A post-ideological index of good governance

A few months ago Statsguy did a post arguing that the Heritage Index of Economic Freedom was in many respects measuring good governance, not small government.  I agree, but it’s also true that much of the index does measure small government.  It gives credit for (lack of) taxes, spending, price regulation, entry regulation, trade barriers, investment barriers, etc, etc.  So the index very definitely is biased toward the more laissez-faire economies.  Not surprisingly, Hong Kong comes in number one.

Here I’d like to develop a sort of post-ideological good governance index.  An index that focuses not on how much governments do but rather how well they do it.  A few days ago Matt Yglesias linked to the World Economic Forum’s Global Economic Report.  My initial reaction is the same as Yglesias’s:

I don’t particularly want to vouch for the methodology behind the World Economic Forum’s “Global Competitiveness Report” since ordinal lists are a little silly and competitiveness is a bit of a weird concept but just think of this as a reflection of something international businessmen think . . .

Yes, the term ‘competitiveness’ is rather vague.  But I was intrigued by the countries at the top of the list:

1.  Switzerland

2. Sweden

3. Singapore

4.  U.S.

5.  Germany

6.  Japan

7. Finland

8.  Holland

9. Denmark

10.  Canada

11.  Hong Kong

12  U.K

13.  Taiwan

14.  Norway

15.  France

16.  Australia

Number 17 was Qatar, at which point I lost interest.  In a paper entitled “The Great Danes” I described three models of neoliberalism, and in each case an outstanding example was provided:

1.  Hyper-egalitarian neoliberalism (Denmark)

2.  Hyper-economistic neoliberalism (Singapore)

3.  Hyper-democratic neoliberalism  (Switzerland)

Given that Sweden is pretty similar to Denmark, it looked to me like these three models did well in “competitiveness,” whatever that is.  Then I looked at the 12 categories used by the WEF:

1.  Institutions

2.  Infrastructure

3.  Macroeconomic environment

4.  Health and primary education

5.  Higher education and training

6.  Goods market efficiency

7.  Labor market efficiency

8.  Financial market development

9.  Technological readiness

10.  Market size

11.  Business sophistication

12.  Innovation

It seemed to me that many of those categories measure “good governance” more effectively than the Heritage Index (which doesn’t tend to measure the output of services traditionally provided by governments (infrastructure, health, education, etc.)  But market size seemed irrelevant to me, and I noticed it partly explained the high scores of the US, Germany and Japan.  And I also thought the last two categories were unrelated.  Innovation would reward countries that happened to have a comparative advantage in tech industries, and what the hell is “sophistication?”  So I averaged the first 9, and here’s what I got:

1.  Singapore   5.852

2.  Switzerland 5.799

3.  Hong Kong  5.696 5.778

4.  Sweden  5.696

5.  Denmark  5.602

6. Finland   5.584

7.  Holland   5.513

8.  Canada   5.509

9.  Australia   5.452

10.  Norway   5.444

11.  Germany   5.361

13.  U.K.   5.358

13.  Taiwan  5.271

13.  France   5.271

15.  U.S.   5.187

16.  Japan   5.147

Actually the WEF list is far longer.  I did not re-compute all of the index numbers; a few other smaller European countries would probably have overtaken the US and Japan if I had.  Here are some reactions to the new list:

1.  Small countries are better governed.

2.  The list has something for both those on the left and those on the right.  Most of the top scorers are the sort of European welfare state beloved by liberals.  France overtakes the US in this list.  On the other hand the top three are usually regarded as pretty capitalistic places, and even if you throw out the two Asian city-states (which I’d oppose) Switzerland is often called the most capitalist country in Europe.

It seems to me this list is exposing a perspective that is orthogonal to the tired left/right debate over big government.  It suggests multiple paths to nirvana.  To explain why, let me return to the three models of neoliberalism discussed in my ‘Great Danes’ paper.  I see those three models as providing answers to the three basic questions of governance:

A.   What values should government policies embody?

B.   What policies effectively deliver those values?

C.  When there is a dispute about which policies work best, how should the dispute be resolved?

The first question is moral, and the answer I give is “utilitarianism.”  Unlike 99% of people in the humanities, I regard utilitarianism as a radically egalitarian value system—where people put the best interest of society ahead of their own narrow self-interest.  The second question is scientific, and my answer is ‘economistic’ policies, those that are implemented by people cognizant of the (counter-intuitive) way taxes and regulations often distort decision-making.  The sort of fiscal regime you get if 100 Martin Feldsteins sat down and designed a country on a pad of paper.  In other words—Singapore.  The third question is political, and my answer is democracy.  And I don’t mean just having elections; I mean a system where the people actually govern.  Where every school is a separate school district.  Where taxes must be approved by referenda.  Where every decision is made at the lowest feasible level of government.

