Charles Murray versus Art Laffer

David Frum and Paul Krugman notice a passage in “Is the White Working Class Coming Apart?” that suggests that the income effect may dominate the substitution effect when it comes to the labor supply curve:

As of 2009, a very bad year economically, the median hourly wage for drivers of delivery trucks was $13.84; for carpenter’s helpers, $12.63; for building cleaners, $13.37. That means $505 to $554 for a forty-hour week, or $25,260 to $27,680 for a fifty-week year. Those are not great incomes, but they are enough to be able to live a decent existence – almost twice the poverty level even if you are married and your wife doesn’t work. So why would you not work if a job opening landed in your lap? Why would you not work a full forty hours if the hours were available? Why not work more than forty hours?

Paul comments:

But this argument applies just as much to the rich as to the poor. And strange to say, you never do find conservatives arguing that we shouldn’t worry about higher tax rates on the rich, because they’ll just work harder to be able to afford those luxury goods; or that a higher inheritance tax probably expands work effort, because it would force the Paris Hiltons of this world to go out and get real jobs.

Art Laffer wanted us to believe just the opposite – that higher tax rates would induce Paris Hilton to work less. In other words, the Laffer curve presumes a very strong substitution effect and a very weak income effect. I guess Charles Murray’s assertion here questions the underlying premise of the Laugher Curve!

Quote: What was the true cause of western inflation in the 1970s?

“The estimated fraction of total inflation attributable to oil price increases had a median value of only 15% for 1973-74, or 9% over the longer period of 1973-76 ....We conclude that American inflation caused by the Federal Reserve System as an exogenous source of world inflationary trends. Because of the unwillingness of their central banks to appreciate or float their currencies until in extremis, the nonreserve countries too caught the American disease. …”

The International Transmission of Inflation

By Michael R. Darby, James R. Lothian

Some Thoughts on Greek “Reforms”

Enough has been said for now on the sins of commission in the Greek austerity program.  (See Floyd Norris in today’s New York Times for an excellent dissection.)  I’m interested in what has been left off the agenda.

My starting premise is that the fundamental cause of Greece’s lack of competitiveness is not its wage level but its pervasive clientelism.  The beef against the national railway, for instance, is not that workers were overpaid, but that jobs were dished out as payoffs without any regard for the country’s transportation needs.  Taxes aren’t collected because tax sheltering is another payoff, in this case for the benefit of a higher income class.  Cartels carve up markets, and regulators look the other way—more payoffs and more waste.  One way to think about Greece is that it has the kind of economy Italy would have if it were all Mezzogiorno.

Although the complexities and national distinctiveness of the Greek political economy cannot be capture by any single model, a reasonable first approximation would be that the country is in the grip of a deeply-entrenched system of clientelism that spans nominally public and private sectors.  By clientelism, I mean a system in which patrons extend material benefits (jobs, tax shelters, monopolistic profits) to clients in return for offers of loyalty (votes, support in conflicts with other bigwigs, etc.).  The theory of clientelism was the topic of a paper I presented at the ASSA meetings in Chicago.

The troika has not directly targeted Greek clientelism, but what should we expect the unintended consequences of its demands to be for this de facto regime?  For instance, if numerical targets are imposed that result in public sector layoffs, will this lessen the grip of clientelism or make it even stronger?

I don’t think theory alone can answer such questions, but it can shed light on the mechanisms through which clientelistic relations operate and are either reinforced or broken.  Here are a few questions that come to mind:

Who controls which public sector jobs will be eliminated?  If some of the jobs are “honest” and others “payoffs” (I realize the reality is not so dichotomous, but this is an attempt to jumpstart a thought process), how will layoffs be apportioned between them?  If payoff jobs become more scarce, will they rise in value?  Will patrons be able to extract even more loyalty from clients by offering favors in a depleted environment?

If the minimum wages on which current payment formulas depend are cut by more than 20%, will the formulas themselves become more flexible, and therefore more susceptible to clientelistic manipulation?  Who gets to decide this?  Will an economy-wide salary freeze reduce clientelist discretion or displace more of it to the enforcement apparatus?

As state capacity falls, will this increase the scope for clientelistic relations according to the principle that the disinterested rule of law is a principal alternative to clientelism, or will it reduce the exercise of clientelism within the public sector itself—or both?  Will the state become more susceptible to the privatization of public goods (like public services) by officials using them to purchase personal loyalty?  In other words, which state capacities are likely to decline fastest and furthest?

