Figure 8 clarifies that the minimum wage means that there are no full time wage earners below M, so that tax and net income are only relevant above it.

Figure 9 gives gives the same result but then as a net income plot. The horizontal axis gives income, the vertical axis net income. The tax is given by the difference between net income and the 45-degrees line. Subsistence now is a horizontal line at B. The intersection of the B-line and the net income line gives the minimum wage M. You must earn at least M to satisfy the minimum net income requirement B.

Let us now combine the earnings distribution and the tax plot.

Note that the tax figures have shaded areas only above the minimum wage. The tax appears effective at and above the minimum wage, but not below it. Though taxes are defined below the minimum wage, there are no taxes collected, since people are unemployed below the minimum wage. The clear area from net minimum till the gross minimum wage M can be called the Tax Void.

The difference between net and gross is called the tax wedge, and it is generally seen as a vertical jump. There is a change of perspective now, in that we see it also as a range, particularly relevant for the minimum wage.

In the Tax Void the tax code has only a paper function (in terms of tax collection). The tax code helps to drive up the minimum wage, but it does not collect any revenue. Abolishing taxes in this area therefor does not cost anything too. Note that abolishing the tax void would mean that exemption would be chosen at subsistence.

Part of unemployment below the minimum wage is still above subsistence. If taxes would be abolished in that section, then the affected people could still earn a living wage, and need no income support. This kind of unemployment can be called the Tax Void Unemployment. Figure 10 gives a plot of that section (shaded) for Holland.

For the record: the Dutch minimum wage only holds for fulltimers, and not for parttimers. Holland has a lot of parttime work (for that reason). We have eliminated parttimers from the present analysis.

How has the tax void come about ? Since abolishing the tax void does not cost anything, and would generate a lot of employment, why don’t we abolish it ? Why do we continue the present absurd situation of mass unemployment ?

It appears that the situation has come about gradually, by a mechanism that is difficult to observe directly. It involves the co-ordination of tax policy with social policy, specifically the indexation of taxes and subsistence.

First note that OECD countries adjust their taxes for inflation, see OECD (1986). Tax exemption in 2002 will often be close to the inflation-adjusted real value of 1950. On the other hand, research in social psychology shows that subsistence tends to rise with the general level of income, the growth of which consists of inflation and real growth (or real net income). So there is “differential indexation”. In the 1950s exemption was pretty close to subsistence, so that there was no void to speak of. Since then, exemption has lagged behind the standard of living. When tax exemption lags behind net subsistence, then there is a multiplier effect on gross subsistence, with an accelerated increase of the tax void. This process also explains the ‘squeezing of income differentials’ in OECD countries.

Holland is the example again. In 1951, exemption for a single person household was € 354 and for a couple without childern € 463. At that time there was no official minimum wage, but it can be taken at that value. The price level in 2002 (1951=1) is 6.25 and the wage index 2002 is 25.59. This allows us to construct Table 4.

* Dutch readers can find the computation in Colignatus & Hulst (2003)

Till 1997, official exemption € 3223 lagged strongly behind the wage adjusted 1951 value € 7369. In recent years the gap has been reduced, but the 2002 official exemption of € 8025 still lags more than € 1000 behind the wage adjusted 1951 value. Most important, it lags € 4500 behind the (single person) net minimum wage of € 12500.

Taxes

If we index tax parameters on inflation only, then this affects exemption x in the Bentham tax function, and thus x should be included in the function call.

We also write the tax function as T[y, x] and net income as Net[y, x].

Subsistence

The indexation of subsistence differs from other incomes. When wages follow, on average, an index wi, the real subsistence index rsi commonly follows the net average wage, i.e. the wage after taxes.

Deduction of the real net average income index

We choose the base year so that x[0] = B[0]. Let W[0] be the average wage in the base year, and let h = B[0] / W[0] be the base year ratio with subsistence. Then the index of real (net) subsistence rsi is set to the index of the real net average wage rnai, and is (proving (13.3d)):

 with B[0] = W[0] h:

               (13.3d)

For example, if base subsistence is half the base year average wage, B[0] = ½ W[0] then  h =0.5. When r = 0.5  then rsi = 0.33 + 0.67 rwi.

These formulas call for a graphical illustration. We only need data on rwi, r and h for a stylized display. We will take r = h = 50%. Then we need data on rwi, and we can use our example of Holland.

