Alan Blinder: Low Capital Gains Taxes Cause Distortions

Alan Blinder discusses distortions that are introduced into the economy when the tax rate on capital gains is lower than the tax rate on other types of income. He begins by explaining the current debate over whether income from private-equity and hedge fund management should be taxed as capital gains or as regular income, and comes down on the side of treating it like ordinary income (see the article for details), and then he asks why the rates should differ at all:

The Under-Taxed Kings of Private Equity, by Alan S. Blinder, Economic View, NY Times: An arcane debate is raging in Congress over the appropriate taxation of the bountiful incomes of people who manage private-equity and hedge funds — incomes that can range into the hundreds of millions a year. I don’t recommend trying to master the details unless you have either an accounting degree or insomnia. But one thing is easy to understand, though hard to swallow: Some people who are richer than Croesus are paying 15 cents in federal income taxes on the marginal dollar, while you may be paying 25 or 35 cents...

Why do we have a preference for capital gains in the first place? The main argument is that lower taxes on capital gains boost investment. But the evidence on that point is iffy at best, and there are better ways to spur investment, like, say, the investment tax credit. Besides, lower taxes on capital gains reduce the tax bills of the rich relative to the rest of us — after all, they own most of the capital. But in this age of hyper-inequality, shouldn’t we be making the tax code more progressive, not less?

A far more important objection is that the tax preference for capital gains undermines capitalism — a system in which capitalists, not the state, are supposed to make the investment decisions. When I discuss this issue with my Economics 101 students, I show them an example of a proposed investment that loses money before tax (and which, therefore, should be rejected) but which actually turns a profit after tax because of the preferentially low capital gains rate. ... The government thus induces people to make bad investments, which is a good way to run an economy into the ground. Come to think of it, that’s just what the old Soviet Union did. It invested copiously, but badly.

But would taxing capital gains like other types of income imperil our economy? No. The Tax Reform Act of 1986 did exactly that, and it did not end capitalism as we know it. In fact, the gross domestic product in 1987 and 1988 grew at about the same rate as in 1985 and 1986, and the investment share of G.D.P. barely budged.

As the tax debate unfolds, you may find it difficult to follow the mind-numbing complexities. Who doesn’t? So just remember one simple principle: If we tax Activity A at 15 percent and Activity B at 38 percent, a free-market economy will give us more A and less B. Some of this shifting will represent genuine movements of resources out of B and into A — including those bad investments I just mentioned. The rest will be paper manipulations devised to avoid taxes.

Which of these do you think our tax code should favor?

Comments

[evagrius]

Investment is a sacred activity, as close to God as one can get, while work, well, that's the Devil's curse.

[pgl]

The distortion effect from preferential tax treatment of certain kinds of capital income is an important point. Alas, the rightwing that pretends they are for efficiency never wish to address this point at all.

[pgl]

Seems Greg Mankiw covered the 1st part of Blinder's oped but not the part you emphasized. Wonder why? Of course his readers decided to attack the latter part of this oped.

[bakho]

There is further benefit because CG losses can be written off against other income. For the most part, losses due to theft, accident, etc, are covered under standard deduction and cannot be written off.

[John M 307]

George Bush Senior, in a 1988 debate, gave the argument for preferential tax treatment of capital gains: lower capital gains tax creates jobs. But it should be clear that a tax favoring capital over labor encourages investment in capital over labor, thereby reducing jobs.

However, we know perfectly well the real reason for the favorable treatment of capital gains over labor. The rich and powerful benefit.

[Bruce Webb]

John gets to the crux.

It really doesn't matter whether they believe their theories about compliance costs, investment incentives, job creation (I suspect there is a typical mix of true believers and cynics) the net effect of each and every right economic proposal is to cut taxes for the wealthy. Eliminate taxes on dividends: check. Lower or eliminate taxes on return from capital: check. Eliminate taxes on corporate profits: check. Flat tax: check. Estate tax reform: check. Now there are different theoretical arguments for each but you cannot ignore that if you granted Norquist and Forbes the full range of tax proposals they present the net result would be the wealthy not paying taxes at all.

You can put lipstick on a pig, hell you can put a tiara and a diamond necklace on a pig, in the end you still end up with a greedy creature that grunts. People get squeamish at the term "class warfare", but really that is just a defense tactic deployed by those that launched it, the wealthy. When Bush 'joked' to that audience that they were his base: "The haves and the have mores", he was not joking at all. He was just expressing the sentiment that Leona Helmsly spoke too frankly: "Taxes are for little people"

[save_the_rustbelt]

There seems to be a theme here that investment is some how antithetical to operations and hurtful to labor. Huh?

