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Yesterday, I posted the first part of my 1987 review of the late Barbara Bergmann's book The Economic Emergence of Women. Here's the next part:

To combat discrimination against women, Bergmann would have the government step up its enforcement of the affirmative action regulations. A hard-liner on this issue, Bergmann proposes: "Each branch of each large firm should have an EEOC [Equal Employment Opportunity Commission] audit officer attached to its case, just as it has an IRS agent looking at its tax compliance."

Bergmann never considers the possibility that government intervention may itself be hampering women. Yet many of the case histories she cites point to laws and regulations that have such effects. Three examples: (1) The Bell System, heavily regulated at the time, had job classifications that segregated women; (2) the state of New Hampshire repeatedly turned down a woman applying for a certain job because she couldn't wield sledgehammers, even though they weren't used in the job; (3) women trying to get into union apprenticeship programs have had endless difficulties. For me, the most telling thing about these examples is that they involve union power, regulated industries and public-sector jobs--all of which have been shaped by government interventions.

Gary Becker explained over 30 years ago in his Economics of Discrimination why unions would be expected to discriminate. Our labor laws help them to monopolize the supply of labor in many situations, and they naturally use their monopoly power to restrict entry. If the union is largely male to begin with, women will inevitably have a tough time getting in.

Similarly, it is not surprising that an organization like the old Bell System, whose profits were regulated by the govermnent, discriminated against women. Another company could cut its costs by hiring lower-wage women into traditionally male jobs, but in Bell's case the cost savings wouldn't necessarily translate into added profits (because the regulators would typically require the saving to be passed along to consumers). In short, a regulated company has less incentive than an unregulated one to hire women.

The same is true of government agencies. Taxpayers, rather than the people running the agency, benefit when it hires equally qualified but cheaper women. So there is no cost to bureaucrats when they discriminate. A major weakness of Economic Emergence is that Bergmann, who advocates plenty of government regulation to end discrimination, seems to have no interest in policies that might remove the government props under monopoly power, or might speed up deregulation, or might work to privatize government
functions.

CATEGORIES: Labor Market , Regulation

   


Bryan Caplan

The Mellow Heuristic

Bryan Caplan
No one protested me when I spoke at Oberlin College last week.  (Topic: The Myth of the Rational Voter).  A few days later, however, Oberlin showed factual feminist Christina Hoff Sommers a rather different face:

The entrance to the classroom where Sommers spoke was surrounded by flyers accusing her of supporting rapists. "F*** anti-feminists," read one sign.

The students responsible for the safe space were more polite, although they did joke about biting people they disagreed with and promised to zealously guard their precious space from "toxic, dangerous, and/or violent" people--anyone who didn't share their perspective, in other words. (Video of that here, courtesy of Nick Mascari, Third Base Politics).

Sommers told Reason that the most bizarre form of protest was the students who sat in the front row during her talk with their mouths taped shut.

"They just stared," she said.

Others did more than stare; they interrupted and booed whenever Sommers said something that irked them. At one point, a philosophy professor in the audience stood up and called for civility. They mocked him and yelled at him to sit down, according to Sommers.

I know a lot about the science of gender, so the crowd's poor behavior has little effect on my views.  But I must confess: If I knew less, this would be a perfect time to apply what I call the Mellow Heuristic.  The Mellow Heuristic is a rule of thumb for adjudicating intellectual disputes when directly relevant information is scarce.  The rule has two steps. 

Step 1: Look at how emotional each side is. 

Step 2: Assume the less emotional side is right and the more emotional side is wrong.

Why should we believe the Mellow Heuristic tracks truth?  Most obviously, because emotionality drowns out clear thinking, and clear thinking tends to lead to truth.  The more emotional people are, the less clear thinking they do, so the less likely they are to be right. 

Furthermore, people who hope to persuade others normally highlight their strongest evidence.  So if advocates of a view spend most of their time emoting on you, it is reasonable to infer that they lack better evidence.  And sides with low-quality evidence are also less likely to be right.

Like all heuristics, the Mellow Heuristic is imperfect.  If Hannibal Lecter debated one of his traumatized victims, the Mellow Heuristic would probably conclude that Lecter was in the right.  But it's a good heuristic nonetheless.  On average, the calm are really are more reliable than the agitated. 

On some level, you already know this.  That's why you tell yourself, "Calm down" when the costs of error are high.  If you don't trust yourself to reach the truth when you're upset, why would you trust strangers who aren't even trying to keep their emotions in check?


   


Over at TheMoneyIllusion I received the following comment:

Macro trading is not about getting it right, it is about getting what others think is right. And that can be almost anything ...
That reminded me of Keynes's famous claim that successful investing was like guessing the winner of a beauty pageant. You don't try to pick the prettiest woman, but rather the woman that you think others will find pretty.

That's a clever line, but I don't think it's correct. I believe markets are roughly efficient, which means that it's very difficult for people to forecast (risk-adjusted) excess returns. But let's say I'm wrong; how would you go about doing so? One option would be to try to forecast the future type of mass hysteria that the public will succumb to. The other option would be to identify current irrationality in the investment community, which will eventually fade away, as new information makes it clear that their forecasts were unrealistic. I believe it would be easier to notice in 1999 and 2000 that tech stocks were too high due to "irrational exuberance," than to forecast back in 1994 that there would soon be a bout of irrational exuberance.

If you look at successful investors like Warren Buffett, they generally don't try to buy stocks that they believe will be overvalued in the future, rather they try to buy stocks that they believe are currently undervalued. Those are not easy to spot, but the alternative approach is even more difficult.

If we return to the beauty pageant example, Keynes's analogy doesn't really make any sense. For example, to make money betting on the winner of a beauty pageant, you'd need to do much more than predict which lady other bettors will find attractive, you'd have to predict how their views of relative beauty would evolve after the pageant. That's because the starting odds on each woman winning would already reflect the public's perception of their relative attractiveness. You'd need to predict how that public appraisal would change after the talent and swimsuit competitions. I suppose that's possible, but it's more about predicting "fundamental values" of beauty.

If we insist on a beauty pageant analogy, here's the one I'd use. Suppose the average beauty pageant gambler bets on the basis of the stock photos provided by the pageant to the press. That's the "public information." If you were Warren Buffett, you'd want to send detectives around observing the women in their daily lives, to get a better overall appraisal of their beauty and poise than you'd get from a single stock photo. (Or their ability to talk convincingly about the need for world peace.) That's what I mean by "fundamental" beauty. You don't want to forecast what others think, that's already embedded in the price, you want to forecast the TRUTH, which is what others will come to think once more information is available (in this case the pageant itself, in the world of stocks that would be how profits play out over an extended period of time.)

