Arnold Kling  

Shlaes and Mandel

The Future... Morning Commentary...

At the Kauffman forum that I attended in Kansas City the other day, I thought that the most interesting comments, neither of which I agreed with, were offered by Amity Shlaes and Michael Mandel, who blog here and here, respectively.

Shlaes argued against cutting payroll taxes. She was making a comment during a discussion, rather than a formal presentation, so she might not agree with my interpretation of what she was saying.

Economists take the view that Social Security benefits and Social Security taxes are basically disconnected, so it does not matter if you substitute another tax for payroll taxes to pay for benefits. Shlaes said that what economists would call the illusion that benefits and taxes are linked is actually a key to maintaining American exceptionalism and avoiding a welfare state. That is, our Social Security system falls within a tradition of individual contracts and obligations rather than a tradition of socialism. Cutting payroll taxes and substituting other taxes would be a cultural shift toward socialism. I may be putting words in her mouth, but I think that is what she was saying.

Michael Mandel's view is that our current macroeconomic and stock market troubles reflect the readjustment of estimates about economic growth since 1997. He sees a need for both investors and statisticians to revise those estimates. The statistical argument is that when a firm outsources production overseas, it fails to report to the government statisticians the payments that it makes to overseas producers. Thus, what should be counted as imports instead gets counted as domestic production. One implication of this is that productivity growth has been over-estimated. We had a long argument starting at about 5 AM Saturday morning (we had early flights out of Kansas City) over whether overall economic statistics are or are not consistent with his suggested revisions.

Apart from that, I have an even harder time with Mandel's story relative to investors. The way I look at it, an investor who looks at a firm's accounting statements would know whether it is producing or importing its intermediate products. If investors knew the reality all along, then this should have been reflected in stock prices all along--it does not explain the sudden drop in the last six months.

Mandel's view is that investors, particularly foreign investors, had a rosy view of American firms' ability to grow and hence to repay debt. Thus, they treated American private debt as risk-free. This changed when the housing bubble burst. High stock prices depended on the "credit bubble" continuing to inflate, and when it popped the market crashed.

Again, I may be putting words in his mouth.

Comments and Sharing

COMMENTS (11 to date)
Randy writes:

I agree with Shlaes' point (if that is her point), but I still think a means tested system for the elderly would be better than the current system because it would put the beneficiaries at the mercy of the majority, rather than creating a majority of beneficiaries.

Ed Hanson writes:

I come down on the side of Shlaes. It is the correct reading of the political sell of Social Security. Perhaps illusion in this case is important. But I have a second reason for finding a temporary payroll tax a poor stimulus. I would like to read from you if my interpretation of the Permanent Income Hypothesis has any merit.

If I have read correctly, the call for cutting payroll taxes have been limited to about one year in length. How is this justified as stimulus according with Friedmans's Permanent Income Hypothesis? My reading of which, is such a temporary measure would have no effect in change of behavior, and no real stimulus effect.

Arnold Kling writes:

Your reading is correct. I am not an advocate of a temporary payroll tax "holiday" for exactly that reason.

I favor a permanent reduction in the employer portion of the tax only. I think that businesses will have a higher marginal propensity to spend than consumers, and in the short run a cut in the employer contribution will flow to businesses.

In the long run, when the slump is over, a cut in the employer portion of the Social Security tax will raise wages. But in the long run, you could undo a "permanent" tax cut.

I want it permanent in order to ensure that businesses see it as a long-term reduction in the cost of labor, so that you get the most possible hiring benefit.

Gary Rogers writes:

I would also agree that reducing the payroll tax is not the way to go right now simply because of the mess we are in from past borrowing. Yes, reducing the payroll tax would stimulate the economy, but we have been down that road before and to do it without controlling government spending is what the democrats call "more of the same." Granted, the current stimulus is worse than more of the same, but that too must stop.

Our biggest danger and the thing we need to address first and foremost is our addiction to borrowing. Borrowing from foreign sources is removing money from the pool of dollars that should be purchasing our exports, insuring weak exports in a time we are trying to promote jobs. Why do all the analyses of the stimulus start with what happens when the government spends a dollar and not what happens when the government borrows a dollar? If we can get out of this without a sovereign debt crisis, there will be time to pick up the pieces but right now we are destroying everything we have left trying to put a bubble back together.

travis writes:

It seems that Mandel is saying companies were gaining in productivity through outsourcing. But productivity gains are productivity gains no matter what the source. So for an individual company, the stock price should increase. The hypothesis does explain why income for Americans didn't increase much, since if worker productivity didn't increase, they shouldn't receive greater incomes. Instead, the greater income should flow to the owners of the capital who are benefiting from the outsourcing.

spencer writes:

Why should it matter to investors whether or not a firm is purchasing components domestically or importing them?

