Saturday, October 18, 2014

Why Shouldn't Governments Compete?

I noticed two interesting editorials in the New York Times this month. On October 1, writing about Ireland's tax treatment of Apple Computer, the Times opined:
Lawmakers around the world must agree not to compete by offering relative tax advantages that hurt everyone.
But in an October 7 editorial about the beer industry, they wrote:
if corporate deal makers have their way, there will be even less competition...Consolidation on this scale leads to higher prices and fewer choices.
Apple employs thousands of people in Ireland.  If Ireland can tax Apple at a low rate and raise enough money to run its government, why is it a concern of the New York Times, or anyone else?  If the United States wants to tax Apple's activities in the United States, it certainly can.  If Ireland can provide the extra government services needed to accommodate Apple less expensively than the United States can, then it is best for Apple to operate in Ireland.

Governments can be inefficient and wasteful.  They sometimes tax too much and provide too little.  Competition between political parties for government control is not always enough to improve the situation; sometimes competition between governments is needed.

In the case of beer, the Times understands that competition is a good thing.  Of course, when I look at the store shelves in my local supermarket I see an amazing number of beer choices, and this week's CVS flyer advertises a 30-pack of 12 ounce cans of Miller High Life for $17.99.  I doubt that the New York Times editorial writers have any idea that folks in the provinces pay 60 cents for a 12 ounce beer, since they are probably paying $15 for 12 ounces of Crooked Stave Vieille Artisanal Saison, with a "floral, citrusy hop character, a subtle herbal note and a tart finish."

In the market the Times complains doesn't have enough competition I see low prices and plenty of choices, but in the market they think is too competitive the situation is just the opposite.  I wish that on April 15 I had the choice and value that is available in a supermarket beer aisle .

Friday, October 10, 2014

Deficits and Warming

Interesting line from Paul Krugman this morning: 
"given all the clear and present dangers we face, it's hard to see why dealing with that distant and uncertain prospect should be any kind of policy priority."
He is probably talking about global warming, right?  Harm from warming is clearly a distant and uncertain prospect.  No, he means problems resulting from federal budget deficits.

Krugman is right that deficits are down for now, but he admits that current projections from the CBO (which Krugman trusts) show "uncomfortable levels of debt a generation from now."  Here is that projection:


Uncomfortable indeed.  But this baseline projection makes a number of optimistic assumptions.  Changing some of these assumptions in plausible ways dramatically worsens the picture.  In this example, spending discipline is relaxed in ways that economists on the left advocate:



If interest rates are higher than projected, health care cost increases accelerate, immigration, mortality, or productivity growth are less favorable than expected the situation will be even worse, much worse.

The first paragraph of the Wikipedia article on the economic effects of global warming states:
...estimates of the results of global warming over the 21st century have varied widely. Many analyses, such as that of the Stern Review presented to the British Government, have predicted reductions by several percent of world gross domestic product due to climate related costs such as dealing with increased extreme weather events and stresses to low-lying areas due to sea level rises. Other studies by independent economists looking at the effects of climate change have found more ambiguous results around the range of net-neutral changes when all aspects of the issue are evaluated...
Warming has certainly been less than expected over the past two decades, even as CO2 emissions have risen, suggesting uncertainty even in the basic mechanisms of warming, let alone the economic effects of warming.  The effects are also certainly distant - William Nordhaus, a major proponent of taking action to avoid warming, said in his Journal of Economic Literature article:

"the projected impacts from climate change are far into the future. Take as an example the high-climate scenario with catastrophic and nonmarket impacts. For this case, the mean losses are 0.4 percent of world output in 2060, 2.9 percent in 2100"

 
I cannot see how objective people could say that we should ignore projected federal budget problems because they are uncertain and distant while at the same time claiming that global warming is a catastrophe that requires immediate action.  It has to be that these people are driven by a larger ideological agenda, and what they say about things like warming and budgets is tactical and dishonest.



Saturday, October 4, 2014

Income Inequality is Inevitable

Income inequality is the current obsession of the Western left.  A lively debate is taking place over the causes, level, and consequences of the gap between rich and poor.  Missing from the debate, I think, is a realistic view of whether anything could actually be done about inequality.

