Immediately after the global crisis touched our shores in latter part of 2008, Romanian government turned to IMF for cash and wisdom. It has been an experiment done many times before by IMF and as many times before it is not working. We are now ending our 3rd year in this experiment and we are once again talking about Romanian economy slowing down due to global economy slowing down. Much like in 2008.
Granted 3 years is not enough to reform an economy but it is enough to out in place the right policies and incentives that would promote long term growth.
Turning to the economy the latest data is not encouraging. The economy is recovering much slower than in 2000, asset prices remain depressed or still falling and there is no job creation. Yes, there might be a good agriculture year and growth close to zero will be delivered in 2011 but this is not the driver for long term growth.
Nevertheless the poor performance of the Romanian economy should not surprise us given the source of the advice, IMF* and EU, and the policies implemented. Everything that was done until now could not have led to growth either in the short term or in the long term. When the economy needed help in 2008, 2009, 2010 the policies implemented – real currency appreciation, higher consumption taxes, high inflation and an increase in arrears – were all growth reducing. And even the no-brain-er like privatizing loss making state companies has been twisted into a solution that will raise questions from the process of selecting the managers to their pay and their accountability. The last three years have been wasted instead of being used to really reform the economy.
What most economists and politicians forget, especially in times of crisis, is that long term growth only comes from increased investment. As expected during crisis both household and business investment has fallen. Unfortunately, this is the area that received the least attention in Romania and it is still showing negative growth from one period to the next.
In the long run investment is driven by a eliminating uncertainty from the economy, clear and transparent fiscal policy, expected stable path for taxes, stable and transparent regulations etc. Most importantly investment requires permanency. Temporary measures would not spur investment.
This brings me to my proposal. There are 4 big and bold steps that fiscal policy needs to do today: cut profit tax to 10% or lower, cut income tax to 10% or lower, reduce social contributions and show a credible plan to cut the public work force by 50% in the next 3 years.
I know these are really difficult to implement but current crisis provides the best opportunity for such solutions to be adopted.
Cutting income and profit taxes are very controversial moves. So is the reduction in social contribution. However, any tax on capital or labor creates distortions. Taxes on capital affect the savings and investment decision while taxes on labor create inefficient allocation and affect hiring decisions.It is time to move beyond the social ideas that “evil” corporations need to be taxed or that “rich” people need to be taxed more than others.
But the most compelling argument is that both income and profit tax account for a very small part of total tax revenues. In fact in Romania most of the companies and households sped a lot of time trying to find solutions to dodge taxes. Again a very inefficient way to spend resources and time in an economy.
The biggest task for Romanian policy makers is to embrace market forces. For this, they have to shed their preconceived notions about the market. They have abandon their core economic and political principals. It is not easy, but if they truly care about Romania and its future it is the only option.