Neel Kashkari’s Supply-Side Solution to Mostly a Demand-Side Problem

Neel Kashkari tries to explain the slow pace of the recovery from the Great Recession:

When accommodative monetary policies were coupled with expansionary fiscal policies, other experts had reasonably expected a strong recovery from the depths of the Great Recession. Going back decades, the U.S. economy has exhibited a remarkable ability to bounce back: The rule of thumb was the deeper the recession, the stronger the recovery. Yet, the U.S. economy has experienced the weakest recovery in the postwar period, despite unprecedented policy responses to a very deep recession. Why?

My question here is why did you frame this so poorly? We had some fiscal stimulus in 2009 but it was not sufficient and followed by the fiscal austerity after 2010. Going back decades as in periods when the Federal Reserve engineered inflation fighting recessions by raising interest rates. Does Kashkari not get the fact that interest rates over the past several years are not at levels we saw a quarter of a century ago? I will give him credit for noting some key facts but his supposed expert on these matters is Greg Mankiw as it turns to seven possible underlying factors. After much discussion, here’s his bottom line:

We have come up with seven diagnoses and, like Mankiw, we don’t know for sure which ones are right. But looking at the symptoms, both domestic and global, suggests to me that we are likely seeing a confluence of three fundamental causes all combining to slow the economic recovery: (1) challenging demographics, (2) psychological scarring from the crisis and (3) lackluster technological innovation. Unfortunately, these headwinds aren’t likely to reverse anytime soon on their own. The good news is that we, as a country, aren’t powerless to address these fundamental causes. We have identified a series of policy responses that could be effective over time and have little downside risk. An obvious way to spur innovation and entrepreneurial activity is to increase government funding of basic research. Another promising policy is immigration reform, especially for high-skilled workers. Over the longer term, policies that improve education, streamline regulations and make the tax code more efficient should allow the United States to retain its dynamism, creativity and willingness to take risks.

Is it all about the supply-side? He continues:

Given today’s low borrowing costs, there is a strong case for increased government spending on deferred maintenance of infrastructure that will be necessary to sustain our economy. However, I am skeptical that a large-scale expansion of government spending by itself is the best way forward, since larger fiscal deficits will lead to higher expected future taxes, which could further undermine private sector confidence. Chronically weak demand might have been an important part of the diagnosis for the U.S. economy in the depths of the recession, when many workers and factories were idled. By 2016, however, the labor market appears closer to normal, which limits how much can be achieved by boosting demand to increase employment further.

His 3rd diagnoses was entitled “Secular Stagnation” and did consider some of the Keynesian suggestions for raising aggregate demand. Alas his post strikes me as too dismissive of this view relying a bit too much on supply-side solutions. But then his expert is Greg Mankiw.

Branko's Lumps

In a post at his blog globalinequality today, Branko Milanovic claims that "Robotics leads us to face squarely three fallacies." He then proceeds to "debunk" technological unemployment, satiation of human needs and the environmental carrying capacity of the earth. He concludes his post with the assurance that "history teaches us" we have nothing to fear regarding limits to growth, exhaustion of natural resources and replacement of humans by machines.

A week ago, I posted Outlaws of Political Economy in which I documented the total absence of evidence for the alleged false belief in a fixed amount of work. The fallacy claim, I argued, is a negative projection that is compulsively repeated by economists.

In my post, I cited the entry on "Economic Law" from the 1893 Palgrave's Dictionary of Political Economy. In turn, the Palgrave's entry cited an 1892 article, in German, by J. Bonar that I was unable to locate [update: found it]. But the search for it led me to Bonar's 1893 book, Philosophy and Political Economy, described by Warren Samuels as "one of the most remarkable works in the history of economic thought." In that latter book, Bonar discussed Niccolo Machiavelli's notion of a "fixed quantity of happiness" and mentioned Francis Bacon's enunciation of the same basic idea -- that one person or country's gain is a another's loss. The rationale, in a nutshell, of mercantilism.

Following up on the Bacon quote, I discovered much the same sentiment had been earlier expressed by Michel de Montaigne and was expressed by the mime author, Publilius before the current era. In short, long before the fallacy became a "fallacy," it was a maxim that circulated among the most distinguished literati, Montaigne, Machiavelli, Bacon...

Publilius's maxim translates as "Profits in trade can be made only by another's loss." Montaigne's is "One man's profit is another's loss."

It just so happens that James Bonar also delivered a series of lectures in 1910 addressing the "subtle fallacies which are apt to invade the reasoning of trained economists in spite of learning and discipline." One of the sources of error that Bonar discussed in his first lecture was "the existence and prevalence" of "watchwords" or "maxims" that keep alive biases inconsistent with the economist's reasoning. A watchword is "a detached phrase that has taken the place of an argument" and may even become "a substitute for an argument."

