Scott Sumner  

Liberalism unbound: Free lunch and dinner--all you can eat!

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Let's think about (left) liberalism over the last 50 years. By the 1960s, income had become relatively equally distributed. Liberal economists grew increasingly skeptical of labor unions. When the UAW demanded higher wages, the money seem to come out of consumer pockets, not corporate profits. By the 1990s there were increasing doubts about the welfare state. The war on poverty was widely seen to have failed. Bill Clinton said we needed to end welfare as we know it. Also in the 1990s, fiscal policy went out of style. New Keynesians believed the Fed had the tools to steer a fairly steady growth path in aggregate demand using Taylor rule-type techniques. Fiscal stimulus gets offset with tighter money in that sort of policy regime, leaving nominal GDP unchanged. Fiscal stimulus conceivably might have some supply-side channels, but liberals never put much weight on those effects.

I don't think liberals were happy about this state of affairs. They tend to be optimists who believe government spending can fix societal problems. The neoliberalism of the 1990s represented a sort of rejection of that optimism. In the last 10 years, however, old-style liberalism has made a big comeback in two areas; fiscal stimulus and income redistribution. Here I'd like to see if there are some hidden connections between those two areas.

Two real world factors have led to a revival of liberalism: near-zero interest rates and increasing income inequality. When rates fell close to zero in Japan, and then later in the US and much of Europe, there was a revival of interest in fiscal stimulus. In retrospect, I think that was a mistake. According to Paul Krugman the year 2013 provided a test of the hypothesis that austerity slows economic growth. The outcome of the test couldn't have been more clear-cut; American GDP growth actually accelerated in 2013. Even worse, European austerity occurred during a period where the eurozone wasn't even at the zero bound. However as Mark Sadowski recently showed, that didn't stop well respected pundits such as Simon Wren-Lewis from claiming that austerity had clearly slowed growth. And that was despite the fact that there is no respectable Keynesian model were austerity significantly slows growth during a time period where the central bank is raising interest rates.

The renewed interest in income redistribution also has its problems, but at least has some firm theoretical underpinnings. There are respectable utilitarian models where increasing consumption inequality calls for increased redistribution. Unfortunately liberals went way overboard, calling for higher minimum wages, higher taxes on capital income, and other extremely dubious remedies.

Here's a common theme I see. Most liberals prefer to think like accountants, not economists. The dismal science focuses too much on the "no free lunch" concept. The idea that there are trade-offs, that incentives affect behavior. The idea that making failure less costly, also makes it more likely to occur. But liberal economists are not stupid, and as the 1990s demonstrate they are willing to adjust their policy prescriptions to reflect changing information about the market system.

Many liberals honestly believe that the past 10 years demonstrates that there are two giant pots of money just sitting there, of which they were not aware (or which were not available) in the 1990s. These pots of money can be spent on all sorts of socially worthy projects at almost no cost. One pot of money is fiscal stimulus. In the multiplier model there's no opportunity cost of using fiscal stimulus, even on wasteful projects like high-speed rail between Tampa and Orlando. Indeed the multiplier effect creates a sort of "opportunity benefit" in the form of extra income above and beyond the government spending. That's a free lunch. Liberals love free lunches. Actually, I love free lunches, I just don't see as many out there as they do.

Fiscal stimulus is not the only free lunch. The increase in income inequality combined with a perception that many high earners are actually collecting unearned rents combined with studies suggesting minimum wage increases may not increase unemployment, have created another huge pot of money to play with. A free dinner. Liberals tend to assume that beyond some point the marginal utility of consumption is very low, especially for the ultra-wealthy. I agree with this. I'm much more skeptical of the minimum wage argument, and also the view that high CEO incomes are mostly unrelated to expected productivity. Both arguments seem highly implausible.