The obsession over inequality is a form of nostalgia for an idealized past to which people believe we can return, but the truth is that "you can't go home again."  Unusual historical circumstances occasionally create societies with more equal income distributions than normal, most recently in the mid-20th century.  Absent the unusual circumstances that leveled incomes, inequality tends toward its natural level.

The circumstances that occasionally equalize incomes are related to disasters and the opening of new frontiers. 

When new lands become available, either by conquest or exploration, new settlers move in.  Settlers are usually not very wealthy, because wealthy people have too much to lose by moving.  The new settlers divide up the land, and for a time, the distribution of wealth and income is far more egalitarian than it was in the home country or region.  As the economy of the newly settled region develops, however, some people make fortunes and others don't, and so inequality eventually resembles what it was in the old country. 

Disasters often hit the rich harder than the poor, at least percentage-wise.  The actual level of hardship might be greater for the poor, but as Bob Dylan put it, "when you ain't got nothin', you got nothin' to lose."  Subsistence farmers who lose 10% of their income might starve, and wealthy people who lose 90% of their income might still live comfortably, but if both happen the distribution of income will be much more equal.

In the United States, we look back to frontier societies consisting of self-made farmers and ranchers without huge disparities of wealth.  In fact, colonial American society had a more equal distribution of income than modern-day America.  But the American frontier has been closed for over 100 years, and there is no going back. 

Americans also look back to the 1950s and 1960s as a time of greater income equality.  World wars and the Great Depression reduced the wealth and income of the rich much more than the poor, creating a temporary period of relative economic equality.  Unless the left wants war and depression to knock the rich off of their pedestals, inequality is probably here to stay.

Income inequality is inevitable because talents and abilities are unequally distributed.  Gregory Clark has shown that the rate of social mobility is remarkably slow under a wide range of circumstances, from Sweden to the U.K. to China. Even after the Cultural Revolution in China, for example, having a surname associated with the pre-revolution elite predicted high social status.

This morning I found data on ethnic diversity and income inequality by country.  Matching them up and running a regression of income inequality on ethnic, religious and language diversity, I found a statistically significant relationship between ethnic diversity and income inequality. (t-statistic=2.73)

The relationship between economic inequality and ethnic diversity could be caused by different levels of talent in different groups, or it could be caused by the largest group exercising political power to take resources away from smaller groups.  It is possible that as the ethnic balance changes in a country and power shifts that there will be a short period of time where income is relatively evenly distributed, but only because the society is moving from dominance of one group to another.

Some readers might think I am leaving out the effects of revolution.  The work of Crane Brinton, however, demonstrates that income inequality is not a sufficient condition for revolution, and that revolutions do not generally succeed in reordering societies.

The distribution of income and wealth might become more and more unequal, but there is nothing to be done about it, short of causing wars, depressions, or other disasters.  Taxes will be avoided and evaded.  We have reached the point of diminishing returns of additional education.  Regulatory schemes create additional complications that the wealthy are better able to exploit than the poor.

As Jesus said, "ye have the poor always with you."  A rising tide lifts all boats, but dinghys are still dinghys, and yachts are still yachts.  Better economic policies can make everyone wealthier, which is a good thing, but I don't think policy reform is capable of doing anything about inequality.

Saturday, September 27, 2014

How Productive were Mad Men?

Paul Krugman complained this week that executives are paid too much, and that things were better during the golden age of equality, the 1950s and 1960s.  He cites a 1955 Fortune Magazine article describing the diminished economic circumstances of executives compared to the days of far lower income tax rates.  Houses and yachts were smaller, servants fewer, and entertaining less lavish.

Krugman is right that after-tax executive pay has risen relative to worker pay.  His unstated assumption, however, is that executives were just as productive 50 years ago as they are now.  I think that executives worked much less during the 1950s and 1960s than they do now because they were paid less.  High taxes might reduce income inequality as Krugman wants, but talented people would be less productive, and everyone would be poorer as a result.