Also Blinders' comment on the investment tax credit doesn't exactly make sense in this context.

Reminds of the blind men who felt different parts of the elephant and came up with different descriptions. I;m not certain what is being debated.

[jpe]

The column somewhat surreally misses that hedge fund investors are being paid for their labor, not their invested capital. And there's nothing especially "arcane" about that: like a waitress, their pay is tied to the amount of capital produced.

No difference between the two that I can see.

[evagrius]

"The column somewhat surreally misses that hedge fund investors are being paid for their labor, not their invested capital. And there's nothing especially "arcane" about that: like a waitress, their pay is tied to the amount of capital produced.

No difference between the two that I can see."

There's a difference between a waiter/tress carrying
mere food and someone handling the sacred object.

[jpe]

That's right, I forgot. And let's not forget another crucial difference: waiters/tresses merely "work hard," while equity somehow emanates from the sweat of hedge fund managers. (I'd love to get my hands on some of that "sweat equity." There must drink some weird stuff to make that happen)

[lonesome moderate]

When I discuss this issue with my Economics 101 students, I show them an example of a proposed investment that loses money before tax (and which, therefore, should be rejected) but which actually turns a profit after tax because of the preferentially low capital gains rate.

I don't see how I can put a lot of stock in this until Blinder, or somebody, actually spells out some of the details of the real-world example(s). WIthout that, it looks an awful ot like the old rhetorical trick of saying that a few examples logically lead to a general conclusion, without giving any of the information that would enable the audience to think for themselves.

[2slugbaits]

It seems to me that the first order effect of a reduction in the capital gains tax would be a big sell off of existing equities once the tax became effective. How does this increase investment? It's just a matter of trading names on the ownership of existing capital stocks. The argument that cutting capital gains taxes not only results in increased investment hinges on a lot of other intermediate (and sometimes hidden) assumptions that may not always hold. And even if it can be shown that cutting capital gains taxes increases investment, that does not in-and-of-itself mean that the increased investment is efficient. For example, what if uncertainty about whether the returns to the new investment will be retained or disbursed as dividends? Presumably that uncertainty carries a risk. And note here that we are talking about "uncertainty" and not variability.

[Peter Schaeffer]

I won't comment on the merits of capital gains taxation. However, the politics are less clear than many think. Check out "Democrats Lead By $100 Million In Money Race" (http://online.wsj.com/article/SB118515382609874577.html?mod=home_whats_news_us). According to the article, the Dems got 69% of the money contributed by the private equity / hedge fund crowd. They also outraised the Reps on Wall Street.

Will President Hillary kill the golden goose? Don't bet on it. It is quite true that the folks visibily pushing for lower capital gains taxes, estate tax reductions, special treatment of dividends, etc. are mostly Reps. However, the Dems are quite willing to provide sotto voce support as need be.

[robertdfeinman]

Why are the comments on Mankiw's blog so uninformative? They either launch into repetitions of standard conservative economic theory or they degenerate into ad hominem attacks.

Let's look at the idea of raising the capital gains tax rate.

1. The data as to whether a specific tax rate is a "good thing" or not is unclear. Therefore anyone who makes an unequivocal statement is not basing their argument on verifiable data.

2. It is true that lowering the tax rate on those who earn capital gains will increase their net income. This leads to two corollaries:

a) Those arguing for a rate cut are wealthy enough that they will benefit personally. In that case they are arguing rationally, they are maximizing their own wealth.

b) Those supporting the position are not wealthy (enough). In that case they are arguing against their own self interest. Money not collected in taxes means that social services that benefit them will be less and/or the deficit will be higher and/or their taxes will have to be raised to compensate.

3. Their last argument is of the form that "investment" leads to more wealth for everyone. Even assuming this is true (and as I said there is no clear evidence) their share of the bigger pie will be slight. So why would they argue that making the Walton's $40 billion richer while they become, say, $4000 richer is worthwhile?

I continue to be puzzled why people of modest economic means continue to support those policies which benefit the super wealthy. I understand the pundits who support these policies, even if they personal gains are slight as well. This is a simple case of not biting the hand that feeds you. It is also why these people are held in such low esteem - being a lackey to the king was never considered a noble profession.

