More on Martin Feldstein

ProGrowth Liberal just posted interesting information about Martin Feldstein on Social Security. Here is an extract from my new book, The Confiscation of American Prosperity, regarding Feldstein's obsession with the subject.

Feldstein first came to national attention in 1974, the same year that Arthur Laffer produced his famous napkin. Feldstein published a model that "proved" that Social Security caused enormous losses for the US economy. According to Feldstein, Social Security was reducing personal savings by 30 to 50 percent. He estimated that if Social Security had not existed, the stock of plant and equipment in the United States would have been as much as 50 percent larger and total personal income 20 percent greater than the level in 1971 (Feldstein 1974). Since Social Security had only been functioning 24 years at the end of the time period that his data covered, Feldstein's article implies that the present effect of Social Security on total personal income today would be far higher ‑‑ perhaps almost 50 percent since the program has had another 35 years at the time of this writing.

The same Jude Wanniski, who popularized supply side economics, later recalled, "I came across a paper that a fellow at Harvard had written on Social Security, saying it was causing the national saving rate to decrease. And I thought, 'Great .... I've got to publish it'" (Bernasek 2004). In other words, because Feldstein's results were welcome, people of influence rushed to embrace him.

The only problem was that Feldstein's work was seriously flawed. A few weeks before the election of Ronald Reagan at the 1980 annual meeting of the American Economic Association in Denver and after Feldstein had already ascended to the head of the National Bureau of Economic Research, two less famous economists, Selig D. Lesnoy and Dean R. Leimer, reported that they were unable to replicate Feldstein's results (later published as Leimer and Lesnoy 1982). Upon analyzing Feldstein's work, they discovered that his results critically depended upon an elementary programming error. With that error corrected, Feldstein's data no longer had the disastrous effects Feldstein claimed. Instead, his model showed that Social Security could have actually had a positive impact on savings.

In all fairness, errors in economic model building are extremely common. In 1982, the Journal of Money, Credit, and Banking began a project to replicate previously published articles. The results were unsettling to say the least. Sixty‑six percent of the authors were unable or unwilling to supply the materials necessary to rerun the model. The authors who responded did so after an average delay of 217 days. All but one of these articles had problems, including programming errors, such as Feldstein committed (Dewald, Thursby and Anderson 1986). This project was hardly likely to inspire confidence in the scientific rigor of economics.

Feldstein admitted his programming error. Undeterred, he soon rejiggled his model. By adding a few new assumptions, he was able to "prove" once again that Social Security was still destructive. Some years later, in 1996, Feldstein gave his own Richard T. Ely lecture. There, Feldstein regaled his audience with new data demonstrating one more time the harmful effects of Social Security. According to Feldstein, the present value of privatizing Social Security would be an astounding $20 trillion dollars ‑‑ about twice the GDP of the United States (Feldstein 1996, p. 12).

In a 2005 Wall Street Journal opinion piece, disingenuously entitled, "Saving Social Security," Feldstein returned once more to his bête noire. This time he was arguing in support of an unpopular piece of Republican legislation to mix Security and private accounts. Feldstein promised great benefits from this "reform": "A higher national saving rate would finance investment in plant and equipment that raises productivity and produces the extra national income to finance future retiree benefits" (Feldstein 2005b). So, Feldstein would rescue Social Security by gutting it.

Earlier in the year, the American Economic Association had given Feldstein a platform to renew his attack on Social Security in his presidential address. Here Feldstein adopted a new pitch. He protested that the program did too little to redistribute income from the rich to the poor. His argument was that because the rich live longer than the poor, they will have more opportunity to benefit from Social Security (Feldstein 2005a).

Without bothering to contest Feldstein's questionable calculations about the redistributional impact of Social Security, this last attack is especially notable for its unusual rhetorical turn. Not too long ago, the same Professor Feldstein discussed the question of inequality with the New York Times. Feldstein began as if he took the subject seriously, observing, "Why there has been increasing inequality in this country has been one of the big puzzles in our field and has absorbed a lot of intellectual effort." Feldstein's own intellectual effort in this debate left something to be desired. Rather than address the question of inequality seriously, he merely trivialized the question, responding to the reporter: "But if you ask me whether we should worry about the fact that some people on Wall Street and basketball players are making a lot of money, I say no" (Stille 2001).