Below are a few quotations from that same Fortune article, referring to the lifestyles of top executives:
...he paces himself carefully. He plays golf and bridge, but really prefers dominoes noontimes at the Pacific Union Club.
On weekends they retire to a small house set in eighteen acres of orchards and wild land, fifty miles from the city, where the only company they have is their Weimaraner dog.
Cotton brokers, planters, merchants, bankers, drift out of their offices for mid-morning coffee, drive home for lunch, and get home again for dinner well before the sun has disappeared behind the levee. Weekends they play golf, fish for bream and channel cat, or stalk the country’s abundant game birds.
He gets home anywhere between four-thirty and six. “Then I take a coupla knocks,” he says, meaning a couple of highballs, “have dinner and fall into bed.”
No executive, twenty-five years ago, could whisk himself and his golf clubs 1,000 miles away just for a weekend. Today a New York executive can play weekend golf regularly all through the winter in Florida or Bermuda, and follow the season north through Georgia and North Carolina.
...those fellows in New York who have two cocktails before lunch and then can’t do anything the rest of the afternoon.
These do not sound like descriptions of today's executives.  To be fair, the Fortune article also describes some executives taking work home with them, but the overall picture doesn't compare to either the business lifestyle of pre-income tax Scrooge or the 24/7 work schedule enforced by smartphone.  Water is now served for business lunches, not martinis.  Golf courses at 2:00 are full of retirees, not executives.

Academic evidence on the price elasticity of labor supply for high income people often focusses on the effects of relatively small changes in tax rates over the past 20 years.  Researchers find that the effects of tax timing swamp the actual effects of taxes on labor supply, so estimates of labor supply elasticities are imprecise.  But when they compare times or countries with large differences in tax rates it is clear that high income people work more when they are paid more.  For example,
men in the high-skill household actually increase their hours of work after 1970, whereas men in the low-skill household decrease their hours of work.
An important paper by Nobel Prize winning economist Edward Prescott finds that differences in tax rates explain the difference in work hours between Europe and the U.S.  It is obvious to everyone except for left-leaning economists, but when smart people are well paid, they work harder.

Krugman doesn't really seem to care about overall economic well being.  Instead he is consumed with envy at the rich, who he calls vulgar show-offs. His view is just like that of Piketty, who I believe is more interested in taking down the rich than helping the poor.

Taxes are destructive weapons - people like Krugman and Piketty would love to fire them at the rich people they hate, regardless of the collateral damage.

Friday, September 19, 2014

War with ISIL

Last week President Obama, a former adjunct professor of constitutional law who ran for president as an anti-war candidate, declared war on something he called ISIL.

Obama claims that he has the authority to wage war against ISIL for two reasons: First, 13 years ago congress authorized President Bush to go to war against groups responsible for the attacks on 9/11/2001.  But ISIL had nothing to do with 9/11.  His second legal justification is that 12 years ago congress authorized Bush to go to war with Iraq.  But Obama has declared that Iraq war to be over, and has always opposed the original authorization.

Article 1, Section 8 of the US constitution gives congress the power to declare war, not the president.  The War Powers Act of 1973 allows the president to commit forces to a conflict, but he must notify congress within 48 hours, and then must receive congressional approval within 60 days, or he must withdraw within another 30 days.  Obama notified congress about a renewed war on Iraq on August 8, 2014, giving him until October 7 to obtain approval, otherwise he would need to withdraw by November 6.  The senate has apparently decided to wait until after the November 4 elections to begin debate on an authorization of the war.  Left and right agree that the war is illegal - the administration's arguments sound increasingly absurd, but they are getting away with them.

Just a year ago, Obama was ready to start bombing Syria, but he was stopped by a domestic political revolt and Russian diplomatic maneuvering.  It seems reasonable to assume that his administration did not give up, and spent a year waiting and working for a change in the political and diplomatic environment.  Now Russia is distracted by events in Ukraine, and a propaganda campaign has convinced American voters that military action in the region is needed.  As I described at the time, the US strategy is probably to prolong the civil war in Syria for as long as possible.  The Syrian government was winning, but now ISIL has given the US a reason to intervene and prolong the conflict.

Twelve years ago, as the US was preparing to invade Iraq, I thought it was a good idea.  The US, still fresh from its Cold War victory and having just easily overthrown the government of Afghanistan, seemed capable of anything.  After the previous great victory, in World War II, the US had remade Germany and Japan in its own image - why couldn't it do the same with Iraq? 

But as a guy in a barber chair next to me sometime in 2003 said, "We'll invade them no problem, but then the trouble will start."  Many of my friends who are smarter than I am turned against the war early.  75% of the country supported the war at its start, but by late 2005 more than 50% opposed the war, and now the country believes the war was a mistake 71% to 22%.  Some of the remaining supporters of the war simply hate to give in to the political party they oppose, while others believe the war was a noble venture regardless of the outcome. 

