Friday, April 21, 2006

Welfarism 3: Spiraling Costs and Rent-Seeking

A story today from the Financial Times reported, "Welfare costs threaten Merkel reform agenda". The related numbers from the same report are as follows:

* Spiralling welfare costs could add €4bn to Germany’s 2006 budget deficit and undermine Chancellor Angela Merkel’s efforts to bring her country’s finances under control

* faster-than-expected rise in the number of households claiming long-term unemployment benefits could bring this year’s deficit from a planned €38.3bn to well above €40bn ($49bn, £27.7bn).

* the number of households claiming “unemployment benefit II”, the most basic form of welfare support, comparable to the UK’s income support, has risen from 2.9m to 3.9m since its introduction 15 months ago.

* According to a labour ministry document obtained by the FT, the actual number is even higher. The document shows the agency’s monthly reports, based on samples, had underestimated the number of claimants by 200,000 a month throughout last year, suggesting today’s figure was around 4.2m.

* estimates total payments in 2006 could reach €28bn, well above the €24.4bn provided for in the budget.

* loopholes appeared in the system that have led to a flood of claims. Young jobseekers, for instance, have moved out of their parents’ homes and into their own flats in order to claim generous rent subsidies.

* news that her fiscal consolidation plan may be in jeopardy could be a blessing for Ms Merkel. It should make it easier to justify a hefty, three-point increase in value-added tax planned for next January.

Never fails. People respond to incentives and shy away from disincentives. If you put a lot of incentives and subsidies on something (unemployment claims, house rental subsidies, etc.), then you'll have more claimants than what you expect. If you tax people more, like the planned 3 point increase in VAT, you'll discourage more investments and job creation that will solve your high unemployment, high unemployment claims spending. Many businessmen will still invest, of course, but not in home country where taxes are high and piling on each other. Many of them will do business elsewhere where taxes are lower, labor and environmental laws are more liberal, then send some income and profit back home.

Many left-leaning, welfarist, socialist and statist groups in the Philippines and other developing countries dream of following the welfare system of Germany, France and many European coutries. They want to force social equality by over-taxing and over-regulating the productive and hard-working people, give the money to guys who are encouraged by generous welfare, with the huge, thick and expensive layers of government bureaucracy and politicians as intermediaries.

Subsidizing personal irresponsibility and penalizing hard work is one formula for social equality and mediocrity. And this is the folly of socialism. As Larry Reed of Mackinac Center pointed out, "equal people are not free and free people are not equal". Not that Germany and other rich countries of Europe are largy socialist, they are still predominantly capitalist but the bureaucratic, high state welfare system and high taxes discourage certain individual initiatives and entrepreneurship of their citizens. European countries are just lucky that they have put up good and less corruptible institutions. Government personnel are less corruptible because of their high pay and generous allowances and pensions someday. But what was corrupted is the system of incentives and disincentives in society.

I guess this is one reason why a number of Asian countries are growing much faster than the rest of the world. Aside from certain philosophical and cultural ethics that drive their people to high ambitions, they are not burdened by strict government-mandated welfare standards and the energy-sapping bureaucratic regulations and taxes. For instance, people work 10 to 14 hours a day, 6 days a week (equivalent to 60 to 84 hours/week), and any government labor laws that limit people's work to only 35 or 40 hours/week are not strictly followed.

Rent-seeking and Government

In the book Government Failure: A Primer in Public Choice written by Tullock, Seldon and Brady (2002, published by Cato Institute, Washington DC), chapter 4 was entitled "The cost of rent-seeking", written by Prof. Gordon Tullock. Dr. Tullock defined the words "rent seeking" as "the use of resources for the purpose of obtaining rents for people where the rents themselves come from some activity that has negative social value."

Examples of rent-seeking are (a) trade protectionism, where the protected local industry benefits but the local consumers are worse off; (b) private monopolies, and (c) direct income transfers by government where A is taxed and B receives the money. The real cost of rent seeking, according to Tullock, comes from the distortion of the voting process. People vote for politicians and legislators who promise them special local projects, barely realizing that the cost of high taxes from many other taxpayers elsewhere, and the high taxes that they themselves pay to finance the special local projects elsewhere, is high.

But the indirect damage of rent-seeking, he says, is even worse than direct damage. Example of indirect damage is drawing a big number of intelligent and energetic people into an activity that has no social product, or may have a negative social product (example, political lobbying for special privileges and protections).

I would say that around 95 percent of all forms of government restrictions, from bureaucratic procedures in starting a business, to erecting rigid labor laws like setting up high minimum wages mandated by Congress, to welfarism financed by high and complicated taxes, are rent-seeking in nature. They are tying productive people's hands, siphoning off if not outrightly confiscating, their income and savings, and transferred to people often driven by envy and too lazy to accept personal responsibilities on things that ought to be their private domain. The huge government bureaucracy and long layers of politicians that stand in-between the people whose incomes are confiscated and the beneficiaries who wait for such wealth transfer, also eat up precious social resources.

* See also:  Welfarism 2: France Riots, Taxes in Welfare States, November 17, 2005

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