Social scientists have become skilled at analyzing a wide range of institutions, such as markets, businesses, political parties and bureaucratic administration, but there has been no systematic investigation of clientelism corresponding to its status as one of the fundamental structures of social organization.  As a result, important questions about the Greek economy and society are not even being asked, much less investigated.

EU Labor Commissioner’s Praise of US Macroeconomic Policy

Ian Talley notes how Laszlo Andor is virtually alone among EU officials condemning their fiscal austerity:

An over-reliance on slimming government budgets is feeding the euro zone’s recession, European Union Labor Commissioner Laszlo Andor warned in an interview. “We need a smarter fiscal consolidation than before, which means that the wrongly calibrated fiscal consolidation measures probably contributed to the deceleration of growth and this second dip,” the EU Commissioner for Employment, Social Affairs and Inclusion said after meetings with the Obama administration, International Monetary Fund and World Bank officials this week. Although the job of labor commissioner isn’t one of the heavyweight roles within the commission, Andor’s comments are one of the first times a top European Union official has publicly suggested that the broad focus on austerity has been harmful to the European economy.

In the U.S. there has been a debate between the political hacks in the Republican Party who think President Obama has worsened our economic performance by excessive fiscal stimulus and the realists who argue that we did not have sufficient fiscal stimulus. Mr. Andor seems to be of a different mind:

The commissioner said he spent much of his time in Washington studying how the U.S. was able to spur demand and cut persistently high unemployment levels. The U.S. government and the Federal Reserve have greater flexibility than the E.U. or the European Central Bank, a lesson he said that has application in Europe.

It only shows how incredibly awful European aggregate demand policy has been when our anemic efforts to restore full employment are seen as a guide to their macroeconomic policies!

The Infamous Example of Rent Control in Introductory Economics

The latest post by Jodie Beggs rehashing the standard story about rent control has me quietly steaming.  It’s not her fault, of course: she is simply regurgitating what has become a mandatory morality tale, an unavoidable rite of passage in Econ 101.  You know the drill: in their misguided desire to be fair to the poor, the authorities have set a ceiling on rents below the market-clearing price, and the result is excess demand in the short run and reduced supply in the long run.  Now that you have mastered the supply and demand diagram, you are so much smarter than they are.

I’m agnostic about rent control myself (it depends entirely on the context and the details), but for me this story is a poster child for the ideological rigidity of economics as it is taught to impressionable youth, not the superiority of “the economic way of thinking”.

There are two huge holes in the textbook argument.  The first is that it overlooks neighborhood effects—literally.  The most compelling argument for rent control is neighborhood stabilization, the idea that social capital in an urban environment requires stable residence patterns.  If prices are volatile, and this leads to a lot of residential turnover, the result can be a less desirable neighborhood for everyone.  Thus the quality-adjusted supply curve is partly a function of price (or at least price stability in a dynamic model), and the S and D curves are not independent of each other.  You’ll notice that not a single textbook treatment of rent control mentions stabilization as an objective, even though this is a standard element in the real-world rhetoric surrounding this issue.  Again, I’m not taking a position, just saying that the representation you get at the introductory level is an ideological construct, not an honest analysis.

The second hole is that rent control ordinances are normally replete with measures intended to maintain supply incentives, like price increases tied to investment in housing quality or simply spreading out increases over a longer time so tenants are able to adjust.  Again, these measures may succeed or fail, but a simple horizontal line in a one-period S&D model doesn’t begin to address them.

In fact, advocates for rent control have taken Econ 101 (most of them), but they just disagree on how large the positive and negative impacts are.  The purpose of economics should be to help us think clearly about the matter—for instance by identifying the potential empirical data that could adjudicate between competing arguments—but in its textbook form it is a ritualistic way of curtailing thought.

UPDATE: Standing in the shower, my mind drifted back to Orwell: "Free markets good!  Price controls b-a-a-a-a-d!"

T-SPLOST: Financing Georgia’s Transportation Projects and Ricardian Equivalence

During the summer of 2010, the state of Georgia passed a plan to invest in its transportation network. The interesting feature to me was how they proposed to pay for this construction as well as the arguments for the proposal put forth by Doug Callaway:

If voters approve a new one-cent sales tax for transportation projects, it could be one of the greatest economic tools in Georgia, according to an official pitching the benefits of the proposal. “This is the best option on the table. Is it perfect? No. Is it the best thing going? Absolutely,” said Doug Callaway, executive director of the Georgia Transportation Alliance — a nonprofit group affiliated with the Georgia Chamber of Commerce. Come July 31, voters in 12 districts throughout the state will be asked to consider a 10-year, one-cent sales tax that will fund transportation projects in their region … Callaway outlined the key points of the T-SPLOST that voters will likely hear until they head to the polls this summer: More jobs, safer roads and revenue that stays in the region. “We’ve got high unemployment, let’s be honest, and little hope for an immediate turnaround,” Callaway said, while pointing to University of Georgia experts who estimate that the economy won’t improve until 2020.Those regions that approve the T-SPLOST stand to possibly create more immediate and long-term jobs — while recovering more quickly from the economic downturn, he explained.

