Tuesday, September 25, 2007

The falling dollar

The New York Times, among many others, is worrying about the falling value of the U.S. dollar against other currencies. They are right to worry: US tax cuts, helped by a ridiculous ideology that “deficits don’t matter” are part of the reason why American consumers have been on a spending binge, and in the process borrowing money from abroad which will have to be paid back one day. Chickens are now coming home to roost – and the dollar is falling. The NY Times went on:

Why worry about a weaker dollar? The United States imported $2.2 trillion of goods and services in 2006. A sharp drop in the dollar makes those items considerably more expensive — the functional equivalent of a tax hike on consumers.

This brings out an important point. Those people who would demonise taxes – and there are plenty of people who do – fail to see that the shift in the tax burden is a bit like a shift in the exchange rate. Currency adjustments that happen too quickly can certainly cause pain – as some Americans fear is starting to happen now – but in the longer term the weakening or strengthening of a currency will not harm an economy per se. What it will do is to shift the mix of economic activity in an economy – both between sectors of economic activity, and also over time. Some people win, others lose, sooner or later. China seems to be pursuing a weak exchange rate to stimulate its manufacturing sector. Some countries, at some times, seem to do well out of having strong currencies: they can, for one thing, make imported goods cheaper. America’s weakening exchange rate will cause pain, certainly in the short run, but that is not to say that it is a bad thing: most economic commentators would agree that this pain is inevitable, like a hangover after a drinking binge, and necessary, in order to rebalance American growth, reduce excess consumption and curb the deficits. Short term pain is balanced by longer term gain.

A shift in a country’s tax take does a similar thing. Higher or lower taxes are not bad in themselves - instead they cause changes inside the economy, creating winners and losers. Higher taxes can, among other things reduce the short-term net profits of businesses and direct returns to shareholders, but can increase their longer-term prospects, because of course taxes pay for public services that businesses need, like education, roads and good market regulation. That is why, contrary to the protests of those who would demonise taxes (and there are many of them in America especially,) some of the world’s highest-tax countries are also considered among the most “competitive”. In the World Economic Forum’s Global Competitiveness rankings, high-tax Finland, Sweden and Denmark are ranked the second, third and fourth most competitive countries in the world, higher than the United States. (Switzerland, which is a middle-tax country, came top.)

Are higher taxes a good thing? Well, first, one argue that taxes can be too high just as they can be too low – that is for electorates to decide. But one economic shift that higher taxation does tend to provoke is that wealth and income inequality in the higher-tax country tends to fall. The tax-demonisers conveniently like to sweep this fundamental point under the carpet. American electorates seem to be more comfortable with inequality than European or Scandinavian ones are, although the pendulum in America seems to be swinging back, a move that current market turmoil seems likely to encourage. And there is one thing that is unequivocally bad: when the wealthiest sections of society can skip offshore to reduce their tax burdens, leaving everyone else to pick up the tab.

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