Eastern Economic Association Conference

So, I returned late last night from Boston where I presented three papers at the 44th Eastern Economic Association conference.  Only about 70% of those preregistered made it due to weather, with airport and train station both closed on Friday, first full day of conference.

One of those who did not make it was James Galbraith, scheduled to give the first Godley-Tobin plenary lecture, sponsored by the Review of Keynesian Economics (ROKE).  However, he managed to do it from a Dallas hotel room, with a full room audience. He spoke on "Global macroeconomics - yes, macroeconomics, dammit - income inequality and distribution."  A good opening for the series.  ROKE editor Tom Palley among those not making it, and the word is out that the last of the founding editors, Louis-Philippe Rochon, is stepping down.

I have accepted an invitation to be one of three editors-in-chief of the fourth edition of the New Palgrave Dictionary in Economics.  I met for the first time with the other two: Matias Vernengo and Esteban Perez Castelnedy, along with publisher, Mike Hermann, from Palgrave.  This will be a large and long project, but at least we know where we are going at this front end for now.

Probably the two groups that have had the best long term relationship with the EEA and were both out in force at the conference despite the absences are URPE, which had 20 sessions there, and the New York Complexity and Computational Economics group, run by Jason Barr and Leann Usher. The latter had some of the best sessions I have seen in several years.  They had 15.

I have been a fairly regular attender along with my wife, Marina, since 1990, although missed it last year due to not being in the country.  It is idiosyncratic and has its ups and downs, but I think there were some good sessions this year, despite all the absences.  Will be in New York next year.

Barkley Rosser

Jeffrey Sachs on Trump’s Trade Fallacies

I heard on some news show an incredibly stupid statement from our President earlier today and in utter disbelief fired off this comment on some blog:

Trump equates our trade deficit with us being ripped off. Let’s do this as a simple example. You walk into Best Buy and purchase a $1000 computer but do not have cash. So you put it on your credit card incurring a $1000 liability. Even though you now have the computer and Best Buy does not – Best Buy just ripped you off as you have a $1000 financial obligation. An odd statement from someone who routinely defaulted on his financial obligations!

Never mind that as on Friday Jeffrey Sachs beat me to this:

But don't expect an impulsive and ignorant man like Trump to heed the lessons of economic history, logic of retaliation, and the basics of trade. His actions are based on three primitive fallacies. First, Trump thinks that America runs trade deficits with countries like China and Germany because the US is being swindled by them. The real reason is that the US saves too little and consumes too much, and it pays for this bad habit by borrowing from the rest of the world. The Trump theory of international trade is like a man in deep debt who blames his creditors for his spendthrift behavior. Come to think of it, that is precisely how Trump has spent his whole business career: over-borrowing, going bankrupt, and blaming his creditors.

Check out his discussion of the other two primitive fallacies! I guess Trump would argue that it was very unfair to me when Best Buy gave me a credit card. Update: Apparently Trump admires the protectionist philosophy of Abraham Lincoln who is famous for this:

When an American paid 20 dollars for steel to an English manufacturer, America had the steel and England had the 20 dollars. But when he paid 20 dollars for steel to an American manufacturer, America had both the steel and the 20 dollars.

This line reminds me of the incredibly dumb logic ala Wilbur Ross. I know he is old but could he have been one of Lincoln’s advisers?

Saudi Crown Prince Tortures Fellow Princes

A new report by Hugh Miles at Middle East Monitor, Is the Saudi Elite Cannibalizing Itself?" linked to by Juan Cole, reports that the recent purge of supposedly corrupt princes and high officials was (and continues to be) much more horrendous than previously reported, which I fear does not surprise me. (Link not working, sorry, but it is at juancole.com/2018.03/saufi-cannibalizes-itself.html.)

Apparently Crown Prince Mohammed bin Salman (MbS), whom I have previously posted about here, hired mercenaries to interrogate those arrested and kept at the Ritz Carlton, which turns out to have not been a luxurious hangout.  Money, signed confessions, and promieses of loyalty were demanded, with most let out wearing electronic tags and not allowed to leave the country.  Many were physically beaten, hung upside down, and tortured in vsrious ways.  One of them died, the privste secretary of a former governor of Riyadh.  Some have not caved yet and remain imprisoned, although this remnant has been moved out of the Ritz elsewhere as of Feb. 11 when the Ritz reopened for business.

Probably the best known of these has been Walid bin Talal, a multi-billionaire heavily involved in many businesses around the world, including in the US.  Reportedly his torture led to three episodes of emergency medical care being involved. His family was brought to KSA and pictures of his young daughter in handcuffs were shown to him.  A televised interview with him prior to his release had him denying he was tortured, but also had him guzzling Pepsi and chomping down condiments that it is known he would never normally eat, being a health fanatic and vegetarian.  It is being touted that this was a sign of him signaling that this interview was under duress.

Supposedly the public is pretty cynical about all this, with an austerity budget in place and many wondering if and or when all the many billions supposedly paid by these supposedly corrupt princes and officials will show up to help the general public.  There certainly has long been widespread corruption there, but as with Putin in Russia (and Xi in China) using anti-corruption purges to get at political opponents while enriching their cronies, there are widespread reports of massive corruption by MbS himself along with his full brothers.  Supposedly MbS offerd Kim Kardashian millions to sleep with him, and, of course he paid a record $450+ million for Leonardo da Vinci's "Salvator Mundi" recently in the midst of this anti-corruption purge.  Frankly, this is just a bit too blatant. Given what a botch he has made of the war in Yemen and the effort against Qatar, some are wondering how long he will last, as the Saudis have a revenge culture, and this unprecedented bout of torturing a bunch of top Saudi princes is going to engender very serious feedback.  But, I suppose his pal Jared Kushner will help him maintain his power against angry rivals.