[evagrius]

"I continue to be puzzled why people of modest economic means continue to support those policies which benefit the super wealthy."

'Cause they're gonna hit the glory hole one day.

[im1dc]

My reading of Alan Blinders editorial in the NYTimes is that he made a rational, reasoned and factually supported argument that treating Capital Gains differently ("preferentially") than other income was irrational tax policy and only directly favored those who hold Capital Gains and did not directly favor wage earners.

Further, he argued that there is no direct evidence that wage earners indirectly benefit by taxing Capital Gains at a preferential rate either.

Maybe it does or maybe it doesn't, there's just not evidence either way.

Yet, he argues there is direct evidence that the current system greatly benefits the holders of Capital Gains.

He seems to be making a pretty simple and straightforward argument.

Stop treating Capital Gains differently ("preferentially") from other income streams.

In other words tax Capital Gains at the same tax rate, or 'non-preferentially', exactly as other income streams.

He makes perfect sense.

Will some of these deal makers go offshore or overseas to avoid paying US taxes? Sure.

But doing so they will only incur greater risks. Everyone with Capital gains ought to be paying their fair share of the nation's overhead.

[ken melvin]

As with the benefits form global trade, I think it mighty decent of them to share. And, I'm thankful. I no doubt that if the shoe were on the other the foot they, too, would be most grateful for any crumbs that might fall from the table. In other words, to hell with a deal; the people should tell them what we will let them have.

[german_reader]

Just an example from the unknown world outside the United States how tax cuts on capital gains really work ( at least in some cases ).

From 2000 on the german ( nominal ) left red-green government under chancellor Gerhard Schroeder lowered corporate taxes significantly , removed taxes on profits from the sales of corporate shares by institutional shareholders and installed new tax privileges for private risk-capital investors like hedge funds and private equity firms.

What followed was the longest period of economic stagnation in Germany's postwar history, a sharp decline of fulltime employment by 1.9 million ( comparable to 6.8 million in the US ), tax losses from corporate taxes of around 100 billion between 2001-2006 ( 30-40% of the additional public debt during this period ) and the decrease of investments from 449 billion in 2000 ( 21.8% of GDP ) to 386 billion in 2005 ( 17.2% of GDP ). During the same period corporate profits grew from 304 billion in 2000 ( 14.7% of GDP ) to 419 billion in 2006 ( 18.1% of GDP ).

None of the arguments that are often presented by supply-side economists proved to be right. There was no acceleration in economic growth, no new jobs were created ( but many destroyed ), tax cuts didn't pay for themselves and longterm investments weren't encouraged.

It would be to simple to tie all these effects exclusively to the tax cuts. The introduction of the Euro, Basel II ( stricter rules for bank credits to companies ) or the increase of the oil price certainly played their role.

But the fact that no other european country, which introduced the Euro, faced such a sharp economic slowdown as Germany, makes the idea somewhat plausible, that the narrow-minded supply-side policy of the german government was a very important factor.

Instead of setting incentives to invest in the domestic market and create new jobs, the tax cuts promoted the maximization of profits and the aspire to short-term profits from financial engagements. This trend was enforced by the liberalizations for private equity and hedge funds.

As Germany shows, there is no simple connection between tax cuts for corporations or capital holders and economic growth and job creation. General, undifferentiated tax cuts for capital holders set the wrong incentives. They encourage short-term investments and financial engeneering. Nothing that improves a society in the long run.

Any responsible government should be very careful with tax cuts for capital holders. The chances to support undesired ( from the viewpoint of the vast majority ) developments in an economy or society are very high. Tax cuts should be limited to sectors of the economy ( for example "green" technology ) or forms of investment, which strengthen the economic and technological base of a country and can serve a society in the future.

The real nasty in regard to neoliberal supply-side ideologies is, that they are completely reality resistent. They ignore the negative effects for major parts of the society and they deny the risks for the long-term stability of economies and whole societies.

Even if the damages for the economy ( and the very real people, who depend on it ) are as obvious as in Germany, many neoliberal supply side ideologues never would confess, that they were wrong. Their worldview shows signs of fanatism, which reminds me very much of the totalitarian ideologies of earlier decades.

[Sebastian Holsclaw]

German Reader, I seem to remember something going on with the misallocation of labor due to hiring/firing restrictions failing to be reformed in opposition to most of the rest of the EU. Could that have been a factor?

[David68]

In general I agree with the concept that capital gains should be taxed at the same rate as salaries & wages.