In his fifth lecture, Bonar specifically addressed one of those tricky watchwords, "in the long run" and replied, 106 years before the fact, to one of Milanovic's key arguments about "the lessons of history":

It is not easy to show that the invention of new machines will tend to increase wages. This was the tendency first supposed by Ricardo; but he changed his mind and wrote: "The same cause which may increase the net revenue of the country may at the same time render the population redundant and deteriorate the condition of the labourer." It was this change of view that made McCulloch doubt the infallibility of Ricardo. The more orthodox position (if we allow that any position of Ricardo's could be heretical) was that machinery tends in the long run to employ more labour than it has displaced; this was to be the consolation of the hand-loom weaver, thrown out of work by the factory system. It was to be a sufficient vindication of an economic principle, that, if it did not fit the facts now, it would fit them at some time in the future. But in the case of machinery there were more economic principles asserted than one. One seems quite to fit the facts: that there is a tendency under the regime of machinery towards a greatly increased production at less cost. It was a different proposition that the increased product tends to be equally shared. The economist has no warrant for saying that any economic tendency exists which by itself brings about good distribution. The sharing of property was matter of law and political institutions, in some countries religious prejudices; and the conditions so established might prevent any such consummation. It does not seem true that economic tendencies are all made beneficial by length of time any more than a man is necessarily made better by growing old. There is no saving virtue in the ''long run."

An economist from the 1930s named John Maynard Keynes also took issue with the policy relevance of the legendary long run. Ironically, our old mime friend, Publilius also had something proverbial to say about the long run: "Patience is a remedy for every sorrow."

Maxim-izing Utility

Lucrum sine damno alterius fieri non potest. -- Publilius Syrus  

Le profit de l'un est dommage de l'autre. -- Michel de Montaigne  

Whatsoever is somewhere gotten is somewhere lost. -- Francis Bacon 

For some two hundred years both economic theorists and practical men did not doubt that there is a peculiar advantage to a country in a favourable balance of trade, and grave danger in an unfavourable balance, particularly if it results in an efflux of the precious metals. But for the past one hundred years there has been a remarkable divergence of opinion. The majority of statesmen and practical men in most countries, and nearly half of them even in great Britain, the home of the opposite view, have remained faithful to the ancient doctrine; whereas almost all economic theorists have held that anxiety concerning such matters is absolutely groundless except on a very short view, since the mechanism of foreign trade is self-adjusting and attempts to interfere with it are not only futile, but greatly impoverish those who practice them because they forfeit the advantages of the international division of labour. […] Nevertheless, as a contribution to statecraft, which is concerned with the economic system as a whole and with securing the optimum employment of the system’s entire resources, the methods of the early pioneers of economic thinking in the sixteenth and seventeenth centuries may have attained to fragments of practical wisdom which the unrealistic abstractions of Ricardo first forgot and then obliterated. -- John Maynard Keynes

Trade will find its own level. -- Dorning Rasbotham

The price of corn, like water, will find its own level. -- Benjamin Franklin

Dexar hazer a la naturaleza allí, y aquí a la moralidad. -- Baltasar Gracian

Patience is a remedy for every sorrow. -- Publilius Syrus

“Select All” Disallowed

Google has just announced that, beginning next month, its popular apps will no longer permit users to check a single “select all” box.  This means, for instance, that if you want to delete a long list of email or phone messages, you need to check the box for each one of them; there will no longer be an option at the top of the list to select the whole lot.

“We don’t want users to make general decisions about their important data,” said a Google spokesperson, who asked not to be identified.  “It’s too easy to select the box at the top, delete, and then lose something you’ll regret later.  We want the user to stop and think about each individual item.”

There is speculation that Google’s decision was influenced by similar thinking on the part of election officials.

Paul Baer

Word has just arrived that Paul Baer, an ecological economist and cofounder of EcoEquity, has died.  Paul helped put together the Greenhouse Development Rights model and was one of the most reliably thoughtful participants in discussions around climate policy.  He was also an exceptionally warm and wonderful person.  I will miss him.

Captain Fantasy

I saw “Captain Fantastic” last night and have some thoughts.  Some are trivial, but eventually I want to get to the socially relevant part.

Start with trivial.  Man, is this movie a fantasy.  So this guy lives in the North Cascades as a Noam Chomsky-loving, leftwing survivalist.  His brood is beyond perfect: athletic outdoorskids, academically brilliant, courageous and creative.  No sibling rivalry, except for one black sheep.  The mountains are stunning, and it’s always summer.  (I’ve hiked the North Cascades, and even at the peak of summer they can get pretty harsh.)  There are no other humans to get in their way or make trouble for them.  They grow, hunt or gather all they need and are generally in great health.

This comic book vision is a problem for Viggo Mortensen.  He’s an extraordinary actor; his portrayal of Freud in “A Dangerous Method” was like a biographical essay.  I feel he was miscast here, however, because his subtlety and intelligence clash with the cartoonish aspects of the story.  The potential for something a lot better glimmered from time to time (for instance, the exchange with a daughter about Lolita), but mostly I found myself thinking, “This is just a put-on, but then, what’s the point?”

Oh, and someone out to show his cultivated musical tastes might specify he prefers the Goldbergs with Glenn Gould, but never the solo cello works with Yo-Yo Ma.  A weird, out of place middlebrow play.*

But let’s get to the more substantial stuff.  The real politics of movies is generally unconscious, what’s assumed by the film maker and the audience in order to get to the more deliberate parts of the package, like plot, character, ambience, or whatever.  Here are three political assumptions about the left that I noticed in this movie:

1. Wide open nature good, crowded cities bad.  The “organic” life is one that needs a lot of landscape.  Just in surface-of-the-earth terms, this family has a pretty big footprint.  How generalizable is their lifestyle?  Not at all.  We have a name for cool things that only a few can have the opportunity to enjoy: privilege.  It’s like people who think “green building” means rammed earth single-family homes surrounded by acres of inspirational forest or desert.  Multiply that by tens of millions and what do you have?  Rammed earth suburbia.