In 1986 Ted Kennedy helped enact a top income tax rate of 28%, despite opposition form a number of GOP senators. In 1987 the New York Times advocated abolishing the minimum wage. In the 1990s lots of liberals favored replacing welfare with workfare. Lots of liberals favored replacing taxes on capital income with a progressive consumption tax. They opposed fiscal stimulus. They thought unemployment compensation created unemployment---it made people lazier. These were all good ideas, and still are. I don't know whether to be bemused or annoyed by the fact that today's liberals think any right-winger that holds these views (that the best and brightest liberals once held) are stupid. Just because they've "jumped the shark" doesn't mean that all the rest of us must follow.

In the 1980s, supply-siders took a good idea and went way too far in downgrading the importance of demand-side issues. Today's liberals are taking a good idea (increased inequality might require more redistribution) and imagining this opens the door for endless free lunches and dinners. The supply-side doesn't matter. If we only put higher taxes on the rich there would be a big pot of money for single-payer healthcare. A week later they forget they've spent the money (in their minds) and now want to spend it on free preschool education. Another week goes by in that same pot of money can be spent on improved infrastructure. The same money can be spent 100 times. The "unmet needs" are endless.

I'm only about 250 pages into the Piketty book, but it already seems to epitomize modern (American) liberalism. So far it seems 99% accounting and 1% economics. In the few times where incentive effects come up they are generally dismissed as being unimportant. For instance we are told that Thatcher's economic reforms didn't really turn around the British economy (hard to accept if you're old enough to recall how poorly Britain was doing in 1979.) It's the kind of argument that appeals to people who just look at times series of average GDP growth rates, and not how Britain was doing relative to France in 1979.

Paul Krugman likes to say that reality has a liberal bias. But economics has a sort of conservative bias, or more precisely a free-market bias. It's innately hostile to arguments that there are big pots of money that can be used without opportunity cost. That doesn't mean liberal arguments are always wrong, I do think there are some good arguments for redistribution. Rather I would argue that there are certain times when events get misinterpreted and people overestimate how much can be accomplished with liberal remedies. The 1930s was one of those times and the period since 2008 is another. Big government liberalism is an ideology built 20% on reality and 80% on cognitive illusions.

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COMMENTS (23 to date)
Student writes:

I there is a good case that CEOs are overpaid. If CEOs weren't overpaid then there wouldn't be much benefit to mergers and acquisitions: i.e. the market for corporate control would approximately be at equilibrium. This article argues that there acquisitions and mergers can generate a great deal of value but are held back due to various regulations. This argument, however, hardly justifies draconian measures of capping executive pay via government fiat (which I fear would introduce more rather than less corruption). But it does suggest that by actually de-regulating we might see lower pay (or we might see more competent CEOs with even higher pay).

Philo writes:

You'll have to do a post on redistribution; there seems to be a certain tension in your views. "The dismal science [exemplar: Scott Sumner] focuses . . . on . . . [t]he idea that there are trade-offs, that incentives affect behavior. The idea that making failure less costly, also makes it more likely to occur." Thus: "Bill Clinton said we needed to end welfare as we know it" (endorsed by Scott Sumner). But: "There are respectable utilitarian models where increasing consumption inequality calls for increased redistribution." This is because "beyond some point the marginal utility of consumption is very low, especially for the ultra-wealthy."

So we have an argument against welfare and an argument for it. What's the upshot?

Foobarista writes:

I like the "accounting" versus "economics" argument, as it captures the sense that left-libs have that government can move resources without cost from one pool in society to another without the "pool owners" reacting to the movement in any way, as if society was a giant ledger and you were just moving cash from the "rich account" to the "poor account".

The very word "redistribution" is rooted in this accounting-rooted thinking.

Scott Sumner writes:

Student, I'm no expert in this area, but I recall an article in the JEP that pointed out that CEO pay has also risen in sectors where there is no principal/agent problem. I don't recall the details. And I'm not reassured by liberals who point out how little Japanese CEOs are paid---their stock market is down more than 50% from 1991, while ours is up 8 fold, or close to it.

Philo, The key phrase is "as we know it." We abolish welfare for those who chose not to work, and then create a system where anyone can work, and income is redistributed from high wage jobs to low wage jobs.

