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Finance & Development, December 1979
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Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
December 1979
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Theodore Geiger

Welfare and Efficiency: Their Interactions in Western Europe and Implications for International Economic Relations

National Planning Association, Washington, D.C., U.S.A., 1978, v + 144 pp., $7.00.

Theodore Geiger sets out to demonstrate that the rise of comprehensive welfare programs in many Western European countries has led to the decline of the work ethic, a sharp drop in productive investment, and the general economic atrophy of advanced industrial societies in Western Europe. This theme of the effect of increased government participation in every phase of economic life is one that is being increasingly debated, particularly in the United States, where the bandwagon of deregulation has picked up momentum. Furthermore, the most recent parliamentary election in the United Kingdom typifies the political trend in many European countries toward the promulgation, whether real or apparent, of a reduced, or more limited, role for government in economic life.

The author’s approach to the problem of analyzing the complex question of the interaction between the public and private sectors is to sketch the growth of government in six European countries (Denmark, the Federal Republic of Germany, the Netherlands, Norway, Sweden, and the United Kingdom), hypothesize about the negative effects of the increased size of government on economic growth and efficiency—focusing on what he regards as particularly pernicious aspects of the welfare system—and then discuss in some detail the government’s role in the economic life of each of these countries. In a final chapter, more general conclusions are drawn regarding the implications for policy in the United States. Two ‘appendices (by Neil J. McMullen and Harold van B. Cleveland) are included.

This reviewer will nail his colors to the mast at the outset and state that he strongly sympathizes with Geiger’s opinions regarding the effects of the growth of government. In this regard, Welfare and Efficiency brings together numerous useful statistics and facts which demonstrate how rapidly the size of the public sector has grown in Western European countries. In addition, there is a description of the growth of what is known as industrial democracy—that is, the participation of workers in both management decisions and (by virtue of state legislation) in the ownership of the companies for which they work.

However, the reader looking for an empirically sound demonstration of the disincentive to economic growth and welfare caused by government intervention will be disappointed. While Geiger effectively documents the growth of government in the six sample countries, on the one hand, and describes the fall in the growth of their output and productivity, on the other, he fails to demonstrate conclusively the link between the two phenomena. The evidence he provides amounts to no more than observation of the correlation between the two. He does not explain empirically why the interaction occurs, nor does he indicate the stage at which government intervention has an overall negative effect on welfare. One of the major flaws of the book is that there is no coherently expressed view of the correct role for government in Western economic society. Presumably, the author does believe that government has some role to play and should, therefore, command some share of the gross national product. However, he provides no indication of what the appropriate share should be. Indeed, the statistics contained in the book indicate that the growth in the proportion of public expenditure as a percentage of gross domestic product was very similar in the Federal Republic of Germany and the United Kingdom between 1965 and 1977, yet the reader scarcely needs to be reminded of differences in the performance of the two economies.

Furthermore, it is disappointing that Geiger appears to be unaware of the growing empirical literature analyzing the effect of welfare payments on the labor market, much of which provides evidence to support at least the theory that an increase in welfare payments reduces work incentives. An additional weakness is that there is little discussion of possible trade-offs between reduced output growth and more equal distribution of income. Alternatively, there is no mention of the encroachment on individual liberties by government intervention.

In sum, therefore, this book will not satisfy those who hope to find a theoretically and empirically well-founded discussion of the influence of government on economic welfare. Nevertheless, it does provide a useful catalog of welfare systems in Western Europe and enough interesting ideas to make it worthwhile reading for those interested in the effect of government intervention on incentives and output growth.

Paul Holden

John Kenneth Galbraith

The Nature of Mass Poverty

Harvard University Press, Cambridge, Massachusetts, U.S.A., 1979, vii + 130 pp., $8.95.

The author begins by examining the conventional explanations of mass poverty in less developed countries—meager natural endowment, shortage of capital and technical skills, inefficient or corrupt administration, unhelpful ethnic or climatic features, and so on, and finds all of them wanting. Generally, they tend to reflect the experience of the rich countries and ignore the fact that both economic circumstance and economic motivation are fundamentally different in the poor countries. It is to these aspects that the rest of the book is addressed.

