Congratulations to Richard Thaler for winning the 2017 Nobel Prize! Check out Congratulations to Richard Thaler, by Scott Sumner, and Henderson on Thaler's Nobel, by David Henderson. See also Richard Thaler's EconTalk podcast interview, Richard Thaler on Behavioral Economics in the Concise Encyclopedia of Economics, an incisive book review Henderson on Thaler's Misbehaving, and more at Richard Thaler, search results.
October 21, 2017The News and Me
October 20, 2017Voters don't hate inflation
October 20, 2017Attacking Civilians in War
October 19, 2017Resentment Not Hate
October 19, 2017Central bank infallibility is a core axiom of modern macro
October 19, 2017Economic Possibilities for our Spacetraveling Grandchildren
October 19, 2017Hassett's Numbers are Plausible
October 18, 2017Anti-Market Bias in One Sentence
October 18, 2017Summers, Kotlikoff, and Mintz on the Proposed Trump Tax Cuts
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Bryan Caplan, David Henderson, Alberto Mingardi, and Scott Sumner, with guest blogger Emily Skarbek, blog on issues and insights in economics.
OCTOBER 21, 2017
For example, I've heard something about what President Trump said to the mother of a soldier killed in action. I've learned over the years that I can almost never get enough accurate information from a headline or even from one whole news story. If I really want to know what happened, I need to read at least 3 news stories or blog posts from media and individuals with diverse viewpoints. That takes time. And it matters for what, exactly? Not much.
Ultimately, I will judge Trump on what he and his appointees do in policy. I will still follow that. Government policy is one of the main things I write about. But the other news items are not worth my becoming informed about, given my high opportunity cost.
And on top of all that, it's simply very liberating to be disconnected from the 24/7 news cycle.
CATEGORIES: Media Watch
OCTOBER 20, 2017
Here's Tyler Cowen:
Many monetary rules call for higher rates of price inflation if the economy starts to enter a downturn. That's often the right economic prescription, but voters hate high inflation.
Tyler is engaged in "reasoning from a price change". A term like 'inflation' doesn't mean much of anything to the public, and certainly not what economists like Tyler mean by the term. When I used to poll my students, I'd find that 99% of students conflated 'inflation' with supply-side inflation. I'd ask, "Suppose all wages and prices rose by exactly 10%, has the cost of living actually increased?" I'd guess 99% would get the answer wrong. (Yes, the cost of living has increased, but they'd say no.)
When the public expresses a concern about inflation, what they really are referring to is living standards. Thus when there is supply-side inflation, prices rise faster than incomes, and living standards fall. That's the type of inflation the public has in mind when they express opposition to inflation. In contrast, when there is demand-side inflation the public sees their income rise faster than prices, so living standards rise (in the short run.)
If the public really did oppose demand-side inflation then they should have greatly enjoyed the economy of 2009. After all, a fall in AD brought inflation down to zero. And yet living standards plunged, because the demand-side disinflation caused incomes to fall faster than inflation. If the Fed had a more inflationary policy during 2009 then the public would have been much happier, as there would not have been as big a decline in real income. A much milder recession and less severe asset price collapse.
Did voters prefer the economy of 2006 or 2009?
In addition, don't take seriously the answers you get from polls of public opinion. When you ask the public how they feel about inflation, they are (in their own minds) holding their own nominal income constant and visualizing rising prices. No surprise that that isn't popular! Thus their answer doesn't really tell you what they think about inflation, and certainly not what they think about demand-side inflation created by the Fed. Rather their answer tells you what they think about supply-side inflation. Yes, we all hate adverse supply shocks. But beyond that the public has no opinion, as they don't really even understand what inflation is.
PS. Also, don't confuse incomes with hourly wages. An unexpected demand-side inflation lowers real hourly wages while raising real incomes and real asset prices. People care far more about their overall real incomes and real asset prices than they do about their real hourly wages.
PPS. The first time I ever recall a politician running on an explicit platform of higher inflation was in 2012. Abe won a massive victory on a promise of higher inflation, in a country where a huge share of voters are old people on fixed incomes. He ended deflation in Japan and was re-elected overwhelmingly. (We'll see how he does this time.)
OCTOBER 20, 2017
by Pierre Lemieux
The more democratic the state is, the smaller the difference between its rulers, combatants, and civilians, and the more justifiable should be a deliberate attack on the latter, ceteris paribus.
In the time of Louis XIV ... conscription was unknown, and the private person lived outside the battle ... For the first time in [American] history, a President of the United States [Franklin D. Roosevelt] looked on the mass of his fellow-citizens as 'human potential,' to be used as might best serve the prosecution of the war! ... Whereas the feudal monarchs could nourish hostilities only with the resources of their own domains, their successors have at their disposal the entire national income.
Sagan and Valentino vindicate Jouvenel by arguing that American public opinion favors the use of nuclear weapons. According to a Gallup poll of August 4, 1945, 85% of Americans approved of the bombs just dropped on Hiroshima and Nagasaki. Today, in retrospect, less than 50% think it was a good idea. But Sagan and Valentino's 2015 opinion survey indicates that, in a similar scenario with Iran instead of Japan, 59% of Americans would support a US government decision to nuke 2 million civilians in order to prevent the deaths of 20,000 American soldiers in an alternative ground invasion. (The scenario presented to respondents was that of a war started by the Iranian government.) And most of these hawkish respondents would not change their minds even if a diplomatic solution were possible.
Of the American respondents who favored either a nuclear or conventional strike on civilians to save American soldiers, 68% agreed with the statement: "Because the Iranian civilians described in the story did not rise up and overthrow the government of Iran, they must bear some responsibility for the civilian fatalities caused by the U.S. strike." Sagan and Valentino express surprise at the number of respondents who "suggested that Iranian civilians were somehow culpable or were less than human."
This reading of American opinion contradicts Thomas Schelling who, in his 2005 Nobel lecture, argued that a strong convention had developed against the use of nuclear weapons. It also contradicts the principle of "noncombatant immunity": as Sagan and Valentino write,
We cannot discount an explanation in terms of nationalism as a modern version of tribalism. But a related and perhaps deeper issue is the idea that the state and the citizens form an undivided whole. And here, we meet what may seem like a paradox. The more democratic the state is, the smaller the difference between its rulers, combatants, and civilians, and the more justifiable should be a deliberate attack on the latter, ceteris paribus. This is especially true if democracy refers not to majoritarian democracy but is based on a sort of unanimous (implicit) social contract where the state is, at some level, identical to its citizens. The more dictatorial the state, on the contrary, the larger is the distance between rulers, combatants, and civilians, and the less justifiable should be a deliberate attack on the latter, even in a just, defensive war.
The first lesson of these reflections seems to be that, under any reasonable moral standard, using nuclear weapons against the civilian populations of dictatorial regimes - like Iranians or North Koreans - must be morally unjustifiable, even in a just war against their Leviathan. Disagreeing with this, as many Americans appear to, is like legitimizing the state as a mass killer. (We don't have comparative data on public opinion elsewhere in the world.) This suggests that de Jouvenel's concern remains very relevant.
These moral considerations seem far removed from the positive economics of war. But welfare economics has taught us that any public policy recommendation ultimately depends on moral judgements because it harms some individuals while it favors others.
In a war between two democratic countries, it would be inconsistent to advocate both the civilian immunity principle and the idea (or the fiction) that the democratic state represents all its citizens. But perhaps democratic states are less likely to engage in wars? The case of Switzerland springs to mind, but it seems contradicted by the American example. Of course, a sample of two does not have much explanatory power.
The second lesson is that we should ponder the question of whether the state should not be conceived as a Nozickian, arms-length protection agency, instead of an association of all its citizens - even a constitutional association à la Buchanan.
