In recent decades two important economic developments have occurred.   First, average per capita income (in real terms, i.e. after adjustment for inflation) has continued to increase in the world.  Second, the distribution of that income has also improved from a global perspective, as the economies of most major ‘emerging’ nations have grown significantly faster than those of rich ‘developed’ countries.   The single most important factor underlying these developments has been the (partial) liberalization of the economies of China (since the early 1980’s) and of India (since the early 1990’s), which has spurred rapid income growth in those countries and elsewhere.  Taken together, these two countries account for about one-third of the world’s population.   

Beyond those two broad generalizations, one must be aware that there is a constant stream of economic policy measures being taken all the time in numerous countries.  Some of these measures do promote the introduction of competition and of market forces, and will tend to promote faster income growth.  At the same time, a number of other measures of a ‘restrictive’ nature will often unnecessarily lower economic growth in the affected countries.   Two recent studies, undertaken by economists at the International Monetary Fund, have examined the impact of (1) laws that limit work time in France, and (2) of government fuel subsidies in several developing countries.

 

The French Straitjacket  

It is well known that on average Europeans work fewer hours than Americans and Japanese do, although there are significant differences within Europe itself.  Assuming other things being equal, the (negative) implications for income growth in Europe should be obvious.  But, from a welfare economics perspective, the implications are not so immediately obvious.  They will depend on (a) whether the long-term trend to shorter work hours reflects tighter labor market regulations and strong trade unions, or (b) whether it reflects a genuine stronger preference for leasure in Europe.  In the first case the welfare impact will be largely negative, in the second case not necessarily so.

In 1998, a new French law forced ‘large’ companies (with more than 20 employees) to institute a 35-hour work week by the year 2000.  Smaller companies were given until 2002 to implement the measure.   The intention of the law was to create more jobs at a time of high unemployment.  As could be expected, it has done no such thing, and by forcing most people into a ‘straightjacket’ is has no doubt lowered economic ‘welfare’ in France.

In their econometric study, the IMF economists studied the law’s effect by comparing the behavior of workers in large and small firms before and after the new rules went into effect.   This is similar to medical experiments were the treatment (35-hour workweek) is administered to one group (large firms) and not to another (small firms).  They found that the law had a number of unfortunate and unintended consequences, and their conclusion (See IMF SURVEY of January 29, 2007, p.32) was quite negative.

“In sum, the 35-hour workweek appears to have had a mainly negative impact.  It failed to create more jobs and generated a significant – and mostly negative – reaction both from companies and workers as they tried to neutralize the law’s effect on hours of work and monthly wages.  While it cannot be ruled out that individuals who did not change their behavior because of the law became more satisfied with their work hours, simple survey measures do not show increased satisfaction”.  
 
The formal conclusion on page 15 of the study makes the same points in a more cautious and ‘nuanced’ way, using more scientific-jargon, and is well worth reading.

 

Fuel Subsidies in Poor Countries

Virtually all national governments intervene in energy markets in a variety of ways, particularly in oil-importing countries.  Even in oil-exporting countries, governments often set domestic prices below world market prices, thereby imposing an ‘opportunity cost’ on the suppliers.   In poor developing countries, governments often control the prices of fuel products and, in effect, subsidize fuel prices for consumers, in part to protect low-income residents.   In another recent econometric study, a number of IMF fiscal economists examined the effectiveness of such subsidies - which are of course always popular - drawing on a number of poverty and social impact analyses in Bolivia, Ghana, Jordan, Mali and Sri Lanka.  

At the level of government, fuel subsidies can contribute to unsustainable fiscal deficits and direct public expenditure away from more productive uses.   At the household level, below-market fuel prices encourage inefficiency in energy use.   They are also not cost-effective as a means to subsidize the poor, because they will inevitably involve a substantial leakage of benefits to higher-income people.  

For the five countries studied, the authors estimated that the aggregate budgetary cost of these subsidies amounted to 2.0 – 3.2 percent of GDP in 2004.  They also identified significant extra-budgetary subsidy costs borne by the private sector as a result of maintaining domestic prices below world market levels, and they found that richer households received a disproportionate share of the benefits.  Finally, they argued for a gradual phasing out of such subsidies and their replacement by better-targeted social assistance measures (e.g. in education, health care, and infrastructure like urban mass transport).