But what about the argument that gains on capital invested, say, 5 years ago contains an element that has been eaten away by inflation and thus should be adjusted for that?

Like I said, I think a guy earning $100,000 should be taxed at the same rate as a trust fund kid earning $100,000 in capital gains on his portfolio, but is there a "fairness" principle at waork here?

[me]

"There seems to be a theme here that investment is some how antithetical to operations and hurtful to labor. Huh?"

The Six Billion IBM invested in India did not create ONE job here. If that isn't hurting labor I don't know what is.

[btgraff]

david68 beat me to the punch - i was going to suggest that there be some adjustment for inflation in terms of capital gains - for each year you held an investment, then the cpi (or some rough equivalent) would be tax exempt. but then, this would also apply to interest earnings - the problem is that the calculations begin to get messy - for example, if you buy stock and then sell some of it, then buy more etc.

the fact there there is no adjustment for inflation has been a huge incentive for those with capital to get the Fed (and other central banks) to over-emphasize inflation as a problem/the only problem for central banks to deal with.

the other thing is that the scandinavian countries have adopted high taxation on consumption, and low taxation on capital investment, with success.

[Tom W]

I thought that the article was just awful. I can't believe that Blinder would so badly misunderstand the issue at stake.

"When I discuss this issue with my Economics 101 students, I show them an example of a proposed investment that loses money before tax (and which, therefore, should be rejected) but which actually turns a profit after tax because of the preferentially low capital gains rate. ... The government thus induces people to make bad investments, which is a good way to run an economy into the ground. Come to think of it, that’s just what the old Soviet Union did. It invested copiously, but badly."

No. An investment which makes money at 15% taxation but loses it at 35% taxation is not a 'bad investment'. It is a correct investment at a lower tax rate. Investing thusly is not a misallocation of capital, because investments which become profitable at lower tax rates do not displace investments which are profitable even at higher rates, but rather lead to additional investment which otherwise would not have been made.

It's not like investors are trying to achieve the lowest profit possible. It's not like reducing taxes to 15% would cause investors to abandon their investments that were profitable even at 35% taxation, just so they could achieve the lower profit.

"Come to think of it, that’s just what the old Soviet Union did. It invested copiously, but badly."

This statement is so hilariously silly that Blinder deserves some kind of award. Does he seriously allege that lower capital gains taxes is somehow analagous to what caused the downfall of the old Soviet Union?

Again: investments which become profitable at 15% taxation are not misallocations of capital!

"But would taxing capital gains like other types of income imperil our economy? No. The Tax Reform Act of 1986 did exactly that, and it did not end capitalism as we know it."

Higher capital gains taxes would not "imperil our economy". But that is not the argument made by people who oppose higher capital gains taxes.

The real argument in favor of lower capital gains taxes (strangely never mentioned in Blinder's article) is that taxes on investment are taxes on _nominal_ gains, not real gains. As a result, the government doesn't tax the investor just for his gains; the government also taxes the investor when the government debases its own currency, which it does every year. Let me provide an example: if you make 10% on an investment in a given year, and inflation is 5%, and taxes are 25% of _nominal_ gains, then the taxes on your _real_ gains are 50%.

But how do we prevent the unfairness inherent in the rich making so much? The answer is quite simple, if Blinder would consider it. Investments should not be taxed at all as long as they remain investments, but when they are sold (and become consumption) then the _real_ gains should be taxed as income. In this scheme, taxes would be deferred even if you sold the investment and rolled the money in to some other investment, or if you re-invested dividends, etc. A person would only pay taxes when he _withdrew_ the investment and wanted to consume, but the taxes would be as income, not some special low rate.

That way, when the rich do something socially useful (like investing in companies) then they are not penalized, but when they consume extravagently (like by buying ferraris) then their money is taxed at a high rate. Remember that luxury consumption is not any more beneficial to the economy that middle-class consumption.

This scheme also has the additional benefit of not penalizing investors who aren't rich. If a person invested in the stock market for years and withdrew his gains for consumption during a period of unemployment, he would pay taxes commensurate with _his income_, not commensurate with some rate intended to soak the rich.

[ECO1]

A=B.

[german_reader]

@Sebastian Holsclaw,

the always same old story about the "sclerotic" German labor market. To give you a clue what's going really on here in Germany just a few facts ( I prefer facts, not ideology like so many "experts" ).