2. Rejection of the division of labor.  Self-sufficiency is assumed to be a foundation of “left” thinking.  It’s the ultimate in localization; forget the global economy, we’re not even going to import from the people down the road.  Of course, the accouterments of a modern, division of labor economy are all there when and as needed: the bus, the hospitals, the climbing gear, and even the Ball jars used for putting up food.  And all the clothing that isn’t made from animal skins.  So what does this family specialize in producing so they can pay their way in this economy?  Beats me.

3. Politics as aesthetics.  We all have our preferences.  We like some foods, music and activities more than others.  Fine.  And aesthetic criticism is OK too.  (I implied this about Yo-Yo Ma’s Bach, although my point was more sociological than musicological.)  The film, however, is steeped in the assumption that a “left” perspective on America is tied to, almost equivalent to, an aesthetic rejection of mainstream American culture.  Maybe that’s an accurate depiction of how it is, but if so, bad news for the left.

*Incidentally, if I read the credits correctly, that wasn’t Gould on the soundtrack, but they did have Ma.  My guess is that the recording quality of Gould would sound strangely antiquarian in this context.

The Asshole Theory of Profits

I’m reading Evicted: Poverty and Profit in the American City by Matthew Desmond and it’s wonderful.  You should read it too if you haven’t already.

In the middle of the book is a section in which the likely profit of one of the two slumlords Desmond tracks is estimated.  Roughly speaking, he takes in about half a million net of all expenses from a single trailer park south of Milwaukee.  To do this he has to make decisions every day that crush the lives of desperately poor people.  (Yes, people with drug issues, chaotic family lives and spotty maintenance habits, but real, breathing human beings all the same.)  He evicts some who have no place to go.  He charges rents that absorb nearly all the renter’s monthly income.  He skimps on repairs.  He does things that most of us could never do, and his reward is an income a lot higher than ours.

So what is the economic explanation for raking in half a million with relatively little work or skill?  He paid just over two million for the entire park, so his rate of return is 25%—rather more than the opportunity cost of capital.  In a competitive economy, either there would be a flood of new trailer parks built to chase these superprofits, or, if that were prevented by regulation, the price of the property would be bid up so its return was back to normal.  We need to understand this.

That’s where my asshole theory comes in.  There are a lot of highly lucrative opportunities out there that require you to basically sell your soul, to act like a jerk.  These are businesses or managerial jobs where you gouge money out of people or force them to work longer and harder or more dangerously than they want.  Your kid is sick and you want to stay home with him?  Do that and you’re looking for another job.  I’m sorry, putting on that gear each time you’re exposed to this machine takes too long; if you don’t like the risk go somewhere else.  It’s not my problem you had to pay the utility to keep your heat on and you don’t have enough for rent this month; you’re out of here.  Most of us can’t do this, but a few can.

Incidentally, this should not be thought of as a compensating differential process.  Whatever their initial feelings, people who choose this way of life quickly become inured to it and may even derive some pleasure from taking out their frustrations on those below.  You can see this in the portrait of the other slumlord in Desmond’s book, who started out with a bit of idealism but is being transformed, step by step, into someone who sees herself meting out justice when she throws tenants out into the street.  In winter.  In Milwaukee.

My theory is it’s a scarcity rent, pure and simple.  There’s a shortage of qualified assholes, and the ones who have what it takes to do these jobs earn the rewards.  Indifference to the hardship of others could be described as a form of human capital, and it earns a high return in an exploitive society.

It Is Labor Day And The Washington Post Is Picking On Workers

Well, heck, usually on Mondays they through Robert J. Samuelson pick on old people and Social  Security.  But this Monday is Labor Day, so obviously it is time to pick on workers.

OK OK, that is an exaggeration.  Indeed,  Robert J. Samuelson's column is far more reasonable and accurate than most of his Monday screeds.  The vast majority of his column, all the way up to the final three paragrapha accurately lays out how employment in the US has become increasingly temporary and part time, "alternative work arrangements," none of them permanent jobs with benefits,and Samuelson makes it clear that this is not a good  thing for workers, even if it might be good for corporate bottom lines. He sees that the overall percentage has risen from 10.7 percent of the US labor force in 2005 to 15.8 percent in 2015.  He notes the precarious nature of these jobs and their lack of benefits. He also dismisses the "gig economy"as employing less than 1/2 percent of workers.

So what is the problem?  In the final three  paragraphs he begins to see light ahead in the form of a supposedly tightening labor market, not noting the much lower rate of labor force participation going on now than before the Great Recession, although he points at the current 4.9 percent unemployment rate as a sign of this tightening, not to mention the impending retirements of lots of  baby boomers.  He also  notes that wages are now rising at 3.5 percent annually, up from 2 percent in 2013, which must be granted as A Good Thing.  The final sentence of the column reads, "On Labor Day 2016, the great hope for American workers is that we are quietly entering an era of labor scarcity."