In both cases you are basically trying to forecast what people will learn over time. Of course my analogy is far from perfect, as even after a pageant you could argue that perceptions of beauty are more subjective than corporate profitability.

PS. In a future post I'll explain what's wrong with claiming, "the market can stay irrational longer than you can stay solvent."


   


EconLog reader Matthew Baker has detected an error in my spreadsheets on the social return to education.  Fortunately, the mistake - a miscalculation of crime risk for the elderly - is so small that none of the main results change by even a tenth of a decimal place. 

Still, all the files have been updated, and I'm immensely grateful to Mr. Baker for being so meticulous.  I'll certainly be thanking him in the book credits when the project's done.


   


While I was heading to the APEE conference in Cancun, I learned that economist Barbara Bergmann had died. I reviewed her book The Economic Emergence of Women in Fortune on March 2, 1987. Here are some excerpts from my review:

The liberal [DRH note: that was Dan Seligman's adjective. I would not have used it myself but I had many battles to fight on this one] feminist agenda has beep pushed hard in the U.S., but the pushing has mainly been done by politicians and "movement" stalwarts. Not many professional economists have been promoting the agenda, which emphasizes the Equal Rights Amendment, "comparable worth," and affirmative action. Now, at last, a trained economist has weighed in heavily on the feminists' side. The Economic Emergence of Women, BasIc Books, $19.95), by Barbara R. Bergmann, presents the most sustained economic caseI know of for much of the agenda.

Bergmann, professor of economics at the University of Maryland, argues persuasively that women are occupationally segregated and major victims of job discrimination. She is less persuasive about other matters, however. For example, what causes the famous 40% male-female wage gap? Bergmann says she is confident that discrimination explains much of it. She rests her case mainly on statistical evidence suggesting that differences in experience, trairnng, etc., explain only half the wage gap--about 20%. The other 20%, she argues, must be mainly discrimination.

But that doesn't follow. The wages of white males also vary widely, and the same kinds of statistical analyses typically explain only half of the variation there too. Economists do not therefore conclude--and Bergmann herself certainly would not--that the unexplained variation mainly reflects discrimination. Instead, they come away from the data saying that our statistical tools are imperfect and that much wage variation reflects factors that we simply do not know how to measure (of which discrimination may well be one).


I'll publish a further excerpt in the next day or two.

CATEGORIES: Labor Market

   


Bryan Caplan

Education and Apostasy

Bryan Caplan
Intriguing and eloquent words from Uecker, Regnerus, and Vaaler ("Losing My Religion," Social Forces 2007):
Sociologists of religion have long linked educational attainment to religious decline (Caplovitz and Sherrow 1977; Hadaway and Roof 1988; Hunter 1983; Sherkat 1998). But the assumption that a college education is the reason for religious decline gathers little support here. Emerging adults who do not attend college are most prone to curb all three types of religiousness in early adulthood.Simply put, higher education is not the enemy of religiosity that so many have made it out to be. So if a college education is not the secularizing force we presumed it to be, what is going on?

Certainly many college students participate less in formal religious activities than they did as adolescents, but church attendance may take a hit simply because of factors that influence the lives of all emerging adults: the late-night orientation of young adult life; organized religion's emphasis on other age groups, namely school-aged youth and parents; and collective norms about appearing "too religious." (Smith and Denton 2005)

The overwhelming majority (82 percent) of college students maintain at least a static level of personal religiosity in early adulthood. Similarly, 86 percent retain their religious affiliation. For most, it seems religious belief systems go largely untouched for the duration of their education. Religious faith is rarely seen as something that could either influence or be influenced by the educational process. This is true for several reasons. First, some students have elected not to engage in the intellectual life around them. They are on campus to pursue an "applicable" degree, among other, more mundane pursuits, and not to wrestle with issues of morality or meaning. They instead stick to what they "need to know" -- that which will be on the exam. Such students are numerous, and as a result students' own religious faith (or lack of it) faces little challenge. Indeed, many university curricula are constructed to reward this type of intellectual disengagement... What is not contested, then, cannot be lost. Faith simply remains in the background of students' lives as a part of who they are, but not a part they talk about much with their peers or professors.

Second, while higher education opens up new worlds for students who apply themselves, it can, but does not often, create skepticism about old (religious) worlds, or at least not among most American young people, in part because students themselves do not perceive a great deal of competition between higher education and faith, and also because very many young Americans are so undersocialized in their religious faith (before college begins) that they would have difficulty recognizing faith-challenging material when it appears. And even if they were to perceive a challenge, many young people do not consider religion something worth arguing over.

On the other hand are devoutly religious college students. They arrive on campus expecting challenges and hostility to their religious perspectives. When they do not get it, they are pleasantly surprised; when they do, it merely meets their expectations and fits within their expected narrative about college life. Campus religious organizations anticipate such intellectual challenge and often provide a forum for like-minded students. In fact, college campuses are often less hostile to organized religious expression and its retention than are other contexts encountered by emerging adults, such as their workplaces. Campus religious organizations provide additional religious community to which non-students lack access. Furthermore, the arrival of postmodern, post-positivist thought on university campuses has served to legitimize religiosity and spirituality, even in intellectual circles. Together with heightened emphasis on religious tolerance and emerging emphases on spiritual development, antireligious hostility on campus may even be at a decades-long low.
"What is not contested, then, cannot be lost."  True enough.


   


Note: The reason for my dearth of blog posts lately is the troubles I've had with my 6-year-old Mac. I now have a new one and all is well. Fingers crossed.

Does the U.S. economy face secular stagnation? I am skeptical, and the sources of my skepticism go beyond the fact that the U.S. economy looks to be well on the way to full employment today. First, as I pointed out as a participant on the IMF panel at which Larry first raised the secular stagnation argument, at real interest rates persistently as low as minus 2 percent it's hard to imagine that there would be a permanent dearth of profitable investment projects. As Larry's uncle Paul Samuelson taught me in graduate school at MIT, if the real interest rate were expected to be negative indefinitely, almost any investment is profitable. For example, at a negative (or even zero) interest rate, it would pay to level the Rocky Mountains to save even the small amount of fuel expended by trains and cars that currently must climb steep grades. It's therefore questionable that the economy's equilibrium real rate can really be negative for an extended period. (I concede that there are some counterarguments to this point; for example, because of credit risk or uncertainty, firms and households may have to pay positive interest rates to borrow even if the real return to safe assets is negative. Also, Eggertson and Mehrotra (2014) offers a model for how credit constraints can lead to persistent negative returns. Whether these counterarguments are quantitatively plausible remains to be seen.)