In 2006 there were 39.1 million people employed in Germany. Of these 39.1 million, 6.2 million were in public employment ( 15.4%, 5.5 million regular public staff + 0.7 million in "active labor market measures" - temporary government paid or supported jobs ) and 4.4 million were self employed. The rest - 28.5 million - were paid private employees. That's 34.6% of the total population ( 82.4 million ).

During the same year the United Kingdom, the cheerleader of "reforms" in Europe, proud of its deregulated labor market, had 28.9 million people in employment. Of these 28.9 million 5.84 million were in public employment ( 20.2% ) and 3.6 million were self employed. The rest 19.36 million were paid private employees ( 32% of the total population (60.4 million)).

Germany with its "sclerotic" labor market had 2.6% more of its population in private sector paid employment than the so incredibly flexible United Kingdom. Under a more "sclerotic" German labor market regulation the United Kingdom would have 1.6 million people more in private sector paid employment than today. And this includes East-Germany with its disastrous unemployment. If you take only former West-Germany without Berlin as a comparison, it would be 3.6% or 2.2 million.

Among European countries only Switzerland has higher private sector employment than West-Germany. If this is a "sclerotic" labor market, what is the rest?

Private sector employment in West-Germany comes very close to the United States or Canada. Every year around 8 million people lose their job and the same number find a new one. More than half of the unemployed find a new job within a year. Of the longterm unemployed ( 1.8 million ) nearly 50% wouldn't be counted as unemployed in the United States or the United Kingdom, because they have either a job ( up to 15 hours a week ) or are marginally attached or discouraged ( not actively seeking ). Unemployment in the United States or the United Kingdom currently stands at 7-8%, if counted like in Germany ( the same as in West-Germany ).

From 2000 to 2005 the manufacturing sector reduced its work staff by around 600,000 ( during an export "boom" ), construction employment declined by nearly 700,000. Do you really think, they could lay off so many workers, if the German labor market regulations were as rigid as many believe. Employment protection simply means, that employers cannot fire workers at will.They must have important reasons ( for example if someone steals or a company runs deficits ). Profitable companies can lay off workers, if they find agreements with their employees and pay them a compensation. It's not much different from what's happening at GM or Ford.

And as a result of "reforms" there are more temporary workers, who are replacing regular employees, often with lower wages. More and more jobs in retail trade and other areas of the service-sector are splited into "Minijobs" ( marginal part-time jobs ), which have lower employment protection and less benefits ( but more than for most US-workers ). Employers are using their new flexibility to cut their costs and to raise profits, not to create additional jobs.

From the viewpoint of companies the "reforms" are a great success, because they gave them the opportunity to enhance their profits on the back of their employees. From the perspective of the average employee or any responsible politician ( seems to be a small minority here in Germany ) or scientist, the reforms are a disaster. It's nowadays harder than ever before to find a good paying full-time job and many people are losing their future perspectives. Even in an official "boom" the number of regular full-time jobs stands slightly above 22 million compared to 24 million in the last economic recovery, which peaked out in 2001.

The "reforms" are part of the problem, not part of the solution.

[Lafayette]

g-r: Germany with its "sclerotic" labor market had 2.6% more of its population in private sector paid employment than the so incredibly flexible United Kingdom.

Perhaps. But, at the same time, German workers worked 1440 hours (per year) whereas the UK worker did 1660 hours (16% more).

Yes, yes, the German worker is more "productive" in each hour worked, you will say. Well the GDP per hour worked is 42.5 for Germany and 38.9 for the UK - a difference of less than 9%.

And, in fact, the above are not really the deciding factors as regards cost of labor. Unit costs in Germany are way, way above those in the UK. That may be OK for Germans who want to pay German prices, but it is decidedly not conducive for FDI (Foreign Direct Investment).

Notwithstanding, it is true that Germany has a dynamic export sector. Thank God for that. At least.

[Peter Schaeffer]

Check out "Democrats Lose Zeal for Raising Hedge-Fund Tax" (http://online.wsj.com/article/SB118584621735982940.html?mod=todays_us_page_one). It makes for an interesting read.

The point is not that the Democrats are worse than the Republicans on this issue. On the whole, they aren't. On average, they are better.

However, the issue is pretty close to a no-brainer. Note that Greg Mankiw recently said on his blog, "Deferred compensation, even risky compensation, is still compensation, and it should be taxed as such.".

The fact that the Democrats can't get themselves together on this issue, shows that really aren't a party of ordinary folks.

