreign investment that makes it better than, say, internal investment? I mean, if in the last 20 years India and China have seen significant increases in foreign investment, leading to increases in wealth, then where are those investment bucks coming from? Can’t we just speak of attracting investment money generically? If investable money finds a better deal overseas, then it’s going to go overseas, but if it finds a better deal here, then investing here is going to have the same effect that the same number of foreign dollars invested here would have. (Except that local dollars invested mean that the profits paid off in dividends and realized appreciation are ALSO spent here.)

    Isn’t it self-evident that reduced regulation does not, inherently, cause reduced social spending? But the types of politicians who typically will see the benefits of upholding subsidiarity in regulating are also likely to see the benefits of upholding subsidiarity in social support structures? But this doesn’t automatically imply a reduced intention for upholding care for the poor.

  7. Blackadder says:

    Balthasar,

    The problem with looking only at what has happened in one or two countries is that it is easier to misidentify what has happened. So, per your example, Ireland had some deregulation, and a couple of decades later cut social spending. Does that mean that the deregulation led to the cuts in social spending? Well, Greece didn’t deregulate, and they are having to cut social spending just as much as Ireland. So perhaps not (my guess, btw, is that Ireland will still be spending more on social programs after the current cuts than it was before it adopted market reforms).

  8. Balthasar says:

    “Well, Greece didn’t deregulate”

    True, but then it’s very difficult to do so when the citizens of Greece have already deregulated the Government.

%d bloggers like this: