Posted by Gary Alexander on 12/10/09 6:20 am
In recent years, the historically socialist – even Communist – nations have led the world in economic growth and stock market performance. What’s the story? Is socialism better than capitalism after all?
The nations I have in mind are Russia – including its former satellites and Soviet nation states – plus Communist China and socialistic India and Brazil (led by a nominal socialist, President Lula).
Last week, we learned that India’s third-quarter GDP grew at an annual 7.9% rate, well above the economists’ consensus estimate of 6.3%, the government forecast of 6.5% and the 6.1% growth rate in India’s second quarter. India’s statistics bureau said the mining sector grew by 9.5%, manufacturing was up 9.2%, while transport and communications both expanded by 8.5%. (The agricultural sector lagged, at +0.9%, due to drought conditions.) In addition, we already know that China grew at an 8.9% annual rate last quarter, and Brazil is up 7.8%. The “BRIC” stock markets are also soaring, by an average 122%.
Click on chart to expand or print
China “B” Shares (in U.S. dollar terms)
By comparison, the U.S. S&P 500 is only up 22.8%, Japan is up 12.6% and the Euro-zone is up 27.5%. Why the difference? Why are some of the current (or former) socialist nations trumping the West?
Corporate Tax Rates are Falling
One major reason is the decline of corporate tax rates around the world, as some formerly repressive regimes have learned what I thought American politicians had learned long ago – that low taxes on capital formation often bring in more revenue, because they drive greater growth. Since 1980, the average global corporate tax rate has fallen from 48% to 25%. The biggest declines have come in formerly poor nations, hungry for new business. It seems that many other nations are practicing Reaganomics and we are not – to the extent that America has the second-highest corporate tax rate in the world, driving businesses away.
The Developed World’s Highest Corporate Tax Rates
United States 39.3%
OECD average 30.3%
Another measure of tax reform in developing nations is the drive toward a low, flat income tax. In the late 1990s, some free-market economists were invited to Russia, to give them some advice on how to draft a tax system. The economists recommended a 20% flat tax, to replace top tax rates of over 50%, plus the dreaded Value Added Tax (VAT). According to economist Richard Vedder of Ohio University – one of the economists present at the Russia meeting – once Vladimir Putin heard about the virtues of the flat tax, he said, “I like your idea of a flat tax. But 20 percent? Nyet! We will have 13 percent.” (The VAT remains, but Putin cut it from 20% to 18% and recommended further cuts to 12%.) Now, we also see low flat tax rates in the old Soviet orbit: 10% in Albania, Bulgaria, Kazakhstan, Kyrgyszstan and Mongolia, 12% in Georgia, 15% in the Czech Republic and the Ukraine, and 16% in Romania.
The effective tax rate in China is estimated at 11%, vs. 31% in 1978, according to Hoover Institution tax scholar Alvin Rabushka, who combed through all the difficult-to-find tax data in China. This does not include all of China’s indirect taxes, but the overall tax burden has been cut by 50% in 30 years. China’s story is well-known by now, but in a nutshell, Deng Xiaoping liberalized the Chinese economy when he took over in 1978, first of all freeing farmers to keep the fruits of their labor. That alone doubled food output within a decade and lifted hundreds of millions of Chinese out of absolute poverty, fueling national enthusiasm for Deng’s later projects, including economic enterprise zones near China’s coastal cities.
Is China really Communist anymore? Deng Xiaoping had three famous answers for that question. First, he said “To get rich is glorious.” Then, when pressed by hard-liners to favor communism over capitalism, he said, “What does it matter whether a cat is black or white, as long as it catches mice?” Pressed further, he said China still practices communism, but “with Chinese characteristics,” meaning entrepreneurialism.
The Chinese have a long history of entrepreneurialism – the “overseas Chinese” dominate the economies of most Southeast Asian nations – so all it took was permission to turn this energy loose at home. The result was growth rates of around 10% a year for the last three decades – a phenomenal growth story.
Some Nations are Socialist in Name Only
In the 1980s, I learned that some “socialists” (in name only) can be some of the world’s best capitalists. When Francois Mitterand of France’s Socialist Party was elected President in early 1981, Wall Street panicked and sold French stocks, but I was reading John Dessauer’s newsletter (Dessauer’s Journal) at the time (now, it’s called John Dessauer’s Outlook). He advocated buying French stocks, saying that Mitterand would not attack French businesses. He was right. French stocks doubled by the mid-1980s.
The same thing is happening in Brazil now. Although taxes are still chronically high in Brazil, the nation has won the oil lottery, becoming the “Saudi Arabia of the South Atlantic.” Now, we see pictures of the nominally socialist President Lula present at the launching of major oil tankers. In addition, Lula said Brazil would NOT spend its oil money before it comes in – something U.S. politicians should heed.
India also burdens businesses with too many taxes, but they are quickly learning that tax liberalism in growth industries increases their total tax income. In the decade after India’s independence from Britain, Nehru and other founding fathers of modern India installed a “Fabian socialist” government, influenced by Harold Laski of the London School of Economics, who favored central planning along Soviet lines.
India created five-year plans and nationalized its major industries, which created a bureaucratic nightmare and a dying economy. In 1991, facing a default on its foreign debt, India sold off many of its state companies, cut tariffs and taxes and eliminated most price- and exchange-controls. As a result, India has averaged nearly 10% per year growth since the mid-1990s, reducing poverty rates and creating new wealth for local entrepreneurs as well as investors in the burgeoning Indian stock market.
Investment Implications: Invest in Pro-Growth Economies
Back on August 4, I wrote about the “War Between the States” in America – how states that favor a low-tax, pro-business regimen are winning the battle for growth within America. Just as 50-state competition is working in America, a 50-nation laboratory is at work around the world. If America becomes too punitive to business and saving, then our capital and business will move overseas. The positive part of that equation is that there will always be a bull market for investors in nations that welcome business.
Taking this lesson home, perhaps the President and Congress can learn from the rest of the world (and our past experiences in the 1920s, 1960s, 1980s and in the recent tax cuts), that lower taxes can work magic. Perhaps politicians will continue to speak their socialist bromides to get elected, then practice capitalism.
We can always hope.