How to Make Democratic Countries More Prosperous

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“We all know what to do. We just don’t know how to get re-elected after we have done it.” – Jean-Claude Juncker, Prime Minister of Luxembourg

Despite its many merits, democracy does not seem to be a very effective system as far as generating prosperity is concerned. Slow economic growth, heavy taxation, high unemployment, and large public debts are common features of contemporary democratic countries. Fortunately, it is possible to change this state of affairs without resigning from democracy as the form of government.

To understand how this could be achieved, we first need to realize the causes of the above undesirable phenomena.

At first sight, it might seem that the democratic process itself should be sufficient to create an appropriate environment for economic development. The political elites that implement policies elevating the living standards of citizens should get re-elected, while those that fail should be sent by voters to political retirement. There are, however, some obstacles for this mechanism to function properly. First, there is usually a significant time lag between actions performed by legislative or executive bodies and the effects of these actions. The reward or punishment for these effects can be reaped by a completely different political team than the one that brought them about. Second, people generally have socialist and interventionist inclinations that make them look up to the state as a source of solutions to social and economic problems. It is easy to win votes by promising to “do something about it”. Yet each such involvement of the state, apart from often causing problems by itself, costs money. Hence heavy taxation and high levels of government debt. At the same time, backing out from the tasks taken on itself by the state is, in most cases, unpopular as some people get hurt and others tend to sympathize with them. Third, there are interest groups that by lobbying and various forms of pressure attempt to shape the law in their favor; and there is also outright corruption. For all the above reasons politicians are often incentivized to take actions that are detrimental to the general welfare, and, at the same time, discouraged from making wise decisions, even if they know what should be done.

How, then, can we make the democratic system work properly? It may be impossible to eliminate the above problems completely, but we can cause the ruling elites to care more about the long-term consequences of their actions. The key is to create a direct and lasting link between the growth of general prosperity and the remuneration received by persons who wield, or have wielded, political power. A possible way to achieve it is to grant the members of the most important legislative and executive institutions, that is congressmen, senators, ministers, etc., a lifelong pension dependent on the rate of economic growth. The right to such a pension could be acquired after, say, a full year in office, and it would never expire until the beneficiary’s death. How would the amount of payment be calculated? That is a matter yet to be considered thoroughly, and what will be presented here is only a proposal. Essentially, the beneficiaries should receive more when the economy booms, and less, or nothing, when the economy stagnates or collapses. What indicators should be taken into account? The most obvious one is the gross domestic product per capita. Admittedly, this measure of economic prosperity has its flaws, but it is widely recognized and has been used for a long time. It is calculated in all countries; in the case of the United States the GDP per capita in 2011 was approximately $48,300. Let us suppose, then, that the beneficiaries will receive a once-a-year payment the amount of which will be the rate of real GDP growth per capita multiplied by a certain Basic Amount. The Basic Amount could simply be the GDP per capita in the previous year, or the average income in the previous year, or some fraction or multiple of these or other measures. The calculation method could also involve some additional variations. For example, the amount of payment could be zero for a GDP per capita growth between 0 and 1 percent or lower, and any rate of growth above 3 percent could be multiplied by 2. Thus, if the real growth of GDP per capita were 4.1 percent, the beneficiaries would receive:

(3 + 2 x 1.1) x BA = 5.2 BA

That may seem a lot if the Basic Amount is the GDP per capita in the previous year, or some higher amount, but some important qualifications should be made. First of all, the GDP growth should not be calculated in relation to the previous year but to the last highest record. Let us imagine that in some country the GDP per capita is exactly 10,000 of their domestic dollars. Then come three years of recession and the GDP per capita falls, in real terms, to 9,000 dollars. In the first year after the recession a GDP growth of 5 percent is experienced, raising this measure to 9,450 dollars. In each of the next two years a still impressive 4 percent growth occurs. The GDP per capita rises to 10,221 dollars. Only now would the beneficiaries be entitled to a payment which, under the above calculation procedure, would amount to 2.21 Basic Amounts. Second, the payment should be diminished according to the rate of inflation and the level of the government deficit in the previous year. In the case of the “inflationary reduction” the aim would be to prevent attempts to accelerate the economy by throwing new money at it in great quantities. Although inflation is already taken into account in the measure of real GDP growth itself, yet there is a lag between inflationary actions and the rise in prices, so inflationary policies may appear to work for some time. Therefore, if not immediately, such actions should at least be additionally punished in later periods. For example, the payment could be reduced by 10 percent for each percent of inflation. A 5 percent rate of inflation would reduce the payment by 50 percent, etc. Some rate of inflation, such as below 2 percent, could be allowed without triggering a reduction. In the case of the “deficit reduction” the payment could be reduced by 15 percent for each percent of GDP that the government deficit amounts to.

An alternative solution, in terms of applied statistics, would be to use the average income per capita as the reference measure. In that case the rate of growth of the average income would determine the amount of payment. Additionally, it could be decided to base the measurement only on the lower 99 percent, or even 95 percent, of income receivers. There is no economic justification for such a limitation, but it could make the reform more popular.

One of the questions to be considered is whether the pension should be paid also to incumbent politicians, or only to those who no longer hold their positions. As it is a relatively minor issue we will not dwell on it here. Instead, let us assume that a middle ground solution will be applied – incumbent politicians will receive a payment only if it exceeds their ordinary salaries, and only in the amount of the excess.

What is supposed to be achieved by the above reform? The first aim is to make politicians more courageous in making unpopular decisions. They will be more inclined to risk losing their positions if they expect a reward afterwards. The second aim is to encourage members of the most important legislative bodies to introduce laws that will limit lobbying and corruption, not only by introducing punishments, but also by limiting the scope of tasks performed by the state. Currently politicians are hardly motivated to do so, as that would curtail their power. But they might be willing to end their political careers with leaving a legacy of a smaller state if they believed that would benefit them personally.

Let us now pass to some potential problems. The use of statistics to determine the amount of payment poses a risk of falsification and manipulation of data. To reduce this risk it would be advisable to use statistical research done by several independent institutions. There should also be public oversight and open debate regarding the statistical methodologies used to measure the economic reality. And any proven attempt to manipulate the data should be punished with a loss of the right to the pension.

An undoubtedly positive aspect of the proposed reform is that it poses no risk of severe harmful consequences if it fails to work. Admittedly, some politicians may uselessly receive some additional public money, and there may be some unnecessary extra expenses on statistical research, but ultimately it is nothing when compared to many other, often wasteful and harmful, expenses of the state.

The above text should not necessarily be treated as a presentation of a ready and complete recipe for ensuring economic prosperity in democratic countries, but it can be viewed as a guide post pointing at a direction where reforms should be headed. If members of the most important legislative and executive bodies are successfully incentivized to set the stage for fast and uninterrupted growth of general prosperity, we will see a major change in the way they perform their jobs. And that is what is needed the most for democratic countries to thrive economically, as all the other necessary elements – industriousness, talent, integrity and spirit – are already there in the minds and hearts of the people.

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About Rafał Rudowski

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