This dismissal of the question of inequality was not some uncharacteristic, off‑hand remark. In an earlier article, entitled, "Reducing Poverty Not Inequality," Feldstein described the proper approach to an imagined increase in inequality occurring because a small number of affluent people received $1000 each at no cost to the rest of society. For Feldstein, only a "spiteful egalitarian" would not welcome such an improvement in society (Feldstein 1999, p. 34).

Of course, Feldstein and his fellow 'spiteful inegalitarians' have been adamant in their hostility to any redistribution of income toward the less fortunate. Such policies threaten to hinder the magical trickle down upon which all progress supposedly defends. Suddenly, however, when it gave credence to his attack on Social Security, Professor Feldstein refurbished himself as a populist advocate of redistribution of income from the rich to the poor by arguing that Social Security benefited the rich. Professor Feldstein never bothered to explain why the rich are so hostile to this program that benefits them so lavishly.

One might expect such a flurry of conflicting arguments from an unscrupulous salesman who wants to earn his commission from a confused customer, but not from one of the most prominent academic economists in the country. One might suspect that ideology rather than an objective search for the truth is at work.

Feldstein did not limit his political activism to Social Security. For example, he used the Wall Street Journal to publicize his work predicting that Clinton's economic taxes would harm the economy while raising little revenue (Feldstein 1993). Unlike his Social Security work, this article made a specific prediction. Unfortunately for Feldstein, his estimates turned out to be demonstrably false. The economy experienced a sudden burst of prosperity during the rest of the Clinton administration.

Alicia H. Munnell, a former student of Feldstein whom he thanked in the acknowledgements to his original Social Security paper and who later rose to become a member of the President's Council of Economic Advisers and Assistant Secretary of the Treasury for Economic Policy, offered this damning verdict in a Business Week article following the Denver meeting: "I get the feeling that the NBER does adopt a position on an issue ‑‑ explicit or implicit ‑‑ and then they go about generating research to support the position" (Anon. 1980). In light of Feldstein's later work, I see no reason to revise her evaluation.

Even if an economist avoids rudimentary programming errors and questionable procedures in handling the data, problems with economic models still remain. The economy is far too complex to reduce it to a mathematical equation or a computer model, even a very large and sophisticated one. As a result, such models necessarily rely on simplifying assumptions.

Although Feldstein proved nothing with his unrelenting attacks on government programs, he demonstrated how clever economists, armed with sophisticated mathematical and statistical techniques, along with the help of well‑trained graduate assistants, are capable of manipulating models to get whatever results they desire. As economists like to joke, that if you torture the data long enough they will confess. So, although economists such as Feldstein can give their work the appearance of scientific precision, their work must necessarily remain suspect.

For example, Social Security's presumably negative effect on saving was at the core of Feldstein's model, but saving has a contradictory effect on the economy. Some models assume that saving encourages investment, while others assume that saving depresses demand, which, in turn, holds back investment. No matter which assumption about the effect of saving economists choose, they can point to reputable theories and models that support them. Admittedly, as economists marginalized Keynesian theory, the models that show the positive influence of saving have become more common. That shift does not reflect an advance in knowledge, but rather a consequence of the right‑wing offensive.

Also, economists can pick and choose among various time periods and data sets, avoiding combinations that do not confirm what they want to find. While such models ‑‑ including many of the models to which I have referred in this book ‑‑ might suggest new lines of research or raise questions about previously accepted truths, they cannot constitute proof by any means.

So, economists may build their models and pundits or politicians can foist the results of these models on the unsuspecting public as if they were scientific evidence, but they are not grounded in science. For example, almost two decades after the errors in Feldstein's original model had been revealed, conservative ideologists, such as those at the Heritage Foundation, still continue to trumpet his long‑discredited calculation as serious evidence of the damage done by Social Security (see, for example, Mitchell 1998).

I believe that Social Security is one of the most effective government programs ever devised in the United States, but I can neither prove nor disprove that assertion with a computer model. In fact, Feldstein's results might possibly turn out to be correct after all, but nobody can know for certain. Different economists have come up with a wide range of estimates (see Lesnoy and Leimer 1985).