As far as an investors is concerned it does not make any difference to the bottom line if a firm buys a component in China or Ohio. The important point is if it can sell the final product for more than the component cost.

Arnold Kling writes:

Your story is this: Suppose a firm sells 10 widgets one year and 15 widgets the next year with the same total cost. Who cares whether the gain in output comes from internal productivity or cheaper purchases of foreign components?

But instead, think of the firm as effectively importing widgets at a constant price and then selling them in the domestic market. The internal accounts say that the cost of widgets must be subtracted from the sales price to get the profit. Maybe profits go up, maybe they don't. But in Mandel's story, the government statisticians see a 50 percent increase in widget "production" by the same work force, because the firm does not report the widget imports. Again, I think that's his story, but I would not swear to it.

Amity Shlaes writes:

Thanks to Arnold for an elegant recapture of my point at the Kauffman Conference (this conference was non-virtual, for once)

The objection to Keynesian cash rebates for consumers is that they infantilize those consumers. Cash rebates assume the consumers will take any money and spend it blithely, or ought to spend it. Regardless of changes in their personal long term financial outlook.

The objection to fooling with Social Security is similar. Any U.S. government, GOP or Democrat, should be shoring up its social contract with citizens. It can do that without promising more, and instead saying: "Here's what I can give you, and here's what I can't. At least I'll be truthful."

President Obama has a better chance to repair voter respect in this fashion because he is new and can ask for sacrifice. He could therefore say: I want to honor FDR's Social Security contract. So I will tell you now that there isn't enough money there if we keep the current system. Let's make a few adjustments, and have reduced payouts but a commitment to at least make those payouts. Here is one part of our culture that is reliable. "Ask not what Obama will do for you..."

Instead the President and Republicans too are saying -- we honor no long-term contracts, we undermine, rather than shore up, whatever is promised long term. We just look at the short-term and shout "crisis." We'll trick the baby and give it candy now so it will be happy (to continue the infant metaphor). A temporary cash break on the payroll tax? It will stimulate. No matter that the message to voters/infants is that Social Security is a tool for managing the business cycle, not a federal retirement program.

From an economic pt of view, the payroll tax holiday makes sense, at least to some. From a civics point of view, it doesn't. Civics are also economics.

pgl writes:

An objection to the Shlaes spin if your interpretation was fair:

Barkley Rosser writes:

I agree with Shlaes that politically the public views social security as a deal, or a contract, which invalidates the economists' argument that "it does not matter," although at some higher level that arguemnt is correct. I would disagree with Shlaes that there really is a serious financial problem with social security. I would suggest that she google Bruce Webb and read his detailed analyses, which I shall not bore people here with regurgitating. But there has been way too much hysterical yapping about the long run financial situation of social security (and I have laid out some of these arguemnts on this blog before).

Now, I recognize that it is perfectly consistent for an anti-big government libertarian to want to reduce or even eliminate social security because it is big government. But I really have no use whatsoever for people who cry out about how we need to "reform" social security because it is "in a financial crisis" and then cry out that we need to have a payroll tax cut in order to stabilize the macroeconomy. This is nothing more than rank hypocrisy of the worst sort.

Michael Coburn writes:

The best way to employ the SS system to stimulate the economy long term is to shift FICA taxes upward; to lower the tax rate and remove the cap. If you want additional near term stimulus then you lower the rate first (like NOW) and wait until next year to remove the cap. It really isn't a difficult problem so long as you do no not let your idiotology get in the way.

There also seems to be an aversion to the reality that dollars are created on a keyboard at the Federal Reserve and that money supposedly "borrowed" today may not be worth much when our kids have to "pay it back". Saying that will get me labeled as a hyperinflationist I am sure, because that is the typical right wing neoclassical approach to denial. Monetary economics are employed as the mainstay of any stimulus and fiscal policy is used to shape the economy and to remove excess money from the system. The true quantity of money and/or its value must inevitably be controlled by taxation.

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