Welcome to the Future—It’s Just Starting Now

Like many of you, I have had a queasy feeling about the loss of privacy in the digital era.  Every online transaction and communication is out there for monitoring, profiling, packaging and retailing, and no promise by a company or government is going to change this.  The commercial implications are troubling enough, but what about the future?  What happens when a really bad government comes along and uses this information for outright repression?

Well, the future is now.  Read this chilling report on the use of new surveillance technologies to control what you can read about such matters as state-sponsored torture (the Kiriakou case) and corrupt insider contracts in the “war on terror” (Sterling).

If it had been Obama and not Google that campaigned on the slogan “Don’t be evil”, we could accuse him of breaking a promise.

Bullard and How We Measure GDP Gaps

Noah Smith had an early and excellent take down of Jim Bullard that included:

So, basically, what we have here is Bullard saying that the neoclassical (Solow) growth model - and all models like it - are wrong. He's saying that a change in asset prices can cause a permanent change in the equilibrium capital/labor ratio.

Tim Duy had another excellent take down of Mr. Bullard that included:

Estimates of potential GDP are not simple extrapolations of actual GDP from the peak of the last business cycles. They are estimates of the maximum sustainable output given fully employed resources. The backbone of the CBO's estimates is a Solow Growth model. So I don't think that Noah Smith is quite accurate ... Bullard can't be saying the Solow growth model is wrong because he doesn't realize that such a model is the basis for the estimates he is criticizing.

I was curious as to how much difference this makes so I extrapolates 2007QIV real GDP by assuming growth equal to 0.5% per quarter for the next four years and compared the GDP gap predicted this Bullard approach (GAP*) to the GDP gap one would get using the CBO estimate for potential GDP. Either way – we are still far below full employment.

A Little More on Rent Control

After posting on this subject a few days ago, I’ve been raked over the coals in the conservative Blogosphere, principally in the Arnold Klingdom.  I am accused of thinking I possess a “superior wisdom”, since I disagree with the majority of economists on this issue.  I ignore “mountains of data” and base my agnosticism on sheer ignorance.  I am really the worst of the worst.

I could rest my case on a simple defense: my post was not about rent control, which I haven’t studied, but on the doctrinaire treatment of the topic by economic textbooks.  Even if they’re ultimately right, they’re right for the wrong reasons, and that matters when the issue is how to use economics as a tool for thinking.

But having had my curiosity piqued, I decided to do a quick literature search.  Sure enough, there is a large literature out there.  I glanced at a few models with their statistical implementations and formed a few reactions.  I will spare you here, since it takes more than a couple of hours to know what’s what in a serious field of study.  But I noticed that two review essays from the 1990's seem to hold pride of place.

Edgar Olsen, a veteran rent control researcher, wrote one of these in 1998 for Regional Science and Urban Economics.  A sample quote:

“Although economists have strongly held views about the effects of rent control, they have provided little convincing empirical evidence in support of these views [Olsen, 1990] and their theoretical analyses typically ignore relevant features of actual rent control ordinances and important responses to them [Olsen, 1988].”

And Richard Arnott asked whether it is “Time for Revisionism on Rent Control?” in the Journal of Economic Perspectives in 1995; his answer was yes.

But of course there was further work in the 00's, and no doubt the subject will look different a few years from now.  The one conclusion I can draw at this point is that a sweeping condemnation of rent control derived from elementary supply and demand analysis (in a frictionless market with no externalities) isn’t a very good way to enter the debate.

UPDATE:  It's not enough to know the US experience with rent control.  I've found out that Germany has had a national system of rent control for decades; it is widely seen as successful, and, as far as I know, no major party has proposed getting rid of it.  Maybe German readers of this blog (all three of you?) will want to chime in.  Once again, this proves nothing, but it does suggest that simplistic, doctrinaire judgments rendered by economics textbooks are not much to go on.  This is not an argument for rent control; it's an argument against the textbooks.

"Why is plagiarism unacceptable?"

