Democracy Lab

Off the Beaten Path

Some of the best economic innovations come from places you wouldn't expect.

Looking for novel solutions to public policy problems? You could check the high-end think tanks in the U.S. or Britain, maybe research from the Fed, or perhaps Sweden's Central Bank or the elite Sciences Po in Paris.

Then, again, you might want to follow a path truly less traveled. While the world has long been accustomed to looking to the mature industrialized countries for models in economic policy, they don't have a monopoly on good ideas. Smaller, less affluent countries that would ordinarily slip under the radar can serve as laboratories for innovation. Indeed, states that are modest in size, newly independent, far from the influence of the big global players, or emerging from devastating wars (choose one or more) often find it easier to obtain sufficient political consensus to institute radical reforms.

Here are a few that come to mind:

Education Incentives. Universal public education pays dividends in myriad ways ranging from raising economic productivity to creating a more sophisticated electorate. But it exacts costs on families, especially in countries where child labor is a fact of life. And it often pits the will and interests of parents who do not value education against the interests of their children.

Hence, the logic of Mexico's pioneering conditional cash transfer program in 1998 (originally called Progresa), in which welfare benefits to the poor are conditioned on their children's school attendance. Note two bonuses here. First, getting the kids to school gives the state some control over the living standards of children who might otherwise be abused and/or malnourished. Second, it allows for controlled experiments to find out which anti-poverty policies work in developing countries and which don't, fostering a very productive field in development economics. Brazil has since adopted a similar program -- as have a long list of countries as diverse as Jamaica, Nicaragua and Zambia. The Progresa approach has even inspired reforms in New York City, which makes cash awards to families in return for regular school attendance and participation in parent-teacher conferences.

Buffering Export Cycles. Prices of commodities ranging from oil to gold to cocoa are highly volatile, putting countries that depend heavily on export earnings in a bind. When prices are high and government revenues are plentiful, political leaders face pressure to spend the money. This, in turn, feeds demand just when fiscal stimulus is least welcome, often generating inflation.

Then, when commodity prices fall, the process reverses. Politicians must find ways to retrench or accept the consequences of budget deficits. And retrenchment reduces demand just when the economy needs it.

Chile, which must cope with broad swings in the price of it copper exports, created rules in 2000 for smoothing the impact of the commodity cycle that largely depoliticize the process. The government may run deficits if the economy slips below the targeted growth rates or the price of copper falls below its long-term trend. Equally to the point, the government automatically accumulates surpluses during booms that cool down the economy and create a trust fund that can be used to stimulate the economy when it again heads south.

Managing Natural Resource Riches. A dozen countries ranging from Saudi Arabia to Venezuela to Algeria to Bolivia depend on natural resource exports (usually, oil and gas) to sustain living standards and pay for public services. But what happens when the resources run out?

The most extreme case is the tiny Pacific island of Nauru, which lived high off exports of bird guano deposits for a few decades, and then was left with nothing but an environmental wasteland. But doleful, if less dramatic, consequences are in store for other resource-dependent countries unless they invest in diversifying their economies or accumulate permanent funds from export proceeds. The model in this regard has been Norway's Pension Fund (what don't the Norwegians do right?) In fact, a better model is Botswana's Pula Fund, built on the earnings from its rich diamond deposits. (The photo above shows a Botswanan diamond sorter at work.) This sovereign wealth fund, managed by independent professionals, is diversified into securities denominated in a variety of currencies -- and, unlike Norway's fund, is carefully walled off from the political priorities of elected officials.

The Flat Tax. Tax reformers have been kicking around the idea of replacing complex income tax systems that are riddled with inequities and distorted incentives with a single "flat" rate -- a rate that that applied to all levels of income and allowed for few preferences. Such taxes can be made progressive (at least at the low-to-middle end of the income pecking order) by giving everybody a basic tax-free allowance. But getting from here to there -- especially in rich, mature economies in which well-organized interests defend their own tax breaks -- has proven next to impossible.

That wasn't the case, though, in Estonia in 1994. The tiny Baltic state, newly liberated from Russia, effectively had a clean slate to work with. Its flat tax was widely emulated over the following decade, spreading to much of the former Soviet bloc including Latvia, Lithuania, Ukraine, Slovakia, Georgia, Romania -- and even the Russian Federation. Rates, tax-free allowances, and breadth of coverage vary widely (some, for example, cover both personal and corporate income). But a World Bank analysis suggests the experiments have largely been a success, both in terms of increasing compliance and simplifying tax systems.

Traffic Congestion Pricing. Cars and trucks aren't free; gasoline isn't free. Why is the use of highly congested urban roads free? Why, indeed. Econ 101 suggests that the failure to charge for road use leads to overuse for the same reason that selling bread for almost nothing in the Soviet Union led many farmers to feed it to livestock. But creating a congestion pricing system that reflects the ever-changing costs of traffic density is a political challenge as well as an economic and technological one. In most localities, the potential losers from congestion pricing have generally been able to veto its imposition.

