Arnold Kling  

Ken Rogoff and Others

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As usual, Mark Thoma has interesting links for today.

1. Ken Rogoff writes,


Many countries' tax systems hugely favor debt over equity. The housing boom in the United States might never have reached the proportions that it did if homeowners had been unable to treat interest payments on home loans as a tax deduction. Corporations are allowed to deduct interest payments on bonds, but stock dividends are effectively taxed at the both the corporate and the individual level.

He argues that "debt bias" in government policy is a bad thing. If anything, there should be "equity bias," because equity finance is less crisis prone. I think there is also debt bias in financial innovation--a point made by John Kenneth Galbraith in his short book on crashes. My outlook on financial safety is that it is hopeless to use regulation to attempt to achieve a system that cannot break. Instead, your best bet would be a system that is easy to fix. Financial excesses that are based on equity fail more gracefully than those based on debt.

2. Ed Glaeser summarizes his thinking on the possibility that the Internet is increasing the value of face-to-face meeting.


If the new media increased the number of relationships - the connectedness of the world - more than it decreased personal meetings within any given relationship, then better electronic communications could increase the number of face-to-face meetings.

In later research and in my book "Triumph of the City" (The Penguin Press, 2011), I emphasized a slightly different idea: electronic connections and face-to-face connections are complements because new technologies increase the returns to innovation.

His book is on my list of hope-to-reads.

Next, I want to point out some weaker arguments to which Thoma links. I am not a fan of spending a lot of time bashing weak arguments. I think a better coaching philosophy is "Catch them doing something right." But in my remaining two comments I will consciously deviate from that philosophy.

3. Kash writes,


If, as the evidence suggests, public sector jobs tend to have compressed pay schedules, with relatively good compensation for entry-level jobs but only modest increases in compensation over an entire career (leaving overall lifetime compensation lower), then that means that individuals who can not afford to wait for the higher pay that they would eventually get in the private sector would tend to prefer public sector jobs.

First of all, what evidence? I seem to recall seeing claims that went the other way--that public sector pay increases more steeply in the early years. In any event, if experienced government workers were badly underpaid, then one would expect to observe a very high quit rate in the public sector. Quite the opposite.

He concludes,


So put me in the camp of those who are not persuaded by the "queuing" methodology of trying to determine if public sector jobs pay better or worse than their private sector counterparts.

He is entitled to his opinion. But suppose you had a private sector CEO under the following circumstances:

--The company's costs exceed its revenues, by a lot.
--The company faces large labor costs.
--The company has no difficulty attracting or retaining workers at prevailing wage rates.

Now, suppose that the CEO were to say, "Consultants tell us that their regression equations show that our employees are not overpaid. So we are not going to try to cut salaries."

What do you think would happen to that company and to that CEO?

A central planner may have the luxury of making decisions based on methodological opinions. A CEO does not have that luxury.

4. Jonathan Chait unleashes an ad hominem attack on John Taylor.


Taylor's basic role is to support Republican fiscal policy in any and all circumstances

Although there is no precise measure of an economist's prestige, there are various ranking systems that use scholarly citations and such. On the REPEC system for ranking economists based on scholarly achievement, John Taylor is number 45. Peter Diamond, who just shared the Nobel Prize, is only 61. And Chait's number?



COMMENTS (14 to date)
David N writes:

"Financial excesses that are based on equity fail more gracefully than those based on debt."

I don't believe that for a second. How do you square that statement with the existence of derivatives?

John Thacker writes:
I seem to recall seeing claims that went the other way--that public sector pay increases more steeply in the early years.

I believe the claim is that public sector employees at the same job title earn less at the upper levels, but at the same time, it takes a shorter amount of time (and is more automatic) for public sector employees to be promoted to that higher job title.

ed writes:

I wonder what Chait things about Krugman. He's even higher on REPEC, and even more of a partisan hack in the popular press.

ed writes:

Defined benefit pensions usually work such that they are worth MUCH more in later years. This effect might outweigh any slow growth in cash wages for public workers.

Floccina writes:
Instead, your best bet would be a system that is easy to fix.