Britmouse writes:

Nice post. We get event studies almost every week showing that investors think execs make a huge difference to firm value, when prices change on announcement of director hires/fires. The question for me is why liberals thinks that execs should not capture some of the value investors attribute to them.

Or if they think the market is wrong, why aren't the liberals making $$$ running hedge funds.

Philo writes:

"We abolish welfare for those who chose not to work, and then create a system where anyone can work, and income is redistributed from high wage jobs to low wage jobs." Well, OK (except for the human vegetables who actually *cannot* work); but there is a serious lack of detail. (Or will you refer me to Morgan Warstler?)

Glen Smith writes:

The only argument that supports income inequality due unearned rents would have to start with the assumption that these rents came from defending against intrusive regulations and taxes (for example, a business that offers training on how to deal with the new regulations) or making money from one of those fiscal spend boondoggles. In the end, income inequality stems from one of two things: innovation or transfer from one group to another. Fiscal boondoggle spend, regulations and taxes all create transfers and tend to increase income inequality without (or very little) productivity increase. Meanwhile, those things discourage the only type of income inequality that occurs because of increased productivity.

Scott Sumner writes:

Britmouse, Yes, I recall the reaction in the Microsoft stock price when Ballmer resigned.

Philo, There are very few people who cannot work, and you can have disability programs for that group. I've always preferred wage subsidies to welfare.

foobarista writes:

As for history, the intellectual event that drove 1990s-era thinking was the Fall of Communism, which poisoned the well for statist-left arguments, temporarily as it turns out.

The intellectual events driving stuff nowadays are rooted in a weird combination of tech celebration + the intellectual bankruptcy of many of the elite in business and government, the rise of statist China (now more fascist than communist) and a strong resurgence in what Arnold Kling calls the "intention hypothesis" (when approaches are judged, the one that is rooted in "best intentions" is held to be better). So, unfortunately for the world, statist-left approaches are making a comeback among intellectuals, as the mistakes of the last generation are repeated by this one.

Add to that a weird worship of knowledge over wisdom that's become commonplace nowadays (probably rooted in tech-driven youth cult stuff), and you end up with "sure, big-state stuff didn't work so well in the past, but now we're smarter, hipper, and care more, so this time, it's different".

ThomasH writes:

I think your analysis of the revival of interest in fiscal policy has to do with events: the perception of unemployed resources when GDP contracts. [There is a separate debate about whether there would have been any unemployed resources if the Fed had followed Scott Sumner's advice, but it didn't.] If there are unemployed resources then there are free lunches available and the way to eat them is for the Federal government which is not credit constrained to invest in projects which have positive net present values when evaluated at shadow prices reflecting the unemployment of resources (which are very unlikely to include high speed rail in Florida). Easier said than done, but there should be a fiscal stimulus in response to a recession.

Seeing how resistant politicians are to arguments for fiscal stimulus during recessions and surpluses in normal times, however, I think that much more should be done with automatic stabilizers. Make transfers to states and local government a function of the impact on their revenues of the economic downturn; make the duration of unemployment insurance and the payroll and corporate tax rates a function of unemployment, etc.

Jeff writes:

Well, given what happened in the 1930's, I suppose we should at least be thankful we are stuck with today's big government liberals rather than 1930's government liberals. There are still lots of '90's style neoliberals around today, which I think has restrained some of the worst impulses of the Elizabeth Warren-Bernie Sanders axis during the recent crisis. In the 1930's, the situation was decidedly worse, ideologically speaking, and so was the outcome, on all fronts.

Garrett writes:
Britmouse, Yes, I recall the reaction in the Microsoft stock price when Ballmer resigned.

I wonder what it feels like to be worth negative $20 billion dollars.

Michael Byrnes writes:

I think we live in a paradise for rent-seekers. Has there ever been a better place and time to rent seek? I would say no, because rent seeking ultimately depends on real wealth. A society of subsistence farmers is no place to be a rent seeker (or other type of thief), because there isn't all that much rent there to be sought.

I would imagine that there is a Laffer-type curve of rent seeking. Rent-seeking is a sort of tax on real production. The "marginal rate "of this tax was much higher in say, feudal England or Soviet Russia, but here in the US in 2014 we are much closer to the revenue maximizing marginal rate of rent seeking.