None of what I have said argues against a defensive war (or preemptive attack) against a foreign tyrant, but it does impose tight limits on the means used and on the cost imposed on foreign civilians. General Paul Selva recently put it in neat terms before a Senate committee: "We take our values to war" - assuming of course that these values are independently defendable, as I believe classical-liberal or libertarian values are. This brings us back to a simple but forceful idea, close to de Jouvenel's thesis: if "we" use liberticidal means to defend liberty, there will ultimately be no liberty left to defend.
Pierre Lemieux is an economist affiliated with the Department of Management Sciences of the Université du Québec en Outaouais. His forthcoming book, to be published by the Mercatus Center at George Mason University, will aim at answering common objections to free trade. Email: PL@pierrelemieux.com.
OCTOBER 19, 2017
People often claim that their political opponents are motivated by sheer hatred. Thus, we have "hate-mongers," "hate speech," "hate groups," and even "hate maps." But almost no one openly claims "hate" as their political motive. When accused of hatred, the normal reaction is something like, "My God, you're naive. You can't even imagine that anyone on Earth sincerely disagrees with you. Oh, we're all horrible villains."
I say both sides are wrong. Full-blown "hate" is indeed a rare motive. But that hardly means that political actors are well-intentioned. The emotional spectrum is wide. And the emotion I routinely see in politics is not hatred, but its milder cousin: resentment. Normal people don't want to literally destroy their political opponents. But when they mentally picture them, they feel distaste. And when they mentally picture their opponents defeated - or just aggravated - their normal reaction is what the Germans call Schadenfreude. Literally, that's "shameful joy" - pleasure derived from the pain of others.
Doesn't well-meaning political disagreement exist? Sure, but it's a laborious motivation. First, you have to carefully listen to what your opponents say. Then you have to study both sides of the issue, weighing arguments and counter-arguments. And the whole time, you have to be careful not to make the disagreement personal.
Disagreement based on resentment, in contrast, comes naturally. Resentment requires no effort; it comes to you. And once it fills your soul, it swiftly (though inaccurately) answers all your questions. Who's wrong? Those I resent. Who's bad? Those I resent. Who stands in the way of all good things? Those I resent. Am I a bad person for hating them? Of course not, because I don't hate them. But I deeply resent them for slandering me as a hater!
Critics of my Simplistic Theory of Left and Right often assume I'm attributing hatred to both sides of the political spectrum. But as I've said before, I think true hatred is rare. My claim, rather, is that both sides are driven by contrasting resentments. What unifies the left is resentment for the market. What unifies the right is resentment for the left. Indeed, every successful political group begins with easy-to-resent enemies: foreigners, the rich, corporations, Muslims, Jews, blacks, whites, Catholics, or Protestants. It's not profound, but search your feelings - and the feelings of those you encounter.
Back in 1966, Lyndon Johnson said, "[W]ar is always the same. It is young men dying in the fullness of their promise. It is trying to kill a man that you do not even know well enough to hate." Beautiful poetry, but exactly wrong. Negative emotions do not require knowledge; negative emotions are the great substitute for knowledge. And in politics, that substitute is almost all most human beings ever bother to have.
OCTOBER 19, 2017
Over at TheMoneyIllusion I have a new post that (among other things) discusses this claim:
Blanchard was prompted to recite his faith in the power of the Phillips Curve by former Fed governor Jeremy Stein, who wondered how central banks were supposed to raise their inflation target to 4 per cent when they are still undershooting the current target of 2 per cent. Blanchard seemed to think the answer was easy: keep rates low, unemployment will fall, and inflation will necessarily accelerate.
I point out that this is a very strange assertion, as the Fed is currently engaged in raising interest rates with the express purpose of holding down inflation. They fear that if they don't raise rates, then inflation will overshoot 2%. That may be wrong, but inability to raise inflation has nothing to do with current Fed policy.
Caroline Baum sent me an equally maddening survey of elite economists, conducted by the University of Chicago. The survey asked them to rate the relative importance of 12 different factors in the 2008 financial crisis. For some strange reason "tight money" was not even mentioned, despite the fact that 2008 saw a steep plunge in NGDP growth, and we were not even at the zero bound. Those stylized facts are almost a textbook definition of a tight money policy reducing aggregate demand, and yet this hypothesis was so far off the radar screen that it wasn't even mentioned as an option.
Modern macroeconomics doesn't just have the wrong answers, we are not even asking the right questions.
It occurs to me that Stein's strange claim about monetary policy ineffectiveness and the UC's glaring omission in their survey have a common root explanation---a belief in central bank infallibility. Of course I'm exaggerating a bit, I'm sure most economists don't actually view the Fed as infallible, but bear with me for a moment.
Suppose it were true that central banks adopted polices that were right in the mainstream, close the consensus of elite macroeconomists. In that case, it would be natural to view any policy mistakes as not resulting from "monetary policy shocks", but rather from other "exogenous shocks." Most elite macroeconomists thought that Bernanke's Fed adopted sensible policies during 2008, so they naturally viewed the bad outcome as resulting from some sort of other factors.
In one sense, this is not particularly surprising. I have enormous respect for Ben Bernanke, who was a highly skilled central banker. Thus one's first reaction is not to view the Fed as an out of control rampaging elephant, causing also sorts of harm to the economy. Rather at first glance it seems more like a medical doctor, trying with varying success to cure the ills of the macroeconomy.
This "infallibility" view is further strengthened by the widespread tendency to misdiagnose low and/or falling interest rates as easy money. Since rates fell sharply in 2008, that made economists even less likely to blame the Fed.
And I think Stein is making the same sort of mistake. He sees central banks like the Fed continually undershooting their inflation target. He also has enormous respect for the competence of the Fed. (Heck, he used to work there.) Therefore instead of blaming the Fed for the undershoot, he looks for macro models where there is literally nothing the Fed can do to raise the inflation rate.
While this is very understandable from one perspective, from another it is very, very strange. Consider:
1. It's very odd for social scientists to make policymaker infallibility a central axiom of their core theoretical model. That's the sort of blind faith you'd associate with uneducated voters sticking with a charismatic but demagogic politician despite numerous well-documented failures. Scientists are supposed to be skeptics--always looking to improve their models.
2. It's not just me who thinks the Fed is not trying to raise inflation right now, virtually everyone agrees that the Fed is raising rates with the express purpose of holding down inflation. This isn't some sort of weird market monetarist claim, it's generally accepted by everyone. So why assume that policy is ineffective?
3. Many economists blame the Fed for the Great Contraction, despite the fact that the Fed cut rates to very low levels and also did QE. That perception of 1929-32 may or may not be true, but given that the stylized facts were quite similar in 2008, why is it not even being contemplated as a hypothesis? Why not at least ask economists if the Fed might have made the same mistakes (to a much lesser degree) in 2008 as in 1929-32, given that the stylized facts were so similar? What is the specific data point that you'd cite to argue that the tight money theory of the Great Recession is not even worth investigating? I don't get it.
4. Before the Great Recession, Western economists blamed the Japanese central bank for the persistent deflation in Japan. Why is the Fed viewed as infallible, but not the BOJ?
The widespread assumption that the Fed could not possibly have caused the Great Recession is now actually distorting macro theory. It's causing economists to abandon solid well-established New Keynesian theories, and seek out more dubious fringe ideas, such as non-monetary theories of inflation and NGDP growth.
OCTOBER 19, 2017
I've been watching on Netflix a new Star Trek series, Discovery, which is sort of a prequel to the classic Kirk & Spock series. I've found the series engaging and extremely well crafted - but, just after a few episodes, it is quite too early to cast a judgment.