The following statement on plagiarism comes from the Université de Liège:

WHY IS PLAGIARISM UNACCEPTABLE?

George Osburne and Crowding-out

Paul Krugman reminds us of a June 22, 2010 speech by George Osburne where he made his case for fiscal austerity. These words jumped out at me:

Higher interest rates, more business failures, sharper rises in unemployment, and potentially even a catastrophic loss of confidence and the end of the recovery ... An economy where the state does not take almost half of all our national income, crowding out private endeavour.

The entirety of this speech reads like standard Republican fare with its call for cuts in government spending but no new taxes. To be fair, however, the advice given by the members of the Council of Economic Advisors to President Lyndon Johnson back in 1966 worried about higher interest rates and crowding-out. But the economy then was at full employment and the Federal Reserve was already raising interest rates to avoid demand pull inflation. We can’t blame Johnson’s Keynesian advisors for the lack of political will to adopt fiscal restraint when needed.

But the UK and the US economies over the past few years have been very different. As Osburne noted interest rates have been low but that is a reflection of very weak aggregate demand and staggering GDP gaps. Let’s turn to a recent speech by Christina Romer to see what Barack Obama was thinking just after the 2008 elections:

The very first meeting I ever had with the President-Elect was on exactly this topic. I was in Chicago in mid-November 2008 for my job interview. The President-Elect began the discussion by saying that the economy was very sick and there was not much more the Fed could do—so we needed to use fiscal policy.

The President-Elect back then seemed to be paying close attention to the liquidity trap blog posts by Paul Krugman. Alas – the actual fiscal stimulus we got was too little and not sustained. I’m sure defenders of the President could counter by noting that the Republican leaders have been uttering the nonsense we say from George Osburne back on June 22, 2010. I guess the best way to close my blog post is to turn the microphone back to Dr. Romer:

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.

The High Yield Low Risk Anomaly

I have posted on this previously, but want to provide a link and more detail. The link is old, to the 2011 Credit Suisse Yearbook, out a year ago, an article entitled "The quest for yield," by Elroy Dimson, Paul Marsh, and Mike Staunton, on pp. 15-23 of credit_suisse_global_investment_yearbook_2011[1].pdf . I note that so far there has not been a single academic publication on the gist of this paper, that over the last 20 years in 19 out of 21 countries, buying annually reconfigured high yield stock portfolios provided both higher returns and lower risk than alternative investment strategies. Needless to say, this is an anomaly that violates CAPM, the Efficient Market Hypothesis, and several other sacred cows of conventional financial economics theory.

Of the 21 countries studied, the only ones where the "yield effect" was negative, higher yield portfolios underperformed lower yield ones on returns over 20 years, were New Zealand and Ireland, not exactly major markets. The yield effect was highest in Austria, France, and Japan.

The more crucial matter is risk, given that standard portfolio theory dating from Markowitz, if not much earlier, is that risk and return are positively related, not negatively (although another violation has been the matter of home asset bias, where most would do better on both risk and return by internationally diversifying portfolios more than they do, although this has been known and much studied in the academic lit for a long time, unlike this matter). So in Figures 8 and 9 one finds the crucial findings, both across all countries and then broken down for them individually, comparing high yield, low yield, zero yield, and country index funds. For the varying yields, it is monotonic, with risk rising as yield declines using both standard deviation and beta, and also with the Sharpe ratio declining (return per extra unit of volatility) across the yields from high to zero. It is a closer call in comparing with the country index funds, which do better than the lower yield strategies on all of these. However, it is only on standard deviation that index beats high yield, but just barely, 21.4 to 22.6. High yield beats index on beta, 0.89 to 1.0, and simply tromps it on the Sharpe ratio, 0.42 to 0.30.

So, how is this explained? Well, it is not likely it is chance, and while there might be some tax effect, the authors provide arguments why this is probably not the case or only minimally so at most. This leaves a behavioral explanation: people overbuy low yield growth stocks in bubbles that end up being more volatile because they crash so much harder. Looks pretty reasonable to me, but nobody in academic economics or finance is talking about this at all.

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)