Mass poverty, the author says, is primarily a rural phenomenon. In the rural communities, the tendency is not toward an expansion of output and income, but an equilibrium of poverty. An improvement in income sets in motion forces—for example, an increase in population—that eliminate the improvement and restore the previous level of deprivation. Not surprisingly, the poor are reluctant to innovate, for innovation involves risk, and risk often means hunger, possibly death. Nothing so reinforces the equilibrium of poverty as the absence of aspiration, of the effort to escape it. Galbraith finds that it is entirely rational that people should accommodate to what they have learned from the experience of centuries to be the inevitable.

What is the way out of this impasse? The attack on poverty, according to the author, should begin with countering accommodation. In the past, accommodation has most often been broken by trauma such as famine, military depredation, or forced expulsion of ethnic or religious groups. But a more civilized means by which the poor can gain access to the world outside their own culture is universal education. Galbraith, however, does not elaborate on the kind of education that may best defeat accommodation.

Once accommodation is rejected, opportunities to escape from the equilibrium of poverty may arise in several directions. They may arise within the rural sector as a result of investment and improved technology in agriculture, outside this sector through industrialization, or outside the country through migration. Galbraith draws two lessons from past failures of rural development programs. Such programs must follow, and not precede, the general educational attack on accommodation, and they must be directed not at all farmers but only at those who are motivated to improve their living standards. He believes that our knowledge about how best to promote industrialization remains inadequate; it therefore promises a possible, but not a certain, escape. Migration, on the other hand, is the oldest action against poverty and remains to this day an ever promising avenue. It benefits the country to which workers go, as they help maintain both stable prices and full employment. And it helps to break the equilibrium of poverty in the country from which they come.

As one would expect from this author, the book is highly readable: the “Galbraith incisiveness, wit, and clarity,” promised by the publishers on the dust jacket, are there in abundant measure. For its small size, the book covers a fairly wide ground. There are interesting historical parallels and well-intentioned barbs directed at conventional advice, socialist or otherwise. And while both the author and his readers have fun, the book is by no means lighthearted. Nevertheless, despite the skillful terminology, the author’s diagnosis of poverty is not really novel; nor are his prescriptions, broad as they are, particularly helpful. But by his provocative style, he has been eminently successful in drawing fresh and serious attention to the intractable nature of mass poverty in important areas of the world.

Subimal Mookerjee

James M. Buchanan and Richard E. Wagner (editors)

Fiscal Responsibility in Constitutional Democracy

Martinus Nijhoff, Leiden, The Netherlands, 1978, xiv + 139 pp., f. 40.

J.S.H. Hunter

Federalism and Fiscal Balance

Australian National University Press, Canberra, Australia, 1978, vii + 271 pp., $18.50.

Present day economic experience points to a chronic tendency in many democratic governments toward deficit finance and inflation. Since 1961 the United States has witnessed a sequence of continuous large deficits, inflation, and a bloated public sector “which can hardly be adjudged to be beneficial to anyone other than the employees of the bureaucracy” (see p. 81 of the first book under review). This is so in spite of theories of public choice which state that elected representatives behave in ways to maximize constituent support. Why voters support what the authors regard as such fiscal irresponsibility is the fundamental paradox that Fiscal Responsibility in Constitutional Democracy seeks to examine.

The seven papers in this volume—presented at a conference in Hot Springs, Virginia in March 1976—provide a wide range of answers to this question. The answer suggested by the editors and organizers of the conference is that the Keynesian revolution left a political legacy with a bias toward inflation. The Keynesian message was that the government ought to accept responsibility to ensure that aggregate demand was sufficient to maintain full employment of the economy. The vital flaw, Buchanan and Wagner contend, is that the dictates of political survival and the nature of contemporary political institutions run counter to the requirements of stable macroeconomic management over time: a deliberate policy of fiscal deficits enabled politicians to increase spending without increasing taxes. The consequence of such a political bias toward deficits was bound to be a bias toward inflation in an environment in which the monetary authorities were likely to be accommodating.