I've always liked Star Trek, particularly as a kid, for its characters and its uncompromising optimism, too. Good science fiction is quite often "dark", it uses the future to showcase the anxieties and fears we feel today. On the contrary, Star Trek brings us to a time when humankind solved most of its long standing problems, learned to cooperate peacefully, and therefore can now explore outer space. Over there, we'll make it known that we come in peace - well, as much as we can.
Sure, Star Trek accounts for the natural, hardwired aggression of men - but it shows that we can govern it (learn from the Vulcans!) and perhaps take it out of the closet just in those key moments in which it'll actually save the day (paging Captain Kirk).
At the same time, the rosy politics and economics of Star Trek is sometimes distressing. You often get the impression that the Federation of Planets is the Soviet Union turned good.
That Star Trek is a beyond money and, really, "beyond scarcity" (think of food synthetizers, the "replicators"!) universe, in which humans are capable of tremendous achievements precisely because they won over most pressing needs, is the way in which the franchise founded by Gene Roddenberry is most commonly understood- Keynes's "Economic Possibilities for our Grandchildren" on steroids.
The book was reviewed critically by Students for Liberty's Vice President Fred Roeder. Roeder maintains that:
Star Trek Federation is a great thought experiment on what a post-scarcity society could look like. However, there are major shortcomings such as the allocation of property rights, a price system for energy, incentivization of services, and the existence of rivalry.
Roeder's point is that there may be more of the price system in Star Trek's dreamed world than most politically minded fans are willing to concede. I recommend his discussion of the "concealed" price mechanism in the United Federation of Planets to be read side-by-side with the DeLong/Krugman's panel discussion of the kind of "meritocracy" Star Trek implicitly endorses. Meritocracy and the market system ain't the same thing, as the latter is a decentralized system to take decisions whereas the first is based upon top down criteria. You can't do without incentives, and Star Trek does not. But how are incentives best come up with? Well, that's a long debate. It dates back to long long ago, in a galaxy far, far away[*].
[*] The Star Wars reference is purposefully here to set the fans of both sagas off.
CATEGORIES: Books: Reviews and Suggested Readings
OCTOBER 19, 2017
In the long run, all of the factor owners' loss from a capital income tax is a loss to labor (the area below the horizontal dashed line is negligible; see A below). Therefore, in the long run, capital-income tax revenue is a LOWER BOUND on labor's loss. Furman and Summers have it backwards.This is from Casey Mulligan, "Furman and Summers revoke Summers' academic work on investment," October 18, 2017.
This is Casey's comment and analysis on the current controversy over whether Kevin Hassett's claim of large increases in wages due to corporate tax cuts make sense.
It's a technical argument and you might not follow all of it. Here's one paragraph that might help:
Why would labor bear all of the burden in the long run? Well, ask Larry Summers back when he used to be an academic studying these matters. His 1981 Brookings paper, which even today is an article commonly used by me and others to teach this in graduate school, says so on page 81 equation (7). The left-hand-side of that equation is a perfectly elastic long-run supply of capital: it says that the supply curve in my picture is, in the long run, properly drawn as horizontal. See also Lucas (1990, p. 303, equation 4.3).
But if you don't know this literature somewhat, the above paragraph might not help you much. So let me explain in simpler words by noting that the key assumption in the above is the assumption of a perfectly elastic long-run supply of capital. Why would it be perfectly elastic? Because capital is quite mobile across countries, so when one country's government cuts it tax rate on capital, that draws in capital from around the world.
Why does this matter? The greater the stock of capital, the higher is the ratio of capital to labor, and, therefore, the higher is the marginal product of labor, and, finally, the higher is the real wage.
Here's Mulligan again, with some of the important parts of the technical argument:
Using a Cobb-Douglas aggregate production function with labor share 0.7, and a 50% capital-income tax rate (combining corporate, property, and the capital components of the personal income tax), I get a Furman ratio of 350%. With a 40% tax rate instead, the Furman ratio is 233% (algebra here; these refer to modest tax-rate reductions -- not going all of the way to zero).
HT2 Greg Mankiw.
OCTOBER 18, 2017
A telling quote from this NYT piece on NAFTA:
According to the National Journal, Brown shares a nine-way tie for most liberal Senator.
For more on anti-market bias, see The Myth of the Rational Voter, now reluctantly enjoying its ten-year anniversary...
OCTOBER 18, 2017
I posted a few days ago on Kevin Hassett's case for the Trump tax cuts, pointing out the huge positive effect on the real wages that he claims they would have. One commenter, JFA, asked the relevant question:
The question is how did Hassett combine the evidence from the literature to come up with those estimates?
I answered that I didn't know. But I would like to know.
Another commenter, MikeW, provided a link to Larry Summers's response to Hassett. The problem is that is long on attack and medium on analysis.
I am proudly guilty of asserting that it [Hassett's analysis] is some combination of dishonest, incompetent and absurd. TV does not provide space to spell out the reasons why, so I am happy to provide them here.
Unfortunately, he doesn't provide enough reasoning. He gets some of the way there, writing:
In contrast, Mr Hassett throws around the terms scientific and peer reviewed, yet there is no peer-reviewed support for his central claim that cutting the corporate tax rate from 35 per cent to 20 per cent would raise wages by $4,000 per worker.
Like Larry, I am stunned by this numbers too, but I don't know whether they're right. Kevin doesn't "throw around" the term "peer reviewed." He claims that his estimates are indeed based on those peer-reviewed studies. As I said, I would like to see even the back of the envelope calculations that led to them. As far as I know, Kevin hasn't provided them.
But in today's Wall Street Journal, Boston University economist and sometime Larry Summers co-author Laurence Kotlikoff and Canadian economist Jack Mintz, argue that there is a model that comes close to giving the results that Kevin Hassett claimed. The WSJ article is gated but they reference a study that's not. It's "Simulating The Republican 'Unified Framework' Tax Plan" by Seth G. Benzell, Laurence J. Kotlikoff, and Guillermo Lagarda.
Here's the abstract:
This short paper simulates the economic and revenue impacts of the Republican \Unified Framework" (UF) tax plan. As in our prior study of the Republican \Better Way" plan, this study uses the Global Gaidar Model (GGM). The GGM is a global 17-region, 90-period, overlapping-generations model, which is closely calibrated to U.N. demographic and IMF fiscal data. In incorporating the entire world's capital market, the GGM is particularly well suited to studying foreign capital inflows arising from U.S. corporate tax reform. We find that, depending on the year considered, the new Republican tax plan raises GDP by between 3 and 5 percent and real wages by between 4 and 7 percent. This translates into roughly $3,500 annually, on average, per working American household. The source of the increase in U.S. output and real wages is the UF plan's reduction in the U.S. marginal effective
By the way, while I share this concern about the long-term fiscal gap, I don't share their concern about fairness. They take as given that the status quo is fair. But high-income people pay a massively disproportionate share of taxes now; that is they pay a much higher percent of their income in taxes than lower- and middle-income people pay.
OCTOBER 18, 2017
I don't doubt that there are some types of human behavior that are both hard-wired and irrational. But it's very dangerous to simply assume that any form of irrationality that you encounter is innate (i.e. genetic). Here's the NYT:
"A good rule of thumb is we shouldn't impose a set of rules that will create moral outrage, even if that moral outrage seems stupid to economists," Mr. Thaler said. . . .
Interestingly, the same article provides evidence that this aversion to surge pricing (aka "price gouging") is not hard-wired:
When Stockholm experimented with a charge to enter the city center in 2006, it was highly controversial, with people in suburban towns especially viewing it as an unfair tax.
I could provide many examples of where the public has gradually become more accepting of surge pricing. Unlike when I was young, airlines now change much higher prices during busy periods. Movie theaters charge more during the evening. Hotels use surge pricing, as does Uber. Gas stations charge more after a severe hurricane hits the Gulf Coast. Groceries use surge pricing for fresh fruits.