Here in the US in 2014, the actual amount of extracted wealth is probably greater than it has ever been anywhere else in history.

The question is, which side of the rent seeking Laffer curve are we on? I.e., will raising the marginal rate increase or decrease the amount of extracted revenue?

Les Cargill writes:

Much of present-day "leftism" is actually ( IMO ) a reaction to Clintonian* Neoliberalism. They're not documentaries per se - they're essays - but people have trouble affiliating with the sort of ... robotic Neoliberal programmes as outlined in Adam Curtis' films.

*for lack of a better label... it's an era, not a person...

The question is 'rents on what?' The present-day firm pays "rents" to employees for helping it get out of its own way. Firms accrue sclerotic processes and institutions and then pay people to defer the inevitable Schumpeterian state of entropy just a little bit longer.

My perception is that returns on *physical* capital ( that is not land ) are just as weak as returns on labor proper. Data centers are cash-flow constrained an that means computers go back to being closer to zero sum. So what's the Thing that's rising? It's not unreasonable to deduce that it's rents, but it looks less like the classic rents every day.

Because of my own biases, a lot of this looks like the failure of AI in the 1980s. Yes, a reasonable simulation is possible but it's not The Real Thing and the more bandwidth you throw at it, the more obvious the deficiencies in the simulation become. Increasingly, employability is a function of the ability to ignore this.

Eric Falkenstein writes:

Krugman wrote a post decrying Sargent's commencement speech that mentioned trade-offs, because he thought it was important to remember that when the government spends money and the economy is below its potential, there is no trade-off.

Of course, in real time we are always below our potential, it's only with hindsight that there leftist think fiscal expenditure doesn't pay for itself.

Kevin Erdmann writes:

I don't think it's a demand for a free lunch, per se. I think there has been a trend of demonizing the major sources of tax revenue and establishing them as "other", so that:

1) Ignorance of costs is a signal of political power.

2) The removal of mutual identity makes it easier to judge them in "far" terms, so that policies can be judged more simply in terms of intentions, instead of outcomes.

Craig Burley writes:

Britmouse: "if they think the market is wrong, why aren't the liberals making $$$ running hedge funds"

Plenty are.

Scott: your "Liberals drive like this, but conservatives drive like this" type of political analysis should probably stay back in the shed.

Steve J writes:

I find it a little difficult to chalk up a clear win for monetary policy when it took over 5 years to recover job losses.

Scott Sumner writes:

ThomasH, You are describing Keynesian economics circa 1955. Even Paul Krugman doesn't believe that.

Jersey Patriot writes:

"Unemployed" is not the same thing as "lazy" or "unproductive". Plenty of people are employed to do nothing productive, or actually even actively destructive. Plenty of unemployed people are producing things of value.

Single-payer healthcare doesn't require higher taxes. The only evidence for this is every other First World nation.

Economics has a terrible track record compared to accounting. That comparison doesn't make economics look good at all. LMAO

J Mann writes:

Craig, serious question: Are there some funds that do well betting against principal-agent inefficiencies, and has anyone taken a serious look at their performance?

One of my favorite books ever is "Capital Markets Reexamined", which looks at behavioral economics by asking whether any of the funds trading on BE insights are making money. (The answer is "maybe, it's hard to tell," but even that answer is interesting.)

mark writes:

One doesn't even have to get into opportunity cost to critique projects like high-speed-rail between Tampa and Orlando. The multiplier argument just doesn't incorporate the long-term contractionary effect of having to divert revenue annually to service the debt incurred to fund such projects.

Thomas Sewell writes:
Liberals tend to assume that beyond some point the marginal utility of consumption is very low, especially for the ultra-wealthy

One of the bigger problems with these assumptions are that the ultra-wealthy spend a significant percentage of their wealth/income on personal consumption.

My understanding is that a far higher percentage goes to investment, which based on their previous track record building wealth competently, is a better use of the money (helping all of us overall) than taking it for a government official to spend.

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