Graphical presentation of the Dutch data

Appendix Table 20 gives the required data on the Dutch economy. Dutch 1951 exemption can be taken as 1951 subsistence. Before we use the data for the formula, let us first see what they mean. Figure 11 and Figure 12 on inflation P and real income growth rwi = wi / P  show that the data fit above classification of subperiods for inflation and real income growth behaviour.

Holland, 1951 = 1

Holland, 1951 = 1

Using the data for our analysis

We now use the data for our analysis. There are four combinations of gross/net and real/nominal. This results into Figure 13. ‘Subsistence’ is always measured as a net term, and ‘minimum wage’ as a gross term. For Holland, we find that real subsistence has risen about 4-fold since 1951, and the nominal minimum wage more than 30-fold. The computed nominal minimum wage relates well to the factual 2002 minimum wage. Not only inflation accounts for the rise, but also an increased tax burden (that encounters inflation again).

While the above considers exemption x, the analysis can be extended with an analysis on the marginal tax rate r.

Many economists hold that a high marginal tax rate is a disincentive for labour effort. They frequently propose a change from the income tax to the Value Added Tax (VAT). If we assume the same total tax revenue then the VAT might allow for a lower marginal tax rate, for the reason that the VAT has no exemption. At least, that is commonly conjectured.

I agree with the basic idea about the disincentive effects of marginal tax rates. Namely, economic theory assumes maximising agents, and the condition for a maximum can normally be expressed in terms of marginals. However, the marginal must be computed correctly. Above marginal rate r is only a static rate, that applies to a specific regime, for example a specific period. However, tax rates are adjusted from year to year. A dynamic situation requires a dynamic analysis.

Let  y = y - y[-1]. Then the proper (dynamic) marginal tax rate is DMR = T / y. For the Bentham function:

Generally the dynamic marginal is lower than the static marginal. In fact, when tax parameters are indexed in a certain way, then the tax can have the same growth rate as income, and then the dynamic marginal rate equals the average tax rate. This holds for individuals and for the macro data if all individuals are on a balanced growth path. Let the balanced growth rate be bgr:

         (13.4)

The following is a small example of how a dynamic marginal rate can equal a normal average. Let exemption be $10000, and let the statutory marginal rate thereafter be 50%. Someone earning $50000 pays the tax of $20000, on average 40%. Let all incomes grow 5%, and exemption be indexed on national income. Then exemption becomes $10500, income $52500, tax $21000, again 40%. Thus on the (dynamic) “marginal dollar” this person doesn’t pay 50% but 40%.

For the Bentham tax function we can derive a simple expression for individual growth. We are most interested in expected developments. Let personal income grow by rate , so that y[+1] = (1 + ) y, and let exemption be expected to be adjusted by rate , so that x[+1] = (1 + ) x. Then we find:

Let us regard the dynamic marginal rate for a Dutchman in 2002 who considers an increase in work effort for 2003 (and beyond), and let us assume a regime of sound economics. In the ideal case, exemption in the base year is put at subsistence, in this case € 12.5 thousand. Ideally, subsistence rises with income, and not just real net average incomes. This ideal implies that exemption is adjusted not just for inflation, but for the nominal growth of income. Let us assume this ideal, and let us assume that national nominal growth is 4%, for example consisting of 2% inflation and 2% real growth. Let us then regard the situation of a single economic agent. He knows that next year exemption will be adjusted with 4%. He has to judge whether it is worthwhile to him to invest or to increase labour effort, so that his income will rise. If his personal income rises with 4%, then his dynamic marginal will be equal to his present average tax rate. If his personal income rises by 8%, then his dynamic marginal will differ; it will depend upon his actual income level, but anyway will be less than the statutory marginal rate of 50%. Figure 15 gives the plot of the dynamic marginal for those two rates, for various levels of income. The 4% line here also gives the average tax level.

Individual income grows at 4% or 8%, while national income grows at 4%
and the statutory marginal rate is 50%

Empirical analysis often shows marginal rates to be less relevant - and average tax rates to be more important - than ‘common theory’ claims. This analysis on the dynamic marginal provides a useful part of the explanation.

Above analysis concerns minimum wage unemployment. The next question is how this relates to other kinds of unemployment.