T-SPLOST stands for the Transportation Special Local Option Sales Tax. If a county decides to increase its sales tax by 1% for each of the next 10 years, then construction on new transportation projects can begin. Mr. Callaway is justifying this proposal on Keynesian grounds. While I hope Georgia’s economy can recovery before 2020, we have to admit the current recovery is going slowly.
Not to dust off an old debate, but let’s recall what Robert Lucas once argued:

But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder -- the guys who work on the bridge -- then it's just a wash. It has no first-starter effect. There's no reason to expect any stimulation. And, in some sense, there's nothing to apply a multiplier to. (Laughs.) You apply a multiplier to the bridge builders, then you've got to apply the same multiplier with a minus sign to the people you taxed to build the bridge. And then taxing them later isn't going to help, we know that.

Several economists challenged Dr. Lucas including this from Simon Wren-Lewis:

If you spend X at time t to build a bridge, aggregate demand increases by X at time t. If you raise taxes by X at time t, consumers will smooth this effect over time, so their spending at time t will fall by much less than X. Put the two together and aggregate demand rises.

If Mr. Callaway has his way, maybe we can have an empirical test along the lines that Christina Romer talked about!

A Generally Positive Jolt

BLS just released its preliminary December figure for job openings (from its Job Openings and Labor Turnover Survey—JOLTS), and the news is good: 258,000 more vacancies.  Combined with previously reported unemployment data, the unemployment to vacancy ratio dipped noticeably from 4.3 to 3.9.  Here is how the ratio looks from the beginning of 2008 to the end of 2011:

Unemployment-to-Vacancy Ratio, 2008-2011

If the decline keeps to the trend it has established since the cyclical peak of 6.9 of July 2009, in another 18 months we’ll be back down to two workers looking for work for every job opening.  This is still above the ratio most economists would prefer (about one-and-a-half to one), but it’s not bad.  There is a big proviso, however: the unemployment numbers do not count the large number of workers who have apparently withdrawn from the (pathetic) labor market.  And, of course, there is no guarantee at all that this trend will stay on course.

Newt’s Objection to Romney’s Minimum Wage Proposal – Does Newt Know Alan Krueger and David Card?

Zachary Roth has found one policy position where Mitt Romney and I agree – that the minimum wage should be indexed so that its real value is not eroded over time by inflation. Naturally this has inflamed a few other Republicans including Newt:

And Newt Gingrich, Romney's leading rival for the nomination, said Sunday on Meet the Press that "virtually every economist in the country believes that [indexing the minimum wage to inflation] further makes it difficult for young people to get a job."

This story next reminds us of a study written by Alan Krueger and David Card, which challenged Newt’s ideology.

Ten Minutes to Grok the Eurocrisis

I like these little mini-lectures where a hyperactive hand scribbles out an animated commentary.  Here, clocking in at under ten minutes, is the Punk Economics explanation of what's wrong with Merkozy's "solution" to the Eurozone fiscal crisis.  (Hat tip: Henning Meyer)

Charles Murray’s Daring Move

Murray has a new book out, Coming Apart: The State of White America, 1960-2010, that argues that the top fifth of the (white) income distribution excels on merit and virtue, while the bottom 30% is mired in a dysfunctional, dead-end culture.  Thus the income divide is just a symptom of the real cause, the widening virtue gap.

It takes guts to go out on a limb like this, doesn’t it?  Imagine trying to convince the upper middle class that they are morally superior: do you think he will be able to drum up any sales?

Towards an economic theory of capitalism - MACRO supply and demand

This afternoon I discovered an interesting publication on the web entitled 'Tragedy and Hope - A History of the World in our Time'. It was published in 1966 by professor Carrol Quigley (an American historian and theorist of the evolution of civilizations) who taught at Georgetown University in the US in the 1960s and is reported to be a mentor for former US President Bill Clinton.