Ah hah!  So, what is the headline for the column, probably picked out by Fred Hiatt, in any case probably not Samuelson?  "A new era olf labor scarcity?"  Hurray!  Problems are over!  Workers can sit back and cheer on Labor Day!   All those increases in "flexible" "alternative work arrangements"?  Not going to be a problem.  Indeed, things are so great, we can probably get back to plotting how to cut their future Social Security benefits, starting out by raising the retirement age so that they can all work longer now that they are becoming so scarce!  Hallelujah!

And, in the meantime, Happy Labor Day everybody.

Barkley Rosser

The Outlaws of Political Economy

'I don't have to show you
any stinking badges.'

Perusing Palgrave's Dictionary of Political Economy from 1894 alerted me to the odd interaction of a pair of distinctions. The first distinction was between the study of "what is" and "what ought to be." The second distinction was between "economic science" (or "economics") and "political economy." Economic science presumably distinguished itself from political economy by its strict focus on describing "what is" rather than on prescribing "what ought to be."

Palgrave's explains the latter distinction to have been at least partly motivated by the confusion that arose over just what kind of laws -- legal or natural -- so-called "laws of political economy" were. Even after the attempt at rebranding, however:

"...even well-educated persons still occasionally speak of "laws of political economy" as being "violated" by the practice of statesmen, trades-unions and other individuals and bodies.

You can't "break" scientific laws. They are simply generalized descriptions of fact. A flying airplane doesn't break the law of gravity. It conforms to a more comprehensive complex of physical laws. The law of gravity isn't the only law.

Palgrave's Dictionary further noted that the "great complexity and variety of circumstance which surround every economic problem are such as to render the enunciation of general laws, on a large scale, barely possible and if possible barely useful."

So the whole "positive" economics rigamarole wasn't just about methodological rigor. It was a purification ritual to rid the political economist of the stigma of dogma. Economists who invoke the violation of so-called laws aren't only forfeiting any legitimate claim to economic science. They are contaminating their profession with atavistic hokum.

Speaking of atavistic hokum, I have been trying to track down ANY accessible published record of a trade unionist or advocate of the reduction of the hours of labor EVER overtly expressing the belief that there is a fixed amount of work to be done or a certain quantity of labor to be performed or whatever synonymous equivalent. There is none.

There is a reasonable explanation for this absence of evidence. The alleged false belief is expressed in abstract language that was not vernacular to the people accused of harbouring it. It's the wrong answer to a question workers never asked themselves.

False belief requires two conditions to be fulfilled: 1. the idea is false and 2. it is believed by someone to be true. The matrix below shows the possible states of belief and falsehood. An idea does not have to be true to be "not false" and it doesn't have to be believed to be false to be "not believed to be true." The fallacy claim asserts a simplistic (and false!) polarization in which the beliefs of the "unenlightened" are "the opposite" of economic orthodoxy.

In an 1861 letter to the Times of London "A Master Builder" alleged that George Potter, secretary of the carpenters' union, and his associates had "absurdly argued that there was only a certain amount of work to be done" during a 1859 strike and lock-out of the London building trades. There is a detailed report on the 1859 strike in an 1860 report on Trades' Societies and Strikes published by the National Association for the Promotion of Social Science. The 23-page account presents several items of correspondence from Potter outlining the union's position with not a hint of a lump in the load. The "certain amount of work to be done" was what Mr. Master Builder thought he heard when he mentally translated Potter's argument into his own capitalistic patois.

There was something else interesting in the 685-page document -- an overarching controversy about whether or not labor was a commodity just like any other and therefore whether or not unions violated the laws of political economy by trying to regulate wages and hours of work. The employers who maintained this were pretty dogmatic about it. "Rates of wages cannot be settled by mediation, but must be left to the free operation of supply and demand." It's the law!

This was not simply political economy It was vulgar political economy of the most self-serving and disingenuous kind. One has no difficulty whatsoever finding multiple evocations by employers of the so-called laws of political economy but the elusive lump remains "one of the most tenaciously held and generally least articulated of trade union beliefs."

Least articulated? Least articulated is an understatement. Try NEVER articulated. There is no there there. The alleged false belief is a pure projection by the laws-of-political-economy crowd onto the unbeliever. The eighth annual report of the New York Bureau of Labor Statistics for the year 1890 contains the responses of over 600 labor union locals to the question of whether and why they support an eight-hour day. Not one claims there is only a certain quantity of work to be done.

Below is an example of what an overt statement of the theory of the lump of labor looks like. It is not from a trade union manifesto or a pamphlet of the eight-hour day movement. It is from a propaganda tract put out by Nassau Senior's crew of Whig-Benthamites in defense of their New Poor Laws, which abolished outdoor relief and established the workhouse test:

The fact is, there is a certain quantity of work to be done, and the question is who ought to do it -- those who live by their labour, and their labour only, or those who have thrown themselves on public charity.

Can anyone find such an unequivocal articulation of the false belief by a trade unionist? Of course not. It's not the way that workers talk about their work. Work is not an abstract, disembodied quantity to those who do it. It is part of a lived experience. "A certain quantity of work to be done" is political economy speak, plain and simple. It's ceteris paribus and "all else being equal."