Barkley Rosser

Wilbur Ross on the Effective Rate of Protection

When I watched this clip by Wilbur Ross – all I could think of was Mr. Ed. But what did he say?

"In a can of Campbell's Soup, there are about 2.6 pennies worth of steel. So if that goes up by 25 percent, that's about six-tenths of 1 cent on the price on a can of Campbell's soup," Ross argued. "I just bought this can today at a 7-Eleven ... and it priced at a $1.99. Who in the world is going to be too bothered?"

Ross is doing his best (I guess) to explain the Effective Rate of Protection:

The principle objective of a tariff is to dampen imports in order to encourage domestic production of the protected industry. Until recently, the protective effects of a tariff were measured in terms of nominal rate of tariff on the imports of final products. It was believed that a higher nominal rate tariff of would bring a larger increase in the output of the protected industry. But the various duties imposed by a country are not likely to give a true picture of the degree of production afforded by the nominal tariff rate. For the nominal tariff rate does not take into consideration the amount of the duty on imported intermediate products and raw materials which are used in domestic import competing industries. The theory of effective rate of protection takes into account duties levied on such raw material and intermediate products. It measures actual rate of protection that the nominal tariff rate provides to domestic import competing industry. The nominal tariff rate is the rate of duty on the value of the imported final product (as for example the ad valorem tariff). It is important to the consumer, because the nominal tariff rate affects the price of final goods which the consumers ultimately consume. The effective rate of tariff, on the other hand, is important to producers, because the degree to which their production activity is protected from foreign competition depends upon effective and not the nominal rate of tariff.

In cases where the percentage of the imported inputs in the locally produced good is very small, then maybe we should not be too bothered, but let’s consider another example:

Consider the following example. Suppose a locally manufactured car has a selling price of $ 10,000. And the selling price of an imported car, having similar specifications, is also $ 10,000 in the domestic market…Now we assume that the government imposes a nominal tariff duty of 20 per cent on the imported car. The amount of tariff duty per year levied at 20 per cent ad valorem would, come to $ 2,000…Suppose now that the local car industry uses imported inputs accounting for 50 per cent of the total cost of producing a car and the rate of duty on these imported inputs, on ad valorem basis is 40 per cent. What would then be the effective degree of protection enjoyed by the local car industry?

I will leave to the reader to consider the case where the tariff on imported cars is zero and the tariff on imported components is 25%. I just wish someone from the Price is Right would have driven up in “a new car” when Wilbur was talking about soup and soda.

On Those Aluminum Tariffs

The global price of aluminum fell below $1500 per metric ton by the end of 2015. By June 2017, it had risen to $1885 per metric ton. This source suggests that this price is even higher. So what happened yesterday?:

The stock market dip reflects the enormous impact that a 25 percent tariff on imported steel and a 10 percent tariff on imported aluminum will have on the economy. That's because so many American industries need steel and aluminum: They’re used to build cars, skyscrapers, roads, bridges, washing machines, refrigerators, and a whole host of other products. More expensive steel and aluminum means higher costs for the American businesses that make these products — higher costs that will likely get passed on to consumers. Trade groups and businesses didn't wait long to slam the president's decision. Some of the country's most influential industry groups warned that the tariffs would hurt more than a company's bottom line

C’mon man! Aren’t there winners from these tariffs?

There are a handful of winners from the proposed tariffs: the companies that produce steel and aluminum in the United States. The CEOs of the big American steel companies were invited to the White House for Trump's big announcement. David Burritt, the CEO of US Steel, was thrilled. "This is vital to the interests of the United States," he said at the White House after the announcement, according to a pool report. "This is our moment, and it’s really important that we get this right." As the stock market slid, share prices for his company — and other steel companies — jumped.

Forget steel – what about Alcoa! Alcoa has seen a recent slide in its revenues and profitability so we will look at certain information from their 10-K filing shortly. But first let’s check with Census to see how much bauxite and aluminum we imported last year. End use code 14200 shows that total imports were $16.255 billion but only $1.267 billion was from China. Yes boys and girls it was those socialists in Canada that sold us $6.978 billion of these products in 2017. That damn NAFTA! I saw some pro-Trump cheerleader commenting on another economist blog that we had to protect our U.S. smelters from foreign competition, which brings me to Alcoa’s most recent 10-K filing: From 2016 to 2017, their sales picked up and they return to profitability. But the details on their smelters is interesting:

In March 2015, management initiated a 12-month review of 500 kmt in smelting capacity for possible curtailment (partial or full), permanent closure or divestiture. This review was part of management’s target to lower Alcoa Corporation’s smelting operations on the global aluminum cost curve to the 38th percentile (currently 38th) by the end of 2016. In summary, under this review, management approved the curtailment of 447 kmt-per-year and the closure of 269 kmt-per-year. The following is a description of each action. At the same time this review was initiated, management decided to curtail the remaining capacity (74 kmt-per-year) at the São Luís smelter in Brazil; this action was completed in April 2015. In 2013 and 2014 combined, Alcoa Corporation curtailed capacity of 194 kmt-per-year at the São Luís smelter under a prior management review. Additionally, in November 2015, management decided to curtail the remaining capacity at the Intalco (230 kmt-per-year) and Wenatchee (143 kmt-per-year) smelters, both in Washington. These two smelters previously had curtailed capacity of 90 kmt-per-year combined. The curtailment of the remaining capacity at Wenatchee was completed by the end of December 2015 and the curtailment of the remaining capacity at Intalco was expected to be completed by the end of June 2016; however, in May 2016, Alcoa Corporation reached agreement on a new power contract that will help improve the competitiveness of the smelter, resulting in the termination of the planned curtailment. Furthermore, in December 2015, management approved the permanent closure of the Warrick smelter (269 kmt-per-year). This decision was made as this smelter was no longer competitive in light of prevailing market conditions for the price of aluminum at that time. The closure of the Warrick smelter was completed by the end of March 2016.