Unfortunately, the public rarely has the opportunity to hear about the full range of economic information. Ideological filters determine who gets hired or tenured in economics departments. Those economists who manage to defy the conventional wisdom face the added barrier of getting their work published in "reputable" journals. Even if such papers manage to find their way into journals, they lack the "megaphone" of powerful agencies, such as the Heritage Foundation, which give wide distribution to long‑discredited material without much fear of being exposed. So, ultimately what the public learns about how the economy works are those results that conform to the desires of the rich and powerful.

Martin Feldstein on Social Security

Via Mark Thoma comes an op-ed by Martin Feldstein. Mark focuses on this:

As everyone now recognizes, the current 12.4% Social Security employer-employee payroll tax will not be enough to finance the benefits specified in current law as the population ages. Continuing to finance those benefits with a pure tax-financed system would require raising the payroll tax rate to more than 18%, or finding other ways to raise tax revenue.

Mark rebuts by turning the microphone over to Dean Baker:

The Congressional Budget Office's projections show that the program can pay all benefits, with no changes whatsoever, through the year 2046... The projected shortfall over the whole 75-year planning period is 0.4 percent of GDP, approximately 30 percent of the current cost of the war in Iraq

Besides playing the shock figure nonsense, Martin Feldstein peddles the free lunch fallacy of privatization so let me focus on this:

Unfortunately, Democratic critics argued that individual accounts would be "gambling" with the retirement savings of working men and women.

I never bought into this increased risk argument, but the flip side of the same coin is that we should not false claim there is some overall increase in expected returns as I tried to explain here by quoting Andrew Abel:

Some economists have argued that investing part of the Social Security Trust Fund in equity is simply a rearrangement of paper assets without any real allocational effects, and they have described such a policy as a “shell game.” The shell game argument is similar to the Ricardian equivalence proposition in public finance and macroeconomics and the Modigliani-Miller theorem in corporate finance. The argumentis that private investors will react to any rearrangement of the social security system’s portfolio in a way that completely neutralizes the effect of the portfolio change. For example, if the social security system sells a dollar of bonds and purchases a dollar of equity, private investors would buy a dollar of bonds and sell a dollar of equity.

Robert Barro and Gary Becker have made similar arguments. So why does Martin Feldstein think that this argument is incorrect?

A Different Cost of Securitization

This article shows how securitization has enriched middlemen, while impoverishing lenders. The difference between mortgage rates and Treasury rates is now more than a half percentage point higher than in 1972-8.

Silva, Lauren and Martin Hutchinson. 2007. "The Cost of Complexity." Wall Street Journal (6 September): p. C 14.

"Well, one defense of all the complexity would be that it saved home buyers money -- but that doesn't seem to be the case. It looks like borrowers now pay more for this financial technology. Between 1972 and 1978, in the days when banks offered mortgages to their customers and held the loans, the average mortgage interest rate was 1.07 percentage points higher than Treasury bonds, according to Fed figures. Between 2000 and 2006, when most mortgages were securitized, the spread was 1.59. The figures don't include more expensive subprime loans. One-half percentage point is a big number in debt markets."

"While home buyers may wonder if they are getting their money's worth, financial institutions probably have no so such qualms about the change in the home-lending business over the past 30 years. Mortgage securitization, despite the slide in the subprime sector, has made Wall Street a lot of money."

Taxes and Employment Growth: How Stupid is Rudy Giuliani?

James Pethokoukis interviewed Rudy right after the “tax summit” in Manchester, N.H.

The Democrats are going to say, "We raised taxes in the '90s, cut the deficit, and the economy boomed." Why not try and rerun the '90s instead of cutting taxes? Because we have actually done more job creation by lowering taxes than by raising taxes.

Really? See this post including the second update with Paul Krugman’s comments. Rudy continues:

The federal government is collecting 21 percent more revenues from the lower taxes than the higher taxes. And when they argue with me about this, most of them are arguing about theory - meaning the Democrats. They've never done it. They've sat in a legislature somewhere and debated. I actually did it. I actually did what I'm talking about. I'm not talking about this from the point of view of theory. I actually did it. I lowered taxes at a time in which we were in economic distress … The Kennedy tax cuts led to the same results of the Reagan tax cuts and the Bush tax cuts. One of the worse tax increases in the history of this country was by Herbert Hoover. They all got frightened with the stock market crash. Taxes got raised, tariffs got raised, and they took what could have been a cyclical problem and turned it into a long, 10-, 12-year problem.