[Lafayette]

PS: The fact that the Democrats can't get themselves together on this issue, shows that really aren't a party of ordinary folks

Apparently true. Ordinary folks have something called "common sense".

Politicians on both sides of the divide are lacking in this attribute. No doubt because it is not a prerequisite for the job.

[german_reader]

@Lafayette,

Your numbers are basically correct. According to the OECD the average worker in the UK worked 1707 hours in 2002, compared to 1444 hours in Germany and 1428 hours in West-Germany ( 1815 hours United States ). Paid employees worked on average 1683 hours in the UK, 1361 hours in Germany and 1326 hours in West-Germany ( 1802 hours United States ).

http://www.oecd.org/dataoecd/34/42/35205504.pdf

The share of part-timers workers in Germany is very similar to the UK ( or Australia, Denmark, Switzerland ...) at around 25% ( 10 million ) of all employed and 28% of paid employees ( in the United States, Canada it's below 20% ). 80-90% of part-timers are women. Part-time work is a typical female phenomenon. The part-time rate for males in Germany is 10% or below. The majority of part-time working women are married women with children. This reflects on one side a more traditional role model ( "mothers should stay at home to care for their children" ) and on the other side the poor status of public child care and the lack of allday (?) schools here in Germany. Tax laws, that tax second family incomes ( normally the wife's income ) relatively high compared to other countries, are another reason. This discourages qualified women from working longer hours.

While only 5-10% of part-time working women in West-Germany declare, that they would like to work longer hours, the comparable share in East-Germany is 40-50%. Women in the former German Democratic Republic ( GDR ) were fully integrated into the labor market and public child care in the eastern part is much better than in West-Germany. East-German women have difficulties to fulfill their expectations under the now dominant West-German labor market model.

Productivity and GDP: As we all now GDP is a very abstract measure. I wouldn't overstate differences, that are in the range of a few hundred Euros. This is close to the error margin and might reflect more differences in the way GDP is measured, than differences in real productivity. And you should not forget, the per capita GDP in West-Germany ( which stands for 80% of Germany ) is around 6-7% higher than the German GDP. The productivity per hour worked in West-Germany is very close to the United States, while East-Germans have a productivity closer to Portugal or Greece at around 70% of the West-German level ( They are working as hard or harder than West-Germans, but the East-German economy lacks more investment to improve productivity ).

My main point was, that the German labor market was never a case for radical "reforms". Much of the differences between Germany and other countries can be explained by the way we measure things ( unemployment in the United States or the United Kingdom would be 2.5-3% higher measured with German standards ). Some are the result of the re-unification, some of the differences in the economic cycle. And most important: The "reforms" have worsened the situation. They have slowed down our economy, they are destroying jobs, they undermine our long-term competitiveness ( declining investment in education and infrastructure ) and they are an eminent thread to the social stability of this country ( stagnant wages, lack of social perspectives for the masses, exploding incomes for the elites ).

Nearly two third of the losses in regular full-time employment are direct job cuts in the public sector ( more than 1 million since 1995 ), job losses in the private sector due to diminishing public investment ( for example construction ) or misguided "reforms" in the labor market like "Hartz IV" ( cut backs in unemployment benefits, higher pressure on the unemployed ), the "Minijob-Reform" ( liberalization of marginal part-time jobs ), which gave employers the opportunity to split full-time jobs into low paid part-time jobs or to find workers for lower wages. The total number of the employed in the current "Booooom!" is nearly the same as during the last upswing 1998-2001. But the number of regular full-time jobs is around two millions lower than 2000/2001 and most of the ninties ( that's a lot in a midsize country like Germany ). And among the industrialized nations only Japan had lower wage growth over the last years than Germany.

Besides: the "reforms" in the United Kingdom were never a success in regard to the labor market. Unemployment under Thatcher and Major always stood between 10-15% according to German standards ( with the exception of a short period from 1988-1992 ). Private sector employment is and was always lower than in Germany ( especially West-Germany ). Tony Blair stabilized the labor market by increasing public employment ( 0.8 million since 1998 ) and public investment.

And even the super-capitalist United States have higher regular public employment ( 16%, 23.4 million, includes armed forces ) than Germany today ( 14%, 5.5 million ). Government and government dependent employment ( the military- and prison-industrial complex ) is around 3% higher than in Germany. Nearly all "successful" nations have significantly higher regular public employment than Germany ( United States/Australia 16%, Ireland 17%, Canada/United Kingdom 20%, Scandinavia 30% ).