Often our moral intuitions change over time. Life insurance was once viewed as a repulsive idea---betting on death---now it's a well established industry.
When the public holds irrational views that cause real harm to people, say on price gouging or rent controls or kidney markets or drug legalization or gay marriage, the solution is not to throw up our hands and assume that these views are hard-wired, rather we need to look for creative ways to nudge people into more sensible views of the world. That doesn't mean businesses can simply ignore these irrational views, but on the other hand don't treat them with undo respect.
Surge pricing can be phased in gradually, so that people become accustomed to the idea that a higher price for electricity on a hot day is just as sensible as a higher price for a hotel room on a holiday weekend.
My criticism of the NYT article is that it doesn't have enough focus on education. It shows much more respect for irrational views of surge pricing than it would to irrational views on race, gender or sexual preference. And yet irrational views on surge pricing do real harm to people.
Surge pricing in Singapore:
OCTOBER 17, 2017
Thoughts on my latest debate:
1. Hans von Spakovsky was the most lawyerly opponent I've ever debated. His first (and second) approach to almost any issue was simply to describe the law. In most cases, he didn't even defend its wisdom or justice. Instead, he simply exhorted people to obey the law or convince Congress to change it.
2. Still, after a great deal of legal description, von Spakovsky finally shared his actual view: low-skilled immigration should be sharply reduced in favor of high-skilled immigration. When asked about refugees, he refrained from calling for outright cuts in the quota; instead, he maintained that existing numbers are roughly the most we are capable of handling.
3. The debate was explicitly about Trump's views on immigration, and von Spakovsky has pretty close ties to the administration. But von Spakovsky said almost nothing about Trump or his policies - and studiously failed to defend the president I repeatedly called "intellectually lazy and irrational." Perhaps he respects Trump so deeply that he considered my claims unworthy of a response. Or perhaps - like many elite Republicans - he avoided the topic because he is well-aware of Trump's glaring epistemic shortcomings.
4. The most engaging part of the debate, at least for me, began when my opponent spontaneously described his traffic tickets. This seems to show that - contrary to his grandiose claims about its sanctity - he's often not ashamed to break the law. In other words, he's an normal American driver. You could argue that traffic laws are uniquely bad, but that's silly. They plausibly protect other human beings from dangerous driving - and compliance is usually only a minor inconvenience. Why, then, would it be wrong to break immigration laws - which immensely harm would-be immigrants at great economic cost to natives? If anything, we should enforce traffic laws far more strictly than immigration laws.
5. During Q&A, Reason's Shikha Dalmia amplified my point by referencing the slogan that Americans commit three felonies a day. Von Spakovsky did not dispute her claim, but drew a strong distinction between natives' accidental law-breaking and illegal immigrants' deliberate law-breaking - an odd retreat for such a lawyerly thinker. When I pointed out that natives often knowingly break the law, my opponent declined to call for a strict crack-down on said scofflaws.
6. I repeatedly pointed out that governments selectively enforce laws all the time. Indeed, they have no choice; there aren't enough resources in the world to enforce all the laws we have. Furthermore, governments often officially announce their enforcement policies, so people know what to expect. Given this, I don't even see what the legal objection to DACA or DAPA is supposed to be.
7. I argued that Trump's travel ban bears little connection to the problems he claims to be worried about. Saudi Arabia isn't on the list, even though 15 of the 19 9/11 attackers were Saudi. Von Spakovsky dismissed my claim by by providing details about how the administration formulated its new policy. He even urged listeners to go to the White House webpage. This morning, I took his advice. A typical passage:
The Secretary of Homeland Security assesses that the following countries continue to have "inadequate" identity-management protocols, information-sharing practices, and risk factors, with respect to the baseline described in subsection (c) of this section, such that entry restrictions and limitations are recommended: Chad, Iran, Libya, North Korea, Syria, Venezuela, and Yemen. The Secretary of Homeland Security also assesses that Iraq did not meet the baseline, but that entry restrictions and limitations under a Presidential proclamation are not warranted.I am perfectly happy to admit that there is a bureaucratic process at work. There always is. But if an intellectually lazy, irrational president wants X, are his functionaries going to tell him he's wrong or unfair? Of course not. Instead, they'll go through a flurry of procedure to get the "right" answer. That's how committees work: Busywork + Legalese = Foregone Conclusion.
8. My opponent strongly rejected any keyhole solutions for alleged downsides of low-skilled immigration. But other than appealing to the value of equality, I detected no concrete objection.
9. I am a weird human being, but I am self-aware. This routinely leads me to wonder how other people perceive me. Von Spakovsky was very polite to me both publicly and privately, but he must think there's something very wrong with me. What exactly would that be? Partly, I'm an Ivory Tower professor who doesn't understand - or just can't accept - how the "real world" works. Partly, I'm out of touch with America. He didn't seem to mistake me for a bog-standard leftist, which was nice. On reflection, I'm probably far worse in his eyes than he ever realized. But seeing yourself through the eyes of another is no mean feat.
10. Did either of us change anyone's mind? I suspect I persuaded a few people to rethink the sanctity of the law. Von Spakovsky, for his part, might have spurred a few people to read some laws for themselves instead of accepting media summaries of them. But overall, I'm afraid even the short-run effect on people's thinking was minimal. Changing minds on this issue is going to require a lot more than a debate.
11. Still, as far as intellectual experiences go, the debate was a far better than a protest.
OCTOBER 17, 2017
Many people have pointed out that the Catalonian secession can trigger an economic shock. The Catalonians say they want to stay in the European Union and keep the euro, but they can't do so. If they secede, they'll need to enter again the EU (and the euro) as an independent state. And Spain would likely veto them out of the EU.
FT columnist Wolfgang Münchau wrote that "Catalan breakaway would make Brexit look like a cake walk", arguing that the main argument against Catalan independence is thus economic.
It may be a matter of words, but I thought that the problem was not "economic." Small states, if they're open economies, can survive and prosper in an era of globalisation. A more extended division of labour doesn't imply political unification, all the more so in an age when transferring information and traveling have never been faster and cheaper.
Rather the problem is political: that is, the European Union doesn't allow for an ordered exercise of the right of self determination. You can consider this inevitable, if you think the EU is nothing but a cartel of states. But it is certainly in striking contrast with that principle of subsidiarity often hailed by the European founding fathers. Or at least so I've argued in a letter to the Financial Times:
Secession from Spain would trigger exit from both the EU and the euro, which may account for a global economic shock. In fact, the Catalans do not want to leave the euro or the single market: only Spain. And yet they'll be forced out of European institutions because the latter are tailored around member nation states.
CATEGORIES: Eurozone crisis
OCTOBER 16, 2017
I'll be giving in two talks in Texas this week.
Southern Methodist University, Dallas
Baylor University, Waco
If you come, please come up afterwards and introduce yourself.
CATEGORIES: Upcoming Events
OCTOBER 16, 2017
I recently attended a conference at the Peterson Institute on "Rethinking Macroeconomics", which mostly meant returning macro to its Keynesian roots. Readers may know that I have a contrarian take on the crisis---I believe it occurred because macroeconomists did not take macro theory seriously enough. We do not need to rethink macro by adding in fiscal policy or paying more attention to the financial sector, rather we need to impress upon the world's central banks the importance of doing whatever it takes to keep aggregate demand growing at an adequate level. The major central banks (except in Australia) did not do that in 2008 (for many different reasons) and hence we had the Great Recession.
1. At an intellectual level the conference was very impressive---there were many brilliant economists presenting and also in the audience. The overall impression was of a center-left perspective, but hardly monolithic. After Alan Auerbach presented a paper on fiscal policy, several panel members (including Robert Rubin) expressed skepticism---viewing the problems we face as mostly supply-side.
