The Agenda

Garett Jones and Lane Kenworthy on Taxes, Scandinavian Exceptionalism, and Much Else

(1) Lane Kenworthy kindly responded to my post on his post on whether “heavy taxation is bad for the economy.” Though Lane’s reply was brief, I found it very insightful. I think it illustrates the difference in approach between a careful social scientist (Lane) and an enthusiast drawn to questions so complex as to be unanswerable (me): 

 

I’m sympathetic to your suggestion that family ought to matter for economic performance. It strikes me as a plausible hypothesis. But I think the data suggest its impact is probably small. One way to think about this: If the share of kids growing up with two parents throughout childhood has a big impact on economic success, Japan and Italy ought to have done extremely well over the past several decades. These two countries also are quite homogenous. Moreover, Japan has low taxes. Put those three together and, on your reasoning here, Japan ought to have outshone most if not all other rich nations in recent times, with Italy perhaps not too far behind. But it hasn’t played out that way.

I would put it differently. My reasoning suggests that Japan ought to have fared better than it would have with a family structure more akin to that of the U.S.

Japan’s rapid growth in the postwar era reflected a high-investment growth model. As Michael Pettis has argued, however, a highly-centralized investment-driven growth model eventually runs into diminishing returns as the resulting debt burden proves unsustainable. But that is a pathology of a highly-centralized investment-driven growth model that would be true regardless of family structure. 

Italy, meanwhile, has a notoriously illiberal economy, very much in contrast with the lightly regulated labor and product markets of Sweden and Denmark. Italy is plagued by low levels of trust and high levels of corruption, and I’m not sure it is fair to characterize Italy as homogeneous given the distinctive pathologies of the mezzogiorno and how it varies culturally, in perception and in reality, from regions like Emilia-Romagna. If “Padania,” the northern Italian region watered by the Po River, were a sovereign state, it would be in the same economic league as Switzerland, and anecdotal evidence suggests that the northern Italian and southern Italian diasporas have fared differently. Another barrier to economic progress in both countries has been high barriers to the full participation of women in market production.

The trouble with believing that economic performance reflects the complex interaction of many variables, lots of which are hard to measure, is that it means that we’re left without conclusive answers. 

I don’t interpret this to imply that family structure or homogeneity or tax levels have no effect at all on aggregate outcomes, but rather that whatever impact they have probably isn’t very large.

This is an honest disagreement. My view is that the impact is best understood in a broader context. Tax levels might prove more salient in some contexts than others.

On the other hand, we have pretty good evidence that (on average) family matters for individuals within countries. The same holds for the structure of taxation. We ought to worry less about the overall level of taxes and more about the incentives, constraints, and capabilities created by particular features of taxes, benefits, wages, jobs, family structure, schooling, and so on.

I agree that we should be more concerned about incentives, constraints, etc. I disagree on worrying less about the overall level of taxes. In my view, the low quality of the U.S. public sector reflects a complicated tangle of political economy challenges that are best addressed through spending discipline, transparency, decentralization, and incentives for improving public sector productivity. To not worry about the overall level of taxes is to cede the argument to those who want to more generously fund dysfunctional public programs that benefit incumbent providers more than the intended beneficiaries.

(2) I asked Garett Jones of GMU, one of my favorite economic thinkers, to comment on this large and ungainly subject.

First, how do Americans of Scandinavian origin fare in the United States? Drawing on Tino Sanandaji’s quick analysis, Garett writes:

Scandinavian-Americans are about 5% more productive than EU-15-Americans, and about 12% higher than average Americans. Seems to line up with the results from my paper “IQ in the Production Function: Evidence from Immigrant Earnings” but my paper used data on recent immigrants only and so isn’t directly comparable.  

Best of all: Scandinavian-Americans are about 50% more productive than Scandinavians. That’s pretty close to the naive tax-based prediction of Prescott–his rule of thumb, mentioned in his Nobel speech, is [loosely] that a 1% rise in taxes causes a 3% decline in labor supply. I suspect Prescott is wrong about that 3% estimate—surely labor laws and generous unemployment benefits are part of the difference–but he got the trip to Stockholm, not me.

One has to assume that Scandinavian Americans are meaningfully different from Scandinavians, e.g., they’re descended from immigrants who presumably had higher risk-tolerance than those left behind, which could have an influence on economic outcomes. But this suggests that Danes and Swedes *might* do better under a more work-friendly tax regime, with “do better” understood as “engage in more productive economy activity,” which is of course different from doing better in some spiritual sense.   

