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Wednesday, April 18, 2007

Alesina and Ichino: Women Should Pay Less Tax

Alberto Alesina of Harvard University and Andrea Ichino of the University of Bologna argue that optimal taxation requires men to be taxed more than women:

Why women should pay less tax, by Alberto Alesina and Andrea Ichino, Commentary, Financial Times: Normally, free-marketeers and those who are worried about the efficiency costs of taxation are in opposite camps from those social activists who believe you need extensive government intervention to achieve a range of social goals. Here is a policy proposal that should make the two camps agree: reduce income taxes on women and increase, by less, income taxes on men.

As surprising as it may look, this can be done while keeping total tax revenue constant and reducing average tax rates. Thus, this policy would at the same time reduce overall tax distortions and increase women’s participation in the labour force. It would achieve similar goals to affirmative action policies, quotas or subsidised childcare and could substitute for those policies. It would also make gender discrimination more costly for employers and would be fair because it would compensate women for bearing the brunt of maternity and for the fact that the possibility of having children can negatively affect their career prospects.

How is it possible to achieve the miracle of raising taxes on men by less than the reduction on women while also holding tax revenue constant? The answer is well known to any graduate student in public finance. The supply of labour of women is more responsive to their after-tax wage, so a reduction in taxes increases the labour participation of women substantially. Men’s labour supply is more rigid, so an increase in taxes does not reduce their labour supply by much, if at all. Ergo, for a given tax cut on women, with a smaller tax increase on men, one maintains the same total revenue with fewer tax distortions. This is simply an application of the general principle of public finance that goods with a more elastic supply should be taxed less. Our computations, available in our working paper, Gender Based Taxation, suggest that the difference in tax rates across gender that would be implied by our proposal ... could be quite large, especially in countries where the labour participation of women is not as high, such as the Nordic countries. ...

In the long run, gender-based taxation may contribute to changing the traditional division of labour within the family, which currently encourages men to work more in the market and women more often at home. If and when a change happens (and many social activists consider that a desirable goal), the response of male and female labour supply ... may become less different from each other... At that point, one may need to reconsider the differences in tax rates, precisely as the basic principles of optimal taxation suggest.

In conclusion: would it be unfair for the fiscal authority to treat women and men differently? We do not believe so. There is nothing more hypocritical than to invoke equal treatment in some areas (taxation) for those who are not treated equally in many other areas (the labour market; sometimes in the family allocation of tasks, such as rearing children or caring for elder family members). ... And do not forget that a large part of the redistribution of the tax burden implied by this proposal would occur within the same family: the husbands of married women who choose to work would also benefit from their wife earning a higher take-home salary.

    Posted by on Wednesday, April 18, 2007 at 12:33 PM in Economics, Taxes | Permalink  TrackBack (0)  Comments (41) 

    New Data Cause Economists to Reconsider Globalization

    See here.

      Posted by on Wednesday, April 18, 2007 at 11:03 AM in Economics, International Trade | Permalink  TrackBack (0)  Comments (6) 

      Market Failure in Everything: The Lack of Antitrust Enforcement Edition

      Is the Justice Department's antitrust division too reluctant to take steps to ensure markets are reasonably competitive?:

      For Consumers, the Raw Deal by Steven Pearlstein, Washington Post: The Bush administration may have failed in its efforts to roll back Franklin Roosevelt's New Deal, but it's racking up more success with Teddy Roosevelt's Square Deal. Health and safety regulation. Labor protections. And certainly the centerpiece of progressive-era economic policy, the antitrust law.

      It should tell you something that when Sallie Mae, the big kahuna in the college loan business, agreed this week to be bought by a group that included two of its three biggest rivals, Bank of America and J.P. Morgan, the question of whether this would reduce competition barely came up. Estimates vary, but the merged company would control 25 to 40 percent of the college loan business. ...

      Ten years ago, there was little doubt this transaction would have faced an uphill fight. Not only would regulators have found the combined market share troubling, they would have worried about how the three players would use their clout to drive out small competitors, prevent new ones from entering and punishing those who got too aggressive about price-cutting. They would have worried about Sallie & Friends spreading around even more largesse to get themselves onto colleges' preferred-lender lists. Or that the combined company would have made it harder for competitors to package loans and sell them to investors.

      But these days, antitrust enforcement has become so lax that even lawyers who might have questions about a deal are advising clients to give it a try. That was one of the conclusions reached by two well-known academics, Jonathan Baker of American University and Carl Shapiro of the University of California at Berkeley, in a paper presented yesterday at an antitrust conference organized by Georgetown University Law Center.

      Baker and Shapiro asked 100 of the country's top antitrust lawyers whether mergers between firms in the same industry are more likely to be approved than they were a decade ago. On a scale of 1 to 5, with 5 being "significantly more favorable," the average score was 4.9.

      And there's good reason for the changed perception. Analyzing the percentage of proposed mergers and acquisitions that have been challenged by regulators, Baker and Shapiro found the rate had fallen only slightly at the Federal Trade Commission but by more than half at the other agency that reviews proposed deals, the Justice Department's antitrust division.

      Robert Pitofsky, a former FTC chairman, opened the conference by asking whether the pendulum had swung too far -- from antitrust enforcement that interfered too much in business dealings to enforcement that interfered too little. From the papers and discussions, there was a general feeling that it had.

      Among the cases frequently cited was the Justice Department's approval of the recent merger of Whirlpool and Maytag, with a combined market share of 70 percent, which rested largely on the premise that because an Asian manufacturer had gained a toehold in the U.S. market, it and other foreign companies would provide sufficient competition.

      To the surprise of many, the Bush Justice Department tried to block the merger of business software rivals Oracle and PeopleSoft. But even that effort was overturned by Judge Vaughn Walker of U.S. District Court in Northern California. ... Judges like Walker, and regulators like Justice Department antitrust chief Tom Barnett, have adopted the same kind of rigid, ideological approach that liberal judges and regulators took until the 1980s...

      This is a view unsupported by economic theory or real-world evidence. And if allowed to prevail, it threatens to suck the diversity, vibrancy and innovative potential from what has been the world's most competitive economy.

      I don't think it would hurt, and it might even help quite a bit in some instances, if a little more attention was focused on the degree of competition present in some markets.

      Update: From the WSJ, an econoblog looking at whether allowing manufacturers to set minimum prices at the retail level hurts or benefits consumers. Two antitrust economists, F. M. "Mike" Scherer, former chief economist at the Federal Trade Commission, and Larry White, a former director of economic policy at the U.S. Department of Justice's Antitrust Division to discuss the economic core of the case.

      Update: Jim Hamilton on patent protection.

        Posted by on Wednesday, April 18, 2007 at 01:42 AM in Economics, Market Failure | Permalink  TrackBack (0)  Comments (33) 

        How to Fill All That Spare Time

        This is what's been keeping me busy:

        Click to enlarge

        It's a simulated loss function for a New Keynesian model that allows for a delay between policy and the reaction of macroeconomic variables, e.g. as described by Woodford (each of the 441 nodes represents 25,000 simulations). The loss, which is a function of the variance of output and the variance of inflation in this particular case, is shown for various values of the parameters of the monetary policy rule including the classic Taylor rule values. If all goes according to plan, and it usually doesn't, I hope to have more to say about this soon.

        Click to enlarge

          Posted by on Wednesday, April 18, 2007 at 01:17 AM in Economics | Permalink  TrackBack (0)  Comments (4) 

          Do's and Don'ts

          Speaking of presidential advisers, Robert Waldmann has some wise advice for Republican candidates:

          Very Dumb New Right Wing Talking Point, by Robert: Three cases make a syndrome but two are plenty for a blog post. The latest idiotic right wing talking point is that the tax code is too progressive and has gotten more progressive since Reagan was elected. This insanity appears on the WSJ editorial page (see Chait slice and dice Fleisher) and see Jared Bernstein attempt to seize defeat from the jaws of victory discussing Larry Kudlow's show. This claim is dumb in two ways. First it is, of course, false. Second, they really really don't want to go there.

          Let me give a bit of advice to Republicans.

          Talk about
          statistics no
          anectdotes ok
          Bush no
          Iraq no
          WMD no
          Democracy promotion no
          the surge no
          victory no
          terrorism ok
          Pelosi no
          health care no
          The French yes
          French health care no
          Hillarycare no
          the veterans' admin no
          Walter Reed no
          HMO's no
          Medicare plan D no
          big Pharma no
          the postal service finally you got it
          Cheney no
          Arabs yes
          Rove no
          the average American yes
          the median American no
          Islam yes
          the average tax burden yes
          government spending no
          the deficit no
          the bridge to nowhere no
          Sunni Islam no
          Social security no
          socialism yes
          Shi'ite Islam no
          law and order yes
          the rule of law no
          Class war ok
          tax progressivity No. Never. not ever. NO. Change the subject. Talk about Abramoff. Talk about Katrina. Do not admit you know what the words mean. Tell jokes about Cheney with a shot gun. Anything but tax progressivity. If the American people start thinking about tax progressivity, your candidate will finish fifth after Patrick Buchanan, Ralph Nader and Lyndon Larouche. Don't go there. Ever.

            Posted by on Wednesday, April 18, 2007 at 12:18 AM in Economics, Politics, Taxes | Permalink  TrackBack (0)  Comments (9) 

            Economic Advisers

            How much influence do the economic advisers to presidential campaigns have over the types of policies candidates will support?:

            The Advisers Are Writing Our Future, by David Leonhardt, Economix, NY Times: In the late 1990s, a small team of economists began traveling down to Austin, Tex., for occasional visits with Gov. George W. Bush, then an unannounced candidate for president. The economists were mostly old Republican policy hands. The youngest member of the group — the only one who hadn’t worked for Ronald Reagan or Gerald Ford — was Glenn Hubbard, a Columbia professor in his early 40s.

            After Mr. Bush won, Mr. Hubbard went on to become the chairman of the Council of Economic Advisers and an architect of the tax cut... Mr. Hubbard was later responsible for bringing Ben Bernanke, then a professor at Princeton, into the Bush orbit.

            All of which is to say that the early advisers to presidential candidates can leave a big imprint. For the 2008 campaign, the six leading campaigns have each signed up their first-string economic policy teams. ... If the next president is going to reform health care, attack climate change or address middle-class anxiety, the solution is going to be shaped by these policy advisers. As Douglas Holtz-Eakin, John McCain’s director of economic policy, says, “If you’re specific about what you want to do and you win, you have a mandate.”

            Continue reading "Economic Advisers" »

              Posted by on Wednesday, April 18, 2007 at 12:06 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (4) 

              Tuesday, April 17, 2007

              Wolf to Wolfowitz: The World Bank Must Regain the High Ground

              Martin Wolf says it's time for change at the World Bank, starting at the top. I agree wholeheartedly, Wolfowitz needs to go and the sooner, the better:

              The World Bank must regain the high ground, by martin Wolf, Commentary, Financial Times: “If you want to make poverty history you have to make corruption history.” Paul Wolfowitz, embattled president of the World Bank, cited this remark by Nuhu Ribadu, head of the Economic Crimes and Corruption Commission of Nigeria, in a speech made only last month. There he emphasised, once again, the guiding theme of his presidency: fighting corruption and improving governance.

              How credible, after recent revelations, is the World Bank as a beacon of good governance and a scourge of corruption? “Much less than it should be” is the answer. ...

              Continue reading "Wolf to Wolfowitz: The World Bank Must Regain the High Ground" »

                Posted by on Tuesday, April 17, 2007 at 02:43 PM in Economics, Politics | Permalink  TrackBack (1)  Comments (24) 

                The Benefits from Blogs

                This is about all of you:

                Blog!, by Bruce Bartlett, NRO [also here]: On April 6, I had an article in The New York Times arguing the term "supply-side economics" (SSE) had outlived its usefulness. ...

                What was really interesting about my article ... was the reaction to it. A University of Oregon economics professor named Mark Thoma posted a long commentary on it on his blog. I posted a response, which led to many other comments, including a couple from Paul Krugman, a Princeton economics professor and New York Times columnist.

                Subsequently, University of California-Berkeley economist Brad DeLong posted much of the discussion from Thoma's Website on his and offered additional commentary, which led to further comments from me and some of those who had also posted comments on Thoma's Website. Since then, Thoma has kept the conversation going by soliciting a commentary by James Galbraith, an economics professor at the University of Texas.