To come to an end ( I have this unpleasant tendency to make extremly long posts ):

Our main problem is the public sector and the simple-minded neoliberal ideology, that public is bad and private is good. That tax cuts for corporations and top earners are more important than investments in education, child care or infrastructure. That the market can resolve all problems and anything becomes good, if only enough of the country is privatized.

[Lafayette]

g_r: Productivity and GDP: As we all now GDP is a very abstract measure. I wouldn't overstate differences, that are in the range of a few hundred Euros.

Sorry, but I don't buy the bit about "measuring things differently". Economic measurements are fairly standard throughout the world. When they differ, it is a matter for footnotes.

The FDI component, which drives a lot of economic activity in our day and age is not prevalent in either the old West or the new East Germany. Germany's decision to make the East German Ostmark equivalent to that of the West German Deutschmark was catastrophic. Had this not been done, then FDI would have been attracted to East Germany in exactly the same manner as elsewhere today (e.g., Slovakia, Poland, Hungary, etc.)

As it is, both East and West Germany have labor wage rates that are excessive and certainly not conducive to low-skill manufacturing.

I agree with you, German labor is not "sclerotic". But, it is incarcerated in a "niche", which is medium-size manufacturing of high-tech machine tools for export. It is only a matter of time before low-tech car manufacturing leaves Germany - just as it left the UK - for points east, which remain close to western EU markets for purposes of distribution but also accessible to the potentially large markets of the old Soviet Union that are largely untapped.

Germany is condemned, so to speak, to developing a vibrant services sector in the face of a continually deteriorating manufacturing sector. But, how is this any different from the rest of the EU ... or the US, for that matter?

We want workers with decent jobs at decent wages? Then, let's put to rest the silly notion that unskilled or low-skilled labor can provide them.

[Peter Schaeffer]

I could never make this stuff up... Maybe J. K Rowling, could...

"In Opposing Tax Plan, Schumer Breaks With Party" (http://www.nytimes.com/2007/07/30/washington/30schumer.html?_r=1&hp&oref=slogin)

[german_reader]

@Lafayette,

I agree with you, that the handling of the the re-unification was a catastrophe ( the exchange rate was an important detail ).

I don't agree with you on the excessive wage rates in the German manufacturing sector. Low qualified, low paid manufacturing has already left Germany nearly completely. What remains is mostly high end manufacturing and specialized work. Employment in the auto industry will decline, that's sure ( studies predict by 200,000-300,000 in the next twenty years ). But other sectors of manufacturing like green technology, high end optics, medicine technology or nano technology could compensate the loss ( if our "experts" are not mistaken ).

Wages in most manufacturing sectors in Germany nowadays are a minor part of the costs. In car manufacturing it is around twenty per cent ( or anywhere in this range ). The exchange rate of the Euro went up by more than 50% over the last years. Even if Germany would have doubled its wage costs, the price effect wouldn't have been that large. And what happened ? Germany runs from export record to export record. And exports to outside the Euro-zone have been rising faster than within.

The price is only one aspect in the decision to buy a good. Micosoft would be bankrupt, if the price were the only measure - given the many good open source alternatives. Nobody "needs" a Porsche, Mercedes or Ferrari. Mercedes can't compete with Hyundai, Nissan, Renault or Ford on the price. Cars and many other goods are status factors. Social positioning is a very strong impulse in the human nature. People like diversity and individual choice. And German manufacturers seem to be very good in producing specialized products of high quality ( sometimes the illusion of quality ) and high status value.

I can't imagine a world, where there are only one or two producers. Some diversity will remain. And China and India are giant new markets, with lots of options for new customers. The more wealthy they become, the higher the chances for western producers to sell their goods. And Germany has proved many times, that it can adapt to new circumstances.

I see the potential risks in other areas. In the age of peak oil and climate change, it will no longer make sense to ship goods thousands of miles around the globe. Energy ( and other ressources ) will be a scanty good. High scale manufacturing as we see today will be more and more difficult. Producers will have to develop new goods, which use less ressources and energy. This will be a challenge for all industrialized nations. China and India ( and the United States, given the extremly high energy consumption and the long distance lifestyle ) might have even more problems to adapt to this situation. For German car producers it will be a problem to combine heavy motorized, large luxury cars with low energy consumption and environment friendliness ( the French are better in this area ).