2. I sometimes had a sort of "Paul Krugman reaction", as the general discussion seemed more grounded in reality than at a right-of-center macro conference. Most speakers seemed very aware of the importance of shortfalls in AD during the Great Recession, a basic understanding that I often feel is missing on the right.
3. On the negative side, I was extremely disappointed by some of the comments on monetary policy. In response to calls for a higher inflation target to avoid the zero bound problem, Jeremy Stein of Harvard University asked something to the effect "What makes you think the Fed can achieve higher inflation?" (Recall that Stein was recently a member of the Federal Reserve Board.) I was pleased to see Olivier Blanchard respond that there is no doubt that we can achieve 4% inflation, or indeed any trend inflation rate we want. But then Larry Summers also suggested that he shared Stein's doubts (albeit to a lesser extent.)
I kept thinking to myself: Why do you guys think the Fed is currently engaged in steadily raising the fed funds target? What do you think the Fed is trying to achieve? How can a top Fed official not think the Fed could raise its inflation target during a period when we aren't even at the zero bound? Why has the US averaged 2% inflation since 1990---is it just a miracle? When Summers came out for NGDP targeting I briefly wondered whether I'd made a mistake in favoring Yellen for Fed chair, but this comment reconfirmed my initial preference.
4. While the left is ahead of the right in their understanding of the importance of demand shocks, they lag far behind in understanding the importance of more subtle forces shaping the economy. Thus they are even less likely than the right to blame the Fed for destabilizing aggregate demand, and they almost entirely ignored the problem of moral hazard in a panel on the financial system. On the left there's a reflex to always seek solutions in more government (financial regulation, fiscal policy, etc.), not in removing government policies that cause problems (moral hazard, unstable monetary policy.) Unfortunately the solutions offered by the left do not address the root causes of economic crises, and hence are likely to be ineffective. Banks will eventually find their way around any regulations enacted to limit their risk taking. Fiscal policy has been repeatedly shown to be largely ineffective. (Remember the 2013 recession trigger by "austerity"? Me neither.)
5. Larry Summers dominated the conference due to a combination of his force of personality and his intellectual brilliance. (That's right, I don't judge intellects based on whether they agree with me.) At one point he was asked what he'd do if put in charge of the Fed. Although Summers had expressed support for a higher inflation target, he was surprisingly cautious in response to this question. He pointed out that it was the job of intellectuals in academia to throw out provocative ideas worth considering, and the job of top policymakers to enact policies based on well-established economic principles. He indicated that he wasn't sure whether it would make sense to use a lot of political capital trying to move the entire Federal Reserve System over to his preferred policy. (This is based on my memory, and may not be precisely correct.)
Summers' comment made me think back to lots of debates I'd had in various comment sections, where I defended Bernanke for trying to nudge the Fed in the right direction. Summers' remarks make me even more confident that I was correct, as if even an "alpha male" like Summers thinks he'd have trouble moving the Fed to his preferred policy regime, imagine the challenge facing a more mild-mannered, consensus-seeking personality like Bernanke (or me!). Summers has worked in the Treasury, and knows how difficult it is to enact policy changes in the real world.
6. When I proposed negative interest on reserves back in January 2009, the idea was widely ridiculed in my comment section. I recall reporters from the Financial Times suggesting that the policy would actually be contractionary. (They looked at monetary policy from the false "finance perspective", not the true "monetarist perspective".
7. Greg Ip from the WSJ asked a really interesting question. He pointed out that many of the factors cited by Larry Summers in his "secular stagnation" hypothesis also might serve to make recessions much less likely in the future. Previous recessions often occurred either when there had been an inflation overshoot (i.e. 1970 or 1981), or (perhaps) when investment has become excessive (think tech in 2000 or housing in 2006.) But under secular stagnation there are no inflation overshoots, and we also don't see high levels of investment. (Don't be fooled by recently recovering home prices; actual construction of homes remains severely depressed relative to the long run average.) I'm already on record predicting that this will end up being the longest expansion in US history, and Ip's question made me even more confident in that prediction.
Some people responded by pointing to past "this time is different" predictions (i.e. 1929, 1966, 2006), which ended up being overly optimistic. But I don't think that sort of cynicism is an adequate response to Ip, especially in a world where Australia has not had a recession in 26 years.
PS. Even though Adam Posen's views are far to the left of mine, I'd like to thank him for inviting me and for hosting an extremely high quality conference. This site has links to videos of the various panels, so you can check the accuracy of my memory.
OCTOBER 16, 2017
Last Friday, I debated Heritage's Hans von Spakovsky on "Does Trump's Immigration Agenda Harm Democracy?" The resolution was unusual for me in three ways:
1. I usually try to stick to timeless issues. For this debate, I had to discuss and analyze current events in detail.
2. We were originally going to discuss Trump's immigration policies, but it's not clear that he'll manage to dramatically change immigration policy. That's why we switched to his immigration agenda - i.e., the policies Trump would like to impose.
3. Since I put no intrinsic value on democracy, I'd rather argue that immigration policies are harmful, rather than "harmful for democracy." But I think I learned a good deal from sticking to the agreed topic. Hopefully you'll agree!
Does Trump's Immigration Agenda Harm Democracy?
Let's start with the big question: What does it mean to "harm democracy"? It's tempting to cynically say: "harms democracy" equals "clashes with my favorite policies" or even "fails to give power to my party." But if you get some distance, there are plenty of plausible standards against which to judge democratic performance. Above all:
1. In a healthy democracy, leaders calmly assess the evidence before forming a plan to solve social problems. They consider costs as well as benefits.
2. In a healthy democracy, leaders seek objective estimates of policies' actual effects, even if they don't like the answers. For example, if they're setting the minimum wage, they'll want sober estimates of the effect of a $1/hour increase on the number of workers hired.
3. In a healthy democracy, leaders defuse popular prejudices instead of pandering to them. If the majority wrongly believes leeches cure cancer, leaders don't advocate a $100B National Leech Fund. Instead, they politely but firmly refuse to waste of taxpayer money.
These standards aren't Democratic or Republican, liberal or conservative. They're common sense and common decency.
Now, you might say, "Common sense and common decency aren't so common." Or even: "I don't know any leaders of either party who live up to these standards. Successful politicians are experts at winning and retaining power, not carefully crafting wise policy. And the way to win and retain power is to tell voters what they want to hear, whether it's true or not."
If that's your reaction, I completely agree. I have a whole book - called The Myth of the Rational Voter: Why Democracies Choose Bad Policies - on the shortcomings of democracy. But the fact that politicians routinely harm democracy hardly implies they're all equally harmful. And of course, politicians could be better on some issues than others. So how does Donald Trump's approach to immigration policy measure up?
1. In the real world, politicians rarely calmly assess evidence before offering solutions. If you know a politicians' ideology, you can generally predict what he's going to say about even the most complex issues. And immigration is an especially emotional issue. Even so, Trump's statements about immigration are unusually intellectually lazy and irrational. Consider some of his main public reflections on the topic.
a. He's claimed there are 30-34 million illegal immigrants in the U.S. - roughly triple the number virtually any quant accepts. When asked for a source, he said, "I am hearing it from other people, and I have seen it written in various newspapers. The truth is the government has no idea how many illegals are here."
b. "The Mexican Government is forcing their most unwanted people into the United States." Evidence for this strange conspiracy theory? None. And: "Likewise, tremendous infectious disease is pouring across the border."
c. "I will build a great wall -- and nobody builds walls better than me, believe me - and I'll build them very inexpensively. I will build a great, great wall on our southern border, and I will make Mexico pay for that wall. Mark my words."
d. On deportations: "We're
rounding 'em up in a very humane way, in a very nice way. And they're going to
be happy because they want to be legalized. And, by the way, I know it doesn't
sound nice. But not everything is nice."