                The point I am getting at is that blogging is finally maturing into a useful way for people to interact with each other to sort out differences. It's like being in a seminar room with some of the smartest people on the planet, where we are all searching for answers to the same questions, but coming at them with very different experiences and philosophical perspectives.

                But it is really better than that -- because in a seminar room only one person can speak at a time, some people speak too long, others go off on tangents, while others effectively sabotage any effort to narrow differences by focusing only on those areas where agreement is impossible. With a blog discussion, these problems go away. There are no time constraints, people must write their comments, those that are off-topic can be skipped over, and those who abuse the forum can have their comments deleted by the host.

                Also, in a seminar room people can sometimes get away with making outrageous claims or factual errors that cannot be responded to in that forum. In a blog discussion, no one can get away with such things. Fact-checkers will immediately swoop down on mistakes and often provide hyperlinks to original sources that can be checked by anyone for verification. The result is an automatic self-correction mechanism that helps keep everyone honest.

                This is not to say that there is no downside to a blog discussion. Too often, those posting comments start arguing with each other about matters that have no relevance to the original post. ... And, of course, people sometimes get abusive and substitute name-calling for rational argument.

                But these problems are really rather minor and result mainly from the blog host lacking the time or the inclination to police the comments, disciple abusers and delete their comments, and bar serial abusers from being allowed to post. Perhaps in the near future, some programmer will invent an effective method of deleting irrelevant, off-topic, and abusive comments automatically...

                Nevertheless, the sort of back-and-forth that my original article stimulated is extraordinarily useful. I learned a lot from those who commented on my article. In particular, I learned that many things I took for granted in terms of my knowledge of the economic experience of the 1970s are not widely shared. It has motivated me to write something more detailed that will explain the atmosphere and context in which SSE was developed. ...

                As it is, both supporters and opponents of SSE implicitly view it in the context of today, thus leading to errors in thinking that what was true at one time is still true today -- or, conversely, thinking that something that is wrong today was also wrong in the past. In terms of SSE, what was right then may be wrong now.

                In terms of what SSE accomplished, I still think it was the right cure for the economic problems we were facing in the late 1970s. I also think it embodies some fundamental truths that are applicable at all times. But these fundamental truths, such as the idea that high marginal tax rates are bad for the economy, are now almost universally accepted. So I say to my fellow supply-siders, let's just declare victory and move on. Insisting on a separate identity only makes enemies out of potential allies.

                Update: Here are links to the posts in the series:

                And, related:

                Update: Ezra Klein has more in "Converted."

                  Posted by on Tuesday, April 17, 2007 at 09:10 AM in Economics, Weblogs | Permalink  TrackBack (0)  Comments (88) 

                  FRBSF: The Economic Outlook

                  John C. Williams, Federal Reserve Bank of San Francisco, uses twelve graphs to illustrate his views on the current economy and the future economic outlook:

                  Continue reading "FRBSF: The Economic Outlook" »

                    Posted by on Tuesday, April 17, 2007 at 12:39 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (11) 

                    Brad DeLong Defends Robert Rubin

                    Awhile back I posted part of an article from The American Prospect by Robert Kuttner on the influence of Robert Rubin within the Democratic Party, "Should Democrats Dump Wall Street?," and noted that it was part of the battle for control of the Democratic Party:

                    Here's the issue, in a nutshell:

                    [In 1992] Clinton famously exploded that his whole economic vision and political future were being held hostage by "a bunch of ... bond traders." At another planning session ..., Clinton declared with sarcastic disgust: "Where are all the Democrats? We're all Eisenhower Republicans … . We stand for lower deficits and free trade and the bond market. Isn't that great?"

                    The article paints a less than favorable portrait of Rubin's influence in the Democratic Party as well as the influence of the Hamilton Project (of which Rubin is a founding member). In particular, it implies that the interests of Wall Street are paramount in the policy prescriptions advocated by Rubin and other members of this group.

                    Brad DeLong, after reading the article, comes to the defense of Robert Rubin (I should note that Brad worked under Rubin at the U.S. Treasury from 1993 to 1995). Here's a shortened version of Brad's post. The problem Brad has is not the quarrels over whether "Eisenhower-Republican-light policies were America's best option in the 1990s," but rather over the "character assassination" carried out in the article:

                    Journamalism Watch: Robert Kuttner Unfairly Trashes Robert Rubin, by Brad DeLong: A friend once told me oh, four years ago, that we would be able to tell when the Democrats are on the upswing: it will be when Robert Kuttner decides that trashing other Democrats--not arguing about the future of a party, not arguing about a good society, not debating honorable adversaries, not thinking about policies, not discussing issues, but simply trashing other Democrats--is his Job #1.

                    Well, it must that time.

                    Robert Kuttner trashes Robert Rubin.

                    It is the shoddiest thing I have seen The American Prospect publish.

                    Consider... Bob Kuttner doesn't dare say that Bob Rubin's real aim is to shape America's public policy to make himself richer--it's false, and it would lose Kuttner too much credibility. But Kuttner does want his readers to think that Rubin is a devious, self-interested plutocrats--hence the insinuations.

                    It gets even worse... Kuttner simply lies about the Brookings Institution's Hamilton Project... And it gets even worse still... Kuttner implies that Rubin sponsored making holders of Mexican bonds whole at the expense of American taxpayers, but he doesn't quite say so.

                    And the reason that he doesn't quite say so? Because it isn't true, and because Kuttner knows that it isn't true--U.S. taxpayers benefitted handsomely ... But Kuttner wants readers of the American Prospect to think that Bob Rubin enriched Goldman Sachs at the expense of the American taxpayer.

                    I could go on: I've only covered about a quarter of Kuttner's article. But what's the point? It's not as though Kuttner is making an argument that Rubin was wrong in thinking that Eisenhower-Republican-light policies were America's best option in the 1990s. You can make that argument (and I believe some of it), but that's not what Kuttner is doing. Kuttner, you see, is not in the information business. He is in the character assassination business.

                      Posted by on Tuesday, April 17, 2007 at 12:04 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (32) 

                      Monday, April 16, 2007

                      "Bad Fiscal Policy Creates Pressure for Bad Monetary Policy"

                      Here's part of a speech on fiscal policy by Richard Fisher, president of the Federal Reserve Bank of Dallas:

                      Fiscal Issues: From Here to Eternity, President, by Richard W. Fisher, FRB Dallas: ...I am going to speak today ... about fiscal policy, an area into which central bankers rarely wander. ... Before doing so, let me remind you that the Federal Reserve is a strictly nonpartisan institution; when you enter the temple of the Federal Reserve, you check your partisan affiliation at the door...

                      According to official government trustee reports, the infinite-horizon discounted present value of our unfunded liability from Social Security and Medicare—in common language, the gap between what we will take in and what we have promised to pay—now stands at $83.9 trillion. The potent combination of lower birthrates, higher medical costs and longer life expectancies provides little reason to hope that the figure will fall.

                      Continue reading ""Bad Fiscal Policy Creates Pressure for Bad Monetary Policy"" »

                        Posted by on Monday, April 16, 2007 at 05:07 PM in Budget Deficit, Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (29) 

                        Paul Krugman: Way Off base

                        Things have changed. It's time for Democrats to speak up loudly and firmly on important issues, just as their base demands:

                        Way Off Base, by Paul Krugman, Commentary, NY Times: Normally, politicians face a difficult tradeoff between taking positions that satisfy their party’s base and appealing to the broader public. You can see that happening right now to the Republicans: to have a chance of winning the party’s nomination, Republican presidential hopefuls have to take far-right positions on Iraq and social issues that will cost them a lot of votes in the general election.

                        But a funny thing has happened on the Democratic side: the party’s base seems to be more in touch with the mood of the country than many of the party’s leaders. And the result is ... reluctant Democratic politicians are being dragged by their base into taking highly popular positions.

                        Iraq is the most dramatic example. Strange as it may seem, Democratic strategists were initially reluctant to make Iraq a central issue in the midterm election. Even after their stunning victory, which demonstrated that the G.O.P.’s smear-and-fear tactics have stopped working, they were afraid that any attempt to rein in the Bush administration’s expansion of the war would be successfully portrayed as a betrayal of the troops and/or a treasonous undermining of the commander in chief.

                        Beltway insiders, who still don’t seem to realize how overwhelmingly the public has turned against President Bush, fed that fear. ...

                        But the public hates this war... Iraq was a big factor in the Democrats’ midterm victory. And far from being a risky political move, the confrontation over funding has overwhelming popular support: according to a new CBS News poll, only 29 percent of voters believe Congress should allow war funding without a time limit, while 67 percent either want to cut off funding or impose a time limit.

                        Health care is another example of the base being more in touch with what the country wants than the politicians. Except for John Edwards, ... most leading Democratic politicians, still intimidated by the failure of the Clinton health care plan, have been cautious and cagey about presenting plans to cover the uninsured.

                        But the ... pressure from the base to get specific ... is doing them a favor ... since ... the public is now demanding that something be done. A recent New York Times/CBS News poll showed overwhelming support for a government guarantee of health insurance for all, even if that guarantee required higher taxes. Even self-identified Republicans were almost evenly split on the question!

                        If all this sounds like a setting in which Democrats could win big victories in the years ahead, that’s because it is.

                        Republicans will, for a while at least, be trapped in unpopular positions by a base that’s living in the past. Rudy Giuliani’s surge into front-runner status for the Republican nomination says more about the party than about the candidate. As The Onion put it with deadly accuracy, Mr. Giuliani is running for “President of 9/11.”

                        Democrats don’t have the same problem. There’s no conflict between catering to the Democratic base and staking out positions that can win in the 2008 election, because the things the base wants — an end to the Iraq war, a guarantee of health insurance for all — are also things that the country as a whole supports. The only risk the party now faces is excessive caution on the part of its politicians. Or, to coin a phrase, the only thing Democrats have to fear is fear itself.

                        Previous (4/13) column: Paul Krugman: For God’s Sake
                        Next (4/20) column: Paul Krugman: The Plot Against Medicare

                          Posted by on Monday, April 16, 2007 at 12:15 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (94) 

                          Microsoft Says the Government Must Stop Google

                          I don't know enough about this market to evaluate the impact of Google's purchase of DoubleClick on competition, i.e. whether there's significant market failure involved here or not, but is Microsoft the best choice to take the lead in complaining about anti-competitive behavior?

                          After bidding on the purchase itself and losing, it appears Microsoft is so worried about Google that it is colluding with AT&T, AOL and Yahoo to find a way to block Google's purchase through rent-seeking behavior. First step - use their collective power to pressure the government to stop Google from potentially becoming the next Microsoft:

                          Microsoft Wary of DoubleClick Buyout Software Giant, Other Firms Want Strict Review of Google Deal, by Sam Diaz, Washington Post: Microsoft said yesterday that Google's proposed purchase of Internet advertising company DoubleClick raises antitrust and privacy concerns that deserve careful review by authorities.

                          Executives at the software giant said they talked over the weekend with AT&T, AOL and Yahoo about similar concerns. Microsoft had bid for DoubleClick but lost to Google.

                          The $3.1 billion acquisition, announced late Friday, would combine the largest providers of online advertising and create a dominant force, Microsoft said. ...

                          "By putting together a single company that will control virtually the entire market . . . Google will control the economic fuel of the Internet," said Brad Smith, general counsel for Microsoft.

                          Microsoft also raised concerns about the privacy of Internet users... DoubleClick ... remembers sites a user visits and serves up relevant ads; Google keeps data about searches conducted on its site.

                          Smith said Google would have "an unprecedented degree" of personal information about a person's activity on the Internet. ...

                          Jim Cicconi, executive vice president of external and legislative affairs for AT&T, said ... his company is reviewing the deal. "I don't think AT&T is drawing a conclusion, per se, whether the transaction should or should not happen, but we do have sufficient concern and feel this deserves careful scrutiny from the government," he said. An AOL spokesman declined to comment...

                            Posted by on Monday, April 16, 2007 at 12:03 AM in Economics, Market Failure | Permalink  TrackBack (0)  Comments (33) 

                            Sunday, April 15, 2007

                            Robert Frank Responds to Greg Mankiw

                            When Greg Mankiw saw Robert Frank's Economic Scene article in the New York Times saying that trickle-down theories don’t hold up against actual evidence, he responded "Frank needs to read more widely":

                            Frank needs to read more widely, by Greg Mankiw: In today's NY Times, Robert Frank says there is little point to cutting marginal tax rates of high-income individuals:

                            Trickle-down theorists are quick to object that higher taxes would cause top earners to work less and take fewer risks, thereby stifling economic growth. ... On close examination, however, this claim is supported neither by economic theory nor by empirical evidence.