Second, he made a Glaeserian point about megacities:

I don’t have any data at hand on Scandinavians living near other Scandinavians—perhaps Utah and Minnesota would be examples of places with large clusters of Scandinavians. Minnesota looks great on a GDP per capita basis (especially considering the fact that it has no megacities) and Scandinavian-heavy northern Utah looks great as well (as a BYU grad, I know the Logan area is Swede-laden). So conditioned on density, I’d lean toward your hypothesis that Scando-clustering is good for an economy (and Richwine-Jones IQ-driven social capital), but I have no hard data. 

Perhaps you can ask Garrison Keillor for a comment on this (In all seriousness, I’d  love to know his candid views on the matter).  

I actually would love to ask him about this — anyone out there know Keillor’s publicist? 

[Aside: While there are likely real social capital benefits to ethnic homogeneity, I’m a big fan of Jane Jacobs’s idea of megacity diversity as a key to long term economic progress–because of the idea hothouse channel as well as the Ricardian comparative advantage channel]

This is hardly an aside. With a population of 305 million, the United States has, as we’ve long emphasized in this space, a lot of low-hanging geographic fruit. The three largest U.S. metropolitan areas, New York, Los Angeles, and Chicago, contain 13 percent of the population and generate 18 percent of GDP. This (crudely) suggests that densification could increase GDP considerably. 

The implications for our comparative puzzle aren’t completely clear: Denmark and Sweden are highly urbanized. But Copenhagen and Stockholm are hardly megacities, though they are part of a densely populated mid-sized cross-border conurbation.  

Third, Garett took strong exception to one of Lane’s claims:

“America’s [GDP per capita] is higher than Denmark’s or Sweden’s. But that’s a legacy of the distant past.”  

This claim does a bit of work for Lane: if higher GDP per capita is a legacy of the distant past, it presumably can’t reflect the divergence in the tax take as a share of GDP. Garett thinks that it isn’t true:

If normal growth theory is right, it takes a lot of work just to keep a rich economy rich. Just replacing the old, depreciating physical capital is an enormous task that only a highly productive economy can accomplish. The more capital you have, the more capital you have to replace every year. If you fall behind in replacing the fast-decaying capital, you quickly become less productive. The fact that the US has been able to keep its relative ranking is evidence that it has stayed highly productive over the decades.  

Solow’s growth model captures this fact—and it’s why a one-time massive gift of capital can’t make a poor country rich. It’s a gift that keeps on wearing out.  

Further, in a modern economy, half of the capital appears to be intangible capital—some mixture of organizational capital and human  capital. That all depreciates as well–new generations are born, firms have to reinvent their corporate processes every few years.  

So both traditional macro and modern macro tell the same story—if you’ve stayed at the top for a long time, it’s because you’ve got your act together right now. In a world of depreciating capital, resting on your laurels is a path to mediocrity. Apparently, U.S. productivity isn’t the “legacy of a distant past…” 

I find Garett’s take on this pretty convincing. One need only consider the diverging quality of colonial-era infrastructure in various post-colonial states to see this principle in action. 

(3) A few scattered thoughts:

(a) Had Japan experienced the same kind of family breakdown as did the postwar United States, it would be a poorer country. And beyond that, quality of life would suffer in ways not captured in GDP. Consider that the crime explosion in the United States helped drive middle-class flight from urban cores. Suburbanization led to greater automobile dependence, which has been a mixed bag at best with negative public health consequences. If high-density environments facilitate productivity-enhancing innovation, the fact that rural Americans migrated to medium-density suburbs rather than high-density cities was also bad news. So cheer up, Japan: it could have been much worse.

(b) Had Japan pursued a more balanced, less centralized growth model, it might have grown at a steadier pace. And Italy has a lot of problems, or should I say confounding variables. 

(c) Is the unusually high quality of the public sector in Denmark and Sweden a marvel, or does it reflect idiosyncratic facts about both countries? Hans Magnus Enzensberger wrote a wonderful meditation on Sweden in the early 1980s that captures some of my thoughts on this subject. 

(d) If we believe Prescott, Danes and Swedes would be much richer under a different tax regime. But wage dispersion would grow enormously, and that might cause more strain in a homogeneous society that places a high value on solidarity than in a heterogeneous society that does not. At the same time, an increase in work hours at the top might create a constituency for more economic migrants who could facilitate the outsourcing of household production — an avenue of upward mobility for at least a small number of developing world workers.

(e) When we ask if “heavy taxation is bad for the economy,” I think we have to ask, “relative to what?”

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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