It is useful to observe that the analysis in these pages is new. Concepts like the tax void, differential indexation and dynamic marginal tax rates, and the insights on their interaction, are really new, and have been concocted by me in a search for new scientific results. That means that governments have not incorporated these concepts in their policy making (even though the occasional civil servant may have been aware of some phenomena). Policy making up to now has been based upon a different analysis, and, alas, by being different from the right analysis, the governmental analysis is a wrong one. This is not without consequence. By analogy, when a patient gets a medicine based on a wrong diagnosis then the illness may get worse rather than diminish. In the present case, the tax void unemployment has important spillover or domino effects on unemployment above the minimum wage, and the channel of transmission is the misguided policy reaction up to now.

For example, in the 1970s governments tried to stimulate the economy by incurring big deficits, but they ended up with inflation. In the 1980s and 1990s governments opt for low inflation, and they end up with high real rates of interests and mass unemployment in Europe and poverty in the United States.

For example, Dutch economic policy is based on a general restraint on wages. This policy has fueled Dutch exports and reduced Dutch imports. The general restraint in fact subsidises exports, and Holland runs an external surplus for quite some years now. The internal imbalance is reflected in an external imbalance. The proper policy reaction however would be a wage cost policy targetted at the minimum.

Please note that the present review only gives a diagnosis, and that it is a different affair to find the proper therapy. The first is necessary step before the second can be considered.

In the course of some years I have experienced that discussing therapy is useless when people do not even understand the diagnosis. Policy makers tend to be focussed on therapy - but judge this from a wrong diagnosis. For example, in The Hague in 1992 (at a social-democratic political rally when I was no longer a member of his party) mr. Wim Kok, the Dutch Prime Minister of 2000, occasional chairman of the European Union and the social-democratic ‘respected elder’ to mr.-s Clinton, Blair, Schröder and Jospin, and a person who did some basic econometrics in his younger years, laughed loudly when I suggested to raise Dutch tax exemption from the then € 3 thousand to € 10 thousand. He must have thought of staggering costs, and it didn’t help when I said that it need not cost anything.

A major remark about therapy is that to undo the damage of the last four decades, it is not necessary to take four new decades. Return to optimality can be much faster.

The alternative and new policy would be to abolish taxes in the tax void and to allow people to earn their own - decent and untaxed - living. This alternative policy reminds of an old rule. The Dutch economist Cohen Stuart proposed in 1889 (cited in Hofstra (1975)) to put tax exemption at the level of subsistence. To drive the point home he drafted the following analogy:

“A bridge must carry its own weight before it can carry a load.”

In 2005 there is the additional argument that abolishing void taxes will not cost anything, while nations will save benefit payments due to more employment.

Note that the ideas of Cohen Stuart’s ‘bridge’ and the tax void are not very complex in themselves. In 1991 I explained them to a 12 year old kid and he commented: “A child can understand that.” Still, the EU and its score of modern governments sin against these concepts.

If unemployment is inefficient, then by definition there is a Pareto optimising solution, that will not cost anything. Most economists don’t believe in cheap solutions. Much of the debate hence focusses on ‘efficient unemployment’, where the sad state is caused for example by globalisation, technology or ‘welfare state scelerosis’ (with poverty traps). But, clearly, the tax void exists, it is a cheap way out, and the other arguments will turn out to be ghosts, which they already can be shown to be.

More employment.... Does that not fuel inflation ? The pieces of the puzzle fall into their places when the tax void is related to the unemployment & inflation problem. The steady rise of the tax void explains the track record of unemployment and inflation. The 1950s have been characterized by relatively low taxes on low income earners, and this allowed for full employment and low inflation. From the 1960s onwards the lagging tax exemption started causing problems with unemployment. The tax policy since at least 1965 enhanced the imbalance of the internal bargaining positions of labour instead of counter-balancing it. Hence inflation was persistent, and high levels of unemployment were required to achieve price stability.

As said, governments suffer from a co-ordination problem. How governments reacted in the past depended upon the view of the day. Since the proper solution was not known, the problem did not go away. The differential indexation of tax exemption and the social minimum did not draw attention to itself. Each year adds only a slight effect which is hard to see. But over the years the void has accumulated, and with huge consequences. And the problem will remain with us in the future unless policy changes.