Yet Singapore -- not, say, Paris, Tokyo or New York -- was the first to introduce congestion pricing some three decades ago. The city-state's willingness to be a pioneer made sense for two reasons. For one thing, Singapore's options for managing congestion were uniquely limited because it did not have the option to sprawl like, say, Los Angeles and Houston. Equally important, Singapore's top-down political rule and compact size made it possible to impose a system that gored a lot of metaphoric oxen. Singapore's initiative did lead to a host of parallel efforts ranging from straightforward congestion-pricing in London, to the auctioning of car-use permits in Shanghai, to high-occupancy-vehicle lanes on commuter road in a dozen U.S. cities.

No Standing Army. It's hard to quarrel with the need for a permanent military establishment in many countries. But in many others, a standing army is a bad deal all round. It doesn't make borders any more secure if neighbors respond by raising armed forces of their own. It creates the permanent threat of a military coup -- or, at very least, limits the range of policy options of civilian government. And of course, it costs resources, diverting money, foreign exchange earnings and manpower from conventionally productive activities (like making stuff people want).

Such arguments haven't carried much weight, though; once an army is created to meet a threat (real or imagined), it's almost impossible to get rid of it. But two developing countries have managed to remain military-free for generations. Costa Rica abolished its army in 1948 after a bloody civil war -- a decision made in part because the United States believed its interests lay in blocking a return to power of the losing side. And Mauritius chose not to create an army after it was granted independence by Britain in 1968.

I don't mean to suggest that smart ideas can be effortlessly translated from one national context to another. Nor do I mean that the countries mentioned here have done everything (or even most things) right when it comes to public policy. Mexico's economy, after all, is stagnating, and Estonia's was among those worst hit by the global financial crisis. But the examples do illustrate the reality that countries small enough to aim for political consensus and flexible enough to avoid interest group paralysis have some major advantages when it comes to policy innovation.



Free Scotland

Why the Scots want independence.

Scotland's nationalist ambitions don't generally get international attention, but the past few weeks have been a uniquely exciting time in the long-running campaign for Scottish independence. On Jan. 25, Alex Salmond, Scotland's first minister, and his Scottish National Party (SNP) government announced plans for a historic referendum on independence to be held in the fall of 2014, attracting coverage, comment, and curiosity from around the world.

The SNP government's proposed question is "Do you agree that Scotland should be an independent country?" The SNP is considering whether a second, as yet undefined question should be asked, suggesting an intermediate step of devolving powers to the Scottish government without full independence. This notion, known as "devo max," has the support of a significant portion of public opinion -- though this support remains unmeasurable given that no serious detailed proposals have yet emerged.

London has not responded well to this development. In a speech on Feb. 16, British Prime Minister David Cameron vowed to "fight with everything I have to keep our United Kingdom together." He continued: "To me, this is not some issue of policy or strategy or calculation -- it matters head, heart, and soul. Our shared home is under threat and everyone who cares about it needs to speak out." In the end, Cameron may find that this type of rhetoric will only hasten the demise of the union he has vowed to protect.

Many are wondering why, exactly, this disquiet has emerged in Scotland. After all, the union has been a pretty peaceful one since at least the 17th century. But there is indeed a strong case to be made for an independent Scotland, a case that has only grown more compelling in light of Europe's and Britain's latest economic woes.

Scotland is a different place from the rest of the United Kingdom, and increasingly there is no such thing as a unitary UK politics, but Scottish, Welsh, Northern Irish, and English politics with devolved parliaments and assemblies in the first three.

The union of Scotland and England created Great Britain in 1707*, but Scotland has grown gradually more independent over the last century. First there was the Scottish Office, a department of the UK government set up in 1885 to oversee the slowly expanding state, followed by the "secretary of state for Scotland" becoming a full cabinet post in 1926 with more junior ministers added over the postwar era. Then, in 1999, the Scottish Parliament was established, with control of most of Scotland's public services.

The SNP was formed in 1934 and in its early days stood for full self-government. It then began to become a serious political force from the mid-1960s onward. In the 1980s, the SNP -- which defines itself as a party of the center-left -- was a vital part of the anti-Tory coalition against Prime Minister Margaret Thatcher. But the SNP is also a big tent reflecting the spectrum of Scottish society, with a majority in the Scottish Parliament and six seats in the House of Commons.

The last 30 years have seen a long, slow decline in Scottish voters' identification with and trust in the British state. In 2009, the Scottish Social Attitudes Survey found that 61 percent of Scots trusted the Scottish government to act in Scotland's interests versus 25 percent who trusted the British government. Increasingly, Westminster's interventions and policies -- including macroeconomic policy, welfare, defense, and foreign affairs -- are seen as problematic to many Scottish voters and inviting challenge. And the majority public opinion increasingly points toward wishing to have a more autonomous, distinctive Scottish political space in which the Scottish Parliament runs most domestic issues, leaving defense and foreign policy to the folks in London.