This is my favorite paragraph from Ben Bernanke's blog post "Why are interest rates so low, part 2: Secular stagnation," March 31, 2015. Bernanke is a clear writer, which is refreshing.

I heard my own version of "Uncle Paul's" example from Sam Peltzman, who had heard it from Martin Bailey. Another person who had heard it from Bailey is Bill Poole. Poole writes:

A convincing counterargument [to the secular stagnation argument] was presented in a 1962 textbook by Martin J. Bailey, with whom I studied at the University of Chicago. Bailey argued that investment spending would not reach a limit at a zero rate of interest because there are some investments that have an annual return that continues in perpetuity. If an investment has an infinite life, then the present value of the project can be made as large as you please by making the interest rate as low as you please. Mathematically, as the discount factor on future returns goes to zero the present value becomes indefinitely large. The lower the rate of interest the greater the number of investments there would be with present value above their capital cost and the total size of these investments would be easily large enough to bring the economy to full employment.

Bailey used the example, and had estimates of the cost, of creating new farmland by filling shallow coastal areas in the Gulf of Mexico. The newly created land would have a return in agricultural output that would continue indefinitely.

Another example discussed by Bailey is leveling the Midwest. This argument always yielded a few smiles from the class. However, anyone who lives in the hugely productive farm areas of the Midwest knows that the land is not perfectly flat. Water collects in the lower spots, damaging agricultural productivity. At finite cost, a farmer can strip off topsoil, level the land, and put the topsoil back. The increase in output continues indefinitely. At a low enough interest rate, the value of the investment exceeds its cost. Bailey had other examples of investments that would create a long string of returns and that, at a low enough interest rate, would be worth doing.


I don't quote this just to show that the point was well known. Poole goes on to make a point that Bernanke doesn't mention: insecure property rights. Poole writes:
As I speak, the yield on the inflation-protected Treasury bond is about zero at the 10-year maturity and slightly below 1 percent on the 30-year maturity. Yet, I have not observed a rush to fill in the Gulf of Mexico or level the Midwest. Why?

For Bailey's argument to work, environmental permits have to allow the investment in the first place. And, the relevant return is on an after-tax basis. Will future tax law permit such an investment to earn enough to cover its capital cost?

I am convinced that the issue in the United States today is not that business is shortsighted and unwilling to take risk. Consider the enormous investment, and risk, Boeing assumed when it launched the 787 Dreamliner project. The exact timing does not matter for my argument, but a quick Internet search suggests that Boeing went public with the project in early 2003. Although the plane is currently about 3 years late to market, when Boeing decided to proceed it must have had a planning horizon of at least five years to bring the first model into service. Boeing expected the 787 to yield a stream of extra returns over many years; discounting those returns back to the decision date, Boeing must have thought the project had a present value above its enormous cost.

This sort of long-horizon investment is frequent in U.S. history. We do not see more such investment now because of uncertainty over the tax and regulatory environment. Martin Bailey, writing before establishment of the Environmental Protection Agency, could not have foreseen that creating new agricultural land in the Gulf of Mexico would have been impossible, and that plans to level sections of the Midwest might have been held up for years and years. And given the unsustainable federal budget situation, returns from risky projects might never be realized because they would be taxed away.


Interestingly, Larry Summers, whom Bernanke let guest blog on secular stagnation, and who, with me, was a colleague of Bill Poole at the Council of Economic Advisers, does hint at some of Bill Poole's point, writing:
Ben grudgingly acknowledges that there are many theoretical mechanisms that could give rise to zero rates. To name a few: credit markets do not work perfectly, property rights are not secure over infinite horizons, property taxes that are explicit or implicit, liquidity service yields on debt, and investors with finite horizons.


   


Pro-life utilitarians are very scarce.  A philosophy professor recently told me that he knows of zero pro-life utilitarians in the entire philosophy profession. 

This is deeply puzzling.  While I'm not a utilitarian, the utilitarian case against abortion seems very strong.  Consider: Even if a pregnant woman deeply resents her pregnancy, she is only pregnant for nine months.  How could this outweigh the lifetime's worth of utility the unwanted child gets to enjoy if he's carried to term? 

A bundle of empirical regularities reinforce this prima facie case.

1. Almost everyone is glad to be alive.  The unwanted infant may have a below-average quality of life, but below-average is usually excellent nonetheless.

2. There is a long waiting list - hence excess demand - to adopt healthy infants, so birth mothers need not raise their unwanted children.

3. Due to the endowment effect, unwanted children often become wanted by their birth mother once they're born - as many would-be adoptive parents discover to their sorrow.

4. Women who just miss the legal cutoff for abortion seem to quickly recover emotionally.  Pregnant women who think "A baby will ruin my life" are, on average, factually mistaken.

How could a utilitarian avoid the pro-life conclusion?  There are two tempting routes:

1. Argue that the utility of the unborn counts for nothing - at least until the fetus starts feeling pleasure and pain.  Convenient.  But once you accept the core utilitarian intuition - that the existence of pleasure is good, and the existence of pain is bad - the creation of creatures who will feel a lot more pleasure than pain seems like a great good.  Picture an uninhabited world capable of supporting happy lives.  How could a utilitarian not want to populate it?

2. Argue that each unwanted child has large negative social effects, even though people are eager to adopt.  Most obviously, utilitarians could embrace an extreme Malthusian story where the birth of one human statistically dooms another.  Once you accept this story, of course, saving any life becomes morally suspect.

When I present the utilitarian case against abortion, people normally reply, "But that implies a further moral duty to have tons of babies."  They're right.  From my perspective, that's yet another convincing argument against utilitarianism.  Creating life is a prime example of what utilitarians conceptually reject: actions that are morally good but not morally obligatory.  But given utilitarians' notorious willingness to bite bullets, why should they demur here?

P.S. If you do know of any pro-life utilitarians, please share URLs in the comments.


   


I recently received this request in a comment section:

Slightly off-topic, but Scott you would *love* an idea which is becoming more widespread here in the UK, that the housing shortage here is being caused by "artificially low interest rates".

It is being peddled by worryingly-influential right-of-centre finance commentators in newspapers.


Let's start with the term 'artificially'---what does that actually mean? It might mean a shortage or surplus exists, as when New York rent controls artificially hold rents below equilibrium. It might mean monopoly power, as when OPEC artificially raises equilibrium oil prices though output restrictions. This latter use of 'artificially' means something more like monopoly power than price controls. Clearly the role of monetary policy in the credit markets is more like OPEC than NYC rent controls. The fed funds rate does find an equilibrium, it's just that central banks are such big players that they can affect that equilibrium rate.