Their most recent 10-K lists 16 smelters with only 4 in the U.S. Canada and Spain have 3 each. Brazil and Norway have 2 each. Alcoa also has smelters in Australia and Iceland. If Alcoa’s sales are enhanced by this tariff – it is not clear that they will not outsource the smelter operations to Iceland:

Alcoa, formerly the Aluminum Company of America, and another American company, Century Aluminum, have opened factories like this in Iceland, and closed factories in the United States, for a simple reason: Electricity is much cheaper here.

Century Aluminum’s share price also rose. Their 10-K also notes their smelters:

We operate three U.S. aluminum smelters, in Hawesville, Kentucky ("Hawesville"), Robards, Kentucky ("Sebree") and Goose Creek, South Carolina ("Mt. Holly"), and one aluminum smelter in Grundartangi, Iceland ("Grundartangi").

They have constructed another facility in Iceland known as the Helguvik project, which has struggled in a competitive aluminum market. I’m sure Century Aluminum is delighted with these tariffs. After all – Make Iceland Great Again!

Begun the Trade War Has

Master Yoda at the end of the second of the Star Wars prequels:

Begun the clone war has

Exactly the right sentiment with this news:

President Donald Trump is expected to announce new tariffs on imports of steel and aluminum as soon as Thursday, a move that could trigger significant economic repercussions. "Our Steel and Aluminum industries (and many others) have been decimated by decades of unfair trade and bad policy with countries from around the world," Trump tweeted Thursday morning. "We must not let our country, companies and workers be taken advantage of any longer. We want free, fair and SMART TRADE!"

I wonder if the agriculture sector will see this as smart:

The tariffs would most likely trigger retaliation from other countries. China is already looking into restrictions on US exports of sorghum and soybeans, both of which are important crops for American farmers. Additionally, the European Union was said to be mulling tariffs on US agricultural products like cheese and bourbon.

Up Against the Wall, NRA!

A Kennedy-Reagan-Trump Fiscal Policy?

Heather Long reports that the White House economists have no clue about the history of U.S. fiscal policy:

President Trump’s policies are driving an economic turnaround that puts him in the company of transformative presidents such as John F. Kennedy and Ronald Reagan, White House economists said Wednesday as they unveiled their first “Economic Report of the President.” The report presents a highly optimistic view of the economy’s current condition and future course, with growth predictions that exceed most nonpartisan economists’ expectations. Economists also caution the White House’s efforts to juice growth could cause the economy to overheat and then careen into a downturn.

Brad DeLong asks whether his latest on fiscal policy and long-term growth belongs in the next edition of Martha Olney's and his macroeconomics textbook? While I say it should, permit me to quote the relevant passages after I inform these clueless White House economists about fiscal policy during the 1960’s and under Reagan as I noted over at Brad’s place:

We did get that 1964 tax cut right after Kennedy died and we did ramp up defense spending for Vietnam. In December 1965 Johnson's CEA had the good sense to tell him that we had gone overboard with fiscal stimulus. Alas we got the 1966 Credit Crunch anyway followed by an acceleration of inflation when the FED backed off on its restraint. Reagan gave us a similar fiscal policy but the Volcker FED did not back off its tight monetary policy so we got the mother of all crowding out - high real interest rates for years and a massive currency appreciation. Glad to see that Trump's CEA has compared this fiscal fiasco to the previous mistakes. Oh wait - Kevin Hassett thinks this is good fiscal policy. It seems the current CEA is as stupid as the President it advises!

OK – now that I’m done with my rant and little history lesson, let’s hear from Brad:

In late 2017 and early 2018 the Trump administration and the Republican congressional caucuses pushed through a combined tax cut and a relaxation of spending caps to the tune of increasing the federal government budget deficit by about 1.4% of GDP. These policy changes were intended to be permanent. Not the consensus but the center-of-gravity analysis by informed opinion in the economics profession of the effects on long-run growth of such a permanent change in fiscal policy would have made the following points: 1. The U.S. economy at the start of 2018 was roughly at full employment, or at least the Federal Reserve believed that it was at full employment and was taking active steps to keep spending from rising faster than their estimate of the trend growth of the economy, so a long-run Solow growth model analysis would be appropriate. 2. The economy's savings-investment effort rate, s, has two parts: private and government saving: s=sp+sgs=sp+sg. 3. The private savings rate spsp is very hard to move by changes in economic policy. Policy changes that raise rates of return on capital—interest and profit rates—both make it more profitable to save and invest more but also make us richer in the future, and so diminish the need to save and invest more. These two roughly offset. 4. Therefore, when the economy is at full employment, changes in overall savings are driven by changes in the government contribution: Δs=ΔsgΔs=Δsg. 5. And an increase in the deficit is a reduction in the government savings rate.

Brad continues using the Solow growth model to demonstrate how the latest fiscal fiasco would lead to less capital per worker over time reducing steady state output, which is what we witnessed in the 1980’s. We have been asking the same question since 1981 – how can anyone argue that a fall in national savings is good for long-term growth? We still have not received a coherent answer.

Will Boilerplate Kill the Invisible Hand?