Scottish politics were once defined by a powerful collectivist and socialist-oriented labor movement and a national culture centered on traditional industries and solidarity with the rest of the United Kingdom. But this tradition has fallen into crisis in recent decades, weakened by the demise of the British Empire, the decline of religion, and Thatcher's assaults on Scottish labor unions.

Scotland and England have evolved in very different directions over the last three decades. Under Thatcher, Tony Blair, and now Cameron, English public services have become increasingly marketized and prone to corporate influence. Scottish public services have pointed in a very different direction, championing equity and clear lines of accountability. For instance, the Scottish and English health services are now very different entities, with Scotland's organized as one national service with targets set by the government, whereas the English system is more fragmented, being run in places by private providers and allowing profits.

In addition, British governments have increasingly misread Scotland as the ties of the union have weakened. Under Thatcher, Scots felt discriminated against by a host of policies including the implementation of a controversial poll tax in 1989. Blair was dismissive of Scottish national aspirations, calling the possibility of an SNP-controlled Scottish government a "constitutional nightmare" and urging his Labour Party to fight against it.

Cameron's coalition government has few Scottish Tory voices giving it advice about its emerging northern problem, with only one Scottish Conservative MP and 11 Liberal Democrats. In recent months, they have displayed a mix of arrogance, ignorance, nervousness, and forgetfulness on the Scottish issue. Cameron described the prospect of an independent Scotland as "desperately sad" and said he thinks the "Scottish people at heart do not want a full separation," despite recent polls suggesting that this might no longer be the case.

Despite growing nationalist sentiment, Scottish nationalists still need to convince voters that an independent Scotland could stand on its own two feet -- a task that became particularly salient in 2008 when Scotland's two leading banks, the Royal Bank of Scotland and Halifax Bank of Scotland had to be bailed out by the British government. Arguably, these banks' crises were due to British light-touch regulation and the explosion of the British debt mountain. If anything, the banks weren't Scottish enough.

What sort of currency would an independent Scotland use? Under most of the current proposals, Scotland would still be in a currency union with the rest of the United Kingdom -- meaning Scots would still be spending pounds. The SNP can also point to the ready example of independent Ireland, which kept its currency linked to sterling for nearly 60 years.

But the question should not be how an independent Scotland could survive. It should be: How can we continue under the current arrangement? An independent Scotland would be the sixth-wealthiest country in the world per head, the SNP claims. Today, it's the third-richest region of the United Kingdom outside London and the southeast. Yet at the same time, one in five Scottish children lives in poverty. Life expectancy in the most deprived parts of Scotland (Glasgow and the west) is the worst anywhere in Western Europe, according to detailed research by the Glasgow Centre for Population Health.

An independent Scotland could become a very wealthy petrostate. Some £250 billion worth of North Sea oil has flown straight from the northeast waters of Scotland into Treasury coffers in London since its discovery, most of which would have come to Scotland. Even if peak production has passed, experts say, the North Sea fields could pump out crude for several decades. Imagine what Scots could do with their own sovereign wealth fund -- the kind of long-term thinking that has made oil-rich Norway the world's most highly developed country.

But what, then, of Britain? A Scotland-less United Kingdom might need a new name, the United Kingdom historically being the name of the union of the two crowns of Scotland and England. But the separation could be less a dramatic rupture than the gradual evolution toward a new understanding of the British state. At a recent lecture in London, Salmond, the Scottish first minister, presented a very pragmatic and flexible vision of the United Kingdom, describing a country with an increasingly divergent, pluralistic set of political systems. A more flexible arrangement would allow for Scottish aspirations -- developing distinct welfare and labor-market policies -- while also permitting pan-British co-operation and perhaps even some kind of political union.

That might be just fine with all but the most traditional Scottish nationalists. The SNP and most of its members are comfortable with the fact that in the age of globalization, the status of autonomous nation-states need not be narrowly defined. While the separatists' goal is still ultimately full independence, the party is comfortable with the gradual emergence of a distinct Scottish state, statehood, and statecraft under the framework of the existing United Kingdom.

How this all turns out will depend largely on the wisdom of the British government. Will the politicians in London be able to respond to the increasingly pragmatic and flexible approach of the Scottish Nationalists? If they are able to, it is likely that Scottish aspirations can be accommodated in a much looser union that falls short of conventional independence.

If, however, they continue to act as they have done in recent months, displaying all the famed arrogance of British governments through time immemorial in dealing with troublesome revolts, then they will increase the prospects of the breakup of Britain and the emergence of a fully independent, self-governing Scotland.

Jeff J Mitchell/Getty Image

*Correction: The union of Scotland and England created Great Britain, not the United Kingdom, as originally stated.