On the other hand, Herbert Stein, another contributor, calls the “balanced budget” doctrine a myth and suggests that the fiscal pattern of the United States has not undergone the radical shift claimed by the editors. In the past, lip service was indeed paid to balancing the budget but the facts are that in 47 of the 140 years between 1787 and the Great Depression of the early 1930s, there were budget deficits—incurred to finance wars or to supplement declining revenues in recessions. The present national debt, while far larger in absolute terms is, at 30 per cent of gross national product (GNP), relatively smaller than it was following the Civil War (50 per cent of GNP) or World War II (100 per cent of GNP). Similarly, public debt is a smaller percentage of government revenues than it was in 1929. Stein’s point is that it is mainly the ideas and attitudes toward the appropriateness of public debt that have altered since earlier days; it is not the size of the deficit but the use of the budget for fine-tuning which is new. These new attitudes toward finance—functional finance has gained wide acceptance—suggest that the “fiscal revolution” has really been no more than a change in emphasis.

Abba Lerners’ essay brings out the suggestion that it is not the Keynesian doctrine of macroeconomic demand management to create full employment that causes inflation, but the application of demand management techniques to present-day recessions in which stimulative policies can create excess demand in certain markets, and can cause these markets—labor as well as product—to overheat, causing inflation, long before the economy as a whole is brought to full employment. His conclusion is that the government has the will but not the means to control the bias toward Keynesian inflation.

Two separate approaches to diminish this fiscal indiscipline are suggested. Jesse Burkhead places his emphasis on the need to control the legislative appropriation process and is optimistic or at least hopeful that the Congressional Budget Act of 1974 may make a major constructive innovation in federal budgetary practice. William Niskanen, on the other hand, can only recommend an amendment to the Constitution to leave greater power with the states.

This provocative volume makes enjoyable reading but its effectiveness is limited by its anecdotal nature. Many of the basic contentions about Keynesianism and about biases of the political system are never examined carefully or in a systematic fashion. Why politicians find inflation less of a liability than taxation is not considered at all. Do public officials have higher discount rates? There is also no systematic examination of the link between deficit finance and inflation, on the one hand, and on the independent role of money in the inflation process, on the other. In sum, there are loose ends that trouble the reader contemplating Buchanan and Wagner’s conclusions. Nonetheless, one is left on balance with the feeling that there is some truth to the concept of a political business cycle but that the hypothesis needs to be developed more carefully.

J.S.H. Hunter’s Federalism and Fiscal Balance is an entirely different sort of book, an exhaustive survey of one of the thorniest subjects in federal finance: revenue sharing and the financial arrangements between central government and states in a federal system. Hunter’s study addresses many of the issues facing present day federations, and provides, in the light of this, an excellent review of recent developments in four of the older federations, Australia, Canada, the United States, and the Federal Republic of Germany.

Hunter begins by relating a country’s economic structure to the role of government. Then revenue and tax sharing methods are discussed, followed by discussions of the fiscal structure of the four countries. Statistical measures of “fiscal imbalance”—the ability of each of the levels of government (federal, state, and local) to carry out its expenditure functions—are evaluated, and the degree of vertical imbalance among the four countries is compared.

Hunter also deals with the issue of horizontal fiscal equity—the idea that location should not unduly affect an individual’s fiscal >well-being: if meeting minimum fiscal needs in resource-poor or low-income states implies a greater tax burden in these states than in richer states, then revenue sharing, to offset this, is appropriate. He is quite persuasive that the “efficiency school” arguments against such resource transfers to areas of low development potential do not hold water. Different methods of achieving regional fiscal balance are discussed in the context of the four countries.

This is an excellent book for anyone who wishes to know more about fiscal federalism: it covers a good deal of basic theory and the country studies provide additional perspective.

C.I. Wallich

Other books received

Anne O. Krueger

Liberalization Attempts and Consequences

Bellinger Publishing Company, Cambridge, Massachusetts, U.S.A., 1978, xxi + 310 pp., $16.50.

Jagdish N. Bhagwati

Anatomy and Consequences of Exchange Control Regimes

Ballinger Publishing Company, Cambridge, Massachusetts, U.S.A., 1978, xix + 232 pp., $18.50.

These two volumes, the end product of a major comparative inquiry into devaluation and liberalization policies in the experience of ten less developed countries (LDCs), were prepared under the auspices of the National Bureau of Economic Research of the United States.

The Krueger volume provides: (i) a review of devaluation theory; (ii) a summary of the episodes in which these ten LDCs chose devaluation as a policy; and (iii) an analysis of economic growth performance in relation to the foreign trade regime. The author notes that a policy strategy commonly adopted by these LDCs—to attempt simultaneously to reduce domestic inflation and to liberalize trade and payments—was bound to fail when the exchange rate was fixed unless the authorities could reduce inflation close to the rate at which world prices were rising. She comes to the conclusion that the transition from exchange controls to a liberalized regime can often best be achieved by adopting a sliding peg as a means of achieving a realistic exchange rate.