The co-ordination problem persists, currently. Governments currently regard minimum wage unemployment as just one type of unemployment, and not even the most important type. Current policy is based upon other explanations for unemployment, notably those of technology, globalisation and flexibility. The policy reaction based on these views is to reduce taxes for higher incomes, so that they are encouraged to work, invest and spend more, and so that labour market flexibility might be increased. However, the ineffectiveness of current policy can be explained by the fact that these views are not entirely logical. The arguments of technology, globalisation and flexibility run up against contradictions:

·         Technology is a source of wealth, and it boosts the productivity of the lowly productive jobs, making the problem of poverty and unemployment less serious than it would otherwise have been.

·         “Globalisation” is a scare word for “trade”. Trade however is another source of wealth, and it too has been with us for ages. Rising wealth in distant countries means rising wages over there, and trade itself thus puts limits to foreign competition. Japan over the last 60 years is a prime example of this phenomenon, but every rich nation has had the same experience.

·         The “flexibility” or “welfare state sclerosis” argument can only explain that the US has poverty and Europe unemployment, but it does not explain that there is a problem with low productivity jobs in the first place. The poverty trap as said does not exist.

Thus to be sure: the real policy target is low inflation, and policy makers only discuss technology, globalisation and sclerosis/flexibility in a second line of the argument. This second line is essentially a cop-out, since it does not concern the real issue - and a discussion can be very tiring if people behave like that.

At the same time, the wrong policies work counterproductively. The reduction of taxes for the higher incomes obviously is financed by a reduction of provisions for the lower incomes, aggravating the minimum wage and poverty problems.

In my analysis, the present situation bears another surprise. We diagnose current unemployment as inefficient. Be sure that you see what inefficiency means: it means that there is a solution that is beneficial to some and that does not hurt others. Having a bright idea always means a “win-win” situation or a free lunch. In the present case there is the move to full employment under price stability. The present unemployed will find jobs. The higher productivity group will have a theoretically larger risk of unemployment, but in practice this risk will be modest as in the 1950s. The real gain for the higher income earners will come from the services that will be provided by the jobs of the presently unemployed. So you do not need to reduce taxes for the higher paid, since they already will have a real gain at current income.

This was it, in a nutshell. Now I beg your understanding. My analysis is more complex than can be stated in these few lines. Both tax policy and social policy are quite complex themselves, and this certainly holds for their interaction with inflation and unemployment. For example, you may ask why I haven’t discussed income redistribution effects. Actually, this is because the alternative policy could be neutral to the income distribution. The reason for this is that the analysis focusses only on the link between wage costs and productivity. But you might want to hear more about this. Also, you might ask whether above explanation covers all possible cases of unemployment and inflation. Of course it doesn’t. The analysis does help to clarify that other types of unemployment need other types of policy, such as education and so on. But you might want to hear more on that too. These are just examples of issues, and there are many more issues that need to be dealt with. Which space forbids. However, given that my model amends existing economic models, much of the required explaining is ‘existing economics’.

This novel explanation is in the tradition of Keynes and Tinbergen while it fits in with mainstream economics. When economists check and confirm these findings, our economies are likely to enjoy more growth with full employment and low inflation.

A breakthrough in economic theory

Since the early 1970s Western economies have been plagued by mass unemployment and the threat of inflation. Over the years since then various economists have proposed various possible solutions, but never quite convincing ones. Now there is a novel analysis that means a breakthrough in economic theory. The present author is quite certain that the “missing link in the model” has been found. If true, this analysis offers guidelines for full employment under price stability, just as Western economies enjoyed in the 1950s. The main point is: don’t tax lowly productive labour. Why ? To keep it competitive so that more productive labour will not demand inflationary pay rises. Though this new analysis is only in the stage of presentation and introduction at the scientific fora, there is no reason to withhold the present rough sketch for a general public.

It is well-recognised these years that Western economies have a problem with jobs with a low level of productivity and thus a low level of market-earned income. The United States tolerate more poverty - the working poor - while Europe sets its minimum wage much higher so that Europa has more unemployment.

This problem with low productivity jobs finds various explanations, notably those of technology, globalisation, and inflexibility - the latter ornate for “welfare state sclerosis”. Policies based on these latter explanations have been enacted for some time now. For quite some time, in fact; while little is being achieved. It is proper that we pose the question: why is it that we don’t achieve much ?

Unemployment obviously has a much longer history than the current problem. Also, the Western track record on unemployment can only be understood when the record on inflation is taken into account too. Economic science has much to say on the complex relationship between inflation and unemployment. Now, we are forced to be brief here. We will concentrate on what is new and on why it is new.