Will Automation Kill Our Jobs? by Walter E. Williams appeared in the Gaston Gazette, Charleston Gazette-Mail, Daily Tribune, Frontpage Mag, Richmond Times-Dispatch, Townhall, Holmes County Times-Advertiser, National Interest, Rocky Mount Telegram and CNS News (not to mention the Dogpatch Völkischer-Beobachter). It features the following cutting edge (& pasting) analysis:

People always want more of something that will create a job for someone. To suggest that there are a finite number of jobs commits an error known as the "lump of labor fallacy." That fallacy suggests that when automation or technology eliminates a job, there's nothing that people want that would create employment for the person displaced by the automation.

Williams is a professor of economics at George Mason University. His column is syndicated by the Creators Syndicate. Apparently there is still a HUGE market for cuts 'n pastes of well-aged boilerplate. The Trump-bots on twitter eat this shit up.

Let's see what Professor Williams thinks of Adam Smith's lump of labor fallacy:

Dear Professor Williams, 

I was interested to read the other day your account of the "lump of labor fallacy" in the Charleston Gazette-Mail. As you pointed out, the number of jobs is unlimited as long as there are people who want more of something that requires work to be done. 

I had previously read a statement by a famous economist claiming that the number of workers who can be employed cannot exceed a certain proportion of the capital of the particular society the workers live in. I am wondering if you can clarify for me whether that economist has committed a lump of labor fallacy by suggesting that the number of jobs is limited by something other than the demand for goods or services, which -- for all intents and purposes -- is unlimited, as you have pointed out.

Furthermore, I am intrigued by the idea that people contribute to the public good without intending to when they are only pursuing what they perceive as their own self-interest within a free and competitive system of market exchange. Would such a contribution to the public good result even if their notion of their self-interest was "erroneous," as in the lump of labor fallacy? 

For example, if truck drivers were afraid that self-driving vehicles would put them out of work, they would presumably be acting in their self-interest if they made campaign contributions to candidates who promised to ban such vehicles on the grounds that they would create unemployment. Such contributions would be free speech, as defined by the U.S. Supreme Court. But wouldn't such a ban, at least on those grounds, be based on a fallacious assumption? 

Finally, I have been wondering who actually said that there is "a fixed amount of work to be done" or that "there is only a certain quantity of work to be done." I have seen numerous rebuttals to such a view but no positive statements of it from representatives of organized labor. I would be grateful if you could identify sources who actually commit the lump of labor fallacy in plain words.

Sincerely, 

Tom Walker

Divide and Rule

There was a time, one I can remember from when I was growing up (the 1950s and 60s), when being a liberal meant you wanted certain rights and benefits for everyone, at least ostensibly.  We had Social Security because everyone should have a basic pension when they retire, and all disabled people need to be cared for.  Freedom of speech was for everyone, even those horrible Nazis in Skokie.  Liberals wanted national health insurance so everyone could afford medical care, but settled for Medicare, a universal program for seniors.  Protestors like me were not against the rhetoric of universalism but the hypocritical practice, where blacks, Mexican and Filipino farmworkers and poor single moms were denied their share.  That was then.

Now, liberals are concerned about minorities and the poor.  They are against privilege, which is defined as not being a minority or poor.  Public programs are designed to give assistance to the most oppressed and not waste their resources on those who have the privilege to fend for themselves.  A poster child for the new politics is higher education.  Liberals want bigger subsidies, like more Pell Grants, for the poorest students and those who self-select by enrolling in community college.  They were distraught at Bernie Sanders’ call for free public higher ed for all, since that would siphon off scarce resources for the benefit of privileged, nonpoor families.  From their perspective, this was proof that Bernie and his ilk were unwoke: unaware of the scourge of privilege, they even wanted public support for it.

In fact, nothing is more important for the future of progressive politics than a return to universalism.  If you doubt this, read this powerful reportage in the New York Times on the divisions opened up by Obamacare.  It describes two women, one working part-time and living below the poverty line who gets ample, free health coverage, the other working full-time in a middle class job who is stuck with monthly $1000 premiums and a big deductible.  That’s not a bug but a feature: the program was set up to focus its support on those at the bottom and charge full freight for everyone else.

The effect is to divide the working class into two groups, poor winners and nonpoor losers.  The politics are toxic, as you might expect.  (Yes, the reporter found a Democrat to represent women below the poverty line and a Republican for women above it, which gives it an unfortunate air of exaggeration, but the logic of the comparison remains compelling.)  It is also bad social policy, since at the margin households making $80,000 a year (the middle class example) can also skimp on care if the financial pinch is too much.

There is an interesting analysis of this phenomenon in “When Exclusion Replaces Exploitation: The Condition of the Surplus-Population under Neoliberalism” by Daniel Zamora.  He points out that modern politics has become a contest between a Right that demonizes poor people, minorities and immigrants as living off the hard work of decent folk (the role formerly assigned to the capitalist class by socialists) and a Left that valorizes these same oppressed groups and regards everyone else as privileged.  They differ over which side they take, but they both see the cleavage between the bottom and the middle as the essential point of departure.  I’m not on board with his solution (explained here), but he is spot on about the problem.

I wish it were enough to just espouse a universalist progressive agenda, but we are so deep in the muck today that we have to go beyond this.  We should be as clear and outspoken as possible about the moral and political dead-end to which “targeted” liberalism has taken us.