                            Apparently, Bob has not read this survey by Stiglitz and come to grips with this theoretical conclusion...:

                            Pareto efficient taxation requires that the marginal tax rate on the most able individual should be negative.

                            The reason for this conclusion is that a negative marginal tax rate on the most skilled worker induces him to work more, and if skilled and unskilled labor are complementary inputs, the wage for unskilled labor rises in general equilibrium.

                            Nor does it seem that Bob has read this empirical work by Gruber and Saez:

                            A central tax policy parameter that has recently received much attention, but about which there is substantial uncertainty, is the overall elasticity of taxable income. We provide new estimates of this elasticity...We estimate that this overall elasticity is primarily due to a very elastic response of taxable income for taxpayers who have incomes above $100,000 per year, who have an elasticity of 0.57, while for those with incomes below $100,000 per year the elasticity is less than one-third as large...

                            Bob is perfectly free to believe whatever he likes and to advocate increasing the top marginal tax rate. But to suggest that there is neither theory nor evidence to support the beneficial effects of lower marginal tax rates on high-income taxpayers indicates a lack of appreciation of the academic literature in public finance.

                            Bob also makes this argument:

                            If lower real wages induce people to work shorter hours, then the opposite should be true when real wages increase. According to trickle-down theory, then, the cumulative effect of the last century’s sharp rise in real wages should have been a significant increase in hours worked. In fact, however, the workweek is much shorter now than in 1900.

                            This seems just wrong to me, if the goal is to analyze tax policy. When comparing work hours today versus a century ago, you have to consider both income and substitution effects of wages on labor supply, which are offsetting to a large degree. But, according to standard theory, the distortionary effect of taxes depends only on the substitution effect. The evidence cited suggests that income effects are larger than substitution effects, not that substitution effects are small.

                            I'm guessing Frank had read the Stiglitz essay (after-all, it's not exactly new, the working paper Greg links is dated 1987), but in any case my reaction was that the Stiglitz paper comes to a theoretical conclusion while the claim Frank makes is mainly about the empirical evidence, i.e. his assertion is that the evidence doesn't support trickle-down claims. Frank wasn't denying that there are theories that allow for the possibility of supply-side effects, though he did point out that the theoretical predictions depend upon the magnitude of responses, i.e. the sign of the response to a change in taxes is not determined unambiguously by theory and hence it is an empirical issue. His point is that the empirical evidence doesn't support the claims made by those promoting supply-side policies. I'm not sure how citing Stiglitz rebuts the claim that there is no evidence for the theory [though to be fair it was offered to rebut that theory does not support supply-side policy, though I interpreted Frank as saying theory doesn't speak unambiguously on the matter, not that there is no valid theory supporting trickle-down effects].

                            My other reaction was that the criticism was a bit unfair. If you are going to accuse someone of not being aware of or lacking appreciation for research in the area, you owe it to us to cite more than one or two papers yourself and hopefully work a little more current than 1987 and 2000, especially if you were Chair of the CEA where public finance issues are at the forefront giving you a strong incentive to be familiar with the cutting-edge work in the area (and not under a word limit). I expected a summary of the research on both sides of the issue, some analysis about why one set of results ought to be preferred over the other, etc., but citing a single paper from 2000 as though that settles the empirical issue doesn't do it, at least not for me.

                            Graciously, Greg has offered Robert Frank the opportunity to respond to his objections [I cut Frank's response down a bit, Greg has the full response]:

                            Bob Frank replies, by Greg Mankiw: A few days ago, I expressed here my skeptical view of a recent column by Bob Frank. I offered Bob an opportunity to respond. Below I am reprinting, in its entirety, what he sends along. There is much that one could debate here, and I am sure the commenters will, but I will refrain. Since I picked this fight, and since I have ample opportunity in this forum to express my perspective, in fairness I will let Bob have the last word--at least for now.

                            First, my thanks to Greg for his gracious invitation to respond... Here I’ll attempt to explain why Greg’s defense of trickle-down theory falls short.

                            Greg discounts the significance of the negative relationship I cite between wage growth and the average workweek over that last century...

                            Greg is right about what this particular piece of evidence shows. But ... the argument I advanced in my column had nothing to do with whether taxes on the rich are distortionary. ... My only point in the column, however, was to question a very different claim—namely, that higher taxes on the rich would reduce work effort. ... In other words, it’s a claim about the combined impact of the income and substitution effects. So the fact that the workweek declined over the last century in the face of substantial growth in real wages is directly supportive of my argument.

                            A necessary and sufficient condition for trickle-down theory’s argument to the contrary is that the elasticity of supply of labor with respect to real wages be significantly positive. The most comprehensive recent econometric study of labor supply elasticity in the United States will be published in the next issue of The Journal of Labor Economics. The authors, Fran Blau and Larry Kahn, estimate that the labor supply curve for men has been essentially vertical for many decades. The clear implication is that higher taxes on top earners, most of whom are men, will not significantly reduce work effort.

                            Greg also mentions research suggesting that higher taxes on the rich may reduce the amount of income they report to the IRS. Perhaps so, but that by itself would not imply any reduction in output. And with even the supply-sider Bruce Bartlett now conceding that tax cuts for top earners don’t boost total tax revenues, it’s important not to exaggerate the problem of unreported income. But irrespective of its magnitude, why isn’t the best solution to this problem a simpler and more strictly enforced tax code rather than tax rates that are too low to sustain minimally adequate public services? ...

                            As evidence for his claim that I need to do additional reading, Greg cites a 1988 paper in which Joe Stiglitz argued that the socially optimal marginal tax rate on the most productive person might actually be negative. ... In the abstract, this is an interesting claim. (Is it any more than that? Stiglitz, for one, never thought to offer tax policy proposals on the basis of it.) But if we’re going to discuss externalities, then complementarities between skilled and unskilled labor are surely not the most important ones to consider.

                            For present purposes, by far the most important externalities are those stemming from the link between context and evaluation. As decades of behavioral evidence clearly demonstrates, virtually every evaluation is heavily shaped by local context. As Richard Layard put it, “In a poor society a man proves to his wife that he loves her by giving her a rose, but in a rich society he must give a dozen roses.” ... The upshot is that almost every consumer choice generates significant context externalities. Consider, for example, a job applicant’s decision about how much to spend on an interview suit. His goal is to make a favorable impression. But his ability to do so depends far less on the absolute quality of his suit than on how it compares with those worn by other applicants. And when he spends more on a suit, he shifts the context within which other candidates will be evaluated.

                            Context externalities are pervasive. ... The dependence of evaluation on context lays waste to any presumption that individual decisions about how many hours to work or how much to spend on interview suits will be socially optimal. ... For the discussion at hand, the relevant finding is that evaluations of leisure tend to be far less context-sensitive than evaluations of income. The implication is that individual valuations of leisure tend to understate social valuations. Thus people work longer hours in the hope of moving higher on the income ladder, only to discover that when others do likewise, their position remains unchanged.

                            It would be unfair to single out Greg for ignoring context externalities. After all, most of the standard economic models ... make no mention of these... But even absent explicit mentions of context externalities, most practical policy analysts already seem to recognize that trickle-down theory’s portrait bears little relation to the behavior of people in the real world.

                            My point is not that people don’t care about money. On the contrary, when the pay in one occupation goes down relative to others, fewer people enter that occupation. ...

                            But trickle-down theory is about what happens when after-tax pay falls not just in some occupations but for top earners generally. In a largely meritocratic society like the United States, most top earners are extremely driven people. And as recent studies have shown, most of them will never spend more than a small fraction of their earnings. The trickle-down theorist’s insistence that they will begin slacking off in response to a small increase in their marginal tax rates strains credulity.

                            While serving as chairman of the Council of Economic Advisers, Greg actively supported the Bush tax cuts targeted at top earners by arguing that the cuts would spur them to work harder. Greg would have been astonished to observe such a response from his colleagues at Harvard. Does he have a behavioral model that leads him to expect different behavior from high achievers in other occupations? Or does he have one that explains why any such differences consistently fail to reveal themselves in the data? In the absence of a plausible behavioral model backed by persuasive empirical evidence to the contrary, I stand by my conclusion that trickle-down theory is supported neither by economic theory nor by empirical evidence.

                            The tax cuts that were sold by invoking this theory did little to promote the well-being of even the well-to-do Americans who were their ostensible beneficiaries. ... In light of what we know about the empirical magnitude of context externalities, the principal effect of such spending was simply to redefine what counts as adequate. As in the familiar stadium metaphor, all stand to get a better view, yet none sees better than if all had remained seated.

                            Greg titled his response to my column “Frank Needs To Read More Widely.” On that point, he is surely right. I don’t know Greg well enough to presume to know what he needs. But he would almost surely offer better policy advice if equipped with an economic model that better fits current scientific knowledge about human behavior.

                            Again, my thanks to Greg for inviting me to respond to his critique of my column.

                            I hope Greg will make his case at some point and I encourage him to do so because, as I noted, he hasn't made it yet. It would be very useful to hear an unbiased, professional presentation that summarizes and evaluates of the vast work on both sides of this issue rather than an attempt to prove a point.

                              Posted by on Sunday, April 15, 2007 at 04:23 PM in Economics, Policy, Taxes | Permalink  TrackBack (0)  Comments (22) 

                              Health Care Reform

                              When I first saw a summary of Jason Furman's health care proposal, my reaction was to say "I'm not all that excited about" it. Briefly, the plan is:

                              Washington Wire: Jason Furman, a one-time economic adviser to President Clinton and Sen. John Kerry, ... now director of the Hamilton Project, a think tank organized ... for centrist Democrats, suggests that the U.S. could reduce health-care spending big time if people shared a larger slice of the cost of care. After all, when consumers know how much something costs, and when they have to pick up a hefty chunk of the bill, they are more careful about what sort of tests and procedures get ordered up on their behalf.

                              This is the philosophy behind Health Savings Accounts, the health plan conservatives love and liberals love to hate. ... The problem with Health Savings Accounts, Furman argues, is that they are risky for low- and moderate-income families. As an alternative, he proposes income-related cost sharing; a typical family would pay half of their health costs until the family's out-of-pocket costs reached 7.5% of the family's annual income. The more money you earn, the more you have to spend on your own health care before full coverage kicks in. Citing an analysis done by the RAND Health Insurance Experiment, Furman estimates this could reduce total health spending by 13% to 30% without hurting health outcomes. ... “This type of idea can come in handy,” he said. “It could be part of a political compromise. But I recognize it’s not something we’re going to do tomorrow."

                              Shortly thereafter, an email arrived suggesting I consider taking a closer look and, since my sentiment is similar to Brad DeLong's

                              His hope is that this will finesse many of the problems with HSAs. I don't know. I'm not a health economist. I just play one on radio sometimes

                              and having also played health economist, I thought I'd try to gather more information about the proposal. Tyler Cowen, Mathew Yglesias, and Arnold Kling have all made positive statements about the plan. But the most complete analysis I've come across so far is by Ezra Klein:

                              Cost Counts, by Ezra Klein, The American Prospect: ..."Universal health care" is an ingenious phrase; it easily garners majority support when polled and is almost impossible to argue against. ... The trouble is, defining the conversation in terms of universality (or a lack thereof) means implicitly defining the problem as an issue of access. Make no mistake, the fact that 45 million Americans are uninsured is a moral disgrace. But if we could achieve full coverage tomorrow, holding all other things equal, the system would collapse within a matter of decades. No one would be able to afford it. ...

                              Continue reading "Health Care Reform" »

                                Posted by on Sunday, April 15, 2007 at 03:33 AM in Economics, Health Care, Policy | Permalink  TrackBack (0)  Comments (64) 

                                Thomas Palley: Real IMF Reform

                                Thomas Palley sends along his thoughts on reform of the International Monetary Fund, something, as he notes in the email, "you have not yet posted anything on":

                                Real IMF Reform: Carpe Diem, by Thomas I. Palley: The International Monetary Fund (IMF) has been the focus of extended debate and criticism, yet reform has been hard to come by. Now, owing to changes in the global economy, the issue of reform has forced itself onto the official agenda. The Fund’s management has responded with its own reform proposals, but they are too narrow. Instead, the IMF should be pressured to adopt bolder reform that incorporates missing social concerns into its mission.