Paradoxically, for old school vulgarians there both is and is not a certain quantity of work to be done. There is a certain quantity of work to be done when it comes to disparaging the idea that workers might increase wages their through collective action:

There is a certain quantity of work to be done, and a certain number of hands to do it; if there be much work and comparatively few hands, wages will rise; if little work and an excess of hands, wages will fall. It is self-evident that combinations and strikes cannot alter this law. They can neither increase capital, nor diminish population; and, therefore, it is utterly impossible, in the very nature of things, that they ever can procure a permanent rise of wages.

But there isn't a certain amount of work when it comes to explaining why such foolish action isn't even necessary:

There is, say they, a certain quantity of labour to be performed. This used to be performed by hands, without machines, or with very little help from them... The principle itself is false. There is not a precise limited quantity of labour, beyond which there is no demand. Trade is not hemmed in by great walls, beyond which it cannot go. By bringing our goods cheaper and better to market, we open new markets, we get new customers, we encrease the quantity of labour necessary to supply these, and thus we are encouraged to push on, in hope of still new advantages. A cheap market will always be full of customers.

Five years ago I compiled a database of over 500 instances of the claim in books and journal articles between 1890 and 2010 (Excel file). That's 500 claims without a single overt statement of the false belief from an alleged believer. Six claimants (about one percent) named culprits whose argument "arguably depends upon..." "makes an error equivalent to..." "indicates a belief..." "seems hopelessly involved in..." "is an example of the strange conclusions to which one may be carried by clinging clinging firmly to..." and "are driven by implicit assumptions." Each of those turns out to be a false alarm -- an uncharitable, speculative inference. Five hundred boys crying "wolf" and not a single wolf to be seen?

This is an astonishing performance. This compulsion to repeat is not "careless" or "dogmatic." It's neurotic.

The patient cannot remember the whole of what is repressed in him, and what he cannot remember may be precisely the essential part of it.. He is obliged to repeat the repressed material as a contemporary experience instead of remembering it as something in the past.

The atavistic return of the repressed "laws of political economy" conforms faithfully to a description toward the end of chapter 3 of Beyond the Pleasure Principle where Freud talks about the experiences of "people with whom every human relationship ends in the same way" and gives as a "singularly affecting" final example the events in a romantic epic, in which the hero, Tancred, repeatedly slays his beloved, Clorinda, each time she reappears in a different guise. In this example, as Gavriel Reisner notes,

Freud reverses the compulsion to repeat, showing how we will sometimes injure others in order to avoid injuring ourselves. Freud concludes that we often project the internal, masochistic drive as the external, sadistic drive, victimizing others to redirect an intent toward self-victimization.

The utilitarian political economists styled themselves advocates for "the greatest good for the greatest number" and viewed opponents as apologists for narrow special interests. The supposed laws they discovered, which operated through isolated exchanges between individuals in the market, vindicated a system of natural liberty and consequently freedom entailed obedience to those laws. Collective action and collective bargaining violated the laws of individual exchange, resulting in sub-optimal outcomes. Such perversity could only be motivated by false beliefs. The false beliefs of the adversary were presumably the opposite of the true beliefs of the faithful: trade unions operated through tyranny and their bizzaro-world political economy assumed that less output meant more income.

Reality discredited that polemic of political economy and calmer heads sought to rebrand the enterprise as economics. The ersatz laws were scaled back to tendencies, which operated within the admittedly abstract ceteris paribus pound of the economist's static model. Real life and the evolution of economic relations operated outside the ceteris paribus pound but maybe the static model could shed light on dynamic economic activity.

It was no longer fashionable to denounce "The Evils of Collective Bargaining in Trades' Unions" (Thomas Cree, 1898) because it was increasingly understood that the so-called laws of supply and demand operated quite differently with regard to the peculiar commodity of labor power (Richard Ely, 1886):

While those who sell other commodities are able to influence the price by a suitable regulation of production, so as to bring about a satisfactory relation between supply and demand, the purchaser of labor has it in his own power to determine the price of this commodity and the other conditions of sale.

But even as old-guard political economy was being gradually displaced by rebranded economics in the universities, employers' associations and business journalism emerged to propound and propagate the old-time religion. The break with quasi-scientific, quasi-legalistic, quasi-religious pseudo-laws was ambivalent, the reconciliation surreptitious. Employers' associations told the college teachers what to teach. Textbooks served up a smorgasbord of the obsolescent and the innovative.

In this twilight of science and superstition, the fallacy claim offered uncertain economists a distinctive advantage. It enabled them to continue to denounce violations of the laws of political economy without actually having to specify which laws were being violated. That left them exempt from any obligation to justify the validity of defunct laws. The burden of proof deftly shifted and the providence of economic science affirmed, albeit by default.

Economic science thus gets to have its "what is" humility... and eat its "what ought to be" hubris too! Evidence be damned.

---

That there was one particular offense singled out for condemnation by the self-appointed economic police is suggested by the example given in Palgrave's Dictionary for the common confusion between the legislative and scientific senses of law: "Thus it is often said that to regulate the hours of labour, or to introduce differential import duties, is to break economic law." The anachronism of such a view should require no explanation. The hours of labor are regulated.