I see Rudy is taking credit for the Clinton boom again. Tax rate cuts leading to more tax revenues - what a complete and utter idiot. Of course, Pethokoukis never challenged this complete and utter horseshit as he rather let Rudy babble some meaningless spin about cutting spending. Rudy notes some government employees will retire, which will likely mean their jobs will have to be filled with someone else. There was not a single serious discussion of what programs would be cut. And not a real follow-up question from Pethokoukis.

I do have a thank you for James Pethokoukis. You had the decency to stop emailing me these utterly worthless pieces of yours. Now if you’d cease from submitting them to U.S. News – maybe they’d hire a real business reporter.

Watch This

The Saturday/Sunday Wall Street Journal for October 6-7 has a special 11 page advertising section for collecting and investing in luxury watches. According to

Frank, Robert. 2007. Richistan: A Journey Through the American Wealth Boom and the Lives of the New Rich (New York: Crown): p. 143: A top of the line Franck Muller watch costs $736,000.

It must be very difficult for somebody earning tens of millions of dollars to figure out what to do with it.

House Democrats on Carbon Controls: Hold the Applause

The House Energy and Commerce Committee just issued a White Paper on carbon controls. To its credit, the report makes a reasonable case for the advantage of using permits rather than taxes as the starting point, but everything else is up in the air. It talks about a target of either 60% or 80% reduction by 2050, when the steeper cut represents the minimum acceptable amount if we are serious about stabilizing at less than 550 ppm. It meanders a bit in its discussion over where the permits should be applied, when the only feasible approach is one that goes after carbon at its point of entry into the economy. And worst of all, it speaks vaguely of “distributing” permits without even raising the possibility that they should be auctioned. It would be interesting to know whether the Democratic policy staff is simply slow to pick up on the ideas the rest of the country is talking about, or whether they think the best chance of surviving an election year is to keep their climate change plans as fuzzy as possible.

The September Employment Report

When Kash was an Angrybear, he would update us as to the latest from the Bureau of Labor Statistics. I would often tag along with something on the household survey with a graph of the employment-population ratio to remind folks that the rightwing spin on the allegedly amazing growth of employment per the household survey had to be put in context of how that compared to the growth in population. I started also adding the labor force participation rate to remind these rightwing idiots that declines in the unemployment rate could comes from a decline in the labor force participation rate. This morning, the tradition continues over at Angrybear with news from September that was a bit better than the news from August. Note, however, an employment-population rate of 62.9 percent is still far below the employment-population rate that we observed in the late 1990’s.

HAPPY SPUTNIK DAY!

by the Sandwichman

Welcome to the future:

Hurtling unseen, hundreds of miles from the earth, a polished metal sphere the size of a beach ball passed over the world's continents and oceans one day last week. -- Time, October 14, 1957

The true picture of the past flits by. The past can be seized only as an image which flashes up at an instant when it can be recognized and is never seen again. -- Walter Benjamin

Meanwhile, technology is speeding up communication's stepchild, the mails. Guided missles loaded with letters instead of war heads are being planned for the distant future. After their successful launching and arrival, new sorting systems now in use will still be indispensible. -- Life, November 11, 1957

But as for rocket mail, remember what they said in London about the V-2: if you heard it coming, you were safe (because the rocket traveled faster than its propaganda). -- Brad McCormick, September 14, 1996

The word 'automation' so new to the English vocabulary that it can't be found in last year's dictionary, is causing a stir in the business world. A shorter workweek is union labor's answer to the new machines. The big trend to automation in factories has leaders talking in terms of 30 to 32 hours -- four days of work instead of five. US News and World Report, October 28, 1955

Do you really want a four-day week? The whole question may be decided not by workers but by their wives. "Do you think," one psychiatrist asked Parade, "that American women can stand to have their husbands underfoot three days in a row?" -- Parade, October 13, 1957

Has Mark Thoma Sipped from the Supply-side Kool Aid?