Within the pages of 'Tragedy and Hope' Quigley has articulated an essential aspect of the behaviour of money versus goods between geographical areas in the capitalist context:

“Capitalism, because it seems profits as its primary goal, is never primarily seeking to achieve prosperity, high production, high consumption, political power, patriotic improvement, or moral uplift. Goods moved from low-price areas to high-price areas and money moved from high-price areas to low-price areas because goods were more valuable where prices were high and money was more valuable where prices were low. Thus, clearly, money and goods are not the same thing but are, on the contrary, exactly opposite things. Most confusion in economic thinking arises from failure to recognize this fact. Goods are wealth which you have, while money is a claim on wealth which you do not have. Thus goods are an asset; money is a debt. If goods are wealth; money is non-wealth, or negative wealth, or even anti-wealth.”[*]

In these times the truth of the above statement appears obvious. Cheap goods are definitely moving from low-priced areas in China and South East Asia (in particular) to fully-industrialised nations where they fetch a much higher price. Money, in the form of capital, has been flowing out of the rich western nations and moving to the 'low-priced areas' around the globe.

The trouble is, that although Quigley's theory has the strong ring of truth to it, his theory contradicts the basic micro-economic theory of supply and demand. Foundational economic teachings have made it clear that it is the demand for individual goods that are impacted by price level, and that the price level is (largely) set by the level of consumer demand. However, Quigley writes about a wide range of goods in a particular geographic areas and not about any particular good.

I assume, therefore, that Quigley is implying that international currency manipulation is a key part of the operations of the world capitalist system. A low value for domestic currency makes goods (and services) cheaper for international buyers, and vice versa.

Capitalism's foundation therefore must rely on processes of unequal exchange where the 'price mechanism' for goods is largely determined by the relative value of the currency they are purchased in.

"It is quite impossible to understand the history of the twentieth century without some understanding of the role played by money in domestic affairs and in foreign affairs, as well as the role played by bankers in economic life and in political life" is Quigley's understatement.

Deregulation did not turn out to be 'no regulation' after all. It appears to have simply meant leaving the management of the world economy largely to the whims of a global and organised cartel of private banks (ie the central banks).

"The power of the State must be invoked for restoring economic freedom just as it has been invoked for destroying economic freedom."
Hilaire Belloc, The Restoration of Property, 1936

REFERENCES:

Quigley ‘Tragedy and Hope’ 1966. http://sandiego.indymedia.org/media/2006/10/119975.pdf

Also see:

Finance leaders fail to resolve currency dispute

Martin Crutsinger, Saturday, October 9, 2010, Associated Press

http://www.activistpost.com/2010/10/finance-leaders-fail-to-resolve.html

Forest Conservation and the Rise of the 1%

Over here we have debate on the decades-long upsurge in inequality, fueled by the increasing share of income going to the top 1%.  Over there we have the politics of forest prevention, specifically the push by the state of Colorado to weaken roadless protection in order, among other things, to try to suppress forest fires.  What’s the connection?

The main purpose of the roadless areas directive is to keep land available for wilderness designation.  The guiding philosophy of wilderness is that large swaths of forest, desert and other ecosystems need to be left alone to provide the sort of habitat, recreation and research that can exist only in the absence of large-scale human interference.  Keeping out roads is a way of putting a ceiling on that interference.

One aspect of wilderness is permitting a natural fire ecology.  Periodic fires are part of the system, so they should be allowed to burn off excess fuel and permit the rotation of tree species.  (Fire-resistant species thrive in the wake of a fire but are eventually displaced by more susceptible competitors, until another fire begins the cycle again.)  The expectation has been that more of these smaller fires will reduce the number of monster burns.

It hasn’t worked out quite that way.  One reason is climate change, which is slowly redrawing the ecological map of North America.  Some land that used to be forest is destined to be savannah or even drier, and fire, abetted by disease, is often the agent of change.

But something else has happened, much more rapidly: large numbers of the newly rich have chosen to build their second (or nth) homes in remote areas of Colorado, Wyoming, Montana and other mountain states.  They like the magnificent vistas and opportunities for recreation provided by public lands, as long as they can own their own private chunk next door.  Naturally, they have the means to fly back and forth, so distance is not a problem .

What is a problem is fire.  Even the small fires envisioned in wilderness philosophy threaten their lovely dachas.  In remarkably bloodless language, the Times summed up this dynamic:

But he [Glenn Casamassa, a US Forest Service supervisor] said the West, and maybe Colorado in particular, has also changed significantly in the intervening years. More people are living near national forests. An outbreak of pine-killing bark beetles that has its epicenter in Colorado and several major fires over those years that roared out to touch the edge of urban life have also changed thinking about intervention in the wild.