Any proposal to repeal the Fair Labor Standards Act of 1938 on the grounds that it "breaks economic law" would no doubt be laughed at by Paul Krugman, David Autor, Jonathan Portes or Alan Manning. But, inadvertently, that is precisely the historical grammar of their lump-of-labor fallacy taunt. Although there is no logical imperative that links the law-breaking claim to the fallacy claim, they have been inseparably paired in usage from their inception. To invoke the latter is either to imply the former or it is a non sequitur.

At long last, economists, have you no scientific self-respect? On this labor day, 2016, would you still insist that regulating of the hours of work breaks the laws of economics?

Internal/External, Validity/Consistency

As every consultant knows, all the mysteries of the universe can be revealed in a two by two matrix.  We divide the cases up one way and then some other way.  That gives us four cells and vast, remunerable wisdom.

Here is my version for economics.  One way of dichotomizing how much faith we should put into hypotheses is between reasoning and evidence.  Reasoning is about consistency.  An inconsistent argument is at war with itself in some way and should be regarded with suspicion.  The other criterion is evidence.  Evidence either adds to or detracts from the validity of an argument.  Ideally a hypothesis should be strong on both fronts, although we know our powers of formulating and testing hypotheses are incomplete, especially in social sciences like economics.  We don’t necessarily rip up and burn theories that have consistency or validity problems, but we take those problems seriously.  Or should.

The other dimension is internal/external.  Internal means “with respect to this particular empirical study or body of theory” and external “with respect to all the rest of the empirical cases and theory out there”.  Each piece of work needs to be judged on its own terms, but research and analysis do not occur in a vacuum.  We also have to be mindful of the empirical world outside our particular sample, and we should respect the models developed by other researchers, especially when they have done well on consistency and validity tests.

The distinction between internal and external validity is familiar from statistics.  Internal validity is about the reliability of our claims based on the quality of our data and power of our analytical tools.  External validity is about how well a given study generalizes to the larger universe of cases we care about.  There has been a move toward experimental and quasi-experimental methods in economics, because studies designed around experiments have more internal validity for questions about causation.  This is controversial, however, because the constraints entailed in setting up or finding experiments often detract from external validity.

But the same tension exists on the theoretical side, consistency.  An extremely important example can be found in the debate surrounding so-called microfoundations in macroeconomics.  (I say so-called because, strictly speaking, representative agent models are not microfounded.)  Models incorporating intertemporal utility maximization are typically preferred by economists because they  possess more internal consistency, where “internal” means “within economics”.  Given that the models do not distinguish themselves empirically, their main defense, in fact, is exactly this type of consistency.  But wherever there’s an internal, there’s an external.  External consistency in this context refers to consistency with the models promulgated outside economics, for instance in psychology, social psychology, neuropsychology and sociology.  Given that academia is siloed, most economists give little thought to this, but they should.  The assumption that there is such a thing as utility, that individuals maximize it, and that they do so over their life cycle is radically inconsistent with the understanding of human behavior one finds in these other social sciences.  That’s a problem.

External inconsistency is not necessarily fatal.  One can always try to make the case that I’m right and you’re wrong.  That sometimes happens when the findings in one scientific field contradict and undermine what practitioners in another field believe.  It could happen here too.  But (1) economists seem unaware of the inconsistency, and (2) a cursory look at the state of knowledge suggests that the basis for the economics way of modeling behavior is its convenience, while other social and natural scientists have actually gone out and tested different behavioral hypotheses.

The irony is that we have now had more than two decades of prominent work in behavioral economics that has established the second point conclusively but hasn’t made a dent in what passes for a “consistent” model.  Yet.

Apple Operations International and the European Commission

Math quiz. If you paid a 36% tax on one-third of your income and a 6% tax on the rest – what is your overall tax rate? If you are Stephen Moore, you might sum 36% and 6% but the rest of us would take a weighted average and get 16%. Which brings me to the latest from Jared Bernstein:

I’m talking about Apple, Ireland, and the European Union, of course. The EU’s tax authorities are accusing Ireland of providing special tax breaks to subsidiaries of the US multinational tech company. Such alleged state subsidies are considered anti-competitive by the EU, which is thus demanding that Ireland claw back $14.5 billion in ten years’ worth of upaid taxes.,, Perhaps surprisingly, given the extent to which the Obama administration has righteously denounced such extensive corporate tax avoidance (e.g., they’ve gone after corporate inversions as best they can without Congress), they’re not at all pleased by the EU’s move on Apple. As tax expert Steve Rosenthal interprets their thinking. “Apple may be a tax cheat, but Apple is our tax cheat.” Perhaps they’re worried that if Ireland succeeds in squeezing some juice out of the Apple, there won’t be any left for our Treasury