Paying for Health Care Over Time

Simon Wren Lewis illustrates the long-run government budget constraint with this tale:

There are many reasons why, outside of a recession, deficits that, if sustained, would steadily increase the debt to GDP ratio may be bad for the economy, but let me give the most obvious here. For a given level of government spending, interest on debt has to come out of taxes. The higher the debt, the higher the taxes. That is a problem because high taxes discourage people from working, and it is also unfair from an intergenerational point of view. This last point is obvious if you think about it. The current generation could abolish taxes and pay for all spending, including any interest on debt, by borrowing more. That cannot go on forever, so at some point taxes have to rise again. A whole generation has avoided paying taxes, but at the cost of future generations paying even more. As a result, unless there is a very good reason like a recession, a responsible government will not plan to sustain a deficit over time that raises the debt to GDP ratio. The problem though is that it is very tempting for a government not to be responsible. The current US government, which is essentially a plutocracy, wants above all else to cut taxes for the very wealthy, and if they do it without at the same time raising taxes on other people but instead by running a deficit they think they can get away with it. Democrats have every reason to say that is irresponsible, although of course the main thing they should focus on is that the last people who need a tax cut are the very rich.

In my discussion of a paper by Jeffrey Miron, I exemplified what he is saying here with the Reagan tax cuts for the rich and defense spending build-up, which may be a description to what Trump is doing now. As Simon admitted after this comment, borrowing to fund infrastructure investment is different:

But surely spending from borrowing and at least some taxation wouldn't necessarily have the same effect. An equilibrium could at least be sought at higher levels of borrowing and higher levels of economic activity. Particularly with spending on education of course (where in any case the intergenerational fairness argument is weaker).

I added a comment that the 1983 prefunding of Social Security benefits is another form of intergenerational equity where we build-up a trust fund to pay for our future retirement benefits – assuming of course that the Republicans do not squander it on more tax cuts for the rich. But let me tackle the issue of health benefits since my noting of the Baumol Cost Disease drew this appropriate response from Barkley:

The Baumol cost disease hits all labor-intensive services, including large amounts of government activities that are not health-related. But somehow the US has had this especially rapid rate of med cost rise not experienced in any other nation, sort of like our exceptionalism on mass school shootings. This is way beyond Bauumol cost disease.

I agree and more on this after noting Barkley’s other comment:

Miron is right that the main upward driver on the spending side is medical care, but somehow Miron does not seem to offer any hope that we can restrain its cost growth to the inflstion rate or even less.

We can and should reign in medical costs. As I see it – there are two issues that both impact how Federal health care payments evolve over time. One is the fairness issue sometimes known as universal health care. If we as a nation do the right thing and make sure health care is both accessible and affordable to all, it is likely that government funding of health care will take a greater portion of total health care spending. I guess we could leave this to the states like Paul Ryan wants to but then states tend to use more regressive forms of taxation. I would prefer a greater role played by funding via a progressive income tax system. Barkley’s point is that we pay a lot more per capita than other developing nations. This chart may not be the “chart of the century” but it is “excellent” as it traces total health care spending as a share of GDP since 1980 for both the U.S. and other nations. Whereas our ratio jumped from 8% in 1980 to near 17% now, other nations have only seen modest increases in their health care spending relative to GDP. So maybe the Baumol Cost Disease is a small part of the story but rising market power for health care providers is a serious problem for the U.S. but not other nations. Timothy Lee is right:

Most of federal and state budgets are spent on services — law enforcement, education, health care, the courts, and so forth — that are subject to Baumol’s cost disease. Government spending on these categories has grown inexorably in recent decades, and many conservatives see this as a sign that there’s something badly wrong with how the government provides these services. But Baumol’s work suggests another explanation: It was simply inevitable that these services would get more expensive over time, at least relative to private sector manufactured goods like televisions and cars. The rising cost of services is an unavoidable side effect of rising affluence generally. There’s probably no way to maintain our current standard of living while cutting the cost of these services back to the levels of the 1950s.

Of course this also means governments need to crack down on market power in these sectors. The relative price of a string quartet’s performance may have to rise over time but there is no reason to pay the musicians twice the market salary. Maybe doctors should be properly compensated even as their productivity does not rise with manufacturing sectors but we need to find a way to hire U.S. doctors at salaries closer to what doctors receive in the rest of the developed world. But let me finish with what really galls me about Jeffrey Miron’s paper:

Given those projected values for real GDP, I construct projections for revenue and discretionary spending by assuming they always equal 17.3 percent and 8.2 percent of real GDP, respectively. The values equal the average revenue-over-GDP and discretionary-spending-over-GDP ratios, respectively, between 1975 and 2014. …Figure 20 suggests that even with tax revenue substantially above its postwar average, and assuming no effect on growth, fiscal imbalance would still be large. If higher taxes have even a modest negative impact on growth, tax increases have no capacity for restoring fiscal balance.

To say we cannot raise the ratio of taxes to GDP much above 17.3% is just absurd. We can if we have the political will. But Republicans either argue this is not fair or there is some Art Laffer magic wand. As an economist, I reject the latter. But on the politics, let’s think of a young man who just got married and is expecting a family of children. Inevitably some parents will face rising health care costs unless they are lucky. I would hope this father would not put going out on the town and expensive vacations ahead of the health care needs of his family. For a nation – rising health care costs over time need to be funded and most hopefully by an equitable Federal government even if the very rich get to take less vacations in the Hampton or fewer shopping sprees on Rodeo Drive.

Shorting China

I just saw “The China Hustle” as part of the Portland International Film Festival.  It’s a very (very) slick documentary about the listing of fraudulent Chinese companies on US exchanges during the post-financial crisis era.  The companies were mostly real, but their financial data were fictitious, although given the stamp of approval by the SEC, investment banks, specialty law firms and the big four accounting firms.  The movie might be called “The Medium Size Short” because it centers on several market players that have righteously fought this upwards-of-$50 billion fraud by shorting it.

