The Public Sector in Economies in Transition

By: Dr. Sam Vaknin
 

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In the previous article, we described the various methods developed in the West to cope with the ever-burgeoning public sector.

Yet, economies in transition everywhere in the world have learned a lesson the hard way : not everything that is Western - necessarily fits their needs. Many Western techniques, methods, systems and ways of thinking cannot be applied in Macedonia, for instance.

The public sector is a great burden on economies everywhere.

It is mostly financed by collecting taxes from individuals and businesses.

Taxes are re-allocation of economic resources. Taxes are nothing but money transfers from one group of citizens (the taxpayers) to other groups : to those who cannot pay taxes (such as children and the elderly) and to those who would not pay taxes, the tax evaders. Taxes are a penalty paid by the more productive and honest segments of society. Small wonder that taxes have a bad reputation in the West. They are considered to be both unjust and inefficient.

But taxes are both necessary and inevitable. There is no better way to finance the operations of the government and of the public sector.

The more taxes collected - the heavier the involvement of the state in the economy. This involvement is measured as a percentage of the GDP - the Gross Domestic Product. As we mentioned in our previous article, the figures are frightening : governments consume from 19% (Singapore, Hong-Kong) to 59% (France) of the products and services produced in the economy !

Research shows that public spending of tax money is 6 times less efficient than the same money invested by the private sector. The two sectors : the Private and the Public compete on the same, limited, amount of resources. Every Denar paid to the tax collector is one Denar less invested in the formation of new businesses and one Denar less invested in private consumption.

We can safely state that taxes inhibit economic growth and increase unemployment.

So the current mood in the West is anti big government and anti taxation.

People evade taxes. About 13 - 25% of the total capital in the world is "black" capital, upon which taxes were not paid. It is estimated that Macedonian firms and individuals hold more than 1 billion USD in undeclared cash - against an official figure of 200 million USD in circulation in the whole Macedonian economy.

People openly refuse to pay taxes and they take their governments to court on these issues.

Governments are doing their best to simplify procedures and tax returns (=the forms on which income is reported).

In fiscal theory, we differentiate between progressive and regressive taxes.

A progressive tax is one which is larger - the larger the income is. A millionaire in a progressive tax system will pay much more (as a percentage of his income) than his driver.

A regressive tax is one that totally unrelated to the level of income. Both the millionaire and his driver will pay the same percentage of tax if they buy a car, for instance.

Governments have become desperate. They introduce one rate income tax systems : all incomes are taxed at the same rate, regardless of their size. They are switching from taxes on income (which are socially progressive in nature) to taxes on consumption (such as VAT - Value Added Taxes) which are socially regressive in nature.

The overall goal is commendable : to lower the burden of taxation to less than 20% of the GDP.

But obtaining this goal means that Governments will have to reduce their involvement in the economy and cut back on services and on the public sector.

This is not a very clever idea for economies in transition.

The public sector in economies in transition could and should be privatized only after three conditions have been met :

First, the establishment of a strong private sector. Individuals and firms in the private sectors are the consumers of electricity, water and phone services. Without a strong customer base, it would be very difficult to sell the PTT, the electricity company or the water companies to any private investor in reasonable prices. The public sector must become profitable to be sold to the private sector (=to be privatized). A losing company is not worth anything to an investor, unless he thinks that he can turn it around and make it profitable. The best way to do this is to increase its sales to a loyal and sizeable group of clients.

The second condition : the de-regulation of prices and the abolition of subsidies.

The state must exit forgo all levels of intervention in the finances of the public sector. It must not fix the prices of its products and services and it must not subsidize it. Subsidies and tax incentives thwart and distort the true economic and financial picture. They hinder the proper and correct valuation of the public sector firm by prospective investors.

An investor must feel certain that he will be allowed to fix any price for the goods and services sold by the public sector firm that he is buying. This is the way to profitability and financial health. The government does not need to worry :

If the investor will charge too high a price - his clients will go to his competition.

But what if there is no competition ? What if electricity is supplied by only one electricity firm (a monopoly) ? Who will the client revert to if the prices that he is charged are much too high ?

This, precisely, is the third condition :

The opening of the marketplace to competition, both domestic and foreign.

To cancel all laws, regulations, rules, precedents which inhibit or prohibit competition. To eliminate tariffs, quotas, permits, licences and controls (barring those which relate to public health and to the protection of the environment).

Why should Macedonia have only one PTT ? Why not six providers ?

Why not allow anyone to produce electricity and sell it to the electricity company ? Why to have only one electricity company ?

Subject to the right regulations concerning safety and financial wherewithal - everyone should be allowed to do anything. Economic history shows that competition provides better goods and services at much lower costs.

It also shows that the public sector is a potential hub of inefficiency and sometimes blatant corruption.

"Lean and Mean" is the name of the game in today's economic environment.

The Public sector is fat and sluggish. It has no right to continue to exist.

Even private sector enterprises are "downsizing" (cutting their labour force considerably).

But certain functions can scarcely be transferred to the private sector. These functions are inherently non-profitable and non-profit motivated. They are usually performed by municipal, local and regional authorities.

The municipal (local) and regional part of the public sector has five sources of income at its disposal :

1. It is empowered to collect taxes from individuals and from businesses - the size of which is normally linked to the (residential or office) space that they occupy.

2. It is allowed to collect fees and charges which are fixed and relate to the provision of services such as : water supply, sewage, sanitation, posting commercial signs, parking and toll roads).

3. It is authorized to levy fines on transgressors against municipal rules and regulations. The best known form of this kind of financing is the parking ticket.

4. Mainly in the USA, local authorities are permitted to sell municipal bonds ("Munis") to the public - through the Stock Exchange - and directly to institutional investors, such as pension funds.

The local authority which issued the bonds pays the bondholders from current income generated by tax revenues and from specific incomes generated to it by specific projects.

An example : a local authority wants to establish a water treatment facility.

It costs 100,000,000 USD. The Authority receives 60,000,000 from the government and sells 40,000,000 USD worth of bonds to the public via the stock exchanges.

Once the facility is built, it begins to supply water to the residents and to businesses. They pay for the water that they consume - and the income from the sale of the water goes to the bondholders. This income covers both the interest payable on the bond (=its coupon) and the money that the bondholders
invested in the bonds themselves and which they have to recover.

5. Lately, a new fashion is developing in public administration, called devolution.

It is the transfer of parts of the national budget directly to the local authorities or granting them the right to regulate their own fiscal (=tax) systems.

Devolution is a prime example of a mega-trend in human societies : that of the dismantling of Big Government. But this is subject for yet another article.