OK, but how would we establish whether the equilibrium interest rate is "artificially" low or high? There's really only one set of criteria, which (AFAIK) were first modeled by the economist Knut Wicksell. He referred to the natural interest rate as the rate that would lead to macroeconomic equilibrium. He used price stability as the benchmark for equilibrium, although in modern central banking the analogous criterion would be something like 2% inflation. Because Britain and other major developed countries are currently experiencing less than 2% inflation, there is no evidence that rates are artificially low. If they were, inflation would be much higher.

Some people argue that supply-side factors such as competition from China are holding down inflation, and that the inflation shows up in asset markets like housing and stocks, instead of consumer prices. That's a good argument in principle, but is it true? George Selgin and others have persuasively argued that something like NGDP growth is a better criterion for monetary stability. Selgin suggests that rapid productivity growth should lead to lower inflation, and that if central banks artificially maintain something like 2% inflation in an environment of fast productivity growth, then the economy might become overheated and distortions would occur. I agree.

Unfortunately most proponents of the "artificially low interest rates" hypothesis don't seem to have a coherent macro model underlying their arguments. If China competition were actually holding down inflation, we should see unusually fast productivity growth. But in the UK there has been almost no productivity growth in the past decade, and hence pointing to supply-side factors actually deepens the puzzle. If rates were artificially low in the UK, then we ought to see either high inflation or high productivity growth. But both of these variables are growing very slowly.

There is absolutely no mechanism by which monetary stimulus could boost asset prices without boosting NGDP. None.

If rates were artificially low, then attempts to raise them should be successful. But recent attempts by central banks to raise rates have all gone poorly. Japan tried in 2000 and 2006, Sweden in 2010, the ECB in 2011. In each case the economy soon went back into recession and/or deflation, and the central bank had to cut rates back to zero to prevent an outright depression.

When I studied macroeconomics at the University of Chicago in the late 1970s, I felt we were ahead of the rest of the profession. One advantage was that we never reasoned from an interest rate change. Friedman emphasized that low rates did not mean easy money, and that you needed to look at other indicators (he preferred M2, and then later in his life inflation.) It's very discouraging to see things flop-flop in 2015, where you now tend to see people on the right drawing all sorts of unjustifiable conclusions from the low level of interest rates. In contrast, many economists on the left recognize that low rates reflect a weak economy and low inflation, as well as possible long-term "stagnation" factors. I guess we'll have to keep fighting this battle over and over again.

PS. I have some comments on interest rates at a new EconTalk interview with Russ Roberts. A commenter pointed out that I didn't clearly enough distinguish between ex ante and ex post returns on capital. I should have emphasized that it is ex ante returns that matter.

CATEGORIES: Finance , Monetary Policy

   


The European Commission is opening an investigation on Google, for alleged anti-competitive practices. The EC is concerned that "the company has given an unfair advantage to its own comparison shopping service, in breach of EU antitrust rules".
Google.png

Wayne Crews has an excellent piece on Forbes. Wayne digs into the political nature of antitrust. He points out that "antitrust's goal is getting forced access to the customer base of the the successful firm and allowing competitors to sit still.
The second but equal goal of antitrust is to enrich the antitrust bar and bureaucracies, expanding the state for new incursions and aspirations for power, such as net neutrality."

There is much of politics in European competition policy. It is not by chance that some of its past major targets have been American corporations: GE, Microsoft, Intel, to whom we may now add Google. Somebody in Brussels may be convinced that competition policy is the only real foreign policy the EU really has.

It is easy to compare the situation of Google today with that of Microsoft some ten years ago, when it got fined by then European Commissioner Mario Monti. (Crews has a nice point: it is nonsense to talk about a "Competition Commissioner").

But Google's situation is much different than what used to be Microsoft's. For one thing, the European case against Microsoft came after a thorough investigation by the DOJ, led by then-Assistant Attorney General Joel Klein. Somehow, part of the world's public opinion was already deeming Microsoft's market dominance to be very dangerous and was somehow surprised when ultimately the American Microsoft case was dropped. (On the Microsoft case, you should read this book by Liebowitz and Margolis). The European Commission is, so to say, taking the lead with Google, which is a company that enjoys a far better reputation - with the general public but with regulators and decision makers, too. This may change, if anything, the way in which the media portrays the case. If Mario Monti was "SuperMario" triumphing over Jack Welch and Bill Gates, I am not so sure Commissioner Margrethe Vestager may easily capitalise on the Google case.

Does this matter? Isn't Antitrust a 'technical' rather than a 'political' issue? If Wayne is right, and antitrust is "predatory corporate welfare policy", which means it is inherently redistributive, it is very political indeed.


   


Bryan Caplan

Are Centers a Mistake?

Bryan Caplan
Suppose you want to convert the world to belief X.  You decide that professors are the best spokesmen for X.  There are ten universities, and you have enough money to fund ten professors.  There are two possible ways to spend the money:

1. Give ALL the money to one school to create a Center for the Study of X - an academic cluster where all ten pro-X professors work together.

2. Give EACH school enough money to hire ONE professor, so every university has a lone proponent of X.

Question: Which option will provide the best return on your charitable investment?  Definitionally, #1 is better if there are economies of scale, and #2 is better if there are diseconomies of scale.  But which description best fits the real world? 

My main thoughts: #1 is probably much more fun for the faculty.  Being part of a center of like-minded folks beats being a lone voice in the wilderness.  #1 also plausibly attracts more media attention.  A Center of ten professors is more visible than ten isolated professors.  However, #2 also has a big advantage: It avoids redundancy.  When a lone pro-X professor converts a student, it's hard to say, "It would have happened even if this professor hadn't been hired."  But if one out of ten pro-X professors converts a student, "It would have happened even if this professor hadn't been hired" is quite plausible.

Bonus question: Suppose #1 is definitely better than #2.  If each school already has one pro-X professor, would it be worthwhile for a donor to give one school enough money to "poach" all the pro-X professors from the other schools?  Could clustering really be that valuable?

Please show your work.

P.S. Thanks to all the great people I met in Ohio.  I'll be back!

CATEGORIES: Economics and Culture

   


David Henderson has a good post on the way that textbooks teach the substitution effect. I have one other bone to pick with principles textbooks---they don't clearly explain to students how to avoid "reasoning from a price change." Start with the textbook definition of substitute goods:

If the price of good A rises, the demand for good B rises.
Now apply it to a real world example. Suppose there is a scientific study indicating that drinking coffee causes cancer. How does this impact the demand for tea? Most students will understand that tea is a substitute for coffee, and hence that the demand for tea will rise. But they won't get the right answer by applying anything they learned in economics. After all, the coffee scare would depress the price of coffee. So the demand for tea is rising despite the fall in the price of coffee.