The past 12 years should have taught us that a Middle Eastern war will not end in victory, and will be very expensive in lives and money.  It will also probably be illegal under US and international law.  But I still wonder whether the apparent debacles of the post-WWII years; Korea, Vietnam, Afghanistan, Iraq, and Libya, might have a deeper logic to them.  The primary goal of US foreign policy is the security of the US, and the only other goal is the prosperity of the US.  It could be argued that the US is secure and prosperous, so someone must be doing something right, an argument I have made in more detail before.

But regardless of whether the war makes sense, it is clear that short of a popular revolution, we are stuck with militaristic US foreign policy.  If six years into the presidency of an anti-war candidate, with a large majority recognizing the folly of the last war, we are still stumbling from one war to another, it must be the case that making war is an inherent feature of the United States and that there is nothing that conventional politics can do about it.

Saturday, September 13, 2014

Scottish Independence

People in Scotland will vote on independence from the UK this week.  A referendum like this is supposed to express the "will of the people" on important issues, but it is good to remember that Kenneth Arrow proved more than 60 years ago that no voting system can coherently express the preferences of voters.  On Thursday there will be a result that everyone will have to live with, but we still won't know what "the people" really want.

The English political and social elite want to keep Scotland in the UK, because the bigger their country, the more prestige they will have in elite circles of the world.  Scottish elites are torn, because they wonder about whether being at the top of the Scottish pyramid might be more fun than being part of the second tier of UK society.  It is similar to the dilemma of American politicians - run for governor of a state, or for a seat in the US senate?  Politicians with different personalities and preferences make different choices.

Businesspeople always worry about change and risk, so business owners in both England and Scotland tend to oppose breaking up the UK.

Ordinary people who do not own businesses and have no political or social ambitions beyond their local communities derive pleasure from team membership.  In both England and Scotland, many of them have emotional ties to the flag of the UK, and would be genuinely sad to see it change.  A large number of ordinary Scots, however, feel a greater emotional connection to the Scottish flag than to the UK flag.  The extent of these feelings will determine the result of the referendum much more than the arguments of economists and political scientists.

In Scotland last year, my driver from Tongue was convinced that the vote would be yes, since he had never met a true Scotsman who didn't want independence.  A stuffier museum guide with an English accent was equally convinced that the vote would be no.  He told me that there was no chance of independence, and implied that Americans who asked the question had no idea of how silly the idea really was.

What would be the economic effects of Scottish independence?  It isn't clear whether an independent Scotland would be able to join the EU, but there are prosperous small countries outside the EU, such as Iceland, Norway, and Switzerland, and prosperous small counties inside the EU, such as Ireland, so it isn't obvious that EU membership matters a great deal.  Another important question is whether Scotland would share a currency with the UK or start their own currency.  It seems to me that Scotland could adopt the pound whether or not the UK approved, just as Ecuador, Panama and other countries use the US dollar as their currency, without ever receiving permission from the US.  Scotland might be better off with its own currency, but it wouldn't want to say so until it created it, so as not to create panic and flows of pounds out of the country.

The most important effects of independence might be political.  Scotland is poorer than England, and so tends to be more liberal politically.  If Scotland left the UK, the UK might move to the right and toward freer markets.  Scotland might experiment with higher taxes and a larger social welfare state, but any economic weakness that resulted might eventually lead them into free market experiments.  As part of the UK, Scotland tends to support a welfare state leading to more benefits paid in Scotland, but as an independent country it might have a different view.

Without Scotland, it might be difficult for the remaining UK to pretend to be a world power.  The nuclear deterrent, participation in foreign wars, the permanent seat on the Security Council, and worldwide diplomatic activity might all be abandoned.  This would save UK taxpayers a lot of money.

Finally, an independent Scotland would encourage separatist movements around the world, including, eventually, the (currently) United States of America.  This might be a good thing.   Wars appear to be random events that happen from time to time between states that interact with each other.  With more countries there will be more wars, but they will be small and geographically contained.  It was the large empires that developed during the 19th and 20th centuries that led to the gigantic wars of the 20th century.  Breakup of these empires has been taking place for the last 70 years, and it might take another 70 years for the process to be complete.  Scottish independence would be another step in that direction.