                                IMF critics have long charged its policies prejudice equitable global growth. Despite the seriousness of these charges, IMF reform has been near impossible. In times of economic crisis reform is viewed as too risky, while in good times the case for reform melts away on the grounds of why rock the boat. However, very occasionally an institution’s business model breaks down, creating an internally generated case for reform. This has now happened to the IMF.

                                Previously, developing countries had limited access to financial markets and had to pay high interest rates. That created an opportunity for the IMF, which borrowed low and lent to needy developing countries at favorable rates, thereby providing an income for the Fund and cheaper loans for countries. For Fund critics, the big drawback was the IMF required countries to adopt neo-liberal economic policies to qualify for loans.

                                This business model has now collapsed. Growth of global capital markets means countries can access private capital at reasonable interest rates and without IMF policy strictures. Additionally, huge U.S. trade deficits have enabled developing countries to run trade surpluses, obviating need for funding. Consequently, demand for IMF loans has fallen, thereby undermining the Fund’s purpose and financial viability.

                                The IMF is now trying to redesign its business model by proposing reform. However, its proposals do not go deep enough. In particular, they continue with the “silo” model of global governance whereby institutions act alone. A better model is the “matrix” model whereby institutions reinforce each other, which is what globalization needs.

                                The IMF has proposed two reforms. One is to increase developing country quota holdings and perhaps also representation rights in recognition of these countries’ increased contribution to global economic activity. The second is to transform the IMF into something akin to a global financial umpire. International economic integration means there can be adverse spillovers from country economic policies, particularly regarding exchange rates. Consequently, an arbiter is needed to help resolve policy disputes.

                                Both of these proposals deserve support. Politically, they recognize the new realities of the global economy. At the policy level, they seek to tackle the problem of strategic exchange rate under-valuation, whereby countries try to grow by draining demand from other countries.

                                However, the Fund refuses to recognize that globalization also creates adverse labor market spillovers. With the world increasingly one labor market owing to trade and outsourcing, labor conditions in one country can spillover and affect labor outcomes in another: hence, need for international labor standards also overseen by a global arbiter.

                                This is where the matrix model of governance enters. The International Labor Organization (ILO) oversees international labor standards, but the IMF (and the World Bank too) also has an important role to play by officially and actively supporting the ILO’s work. That means Fund policy advice should be obligated to encourage countries to comply with labor standards; Fund loan programs should not promote economic reforms that undermine labor standards; and Fund Article IV country reviews should spotlight failures to meet labor standards. Furthermore, countries borrowing from the Fund could be screened for compliance with labor standards. Those failing the screen might still be allowed to borrow, but they would require special approval and they would have to develop a strategy for future compliance.

                                Globalization is suffering from lack of attention to the social dimension. The IMF has resisted any responsibility for remedying this weakness, claiming it is not part of its mission. The reforms proposed by IMF management do nothing to change this stance. That should not be allowed.

                                Today’s global economic system was stitched together in the last quarter of the 20th century, a period of labor weakness and laissez-faire revival. Consequently, labor and social issues were left off the table. It is time to remedy that omission, and the reform process underway at the IMF provides a good place to start.

                                  Posted by on Sunday, April 15, 2007 at 12:45 AM in Economics, International Finance, International Trade | Permalink  TrackBack (0)  Comments (16) 

                                  The Gold Bug Variations

                                  Since supply-side economics has come up here, so has the gold standard - or perhaps more precisely the gold bugs. Here's the story on that:

                                  The Gold Bug Variations, by Paul Krugman, Slate, 1996: The legend of King Midas has been generally misunderstood. Most people think the curse that turned everything the old miser touched into gold, leaving him unable to eat or drink, was a lesson in the perils of avarice. But Midas' true sin was his failure to understand monetary economics. What the gods were really telling him is that gold is just a metal. If it sometimes seems to be more, that is only because society has found it convenient to use gold as a medium of exchange--a bridge between other, truly desirable, objects. There are other possible mediums of exchange, and it is silly to imagine that this pretty, but only moderately useful, substance has some irreplaceable significance.

                                  But there are many people--nearly all of them ardent conservatives--who reject that lesson. While Jack Kemp, Steve Forbes, and Wall Street Journal editor Robert Bartley are best known for their promotion of supply-side economics, they are equally dedicated to the belief that the key to prosperity is a return to the gold standard, which John Maynard Keynes pronounced a "barbarous relic" more than 60 years ago. With any luck, these latter-day Midases will never lay a finger on actual monetary policy. Nonetheless, these are influential people--they are one of the factions now struggling for the Republican Party's soul--and the passionate arguments they make for a gold standard are a useful window on how they think.

                                  There is a case to be made for a return to the gold standard. It is not a very good case, and most sensible economists reject it, but the idea is not completely crazy. On the other hand, the ideas of our modern gold bugs are completely crazy. Their belief in gold is, it turns out, not pragmatic but mystical.

                                  The current world monetary system assigns no special role to gold; indeed, the Federal Reserve is not obliged to tie the dollar to anything. It can print as much or as little money as it deems appropriate. There are powerful advantages to such an unconstrained system. Above all, the Fed is free to respond to actual or threatened recessions by pumping in money. To take only one example, that flexibility is the reason the stock market crash of 1987--which started out every bit as frightening as that of 1929--did not cause a slump in the real economy.

                                  While a freely floating national money has advantages, however, it also has risks. For one thing, it can create uncertainties for international traders and investors. Over the past five years, the dollar has been worth as much as 120 yen and as little as 80. The costs of this volatility are hard to measure (partly because sophisticated financial markets allow businesses to hedge much of that risk), but they must be significant. Furthermore, a system that leaves monetary managers free to do good also leaves them free to be irresponsible--and, in some countries, they have been quick to take the opportunity. That is why countries with a history of runaway inflation, like Argentina, often come to the conclusion that monetary independence is a poisoned chalice. (Argentine law now requires that one peso be worth exactly one U.S. dollar, and that every peso in circulation be backed by a dollar in reserves.)

                                  So, there is no obvious answer to the question of whether or not to tie a nation's currency to some external standard. By establishing a fixed rate of exchange between currencies--or even adopting a common currency--nations can eliminate the uncertainties of fluctuating exchange rates; and a country with a history of irresponsible policies may be able to gain credibility by association. (The Italian government wants to join a European Monetary Union largely because it hopes to refinance its massive debts at German interest rates.) On the other hand, what happens if two nations have joined their currencies, and one finds itself experiencing an inflationary boom while the other is in a deflationary recession? (This is exactly what happened to Europe in the early 1990s, when western Germany boomed while the rest of Europe slid into double-digit unemployment.) Then the monetary policy that is appropriate for one is exactly wrong for the other. These ambiguities explain why economists are divided over the wisdom of Europe's attempt to create a common currency. I personally think that it will lead, on average, to somewhat higher European unemployment rates; but many sensible economists disagree.

                                  So where does gold enter the picture?

                                  While some modern nations have chosen, with reasonable justification, to renounce their monetary autonomy in favor of some external standard, the standard they choose these days is always the currency of another, presumably more responsible, nation. Argentina seeks salvation from the dollar; Italy from the deutsche mark. But the men and women who run the Fed, and even those who run the German Bundesbank, are mere mortals, who may yet succumb to the temptations of the printing press. Why not ensure monetary virtue by trusting not in the wisdom of men but in an objective standard? Why not emulate our great-grandfathers and tie our currencies to gold?

                                  Very few economists think this would be a good idea. The argument against it is one of pragmatism, not principle. First, a gold standard would have all the disadvantages of any system of rigidly fixed exchange rates--and even economists who are enthusiastic about a common European currency generally think that fixing the European currency to the dollar or yen would be going too far. Second, and crucially, gold is not a stable standard when measured in terms of other goods and services. On the contrary, it is a commodity whose price is constantly buffeted by shifts in supply and demand that have nothing to do with the needs of the world economy--by changes, for example, in dentistry.

                                  The United States abandoned its policy of stabilizing gold prices back in 1971. Since then the price of gold has increased roughly tenfold, while consumer prices have increased about 250 percent. If we had tried to keep the price of gold from rising, this would have required a massive decline in the prices of practically everything else--deflation on a scale not seen since the Depression. This doesn't sound like a particularly good idea.

                                  So why are Jack Kemp, the Wall Street Journal, and so on so fixated on gold? I did not fully understand their position until I read a recent letter to, of all places, the left-wing magazine Mother Jones from Jude Wanniski--one of the founders of supply-side economics and its reigning guru. (One of the many comic-opera touches in the late unlamented Dole campaign was the constant struggle between Jack Kemp, who tried incessantly to give Wanniski a key role, and the sensible economists who tried to keep him out.) Wanniski's main concern was to deny that the rich have gotten richer in recent decades; his letter is posted on the Mother Jones Web site, and makes interesting reading.

                                  But, particularly noteworthy was the following passage:

                                  First let us get our accounting unit squared away. To measure anything in the floating paper dollar will get us nowhere. We must convert all wealth into the measure employed by mankind for 6,000 years, i.e., ounces of gold. On this measure, the Dow Jones industrial average of 6,000 today is only 60 percent of the DJIA of 30 years ago, when it hit 1,000. Back then, gold was $35 per ounce. Today it is $380-plus. This is another way of saying that in the last 30 years, the people who owned America have lost 40 percent of their wealth held in the form of equity. ... If you owned no part of corporate America 30 years ago, because you were poor, you lost nothing. If you owned lots of it, you lost your shirt in the general inflation.

                                  Never mind the question of whether the Dow Jones industrial average is the proper measure of how well the rich are doing. What is fascinating about this passage is that Wanniski regards gold as the appropriate measure of wealth, regardless of the quantity of other goods and services that it can buy. Since the dollar was de-linked from gold in 1971, the Dow has risen about 700 percent, while the prices of the goods we ordinarily associate with the pursuit of happiness--food, houses, clothes, cars, servants--have gone up only about 250 percent. In terms of the ability to buy almost anything except gold, the purchasing power of the rich has soared; but Wanniski insists that this is irrelevant, because gold, and only gold, is the true standard of value. Wanniski, in other words, has committed the sin of King Midas: He has forgotten that gold is only a metal, and that its value comes only from the truly useful goods for which it can be exchanged.

                                  I wonder whether the gods read Slate. If so, they know what to do.

                                    Posted by on Sunday, April 15, 2007 at 12:15 AM in Economics, International Finance | Permalink  TrackBack (0)  Comments (68) 

                                    Saturday, April 14, 2007

                                    Plonking, Type Two

                                    In the last installment of the series looking back at theory and policy of the late 1970s and early 1980s by those who were there, "Jamie Galbraith speaks for the 'vulgar Keynesians'". In the latest contributions, Bruce Bartlett responds to Jamie, and Jamie provides additional comments:

                                    Bruce Bartlett: As always, I find Jamie's observations illuminating. I would just make a couple of points. First, it is unfair to take the actual operations of a government as being a coherent representation of any economic philosophy. If I were to use every action taken by the Roosevelt Administration to refute Keynes, that would be just as unfair as what Jamie has done in using Reagan's actions as the sole basis for judging supply-side economics.

                                    Second, I think he conveniently leaves out an important part of the story as far as the JEC [Joint Economic Committee] was concerned. Before he and I joined the staff, the committee had endorsed a version of supply-side economics. The chairman, Senator Lloyd Bentsen, got every member of the committee to sign a report to that effect in 1980. So Jamie's actions were as much a counterrevolt against the position that had been adopted by the committee's Democrats as it was in opposition to what we on the Republican side were doing.

                                    Third, by starting his commentary with 1981, Jamie goes well past the point I was trying to make in my New York Times article. I was writing about what motivated people to even think of supply-side economics in the first place, not about its operational consequences during the Reagan years. My focus was on the 1976-1980 period, when a small handfull of people were trying as best they could to grapple with an economic crisis caused by rising inflation. Just as with Keynesian economics, those who later became advocates for supply-side economics carried the arguments, the policies and the rationale off in a different direction. That was the whole point of my article. What Jamie really shows is that the bastardization of supply-side economics began much earlier than this administration, and he's certainly right about that.