On could argue that other things equal, a lower coffee price should lead to less demand for tea. But even that's not quite right, as "other things equal" a lower coffee price would lead to a shortage of coffee. That's because if you assume "other things equal" you are assuming that only the price of coffee has changed, nothing else. The supply and demand curves for coffee stay where they are. And in that case there is more demand for tea due to the coffee shortage.

Of course students who take advanced economics understand that a health scare in coffee causes a big increase in the demand for tea, whereas the accompanying fall in coffee prices makes the increase in tea demand a bit smaller, but that's way over the heads of principles students. I see so much reasoning from a price change that I wonder whether even 1% of economics students actually understand supply and demand. Many students believe they are taught that "in years when coffee prices soar much higher, we would normally expect to see a rise in the demand for tea," which is not at all what we are trying to teach.

In Mankiw's Principles text he says:

Suppose that the price of frozen yogurt falls. The law of demand says that you will buy more frozen yogurt.

(That's the third edition, p. 68, perhaps it's been fixed in later editions.) Of course the law of demand says no such thing. It depends why the price of yogurt fell. Defenders of Mankiw tell me that there's no problem, because he is implicitly assuming the demand curve for frozen yogurt is stable. And how many students will understand that subtlety? The vast majority will leave economics thinking that they've been taught that you can expect people to buy more when the price is lower. And then we wonder why the public is confused when economists complain about deflation.

Recently I've had lots of debates about the effect of a change in interest rates. In fact, it's nonsensical to talk about a change in interest rates having any sort of predictable effect on the economy. Rather it's the things that cause interest rates to change that will have an effect. Back in 1992, Milton Friedman complained about how the profession reasons from a price change, assuming that low interest rates always mean easy money:

Declining or low interest rates may at times correspond to easy money, but so may rising or high interest rates. To illustrate the first possibility, the short-term commercial paper rate remained around 0.75% from 1939 to 1946, while the money supply nearly tripled and the price level rose by 60%. To illustrate the second, the federal funds rate hit 20% in January 1981, and again in July, a period when both M2 and consumer prices were rising at nearly 10% a year. If the Fed can control interest rates, does anyone really believe that we would have seen the federal funds rate at 20%?

Unfortunately, I haven't seen any signs of improvement since 1992, if anything the profession is going backwards. I see people say "normally you'd expect more investment when rates are low" or "normally the government should invest more in infrastructure when rates are low" or "normally you'd expect more bank lending when rates are low," all reasoning from a price change.

Update: Speaking of Reasoning From a Price Change, there is a new podcast where Russ Roberts interviews me on that very subject.

PS. Years ago when I was teaching principles I used Mankiw's text because I thought it was the best one available, so don't take this post as trashing his book. It's actually very difficult to teach anything in economics without cutting some corners here or there.

PPS. The coffee example is not some sort of weird trick question. A priori, you'd expect roughly 50% of price changes to be due to demand shifts and 50% due to supply shifts. We'd like our principles models to be more accurate than a coin flip

HT: Benjamin Cole

CATEGORIES: Economic Education

   


In the Energy Economics course I'm teaching this quarter, I have a number of students who have never had economics before. So I'm using selected chapters from the Microeconomics portion of Greg Mankiw's Principles of Economics, and I add a few dozen readings from the literature, especially from the literature on energy. I use the 5th edition of Mankiw so that the students spend closer to $20 than to $150.

I like the book, which is why I use it, but each time I use it, I find things that are off. This is about one of those.

In a section on determinants of elasticity of demand, Mankiw lists four. The first is "Availability of Close Substitutes." The third is "Definition of the Market."

Here's Mankiw:

Availability of Close Substitutes
Goods with close substitutes tend to have more elastic demand because it is easier for consumers to switch from that good to others. For example, butter and margarine are easily substitutable. A small increase in the price of butter, assuming the price of margarine is held fixed [by the way, this is not my criticism, but some students will read that as "assuming the government keeps the price fixed," when what he really means is "assuming the price of margarine doesn't change"] causes the quantity of butter sold so fall by a large amount. By contrast, because eggs are a food without a close substitute, the demand for eggs is less elastic than the demand for butter."

Definition of the Market
The elasticity of demand in any market depends on how we draw the boundaries of the market. Narrowly defined markets tend to have more elastic demand than broadly defined markets because it is easier to find close substitutes for narrowly defined goods. For example, food, a broad category, has a fairly inelastic demand because there are no good substitutes for food. Ice cream, a narrower category, has a more elastic demand because it is easier to substitute other desserts for ice cream. Vanilla ice cream, a very narrow category, has a very elastic demand because other flavors of ice cream are almost perfect substitutes for vanilla.

On their own, each of these is fine. The problem is that Mankiw never makes it clear that they are the same point. Notice how he discusses the definition of the market. It's all about close substitutes, which is the point of his "Availability of Close Substitutes" point.


   


George Selgin has a new post discussing a paper he wrote with David Beckworth and Berrak Bahadir. In the paper they argue that the Fed set its policy rate too low during the early 2000s, and that this decision contributed to the subprime boom:

It is widely believed that, in the wake of the dot.com crash, the Fed kept the federal funds target rate too low for too long, inadvertently contributing to the subprime boom. We attribute this and other Fed departures from a "neutral" policy stance to the Fed's failure to respond appropriately to exceptional rates of total factor productivity growth. We then show how the Fed, by adhering to a nominal GDP growth rate target, might have succeeded in maintaining such a neutral stance.
This is certainly a defensible claim, and I agree with the policy implications they draw from their analysis. Nonetheless, I am going to offer a few words of caution:

1. We should never leave the impression (even unintentionally) that sound monetary policy will prevent severe sectoral imbalances. It's quite possible that a housing boom of almost equal size would have occurred during the early 2000s, even under a perfect NGDP targeting policy.

2. It's dangerous to focus on interest rates, even if everyone else in the world insists on talking about monetary policy in terms of interest rates.

Here are some other claims about the housing "bubble" period, that I would argue push a little bit back against the view that the Fed played an important role:

1. Low interest rates don't imply easy money, unless it can be established that they were below the Wicksellian equilibrium rate. And this can only be determined by looking at NGDP growth rates.

2. NGDP growth during the 2001:4 to 2007:4 expansion averaged well under 6%. At the time it was the lowest growth rate during any economic expansion since NGDP data collection began in the 1940s. In retrospect, NGDP growth during the early 2000s expansion probably should have been even less. However I'm reluctant to attribute major economic events to excessive NGDP growth in an economic expansion, when NGDP growth during that expansion was unusually slow.

