Whose Responsibility Is it that the Public Doesn’t Understand Public Finance?

While education wonks debate microscopic movements in the NAEP and other standardized measurements of student learning, those of us who care about the capacity of democracy in the modern world face data like this
:

Obviously, a great majority of the American people lack the elementary knowledge of government budgets to formulate a sensible answer—and, yes, there is only one sensible answer.There are at least three things they apparently fail to understand:

1. An increase in the debt ceiling simply follows through on the revenue and spending commitments that Congress has already made. Not raising it is like check kiting.

2. The only way the debt can fail to rise each and every year is if the government runs a budget surplus. Such a surplus is impossible this year, all but impossible for the next several, and has been a rare event not only in the US, but in every other modern economy. Moreover, there is no theoretical reason why such surpluses should be the norm, and many why moderate, intelligently directed borrowing should be.

3. Failure to raise the debt ceiling would lead to an immediate economic calamity. US Treasury bonds play a crucial role in the national and world economies, and all of us depend, directly or indirectly, on the income people get from government employment and social programs.

But there’s no point in complaining. The question is, how did we get into this political mess, and how can we get out of it? Real answers depend on real data, but in the meantime here are some speculations:

1. There is no functioning incentive in the media (print and electronic) from which most people get their information to be factually correct. Whether to portray the world as it actually is or make stuff up is a choice, and those who go for option #2 suffer no ill effects. Hence there is a vast amount of misinformation out there. The solution is not government regulation of the media, but a societal effort to build incentives for journalistic integrity. For instance, professional associations could not only give awards for exceptional service, but also black marks for incompetence and deceit. Teams of journalists could noncoercively “accredit” news outlets (including megablogs) the way colleges and universities are accredited, through an open process with transparent criteria.

2. Economists have collectively taken little responsibility for public education. For instance, I know of no attempts to identify the critical gaps in the public’s understanding of economics in order to mobilize a response. Even in the obvious places, like introductory textbooks, there is no systematic attempt to address economic illiteracy. If you think I’m exaggerating, show me the textbooks that speak to the three elementary observations made above—that make it clear that public debts are rarely capped, much less “repaid”, and that these debts are also economically vital assets.

3. There is a deep cognitive dimension to economic illiteracy. The term “national debt” is perceived by most people to be ominous and threatening, especially when numbers in the trillions are thrown around. They think governments are like households, going on consumption binges and waking up to debt bondage. In other words, they have a one-way view of causation, beginning with one’s own economic choices and leading to debt, and cannot see the other, from debt choices made by the government back to the economy, since each individual household’s insertion into the economy (their frame of reference) has only the first dimension. In addition, they see their own debts only from the liability side and not from the asset side. In other words, they are applying a personal, household template to the systemic terrain that economics is supposed to illuminate. Without getting more specific, all I can say is that a defective frame can be countered only by a better one: we need a coordinated effort to popularize a framework for visualizing the economy that is also based on us as a community, not just me as an atom.

4. The first three of these causal factors are exploited and amplified by a wealthy and politically powerful business-conservative coalition. They bankroll media that cynically make stuff up, and where none exist they create them. They reward economists who twist evidence and invent fanciful models that just happen to justify misinformation and cognitive errors regarding the real-world economy. And of course they make constant reference to images and framing devices that reinforce the inability of the public to think clearly about economic choices. Their political strategy is predicated on mass ignorance and error, so any movement for rationality and honesty has to be political as well.

Priorities in a declining empire

Schumpeter, Joseph A. 1954. "The Economic Crisis of the Tax State." International Economic Papers, 4; reprinted in Schumpeter, Joseph A. 1991. The Economics and Sociology of Capitalism, ed. Richard Swedberg (Princeton: Princeton University Press): pp. 99-140.


"... public finances are one of the best starting points for an investigation of society. The spirit of a people, its cultural level, its social structure, the deeds its policy may prepare -- and this and more is written in its fiscal history." He cites Goldscheid. 1917. Staatsozialismus order Staatskapitalismus. "the budget is the skeleton of the state stripped of all misleading ideologies."


