When you read economic articles from the mainstream media or from popular "experts", one would accrue two significant but misleading impressions:
1. governments are the sole entities that are engaged in trade (from discussions of trade imbalances)
2. low wages are the only criteria that ensures success or economic prosperity (from discussions of currency manipulation)
But of course, such discussions is far from the truth or reality.
Governments generally don't produce anything but generates its revenues by taxation. This means that people through various forms of enterprises, and NOT the government itself, are engaged in trade.
Next, investment is a function of returns: particularly, the rate of return on investments. Of course before establishing the rate of investments, the most important factor would be the return OF investments (via security of property rights).
In other words, expected profits (revenues-costs) determine investment activities.
In contrast to mainstream polemics, the fact is that wages constitute only one of the many variables that adds up to the long list of costs.
Yet there are other factors that determine the profitability of an enterprise among them: as stated above is the varying degree of property rights, different conditions of existing infrastructure, operational institutions, legal framework (which secures contracts and resolves disputes), cultural variables (traditions, superstitions etc.), security, political stability, capital and production structure, access to markets, access to raw materials, access to finance, degree of labor and skills available, education of the labor force, cost of energy, transportation and connectivity, quality of management, regulatory structure, transaction costs, tax policies, degree of economic freedom and etc...
Importantly these cost structures can be nuanced by the operating principles of the comparative advantage and specialization or the division of labor.
Yet all these very important variables are frequently ignored when arguments get oversimplified but cloaked with technical gobbledygook.
Below is an example of a more important factor that influences business activities.
It's about tax structures.
The chart taken from the Economist, highlights on the world's declining corporate tax rates.
The Economist with a tinge of demur from falling tax rates writes, (bold highlights mine)
``CORPORATE-TAX rates in OECD countries have fallen remorselessly over the past 30 years. A survey by Robert Carroll of American University in Washington, DC, found that the top rate in OECD countries (excluding America) had dropped from 51% in the early 1980s to 32% by 2009. Competition among countries to attract business and with it bring employment was fierce in the late 1990s and early 2000s. Ireland reduced its corporate-tax rate to just 12.5% and chose not to raise it last year during an emergency budget. Such differentials may not last long. High-tax European governments have complained in the past about competition from countries such as Ireland and the current economic crisis may lead to more calls for co-ordination of tax policies."
Of course, coordination of tax policies won't work. Competition among governments will still determine investments.
This from World Bank's Paying Taxes 2010
According to Doing Business 2010 (all bold and italics emphasis mine)
``The size of the tax burden on businesses matters for investment and growth. Where taxes are high and corresponding gains seem low, the incentive for businesses to opt out of the formal sector increases.
``A recent study shows that higher tax rates are associated with lower private investment and fewer formal businesses. A 10 percentage point increase in the effective corporate tax rate is associated with a reduction in the ratio of investment to GDP of up to two percentage points and a decrease in the business entry rate of about one percentage point. Other research suggests that a one percentage point increase in the statutory corporate tax rate would reduce the local profits of existing investments by 1.31 percentage points on average and lead to an 18 percentage point increase in average debt-to-asset ratios (part of the reason for the lower reported profits). A one percentage point increase in effective corporate tax rates reduces the likelihood of establishing a subsidiary in an economy by 2.9 percentage points.
``Besides the taxes paid, there are costs of complying with tax laws and of running the revenue authority. Worldwide on average, a standard small to medium sized business still spends three working days a month complying with tax obligations as measured by Doing Business. Where tax compliance imposes heavy burdens of cost and time, it can create a disincentive to investment and encourage informality. Particularly in developing economies, large informal sectors contribute to the creation of an uneven playing field for formal small and medium sized enterprises, squeezed between smaller informal competitors and larger competitors whose greater resources can help win a more effective audience with government and thus greater tax concessions."
``Worldwide, economies that make paying taxes easy tend to focus on lower tax rates accompanied by wider tax bases, simpler and more efficient tax administration and one tax per tax base. They also tend to provide electronic filing and payment systems, which reduce the tax burden for firms while lightening their administrative requirements."
So as the multilateral government institution World Bank points out, tax rates juxtaposed with tax and regulatory compliance plays a major role in the shaping of trade balances among nations and in domestic economic development.
The sub-Saharan Africa has the highest tax rates around the world along with dubious recognition for property rights and mired with political instability ,which offsets its lowest wage framework, hence remains the least attractive venue for investors which has stagnated their economies.
On the other hand, the reasons why Asia and many Emerging Markets has been generating increasing investments is due to the relative advantage of their tax structures.
As we said above competition among governments will ascertain the flow of investments and the recent bubble bust just drove a wedge between responsible and profligate governments.
To wit, the responses by the OECD governments to the recent bubble bust is likely to amplify these differences: higher taxes-lower return for OECD economies as against lower taxes-higher return for Asia and emerging markets.