Mark Thoma features the Iraq War surtax proposal endorsed by James McGovern. As a member of the deficit hawk wing of the Democratic Party, I like this idea. Mark objects:

While it's certainly true that someone will have to pay for the war at some point - somebody, someday, somewhere will have to give up something to pay the bills - raising taxes right now is not good short-run economic policy given the current weakness in the economy. Driving the economy into a recession would show sacrifice, but that's not the best way to show our support.

If this had been written by someone in the White House, I’d expect Mark to actually mock this suggestion. But this is Mark making the statement and as much as I respect his insights on these matters, it’s my turn to do some mocking. Sure we have seen some recent weakness in aggregate demand growth. But is an increase in national savings necessarily recessionary? Has easy monetary policy lost all of its potency? After all, lower interest rates could encourage more investment as well as even more dollar devaluation with its encouragement of more net exports.

Absurd Interpretation of Fairness

This article condemns Radiohead for ripping off consumers by allowing them to pay what they think is appropriate to download the group's new album. Apparently, some consumer might pay Radiohead money that should rightfully go to the major labels. Read this and laugh.

"Will Radiohead leave fans high and dry? It may sound preposterous to accuse the British rockers of gouging their followers. The band is letting them decide how much to pay for a downloaded version of new album "In Rainbows." But early indications suggest that Radiohead's loyal followers are paying too much for the band's seventh disc."

"According to a poll conducted by United Kingdom music magazine NME, the average fan appears to be willing to pay $10 for a digital copy. Now, that may not sound like a blow out. It's the going price for most records on Apple's iTunes. And that price, in turn, looks to be about right for a digitally downloaded album."

"Consider the economics of the average CD. It retails for about $16 and costs about $6.40 to manufacture, distribute and sell in a store, research outfit Almighty Institute of Music Retail says. These costs are essentially zero when music is sold online. That's why iTunes can charge roughly $10 for a downloaded album."

"Radiohead's fitter, happier approach slices out even more cost. The band pulled the ripcord on EMI, so it doesn't have to share profits or help pay the label's overhead. As a well-known band it's also able to take the knives out on marketing and promotion costs, cutting these by as much as two-thirds. Subtract these expenses and Radiohead may be able to distribute an album for as little as $3.40 a copy."

"Now, fans may be delighted to pay $10 because they think the album is

so good and Radiohead deserves the extra cash. But Radiohead prides

itself on its anticorporate and anti-materialistic ethos. To avoid letting down fans, it might be more productive to adopt a no-surprises policy and fix a simple, fair charge for its record."

Cyran, Robert, Rob Cox and Mike Verdi. 2007. "What Price a Download? Given the Option to Name Their Own Price for Album, Radiohead Fans Overspend." (3 October): p. C 14.

http://online.wsj.com/article/SB119136863867147050.html?mod=googlenews_wsj

Heterodoc Speaks

from INSIDE HIGHER EDUCATION, 10/3/07, by Andy Guess:

>That label ["heterodox"] is sometimes reserved for a coterie of economists who go further, rejecting even some of the basic founding principles of economics. Sequestered in departments at the University of Notre Dame, the New School and others, the heterodox economists often complain that they aren’t respected in the field and are systematically kept out of mainstream debates. Most find it difficult to publish in mainstream journals or present at major conferences.

> “It’s kind of like the third parties in politics,” said James Devine, a professor at Loyola Marymount University who describes his approach as within the heterodox tradition.

>But, as with any vaguely defined term, “heterodox” can be used to mean anything. It’s “an ambiguous term,” Gordon said. “What’s heterodox changes over time,” said Avinash K. Dixit, at Princeton, who is the president-elect of the AEA. Sure enough, the Association for Heterodox Economics lists researchers who approach the discipline from an Austrian perspective — like some at George Mason.

>“Very conservative people can be heterodox,” added Devine, whose areas of interest include labor economics and Marxian political economy. “We’re basically seen as consumers. That’s the dominant [view] and I don’t think that’s going away in the near future, but there is some change, an opening, towards heterodox views, and that comes mostly from experimental economics and behavioral economics,” he said.