The Bhagwati volume provides a comparative summary of the anatomy and the consequences of exchange control regimes. The care with which exchange control measures are examined in theoretical terms and the wealth of materials brought together from the ten country studies and from other literature which is relevant to a judgment about the consequences of exchange control regimes make this volume of interest both to the student and to the policymaker.

The two authors conclude from the evidence that an export-promoting strategy is superior to an import-substitution policy for the LDC seeking to promote economic growth.

Harry I. Greenfield, Albert M. Levenson, William Hamovitch, Eugene Rotwein (editors)

Theory for Economic Efficiency: Essays in Honor of Abba P. Lerner

The MIT Press, Cambridge, Massachusetts, U.S.A., 1979, ix + 243 pp., $25.00.

This collection of essays represents the creative efforts of 15 distinguished economists, 4 of whom were recipients of the Nobel Prize in Economics. It includes papers on international economics, on macroeconomics and economic controls, and on problems of pure theory.

Vincent Cable and Ann Weston

South Asia’s Exports to the EEC-Obstacles and Opportunities

Overseas Development Institute, London, England, 1979, vii + 179 pp., £5.00.

A study of the bilateral commercial relationships between the European Community and Bangladesh, India, Pakistan, and Sri Lanka that highlights the mutuality of benefits derived from improved access to markets by the Community and these South Asian economies.

Dirk J. Wolfson

Public Finance and Development Strategy

Johns Hopkins University Press, Baltimore, Maryland, U.S.A., 1979, xiv + 264 pp., $16.50.

An attempt to treat the subject of public spending and resource mobilization in developing countries with political and administrative considerations in the forefront. The book covers tax structure, the distributional aspects of public spending, resource allocation, and stabilization policy, as well as such less conventional topics as the political economy of the budgetary process and the administrative hurdles to effective, efficient, and adequate mobilization of resources.

Wilson E. Schmidt

The U.S. Balance of Payments and the Sinking Dollar

New York University Press, New York, N.Y., U.S.A., 1979, xii + 157 pp., $10.00 (cloth), $4.95 (paperback).

The author argues in this brief book that the U.S. balance of payments situation does not matter if the exchange rate is allowed to float freely without management and that the U.S. authorities should not, as they did in the past, either impose undesirable controls on the international transactions of the United States or intervene in the foreign exchange market.

F.L.C.H. Helmers

Project Planning and Income Distribution

Martinus Nijhoff Publishing, The Hague, The Netherlands, 1979, pp. 295, $19.95.

The economic evaluation of projects has become a rapidly expanding industry and much effort is going into the refinement of concepts and of tools. Mr. Helmers has produced a useful guide for practitioners which covers the conventional topics such as the measurement of costs and benefits by means of shadow pricing, the timing and scale of projects, and the merits of different ranking criteria. What differentiates this manual from other contributions to the genre is that the second part of the book—over a third of the total space—is devoted to a detailed examination of the distributional aspects of project evaluation.

J.O.N. Perkins

The Macroeconomic Mix to Stop Stagflation

John Wiley and Sons, New York, N.Y., 1979, ix + 193 pp.

A general review of alternative domestic policy instruments available to government officials in an open economy, and recommendations by the author concerning how they might best be combined to stop stagflation in varying national circumstances.

Dan Haendel

Foreign Investments and the Management of Political Risk

Westview Press, Boulder, Colorado, U.S.A., 1979, xviii + 206 pp., $18.50.

A specialized examination of political risk as an independent factor affecting the foreign direct investment decisions of multinational enterprises. The author stresses the need for the systematic review of information about political conditions along with the usual financial analysis before decisions are made. He examines and tests several types of quantitative measures of political risk.

Samuel I. Katz (editor)

U.S.-European Monetary Relations

American Enterprise Institute, Washington, D.C., U.S.A., 1979, 282 pp., $10.75 (cloth), $5.75 (paperback).

Papers prepared for a conference held in Washington, D.C. in 1977 to consider what practical steps could be taken next to halt the trend toward national fragmentation in global and in European regional monetary affairs.

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