Hasn't Trump also made numerous seemingly incompatible statements about immigration? Sure. Which proves my point: he's so intellectually lazy and irrational he can't keep his own story straight.
2. Trump's low-quality thinking might be forgivable if his conclusion about immigration were, by coincidence, roughly accurate. But they're not. Careful scholars have been studying immigration for decades. Here are their top discoveries.
a. Contrary to Trump's many claims about the economic damage of immigration, the overall economic benefits of immigration are enormous. The idea is simple: Immigrants normally move from countries where wages are low to countries where wages are high. Why do employers them pay so much more in rich countries than in poor countries? Because foreign workers are much more productive in rich countries than they are in their home countries. A Mexican farmers can grow a lot more here than he can in Mexico. When he does so, the immigrant isn't merely enriching himself. He enriches everyone who eats. Immigration's gains are so vast that researchers estimate that - in a world where anyone could work anywhere - global production would roughly DOUBLE.
b. Trump has blamed immigration for seriously harming native workers. Scholarly estimates, however, generally say that Americans workers are, on balance, richer because of immigration. Basic point: Immigrants who sell what you sell hurt you, but immigrants who sell what you buy help you. Since immigration raises total production, gains naturally tend to outweigh losses. There is debate about immigration's effects on wages and employment of native high school dropouts. But even estimates of these losses are low.
c. Trump has also argued that immigrants are a clear fiscal burden on native taxpayers. This goes against the latest National Academy of Sciences report, which finds a long-run average net gain of $58,000 per immigrant. There does seem to be a net fiscal burden of high school dropout immigrants, especially older high school dropouts. But even they're a much better fiscal deal than native-born dropouts, because their home countries pay for their education.
d. Trump's claims about immigrant crime have been widely-quoted. But specialists in immigrant crime almost universally find immigrants have lower crime rates than natives - about one-third lower in recent data.
3. Is Trump's immigration agenda at least sincere? Let's look at the problems he says he want to solve and the solutions he proposes to solve them - and see how well they fit together. If Trump really thought "[T]remendous infectious disease is pouring across the border" with Mexico, you'd expect him to instruct the Centers for Disease Control to prioritize this problem, or impose new health restrictions at the Mexican borders. He hasn't; in fact, it seems like he's forgotten he ever mentioned Mexican epidemics. Similarly, if Trump were really worried about Muslim terrorists, he would presumably want to extend his high-profile executive order to Saudi Arabia. After all, 15 of the 19 9/11 attackers were Saudi. But, no. The heart of Trump's immigration strategy is to pander to popular prejudices against foreigners, then loudly call for some kind of action. It's the Activist's Fallacy: "Something must be done. This is something. Therefore, this must be done."
But you don't have to believe me. You can also see what Trump says when he thinks voters aren't watching. The transcript of Trump's conversation with Mexican President Nieto was leaked a few months ago. Trump speaking: "Because you and I are both at a point now where we are both saying we are not to pay for the wall. From a political standpoint, that is what we will say. We cannot say that anymore because if you are going to say that Mexico is not going to pay for the wall, then I do not want to meet with you guys anymore because I cannot live with that. I am willing to say that we will work it out, but that means it will come out in the wash and that is okay. But you cannot say anymore that the United States is going to pay for the wall. I am just going to say that we are working it out. Believe it or not, this is the least important thing that we are talking about, but politically this might be the most important talk about."
In short, Trump doesn't really care if Mexico will pay for the wall, but he really cares if Americans believe Mexico will pay for the wall.
brings me to the one good thing I have to say about Trump's immigration agenda:
He's unlikely to actually accomplish much of it. While he presents himself as a great
negotiator, he's primarily an entertainer.
When he endorsed the RAISE Act - which really would greatly reduce immigration
- even fellow Republican politicians showed little interest. So Trump got bored and moved on to the next
exciting scene on his Presidential Reality Show.
But aren't other politicians bad, too? Of course. Demagoguery is a key ingredient of any politicians' path to power - and scapegoating foreigners is classic demagoguery. But Trump has taken anti-foreign demagoguery to a new level - or at least a local maximum. If he had his way, we'd lose most of the tremendous social gains of immigration we've enjoyed over the last fifty years. And his problem is not that he's made subtle errors. Trump's problem is that he emoting, not thinking - like a kid who tries to solve algebra problems by asking, "How do x and y make me feel?" Our problem is that instead of giving him an F, we've made him president.
CATEGORIES: Behavioral Economics and Rationality , Economic Methods , Economic Philosophy , Labor Market , Politics and Economics
OCTOBER 16, 2017
Law and economics scholar Fred McChesney died last Thursday at age 68. He was a first-rate scholar, a wonderful friend, and an engaging conversationalist. I'm so glad that he called me up when he was in Monterey a couple of years ago. I went to his hotel and had a great visit with him and his lady friend. I remember feeding the parking meter for an hour, thinking that would be enough, and then finding the conversation so interesting and fun that I went out after an hour and a quarter and fed it for another hour.
Here's a great write up of some of his accomplishments.
Fred wrote the antitrust article for The Concise Encyclopedia of Economics. Out of the over 160 entries, it is one of my 20 favorite pieces. It covers a lot of territory succinctly while still giving the essential economic analysis on each issue.
Here's a great paragraph from "Armen Alchian: An Economist-Lion in Winter":
Perhaps no other economist of our time has given as much attention to costs as has Armen Alchian. He discovered, while working at the RAND Corporation after the war, that military engineers and economists disagreed over the efficient ways to produce armaments because their concepts of cost were quite different.6 Engineers registered cost as a function of total output, and so saw costs as generally declining. But to economists, the costs associated with different levels of output depend on the rate at which they are produced: Producing the same volume but in a shorter period of time would be more expensive, ceteris paribus. Moreover, once one recognized the importance of time for reckoning cost, one had also to take into account the present value of the outlays required to produce, outlays that would vary depending on the timing of production. All of this Alchian explained in one of his most important articles.
Here are two great paragraphs from "Smoke and Errors":
In short, good old-fashioned rent seeking accounts for the rise of public fire-fighting. It explains as well the survival of an entity that, more and more, is losing its raison d'être. Modern building materials are relatively fire-proof, while clothing and other fabrics are flame-retardant. Municipal codes increasingly require sprinkler systems, smoke detectors and other devices to reduce the incidence and costs of fire. So today's fireman has much less to do. The number of home and building fires has plunged 40 percent in the past two decades.
HT2 Tyler Cowen.
OCTOBER 16, 2017
It is of great comfort to us who share an antiquarian passion for the history of political thought that fundamental questions such as, "What is the state?" invariably come to the surface. But sometimes you get the impression that new interpretations focus more on the 'political' than on the 'thought'.
I'm referring to a long opinion piece published by Yoram Hazony in The Wall Street Journal. From his byline we know that Mr Hazony, President of the Jerusalem-based Herzl Institute, is publishing a book entitled The Virtue of Nationalism.
His article's political goal is clear: he wants to argue that Donald Trump's blend of conservatism is in line with an old tradition that goes back to Edmund Burke. Trump is thus implicitly considered the torch-bearer of a system of ideas that value the nation-state as providing the soil which allowed Western liberty to flourish. From this comes skepticism towards exporting such values in different cultures and a similar anxiety for opening the door to immigrants that come from illiberal cultures.
But leaving aside what President Trump stands for, or rather represents, Mr Hazony's story is quite problematic. He thinks that "Classical liberalism ... offers ground for imposing a single doctrine on all nations for their own good. It provides an ideological basis for an American universal dominion." So, for Mr Hazony it was "liberal abstractions", based upon John Locke's ideas that matured into contemporary neo-conservatism.
