The Final End Of The As-Is/Red Line Agreement

In London yesterday visiting Saudi Crown Prince, Mohammed bin Salman (MbS) allowed the signing of a set of trade memoranda with various British companies, including buying Typhoon aircraft, and many other things, 18 such deals, although some sources say only 14, total value maybe about $90 billion, although much of that already in the works and in the end may amount to what the $110 billion plus deals he agreed to with Trump, not much at all.  One large item not in the deal, a promise to let London handle the upcoming massive IPO for 5% of ARAMCO, with both New York and Riyadh itself still in contention for that one, the main claim to "privatization of the Saudi economy" that its PR machine has been relentlessly spinning about loudly for some time now.  I continue to forecast that wherever it is done, it will end up being a Saudi insiders deal to get some shares of ARAMCO into MbS approved private princely hands.

But the deal that triggers this post is one that signals the final end of two closely related deals made in 1928 between the leading oil companies of the day, the As Is Agreement and the Red Line Agreement.  The first is the more important one, although the latter involved the dramatic drawing of a red line on a map by Calouste Gulbenkian that basically supported the As Is one, although involving surface holding companies.  The As Is one was made at a secret meeting held at Achnacarry Castle in Scotland, after a round of grouse hunting, between the world's three most powerful oil CEOs, Sir Henri Deterding, host and owner of the castle and Chairman of Royal Dutch Shell from 1900-1936 (created by him by merging his Royal Dutch shipping company with Marcus Samuel's Shell Company based in the Dutch East Indies, now Indonesia, originally actually dealing in shells but then in oil production), Sir John John Campson, Chairman of then Anglo-Persian Oil Company, which became Anglo-Iranian Oil Company in 1935 when the nation showed its alliance with Hitler and his Aryan racial master race theory (and was briefly nationalized by Mossadegh in Iran in 1951, only to have that undone by the mostly US Project Ajax, which let some US oil minors in) and which is now British Petroleum (and was 50% owned by the British govermment from WW I when Churchill nationalized it to guarantee oil for the British navy until Thatcher sold off the "family silverware" shares in the 1980s) with BP responsible for the Deepwwater oil spill in the Gulf of Mexico some years ago, and finally Walter Teagle, Chairman of New Jersey Standard, the largest successor to Rockefeller's Standard Oil, which would later become Exxon after being Esso as a brand, and more recently would buy up the second largest successor, Mobil, originally New York Standard.

They divided up the Middle East among them, with the Red Line emphasizing it, with APOC/AIOC/BP getting Persia Iran mostly and Royal Dutch Shell basically getting Iraq and Kuwait, all these holdings nationalized by the 1970s.  For our purposes here, the crucial matter is that Saudi Arabia, not then definitely known to have any oil, was granted to Jersey Standard, aka Esso aka Exxon.  In 1938 petro-geologists from the company found oil and cut the first deals with then King Abdulaziz to start production, which did not really take off until after his death in the early 1950s, although it was co-founder (with Venezuela) of OPEC in 1960, and is and long has been and will continue to be the world's largest exporter of oil.  ARAMCO was the company, originally Jersey Standard (Exxon), New York Standard (Mobil) , Califonrnia Standard (Chevron), and the now defunct Texaco.  By the end of the 40s, the Saudis hasd intiated a 50-50 profit sharing agreement.  By the time of the first oil price shock in 1973 that they initiated, they had bought out these US companies, and while everybody calls it ARAMCO (Arabian-American Oil Company), it is officially the Saudi Arabian Oil Company now.  Nevertheless, the old US companies continued to get contracts to do various things for and with ARAMCO.

So, in London MbS has allowed a British breach of the 90-year old As Is/Red Line Agreement from 1928.  For the first time a Briitsh-based oil company will get in on the action in Saudi Arabia, in this case, good old Royal Durtch Shell, which is really part British part Dutch (the Dutch royal family still holds shares, I unserstand).  They are going to be brought in, reportedly, to help with developing shale production of natural gas, apparently on the fringes of the al-Ghawar field, by far the largest oil pool in the world, responsible currently for about 4-5% of world oil production.  This may yet not come to pass, but it does indeed mark the final end of the 90 year old agreement that said oil production in Saudi Arabia was strictly for the American oil companies (among non-Saudi ones).  Time passes on.

Barkley Rosser

Basil Moore dies

I have just learned that prominent Post Keynesian economist, Basil Moore, died yesterday.  I do not know of what or how old he was, although he retired over a decade ago.  He is best known as the author of Horizontalists and Vericalists, in which he strongly argued for the endogeneity of money. In more recent years he had become interested in dynamic complexity economics.

He long taught at Wesleyan in Connecticut.  In the final years of his career he taught at Stellenbosch University in South Africa, his wife, Sibs, being from there, and they continued to live there after he retired.  He will be missed by many, including me.