Low and behold, all three of these models are represented in the top 5 of my list.  What are the odds of that?  Even better, the other two countries (Sweden and HK) are nearly as good examples of hyper-egalitarian and hyper-economistic neoliberalism as Denmark and Singapore.  So here’s my point.  These countries don’t at all resemble each other.  You can’t get much more different than Hong Kong and Denmark, at least by the criteria used by most people on the left and right.  But they all do at least one thing extremely well.  They all are exceptionally good at one of the three attributes of a highly successful neoliberal society.  Either they are highly civic-minded (Denmark, Sweden), or highly aware of the sorts of policies that produce economic efficiency (Singapore, Hong Kong) or highly democratic.  Switzerland had more national referenda in the 20th century than the rest of the world combined.  And it also seems that all three have very good governance.

Because I am a right-wing liberal who thinks incentives matter more than progressives believe they do, I’d vote for the Singapore/HK low tax model, not the Danish/Swedish high tax model.  I was glad to see Hong Kong scored number one in the world in the infrastructure category.  So much for Galbraith’s “private wealth, public squalor.”  But unlike many right-wingers, I believe the Nordic approach is also pretty successful.  And I attribute their success to extremely effective governance, which overcomes the drag of high taxes and transfers.  Sweden has an educational system that every US right-winger can only dream about—100% voucherized, and even for-profit schools qualify.  They were the first to adopt a system of Social Security, but now have taken George Bush’s advice and started privatizing it through personal accounts.  Denmark even has privately run fire departments–you can’t get much more “public good” than fire-fighting, can you?  In other words, these countries have economic systems that would horrify the fashionable leftists in the U.S. and U.K. who regard terms like ‘profit’ as ‘privatization’ as dirty words (at least when applied to services traditionally in the public sector.)  BTW, there are many other examples I could provide of privatization of traditional government activities in the Nordic countries.

This list also highlights the “small is beautiful” point I keep making.  The top six countries all have fewer people than Los Angeles County.  I’m guessing they don’t spend $550 million dollars on new high schools (as LA just did.)  The Economist noted that America is spending $11 billion on its census ($36 per person) whereas Finland spends a measly $1.2 million (20 cents per person.)  It’s no surprise that the bigger countries fell sharply down the rankings, as soon as bogus categories like market size and “sophistication” were removed.  Huge size didn’t hurt us much in the US as long as we were a fairly small and laissez-faire government.  But as our government gets increasingly active (think health care) the large size and diversity of the US becomes an increasing drawback.  What works in Minnesota doesn’t work in McAllen, Texas.

So why has the US been so successful?  Because good governance isn’t everything; it turns out small government also helps a lot.  The early studies of the supply-side effects of high taxes (Lindsey, Feldstein, etc) showed the effect was powerful.  Revisionist studies by Slemrod, Saez, Goolsbee, etc, suggested the effects were rather small.  But I didn’t find the methodology of either group of studies to be at all convincing, as they measure immediate effects, whereas the important effects probably occur very gradually.  This is especially true of human and physical capital formation, which is slowed by high MTRs.  Imagine a scenario where people are only willing to put in the hard work of becoming a doctor if the pay is twice as high as other professionals—say $200,000 instead of $100,000.  If you put a 50% tax on income above $100,000, fewer people will go to medical school until salaries rise to $300,000.  Note that patients pay 100% of that tax in higher prices.  (So much for all those articles on distributional effects of taxes.  That’s right, they are all worthless.)  But the effect doesn’t occur immediately.  It takes a long time to study medicine, and the cost is sunk once the courses are completed.  The tax probably won’t stop people who are already doctors from continuing to practice.

These insights suggest that cross-sectional tests of the sort Ed Prescott did are best.   And those suggest a strong Laffer curve effect.  Despite much higher tax rates, most European countries raise about the same amount of revenue as the US does (in PPP terms.)

Here’s a prediction.  Take the 20% of GDP raised by the Federal government in 2000.  Now draw a trend line from 2008 going forward assuming a very modest 2.5% RGDP growth.  I say Obama won’t be able to raise any more than 20% of that trend RGDP in revenue, even if he pushes Federal taxes up to 22% or 24% of GDP.  That doesn’t mean 20% is the top of the Laffer curve for an efficient tax system, like what they have in the Nordic countries.   But for our ramshackle tax system, 20% Federal and 30% total (federal, state and local) are probably close to the top of the Laffer curve.   We could get a higher share of GDP, but only at the expense of reducing RGDP growth.

In my view the left/right debate is this country is so vicious because we are debating second best policies in a policy-making regime that is profoundly dysfunctional.  Thus Matt Yglesias and I probably disagree strongly about extending the Bush tax cuts for the rich, but we both favor a simple progressive consumption tax as the ideal.  I see these small countries with good governance as models that point the way forward, past our stale ideological debates.  The question is whether we will pay attention to the lessons they are providing.