Note that for Mr Hazony classical liberalism is "rationalist". I'm not so sure that Locke can be considered a "constructivist", but it is hard to assume that David Hume and Adam Smith were not central to the original arc of liberalism--that is, classical liberalism. Moreover, it could be argued that Burke himself had strong (classical) liberal leanings. On issue after issue, his tendency was usually liberal.
Mr Hazony seems to ignore the extent to which the modern libertarian movement, in the United States, tends to favour anti-interventionism and how skeptical prominent libertarians were of exporting democracy, let alone neo-conservatism itself. He quotes from Mises's 1927 pamphlet "Liberalism" to argue that classical liberals are actually internationalist advocates of world government. So writes Hazony:
Ludwig von Mises thus advocates a 'world super-state really deserving of the name,' which will arise if we 'succeed in creating throughout the world . . . nothing less than unqualified, unconditional acceptance of liberalism. Liberal thinking must permeate all nations, liberal principles must pervade all political institutions.Let's read the quotation in its entirety:
To be sure, the League does hold out, even though very cautiously and with many reservations, the prospect of some future boundary adjustments to do justice to the demands of some nations and parts of nations. It also promises--again very cautiously and qualifiedly--protection to national minorities. This permits us to hope that from these extremely inadequate beginnings a world superstate really deserving of the name may some day be able to develop that would be capable of assuring the nations the peace that they require. But this question will not be decided at Geneva in the sessions of the present League, and certainly not in the parliaments of the individual countries that comprise it. For the problem involved is not at all a matter of organization or of the technique of international government, but the greatest ideological question that mankind has ever faced. It is a question of whether we shall succeed in creating throughout the world a frame of mind without which all agreements for the preservation of peace and all the proceedings of courts of arbitration will remain, at the crucial moment, only worthless scraps of paper. This frame of mind can be nothing less than the unqualified, unconditional acceptance of liberalism. Liberal thinking must permeate all nations, liberal principles must pervade all political institutions, if the prerequisites of peace are to be created and the causes of war eliminated. As long as nations cling to protective tariffs, immigration barriers, compulsory education, interventionism, and etatism, new conflicts capable of breaking out at any time into open warfare will continually arise to plague mankind.Mises was actually criticising the international body of the time (the League of Nations), but expressed hope for "a frame of mind" that looks to see individual rights protected, not just within one's country but also abroad. I agree that Mises's use of the word 'superstate' is unfortunate, but it is clear that all he is pointing toward is a liberal sensibility that traverses national boundaries.
The passage is part of the book's section on "a liberal foreign policy". Chapter 3 of that section is a remarkable collection of caveats, against allegedly peace-creating policies that could backfire (from "standardised" education to the creation of "economic areas"). Indeed, Mises thinks that "a world order must be established in which nations and national groups are so satisfied with living conditions that they will not feel impelled to resort to the desperate expedient of war". Such a humanitarian attitude, which is indeed part of the classical liberal legacy, was all the more cogent after the disastrous experience of World War I. Mises was not so eager to buy into "the virtues of nationalism" as he saw Europe on fire because of it - and understood that may happen again, as unfortunately it did.
Can Mises be considered a champion of exporting democracy? "The unqualified, unconditional acceptance of liberalism" was for Mises a cultural goal, not a strategy to be pursued at gunpoint. When it comes to the issue of national identity, the second chapter in that very section of the book is devoted to the principle of self-determination. The drift of Mises's discussion is the aim to dilute conflicts and allow for peaceful coexistence. There was no thirst for American 'hegemony': but the idea that people, by having fruitful commercial relationships, will eventually sheathe their swords. Such vision can perhaps be considered naive, but it certainly cannot be considered propaganda for world government.
Mises's liberal vision included the idea of "multi-national" states: states within which multiple national identities coexist, like they did in Europe for centuries before the idea "one state, one nation" became hegemonic. Was this nostalgia for the old Habsburg empire? Well, perhaps it was. Let's look at conservatives for a minute. Think about Europe. Those "empirical" conservatives Mr Hazony purportedly admires couldn't be enthusiastic about national identities which were very recent artifacts--in some respects themselves products of constructivist rationalism. Didn't the Congress of Vienna after all have an "anti-national" character? Weren't European conservatives favouring empires or, yes, the "empirical" history of territorial divisions and royal dynasties as principles of legitimization deeply opposed to then emerging idea of the "nation"?
I'll read Mr Hazony's book, about which now I'm truly curious. But on these matters, so far my recommendation would be to go back to good ol' Lord Acton.
CATEGORIES: Economic Philosophy
OCTOBER 15, 2017
On October 5, Kevin Hassett, the new chairman of President Trump's Council of Economic Advisers, gave an excellent talk at the Tax Policy Center. The topic was taxes and economic growth. The transcript of the talk is here. The video is here.
In the talk, Kevin gave some estimates of the effects of cuts in marginal personal and corporate income tax rates on growth. Drawing on the literature, he came up with substantial estimates of both.
A few excerpts follow.
First, his own background on this issue:
Perhaps the reason I hold these beliefs is that I started graduate school back in 1984, and was taking Alan Auerbach's public finance class when the 1986 Tax Act was enacted. At the time, I began working on how the 1986 reforms would affect business capital spending. The literature surprisingly found little effects of tax policy on the economy, often suggesting that tax and interest rate variables did not drive capital spending. But Alan and I noticed something funny in the data. Politicians tended to pass Investment Tax Credits in recessions, then let them expire when the recession was over. Thus it appeared that the economy partly drove tax policy, even if to [sic] tax policy also affects the economy. However, because recessions induced tax-cuts, any analysis of how tax cuts affected the economy would need to separate this out to not wrongly conclude that tax cuts caused recessions. When Alan and I discovered a way to overcome this problem, we found very large effects of tax policy on investment behavior. Since then, there has been a veritable scientific revolution of papers that use different methods to identify tax effects, and like our first study, they have found again, and again and again, that tax policy is a major driver of economic growth, if one does the science correctly.
His summary of the literature:
I don't have time to go into the scientific methodology in great detail, but have done so in more detail in a number of recent review articles. But for thinking about the broad-brush growth impact of the President's proposals, a number of recent papers published in top journals provide a guide to the possible scale of the growth effects. Romer and Romer (2010), utilize narrative history to separate out tax changes with motivations unlikely to be driven by the business cycle; they estimate that a 1 percentage point reduction in the total tax share of GDP increases GDP by 1 percent on impact, and by between 2.5 and 3 percent over three years. Cloyne (2013) and Hayo and Uhl (2014) apply the same approach using data from the United Kingdom and Germany, and obtain almost identical estimates. Other authors, such as Mertens and Ravn (2013), have extended this work with more sophisticated methods and find that a 1 percentage point reduction in the average personal income tax rate raises real GDP per capita by 1.4 percent in the first quarter, and by up to 1.8 percent after one year. They further find that a 1 percentage point cut in the average corporate income tax rate raises real GDP per capita by 0.4 percent in the first quarter, and by 0.6 percent after a full year. Using a similar approach, Mertens and Olea (2017) find that in the first two years following a tax decrease of 1 percent, GDP is expected to be higher by about 1 percentage point.