I think it does a great job of explaining the financial mechanisms at work (especially the short itself), and it holds your attention with lots of jump-cutting, extreme facial closeups, brightly lit à la Errol Morris, and the other techniques of zingy video journalism.  It would make a great classroom enhancer in courses on finance or political economy, provided you’ve got a 90-minute block of time to spare.

I have two qualms with the content.  First, it makes the case that the victims of this crime are the millions of small investors and pension-savers, people like you and me.  And it’s true that many pension funds and ordinary folks were ripped off.  But the real indictment is this: the financial sector has doubled its share of the economy, and its ballooning profits are a major contributor to the rise in inequality.  What are we paying for?  As this film clearly shows, we are definitely not buying better information or a more productive allocation of capital, at least not in the sectors of the market it shines its light on.  On the contrary.  We are being fleeced by sharp operators whose only reason for existence is that they can stash away their cut of the loot before anyone learns enough to stop them.  That’s a pretty big lesson, in my book.

Also, the film ends by suggesting that the entire market capitalization of the major Chinese firms—they point to Alibaba in particular—may be fraudulent, and that we’re on the verge of another 2008-style market meltdown.  I’m not a specialist in Chinese equities, so I won’t take a position on this.  Nevertheless, it’s clear that there is a lot of genuine economic growth going on in China, and some of it must be serving to support asset values.  It is unlikely that the entire capitalization of Chinese firms will prove to be as flimsy as that of the smaller pseudo-firms exposed in the film.  Of course, between full current market value and zero there’s a lot of potential space for unpleasant surprises.

A Critical Review of Jeffrey Miron’s Call to Slash Entitlements

I accused John Cochrane of incoherent babbling on the Federal deficit issue noting his update where he flip flopped:

He went from fiscal policy being sober to we are in dire straights just like that! Oh my the sky is falling. We have to take away those Social Security benefits that my generation have been paying into for 35 years. We cannot afford Federal health care spending. After all those tax cuts for the rich can never be reversed. Yes John Cochrane is part of the Starve the Beast crowd even if granny starves from these supposedly required reductions in transfer payments.

But let’s note why Cochrane flip flopped in his update:

Jeff Miron wrote to chide me gently for apparently implying the opposite, which is certainly not my intent. One graph from his excellent "US Fiscal Imbalance Over Time".

Having read this Cato paper, it is time for my critical review that I promised. The review will start with the technical finance which in one way is a lot better than Cochrane’s rants but still troubling in certain ways. I will next turn to the policy if not political issues where this paper is even worse than Cochrane’s update. Beware – we will have to cover a fair amount of numbers but I hope to keep this within the context of my present value model:

Let g = the ratio of Federal expenditures excluding interest payments to GDP and t = the ratio of Federal taxes to GDP. If we assume a steady state model, the present value of future primary surplus is simply V = (t- g)/(r – n), where r = the real interest rate and n = the long-term growth rate. As long as V is at least as great as the debt/GDP ratio, we are not on the bankruptcy path that economists were talking about when Reagan initiated his 1981 fiscal fiasco. Tax rates were massively cut and defense spending spiked and had this fiscal stance continued forever, then the debt/GDP ratio would have exploded. Of course it didn’t as there were future tax increases and the peace dividend.

Miron is using the same basic model, which he expresses as:

Fiscal Imbalance = Present Value of Future Expenditure – Present Value of Future Revenue + Outstanding Debt

What I like about this equation is its focus on future spending and revenue not historical decisions which can be summarized as the current level of debt in terms of our model. Cochrane’s rant was a bit weak in this regard. May I suggest Cochrane rent the 1989 movie and check out this scene as the Joker gets basic finance! While I may quibble with Miron with respect to his forecasts, my big problem the use of nominal figures to draw his graph – which is far from “excellent”. Note his measure doubled in nominal terms since 2000 but so has nominal GDP (higher prices, more people, and higher income per person). Which is why this title and introduction is misleading:

U.S. Fiscal Imbalance over Time: This Time Is Different. The U.S. fiscal imbalance—the excess of what we expect to spend, including repayment of our debt, over what government expects to receive in revenue—is large and growing.

Evsey Domar introduced “The Burden of Debt” in 1944 by expressing everything as a percentage of GDP. While his approach was first order differential equations, our present value approach done properly is easier to follow and perhaps more policy relevant. But let’s be clear – Domar was trying to figure out how high tax rates needed to be to cover past fiscal decisions captured in the debt/GDP plus the present value of expected future government spending. We will return to the policy implications of this shortly. Back to Cochrane’s ranting:

The US fiscal situation is dire. The debt is now $20 trillion, larger as a fraction of GDP than any time since the end of WWII. Moreover, the promises our government has made to social security, medicare, medicaid, pensions and other entitlement programs far exceeds any projection of revenue.

Could he have admitted that nominal GDP now is about twice that of the circa $10 billion per year level in 2000? Back then the debt to GDP ratio was 54% while it is 104% now. Back then the nominal interest cost was 3.5% of GDP which is the same ratio as it is now. Yes the debt ratio has almost doubled but we see both lower inflation rates as well as lower real interest rate. One the things that might puzzle you is how Cochrane paints 2000 as a period of large primary surpluses whereas Miron suggests it was a period of fiscal imbalance. This is where forecasting comes in as it might be naïve to assume that the current levels of g and t are good means for forecasting the future. But before we get into the forecasting which involves politics, let’s talk a bit about r and n by going back and poking a little fun at DOW 36000:

Imagine the whole U.S. corporate sector as if it were a single company. And imagine that this company - and the economy - will grow steadily forever, say at 5 percent nominal (3 percent real plus 2 percent inflation). Suppose also that the interest rate is 6 percent. What is this company worth? The answer should be that it is worth 100 times dividends.