Guess where investments will flow to?
1. governments are the sole entities that are engaged in trade (from discussions of trade imbalances)
2. low wages are the only criteria that ensures success or economic prosperity (from discussions of currency manipulation)
But of course, such discussions is far from the truth or reality.
Governments generally don't produce anything but generates its revenues by taxation. This means that people through various forms of enterprises, and NOT the government itself, are engaged in trade.
Next, investment is a function of returns: particularly, the rate of return on investments. Of course before establishing the rate of investments, the most important factor would be the return OF investments (via security of property rights).
In other words, expected profits (revenues-costs) determine investment activities.
In contrast to mainstream polemics, the fact is that wages constitute only one of the many variables that adds up to the long list of costs.
Yet there are other factors that determine the profitability of an enterprise among them: as stated above is the varying degree of property rights, different conditions of existing infrastructure, operational institutions, legal framework (which secures contracts and resolves disputes), cultural variables (traditions, superstitions etc.), security, political stability, capital and production structure, access to markets, access to raw materials, access to finance, degree of labor and skills available, education of the labor force, cost of energy, transportation and connectivity, quality of management, regulatory structure, transaction costs, tax policies, degree of economic freedom and etc...
Importantly these cost structures can be nuanced by the operating principles of the comparative advantage and specialization or the division of labor.
Yet all these very important variables are frequently ignored when arguments get oversimplified but cloaked with technical gobbledygook.
Below is an example of a more important factor that influences business activities.
It's about tax structures.
The chart taken from the Economist, highlights on the world's declining corporate tax rates.
The Economist with a tinge of demur from falling tax rates writes, (bold highlights mine)
``CORPORATE-TAX rates in OECD countries have fallen remorselessly over the past 30 years. A survey by Robert Carroll of American University in Washington, DC, found that the top rate in OECD countries (excluding America) had dropped from 51% in the early 1980s to 32% by 2009. Competition among countries to attract business and with it bring employment was fierce in the late 1990s and early 2000s. Ireland reduced its corporate-tax rate to just 12.5% and chose not to raise it last year during an emergency budget. Such differentials may not last long. High-tax European governments have complained in the past about competition from countries such as Ireland and the current economic crisis may lead to more calls for co-ordination of tax policies."
Of course, coordination of tax policies won't work. Competition among governments will still determine investments.
This from World Bank's Paying Taxes 2010
According to Doing Business 2010 (all bold and italics emphasis mine)``The size of the tax burden on businesses matters for investment and growth. Where taxes are high and corresponding gains seem low, the incentive for businesses to opt out of the formal sector increases.
``A recent study shows that higher tax rates are associated with lower private investment and fewer formal businesses. A 10 percentage point increase in the effective corporate tax rate is associated with a reduction in the ratio of investment to GDP of up to two percentage points and a decrease in the business entry rate of about one percentage point. Other research suggests that a one percentage point increase in the statutory corporate tax rate would reduce the local profits of existing investments by 1.31 percentage points on average and lead to an 18 percentage point increase in average debt-to-asset ratios (part of the reason for the lower reported profits). A one percentage point increase in effective corporate tax rates reduces the likelihood of establishing a subsidiary in an economy by 2.9 percentage points.
``Besides the taxes paid, there are costs of complying with tax laws and of running the revenue authority. Worldwide on average, a standard small to medium sized business still spends three working days a month complying with tax obligations as measured by Doing Business. Where tax compliance imposes heavy burdens of cost and time, it can create a disincentive to investment and encourage informality. Particularly in developing economies, large informal sectors contribute to the creation of an uneven playing field for formal small and medium sized enterprises, squeezed between smaller informal competitors and larger competitors whose greater resources can help win a more effective audience with government and thus greater tax concessions."
``Worldwide, economies that make paying taxes easy tend to focus on lower tax rates accompanied by wider tax bases, simpler and more efficient tax administration and one tax per tax base. They also tend to provide electronic filing and payment systems, which reduce the tax burden for firms while lightening their administrative requirements."
So as the multilateral government institution World Bank points out, tax rates juxtaposed with tax and regulatory compliance plays a major role in the shaping of trade balances among nations and in domestic economic development.The sub-Saharan Africa has the highest tax rates around the world along with dubious recognition for property rights and mired with political instability ,which offsets its lowest wage framework, hence remains the least attractive venue for investors which has stagnated their economies.
On the other hand, the reasons why Asia and many Emerging Markets has been generating increasing investments is due to the relative advantage of their tax structures.
As we said above competition among governments will ascertain the flow of investments and the recent bubble bust just drove a wedge between responsible and profligate governments.
To wit, the responses by the OECD governments to the recent bubble bust is likely to amplify these differences: higher taxes-lower return for OECD economies as against lower taxes-higher return for Asia and emerging markets.
Guess where investments will flow to?