We set out with the empirical evidence since 1950. This track record can be divided in meaningful decades:

·       The 1950s had low unemployment and low inflation.

·       The 1960s had the threat of unemployment, and governments accommodating inflation in order to actually prevent it.

·       The 1970s nevertheless had mass unemployment bursting into the open, and governments accommodating high and accelerating inflation to battle it.

·       The 1980s-till-now had governments come down hard on inflation, and accepting high levels of unemployment as the price for stability.

One sees a certain “trade-off” between unemployment and inflation. From the 1950s till the end of the 1980s the common view among economists and policy makers was that the unemployment in the trade-off was “general” unemployment. Nowadays we tend to link unemployment to lowly productive labour. For us it may be obvious, but compared to the earlier view it is revolutionary that the once-thought-to-be “general” unemployment now turns up as a rather specific type. To make the revolution specific: we will hold that the unemployment in the trade-off has always been related to the distribution of productivity across labour.

The crucial insight is that the people who can demand pay rises need not be the people who run the risk of unemployment thereof. High productivity workers run less risk of unemployment and can more easily demand pay rises, while low productivity workers run the larger risk of unemployment. High productivity workers are more versatile and are able to shift the risk of unemployment to the lower income groups. When jobs are scarce, the high productivity workers even crowd out others from the labour market.

Now obviously, when this is new, then it has not been recognised before, and then it has likely been missing in policy. And policy that was based on a wrong analysis, is likely to have been the cause of the very problem that it wanted to solve.

Let us see how it went wrong. Regard the legal minimum wage and note that people are not allowed to work below that minimum. Note too that there hence will be no earnings that can be taxed in that range. We can call this range the “tax void” or “tax vacuum”. However, tax statutes are defined in that range anyhow. Tax statutes in that void are actually used to define the gross minimum wage. In Europe, the high gross wage will cause unemployment and its related benefit burden. In the US, the void is reduced a bit by accepting poverty. In common economic terms: tax policy and social-economic policy are badly co-ordinated.

How this has come about is a story of a more technical nature. First note that OECD countries adjust their taxes for inflation. Tax exemption in 1996 will often be close to the inflation-adjusted real value of 1950. On the other hand, research in social psychology shows that subsistence tends to rise with the general level of income, the growth of which consists of inflation and real growth. So there is “differential indexation”. In the 1950s exemption was pretty close to subsistence, so that there was no void to speak of. Since then, exemption has lagged behind the standard of living. The inflation-adjusted subsistence of 1950 may be only a third of 1996 subsistence. When tax exemption lags behind net subsistence, then there is a multiplier effect on gross subsistence, with a fast increase of the tax void.

The alternative and new policy would be to scratch taxes in that void and to allow people to earn their own - decent and untaxed - living. This alternative policy reminds of an old rule. The Dutch economist Cohen Stuart proposed in 1889 to put tax exemption at the level of subsistence. To drive the point home he drafted the following analogy: “A bridge must carry its own weight before it can carry a load.”  In 1996 there is the additional argument that abolishing void taxes will not cost anything, and that nations will save benefit payments due to more employment.

More employment.... Does that not fuel inflation ? The pieces of the puzzle fall into their places when the tax void is related to the unemployment & inflation problem. The steady rise of the void explains the track record of unemployment and inflation. The 1950s have been characterized by relatively low taxes on low income earners, and this allowed for full employment and low inflation. From the 1960s onwards the lagging tax exemption started causing problems with unemployment. The tax policy since at least 1965 enhanced the imbalance of the internal bargaining positions of labour instead of counter-balancing it. Hence inflation was persistent, and high levels of unemployment were required to achieve price stability.

How governments reacted depended upon the view of the day. Since the proper solution was not known, the problem did not go away. The differential indexation of tax exemption and the social minimum did not draw attention to itself. Each year adds only a slight gap which is hard to see. But over the years the gap has accumulated, and with huge consequences. And the problem will remain with us in the future unless policy changes.