Krugman was assuming real growth = 3% and a real interest rate = 4% back in 2000. Sounds about right for then but I would lower both of these by 1% for today. In either case, the present value of a primary surplus would be 100 times the current surplus in a steady state model. In other words, we would have needed a primary surplus equal to 0.55% of GDP back then but now we would need a primary surplus equal to 1.05% of GDP now. Permit me to quibble a bit with Miron’s assumptions:

I create projections for real GDP, starting in 1965 and going forward as far as necessary. Those projections are calculated by taking actual real GDP in 1965, followed by 2.55 percent growth every year thereafter….All present values assume a real interest rate of 3.22 percent, which equals the average real interest rate on 30-year long-term government bonds in the United States over the past four decades.

Historical averages do not strike me as a reasonable approach to forecasting future long-term growth or interest rates. But this is just a quibble as we are not that far off in terms of our denominator (r – g) so let’s focus on the numerator that is expected cash flows. As I noted:

In 2017, g was 19.5% and t was 18.5% so maybe we should be more concerned especially since we have had another tax cut for the rich as well as a call for a larger defense budget.

Back in 2000 government spending including interest rates was only 19.5% so government spending excluding interest rates excluding interest rates was only 16%. Government revenues exceeded 20% of GDP. If these ratios were expected to continue forever, then one might get Alan Greenspan’s concern that we might pay off the national debt very quickly. Of course we did not and Miron suggests we should have known that government spending would rise over time. Glassman and Hassett’s glaring error in many ways was to have a very stupid model of expected cash flows as they pretended cash flows equal profits even as a firm has to invest some of its profits for new capital in a growing economy. And to think Hassett is now heads the CEA! Miron may be better at forecasting but we need to think about the politics of what he is arguing:

As of 2014, the fiscal imbalance stands at $117.9 trillion, with few signs of future improvement even if GDP growth accelerates or tax revenues increase relative to historic norms. Thus the only viable way to restore fiscal balance is to scale back mandatory spending policies, particularly on large health care programs such as Medicare, Medicaid, and the Affordable Care Act (ACA)… Despite widespread agreement that spending or tax policies must change, however, appropriate adjustments have so far not occurred. Indeed, many recent policy changes have worsened the U.S. fiscal situation. These changes include the creation of Medicare Part D ($65 billion in 2014), new subsidies under the Affordable Care Act ($13.7 billion in 2014), the expansion of Medicaid under the ACA (from $250.9 billion in 2009 to $301.5 billion in 2014), higher defense spending (from $348.46 billion in 2002 to $603.46 billion in 2014), increased spending on veterans’ benefits and services (from $70.4 billion in 2006 to $161.2 billion in 2014), and greater spending on energy programs (average annual spending was $0.52 billion over 1998–2002 but $11.43 billion over 2010–2014).

I’m not a big fan of using terms like mandatory versus discretionary spending preferring to look at defense purchases, nondefense purchases, Social Security payments, and health care benefits. Miron’s figure 9 shows Social Security benefits have risen to 5% of GDP but we knew this would happen back in 1983 when Greenspan chaired Reagan’s Social Security reform commission which led to a large increase in the payroll tax to prefund the Social Security Trust Fund. I guess Greenspan in 2001 had forgotten the notion to “think about the future” that so ably guided him in 1983. Paul Ryan and President Trump at times tells us that they do not want to take away the Social Security benefits that my generation has been paying for since we entered the workforce. Miron also notes:

Defense spending averaged 8.4 percent of GDP in the 1960s, 5.6 percent in the 1970s, 5.6 percent in the 1980s, 3.8 percent in the 1990s, 3.7 percent in the 2000s, and 4.2 percent in the past four years.

While the defense spending/GDP ratio fell below 4% at the end of Obama’s second term, Mitt Romney promised to keep at above 4% had he and Paul Ryan been elected in 2012. Which is odd since Ryan told us that total Federal purchases (defense and nondefense) would be limited to only 3.5% of GDP. President Trump has promised a large increase in defense spending so let’s get more realistic about nondefense purchases than the Ryan promise to run the rest of the Federal government on a budget of negative 0.5% of GDP. Nondefense purchases rose from 2.34% of GDP in 2000 to 3% of GDP in 2011 before falling back to 2.66% of GDP in 2017. While it is true that Trump wants to cut this ratio a bit, he has also promised to fixed the underinvestment in infrastructure . William Galston is not impressed with the Trump proposal:

But there is a void at the core of the administration’s plan: funding. Not only does the administration not specify where it will find the additional $200 billion of direct spending it calls for over the next decade, but also it makes what most experts regard as wildly unrealistic assumptions about the amount of state, local, and private funding this modest increment will spark. Although the word “leverage” is sprinkled liberally throughout the plan, hardly anyone believes that $200 billion federal dollars will produce an additional $1.3 trillion investment from non-federal sources, especially when state and local budgets are being squeezed by rising costs for education and health care.

Privatizing our toll roads was one fiscal trick used by certain states but that turned out to make their long-term financing worse, while their roads will likely be poorly maintained. States could pick up the tab if state taxes are raised in lieu of higher Federal taxes. Or are conservatives saying we should cut education spending as well as police protection? Speaking of healthcare, let’s return to Miron:

even projections that incorporate less rapid health care cost inflation still show Medicare and other health care expenditure growing faster than GDP by enough to make fiscal imbalance large…the main drivers of America’s fiscal deterioration appear to be the ever-growing costs associated with Medicare, Medicaid, and other health programs. Whereas Social Security has accounted for a relatively constant share of expenditure in proportion to GDP, Medicare and Medicaid costs have been growing as a ratio of GDP for the past four decades. This growth is what makes the country’s fiscal path unsustainable.