Following Schumpeter, the budget debates illustrate the kind of life that the rich and powerful wish on the rest of society. Get rid of the social safety net, destroy unions, turn the clock back to the nineteenth century. And yes, a bloated military to fight in every corner of the world.

The one area that the Obama is willing to rein in military spending is on medical care for the troops -- at least Robert Gates emphasized that approach.

What is weird is that virtually nobody with access to the public media is talking sense. Even the unions seem to be swallowing the Kool Aid.

Balancing the Budget by Magic

Brian Beutler reports on the Republican “cuts, cap, and balance” fiscal proposal:

Tuesday, the House of Representatives will vote on, and likely pass, a conservative Republican plan called "Cut, Cap, and Balance." The package will include some immediate, as-yet unspecified spending cuts, a statutory cap to keep spending below 18 percent of GDP, and a promised separate vote on a Constitutional amendment that requires Congress to maintain a balanced budget, but essentially forbids any future tax increases.

Unspecified spending cuts is right! Taking the 2010 figures from the Bureau of Economic Analysis for various types of Federal spending as a percent of GDP, we have the following: (1) defense purchases at 5.6%; nondefense purchases at 2.7%, interest payments at 2%, and transfer payments (mainly Social Security, Medicare, and Medicaid) at 15.9%. So how is the sum of all of this supposed to magically be reduced to only 18%?

Transfer payments as a share of GDP will decline a bit if we ever return to full employment. Of course, the GOP zest for immediate spending cuts – if politically successful – could trigger another recession. But even under the most optimistic assumptions, transfer payments as a share of GDP will remain fairly high if we do not slash and burn our SocialSecurity MedicareMedicaid system, which is not going to happen. So what do these Republicans “leaders” propose we cut? Certainly not defense spending. But unless they are proposing to do away with all nondefense Federal purchases, this notion that we can limit Federal spending to 18% of GDP is nothing more than bad arithmetic.

Me On Debt Ceiling On Local NPR

This afternoon between 3 and 4 I shall be on Virginia Insight discussing the debt ceiling. This is NPR covering western Virginia and is a call-in show.

Blaming it on the Economists

So what was the New York Times supposed to say? Economists agree that the Republican Party is acting like a bunch of lunatics? No, you can’t do that. So they came up with an analysis piece that says that there is economic support for all sides in the debt ceiling debate. It’s like climate change: you have some scientists over here who say we’re in trouble, and over there are others who say not to worry. You aren’t allowed to tell the public who to believe, and you certainly can’t say that a party led by climate deniers is in the hands of idiots.

Now it is true that, if the question is whether, to reach a particular deficit target, it is better, ceteris paribus, to cut spending or raise taxes, economic research won't give you a clear signal—but that’s not the question.

The first question is whether we should be talking about tightening fiscal policy on the brink of a second dip, in the midst of a nonrecovery from a balance sheet recession. Textbook economics says no.

The second question is whether it makes sense for a country near the bottom of the OECD in tax revenues as a percent of GDP to burrow down even further. Unless you think the rest of the world is wrong and only Friedrich Hayek (or Ayn Rand) knows the score, you would find this dubious on its face.

The third question is whether there is actually much scope for deficit reduction even in the medium to long run as long as the US runs enormous current account deficits. And how are we going to balance our current account unless the rest of the world lets the dollar devalue drastically, or we accept permanent austerity—or we wake up and begin making the investments in human capital and infrastructure that a competitive economy needs? And that third option means borrowing and spending more in the short run.

Incidentally, you can tell the author of the article has no clue about the topic when he writes, “The key point of contention is whether the government should pay any part of its debts by raising revenue, or solely by spending less.” Aside from its larger conceptual problems, this sentence confuses stock and flow. Fiscal tightening can cut the deficit, but no one is talking about the budget surplus that would be required to pay off existing debts. “Paying back the debt” is the sort of thing that only the economically uninformed say, since budget surpluses are extremely rare, and debts are hardly ever reduced. You grow or inflate your way out of a debt overload, or you get whomped.

Italy Versus Japan, External Deficit Versus External Surplus

Paul Krugman asks

A question (to which I don’t have the full answer): why are the interest rates on Italian and Japanese debt so different? As of right now, 10-year Japanese bonds are yielding 1.09%; 10-year Italian bonds 5.76%.