3. Monetary policy is not a surgical tool that can be used to affect specific sectors of the economy. It can only affect any given sector by affecting the overall economy (NGDP.) Thus in 1928 and 1929 when the Fed tried to use higher interest rates to slow the stock market boom, and the policy was a complete failure until rates were raised so high that NGDP began plunging. Then stocks crashed. It wasn't the high interest rates, it was the falling NGDP. If Fed policy contributed to the subprime boom, it was not from low interest rates, but rather excessive NGDP growth.

4. If the Fed's policy had aimed at slightly slower NGDP growth during 2001-07, then interest rates in the counterfactual policy would have been a bit higher in 2001-02, but substantially lower in 2003-07. In the long run rates tend to follow the economy, and that is why slower NGDP growth in 2001-07 would have implied lower interest rates by 2003-07. That's something to think about if you believe low rates fed the housing boom by making mortgages "affordable."

5. Even under an ideal monetary policy, the subprime boom might have occurred due to Federal government policies aimed at boosting mortgage lending (FDIC, GSEs, TBTF, CRA, etc.) and/or mistakes made by private sector lenders. There doesn't seem to be much correlation between easy money and what are viewed as "bubbles," indeed bubbles were noticeably absent in the Great Inflation of 1966-81, and the 1928-29 stock boom occurred during a period of mild deflation and extremely high real interest rates. (In fairness, NGDP growth was probably reasonably good in 1928-29.)

None of this should be viewed as criticism of the key analytical points in their article. Fed policy is too expansionary during periods of rapid productivity growth because the Fed focuses on inflation, rather than NGDP growth. With a policy of NGDP targeting, level targeting, the past 15 years would have been far more stable. However in my view that extra stability would come more from easier money after 2007 than tighter money before 2007.

PS. I put the term "bubble" in quotation marks because I don't really believe in bubbles. I'm referring to periods that other people view as bubbles.

CATEGORIES: Monetary Policy

   


Yesterday's electronic New York Times and today's print edition carries the news story "Use of E-Cigarettes Rises Sharply Among Teenagers, Report Says" by Sabrina Tavernise.

It's actually very good. Indeed, it reminds me of some of the best of the Wall Street Journal news stories of the 1970s when I started reading that publication daily in graduate school. It's a mix of interesting facts put together in an understandable narrative that will show any reader with an open mind that e-cigarettes are substituting, especially with young people, for cigarettes, pipes, and cigars. An excerpt:

But the report also told another story. From 2011 to 2014, the share of high school students who smoked traditional cigarettes declined substantially, to 9 percent from 16 percent, and use of cigars and pipes ebbed too. The shift suggested that some teenage smokers may be using e-cigarettes to quit.

The narrative also cites the view that, from a health point of view, this is good. An excerpt:
Smoking is still the single-biggest cause of preventable death in the United States, killing more than 480,000 Americans a year, and most scientists agree that e-cigarettes, which deliver the nicotine but not the dangerous tar and other chemicals, are likely to be far less harmful than traditional cigarettes.

I was also pleased to see her place a counterpoint to the "ain't it awful" views of those who simply want people not to smoke and not to vape. She quotes an "ain't it awful" official:
"This is a really bad thing," said Dr. Thomas R. Frieden, the director of the C.D.C., who noted that research had found that nicotine harms the developing brain. "This is another generation being hooked by the tobacco industry. It makes me angry."

Then she lays out the counter position:
But the numbers had a bright side. The decline in cigarette use among teenagers accelerated substantially from 2013 to 2014, dropping by 25 percent, the fastest pace in years.

The pattern seemed to go against the dire predictions of anti-tobacco advocates that e-cigarettes would become a gateway to cigarettes among youths, and suggested they might actually be helping, not hurting. The pattern resembled those in Sweden and Norway, where a rise in the use of snus, a smokeless tobacco product, was followed by a sharp decline in cigarette use.

"They're not a gateway in, and they might be accelerating the gateway out," said David B. Abrams, executive director of the Schroeder Institute for Tobacco Research and Policy Studies, an anti-tobacco group.


What's striking is the amount of space she gives to that position.

She also points out that the FDA is taking steps toward regulating e-cigarettes, and here is the only place where I would fault the reporter. Ms. Tavernise writes:

The numbers came as a surprise and seemed to put policy makers into uncharted territory. The Food and Drug Administration took its first tentative step toward regulating e-cigarettes last year, but the process is slow, and many experts worry that habits are forming far faster than rules are being written. Because e-cigarettes are so new, scientists are still gathering evidence on their long-term health effects, leaving regulators scrambling to gather data.

There's nothing inaccurate in that paragraph. So what's the problem? There's no hint in the news story--possibly because Ms. Tavernise thinks it's going beyond the story but, if so, I disagree--about what some plausible FDA regulations will look like.

Think about it. If the FDA regulates, it will not be to make e-cigarettes more available. It will be to make them more costly, either in terms of accessibility or in terms of price, or both. If so, the FDA regulation will slow this healthy substitution away from more-toxic substances. Possibly, she couldn't find an economist willing to apply basic microeconomics to this issue. If so, I'm available.


   


Over at TheMoneyIllusion I have a long post discussing Ben Bernanke's recent comments on monetary reform. There is one issue that seems especially important, and I wanted to devote an entire post to the subject. Here's Bernanke:

I want to raise a few practical concerns about the feasibility of changing the FOMC's target, at least in the near term. First, whatever its strengths and weaknesses, the current policy framework, with its two explicit targets and balanced approach, has the advantage of being closely and transparently connected to the Fed's mandate from Congress to promote price stability and maximum employment. It may be that having the Fed target other variables could lead to better results, but the linkages are complex and indirect, and there would be times when the pursuit of an alternative intermediate target might appear inconsistent with the mandate. For example, any of the leading alternative approaches could involve the Fed aiming for a relatively high inflation rate at times. Explaining the consistency of that with the statutory objective of price stability would be a communications challenge, and concerns about the public or congressional reaction would reduce the credibility of the FOMC's commitment to the alternative target.

Second, proponents of alternative targets have to accept the fact that, for better or worse, we are not starting with a blank slate. For several decades now, the Fed and other central banks have worked to anchor inflation expectations in the vicinity of 2 percent and to explain the associated policy approach. A change in target would face the hurdles of re-anchoring expectations and re-establishing long-term credibility, even though the very fact that the target is being changed could sow some doubts. At a minimum, Congress would have to be consulted and broad buy-in would have to be achieved.


This is obviously a very difficult subject, and there is clearly no single right answer. And yet I sometimes feel that people confuse mandates and targets, so I'd like to offer a few perspectives that might be useful. Let's start with the original intent:

1. The Fed's mandate was enacted by Congress in 1977, and includes both "reasonable price stability" and maximum employment. I think it's fair to say that 1977 was pretty close to the nadir of our understanding of monetary economics. I doubt one Congressman in 10 would have seriously thought the Fed could target inflation at say 2%. They would have been thrilled with 4% inflation. There is even a third mandate for low long-term interest rates, which is (rightfully) ignored.

