Not only is the prisoners’ dilemma a well-known example in game theory. It is also a central issue in political negotiations. One of these negotiations that has to be conducted concern corporate taxes.
It was one of our past ministers of finance, Karl Heinz Grasser, who meant that he loves competition and that it was a good idea to compete with other countries by means of reducing the corporate tax rate. The incentive is clear: Lower corporate tax rates attract firms and firms crucially determine economic growth and employment. Business administrators and politicians might think that this indeed is the end of the story and so far it seems to be a reasonable plan.
However, economists know it better. Following the logic from above, any other country has an incentive to lower their corporate tax rates too. Furthermore, if they love competition as much as Karl Heinz Grasser and exhibit the same lack of information, they will continually underbid one another. Economists call this process the race to the bottom.
Theoretically, this race only ends as the public budget is not able to refinance the gifts anymore, which they handed to enterprises in terms of low tax rates or even subsidies. The burden of this policy has to be borne by households.
While this issue alone can already be criticized, it does not even take the instability and the transition costs that have to be avoided into account. So, for just a moment ignore whether the mistakes occurred in Austria or Ireland or elsewhere. Maybe in the short run even abandon the determination and enforcement of the so called efficient corporate tax rate. Just ensure that it is uniform, at least within Europe.
In her last post, Katharina pointed to a great data source on R&D expenditure, GERD. In the comment section of that post we discussed the issue of cuts in government R&D expenditures. An interesting question in this context is whether public R&D expenditure is a complement to private R&D expenditure or a substitute. If it is a complement, cuts in the public R&D budget are very bad, because they can be expected to be followed by cuts in private research budgets. If it is a substitute, public R&D ‘crowds out’ private R&D, so that public cuts are not that bad because they can be expected to be replaced by private R&D.
There is an extensive literature on this question, yielding mixed results. So I asked myself what does GERD say? The figure below shows a scatterplot of government and private expenditure on R&D as a share in GDP for 36 countries in 2008. You can see that the data points are pretty much all over the place (Austria is marked red). It turns out that if you regress private on public R&D expenditure, you get a positive coefficient indicating complementarity. However, the coefficient is not statistically significant (t-ratio of 1.63) and the R-squared is very low. So we have no strong evidence for complementarity, but also no evidence for substitutability. Instead, what my recreational econometrics exercise suggests is that private R&D expenditure is pretty much independent from government research budgets.
In part 1 we have established that growth in the West relies on innovation and technology much more than growth in developing countries. We are the ones at the technology frontier, so if we want to grow, we need to be more innovative. In this blog I’ll mainly cover government policies regarding R&D and higher education, focusing a lot on expenditure (1). If you’re interested in broader measures, you could start here, with the Innovation Union Scoreboard 2014.
For those of you who like the big numbers, let me introduce you to GERD. GERD is the Gross Domestic Expenditure on R&D, which includes expenditure by business enterprises, governments and foreigners. In 2010 GERD stood at 245 673 million in absolute terms in the EU-27. Given that this does not really tell us much, GERD is normally calculated relative to GDP. Between 2000 and 2010 the ratio has roughly been flat at around 1.80-2% of GDP. This means that internationally the EU-27 figures are below those in other countries: Japan (3.45%), US (2.80%).2 There are also substantial differences within the EU. The highest expenditures in 2010 were reported from (how could it be different) Finland (3.87 %), Sweden (3.42 %) and Denmark (3.06 %).
Over the past couple of months a number of things have been happening, which made me want to start writing a blog. So, when I finally sat down and started writing on one of them I realised that the topics are all linked and can be wonderfully put together under one question: „Are we being stupid?“ If I had to give this series a more technical title then it would be something along the lines of „Are Europe’s efforts to stay competitive appropriate to ensure the future growth of the region“, but, let’s face it, „are we being stupid?“ is a much more catchy title and regarding some of the things I’ll be talking about also way more appropriate. I wanted to jump right in, but some of you may have very little background in economics or economic growth, so I’ll use part I to put the whole debate into context (by heavily oversimplifying things!!!). By the end of this blog you should know why Western economies are innovation-driven and why that matters. In part 2 we’re getting more to the core of the issue about how innovative Europe is in comparison to other developed countries. Part 3 is a proposal for the changes I consider necessary. Let’s get started…