Barkley Rosser

Cochrane Fails to Make His Case for the Trump Tax Cut Again

John Cochrane recently noted:

Stock Buybacks Are Proof of Tax Reform’s Success… A short oped for the Wall Street Journal here on stock buybacks. As usual, they ask me not to post the whole thing for 30 days though you can find it ungated if you search.

I did search and found this. Does the Wall Street Journal get the fact that rebutting weak arguments against a policy are not exactly making an affirmative case for the policy? Permit me to note two places where Cochrane and I agree:

echoing illogical claims is not a contribution to that debate. Granted, Republicans invited the attack by trumpeting worker bonuses. But a bad argument for the cut does not redeem a worse counterargument.

Well thanks for that and now an argument from the left that is also weak:

To cast corporate tax cuts as a “scam” and redistribution to the wealthy, opponents have shifted their focus to the evils of stock buybacks and dividends…Share buybacks and dividends are great. They get cash out of companies that don’t have worthwhile ideas and into companies that do. An increase in buybacks is a sign the tax law and the economy are working. Buybacks do not automatically make shareholders wealthier. Suppose Company A has $100 cash and a factory worth $100. It has issued two shares, each worth $100. The company’s shareholders have $200 in wealth. Imagine the company uses its $100 in cash to buy back one share. Now its shareholders have one share worth $100, and $100 in cash. Their wealth remains the same.

When I read this argument over at Cochrane’s blog, I decided to provide this link:

Merton H. Miller liked to tell a joke about Yogi Berra, the famous baseball catcher. Berra once told his trainer that he was particularly hungry, and he instructed him to cut his pizza into 12 pieces instead of six. The quip illustrated vividly the celebrated theorem about capital structure that Miller devised with MIT’s Franco Modigliani and published in 1958. As every finance student is taught, the Modigliani-Miller theorem states that a firm’s value is independent of how it is financed, much like the size of a pizza is independent of how you slice it. The two researchers published another landmark paper three years later, the same year in which Miller—who would go on to win the 1990 Nobel Memorial Prize in Economic Sciences—moved to the University of Chicago Graduate School of Business (now Chicago Booth). “Dividend Policy, Growth, and the Valuation of Shares,” which appeared in the Journal of Business, told essentially the same story as its predecessor paper but using a different mechanism.

Cochrane rebuttal of the buybacks argument is simply the other Miller and Modigliani proposition. I sometimes wonder why a professor of finance does not simply say so. But my main complaint with his Wall Street Journal oped is how he made – actually did not make – the case for the reduction in the corporate tax rate:

Wouldn’t it be better if the company invested the extra cash? Wasn’t that the point of the tax cut? Perhaps. But maybe this company doesn’t have any ideas worth investing in. Not every company needs to expand at any given moment. Now suppose Company B has an idea for a profitable new venture that will cost $100 to get going. The most natural move for investors is to invest their $100 in Company B by buying its stock or bonds. With the infusion of cash, Company B can now fund its venture. The frequent rise in stock price when companies announce buybacks proves the point. In my example, Company A’s share price stays fixed at $100 when it buys back a share. But suppose before the buyback investors were nervous the company would waste $40 of the $100 cash. Imagine an overpriced merger or excessive executive bonuses. Not every investment is wise!

Hold on a second. Company A does not invest more on its business regardless of what the corporate tax rate is whereas Company B wanted to invest more in its business even before the reduction in the corporate tax rate. OK! But in a Miller-Modigliani world, company B would have all sorts of means for financing the new investment even without Company A’s assistance. So where in this oped has Cochrane make his alleged case that the new tax law will increase investment demand? Is this it?

The economic logic of the tax cut is to create good incentives for profit-maximizing management teams—not to “trickle down” cash to workers from philanthropic management.

What exactly is this logic again? Yes company B will get to keep more of its cash flows with a lower tax rate but then it also bears more of the systematic risk. Furthermore, the general thrust of Trump’s fiscal policy is to reduce national savings even as it allegedly may shift the investment demand schedule outwards. Brad DeLong casts this argument in terms of the standard Solow growth model:

One thing we in the academy can do is to explicitly make bulls--- deduction an explicit student learning goal. For example: We ask students to do practice problems using the Solow growth model on paper, and then to reproduce the analysis and draw the graphs on the exam. But the problem is that after the final exam students are very unlikely to ever be asked to do anything similar again. If Intermediate Macroeconomics is to be useful—if its learning goals are to be worth anything—it is because it will put in the back of your brain stuff so that when they in the future read things like

He was referencing:

the Nine Unprofessional Republican Economists who placed their letter in the Wall Street Journal

And it seems that this same Wall Street Journal published the latest non-case from John Cochrane.

Put the "Stone" Back in Estonia

From here.  Hat tip: Naked Capitalism.

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.