Saturday, February 28, 2015

Pointless Regulation

A recent issue of the American Economic Review contains a great example of pointless regulation.  The paper, Cellular Service Demand: Biased Beliefs, Learning, and Bill Shock, by Michael Grubb and Matthew Osborne, begins with a statement from President Obama:
Far too many Americans know what it’s like to open up their cell-phone bill and be shocked by hundreds or even thousands of dollars in unexpected fees and charges.  But we can put an end to that with a simple step:  an alert warning consumers that they’re about to hit their limit before fees and charges add up. Our phones shouldn’t cost us more than the monthly rent or mortgage.
The Obama administration, threatening to impose regulations, reached an agreement with mobile phone companies under which they would inform consumers when they approach their voice, text and data limits.  This agreement is why you now receive annoying texts from your service provider - I count 23 from my provider over the past 6 months.

How could anyone argue with something as consumer friendly as this?  Particularly since it only provides information?  More information is always good, right?  Not really.  Grubb and Osborne show that firms can change their pricing plans to take account of consumer reactions to the new information, and that overall consumer welfare will be lower than before the new information was provided. Phone company profits would be unchanged.

Politicians want voters to think that they are addressing the problems of ordinary people, like high phone bills.  Anything they do, however, only makes things worse.  Economists read about it in the AER, but voters only hear the speeches and campaign commercials and are fooled over and over.

Monday, February 23, 2015

Capital Confusion

Today's column by Paul Krugman dips into some interesting issues.  I agree with Krugman that efforts to educate more people will not improve the employment situation, although my reasons for thinking so are different from his.  But this paragraph puzzled me:
Corporate profits have soared as a share of national income, but there is no sign of a rise in the rate of return on investment.  How is that possible?  Well, it's what you would expect if rising profits reflect monopoly power rather than returns to capital.
This isn't explained very well, probably because Krugman has limited space in his column. The column was prompted by comments made by Larry Summers, some of which were transcribed here.  Summers said:
you tend to think record high profits would mean record high returns to capital, would also mean really high interest rates. And what we actually have is really low real interest rates. The way to think about that is there's a lot of rents in what we're calling profits that don't really represent a return to investment, but represent a rent.
Summers is apparently saying that companies earning record profits are essentially stealing money from labor or consumers, which doesn't increase overall demand for capital, which means that interest rates stay low.  Productive investment, by contrast, makes everyone richer, raising demand for all types of capital, raising interest rates.  Krugman's statement that there is "no sign of a rise in the rate of return on investment" isn't quite right, because investments in whatever generates rents would show high rates of return.  But if he means interest rates, then there is some logic to the story.

But there are other reasons why interest rates might be low, even if companies are making productive investments.  The investments might be risky, resulting in a large risk premium for rates of return on capital over returns on lower risk bonds or government securities.  Investors might be very risk averse (still skittish from the crash), resulting in high risk premiums. Or the Federal Reserve might be buying up bonds, driving down interest rates relative to rates of return on equity capital.

Krugman jumps to the conclusion that corporate monopoly power has risen, but I don't think there is any credible evidence to support the hypothesis.  As I wrote here, and as a recent paper* shows, monopoly power measured by industrial concentration has, if anything, declined over the past several decades.  He then jumps further, claiming that "a tiny group of individuals holding strategic positions" is getting "all the big gains."

The big story is the leaps of logic Krugman makes to get to his preferred conclusions.  A smaller, but still interesting story is his use of the word "capital."  I use the word to mean resources of any kind that anyone uses to produce future consumption.  Krugman seems to resist using the term to describe assets that produce rents, as opposed to assets that are genuinely productive.  He also hates the use of the term "human capital." Why?  Of course he is right that labor is different than factories, but the genius represented by the term "human capital" is the recognition that they have certain things in common.  Sensitivity about the use of the term "capital" seems to me to indicate extreme ideological preferences, and a soft spot for Marxist thinking.

*Joshua Drucker, "Regional Industrial Structure Concentration in the United States: Trends and Implications," Economic Geography, October 2011, v. 87, iss. 4, pp. 421-52.

Friday, February 20, 2015

Libya's Unraveling

Last Sunday's New York Times editorial is a good illustration of what can go wrong with the thinking behind U.S. foreign policy. The editorial is correct about how bad things are in Libya, but it makes no mention of U.S. responsibility for contributing to the mess.

Four years ago, during the U.S. "led from behind" military campaign to overthrow Libya's government, a Times editorial criticized Republicans for considering "bailing out" of the operation, arguing that Qaddafi had to be removed from power because "We are certain if NATO had not intervened, thousands more Libyans would have been slaughtered."

The New York Times is a window into the thinking of the U.S. policy making elite.  In 2011 they were caught up in the excitement of the "Arab Spring," cheering on protests in Egypt, which inspired protests in Libya.  The Libyan government cracked down, leading the Times to encourage the U.S. to support a revolution.