The short answer has to be that Italy is a deficit country, and Japan is a surplus country. To wit:


Invoke the macro identity: the current account equals the sum of private and public net saving. Japan is a net saving country; the savings of its households and firms exceeds the borrowing of its government. As long as Japanese savers and financial institutions are willing to stockpile Japanese bonds, interest rates will remain low. This willingness results not only from general financial sentiment, but also institutional linkages between public and private institutions, which are commingled at a deep level.

Italy in recent years has increasingly become a deficit country. It is not as chronic a case as some of the Eurozone strugglers, but it is headed south. It depends on external creditors whose evaluation of its financial soundness includes the fact that it depends on external creditors.

In short, capital is not yet borderless. It is easier to borrow domestically than from abroad. Japan and Italy are on different sides of the current account divide.

What Is Public Capital?

Floyd Norris really missed the boat this morning in his column on the European Banking Authority’s latest round of stress tests. There are big issues with the stresses EBA elected to test, but that’s a story for another day. For now, focus on Norris’ criticism of Helaba, the state bank (landesbank) for Hesse and Thuringia:

Helaba is outraged that the E.B.A. will not count “hardened silent participations” as core capital. And what is that? As near as I can tell, it amounts to promises by the two states that own the bank that the states will put up more money if needed....

The fact that these arguments are going on does provide some evidence that the stress tests are more credible than previous ones. They also remind us that one of the games that banks have played in the past — often with support from bank regulators — has been to count some pretty dubious things as capital. When the crisis hit, a lot of that “capital” turned out to not be of much use.

This makes it sound as though Helaba is a band of sharp operators trying to hide how overleveraged they are—like some of the Wall Street players that blew up in 2008. There is a lot you could say about the landesbanken, but sharp is not what comes to mind.

The first thing you need to know is what the state banks like Helaba are. They are publicly owned entities that rest on top of a pyramid of thousands of municipally owned savings banks. If you add in the specialized publicly owned real estate lenders, about half the total assets of the German banking system are in the public sector. (Another substantial chunk is in cooperative savings banks.) They are key tools of German industrial policy, specializing in loans to the Mittelstand, the small-to-medium size businesses that are at the core of that country’s export engine. Because of the landesbanken, small firms in Germany have as much access to capital as large firms; there are no economies of scale in finance. This also means that workers in the small business sector earn the same wages as those in big corporations, have the same skills and training, and are just as productive.

But the EU doesn’t like the landesbanken. They denounce the explicit and implicit public subsidies that state ownership entails, saying they violate the rules of competition policy. For over a decade they have fought to have the system privatized. In the end, the dispute is simply ideological: if you think that public ownership should only be an exception, narrowly crafted to address specific market failures, you want to see the landesbanken put on the auction block. If you think an economy should be organized to meet socially defined needs, you would want a large part of capital allocation to be responsive to public input, and you’d fight to keep the landesbanken the way they are. (There is a movement afoot in the US to promote public banking.)

One result of the EU attack has been pressure on the landesbanken to demonstrate competitive rates of return. The folks who move money in these banks are public servants, very good with forms and checklists in hallowed German tradition, but not very savvy in nouveau finance. Sadly, some of these naive beamters loaded up on the mortgage-based securities that collapsed in the financial crisis, since the returns were what Brussels was demanding, and, well, they were AAA.

But on to the topic at hand. What constitutes equity for the landesbanken? For a privately owned bank, capital is raised by drawing on private funds, for instance through a share offering. For a public bank, capital is the financial commitment authorized by the public institutions that guarantee the bank’s liabilities. It’s pretty obvious when you think about it, and that’s the position taken by Helaba and the other landesbanken.

According to the EBA, however, public commitments don’t count. They don’t think there should be public banks in the first place, and they don’t want to legitimize the financial structure of the German public banking system. In other words, their opposition isn’t about whether the landesbanken can cover their liabilities, but is pure ideology.