                                    Finally, if I were in Jamie's shoes, I would also be trying to make Jude Wanniski the focus of the discussion. Jude was a brilliant man, but also more than a little crazy. A much more important figure and one much more difficult to attack was Norman Ture, which is why people like Jamie tend to ignore him. But Norman was absolutely critical, not just because he was one of the leading tax economists in the U.S., but because his involvement with tax policy went well back into the 1950s.

                                    Just as an aside, I would note that Norman had been on the JEC staff in the 1960s, where he functioned as staff economist for Wilbur Mills while he was chairman of the House Ways & Means Committee. It was Mills who really got Kennedy to propose a cut in marginal tax rates in 1963, based on Ture's ideas. Since Norman was also deeply involved in the development of the Kemp-Roth bill, he was a bridge to both major tax-cutting episodes. To the curious, I would recommend Julian Zelizer's book, "Taxing America," on both Mills and Ture.

                                    Next, James Galbraith responds:

                                    James Galbraith: Bruce [Bartlett] in his first response concedes my basic point: Reaganomics was incoherent. We crude and vulgar Keynesians knew this at the time.

                                    So did Murray Weidenbaum. I saw Murray frequently in those days, at hearings, social events and at meetings of the U.S. Gold Commission, a gold bug endeavor foisted on the public by Jesse Helms and treated by nearly all the participants, Democrat and Republican alike, with amused contempt.

                                    At one such meeting, fittingly held in the Cash Room of the U.S. Treasury, in early February of 1982, Murray came up to me with a sly smile on his face.

                                    "Did you see Leonard Silk in today's Times?" I had not.

                                    "Well, Leonard wrote about our Economic Report. He said there was plonking in it? Do you know what plonking is?" I did not.

                                    "Well according to Leonard, there is Plonking, Type One: 'A little wild-eyed obfuscation' -- and then he quoted something that Bill Niskanen wrote." Niskanen was the CEA's resident libertarian.

                                    "And then Leonard said there is Plonking, Type Two: 'The stupefaction of the blindingly clear' -- and then he quoted something Jerry Jordan wrote." Jordan was the house monetarist.

                                    "And then," Murray concluded, "Leonard said there was actually something sensible in our Report, and he quoted something I wrote."

                                    My comments were aimed at the incoherence of Reaganomics as public policy; it was my job, then, as a policy economist to make this argument. It did not matter to me whether or not the individual pieces of the Reaganaut argument were defensible. The fact that they were at war with each other was sufficient to make the combination into bad policy.

                                    I opposed monetarism, then and since, on the ground that the Federal Reserve could not effectively treat the money supply as a control variable, without wrecking economic growth. I believe Bruce and I agreed on this point. We were, of course, vindicated (unhappily) by the recession of 1981-2, and by the statistical and intellectual collapse of monetarism in the following years.

                                    As for supply-side economics, Bruce is right to note that I was part of a counter-rebellion against the bipartisan consensus in its favor at the JEC in the late 1970s, when I was dividing my time between the Banking Committee and graduate school, and largely engaged on other matters. I disputed supply-side economics, then as now, on the ground that the substitution effects of tax changes were unimportant compared to the income effects.

                                    The supply-siders seemed to pretend that income effects did not exist.

                                    We, of course, thought that the claims made for the substitution effects were grossly overstated. Henry Reuss and I did not expect tax rate cuts to produce significant increases in saving, investment or work effort. (And, of course, none occurred.) We did oppose the upward redistribution of after-tax income that the supply-siders were pushing for. And we did suspect that this was the true impetus behind their program. When Reuss became chair and I arrived at the JEC in 1981, these arguments began to be heard in JEC work.

                                    But, in our minds, the greater danger from the supply-siders came from the blowback of their efforts on the other side of the budget. The supply-side agenda threatened to open up large budget deficits, and in 1981 those of us whose models (accurately) predicted that result feared that the consequence would be even more crushing cuts in social programs.

                                    Events proved out somewhat differently. We got the tax cuts, but (as David Stockman discovered to his chagrin) the Republican votes for all the spending cuts the far right wanted were not there. Social Security, notably, survived. And when the recession hit, supply-siders and Keynesians were in approximate alliance on the key issue, which was first and foremost to force the Federal Reserve to bring interest rates down.

                                    Later on, supply-siders and vulgar Keynesians were in the minority in both parties in being skeptical of the need to make deficit reduction the principal priority of fiscal policy. However, we continued to take opposite positions on what fiscal policy should actually do.

                                    The major joint impact of monetarism and tax cuts in 1981-83 was, I think, not fully anticipated by either side. It was the rapid appreciation of the dollar, increased trade deficit, and financial globalization. (I began to write about this in my 1989 book, Balancing Acts). The effect was the early and *permanent* elimination of domestically-generated inflation from the system.

                                    An interesting feature of our current discourse is, of course, that twenty-five years later mainstream monetary macroeconomics has still not figured out what happened. We still hear the voices who credit the vigilance of the Federal Reserve, its "credibility" "commitment" and so forth with keeping the economy from slipping back into excessive inflation. This, despite the plain evidence of the late 1990s, that even at full employment there is no inflationary risk.

                                    It will be very interesting to see how long it takes (if it ever happens) for reality to penetrate this particular redoubt of academic and policy thinking. Of course, when it does, the proper role of the Federal Reserve will have to be very carefully re-examined.


                                    Update: Follow-up from comments:

                                    Bruce Bartlett: The great thing about Jamie is that he never hides his underlying assumptions or pretends that economics is a purely scientific endeavor, with no philosophical core. What he has brought out in this post is that much of the debate in the 1970s and 1980s over the proper role of monetary or fiscal policy was really about the proper role of government. Supporters of supply-side economics favored smaller government on both economic and philosophical grounds. We thought it would leader to a larger economy and more freedom. Keynesians like Jamie were not concerned about the size of government and saw no inherent loss of freedom from its expansion. Nor did they share the belief that there was any trade-off between equity and efficiency. The whole economic question could really be reduced to a simple one from their point of view: there were two equally effective paths to growth and prosperity; one that enriched the wealthy and screwed the poor and was therefore immoral; and another that was compassionate to the poor and viewed the wealthy essentially as rentiers who could be taxed heavily at no economic cost and was therefore moral. Clearly, those of a liberal persuasion would be attracted to the second approach even if they knew nothing whatsoever about economics.

                                    The supply-siders felt that it was irresponsible and demagogic for the liberal Keynesians to make the promises that they were making because they could not deliver on them. The result of their policies were inflation and slow growth that would eventually impoverish the poor. The wealthy would be largely unaffected because they would simply move away or find other ways to enjoy their wealth in ways that the tax man could not get at. I remember Paul Craig Roberts pointing out that the reason Rolls Royces were so prevalent in England during the time that its tax rates were confiscatory was that the pleasure of driving the world's best automobile was a form of income that was not taxed. The supply-siders thought it would be better for such people to start businesses and buy stocks and bonds instead of expensive autos, because then some of the benefits would flow to society and not just to themselves.

                                    There is another point about the supply-siders that I think Jamie is genuinely unaware of. Unlike conventional conservatives, the supply-siders never made a fetish out of cutting government spending. The original supply-siders thought that if we could simply hold the line on spending while raising the GDP growth rate, then spending as a share of the economy would fall painlessly. They also believed that many of the demands on government to supply income, jobs and social services were a function of slow growth. Therefore, raising the growth rate of the economy would both reduce the relative size of government and aid those at the bottom of society more effectively than government could do through direct action.

                                    The events of the last 30 years have not resolved the question of which approach is better. In our own minds, Jamie and I know which is best and that we are not going to change each other's mind on the matter. We also accept each other's sincerity and that we aren't arguing our alternative approaches simply out of self-interest. That's why we can be friends despite our differences. But in the course of day-to-day debate in Washington, people don't have time to lay out their philosophy and operating assumptions. These things tend to get reduced to sound bites. Moreover, the longer a particular economic approach has been operational, the more likely that those in power are long removed from the original circumstances and analysis that it is based on. Thus the Keynesians of the 1960s had really lost touch with Keynes himself and were pursuing policies that were appropriate in the conditions of the 1930s, but not the 1960s. Likewise, I think that some of the policies being pursued under the guise of supply-side economics today cannot be justified on the same basis today that they were in the 1970s. That's what I was trying to say in my original article.

                                    This disconnect is inherent in the nature of public policy and leads to cycles. The liberal Keynesian cycle lasted 30-some years from the 1930s to the 1960s. The conservative supply-side view also last about 30 years from the mid-1970s to the present. Both were successful initially because they offered solutions to real problems that could be embodied in specific policies that Congress could enact and which appealed to the philosophical and political interests of one of the major parties. They both ended when the problems they were initially created to deal with were essentially solved and when the advocates of their position lost touch with the fundamental truths of their position. Increasing, their advocates' arguments became caricatures of those that were made originally, became increasingly incoherent, and less able to deal with new problems as they arose over time.

                                    Therefore, the real question is what comes next? I don't think Jamie's vulgar Keynesianism is going to be making a comeback unless the economy plunges into another depression. And I have no idea what will replace supply-side economics on my side. I can only assume that we are in for a period in which the right and left will be searching for new ideas and new gurus. That's not a bad thing.


                                    James Galbraith: I think I did eventually figure out the supply-side position on government spending, but it's quite true that it wasn't clear to me in early 1981.

                                    The effects of tax rate changes were being debated at that time in terms that were truly "crude and vulgar," but the topic is worth exploring a bit more.

                                    The Keynesian position on the effect of marginal tax rate changes on saving was partly skepticism about a substitution effect, but not only that. It stemmed also from Keynes's argument that saving was a residual of the consumption decision and the determination of income. Therefore, saving was not something that should be treated as an independent decision variable of the household.

                                    Similarly, employment is determined via the aggregate demand for output, itself a function of expected profitability and investment. For this reason, a thoroughgoing Keynesian could not accept that changing the post-tax reward to work effort would change effective effort or output.

                                    These were key supply-side arguments at the time and key points of difference.

                                    But the supply-siders have over the years emphasized other aspects of the effect of marginal tax rate changes as well, and much of today's discussion turns on these somewhat more subtle questions, namely income reporting and expenditure-switching effects. At the time, I did not think very much about these, but clearly they are significant and -- like anyone else who's followed the real world -- I realize that now.

                                    For instance, it's clear that changing the tax treatment of capital gains, or lowering marginal income tax rates, will change the way income is reported, particularly among high-income people. The large increase in measured income inequality in the US that occurs around 1987 in income data seems, to me, suspiciously like an effect of the tax law rather than of anything that happened in 1986 or 1987, which were otherwise fairly uneventful years, at least until the stock crash in October, 1987.

                                    Likewise, the decision in 1986 to end the deductibility of everything but mortgage interest was fundamental to an acceleration of homeownership rates, which started that very year and has been going on since. Lowering personal income tax rates at the top also meant that income would shift from business uses (those corporate Rolls-Royces Craig Roberts saw in England, but also the skyscrapers of New York) into household uses (and CEO pay).

                                    After the internet crash, these effects combined. It's an irony of Craig's position that when the Bush tax cuts were made in 2001, the effect was, in substantial part, felt in the market for mansions.

                                    Bruce's truly telling argument against the Keynesian position is that we could not deliver. And here, of course, he has me to rights, because (as he knows), there was a deep split among those who considered themselves Keynesians on what it would take.

                                    The dominant American Keynesianism restricted itself to a very limited set of tools: tax cuts, spending increases, and interest rate manipulations. They were willing to tolerate wage-price guidelines but only barely. My first published article, in 1978, was entitled "Why We Have No Full Employment Policy;" it examined the limits to what these people were prepared to do.

                                    On the other hand, the really crude and vulgar types, notably in my circle my father and Henry Reuss, were willing to intervene much more forcefully, selectively and (we thought) effectively. JKG and HSR, and many others of their generation, had worked on the World War II mobilization, with impressive results. They therefore did not share the policy pessimism of either mainstream Keynesians or the supply-siders.

                                    Were they right? We should distinguish between what is technically possible and what is politically possible at any given time.

                                    Part of the reason my father attracted so much derision, over the years, from both conservatives and mainstream liberals is that he threatened their authority, and not merely by attracting a large audience to his writing. He'd had the experience of directing a policy (war-time price control) that truly did change the world, and his adversaries did not much want to have that remembered.

                                    So I think that well-designed policy can, in principle, change things fundamentally. Exactly what policy? That depends on the problem and conditions at any particular time.