And that’s how it is.  If a proposed financial regulation runs afoul of the 1%, out it goes.  If closing a tax loophole brings their rate up to everyone else’s, no go.  And if wilderness gets in the way of their weekend getaways, then this requires “changed thinking” among forest managers.

Plutocracy does have consequences.

Would President Gingrich Hire Christina Romer as Economic Advisor?

Christina Romer presented an excellent discussion on the effects of fiscal policy with this closing line:

The one thing that has disillusioned me is the discussion of fiscal policy. Policymakers and far too many economists seem to be arguing from ideology rather than evidence. As I have described this evening, the evidence is stronger than it has ever been that fiscal policy matters—that fiscal stimulus helps the economy add jobs, and that reducing the budget deficit lowers growth at least in the near term. And yet, this evidence does not seem to be getting through to the legislative process. That is unacceptable. We are never going to solve our problems if we can’t agree at least on the facts. Evidence-based policymaking is essential if we are ever going to triumph over this recession and deal with our long-run budget problems.

Gingrich isn’t exactly known for seeking reality based advice, which is why this stunned me:

Newt Gingrich said Sunday that an “age of austerity” is the wrong solution for the economy and would “punish” the American people. He said he prefers “pro-growth” policies instead. The comments appear to pour cold water on the modern Republican belief that austerity and growth go hand in hand.

I just wish we could take the latest from Newt seriously!

The Chinese Question: Liquidity or Solvency?

Once again the EU is trying to get China to commit a few hundred billion of its foreign exchange reserves to shoring up Eurozone sovereign debt.  The European “stability” mechanisms (EFSM and ESM) need more money, and no one in Europe is willing to lay that much on the line.  China says it would be willing to step in, but under one condition: that its investments are guaranteed.

This is perfectly reasonable.  China is still a largely poor country, and there is no reason why its people should risk losing their savings in order to help manage the affairs of much wealthier Europe.  At the same time, however, their demand exposes the fundamental dishonesty of Eurozone policy.

Except for Greece, the official line is that all sovereign debts will be honored and all fiscal targets met.  The rescue facilities exist only to provide bridge loans that markets are unwilling to extend at a reasonable cost.  With enough liquidity, austerity and reform, financial sustainability is assured.

If this were really the case, however, there would be little risk in giving the Chinese the guarantee they demand.  And no one seriously expects such a guarantee to be offered.

The reason is that the true situation in the Eurozone bears little relation to the optimistic talk still issuing from summits like the one just concluded in Brussels.  Greece is only the first in line; Portugal too will need debt relief and perhaps also Ireland.  Spain faces an entire banking system that may well be technically insolvent, and it can neither survive a banking collapse nor come up with the funds to forestall one.  All the severely indebted countries are at risk from the gathering recession, and the need for further recapitalization of the banks across the continent is a further risk.

In the face of this frightening public and private debt overhang, the official policy has been to lend, lend and lend some more.  The ECB has turned back the doomsday clock by lending half a trillion or so euros at close to zero interest to private banks in return for their own lending to overstretched sovereigns.  So-called bailouts, like the next tranche at issue in Greece, are also loans.  Politicians give stern speeches about how debt cannot be the solution to debt, and then they find more spigots for lending: beef up the European Financial Stability Mechanism, bring on a permanent mechanism, go door to door in China.

But if the problem is not liquidity but solvency, this avalanche of credit is profoundly wrongheaded.  The solution for insolvency is always the same: write down existing unpayable debts and generate income—transfers if necessary—to forestall new debts.  In the current environment each is associated with an immense political-economic challenge, since the first requires confronting the European financial oligarchy and the second creating a true, zone-wide fiscal entity (the feared transfer union).  Achieving either alone would be a miracle; accomplishing both is almost beyond utopia.

At least we can thank the Chinese for clarifying the contradiction at the heart of the current policy charade.

What happens when monetary values replace notions of real wealth? Quotes from 2011

“The Fed can’t print oil.” [1]

"What’s most terrifying, we are having this discussion about the risk of recession at a time when unemployment is already too high, at a time when a quarter of homeowners are underwater on their mortgages, at a time then the fiscal deficit is at 9 percent and at a time when interest rates are at zero." [2]

“We’re on the verge of a great, great depression. The [Federal Reserve] knows it” [3]

Since China entered the WTO in 2001, the U.S. trade deficit with China has grown by an average of 18% per year. The U.S. trade deficit with China in 2010 was 27 times larger than it was back in 1990. The United States has lost an average of 50,000 manufacturing jobs per month since China joined the World Trade Organization in 2001. [4]