I think the problem is one of feedback. I think that we need a system where the failure of weak financial institutions strengthens that remaining financial institutions. I think that competing currencies backed only in bank assets would give us that. I do not know how to get there though.

Steve writes:

David N:

How do derivatives' existence support or refute the relative stability of a debt- vs. equity-heavy financial system? There are many debt- and equity-based derivatives out there. What is your point?

David N writes:

First, I share the general dislike for a tax scheme that favors debt financing over equity financing. It's not right that interest is taxed once and dividends twice. I disagree that the answer is to tax interest twice. I also disagree that interest expense which has been deductible since 1913 has anything significant to do with the last housing boom.

In terms of which firm fails more "gracefully," I think debt vs. equity finance is a distinction without a difference. Insane leverage is insane leverage regardless of whether your assets have an income stream or not.

aarong writes:

David N:

In terms of which firm fails more "gracefully," I think debt vs. equity finance is a distinction without a difference. Insane leverage is insane leverage regardless of whether your assets have an income stream or not.

I think you are misunderstanding the difference between debt and equity. If a company has total assets of A, and total liabilities (debt or any other financial obligation, such as being short options) D, then by definition equity E is:

E = A - D

Financial leverage is often expressed as a ratio of assets to equity;
Leverage = A / E

Insane leverage, as you put it, implies a large amount of debt relative to equity.

Dan Carroll writes:
First of all, what evidence? I seem to recall seeing claims that went the other way--that public sector pay increases more steeply in the early years. In any event, if experienced government workers were badly underpaid, then one would expect to observe a very high quit rate in the public sector. Quite the opposite.

I can't speak for all public sector jobs, but anecdotally, novice public school teachers in my home state (Texas) have salaries that are only a little less than their more experienced counterparts. And they have a high quit rate.

ed:

Defined benefit pensions usually work such that they are worth MUCH more in later years. This effect might outweigh any slow growth in cash wages for public workers.

Defined benefit pensions are effectively set asides guaranteed by the employer. Thus, the value of the pension, theoretically, is equal to the future value of the cash salary deferred minus the risk premium of employer insolvency. In reality, political interventions alter that equation, but the principle remains.

David N:

I don't believe that for a second. How do you square that statement with the existence of derivatives?

Most derivatives employ implied debt, including equity derivatives. In fact, the reason derivatives are so destructive is that, in some cases, they are able to employ massive leverage without an equity "downpayment."

David N writes:

I'm not misunderstanding the definitions. If I pay cash for call options that is a form of leverage.

Left Outside writes:
Although there is no precise measure of an economist's prestige, there are various ranking systems that use scholarly citations and such. On the REPEC system for ranking economists based on scholarly achievement, John Taylor is number 45. Peter Diamond, who just shared the Nobel Prize, is only 61. And Chait's number?

So you meet an ad hominem with an ad hominem? Was that meant to be ironic?

Heidegger is an important and respected philospher. His politics were hateful.

Now I don't want anyone getting Godwin out his box, I'm, not trying to slur Taylor, I'm just pointing out that there is often a difference between academic respectability and political infallibility.

Andy writes:

I would like to see a better breakdown of quit rates. I have observed that government lawyers seem to have high quit rates. They can join the government right out of law school, be paid less than their counterparts in the private sector but do more interesting work, and rejoin the private sector at a higher level and having gotten to avoid all the tedium of a first-year associate.

It is also possible that people who get utility from power tend to join the government and that those who get utility from money work in the private sector. Then you would see lower government pay scales and low quit rates but there may still be adverse selection into the government that could be avoided by raising pay.

Andujar Cedeno writes:

Why not an effective transparency bias. I find it virtually impossible to believe the claims of debt or equity in regards to large institutions today because of the ability of firms to obfuscate.

Anyone else feel this way.

Give me more transparency and I'll make the decisions for myself. Less transparent firms will see capital flight and more transparent firms capital inflow.

Just a thought outside of the debt-equity argument that I find difficult to verify in the first place.

Andujar Cedeno writes:

Jonathan Chait, I went to the website http://ideas.repec.org/top/top.person.all.html
and didn't even find him ranked in the 1369 names listed. Did I miss him? I double-checked.

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