In 2010 my family and I almost traveled to Libya.  Tour companies were just beginning to offer trips there, because the country seemed safe and stable.  We ended up going to Morocco instead, but hoped to see Libya another year.  The murder rate in Libya was the second lowest in North Africa, and the standard of living was high for the region.

The revolution enabled by the U.S. has resulted in thousands of deaths, certainly more than would have died in a government suppression of the revolt, and hundreds are still being killed every month.  The economy is in shambles.  Destroying a government that the West was able to work with has opened opportunities for ISIS and other groups that are unalterably opposed to the West.

Instead of calling for the UN to "redouble efforts" in Libya, the Times should admit that the 2011 intervention was a mistake. Perhaps the U.S. should have saved up its intervention capital for a situation where it is really needed, such as Ukraine.

Saturday, February 14, 2015

Killing Russians

In the late 1970s, National Security Advisor Zbigniew Brzezinski was being briefed on nuclear war plans against the Soviet Union:
Brzezinski asked the question: “Where are the criteria for killing Russians?" The briefer misunderstood the thrust of the question and replied that a nuclear barrage against Soviet industrial centers would kill roughly 113,000,000 people. Brzezinski retorted, “No, no, I mean Russian Russians.” To Brzezinski the ethnic Russians bore the responsibility for the Cold War because they were the core group within the Soviet Union.  This was the group you had to "deter," or, if it came to war, kill.  The briefer “felt that he was listening to the voice of 600 years of Polish history.” Robert C. Grogin, Natural Enemies: The United States and the Soviet Union in the Cold War, p. 296
Although on a far smaller scale, something similar is going on today.  A recent New York Times story based on high-level sources, including Hilary Clinton's probable pick for defense secretary, makes it clear that the U.S. wants to kill Russians in order to convince Putin to withdraw from Ukraine. 

The story notes that the issue of Russian casualties in Ukraine is "delicate" because, officially, Russia is not intervening there.  Funerals are held in secret, and families are told that their sons died in training accidents.  If the cease fire fails, the U.S. has contingency plans to exploit the potential for unrest over casualties by causing more of them with Javelin anti-tank missiles.

Saturday, February 7, 2015

Excess Government

Last month I was in Nicaragua, a fascinating country.  While I was there I thought about something I will call "excess government."  I start by assuming that the most basic need of a society is order - meaning that people feel safe in their homes and businesses, and while walking the streets.  Once there is order, people will find ways to feed, clothe, house and entertain themselves.  Government should be strong enough to ensure order, but no bigger.  In some countries, the optimal size of government might be zero, but others might require tyrannical dictatorship.

Societies differ in their natural tendency toward disorder and civil war.  The greater the tendency toward disorder, the more beneficial a strong central government can be.  Libya is perhaps the best recent example of a country that might have required a strong, perhaps even tyrannical government.  When that government was destroyed, chaos ensued.

Nicaragua is an interesting case.  I was told by senior officials there that it is the safest country in Central America.  (They claimed that Costa Rica falsifies its numbers to placate tourists. I need to learn more about Costa Rica)  According to available statistics, of the 11 countries that are within 500 miles of Nicaragua, only two have murder rates lower than Nicaragua's; Cuba, whose central government is even stronger than Nicaragua's, and Costa Rica.  Even the Cayman Islands report a higher murder rate than Nicaragua.

Given the neighborhood and Nicaragua's history of civil war and revolution, the level of social disorder would probably be much higher without the strong hand of the Sandinista government.  Perhaps there is no "excess government" there at all.

The graph above shows government strength on the vertical axis, and the country's background, exogenous risk of civil disorder on the horizontal axis.  The green line shows the optimal strength of government given the risk of civil disorder.

many European countries are stable enough to do well with no government at all - the U.S., with a slightly higher risk of disorder, could manage with very limited government.  Both have significant excess government.  North Korea has the most excess government, while Libya currently has too little central government.  China has a high risk of disorder, but still has too much government.  Nicaragua and Russia have the right level of government given the risks.

I am, of course, only guessing at the positions of the countries in the chart, but I think there are objective ways that could be used to measure the risk of civil disorder and the strength of government.  A line fitted to the points might be a way to guess at the optimal tradeoff, and vertical deviation from the line would be a reasonable measure of excess government.

By labeling strong governments as optimal, I don't mean to suggest that big government is costless. Strong governments mean high taxes which distort and reduce economic activity, and they reduce personal freedom, which has intrinsic value.  In addition, strong governments are inevitably corrupt, and extract wealth from the private economy.

But chaotic violence is even more costly than big government.  I still believe that the ideal human society would have no government, but there are very few countries in the world that are ready for it.

Saturday, January 31, 2015

New Cold War?

Another session I attended at the ASSA meetings in Boston was titled "Avoiding a New Cold War."