All in all low wage, work intensive manufacturing has gone and it will never return to Europe or the United States. At least as long as China, India and other developing nations can be so much cheaper in this field. And our problems here in Germany are not mainly in manufacturing. It's already less than 20% of all employment. Our problems are in the public sector and the domestic market ( which is mainly a service market ). And stagnant wages are a poison to domestic demand.

P.S.

I've looked up again the employment statistics. It's not only private sector part-time employment Germany has more than the United Kingdom. Great Britain would have between 1 and 1.5 million more private sector full-time jobs, if it had the same employment structure as Germany. And the differences in full-time employment between the United States, Canada on one side and Germany on the other, can be explained nearly exclusively by differences in the economic cycle, the better integration of women into the labor market and the bad situation in East-Germany. Male full-time employment is close to US levels in West-Germany.

[anne]

German Reader:

"My main point was, that the German labor market was never a case for radical 'reforms'. Much of the differences between Germany and other countries can be explained by the way we measure things ( unemployment in the United States or the United Kingdom would be 2.5-3% higher measured with German standards )."

Agreed completely, as several American researchers have recently noticed.

[anne]

The time of integration of West and East hase only been 15 years, and I do not find the integration at all regrettable or failing. I think German success has been remarkable in an effort that has scant parallel.

[Lafayette]

BBC NEWS | Business | Waiting for the East to flourish (9 September 2005):

It's been 15 years since Germany's reunification, and the once communist east of the country is still in the economic doldrums. But it could be here that the next general election - just a week away - could be decided.
The statistics are bleak.

Germany's 'Aufbau Ost' - the rebuilding of Eastern Germany - has cost an estimated 1.25 trillion euro (£843bn, $1,550bn) so far.

Despite the capital injection, the East's unemployment rate is still 18.6% - in many regions it tops 25%. The economy grows by about 5.5% a year, but from a very low base - and that is not enough to create many new jobs.

As a result the East is emptying. Since unification some 1.4 million people have moved to the West, most of them young and well-educated.

Hardly an upbeat assessment.

Accepting the Oestmark at parity with the Deutshmark, at the time, was intended to present a massive flow of people from East to West Germany, which the Kohl government feared at the time.

It also condemned East Germany to the labor wage rates of West Germany (about 70 DM per hour, or $26/hour) . Aside from internal investments from West Germany, there was little or no FDI.

The parity was colossally stupid. The result is noted in the above excerpt. The young East Germans voted with their feet.

Fifteen years is not enough, anne? You're not the one waiting, evidently.

[german_reader]

Tiny Ireland needed more than 25 years with massive financial subsidies from the EU to develop from a poor agricultural nation to the dynamic prosperous little superstar it is now.

Economic recovery in the east was also slowed down by the excessive sell out of the East German industry to West German and other competitors and the rash shut down of East German industries, that could have been the core of a new independent East German economy. We see today, that much more of the East German economy could have been saved. There are more and more examples of companies from the former GDR, that nowadays compete successfully in the national and international market.

I would like to send you, dear Americans, some of our politicians, economic "experts" or leaders to show you, that you're not the only ones, beaten with incompetent politicians and greedy, selfish "elites".

[Lafayette]

g_r: I would like to send you, dear Americans, some of our politicians, economic "experts" or leaders to show you

It's a deal!

We'll give you Dubya if you'll send us Angela!

[reason]

Lafeyette...
very good. But no we get to pick who.

[Lafayette]

reason: But no we get to pick who.

Even if we send him to you on consignment for the next 16 months?

We'll pay the rent ... :^)

[Wayneoh]

robertdfeinman writes
...3. Their last argument is of the form that "investment" leads to more wealth for everyone. Even assuming this is true (and as I said there is no clear evidence) their share of the bigger pie will be slight. So why would they argue that making the Walton's $40 billion richer while they become, say, $4000 richer is worthwhile?

This is another example of the left's use of the politics of envy, aka class warfare. Why would anyone care if the Walton's earn 40 billion (a dubious figure at best) if it didn't affect them & indeed they were allowed to earn 4000? I mean, what would thw Walton's do with the increase in earnings? Put them in the "mattress"? No, they would most likely invest in another store, employ more people or invest in new technologies to increase their operational efficiency.
Any of which would be beneficial in the aggregate. Many of us in the lower income brackets actually understand the left's appeals to our baser instincts and are able to resist the rhetoric, Mr. Feinman. And besides, I have never, ever been offered a job by a poor person...