2. On the other hand things change, and we now have a much better understanding of monetary economics. It's probably reasonable to assume that the Congress of 2015, and the public as well, would prefer that we do not return to 4% inflation. Nonetheless, the 1977 law is pretty vague, and I'd argue that today a 4% NGDP target is just as compatible with "reasonable price stability" and "maximum employment" as a 2% inflation target.

Many of my friends criticize the dual mandate because the Fed can only target one variable at a time. I used to feel the same way, but now I'm slightly more forgiving of Congress. I think the dual mandate could be regarded as sort of aspirational---the Congress telling the Fed to do the best it can in producing a stable economy with something close to price stability and high employment. But again, given that the law was passed in 1977, it's hard to believe that Congress envisioned they were instructing the Fed to hit any sort of single rigid inflation target, no one except a few monetarists would have even thought that possible in 1977.

Instead Congress was probably saying something like, "The Fed is one of many policymakers, we'd like them to do their part in contributing to good inflation and employment outcomes." Or perhaps Congress was saying, "Here are our goals, you figure out the best way to achieve them." If Fed officials think NGDP targeting is the most effective way to stabilize the economy, I think they already have all the authority they need under the very vague 1977 law. The only concession I'd make is that while I prefer a pure NGDP target which lets long term inflation fluctuate inversely to changes in long term RGDP growth, as a practical matter Congress does clearly care more about inflation than I do. Thus the actual target would probably be something like the Fed's estimate of trend RGDP, plus 2%, where the trend gets re-estimated every 5 years. That allows some inflation variation, but not much.

Some readers of this post might feel I'm granting the Fed far too much discretion. If so, I'd encourage you to re-read my earlier post on Fed accountability. I think it's reasonable for Congress to let the Fed determine how best to carry out the mandate, but then they should insist that the Fed clearly spells out its intermediate targets in such a way that monetary policy is clearly accountable, where we can say after the fact that the Fed did or did not hit its policy targets. In that respect, NGDP targeting is a vast improvement over the vague "2% inflation plus unemployment close to the natural rate" approach used in recent years. Under that approach it looks (to me) like monetary policy was clearly far too tight in 2008-13, and yet the Fed refuses to say that policy was much too tight, nor do they tell us why they don't think it was too tight.

So by all means keep the dual mandate, but have the Fed move from two targets to one, so that the spotlight shines more clearly on their policy. Institutions that are highly accountable will do better, even if the managers are already very civic-minded. That's because the accountability would make it easier for the Fed to take the tough decisions in periods like 2008-09 that it should have taken, but perhaps held back due to fears of provoking controversy. Under an ideal regime you want the Fed to be able to say, "Look, this is our mandate, we'll do whatever it takes to hit the mandate."

I'm not an expert on Congress, but I would think that the Fed would want explicit Congressional authorization for a major policy change such as raising the inflation target to 4%. That's not price stability. But as for a NGDP intermediate target that was consistent with expected 2% inflation, Fed consultation with Congress should be sufficient.


   


With the UK and Spain going to the ballot box in the next few months, European politics is certainly more than Greece, at the moment. We know that the polls are rather foggy about England, but Spanish politics risks becoming very "lively," too. Spain is a member of the Eurozone and has a strong, emerging extreme leftist party, Podemos. So, the way in which the Greek story is moving may have a very strong influence on what happens in Spain, too.

It appears that after the next election Spain will switch from a two party system to a four party system, as Vincenzo Scarpetta argues here. The fourth party (after the Christian Democrats, the Socialists, and the extreme left Podemos) is called Ciudadanos ("Citizens") and portrays itself as a "centrist" party, aiming at (of course) the "democratic regeneration" of Spain. Ciudadanos has its roots in Catalonia, but strongly opposed its attempts to secede from the Madrid government.

When you read about Ciudadanos in the international press, they're often portrayed as the "free market" twin brother of Podemos: a much better, more fiscally responsible alternative for Spanish voters that are fed up with the two major parties.

Juan Ramon Rallo, of the Institudo Juan de Mariana, offers some caveats in a very interesting piece (in Spanish). He considers Ciudadanos basically another social-democratic party. However, Rallo thinks they may nonetheless be


good news for classical liberals in the short term; not because their program (at least for what we know as of now) suggests any pro-Liberal enthusiasm, but because at least represents a threat--and an alternative--to the illiberal degeneration promoted by the political caste. [please forgive my very imperfect translation]

CATEGORIES: Eurozone crisis

   


In the comment section of a recent blog post, David Andolfatto asked the following question:

Scott,

Does it fall within the Fed's present Congressional mandate to create markets in the instruments you want? (I honestly don't know. If we do, I'll do everything I can to help.)

David


David is a distinguished blogger and also works at the St. Louis Fed. We were discussing my proposal that the Fed set up and subsidize trading in NGDP and RGDP prediction markets (sometimes called futures markets.)

First a bit of background information:

1. Private companies sometimes create prediction markets to forecast important variables such as sales or revenue. This concept is based on the "wisdom of crowds."

2. There is a lot of academic research by people like Justin Wolfers and Robin Hanson that suggests that prediction markets are useful.

3. We know that the Fed cares about market forecasts, as the minutes of Fed meetings show that variables such as TIPS spreads (implicit inflation forecasts) get discussed.

4. In theory, NGDP is a better indicator of demand expectations than TIPS spreads (which are affected by both supply and demand shocks.)

5. The Fed spends a lot of money each year on economic research. Prediction markets are relatively inexpensive.

6. The US government has previously approved prediction markets such as Iowa Electronic Markets for academic research purposes.

7. These markets would be extremely useful for two reasons:

a. They provide market indicators of expected growth in demand.
b. They would show the impact of unexpected monetary shocks on both NGDP and RGDP expectations.

This latter point is especially important. Some Keynesian theories deny that monetary policy can impact expected NGDP growth, when at the zero bound. Real Business Cycle theory suggests that a monetary policy shock that impacted NGDP growth expectations would not impact RGDP growth expectations. Market monetarism suggests that monetary shocks can impact both NGDP and RGDP growth expectations at the zero bound.

I believe that it is clearly within the Fed's mandate to spend a modest sum of money setting up NGDP and RGDP prediction markets. But it doesn't matter what I think it matters what Congress thinks, and what the Fed thinks that Congress thinks.