The White House thinking seems to be related to something called the foreign tax credit which would be relevant if Apple was repatriating all that foreign sourced income but guess what – it is repatriating none of it at least for now. Yet Apple is telling its shareholders that its effective tax rate is over 26%. Maybe this is not as bad as Stephen Moore arithmetic but does this make any sense? Last year, Apple told its shareholders it made $72.5 billion before taxes with $47.6 billion sourced abroad and a provision for foreign taxes around $2.9 billion. So OK, U.S. sourced income is actually 35% and the foreign tax provision is such over 6%. But how on earth does E&Y say their tax provision is over $19 billion? Are they providing for the repatriation tax even if they are not repatriating? How is this consistent with APB 23? Of course they did tell shareholders:

On June 11, 2014, the European Commission issued an opening decision initiating a formal investigation against Ireland for alleged state aid to the Company. The opening decision concerns the allocation of profits for taxation purposes of the Irish branches of two subsidiaries of the Company. The Company believes the European Commission’s assertions are without merit. If the European Commission were to conclude against Ireland, the European Commission could require Ireland to recover from the Company past taxes covering a period of up to 10 years reflective of the disallowed state aid. While such amount could be material, as of September 26, 2015 the Company is unable to estimate the impact.

But if this is without merit – why provide a tax provision for it? So much confusion, so little time. Speaking of confusion, let’s highlight some of the testimony from Tim Cook when he appeared before the Senate hearings back in 2013:

In accordance with US law, Apple pays US corporate income taxes on the profits earned from its sales in the US and on the investment income of its Controlled Foreign Corporations (“CFCs”), including the investment earnings of its Irish subsidiary, Apple Operations International (“AOI”). Apple does not use tax gimmicks. Apple does not move its intellectual property into offshore tax havens and use it to sell products back into the US in order to avoid US tax; it does not use revolving loans from foreign subsidiaries to fund its domestic operations; it does not hold money on a Caribbean island; and it does not have a bank account in the Cayman Islands… Under US tax law, these foreign intercompany payments are not taxable.

Sufficiently confused? Most of Apple’s income ends up in this Apple Operations International (AOI). Cook seems to be saying its income is not subject to US taxation which would be consistent with no repatriation tax. That income turns out not be to be taxed anyway so when he claims there are not using tax havens – that is not true. OK, AOI is not located in the Caymans but that is not the only tax haven. Apple’s 10-K filing notes only three material affiliates – all in Ireland. Apple Sales International and Apple Operations Europe are taxed at the Irish rate of 12.5%. The European Commission’s position is that these entities get very little income with most of it sourced in AOI where it is not taxed. How does that work? Phillip Elmer DeWitt explains:

it’s in the southern Irish city of Cork that Apple pioneered its famous “double irish with a Dutch sandwich” — a tax avoidance technique designed to take advantage of a quirk in Ireland’s tax laws that allows foreign corporations to move money around the world tax free…AOI is incorporated in Ireland; thus, under US law, it is not tax resident in the US. AOI is also not tax resident in Ireland because it does not meet the fact-specific residency requirements of Irish law.

This last sentence is actually from Cook’s testimony. What it basically says is that AOI is located nowhere. It might as well be on Gilligan’s Island or even Mars. But how is this Double Irish Dutch Sandwich (doesn’t that make you hungry) not a tax gimmick? Wasn’t Tim Cook under oath when he testified? And how is lying to the Senate “perfectly legal”?

Nominal Unit Labor Cost Growth in the 1970’s Versus Recently

Jeffrey Frankel reads some nonsense from Wilbur Ross so we don’t have to. Let me pick on one of Jeff’s points:

Okay, what he means is the rate of productivity growth, which has indeed fallen since the turn of the century, and is indeed a problem. But what numbers does he choose to cite to measure the productivity slowdown? “During the 1970s growth in US unit labour costs was 6.8 per cent a year but it dropped…to 1.2 per cent so far this century.” What a bizarre thing to say! Growth in unit labor costs (ULC) equals the rate of wage increase minus the rate of productivity growth. Other things equal, the productivity slowdown would show up as a higher rate of increase in ULC, not lower.

FRED provides nominal unit labor costs from 1947QI to 2015QIV. Over the thirteen year period from 1970 to 1982 this series did rise by 129.71% whereas it rose by only 18.09% over the thirteen year period from 2003 to 2015. This comparison is meaningless as the 1970’s was a high inflation period whereas inflation has been very modest during recent years. I trust Wilbur Ross knows this. So why not examine the changes in unit labor costs relative to the GDP deflator? Of course if he did that, he might have noticed that this real series fell by 3.4% during the 1970 to 1982 period whereas it fell by 8.47% during the more recent period. To continue with what Jeff noted – the change in the real value of unit labor cost equals the change in real wages minus the change in productivity. Yes productivity increases have been very modest of late and real wage growth has been worse, which contributes to the income inequality problem. But a chief advisor to Donald Trump seems to be clueless on what he is even measuring. Happy Labor Day!

The Outlaws of Political Economy!

Coming Labor Day to This Blog!

Did Jonathan Portes Cause Brexit?

I should like to show that Jonathan Portes most probably did not cause Brexit. To do so, however, I first must examine the plausibility of the case that his actions and words did indeed provoke a decisive margin for the Leave vote in the EU referendum last June.

Portes is Principal Research Fellow, formerly Director, at the National Institute for Social and Economic Research in London. From 2002 to 2008, he was chief economist at the U.K. Department of Works and Pensions and, following that, chief economist at the Cabinet Office. David Goodhart has described Portes as "one of the architects of Labour's immigration policy" during that period. He is a regular contributor to the Guardian, frequently on migration issues.