OMG – Federal spending on health care is out of control! Well no. We earlier discussed the implications of Baumol’s Cost Disease for relative prices of certain services nothing this from Timothy Lee:

Most of federal and state budgets are spent on services — law enforcement, education, health care, the courts, and so forth — that are subject to Baumol’s cost disease. Government spending on these categories has grown inexorably in recent decades, and many conservatives see this as a sign that there’s something badly wrong with how the government provides these services. But Baumol’s work suggests another explanation: It was simply inevitable that these services would get more expensive over time, at least relative to private sector manufactured goods like televisions and cars. The rising cost of services is an unavoidable side effect of rising affluence generally. There’s probably no way to maintain our current standard of living while cutting the cost of these services back to the levels of the 1950s.

During the 2012 campaign both Obama and Paul Ryan had plans to reign in the growth of Medicare spending with Ryan wanting to cut benefits to people leaving the obscene profits of the providers untouched as opposed to Obama wanting to expand benefits but reigning in this market power. But let’s be clear – we will spend as a nation more on health care as a share of GDP. The policy question is who pays for it. Ryan’s proposals on Medicaid are akin to Trump’s on infrastructure – force this burden on state governments and if they do not choose to raise their taxes, let the private sector pick up the slack. On both issues, the private sector does a poor job of providing services equitably. If we want an honest debate on fiscal policy these discussions from Cochrane and Miron fall miserably short in their arbitrary rejection of the possibility that we cannot raise taxes as a share of GDP. Let’s add that if the fiscal situation was so dire – why were conservative economists so eager to reduce taxes on the rich? And do not peddle that Laffer canard that reducing the national savings rate will lead to some growth miracle.

Fiscal Stability or Dire Straights: John Cochrane’s Latest Rant

At times John Cochrane babbles on incoherently on what should be a straight forward issue. This post is one example:

Once you net out interest costs, it is interesting how sober US fiscal policy actually has been over the years. In economic good times, we run primary surpluses. The impression that the US is always running deficits is primarily because of interest costs. Even the notorious "Reagan deficits" were primarily payments, occasioned by the huge spike in interest rates, on outstanding debt. On a tax minus expenditure basis, not much unusual was going on especially considering it was the bottom of the (then) worst recession since WWII. Only in the extreme of 1976, 1982, and 2002, in with steep recessions and in the later case war did we touch any primary deficits, and then pretty swiftly returned to surpluses.

I too advocate looking at the primary surplus. Cochrane is a finance professor so let’s make this simple. Let g = the ratio of Federal expenditures excluding interest payments to GDP and t = the ratio of Federal taxes to GDP. If we assume a steady state model, the present value of future primary surplus is simply V = (t- g)/(r – n), where r = the real interest rate and n = the long-term growth rate. As long as V is at least as great as the debt/GDP ratio, we are not on the bankruptcy path that economists were talking about when Reagan initiated his 1981 fiscal fiasco. Tax rates were massively cut and defense spending spiked and had this fiscal stance continued forever, then the debt/GDP ratio would have exploded. Of course it didn’t as there were future tax increases and the peace dividend. Cochrane takes us through the Great Recession:

Until 2008. The last 10 years really have been an anomaly in US fiscal policy. One may say that the huge recession demanded huge fiscal stimulus, or one may think $10 trillion in debt was wasted. In either case, what we just went through was huge. And in the last data point, 2017, we are sliding again into territory only seen in severe recessions. That too is unusual.

The Great Recession did demand huge fiscal stimulus – we got a tempered version of what was really needed. The last decade has taken the debt/GDP ratio to 100% but we have returned to near full employment so I do not get his 2 last sentences quoted. In 2017, g was 19.5% and t was 18.5% so maybe we should be more concerned especially since we have had another tax cut for the rich as well as a call for a larger defense budget. But then comes his update!

“The US fiscal situation is dire. The debt is now $20 trillion, larger as a fraction of GDP than any time since the end of WWII. Moreover, the promises our government has made to social security, medicare, medicaid, pensions and other entitlement programs far exceeds any projection of revenue.”

He went from fiscal policy being sober to we are in dire straights just like that! Oh my the sky is falling. We have to take away those Social Security benefits that my generation have been paying into for 35 years. We cannot afford Federal health care spending. After all those tax cuts for the rich can never be reversed. Yes John Cochrane is part of the Starve the Beast crowd even if granny starves from these supposedly required reductions in transfer payments. Give me a break!

All Economists Are Bastards -- Except Us

Peter Frase has a very interesting post up about the role of popular culture in legitimizing the police. Frase recounted a forum he attended with Alex Vitale  talking about his book, The End of Policing. In response to a question about why people believe that the function of policing is to maintain peace in the liberal order when its actual practice and history suggest otherwise, Vitale cited television cop shows like  as "a relentless machine for producing and reproducing the legitimacy of policing in the public mind."

This is what called to Frase's mind the perpetual plot line he calls "'ACAB-EU': All Cops Are Bastards, Except Us.":

The trope works by consistently portraying its central characters as liberal fantasies of the good cop–whether it’s the pseudo-scientists of CSI, the workaday victim-protectors of SVU, or the magical profiler-geniuses of Criminal Minds. At the same time, it makes a seeming concession to concerns about police misconduct, by constantly putting its protagonists in conflict with "bad cops" and their enablers, whether it be a rapist Corrections Officer or a corrupt small town department whose cover-up leads all the way to the Governor.

 Of course this trope works for politicians too. And economists.