Sometimes when I travel to DC I meet Congressional staffers, who ask me how they could help. Here's one good area. It would be great if we could get some important Congressional figures to go on record as supporting the concept of the Fed setting up prediction markets to ascertain useful market forecasts, which could help make monetary policy more scientific. The cost is trivial and the potential benefits are huge.

PS. In my view it would be better if Congress said it was OK with them, but up to the Fed. Why not have Congress mandate these markets? I think as soon as you go down that road things get very politicized, and people become much more worried about a loss of independence. I find it hard to believe that the Fed wouldn't want to do at least a pilot study, if they had a clear go-ahead from Congress.

PPS. This is also something that Treasury could consider doing. I would think that at some point the Fed and Treasury would want to sit down and discuss where it fits best, once they accept the basic concept. I tend to prefer the Fed, as (rightly or wrongly) it's viewed as being more independent.

PPPS. The St Louis Fed where David works has spent money setting up a vast database ("FRED"), which is incredibly useful in economic research, teaching, blogging, journalism, etc.

PPPPS. It would help if other bloggers and journalists would encourage the Fed to set up some prediction markets.


   


The earliest 20th-century reference I have been able to find to a Laffer curve effect is in a 1901 article by London School of Economics professor Edwin Cannan. While conceding that a 100 percent tax rate on amounts earned that exceed £50,000 (£4.23 million today) would be fair, it would not raise any revenue, he said. After the first year, no one would earn more than that amount (at least where the state could see it), and the revenue yield would be zero.
This is a quote from Bruce Bartlett, "The Laffer Curve, Part 3," Tax Notes, October 1, 2012. HT to Brad DeLong.

I was surprised when I read that quote. When I attended the first Austrian Economics Conference in South Royalton, Vermont in June 1974, I had met a sweet old man, still sharp as a tack, named William H. Hutt. Hutt liked to quote his mentor Edwin Cannan. When I got back to UCLA, I went to the stacks at the library and found a book of Cannan's popular essays and newspaper columns titled An Economist's Protest. Milton Friedman's publisher later used that same title for a compendium of his Newsweek articles.

Reading that book, by the way, encouraged me to hone my writing skills so that I could do the same thing later in my career.

Back to Cannan. Bartlett's claim that Cannan thought a 100% marginal tax rate would be fair just did not ring true. And, it turns out, it wasn't true. I went to the 1901 Economic Journal article from which Bartlett quoted and found the relevant passage. Here's what Cannan actually wrote:

Considered in its immediate effects, the kind of income tax described by Professor Edgeworth in one of his fascinating studies, which would simply remove the superfluity of the very richest persons, reducing say every one with more than £50,000 a year to that sum, would be productive of least aggregate suffering. It would make a given income go furthest. But the given income would not remain. The persons with more than £50,000 a year would not continue to have more than £50,000 a year, at any rate within the purview of the state, and next year the limit might have to be reduced to £40,000 a year, and so on till the interference with the productive force of the community far more than counter-balanced the economic saving secured by making the given income go furthest.

Note that, contra Bartlett, Cannan does not judge the fairness of such a tax. Rather, he, correctly, attributes to Edgeworth the claim that such a tax "would be productive of least aggregate suffering."

Interestingly, and not surprisingly, there is a lot of good analysis in Cannan's article.

On taxes on alcohol:

There is, too, in the chief European countries, a very large revenue derived from taxes on alcoholic liquors. Will any one pretend to believe that this taxation is maintained out of respect for the principle of payment according to ability? When did the habitual drunkard become so capable of bearing taxation? There are few forms of expenditure which form a less trustworthy criterion of ability than expenditure on alcohol. We all know very well that the drink taxes exist because, in addition to bringing in a large revenue, they are supposed to limit, to some extent, the consumption of a commodity in which people are prone to indulge to excess.

Another excerpt:
There might, of course, be taxes of such a character that no lapse of time would condone their original iniquity. A special tax, for example, on red-haired people, or people under 5 feet 6 inches high, could not be sanctified by any length of time.

If I recall correctly, the red-haired example has persisted. Harvey Rosen and Ted Gayer use it in their textbook, Public Finance.


   


Governor Chris Christie wants to reduce Social Security benefits for the rich:

As part of the plan, he'll propose phasing out Social Security payments for those making more than $80,000 in other income and eliminating them for those making $200,000 or more a year.
This is a good idea in general, but the specific proposal is awful. He should be trying to make the program more progressive, but ends up with a plan that is unfair to savers. Christie should be proposing higher payroll taxes on the rich, but is actually proposing higher income taxes on the rich.

Many people have trouble understanding this distinction, so consider the following thought experiment:

Imagine identical twins that each make $150,000/year from age 25 to 65, and then retire.

Can we agree that these two people are equally affluent? Now suppose one chooses to spend all that money when it's earned and relies on Social Security when he is old. The other invests half his income each year and becomes quite affluent by age 65. Neither brother is better off than the other; they both have identical lifetime consumption in present value terms. It's just that the thriftier brother chooses to defer his consumption to later years, and thus consumes more in nominal terms. The other brother could have done the same, but chose not to. Just as you can't say apples are better than oranges if their price is the same, you can't say four apples in 40 years is better than one apple today if their price is the same.

Economic theory suggests that both brothers should face the same tax rate. Their lifetime consumption should be reduced equally, relative to the no-tax case. A simple payroll tax would be neutral regarding the saving vs. consumption decision. So would a VAT. Indeed even a progressive payroll tax would be neutral. But an income tax would discriminate against the thriftier brother, imposing a higher tax rate on future consumption than current consumption. It would double tax money that is saved. That's perverse, especially given that saving provides the funds for investment, and hence future economic growth.

Now suppose there was a third brother, who made only $50,000/year. Is there an argument for taxing that person at a lower rate? Yes, you can easily make an argument for progressive taxation on utilitarian grounds. Not everyone will buy the argument, as it's hard to do interpersonal utility comparisons, but you can make a plausible case for progressive taxation.

But there is no plausible case to be made for Christie's proposal, which is to raise income tax rates on the affluent elderly. If he wants to fix Social Security in a way that makes the system more progressive, he should have proposed trimming retirement benefits for those whose lifetime wage income was above a certain threshold. Unlike the Christie plan, a phase out based on lifetime wage income would not distort the decision as to whether to consume now or in the future. It would not discourage saving and investment.

I usually visualize the Democrats as representing the "one marshmallow" Americans. Tax policy is one of the very few areas where the GOP appeals to voters favoring free markets and small government. If the GOP also begins to favor anti-saving tax policies then we are really in deep trouble. Let's hope Christie is an outlier, one of those RINOS who will soon switch to the Democratic Party.

CATEGORIES: Taxation

   


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