My guess is that Norris is unaware of the battle lines that have formed around the landesbanken and has adopted the EU position by reflex, out of distrust for all financial institutions. The cynicism that serves so well in the US, however, has to be translated into the European context before you can understand why Helaba is so stressed about its stress test.

Sex, Lies, and Economics: please help

I have just finished my introduction to the book, which is shaping up. I would very much appreciate any comments.

http://michaelperelman.files.wordpress.com/2011/07/intro.doc

Consciousness Lost. Looking back at 1972

I experienced 1972 as another letdown year of revived 'business as usual'. The shutdown of the alternative press and progressive environmental and social thought was pretty obvious in the mass media at the time and it has continued to this present day. It is so hard to imagine, for those born in latter decades, that open discussion and heated debate on our most important and vital issues did occur for a short and glorious few years in the 1960s. Then blackout.

1972 – The World3 'reference run' projected that the industrial output per capita (IOPC) would reach its all-time peak in 2013 and then would steeply decline through 2100. Moreover, the duration of Industrial Civilization (as measured by the leading and lagging IOPC 30% points) came out to be about 105 years. [Industrial Civilization, defined herein, began in 1930 and is predicted to end on or before the year 2030.] [1]


1972 Conference on the Human Environment. The Stockholm deliberations were confused by the fact that the luckier nations which happened to achieve industrial prodigality before the earth's savings became depleted had already infected the other nations with an insatiable desire to emulate that prodigality. The infection preceded recognition of the depletion. The result of this sad historical sequence was the pathetic quarrel over whether the luxury we cannot afford is economic growth or environmental preservation. Neither was a luxury; worse, neither was possible on a global scale. [2]

1972 – 1981 – The price of oil increased nine-fold. This fueled stagflation. Important changes occurred within the World Bank as a result of the energy crisis. It moved from supporting protection for infant industries and state planning and lending for state-owned enterprises to a commitment to trade liberalization and abandoned its support for public enterprises.[3]

1972 – December. John Kenneth Galbraith restates that the neglect of power in economics serves conservative political and social functions. The state is the only social entity that could exercise countervailing power to the corporate oligarchy but this situation is problematic given the state’s ‘consanguinity’ to the very corporate oligarchy that must be challenged. [4]

REFERENCES:
[1] THE PEAK OF WORLD OIL PRODUCTION AND THE ROAD TO THE OLDUVAI GORGE
Richard C. Duncan, Ph.D.1
Pardee Keynote Symposia
Geological Society of America
Summit 2000
Reno, Nevada
November 13, 2000
http://dieoff.org/page224.htm

[2] Industrialization: Prelude to Collapse
by William Catton
(Excerpt from Overshoot: The Ecological Basis of Revolutionary Change)
Unrecognized Preview
http://dieoff.org/page15.htm

[3] jkissing on April 23, 2006 - 7:24pm
http://www.theoildrum.com/story/2006/4/22/23169/4783

[4] Galbraith and Robinson's second crisis of economic theory.
Publication: Journal of Economic Issues
Publication Date: 01-MAR-08
Author: Wrenn, Mary ; Stanfield, James Ronald ; Carroll, Michael
http://www.accessmylibrary.com/coms2/summary_0286-34227679_ITM
COPYRIGHT 2008 Association for Evolutionary Economics

Ambient Stupidity Alert: Opinion Polling about the Federal Budget Deficit

There is crazy-making economic noise all around us, and one way to grope our way back to sanity is to recognize it, bottle it, and stuff it into an Ambient Stupidity Alert.

My contribution today is to make yesterday’s Five Thirty Eight column in the New York Times disappear, cognitively at least.

Nate Silver, who really knows his polling numbers, processes a recent Gallup poll on policies to reduce the federal budget deficit. Here’s the question Gallup asked:

Now let’s try to cut through the noise. Why should a rational person have a preference for how to cut the budget deficit before deciding whether to cut the deficit? As the most recent employment and job vacancies numbers make clear, the economy is treading water at best, and, as the last remaining stimulus funds are spent, budget policy at both state and federal levels is dangerously procyclical. On top of that, our trade deficit just bumped up to an annualized rate of $600B, and that means that, between them, households, firms and the federal government will have to borrow more if that trend continues. The external deficit is identically and simultaneously a flow of borrowing, and the only question is who goes into hock. How about a poll question about that?