In a 2012 blog post, Portes fondly reminisced that explaining the lump-of-labour fallacy "to six successive Secretaries of State for Work and Pensions, usually in the context of immigration… was probably the most useful thing I did, from a public policy perspective, in my six years as Chief Economist at Department for Work and Pensions."  The lump-of-labour fallacy is the spurious claim that supporters of some policy or other are motivated by a false belief that there is only ever a "certain amount" of work to be done.

The alleged belief is indeed false, as is the claim that support for the policy in question is motivated by it. The bogus fallacy claim was a staple of 19th century anti-trades union propaganda. Portes thus prided himself on his acumen in persuading Labour cabinet secretaries "to go out and defend policies that were consistent with" an archaic, reactionary view of the labour market.

That is not to say that the policies defended by cabinet secretaries coached by Portes were reactionary. The phrase "were consistent with" is notoriously ambiguous. Wearing an amulet is "consistent with" being a Satanist. It is also consistent with not being a Satanist. One must always be wary of "affirming the consequent."

Not wearing an amulet is consistent
with Portes not being a Satanist.

The Friendly Irish Skies for Transfer Pricing Games

My discussion of the Apple Structure promised to elaborate on a gem from Aidan Regan:

Wow! Exports are up 34%; Investment is up 27%; imports are up 22%. Wham, bam, the economy grew by 26%. Sensational. Per capita income per person in employment has increased from a whopping 88k in 2010 to 130k in 2015. I’m sure you can feel the booming economy in your pocket? Of course you can’t, the national accounts are a sham. So what’s really going on? The increase in investment, although you can’t see it in the national accounts, is being driven by airline leasing. My hunch is that this has increased by about 110%. Airline companies of the world are effectively transferring their financial activities (as new aircraft machinery) into Ireland for tax purposes….imagine all those massive Boeing planes flying around the world, then imagine them in Ireland, and hundreds of people working on them. Where are they? In truth. We couldn’t even fit these planes in Ireland. It’s just around 20 people managing a financial fund for tax avoidance purposes. Then using the generated money for profit redistribution. That’s what’s really go on.

Let me preface our discussion by noting this game is played by hotels in the U.S. who establish Real Estate Investment Trusts as well as oil drilling rig multinationals. After all those rigs in the North Sea off the coast of Norway and Scotland are formally owned by tax haven affiliates in Switzerland and the Cayman Islands. So how much income is being diverted to these tax havens? Let’s start with a discussion from Tom Bergin of Reuters:

The change, announced by Finance Minister George Osborne in March, caps the amount a UK company can deduct from profit for leasing drilling rigs from an overseas unit in the same group. The rig-leasing units are typically based in countries where their income is taxed lightly or not at all…Companies that have benefited from the current rules include Ensco Plc, Rowan Companies Plc and Transocean Ltd, which collectively accounted for over 60 percent of the UK market in 2012…"Currently, some companies making significant operating profits in the UK are able to move up to 90 percent of these profits overseas and out of the UK tax net," a spokeswoman for the UK Treasury said."In 2012, more than 1.75 billion pounds ($2.95 billion) was paid by oil and gas operators in the UK to contractors who lease drilling rigs and accommodation vessels. Almost no corporation tax was received on this," the finance ministry added. GENEROUS DEDUCTIONS Osborne's change, which will limit the amount companies can deduct from profit for such lease payments to 7.5 percent of the historical cost of the rig, will replace generous deductions calculated on the market value of rigs, which has been soaring.

While Osborne was right that a lease to value ratio near 15% is overly generous, his 7.5% might be a tad skinny. Let’s imagine an Irish affiliate that “owned” $30 billion in planes (see the financials for AerCap) that incurred operating and depreciation costs equal to 5% of assets ($150 million). I would argue for a 10% lease to value ration so the intercompany payment is $3 billion and profits of $150 million. This 15% lease to value ratio doubles those profits and leave the operating entities (the ones in high tax jurisdictions) with very little profit. So which approach is right? The OECD’s Action Plan 9 notes in its paragraph 63:

Risks should be analyzed with specificity, and it is not the case that risks and opportunities associated with the exploitation of an asset, for example, derive from asset ownership alone. Ownership brings specific investment risk that the value of the asset can increase or may be impaired, and there exists risk that the asset could be damaged, destroyed or lost (and such consequences can be insured against). However, the risk associated with the commercial opportunities potentially generated through the asset is not exploited by mere ownership.

The 15% lease to value ratio inappropriately assigns the expected return for bearing commercial risk to the Irish owner of the assets whereas the approach suggested here is to grant it only the return for bearing ownership risk or obsolescence risk as Miller and Upton noted. Their model would suggest that the appropriate profits for the Irish affiliate represent only a 5% return to assets with the remaining system profits accruing the operating entity. What the OECD has noted here is simply good finance and yet we often see the representatives of multinationals arguing for the overly generous 15% lease to value ratio. This is how transfer pricing abuse is done – these representatives basically lie to tax authorities under the assumption that the tax authorities are too stupid to realize they are being lied to.