>As Devine sees it, the neoclassical model that dominates economics has a subset — laissez-faire market economics — that he calls “more of a political commitment” than a scholarly consensus. So within the field, he said, economists like Blinder and Card (who subscribe to most of the mainstream tenets) are rebelling against that political orthodoxy, while the “experimentalists” working in behavioral economics or more fringe heterodox circles are chipping away at the neoclassical foundations themselves.<

-- Jim

EADS Insider Trading and Rule 10b-5

I find this shocking:

Shareholders and executives at Airbus parent EADS engaged in "massive" insider trading, a press report said Wednesday, citing a document that also alleges the government had been aware of difficulties at EADS prior to the lucrative sale of shares … It cited the AMF as describing the selling, which took place between November 2005 and March 2006, as "simultaneous and massive" in scale. It said problems in the key Airbus A380 superjumbo programme that led to a June 2006 profit warning had been raised as early as June 2005 in an EADS board meeting.

I don’t know anything about security laws in France but I am aware of what the U.S. calls Rule 10b-5:

This provision defines when a purchase or sale constitutes trading "on the basis of" material nonpublic information in insider trading cases

Financial economists define an efficient market as a market in which security prices reflect all available information and adjust instantly to any new information. But what happens when the senior management of a company fails to disclose material information in a timely fashion? Fraud on the market can occur in a couple of ways. Perhaps the easiest to grasp is the case when an insider provides information that is false. For example, the CEO of a pharmaceutical company might try to claim their in-process R&D is about to garner regulatory approval for a hit new drug even though he knows the recent lab tests were discouraging. His fraudulent information sends the stock price soaring, which allows the CEO to cash in by selling his stock at a price above the true value of the firm based on full and correct information. This EADS situation is a good example where had negative information been provided in a timely way, the stock price would have declined as soon as the negative information was realized both by insiders and the public. However, the insiders here decided not to let this negative information become public, which means the stock price remained about what it would have been under full information.

Nice discussion of my new book

David Warsh, longtime reporter with the Boston Globe, covering economics rather than the economy, discussed my new book, comparing it favorably to recent works by Krugman and Chait.

http://www.economicprincipals.com/issues/07.09.30.html

Quick Thoughts on Carbon Sequestration

Carbon sequestration is an excessively expensive and probably technically impossible method of capturing significant amounts of carbon. Planting trees is another popular suggestion for sequestering carbon, but a more traditional method has not been mentioned to the best of my knowledge.
Building up the soil is a simple low-tech technique for sequestering carbon. For centuries, careful farmers have realized how to build up the fertility of the soil, not really thinking in terms of carbon sequestration.
Commercial US agriculture is largely based on "robbery agriculture," as the great German chemist of the century and a half ago, Justus von Liebig, put it. When I published my book, Farming for Profit and a Hungry World, 30 years ago, I discovered that US agriculture was eroding about 30 pounds of soil for every pound of food it delivered to an US table. At the same time, my research for the book found that US agriculture was burning about 10 calories of fuel for every calorie of food that it was delivering to a US table.

I have no reason to believe that these imbalances have gotten any better since then. I strongly suspect that they have gotten worse.
So, the plan for reducing carbon by way of agriculture is to grow corn, perhaps the most industrialized crop, in order to produce ethanol. This process produces more energy than it consumes, only if a lot of credit is given to the energy value of the residues, which are fed to cattle. Even then, the net gain in energy is minimal and ignores the intensive consumption of water and the carbon released from the soil.
Yet, careful agriculture, by putting more organic matter back into the soil, builds up fertility, while sequestering carbon. This kind of traditional agriculture uses less mechanization.
Does this technology mean that society must revert to turn more people into downtrodden farmworkers? Capitalism might impose such an imperative, but the technology certainly does not. After all, many Sunday newspapers have a special section devoted to gardening because people find that sort of activity pleasant.
Final caveat: I do not pretend to have developed detailed data on how much a rational and cultural system could contribute slowing down global warming, but I do know that the direction we are heading is wrong.

You Say Militia, I Say....?"

Let me see if I understand this. When someone in Iraq or some other such country hires a private army, we call it a militia. When someone in the US hires a private army and sells it to the highest bidder, we call it a security firm. And the reason is?