But it gets worse. Gallup asks abstractly about “spending cuts” and “tax increases”, as if it were rational to have monolithic preferences about these wildly heterogeneous categories. If I wanted to cut the budget deficit, the very first thing I would do is put a quick end to counterproductive wars and provocative military spending projects. The last thing I would do is cut the social safety net when un- and underemployment are wreaking havoc. I would certainly favor increased taxes on above-median earners (which includes me incidentally), but I would be against raising them for those in the bottom slice. So how am I supposed to answer Gallup’s brain-dead questions?

Here’s a hypothesis: When the Gallup interviewer asks what people think about “tax increases”, most of them translate that into “tax increases on me”, and they don’t like them. What if you asked them about tax increases only on those at the top of the heap, whose income is well above most of the respondents? I’m not saying that soak-the-rich would push aside all the other choices, but it would fare better than soak-yourself.

And another: What if, instead of asking about “spending cuts”, Gallup gave people a short list of spending categories, how much is in each of them, and ask, how much would you want to cut from them? Don’t ask if people want to cut “foreign aid” with no clue about how much money is at stake—show them the money, alongside the amounts in the other categories, and let them make at least a potentially reasoned choice.

Reading this column was like getting sucked into an alternate universe, where pod people with blank expressions mumble strange things about economics. Wake up, before you become one of them.

Obama, Social Security, My Totalled Car

A young student side-swiped our car a few days ago totaling it. We need a new one. I can do everything on a bike, but Blanche cannot.

I had read that Hyundai was making good low cost cars. We went to see them yesterday. I was appalled how much of the car was made of cheap plastic that was very vulnerable and sure not to last. It seemed like a disposable vehicle.

The article about the quality of the GM cheap car struck home.

http://www.nytimes.com/2011/07/13/business/with-chevrolet-sonic-gm-and-uaw-reinvent-automaking.html?src=me&ref=business

The car made me think about the CPI. I am sure that such quality deterioration will not show up in the cost of living, speeding up Obama's plan for undermining Social Security via the Consumer Price Index.

My Latest Book Published!

Over a decade in the writing, my latest book has just been published by Springer, Complex Evolutionary Dynamics in Urban-Regional and Ecologic-Economic Systems: From Catastrophe to Chaos and Beyond. It is an unpleasant $119.00 from the publisher, but "only" $98.49 at Amazon, where it is apparently selling well for a book of this sort.

An oddity is that they left the "Jr." off my name on both the cover and the copyright page, which means that some people may think the book is by my late father. However, ironically, a recent reprint of his most famous book, Logic [for Mathematicians], is being advertised by eBay on the internet as being by "J. Barkley Rosser, Jr." and somebody has put into my father's Wikipedia entry that the book is by "John B. Rosser," ugh, with neither he nor I ever using our first name(s) in any of our publications of any sort ever. Oh well, darned computer software and who knows what all.

For a Stochastic Jubiliee

Modern economies depend on credit: a credit system moves economic resources from where they are acquired to where they are needed. In most times financial systems do a tolerably good job of this—not as good as they could do (since incentives and prices are often misaligned with needs), but good enough that we allow the system to operate.

But credit systems are inherently unstable. Without going into Minskyan detail, it is enough to say that loans sometimes fail to work out as intended, and that systemic overleveraging and herd dynamics can lead to massive, rogue waves of default. This “can” is actually a “will”: you can be certain that, from time to time, major credit disruptions will occur.

The financial crisis of 2007-8 was such an event. It is not over, as the Eurozone credit overhang builds to a potentially disorderly default. Large scale defaults are dangerous, posing enormous technical management challenges and even greater political-economic ones. The one we are in has been very bad and is sure to get worse. Everything we know about credit systems tells us that it won’t be the last.

What to do?