                                    A truly Keynesian view, after all, holds that there is no fixed formula; policy design should be adapted to the circumstances of the challenge. The job of the economist is to work out what the circumstances are, what should be done, and also how best to make it politically possible to do what is needed. (This makes our job complicated, but interesting.)

                                    Will the chance come around again? Climate change may give us a chance to find out.


                                      Posted by on Saturday, April 14, 2007 at 01:08 AM in Economics, Policy | Permalink  TrackBack (0)  Comments (27) 

                                      Fama-French: Did Fama Really Do All the Work?

                                      From Mahalanobis:

                                      Fama Factors Out French: "I Did All The Work": After 15 years of sharing the credit for groundbreaking research with Ken French, Eugene Fama is on a mission to expose his former colleague, and himself. The result is an alarming behind-the-scenes look at how academic careers are made and broken.

                                      "I hired Ken French in 1990 when he was a driving instructor in Winnetka. Chicago was pressuring me to partner with another researcher; I couldn't stand the idea so I hired a stooge. The man has never contributed a single idea to my research, and yet his name is constantly mentioned in the same breath as mine."

                                      Many of French's students are not surprised. ... [read more]

                                      [Update: I thought it would be obvious, but apparently it isn't -- this is a joke.]

                                        Posted by on Saturday, April 14, 2007 at 12:57 AM in Economics, Financial System | Permalink  TrackBack (0)  Comments (7) 

                                        FRBSF: Do Monetary Aggregates Help Forecast Inflation?

                                        Should the Fed use monetary aggregates to help guide monetary policy, or should they continue with the present approach which mostly ignores monetary aggregates, a position supported by modern macroeconomic theory which "does not assign money an important role in the conduct of monetary policy"?:

                                        Do Monetary Aggregates Help Forecast Inflation?, by Galina Hale and Òscar Jordà, FRBSF Economic Letter: The European Central Bank (ECB) and the Federal Reserve share a similar goal, price stability, and their strategies to pursue their goals are similar--with one notable difference. When considering long-term risks to price stability, the ECB places an explicit emphasis on the link between prices and measures of the money supply (also known as monetary aggregates); the Federal Reserve System, in contrast, does not specifically emphasize monetary aggregates.

                                        Continue reading "FRBSF: Do Monetary Aggregates Help Forecast Inflation?" »

                                          Posted by on Saturday, April 14, 2007 at 12:54 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (5) 

                                          Should We Abandon the Phrase “Supply-Side Economics”?

                                          Here's more on supply-side economics. After having stated bluntly that Jude Wanniski is not a good source for anyone interested in understanding the economic reasoning behind supply-side economics, I feel obligated to present rebuttal.

                                          This came by email from Wayne Jett "who was privileged to be a colleague of Jude Wanniski during the last two years of his life." He would like an opportunity to respond generally, and to some of the specific comments made about the role of supply-side economics in policy discussions. Before posting his response, however, I do want to make clear that posting this is by no means an endorsement of the views that are expressed. I strongly disagree with many of the claims and characterizations:

                                          The End of History for Economics?, by Wayne Jett:


                                          This is my first post on Economists' View, which results from my attention being called to recent discussions here on the role of supply side economics in current discourse on public policy. Bruce Bartlett's commentary in the NYT suggests supply side economics "... did its job, creating a new consensus among economists on how to look at the national economy ..." and ought to be "put to rest." Supply side economics, BB says, has become "associated with an obsession for cutting taxes under any and all circumstances ...," so the best thing to do is to "... kill the phrase “supply-side economics” and give it a decent burial."

                                          You and others have commented on the subject and, with your permission, I would like to add a few thoughts from my perspective. This is not the perspective of one who was in the Reagan administration, but one who was privileged to be a colleague of Jude Wanniski during the last two years of his life. In addition, although I have not been a part of your discussions here, I have undertaken in recent years to participate in public analysis of economic issues, particularly monetary policy.

                                          What is supply side economics?

                                          Continue reading "Should We Abandon the Phrase “Supply-Side Economics”?" »

                                            Posted by on Saturday, April 14, 2007 at 12:40 AM in Economics | Permalink  TrackBack (0)  Comments (26) 

                                            Friday, April 13, 2007


                                            On the run - here's a few links:

                                            I might not be able to do much until quite a bit later, so let's open this up. Of course comments on the links above are welcome, but please feel free to bring up other subjects in comments - nothing is off-topic.

                                              Posted by on Friday, April 13, 2007 at 02:07 PM in Economics, Politics | Permalink  TrackBack (0)  Comments (13) 

                                              Paul Krugman: For God’s Sake

                                              Paul Krugman looks at "one of the most important stories of the last six years," the administration's attempt to place people with a religious agenda into positions of power within the federal government:

                                              For God’s Sake, by Paul Krugman, Commentary, NY Times: In 1981, Gary North, a leader of the Christian Reconstructionist movement — the openly theocratic wing of the Christian right — suggested that the movement could achieve power by stealth. “Christians must begin to organize politically within the present party structure,” he wrote, “and they must begin to infiltrate the existing institutional order.”

                                              Today, Regent University, founded by the televangelist Pat Robertson to provide “Christian leadership to change the world,” boasts that it has 150 graduates working in the Bush administration.

                                              Unfortunately for the image of the school, ... the most famous of those graduates is Monica Goodling a product of the university’s law school... who appears central to the scandal of the fired U.S. attorneys...

                                              The infiltration of the federal government by large numbers of people seeking to impose a religious agenda — which is very different from simply being people of faith — is one of the most important [and underreported] stories of the last six years...

                                              The official platform of the Texas Republican Party pledges to “dispel the myth of the separation of church and state.” And the Texas Republicans now running the country are doing their best to fulfill that pledge.

                                              Kay Cole James, who had extensive connections to the religious right and was the dean of Regent’s government school, was the federal government’s chief personnel officer from 2001 to 2005. ... And it’s clear that unqualified people were hired ... because of their religious connections.

                                              For example, ... one Regent law school graduate ... was interviewed by the Justice Department’s civil rights division. Asked what Supreme Court decision of the past 20 years he most disagreed with, he named the decision to strike down a Texas anti-sodomy law. When he was hired, it was his only job offer. ...

                                              One measure of just how many Bushies were appointed to promote a religious agenda is how often a Christian right connection surfaces when we learn about a Bush administration scandal.

                                              There’s Ms. Goodling, of course. But did you know that Rachel Paulose, the U.S. attorney in Minnesota — three of whose deputies recently stepped down, reportedly in protest over her management style — ... quot[es] Bible verses in the office?

                                              Or there’s the case of Claude Allen, the presidential aide and former deputy secretary of health and human services, who stepped down after being investigated for petty theft. ...[H]e built his career as a man of the hard-line Christian right.

                                              And there’s another thing most reporting fails to convey: the sheer extremism of these people.

                                              You see, Regent isn’t a religious university the way Loyola or Yeshiva are religious universities. It’s run by someone whose first reaction to 9/11 was to brand it God’s punishment for America’s sins.

                                              Two days after the terrorist attacks, ... on Mr. Robertson’s ... “The 700 Club.” Mr. Falwell laid blame for the attack at the feet of “the pagans, and the abortionists, and the feminists, and the gays and the lesbians,” not to mention the A.C.L.U. and People for the American Way. “Well, I totally concur,” said Mr. Robertson.

                                              The Bush administration’s implosion clearly represents a setback for the Christian right’s strategy of infiltration. But it would be wildly premature to declare the danger over. This is a movement that has shown great resilience over the years. It will surely find new champions.

                                              Next week Rudy Giuliani will be speaking at Regent’s Executive Leadership Series.

                                              Previous (4/9) column: Paul Krugman: Sweet Little Lies
                                              Next (4/16) column: Paul Krugman: Way Off base

                                                Posted by on Friday, April 13, 2007 at 12:15 AM in Economics, Politics, Religion | Permalink  TrackBack (0)  Comments (71) 

                                                Charles Plosser: Credibility and Commitment

                                                Which produces a better outcome for the economy, a central bank with the discretion to respond as needed to any situation that might arise, or a central bank credibly committed to a rule that it will follow even when unusual events occur? Philadelphia Fed President Charles Plosser has a very nice non-technical discussion of this issue [see also "Explicit Inflation Targeting as a Commitment Device," something similar I wrote about a month ago, which includes responses from Jamie Galbraith and Dean Baker to the idea of committing to inflation targets, disagreements with the story I told and the story told below about why inflation fell in the 1980s, and related issues]:

                                                Credibility and Commitment, by Charles I. Plosser, President Federal Reserve Bank of Philadelphia: ...I’d like to begin by asking a question. How many of you have ever decided that you would be healthier and happier if you lost a few pounds and so made a New Year’s resolution to go on a diet? I know I have. But, if you are like me, tomorrow comes and it’s your wife’s or husband’s birthday... Then over the weekend there is a party in the neighborhood and the food is outstanding, so you decide that the diet can wait until next week. But as the days and weeks go by, next week just never comes, and you, in effect, abandon your dieting plan altogether. We all know we would have been better off if we had just stuck to our diet. Yet somehow we failed to follow through consistently on what was basically a good plan.

                                                At this point some of you may be thinking, "What does this have to do with monetary policy?" But the fact is that policymakers often have a good plan, as well, but may not be able to resist eating that soufflé. Consequently, not only would the good plan go out the window, but the public would lose confidence in the policymaker’s credibility to follow through on its promises. ...

                                                Today, I am going to address one critical element of the Fed’s ability to achieve its objectives—the importance of making credible commitments.

                                                Continue reading "Charles Plosser: Credibility and Commitment" »

                                                  Posted by on Friday, April 13, 2007 at 12:06 AM in Economics, Fed Speeches, Inflation, Macroeconomics, Monetary Policy | Permalink  TrackBack (0)  Comments (5) 

                                                  Joseph Stiglitz: Growing Pains

                                                  Joseph Stiglitz says China is not the big bad wolf, if its "new economic model" leads to success, it could make us all better off:

                                                  Growing pains, by Joseph Stiglitz, Project Syndicate: China's success since it began its transition to a market economy has been based on adaptable strategies and policies... This process includes social innovation. China recognised that it could not simply transfer economic institutions that had worked in other countries; ... what succeeded elsewhere had to be adapted to the unique problems confronting China.

                                                  Today, China is discussing a "new economic model". Of course, the old economic model has been a resounding success... The changes are apparent not only in the statistics, but even more so in the faces of the people that one sees around the country. ...

                                                  [But] China knows that it must change if it is to have sustainable growth. At every level, there is a consciousness of environmental limits... As an increasing share of China's population moves to cities, those cities will have to be made liveable, which will require careful planning, including public transportation systems and parks.

                                                  Equally interesting, China is attempting to move away from the export-led growth strategy... That strategy supported technology transfer, helping to close the knowledge gap and rapidly improving the quality of manufactured goods. Export-led growth meant that China could produce without worrying about developing the domestic market.

                                                  But a global backlash has already developed. Even countries seemingly committed to competitive markets don't like being beaten at their own game, and often trump up charges of "unfair competition". More importantly, even if markets are not fully saturated..., it will be hard to maintain double-digit growth rates for exports.

                                                  So something has to change. China has been engaged in what might be called "vendor finance", providing the money that helps ... Americans to buy more goods than they sell. But this is a peculiar arrangement: a relatively poor country is helping to finance America's war on Iraq, as well as a massive tax cut for the richest people in the world's richest country, while huge needs at home imply ample room for expansion of both consumption and investment.

                                                  In fact, to meet the challenge of restructuring China's economy away from exports ..., China must stimulate consumption. While the rest of the world struggles to raise savings, China, with a savings rate in excess of 40%, struggles to get its people to consume more.

                                                  Providing better social services (public health care, education, and nation-wide retirement programs) would reduce the need for "precautionary" savings. More access to finance for small and medium sized businesses would help, too. ...

                                                  Too many people think of economics as a zero-sum game, and that China's success is coming at the expense of the rest of the world. Yes, China's rapid growth poses challenges to the west. Competition will force some to work harder, to become more efficient, or to accept lower profits.

                                                  But economics is really a positive-sum game. An increasingly prosperous China has not only expanded imports from other countries, but is also providing goods that have kept prices lower in the west, despite sharply higher oil prices in recent years. This downward pressure on prices has allowed western central banks to follow expansionary monetary policies, underpinning higher employment and growth.

