Good governance and protecting property rights are as welcome as tax cuts and privatisation

This is a column about free market reforms, so you would probably expect stories about tax cuts, privatisation programmes, deregulation initiatives, trade liberalisation, or other ways of transferring power and resources from the state to the market and civil society. This is what we normally have in mind when we talk about “market reforms”, because these are the headline-grabbing, controversial examples. 

But there is also a less high-profile category of market reforms, namely reforms aimed at improving the legal framework within which market exchange takes place. This means strengthening the protection of property rights, the transparency of property relations, the ability to enforce contracts and swiftly settle legal disputes, the impartiality of courts, and the consistency of the legal system. 

Africa would be well advised to model the CFTA more on EFTA, and less on the EU. 

Such seemingly boring, technical issues often represent “reform bottlenecks”, in the sense that improvements in other areas count for little as long as countries fail to get these basics right. As Prof Martin Ricketts of Buckingham University explains: 

“Capitalism fails where the supporting institutions are absent. Accordingly, policy changes unaccompanied by some remedial action to address this underlying institutional weakness cannot be expected to bring the hoped-for results.”

Indeed – and this is the main reason why, for example, large parts of Eastern Europe and the Balkans have not been able to fully capitalise on the relative liberalisation that has taken place since 1991. However, judging from the latest edition of the Heritage Foundation’s Economic Freedom of the World index, this may be about to change. A number of countries in that region have recently made large improvements in strengthening the protection of property rights, especially Armenia, Azerbaijan, Kazakhstan, the Kyrgyz Republic, Macedonia, Uzbekistan, Kosovo and, perhaps surprisingly, Belarus. 

A particularly interesting example is Latvia, which has improved its overall economic freedom score by more than four points (out of 100), even though the country has neither slashed taxes, nor sold off state assets (at least not recently). But, as Heritage reports: 

“Latvia has made contract enforcement and property transfers easier by restructuring its courts and introducing other new procedures […] judicial independence is generally respected and property rights are protected.” 

From a classical liberal perspective, the improvement in governance indicators across the region constitutes real progress; it is every bit as welcome as, say, another round of privatisation or deregulation would have been. 

Meanwhile, Africa has been making progress on the way towards the establishment of its Continental Free Trade Area (CFTA), which will create a pan-African single market in goods, services, labour and capital. The idea is not new, but this time, they seem to mean it. Intergovernmental working groups have been established, and negotiations over the removal of tariffs, quotas and non-tariff barriers are underway. If all goes according to plan, a preliminary version of the CFTA will be operational by the end of this year. 

It is tempting to assume that in an era of global markets, regional trade blocs are no longer that important, but this would be a mistake. Geography still matters. The website “Our World in Data” illustrates this with a map of France that shows the location of French companies, according to their main export destination. It turns out that companies which mainly export to Belgium really do tend to cluster near the Belgian border, companies which mainly export to Spain really do tend to cluster near the Spanish border, and so on. 

Still, economists are generally ambivalent about trade blocs. While they reduce trade barriers between the participants, they can also lead to a more protectionist trade policy vis-à-vis non-participants, especially when accompanied by the creation of a customs union (as is currently envisaged for the CFTA). In a customs union, the more protectionist-minded members can hold back the more free-trade-minded members, which is, of course, what we currently observe in Europe. Africa would be well advised to model the CFTA more on EFTA, and less on the EU. 

The flat tax may have fallen out of fashion, but the economic arguments for it have never been refuted.

On a different note: remember the flat tax? The idea of replacing the income tax code with one single rate (above a tax-free allowance), with no exemptions, no deductions, and no differentiation between different income sources? Tax policy experts used to get very excited about the concept, and in the late 1990s, several (mostly post-Communist) countries began to adopt it. After the 2008 crash, the concept slipped off the radar.

But the flat tax is not dead yet. Two US states, Georgia and West Virginia, are about to turn their state income taxes into flat taxes of 5.4 per cent and 2.65 per cent respectively. The economic effects will not be huge, because state income taxes are not nearly as important as the federal income tax. But as far as it goes, it is a welcome move. The flat tax may have fallen out of fashion, but the economic arguments for it have never been refuted. Flat taxes do not just improve work incentives; they also reduce distortions. Under a flat tax, (especially high-income) taxpayers dedicate less energy to rearranging their activities in “tax-efficient” ways, and more energy to creating wealth. Add the reduction in compliance, enforcement and revenue collection costs, and you have a solid economic case. 

Since 2008, there has also been a backlash against private, pre-funded pensions. Several countries that had previously moved towards such a system have U-turned, especially Argentina and Hungary. However, the latest OECD figures show that elsewhere, the role of private pensions continues to grow. In the US, Canada, Australia, the Netherlands, Switzerland, Denmark and Iceland, the value of the assets accumulated in pension funds now exceeds 100 per cent of the respective country’s GDP.

So it’s not all doom and gloom. Despite the virulence and pervasiveness of anti-capitalist rhetoric, green shoots of growing market freedoms can still be found.