Current policy is based upon other explanations. Notably those of technology, globalisation and flexibility. The ineffectiveness of current policy can be explained by the fact that these views are not entirely logical. The arguments of technology, globalisation and flexibility run up against contradictions. Technology is a source of wealth, and it boosts the productivity of the lowly productive jobs, making the problem of poverty and unemployment less serious than it would otherwise have been. “Globalisation” is a scare word for “trade”. Trade however is another source of wealth, and it too has been with us for ages. Rising wealth in distant countries means rising wages over there, and trade itself thus puts limits to foreign competition. Japan over the last 40 years is a prime example of this phenomenon, but every rich nation has had the same experience. Finally the “flexibility” or “welfare state sclerosis” argument can only explain that the US has poverty and Europe unemployment, but it does not explain that there is a problem with low productivity jobs in the first place.

The present situation bears another surprise. We diagnose current unemployment as inefficient. Be sure that you see what inefficiency means: it means that there is a solution that is beneficial to some and that does not hurt others. Having a bright idea always means a “win-win” situation or a free lunch. In this case it is the move to full employment under price stability. The present unemployed will find jobs. The higher productivity group will have a theoretically larger risk of unemployment, but in practice this risk will be modest as in the 1950s. Their real gain will come from the services that will be provided by the jobs of the present unemployed.

Policy makers will be hesitant about an overhaul of the tax system. Note, then, that the tax system defines our notion of a subsidy. A wrongly levied tax, in this case the tax void, can be compensated for by a wage cost subsidy. Abolishing the tax void is more sensible in the long run, but when this can only be done gradually, then some general subsidy directed at lowly productive jobs would speed up short term adjustment. If only those subsidies are reduced when tax exemption rises towards subsistence.

This was it, in a nutshell. Now I beg your understanding. My analysis is more complex than can be stated in these few lines. Both tax policy and social policy are quite complex themselves, and this certainly holds for their interaction with inflation and unemployment. For example, you may ask why I haven’t discussed income redistribution effects. Actually, this is because the alternative policy could be neutral to the income distribution. The reason for this is that the analysis focusses only on the link between wage costs and productivity. But you might want to hear more about this. Also, you might ask whether above explanation covers all possible cases of unemployment and inflation. Of course it doesn’t. The analysis does help to clarify that other types of unemployment need other types of policy, such as education and so on. But you might want to hear more on that too. These are just examples of issues, and there are many more issues that need to be dealt with. Which space forbids. However, given that my model amends existing economic models, much of the required explaining is ‘common economics’.

There remains one major point. That tax exemption is low, is defended by OECD governments with the argument that it keeps marginal rates down. And the attractiveness of low marginal rates is that they spur economic activity. My finding however is that the latter claim is only true when the marginal rate has been defined properly. Thus I agree with the claim, but it must concern the proper marginal tax rate. There is a difference between the proper rate, which is dynamic, and the rate used by OECD governments, which is the static and statutory rate. Dynamic analysis shows that the proper marginal rate will be close to the average rate. This part of my analysis is important for economic growth. Having less unemployment will mean lower average taxes, and thus lower proper marginal rates, and thus more incentives for sustainable growth. For many of my fellow economists it is this part of my analysis that will come as the greatest surprise of all. However, this is not an issue that can be settled in this review, and here I definitively have to refer to my extensive analysis.

This novel explanation is in the tradition of Keynes and Tinbergen while it fits in with mainstream economics. When my fellow economist check and confirm these findings, our economies are likely to enter into a new high growth path with full employment and low inflation.

Allow me to add the personal note that I am overjoyed by these findings.

(March 1996)

World developments in the 1990s show a worrysome parallel to the 1930s with the Great Depression. Present-day Russia reminds of the pre-war Weimar republic, where a devastated economy and weak democracy allowed Hitler to take power. Western nations in the 1990s hinder trade with Russia and the Eastern nations for fear of unemployment at home, as they did in the 1930s with Germany. If trade were stimulated instead of hindered, Russia could regain economic and political stability by itself. The moral problem is not external and does not concern whether Russia would need financial aid. The moral problem is internal, and concerns whether Western political leaders are willing to face their own errors that cause the present mass unemployment at home.

Russia is shrouded in a veil of doom. A nation once proud about its achievements, is now, as so many feel, humiliated in the face of history. A loss of empire, a collapse of economic security, some coup attempts in both Kremlin and Duma, a rising reign of violence by a mafia in the main cities and by full-blown fighting at the geographical fringes, and a political arena that smells more of fear than of confidence. Like the Weimar republic in pre-war Germany, Russia has been subjected to the rules of chaos, and yet again the odds are risky - and risky for the world at large.