                                                  We should all hope that China's new economic model succeeds. If it does, all of us will have much to gain.

                                                    Posted by on Friday, April 13, 2007 at 12:03 AM in China, Economics | Permalink  TrackBack (0)  Comments (24) 

                                                    Thursday, April 12, 2007

                                                    Tim Duy's Fed Watch: Jobs, Productivity, and the Fed

                                                    Tim Duy and Menzie Chinn have been trying to determine whether the recent employment report indicates that employment is growing above trend or whether it shows signs of weakness in the economy, a task that is complicated by uncertainties over how demographic changes affect labor force participation rates and about whether the recent decline in productivity growth is permanent or temporary:

                                                    Jobs, Productivity, and the Fed, by Tim Duy: Menzie Chinn at Econbrowser has an excellent piece taking another look at the employment report in which he presents a model to explain the consensus forecast for March job creation. The motivation for the model stems from a Deutsche Bank report detailing the lagged response of the labor market to economic activity:

                                                    Hence, I estimate a regression of the q/q change in quarterly payroll employment growth on one lag of the change in real equipment and software investment and three lags of real GDP over the 19671-07q1 period. This leads to the following regression result:

                                                    dnt = 0.0002 + 0.045(dequipt-1) + 0.197(dyt-1) + 0.173(dyt-2) + 0.126(dyt-3) + ut
                                                    Adj. R2 = 0.53, SER=0.0035, n=157

                                                    Where dn is the first difference in log payroll employment, dequip is the first difference in log real equipment investment, and dy is the first difference in log real GDP. All coefficients except the constant are statistically significant at the 10% MSL, using Newey-West standard errors for inference

                                                    Menzie uses this model to explain why the March forecast of 135k gain in NFP was reasonable, and why an average 70k monthly gain over the next three months is also reasonable.

                                                    Two things leapt to mind when I read this post. First, this is a neat idea. Second, can we use it to get at the question of the productivity slowdown? To simplify the analysis, I used 1983:1 as a start date, acknowledging a structural break in the data in the early 1980s reported by many practitioners. Then I create three models. The first is simply Menzie’s model over the period 1983:1-2006:4, which I call the productivity agnostic model. The second is a productivity optimist model that  includes a dummy variable beginning in 1995:1 to account for the productivity boost delivered by the IT boom. The third is a productivity pessimist model, in which the dummy variable identifies the period 1995:1 – 2005:1. This assumes the productivity boom fades beginning in 2005. The resulting regressions are:

                                                    Productivity Agnostic

                                                    dnt = -0.0009 + 0.0241(dequipt-1) + 0.285(dyt-1) + 0.220(dyt-2) + 0.110(dyt-3) + ut
                                                    Adj. R2 = 0.63, SER=0.0023, n=96

                                                    Productivity Optimist

                                                    dnt = 0.0001 – 0.002(dummy)+ 0.0289(dequipt-1) + 0.269(dyt-1) + 0.209(dyt-2) + 0.101(dyt-3) + ut
                                                    Adj. R2 = 0.67, SER=0.0022, n=96

                                                    Productivity Pessimist

                                                    dnt = 0.0 – 0.002(dummy)+ 0.0288(dequipt-1) + 0.270(dyt-1) + 0.209(dyt-2) + 0.108(dyt-3) + ut
                                                    Adj. R2 = 0.67, SER=0.0022, n=96

                                                    With the exception of the constant term, all coefficients are significant at the 10% level. Compared to Menzie’s long sample, the shorter sample shows a greater importance of lagged GDP on employment. The coefficient on the dummy variable is negative as expected; higher productivity growth suggests lower job growth holding output growth constant. The coefficients in the latter two models are virtually identical. This is not surprising; the dummy term turning off in 1995:2 does the work. I use Menzie’s estimates of 2% annualized 1Q07 GDP gain and real equipment and software decline of 2.5% y-o-y to generate a dynamic forecast of nonfarm payrolls for the first two quarters of 2007. Estimating the model through 2006:4, and then forecasting nonfarm payrolls for the first two quarters of 2007:


                                                    In 2007:1, the economy added 513k jobs compared to the previous quarter (note that I am using quarterly averages, not the average of the monthly gains). The expectation given the productivity agnostic model was a 310k gain; interestingly, this works out to 100k a month, or close to the Fed’s estimate of NFP growth consistent with a stable unemployment rate and similar to Menzie’s results.

                                                    The productivity optimist would be expecting a gain of 189k jobs as the economy had just experienced three quarters of growth well below the trend we became accustomed to in the late 1990s. Of course, this prediction could not be made given the stability on initial unemployment claims throughout the quarter and, more importantly, the pervious quarter. In contrast, the productivity pessimist would have been looking for a 403k gain, closer to reality but still 100k less than the actual gain.

                                                    The real story is the current quarter. With another weak GDP report anticipated in 2007:1, expected job growth is between a meager 98k gain to a 313k gain, with the productivity agnostic model in the middle at 229k, virtually the same as Menzie’s estimate of 70k per month. The implication is that solid job growth (roughly 100k per month) in the current quarter would suggest that potential GDP growth has shifted down substantially, to as low as 2.25%. Perhaps this is simply a reflection of a late-cycle productivity slowdown; perhaps an indication that trend productivity growth is slowing. Discriminating between these two options is the challenge for policymakers; from the minutes of the most recent Fed meeting:

                                                    Most participants continued to expect that core inflation would slow gradually, but the recent readings on inflation and productivity growth, along with higher energy prices, had increased the odds that inflation would fail to moderate as expected; that risk remained the Committee’s predominant concern….

                                                    …Participants expected that productivity growth would pick up as firms slowed hiring to a pace more in line with output growth but acknowledged that the improvement might be limited, particularly if business investment spending were to remain soft.

                                                    To me, the second quote sounds as if the Fed expected the March employment figures to come in considerably softer, closer to 100k. They also must be surprised that the unemployment rate dipped to 4.4% - the central outlook for the fourth quarter of this year is 4.5-4.75%. I think the Fed does see indications that the economy slowing. And I am sure they understand the implications of the drop in durable goods orders. They are trying to resolve this weakness in other areas with the relatively strong job market and persistent inflation. The problem the Fed faces is that any shift in the trend rate of productivity growth will only be known with certainty in hindsight, an issue reiterated by Governor Mishkin earlier this week:

                                                    In particular, over the past few decades the natural unemployment rate and the path of potential output have apparently moved around quite substantially. If we do not recognize the potential for such shifts, they can pose serious pitfalls for the conduct of monetary policy.

                                                    A slowdown in trend productivity growth helps explain the combination of low economic growth coupled with a stable to falling unemployment rate and persistent inflation. Moreover, the possibility of such a slowdown suggests a higher bar for a rate cut. Note, however, that a slowdown in productivity growth does not preclude an aggressive policy response to a substantial deterioration of activity. Mishkin also noted:

                                                    Finally, central banks should respond aggressively to output and employment fluctuations on those (hopefully rare) occasions when the economy is very far below any reasonable measure of its potential. In this case, errors in measuring potential output or the natural rate of unemployment are likely to be swamped by the large magnitude of resource gaps, so it is far clearer that expansionary policy is appropriate. Furthermore, taking such actions need not threaten the central bank's credibility in its pursuit of price stability.

                                                    This means that when we are in a recession, we are well below potential growth, regardless of the measurement uncertainty.

                                                    Regarding that recession, a productivity optimist would be expecting the labor market is going to show substantial weakening this quarter and, considering the reduction in GDP forecast this year, likely the next, consistent with my read on the yield curve. (Does this suggest that most market participants are productivity optimists?) In this case, one could expect a rate cut in the late summer or early fall. Watch initial unemployment claims; under this scenario, they should start rising rapidly. On that note, this week’s read was higher than expected, but we need to take a single data point with a grain of salt, as there are challenges seasonally adjustment weekly data. Be patient; when claims start moving, they move fast.

                                                      Posted by on Thursday, April 12, 2007 at 12:33 PM in Economics, Fed Watch, Monetary Policy, Unemployment | Permalink  TrackBack (0)  Comments (17) 

                                                      Jamie Galbraith Speaks for the "Vulgar Keynesians"

                                                      Here's more on the series of posts on supply-side economics, what we knew in the late 1970s and early 1980s, the gulf between academia and Washington, and other issues. This is Jamie Galbraith from comments with a view from inside "the trenches," a view from a "vulgar Keynesian" who stood "against the Reagan Revolution in the early 1980s":

                                                      James Galbraith: Bruce Bartlett joined the staff of the Joint Economic Committee in 1981, when I did. I was the executive director in charge of the Democratic staff; Bruce was the deputy director in charge of the Republican staff. We set up the committee (which had ten Democrats and ten Republicans, chaired by my boss, Rep. Henry S. Reuss of Wisconsin) so that both sides could fully make their case to the Congress and public. And we battled merrily for a couple of years, and then in 1983 switched jobs, so that we could continue battling under a Senate Republican chairman.

                                                      Bruce has been a friend ever since, though neither of us yields an inch, I don't believe, on our economic differences.

                                                      This little history makes me, I believe, a useful representative of the despised sect of "vulgar Keynesians," "crude Keynesians," "discredited Keynesians" and so forth, not yet heard from in this discussion. I was in fact a product of an eclectic economics training at Harvard (Leontief, notably), a bracing year among the Old Keynesians (Kaldor, Robinson) at Cambridge, and a Ph.D. at Yale,in the environment of Tobin but not under his wing.

                                                      Paul Krugman and I became friends at Yale, and remain so, though we too have had strong differences over the years.

                                                      Those of us who were in the trenches, standing against the Reagan Revolution in the early 1980s, saw things differently from either the shock troops of that revolution, such as Bruce, or the academic bystanders, including Paul.

                                                      I and those around me -- the Democratic staff at the Joint Economic Committee -- were bitterly opposed to Reaganomics, both as economics and politics. Why?

                                                      First, because as politics Reaganomics was aimed at enriching the rich and destroying the economic life of working Americans and the poor. And this is no joke: it did exactly that. Recession, unemployment, the wanton and irreversible destruction of major industries and the fiscal base of the cities, the destruction of unions: all that happened. The cost of curing inflation in 1981-82 was enormous, far higher than the airy comments made above concede. We crude Keynesians believed then, and I believe now, that the steps taken were brutal and unnecessary, and that with hard policy work the problem could have been managed in ways that were far less costly, but that were rejected on ideological rather than economic grounds.

                                                      Brad DeLong's summary of Bruce's summary of our vulgar Keynesian policy beliefs is, here, reasonably close to the mark, except in one respect. No one in my circle doubted the capacity of monetary policy to crush the economy if pushed sufficiently far. Rather, we believed (accurately, as events would prove), that monetary policy worked against inflation *only* insofar as it brought on a brutal recession. We did not accept the monetarist/supply-side claim, which was presented at the start of the Reagan administration in official projections, that the trick could be pulled off without a recession. We were, of course, perfectly right about that.

                                                      Second, as a matter of economics, we thought that the combination of supply-side economics and monetarism was fundamentally incoherent -- and we were well aware that the supply-siders and monetarists disagreed with each other more violently than they disagreed with us. As an anti-monetarist and one of the very few Democrats willing to criticize the sainted Paul Volcker, I found myself in rough alliance with the supply-siders more than once (and I have a few handwritten notes from Jack Kemp in my files somewhere).

                                                      I ultimately came to see the supply-siders as the most effective practical Keynesians around. They were not only willing to run deficits when the situation required, but able to do so, because they skewed the benefits toward the rich, and thus brought political power into play behind the cause of fiscal expansion. This of course is also what George Bush did in 2001 and in 2003-5.

                                                      I didn't like the redistributive bias, and for that reason I fought the Reagan tax cuts. But I had no doubt, from 1981 onward, that the tax cuts and military buildup, coupled with a reversal of the tight money policy, would produce a strong recovery in time for Reagan's 1984 re-election campaign. And it's worth noting that Reagan had a Tory Keynesian (Murray Weidenbaum) as his CEA chief, who knew this very well.

                                                      Jude Wanniski was a hugely influential force in the supply-side camp, and his views were the epitome of the supply-side position in Washington. I thought Jude was a crackpot in economics and economic history (his idea that Smoot-Hawley caused the Great Depression, notably; also his passionate advocacy of the gold standard), but there is no doubt that he played a crucial role. There is no complete or accurate account of supply-siderism without Jude Wanniski; he cannot be airbrushed from history simply because sober academic types now think him inconvenient.