There is an ancient idea that is almost right. The Book of Leviticus calls for the freeing of all slaves and the annulling of debts every 50 years. Today we would not wait so long to restore freedom, but the idea of a periodic debt annulment is attractive. The big problem is that the biblical solution to annulment risk is not practical. God, at this early stage of economic analysis, thought that it would be possible to price in the risk, so that implicit interest rates would rise as the jubilee year approached. Clearly this is wrong. With a fixed date for wiping out debt obligations, the economy would come to a standstill many years in advance.

The solution is obvious: rather than fixing a date for the jubilee, it should be a random draw with a 2% chance in any given year. This would necessitate an additional 2% risk premium on all contracts—a burden to be sure, but one that is bearable, especially since monetary authorities could compensate in part by targeting lower policy rates than they do at present. (This expedient falls short in a liquidity trap, but such a trap would be far less likely if debt overhangs were periodically drained via jubilees.)

It would be an interesting empirical project to simulate a global stochastic jubilee using data from, say, 1950 from the present. Suppose the 2% draw were introduced at the beginning of this period, and suppose, for the sake of simplicity, that monetary authorities were able to fully offset its interest rate effect so as to neutralize its impact on the real economy. Do a Monte Carlo to see the impact of different jubilee dates on the debt accumulation profiles of the runs compared to that which actually occurred. How would these differences have altered the consequences of crunch points like 1982, 1997 and 2007?

One way to think about the agonizing negotiations taking place in Europe today is that they are attempting to work out the dimensions and modalities of a partial jubilee in real time under crisis conditions. Wouldn’t it be a lot easier to work out a preventive system that operates routinely and, except for its timing, predictably?

Sex, Lies, and Economics Video

I was invited to give a lecture to the Annual Summer Institute of the History of Economic Thought. The people there mostly tend to be followers of Hayek or James Buchanan, who was the keynote speaker. Although the people there are very conservative, every one of them was open to constructive dialogue, making the eperience very constructive and very enjoyable.

Here is the video of my lecture.

www.youtube.com/watch?v=iwPROPfSDU4

A Partial Cure for the “Is Consistent With” Syndrome

As I’ve argued in the past, economists often pretend to test their theories by identifying an outcome their model predicts, and analyzing a real-world dataset to see if the outcome occurs. If it does, they crow about how the result “is consistent with” their theoretical musings. Of course, they use the latest and greatest econometric techniques, scrupulously avoiding Type I error (false positives) in that aspect of their work. This way they can claim that there is absolutely no chance the result they found was due to unobserved endogeneity, an inappropriate parametric assumption or some other glitch.

Fine: but nothing in this approach addresses the far larger problem of how likely it is that this result could occur even if the theory is wrong. That’s the real issue for Type I error minimization. While there is no formal test for this problem, there is a procedure which can address it and even turn it to some advantage.

A researcher has a theory, call it X1, that can be expressed as a model of how some portion of the world works. Among other things, this theory predicts an outcome Y1 under a specified set of circumstances. There is a dataset that enables you to ascertain that these circumstances apply and to identify whether or not Y1 has arisen. How should this test be interpreted?

My proposal is simply this: the researcher should be expected to consider how many other plausible theories, X2, X3 and so on, also predict Y1. This should take the form of a section in the writeup: “How Unique Is this Prediction?” or something like that. If X1 is the only plausible theory that predicts, or better permits, Y1—if Y1 is inconsistent with all X except X1—the empirical test is critical: it decisively scrutinizes whether X1 is correct. If, however, there are other X’s that also yield Y1, the test is much weaker. It will accurately determine if X1 is false only if all the other X’s are false as well.

The first point, then, is that this additional part of the writeup will indicate to the reader how much weight to place on the demonstration that X1 has passed the Y1 test.

The second point is perhaps even more valuable. By giving some thought to the alternative theories that also explain Y1, the researcher may notice other predictions that enable her to discriminate between them. It may be that X2 predicts Y1, but only X1 predicts both Y1 and Y2. This moves the test closer to criticality, depending on how many other X’s there are in the game. Getting into the habit of testing theories not in a vacuum, but in relation to other, competing theories would be a huge advance. As a further bonus, it would push researchers in the direction of expanding their knowledge of competing theoretical traditions.

I’m going to begin making this suggestion in all theory-plus-empirical-test articles I review from now on.