Applying the estimates from the literature to Trump's proposed cuts:
Applying these estimates to the proposed reduction in the statutory corporate income tax rate from 35 to 20 percent and the simultaneous introduction of full expensing requires calculating the effect these changes would have on federal tax liabilities, which will depend on the bill's final details. But just to illustrate the scale of these effects, a rough preliminary estimate of the combined revenue effect of the corporate tax proposal, combined with these macro elasticity estimates, implies that tax cuts of this scale would lift GDP per capita by approximately 4 percent over the first year. Although there are a number of reasons to expect that the actual impact of the reform would be much smaller than that, including the fact that we are currently near full employment, the potential for a significant growth effect is still very reasonable and empirically valid. (emphasis mine)
The effect of the current high corporate tax rates in the United States on transfer pricing and, therefore, on the current account deficit:
The authors correct for this mismeasurement by "reweighting" the amount of consolidated firm profit that should be attributed to the U.S. under a method of formulary apportionment. Under this method, the total worldwide earnings of a multinational firm are attributed to locations based upon apportionment factors that aim to capture the true location of economic activity. The authors use equally weighted labor compensation and sales to unaffiliated parties as proxies for economic activity. Applying the formulary adjustment to all U.S. multinational firms and aggregating to the national level, the authors calculate that in 2012, about $280 billion would be reattributed to the U.S. Given that the trade deficit was equal to about $540 billion, this reattribution would have reduced the trade deficit by over half in 2012.
The amazingly high estimate of the effect of the proposed tax cuts on workers' real income:
Based on the scientific evidence, to me at least, it therefore seems prudent to adopt these reforms. Over the course of the Obama administration, U.S. corporate profits rose by a healthy 11 percent per year. But workers' pay didn't keep pace, and median wage growth was a paltry 0.6 percent per year. This disconnect between profits and wages is a radical departure from previous economic norms. Workers used to get a 1.1 percent raise for a 1 percent increase in corporate profits. Now the pass-through to workers is closer to 0.4 percent. Why did it change so much? Because the profits are offshore, benefiting other nations' workers. In 2016, U.S. firms kept 71 percent of foreign-earned profits abroad. What would happen if they didn't do that? A simple back-of-the envelope calculation suggests U.S. workers in 2016 would have received a raise of nearly 1 percent. What if these firms didn't do that for the next 8 years? The median U.S. household would get a $4,000 real income raise.
Kevin's theoretical argument is strong--lower tax rates on accumulation of capital lead to more capital, and more capital per worker leads to higher marginal product of labor, which implies higher real wages. I was a little surprised by how high the magnitudes were, but he did draw on the literature to come up with his estimates.
In the discussion afterward, Scott Hodge, the head of the Tax Foundation, asked Kevin whether he didn't think the tax cuts were too tilted toward high-income people.That question might have made sense before Kevin's talk, but it didn't make sense after. Kevin's point, which he said a number of times in various ways in the talk, is that changes in tax rates have real effects and not just on the amount of tax people pay. Possibly Hodge was just giving Kevin a slow pitch so that Kevin could emphasize the point of his talk.
HT2 Greg Mankiw.
OCTOBER 14, 2017
I've occasionally done blog posts explaining how it's possible to prevent recessions from occurring, even after they have begun. That's because a recession is dated from the point where output starts falling, but it's not considered a recession unless the decline persists for a considerable period of time. This is one reason why economists are so poor at predicting recessions. During the past three recessions, a consensus of economists failed to predict the recession until it was well underway.
It occurred to me that I failed to provide an example of a recession that was prevented after it had already began. Today I will do so.
In 1966 the Fed tightened monetary policy to slow inflation, which had recently been increasing. As a result, industrial production fell by 1.9% between October 1966 and July 1967.
Now let's look at industrial production during late 2007 and early 2008:
Unlike in 1967, the Fed decided not to ease monetary policy in the middle of 2008, despite growing signs of recession. Indeed policy was actually tightened sharply, as the fed funds target was held at 2% from April to October, despite a rapidly falling natural rate of interest. If the Fed had eased aggressively in June 2008, then they might have entirely prevented a recession that technically began in December 2007. It wasn't too late!
The decline in output from late 2007 to June 2008 was too small to constitute a recession. Yes, the NBER eventually declared that the recession began in December 2007, but there would have been no recession to date in the first place if industrial production had risen in the second half of 2008, as it did in the second half of 1967. (I would add that the post-Lehman crisis might also have been milder, indeed Lehman might not have even failed.)
Ironically, the Fed made the wrong call in both 1967 and 2008. In 1967 the Fed should have allowed a (very mild) recession to occur, in order to prevent the "Great Inflation" of 1966-81 from occurring. That inflation did far more damage than a rise in unemployment to, say, 5% in late 1967. Indeed, a mild recession in 1967 might have made the 1970 recession unnecessary. In contrast, the Fed should have prevented the 2008 recession.
In 1967, the Fed was too worried about unemployment and not worried enough about inflation, whereas the reverse was true in 2008. The solution is to ignore both inflation and unemployment, and focus on keeping NGDP growing at a stable rate.
Even at the low point of the second quarter of 1967, 12-month NGDP growth was running at over 5.4%. There was no reason at all for the Fed to ease monetary policy. By the 3rd quarter of 1968, 12-month NGDP growth had soared to 9.9%---the Great Inflation of 1966-81 was underway. Now look at NGDP growth in early 2008:
So why did the Fed (passively) tighten policy in mid-2008, by keeping rates at 2% as the natural rate of interest plunged sharply lower? In a word, inflation. An economic boom in developing countries such as China pushed global oil prices to a peak of $146/barrel in mid-2008. In the US, 12-month (PCE) inflation rose to a peak of 4.2% in July 2008, far above the Fed's 2% target. (CPI inflation reached 5.5%). Even though the Fed was aware that oil prices were distorting the data, they were so frightened of losing credibility on inflation that they allowed monetary policy to tighten sharply.
The Fed should have focused on NGDP growth, which was falling to dangerously low levels. As long as NGDP growth is kept at a modest level, any rise in inflation due to soaring oil prices will be transitory. Indeed by the end of 2008, the 12-month PCE inflation rate had plunged to below 0.4%, far below the Fed's target. So one of the many causes of the Great Recession was the focus on inflation, when the Fed should have actually been focusing on NGDP growth. Indeed this mistake is now so obvious that it goes a long way toward explaining the rapid increase in support for NGDP targeting.
PS. I am indebted to Robert Hetzel for educating me on the situation in 1967. However he is not to blame for any mistakes in this post.
PPS. I recently read a very interesting Time magazine article from December 1965, entitled. "We are all Keynesians now". It's amazing how confident people were back then that we had it all figured out.
OCTOBER 12, 2017
I am currently in DC attending a star-studded macroeconomic policy conference at the Peterson Institute. Today's participants included Bernanke, Summers, Blanchard, Draghi, Fischer, and many other eminent economists. Bernanke's paper was by far the most interesting, especially his proposal for addressing the zero bound problem:
Of course I'd prefer NGDP level targeting, partly for reasons outlined in this post. But Bernanke's proposal would still be a dramatic improvement over current policy. More importantly, this is something that is much more politically feasible than any other proposal that I've seen. It actually makes the long run future price level more predictable than under current policy, which conservatives should love. It makes policy more expansionary at the zero bound, which liberals should love. It also eliminates the need to offset under and overshoots of inflation when not at the zero bound, which should assuage the fears of those who oppose traditional forms of level targeting. Indeed I think Bernanke's proposal is now the odds on favorite to be official Fed policy the next time the US hits the zero bound. Most people at the Fed understand that something like this is needed at the zero bound, and Bernanke's proposal could be sold to Congress as being fully consistent with the Fed's 2% inflation target.
You might assume that under Bernanke's proposal we'd still be at the zero bound, because we are still far below the 2% trend line from 2008. Not necessarily:
Note though, that if this policy rule had been in place prior to 2008, and if it had been understood and anticipated by markets, then longer-term yields would likely have been lower and the effective degree of policy accommodation during the past decade might have been significantly greater. In that counterfactual world, inflation might have been higher and the average-inflation criterion might have already been met. This is because the Fed would have already communicated their intention to be more accommodative going into the ZLB episode.
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