Probably the most interesting point made in the session was the low priority the Obama administration has given to nuclear arms control.  Presidents Bush I and Bush II reduced the U.S. stockpile by around 14,000, while President Obama has reduced it by around 500.  Even more interesting is the fact that Obama is spending tens of billions of dollars to upgrade nuclear weapons, and plans to spend $355 billion on modernization over the next decade.  At the same time he is cutting his request for funds to support non-proliferation, and it is possible that his modernization program violates the existing non-proliferation treaty.

The speakers argued that Russia is weak and relatively unimportant to the U.S., so a new cold war would be foolish.  They also suggested that Americans might not realize how provocative NATO expansion and U.S. alliances with Ukraine appear to Russians.  One speaker also suggested that it was the nuclear freeze movement of the 1980s that saved the world from cataclysm. 

The speakers were prominent academics, politicians and journalists, but either they have no clue about how the U.S. really operates, or they were being disingenuous. 

The goal of the United States is the elimination of Russia as a potential threat to American security, a goal that has not changed since the end of World War II, and really dates back to the Russian Revolution.  Russia was weakened by the breakup of the USSR, but a breakup of the Russian Federation would weaken them even more, and the U.S. defense establishment believes that this would enhance U.S. security.  The only important exception is Russia's role as a counterweight to China, but I think the U.S. would prefer an alliance of small nations encircling China to a powerful Russia that might someday ally with China.

To the U.S., Russian weakness is an opportunity to finish them off for good, not a reason to disarm and sing Kumbaya.

Once this fact is understood, it is no mystery why the U.S. has supported westernization in Ukraine and is modernizing its nuclear arsenal.  The U.S. view is that the nuclear freeze movement almost snatched defeat from the jaws of victory in the 1980s, since it was the Soviet attempt to compete with the U.S. arms buildup that bankrupted them.

During the 1950s many people would have assumed that the speakers were secretly loyal to the Russians.  Today that seems unlikely, and so I think the establishment simply assumes that people like this are just na├»ve. 

Great powers behave in predictable ways.  In particular, they identify threats and attempt to eliminate them.  The Roman Senator Cato the Elder supposedly ended every speech with the phrase "Carthage must be destroyed!"  America and Russia both believe they are the new Rome, and one of them will probably end up like Carthage, which I visited many years ago.  From Wikipedia:
The Romans pulled the Phoenician warships out into the harbour and burned them before the city, and went from house to house, capturing and enslaving the people. Fifty thousand Carthaginians were sold into slavery. The city was set ablaze and razed to the ground, leaving only ruins and rubble. ...The legend that the city was sown with salt remains widely accepted despite lacking evidence among ancient historical accounts.

...The historical study of Carthage is problematic. Because its culture and records were destroyed by the Romans at the end of the Third Punic War, very few primary Carthaginian historical sources survived.

Saturday, January 17, 2015

Madness of Economists

According to the secular stagnation hypothesis, equilibrium real interest rates are negative.  Since anyone with cash can hold it in a bank account or as currency at a 0% return, the savings and investment market cannot clear, and many investment projects that savers would otherwise fund and investors would undertake will not happen.

I have written before about why I think this is wrong, but what struck me at the ASSA meetings in Boston earlier this month was the amazing things some economists are willing to consider to deal with this supposed problem.

 To believers in the stagnation hypothesis, the problem is that cash earns at least a 0% return.  They would like to fix this by eliminating currency and forcing everyone to keep all of their money in bank accounts, where it could be taxed (by the bank or the government), creating a negative interest rate for savers.

I heard Kenneth Rogoff make this suggestion, and in another session I heard Greg Mankiw suggest requiring that money be stamped every year to remain valid.  A fee could be charged for the stamp, creating in effect a negative interest rate.  Both Rogoff and Mankiw are considered conservatives.

Another way to put this is that losses on cash holdings would make savers more willing to invest their money instead of holding it in bank accounts or currency.

When famous economists say things in public, there is a chance that someone will take them seriously and actually implement their ideas, so I think it is worth thinking through the consequences.

The most obvious effect of a currency crackdown would be capital flight out of the U.S.  Savers would move money out of the country and convert it into foreign currency that had a high likelihood of at least maintaining its nominal value. The value of the dollar would fall.

The second effect would be a reduction in the size of the underground economy.  I have written about the underground economy before - probably somewhere between 10% and 20% of the U.S. economy is underground, and conducted using paper currency. 

My guess is that currency elimination advocates would see a reduction in the size of the underground economy as a feature, not a bug. Politicians and government bureaucrats see little value in economic activity that they cannot tax.  But the underground economy keeps a lot of people fed, and I believe that it has large multiplier effects.  Eliminating cash would eliminate a lot of shadow jobs, and many newly unemployed people would end up on public assistance.

A third effect, which might not be so bad, would be the emergence of private alternatives to government-issued cash.  Bitcoin and gold would be big winners.  Merchants would expand their gift card offerings, which could function as zero interest cash.  Eventually these alternatives might replace dollars for everything except payment of taxes.

Actually, I might have just talked myself into supporting the elimination of paper dollars - the private alternatives that would spring up might result in huge net benefits!  Maybe that reasoning makes me one of the mad economists.