Overall, I think the effects of independence would be positive, although some people will be worse off and there will  be transition difficulties.  Even if independence narrowly fails, however, Scotland will be given additional autonomy, and will probably try another referendum sometime in the next decade. 

Sunday, September 7, 2014

Krugman Has a Point

Between political rants, Paul Krugman occasionally writes about economics.  When he does, he is obviously worth taking seriously.

His latest crusade is against what he calls "The Deflation Caucus."  Krugman believes in monetary expansion by the Federal Reserve, and attacks the
Pundits, politicians and plutocrats [who] have accused them [the Fed], over and over again, of “debasing” the dollar, and warned that soaring inflation is just around the corner.
Monetary expansion means electronically creating money to buy things, usually bonds.  The pundits, politicians and plutocrats Krugman attacks are now calling on the Fed to reverse course, sell what they have bought, and extinguish the new money.  Doing so would lower the price of bonds, raising interest rates.  They think this will head off future inflation, while Krugman believes it would initiate a deflationary spiral, resulting in an economic depression.

I disagree with Krugman about the effects of deflation itself and any virtues of inflation, but I agree with him that this is the wrong time for monetary contraction.  He is right that there is no evidence of accelerating wage and price inflation, and no evidence that financial market participants expect high inflation in the future.

Just this week I received a one page argument against monetary expansion from a salesman promoting an investment advisor that I think does a good job illustrating Krugman's criticisms.  The key sentence in the piece is:
If printing money actually created wealth, then we should allow every citizen to counterfeit their own money.
Suppose there is an optimal quantity of money in an economy in the same sense that there is an optimal quantity of hair ribbons, given the cost of production and demand.  Of course, if prices could be costlessly denominated in any multiple, then any "quantity" of money would suffice, since a single dollar could be distributed to everyone in trillionths, with prices adjusted accordingly.  But given the value of having prices quoted in familiar, stable units, it makes sense to say that too little or too much money in the economy can cause problems.  As the monopoly provider of money, government determines supply.  At the moment, it seems more likely that there is too little instead of too much money, so government can improve the economy (in other words, create wealth) by creating more of it.  Allowing a few people to counterfeit U.S. dollars would accomplish the same thing, but once started, that process would be hard to control, resulting in too much money.

The anti-expansionist also said this:
No monetary policy expert has argued that the US experienced the crisis of 2008 because the Fed was too tight.  And no one, with credentials, argues now that the US economy is growing too slowly because money is scarce.
The crash of '08 had many causes, but I don't think it is crazy to think that Fed tightness had something to do with it.  Here is a chart of the Federal Funds Rate from 2002 to 2014:

 
From the summer of '04 to the summer of '06 the Fed went from 1% to 5.3%.  This was the steepest hike since the late 1970s when the Fed deliberately triggered the recession of the early 1980s in order to reduce inflation.
 
My old boss at the Federal Reserve, Arturo Estrella, once wrote a paper showing that inverted yield curves are good predictors of recessions.  What causes inverted yield curves?  Fed tightening at the short end of the curve!
 
Moving to the second sentence of the previous quote, is it possible that the economy is now growing so slowly because money is scarce?  I think so - I meet a lot of people who have a much harder time borrowing now than they did 10 years ago.  According to Larry Summers, the reason for the slowdown is that the intersection of supply and demand for loans is at a negative interest rate.  Since rates must be positive (otherwise people would hold cash instead of lending it) the economy is stuck.  I don't quite agree with this argument, but it is an example of a "credentialed" economist claiming that scarce money is holding back growth.
 
So I agree with Krugman that the sky-is-falling inflation hawk crowd is wrong, and that Fed tightening now would likely cause an unnecessary recession.  I also think his discussion of the motivations of tight money advocates is interesting.   
 
I think that my major disagreement with Krugman is over "austerity" in government spending.  If the federal government cut spending and cut taxes by the same amount, I think there would be a positive economic effect, because I think that distortions caused by taxation are much larger than Krugman  seems to think they are.  I also worry more about the unsustainability of federal government debt than Krugman does.  I think there is a fairly low ceiling on potential federal tax revenue, for both economic and political reasons.  Krugman might agree, but would put the blame on Republicans who won't raise taxes.  But if Republicans are here to stay, piling up debt that won't be repaid is a big mistake.