Tuesday, October 09, 2007

How a Successful Economy Works!

The Republican Debate today about economic issues inspired me to surf the web for something about a country that has produced a remarkable success story, Estonia. Known as the Baltic Tiger, Estonia has consistently experienced 8% economic growth, dramatically reduced inequality, and is the home of world leading technology development, including the internet telephony service, Skype.

Historian, twice Prime Minister of Estonia (1992-94 and 1999-2002), and current member of the Estonian Parliament, Mart Laar is widely recognized for his leadership in bringing his country from economic and social ruin under communism to being one of the most vibrant societies in the world today. When he first became Prime minister at age 32 he initiated wide ranging reform of the economy including privatisation, unilateral free trade, a technology savvy government, and the world’s first introduction of flat tax. He is now credited with Estonia’s astonishing economic turnaround.

I found an interview that a Canadian, David Seymour, had with Mart Laar in August, 2007.
I laughed when I got to end of the interview because the liberal Canadian heard some things that kind of shook him up. I encourage everyone to read the entire interview.
Here is a little sampling of it.

David: Mart could you please give the people of Canada an overview of how you changed the government and economy in Estonia in your two terms as prime minister, and what have the results been for ordinary Estonians?

Mart Laar: When we started, in 1992, our economic reforms, Estonia was in a state of economic collapse. Communism means a system which fails and the longer it lasts, the more it fails. The heritage of the communists is what we had, when my first government took power in '92 we had huge hyperinflation of 1000%, we had most of our industries and economy owned by the state, we nearly produced nothing that we could sell to the west, so we were dependent on the Russian market, and this was the worst. During the time of hyperinflation, social inequality and power inequality in the country raised tremendously. There was a small group of people motivated by the former communist regime who had access to the foreign currency, and during the hyperinflation, this was a source of very high inequality at the beginning of the reforms. And we had a very high poverty rate. So the task of the reforms was to really to get the country and the Estonian people out of this poverty. To do this, the only way was really a radical economic approach, starting with the macroeconomic stabilization, bringing the hyperinflation down and stabilizing the monetary system. And the last reforms were taking the power from the hands of the government to the hands of people. That was the main goal of the reforms because any government, any Prime Minister can’t change the country, the people can. So the government’s goal was to empower the people, and this was done by different reforms. Starting from the property reforms, privatization, liberalization of all of the economy, and the tax reform which was a very important part. We created the first flat tax in the modern part of the Western hemisphere.

David: Many Canadians would be surprised about flat tax reducing inequality. They generally believe that progressive tax gives more revenue to the government and makes sure that those who can pay more do so. What has been the Estonian experience of government revenue and equality with a flat tax?

Mart Laar: It is not now, anymore, only an Estonian experience because a flat tax has worked so well in Estonia it is now copied by more and more countries. So every year we have the next one or two countries joining the club and they are not only small countries, among them are quite big countries. The experience is, nearly everywhere, the same. First of all what happens is the government revenues will go significantly up. Lowering taxes often makes the economy grow, but especially the introduction of the flat tax, which makes the government revenue higher because progressive taxation with the huge amounts of exemptions is actually such a complicated tax system that it is very easy to avoid the taxes. Especially the very rich people can do this because they can hire the lawyers and tax experts, but for the poor people that is a possibility that doesn’t exist. With the flat tax the tax system becomes simpler. It is easy to understand for the people but it is very easy to understand for the officials as well, so it is very hard to avoid. The results will be not only that you get more revenue but you get a lot more revenue. There is very clear evidence in all the countries that have introduced a flat tax, especially when we compare to the countries that have done this to the countries in the same region that have not done it. Then you see the real change and the real difference. Then you see what it means to move to the flat tax.

The second part is the social equality question. Actually when you analyze the flat tax, the first evidence is that in every country that has introduced the flat tax, the Gini coefficient, which has been the important measure of inequality has come significantly down, not up, in every country that has introduced the flat tax. The second part is that the poverty rate has gone significantly down as well, so it is very clear, the result. And now many mathematical studies have been done on the flat tax. It has been found, very interestingly, that in the most used form of the flat tax where there is one exception, so there are two levels of taxation, zero and the flat tax rate, which means that a lot of groups, the most poor part of society, are actually liberated from the taxes. And in this [flat tax] system, the progressivity of the system, is actually higher than in the progressive system. As I said earlier, it is fair. These people who use the exemptions [in a progressive system] are not the people to whom the exemption is targeted, and most exemptions are not reaching the groups they are there for, but they are used by the richer part of the population. Which means, actually, that this [flat] tax system is actually more [progressive]. And the studies are really proving that the progressivity of the [flat tax] system is actually higher than the progressive system due to the large exemptions. So it is a little bit of a paradox but, when you look at the system it is quite easy to understand how it works. It is just fair.

David: Picking up on the fact the Skype was generated in Estonia, a lot of people in some provinces of Canada, particularly Saskatchewan and Manitoba are concerned that free trade agreements, even with other Canadian provinces, will make local industries victims, can you tell us a bit about how a country that had previously been wrecked by communism is able to compete with Western Europe?

Mart Laar: I think that was … one part of our economic reforms, in 1992 we abolished all custom taxes, making Estonia a free trade area. A lot of managers from the former Soviet factories came to me and said that I would destroy Estonian industry. I said it must be a very weak and uncompetitive industry which needs to be destroyed. I think this is such a perception in the minds of politicians that, they know what is competitive industry and business doesn’t know. It is not true. I think the task of the government is to create in your country the competitive industries which are really competitive, and free competition is the best source to do this. Estonia has been an excellent example of how this kind of competition makes the economy stronger. Countries around us who have used different strategies have gotten significantly smaller growth and less prosperity than countries that have opened themselves and moved to free trade. Competition decides which industries are efficient and which are not, so you have the industries that really can compete all over the world.

David: About privatization, again, it is a big concern in Canada that if certain government businesses are privatized, our energy, our telecommunications, even, in some cases, transportation –if we privatized those then the companies would be run for the owners rather than the people.

Mart Laar: Again, this is a very wrong perception because, if the [privatized] companies are not run for the people they are not competitive. Which means the private owners, these people are not stupid. They are not risking the taxpayers’ money they are risking their own money. And, to earn the money they must provide the services, in the open theory of competition, if they are not doing this they will fail. Whereas when the government can risk the taxpayers’ money and lose it, the private sector find they can’t do this. So in most areas they are significantly more competitive and reliable than the government owned company.

David: Two final quick questions, how hard is it to learn Estonian, and what is your immigration policy?

Mart Laar: Estonian is a little bit different from the other European languages, like the Nordic languages mostly spoken by the Finns, Hungarians, Estonians, so it’s complicated but it is absolutely doable. I have seen American Peace Corps members who have all learned within three months. The girls are beautiful and the beer is good, so it goes fast!

David: Well you might find you have a few more Canadians over there soon, thank you very much.

Mart Laar: We have, we have, thank you.

I also found another news article of Mart Laar speaking to a conference in Bulgaria. In his speech Mart emphasized that the free internet service in Estonia was a critical factor for success.

An important step in the radical reforms and the fight against corruption had been the establishment of e-government in Estonia. E-government had achieved higher transparency, holding public officials accountable for every penny spent while giving citizens access to the decision making process. People could read proposed bills online and have a public debate about them, before the bill would go to parliament to be voted into law. This process resulted in fewer mistakes being made in new legislation.

Maybe instead of wishing for a Republican President to be the next Ronald Reagan we need a President with the economic common sense of Mart Laar.

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