Something needs to be done. Something smart, something humane, something effective and efficient, and something courageous. Therefor, something which is not likely to happen quickly. However,  there is one single possibility that is very much worth of our attention. It is something what we actually could do. And what - given the risks of this moment - we should do

It is trade that will help Russia and the Eastern nations to recapture economic security and thereby regain political stability. And, since it is our fear of unemployment that motivates us to block that trade, Western nations should tackle unemployment at home directly.

Our comparison of present-day Russia with pre-war Germany is no coincidence. World developments in the 1990s show a worrysome parallel to the 1930s. The 1930s suffered from the Great Depression. In the 1990s the world is again plagued by mass unemployment. Again there is a major region that is economically devastated and that desperately needs access to the world market, and yet again the other wealthier nations hinder that entry, while concentrating shortsightedly on their own problems at home, and neglecting the consequences of neglect. The West might want to reduce the risk of a Russian disaster, but not at the cost of jobs at home. Trade barriers are there to keep cheap Eastern products from “flooding” its home market. Europe throws in huge subsidies for its agricultural exports. Western tariffs or quality requirements are pitted against Eastern exchange rates, in a war on trade whatever its consequences on economic and political stability.

The West is dugging in and seems to repress the recognition that history is repeating itself. Again the world finds itself in a deadlock, and yet again chaos feeds on it.

But we should remember the trade war of the 1930s and the rise to power of Adolf Hitler ! In the 1930s the same mechanism of trade, unemployment and political instability applied. In this period it was Germany that was the weak nation. The Versailles Treaty of 1919 that ended World War I put Germany under a huge reparations bill. The world forgot that the war had been started by an autocratic Kaiser and that Germany now had a new, fidging democracy. To pay that bill, this weak democracy was obliged to cut imports and to spur exports. The reparations bill worked like a foreign tariff that took away funds that could have been invested otherwise. By the end of the 1920s Germany defaulted on its international debt - and thereby indirectly caused the Wall Street Crash of 1929. Thereafter, all nations scrambled for the life-boats. Nations feared for their home markets and employment, and defended themselves by exchange rates and tariffs. In their fear they made things only worse. The German economy collapsed, and on the teutonic waves of resentment its weak democracy toppled and Hitler took power.

Let us now compare: Is the Russian democracy anything other than new and fidging ? Have its generals not tried to seize power ? Have its tanks not roared against its very own Parliament building ? Has its economy not dropped by a third?  Or conversely, have all its nuclear weapons and uranium stores been savely secured ? Have the Western nations done their utmost in opening their markets ?

Of course, there is a glimmer of hope. The Russian capacity for suffering is impressive. Few nations could sustain this suffering and national disgrace without lapsing into resentment, cruelty and violence on a much larger scale than we actually see in Russia. The West has provided some funds and done something more. The world is not at war and may not be at war for some time. The probability that things go right is large, and there is only a small chance that things go wrong.

But please consider: If the only glimmer of hope is that the world is not at war, then the situation is quite depressing. Hope is not the point, and neither likelihood nor expectation. The point is risk. Risk comes from the arithmetic of loss multiplied by chance. Thus: risk = loss * chance. If things go wrong in Russia then the consequences will be huge, and a small chance times a huge loss gives a risk too large.

The West should open its eyes and see the economic logic. Eastern nations need to take part in the international economy and thus need modern Western equipment. To buy the latter goods they need the proper currency. Either someone gives them that foreign currency, the dollars, yen or marks, or they have to earn it themselves by exporting. To simply give them credit, on the scale required, is absurd. Therefor it is access to Western markets that is essential for those nations and for political stability. Indeed, if they had access, and if the flow of trade were to start, then the World Bank and IMF could extend credits and thereby fuel the process towards stability.

At the same time, economic science tells us that it is not trade that has caused present Western unemployment. Marking trade down as the culprit, and using trade barriers to solve a situation that trade has not caused, only makes things worse.

The moral problem is internal and not external. The cause of present-day unemployment in Western economies is internal management and not external trade. There is a failure within the internal co-ordination of macro-economic policy, a failure by our very own governments. Western nations could tackle their unemployment problem at home - if only our political leaders were willing to take a hard look at their own internal policies.

The historic parallel also concerns the current lack of attention for the internal question. Policy makers that concentrate on an external trade war neglect the internal opportunities. There is the following sobering story about the economist John Maynard Keynes. From the early 1930s Keynes advanced his solutions to the Great Depression, and this culminated in his 1936 book that changed macro-economics. Policymakers could have reacted already in the early 1930s, ... but only did so after World War II had already begun.

We might ask: Do we care about the peoples of Russia and the Eastern nations ? And should we act with economic sense ? However, those questions are imprecise. The real question is whether our leaders care so much that they will reschedule their busy agenda’s and really look into a problem that they cause themselves.

There is every reason to believe that political leaders are quite deaf on this. So pray that there will not be a new world war. So shout to your political leaders: Stop that trade war !

Do something about external trade tariffs and internal unemployment. Enable Russia to help itself.

(March 1996)

Asia and the Eastern European nations are in a state of economic turmoil. An important element for improvement is that Western nations open their markets to more trade. This is in fact what the West could have done after the fall of the Berlin Wall. But petty shortsightedness of the governing elites in the West blocks this kind of solution. The situation reminds one of the Versailles peace conference after World War I that fostered a lot of resentment and helped cause World War II. The basis conclusion is that sound economic advice is not listened to. The best advice on how to steer out of the current world macro-economic mess is that every parliament installs a committee to enquire into the process of economic advice. They could study the books by Paul Krugman, and possibly also my analysis on unemployment and my suggestion for an Economic Supreme Court.

Western nations show an inadequate reaction towards the Eastern nations since the fall of the Berlin Wall, and this inadequate reaction is repeated with respect to the current economic throes of Asia. The West displays disinterest in the hardship and actual physical pain inflicted on millions of our fellow human beings, and a neglect of the long run effects of this egotistic behaviour. Part of this inadequate reaction however is also caused by wrong applications of economic theory, so that true compassion that is out there doesn’t get the chance to show itself. One lesson is that Western nations are advised to restructure their policy making process so that governments are better served with proper economic advice.

The negligent way that the Western nations treat the other nations reminds one of the Versailles peace conference after World War I. Historians agree about the sad Western attitude at the Versailles conference. The Western Allies humilated Germany and subjected that country to decennia of economic hardship, purposely crippling its economy. These events caused a huge resentment in Germany, and this fostered the rise of Adolf Hitler. Also, Germany’s defaults on its financial obligations were a major cause for the 1929 Crash and the subsequent Great Depression. This episode is another example that two wrongs don’t necessarily make a right, and it also shows how wrongs can backlash at the wrong-do-er.

The lesson of Versailles is that opponents can often best be allowed to grow into a relationship of companionship and economic competition and co-operation for the betterment of all. Rather than subdue them or take advantage of temporary weaknesses, they could be helped so that they could help us. This lesson should now be applied to the current situations of Asia and Russia.

It is useful to recall that Western nations were not without proper advice at the time of Versailles. They were warned, and by nobody less than J.M. Keynes. As Paul Krugman recently stated about Keynes: “After that war he became famous as the author of The Economic Consequences of the Peace, an eloquent condemnation of the vindictive terms imposed on the defeated Germans; his concern was vindicated by the rise of Adolf Hitler, and the memory of his warnings helped convince a victorious America to aid, not punish, its prostrate enemies after World War II.”

Indeed, after World War II the Allies helped Germany and Japan to reorganise their countries and to prosper again. While the average citizen may be deluded by sentiments of nationalism, religion or ideology, it normally is a governing elite that abuses those sentiments for purposes of its own grandeur - and once a decent government is in place, there often appears little reason to blame that average citizen for the errors of its country. In the same way post-communist Russia deserves our sympathy, and the same holds for Asia with its different history.

But why has the West forgotten this valuable lesson ? Why do Western governments neglect Nobel Prize winner Jan Tinbergen’s work on the Optimal Economic Order, and why do we again have a show of petty egotism and shortsightedness ?

The reason is that the West is not immune to the same ‘governing elite’ processes that can be at the detriment of common welfare. The governing elites and bureacracies in the West have agenda’s of their own, and though they are restrained by democratic rules, these rules are not as strong as they could be. Our systems of checks and balances are a product of history, and not necessarily of the quality required. Politicians and bureaucrats often still can lie and get away with it. The United States e.g. had David Stockman on the budget deficit, and it took too long before that matter was settled. In general, sound economic advice still is obstructed by political processes, and policies and the electorate itself then grow misguided in their choices.