                                                      Notwithstanding our disagreements, Jude and I also became friends; late in his life he staged a vehement and prescient stand against the Iraq war.

                                                      Incidentally, it is not correct that we crude and vulgar Keynesians were wedded to high marginal tax rates for their own sake. The Bradley-Kemp tax bill, which had much more Bradley than Kemp in it, was endorsed by the JEC Democrats in 1984, in a report that I wrote. It became law in 1986. We made the argument for that bill, because we did understand the usefulness of a broad-based income tax, and the difference between high marginal rates per se and progressive tax system. We also understood that the previous income tax structure was politically indefensible, and that alternatives such as a VAT, which were serious threats, would be worse.

                                                      The 1986 tax reform saved the income tax, and laid the groundwork for the 1993 upper-bracket increases, which did quite a bit to restore the overall progressivity of the code, and which laid a template for future tax changes.

                                                      Turning to the monetarists, it's another forgotten fact that the lead monetarists on Capitol Hill at that time were Democrats. One of them was Bob Weintraub, who worked for Parren Mitchell, chairman of the congressional Black Caucus. Another was Bob Auerbach, a Milton Friedman student. Bob Auerbach and I both worked for Reuss, and we shared an office at the House Banking Committee for three years in the late 1970s. Bob A. abandoned monetarism when it fell apart in the 1980s; he now teaches at the LBJ School, and as a matter of fact, we had dinner together tonight.

                                                      As for the MIT and other conventional-Keynesian academics, those of us in the trenches found them sometimes helpful but often preoccupied with their models and largely unaware of the political issues within which these economic questions were embedded. For instance, we did not have a lot of use for the theoretical supply-side effects of tax policy on individual behavior that respectable liberal economists were prepared to concede. The fact was, dwelling on those supposed effects simply gave aid and comfort to the Reaganauts; there was no way to make the point in political debate and not give away the store when it came time to write a tax bill. As a technical matter, it also seemed clear that the income effects of these tax changes would dwarf the substitution effects, and the evidence I've encountered since does not incline me to change this view.

                                                      Among academic economists at that time, Bob Eisner was my hero and closest friend and ally; I think no one would call Bob either crude or vulgar, and that is perhaps why he is seldom mentioned in these discussions. (His daughter, Mary Eccles, was on my staff.)

                                                      As Brad notes, Rudi Dornbusch was, indeed, a politically- attuned advocate of the effect of monetary policy, and as he did more politics, he became more Keynesian. (Rudi's future wife, Sandra Masur, was also on my staff.)

                                                      But the idea that monetary policy worked to control inflation expectations directly seemed to us to be a gross overstatement of its powers. Bob Auerbach and I designed the Humphrey-Hawkins hearings beginning in 1975, and wrote those provisions of the HH law in 1978. We did it to extract information from the Federal Reserve and not because we thought that setting monetary targets would have some fundamental effect on the psychology of the nation. And while I'm proud of those hearings, that's because they established the constitutional authority of the Congress over the Federal Reserve, not because they somehow cured inflation expectations, as it seems some magical-thinking economists appear to believe.

                                                      To Paul, these issues were sufficiently "academic" at the time that he could in good conscience accept a staff position in the Reagan administration (on the CEA under Martin Feldstein, after the first wave of Reaganomics had passed). To him, at the time, it basically wasn't a political assignment, just a chance to see Washington under the redoubtable Feldstein.

                                                      Perhaps Paul and all the others who lined up in the Reagan camp were right - that these were academic issues to be debated and resolved among people who all shared the same larger objectives for the economy. In some ways, I accept this as a subjective matter. I came to respect the sincerity of Bruce, Jude, Murray and others working in the Reagan administration about their goals. Otherwise, I could hardly think as well of them now, as I do.

                                                      But to me and those in my camp, at the time, it would have been unthinkable to go over to their side. At the time, I saw the Reagan administration as, objectively, a vicious assault on the economic life of ordinary Americans, brought about by the willful and arbitrary rejection of useful policies that aimed to solve problems without inflicting savage harm on the weakest economic agents. I thought, also, that with honorable exceptions the academic economists on the sidelines were weak and indifferent to that harm.

                                                      I don't think I was wrong about that.


                                                      Update: Bruce Bartlett, whose column in the NY Times began this discussion, responds to Jamie in comments.

                                                        Posted by on Thursday, April 12, 2007 at 12:12 AM in Budget Deficit, Economics, Macroeconomics, Policy, Politics, Taxes | Permalink  TrackBack (0)  Comments (58) 

                                                        Robert Frank: Trickle-Down Theories Don’t Hold Up

                                                        Speaking of supply-side economics and trickle-down, Robert Frank explains that trickle-down theory, which says that higher taxes on the wealthy will reduce incentives causing lower growth and hence lower employment and income generally, "is supported neither by theory nor evidence." Thus, contrary to what its proponents argue, trickle-down theory does not provide a valid objection to a more progressive tax code:

                                                        In the Real World of Work and Wages, Trickle-Down Theories Don’t Hold Up, by Robert Frank, Economic Scene, NY Times: When asked why he robbed banks, Willie Sutton famously replied, “Because that’s where the money is.” The same logic explains the call by John Edwards, the Democratic presidential candidate, for higher taxes on top earners to underwrite ... universal health coverage.

                                                        Providing universal coverage will be expensive. With the median wage, adjusted for inflation, lower now than in 1980, most middle-class families cannot afford additional taxes. In contrast, the top tenth of 1 percent of earners today make about four times as much as in 1980, while those higher up have enjoyed even larger gains. ... In short, top earners are where the money is. Universal health coverage cannot happen unless they pay higher taxes.

                                                        Trickle-down theorists are quick to object that higher taxes would cause top earners to work less and take fewer risks, thereby stifling economic growth. ... On close examination, however, this claim is supported neither by economic theory nor by empirical evidence.

                                                        The surface plausibility of trickle-down theory owes much to the fact that it appears to follow from the ... belief that people respond to incentives. Because higher taxes on top earners reduce the reward for effort, it seems reasonable that they would induce people to work less... As every economics textbook makes clear, however, a decline in after-tax wages also exerts a second, opposing effect. By making people feel poorer, it provides them with an incentive to recoup their income loss by working harder than before. Economic theory says nothing about which of these offsetting effects may dominate.

                                                        If economic theory is unkind to trickle-down proponents, the lessons of experience are downright brutal. If lower real wages induce people to work shorter hours, then the opposite should be true when real wages increase. According to trickle-down theory, then, the cumulative effect of the last century’s sharp rise in real wages should have been a significant increase in hours worked. In fact, however, the workweek is much shorter now than in 1900.

                                                        Trickle-down theory also predicts shorter workweeks in countries with lower real after-tax pay rates. Yet here, too, the numbers tell a different story. ...

                                                        Trickle-down theory also predicts a positive correlation between inequality and economic growth, the idea being that income disparities strengthen motivation to get ahead. Yet ... researchers ... find a negative correlation. In the decades immediately after World War II, for example, income inequality was low by historical standards, yet growth rates in most industrial countries were extremely high. In contrast, growth rates have been only about half as large in the years since 1973, a period in which inequality has been steadily rising.

                                                        The same pattern has been observed in cross-national data. ... Again and again, the observed pattern is the opposite of the one predicted by trickle-down theory.

                                                        The trickle-down theorist’s view of the world ... bears little resemblance to reality. In the 1950s, American executives earned far lower salaries and faced substantially higher marginal tax rates... Yet most of them competed energetically for higher rungs on the corporate ladder. The claim that slightly higher tax rates would cause today’s executives to abandon that quest is simply not credible.

                                                        In the United States, trickle-down theory’s insistence that a more progressive tax structure would compromise economic growth has long blocked attempts to provide valued public services. Thus, although every other industrial country provides universal health coverage, trickle-down theorists insist that the wealthiest country on earth cannot afford to do so. Elizabeth Edwards faces her battle with cancer with the full support of the world’s most advanced medical system, yet millions of other Americans face similar battles without even minimal access to that system.

                                                        Low- and middle-income families are not the only ones who have been harmed by our inability to provide valued public services. For example, rich and poor alike would benefit from an expansion of the Energy Department’s program to secure stockpiles of nuclear materials that remain poorly guarded in the former Soviet Union. Instead, the Bush administration has cut this program, even as terrorists actively seek to acquire nuclear weaponry.

                                                        The rich are where the money is. Many top earners would willingly pay higher taxes for public services that promise high value. Yet trickle-down theory, which is supported neither by theory nor evidence, continues to stand in the way. This theory is ripe for abandonment.

                                                        Here's a simple way to show that a an increase in taxes does not necessarily reduce effort. Suppose you have a summer job and you have to earn $2,000 for the summer. You don't need to earn any more than that, and don't plan to, but it is a necessity that you reach this goal. Also suppose that you have a job paying $10 per hour so that you can earn the money in 200 hours, or five 40 hour weeks. Let taxes be zero initially.

                                                        Now let the government tax you at 50%, surely enough to reduce effort. But in this case it won't. Instead, you will now work twice as long, 10 weeks or 400 hours at $5 per hour, in order to reach your goal of $2,000. So in this example, a tax of 50% doubles work effort rather than reducing it.

                                                        This is, of course, a special case and it is possible in the more general framework for the opposite to happen, i.e. for a reduction in the take-home wage to reduce effort, though as noted above the evidence is against the trickle-down story. But this does show clearly that the claim that higher taxes will reduce effort is not necessarily correct. If there is a strong incentive to recover income losses after an increase in the tax rate, effort will increase in contradiction to the trickle-down claims.

                                                          Posted by on Thursday, April 12, 2007 at 12:06 AM in Economics, Health Care, Income Distribution, Taxes | Permalink  TrackBack (1)  Comments (46) 

                                                          Wednesday, April 11, 2007

                                                          Supply-Side Economics: Paul Krugman Responds

                                                          Via email, Paul Krugman responds to recent posts on supply-side economics. The posts he is responding to are on the continuation page:

                                                          OK, here's what I would say:

                                                          Let's suppose that it's true that people in DC were still thinking in terms of crude, 1950-vintage vulgar Keynesianism, even while people in Cambridge were thinking in terms of a framework in which money mattered, there was no long-run tradeoff between inflation and unemployment, etc.. Even so, why did you need a doctrine called supply-side economics, which purported to challenge the fundamentals of Keynesian economics? All you really needed was to bring policymakers up to date with the current state of Keynesianism!

                                                          Furthermore, if we're going to judge an economic doctrine not by what well-informed people thought, but by the crude caricatures of the doctrine that penetrated the consciousness of ill-informed policymakers, what does that say about supply-side? I was in DC, on the staff of the Council of Economic Advisers, in 1982-3; let me tell you, the supply-siders around really did believe the crudest, most caricatured versions of the doctrine you can imagine. I recall a meeting in which David Stockman tried to explain why we were having a recession, without the benefit of any coherent economic model - and it made the most vulgar Keynesianism sound like Nobel-quality thought.

                                                          The key thing is that good Keynesianism, as embodied even in undergrad textbooks of the time, was *perfectly OK*: Dornbusch and Fischer, 1978 edition, offered a description of what disinflation would look like that matches the experience of the 80s reasonably well, and the textbook does not seem all that dated even now. The idea that we needed a new doctrine to get our heads straight is just all wrong.

                                                          Continue reading "Supply-Side Economics: Paul Krugman Responds" »

                                                            Posted by on Wednesday, April 11, 2007 at 02:00 PM in Economics, Macroeconomics | Permalink  TrackBack (0)  Comments (19) 

                                                            Sacrificing for Equality

                                                            A new experiment concludes that we are willing to pay a cost in order to reduce inequality:

                                                            Robin Hoods: Study Determines We Prefer Distributed Wealth, Scientific American: Seems we like to give to the poor, but only slightly more than we like to rob the rich, according to a new study published in Nature.

                                                            Researchers at the University of California, Davis, ... randomly separated 120 students into groups of four. Each subject was arbitrarily assigned a certain amount of money; players knew how much money the others in their group had, but not to whom each amount belonged. Each player had the option of using some of his or her money to purchase the right to have the researchers subtract or award cash to another participant.

                                                            Subjects played the "game'' with different people in each of five trials Each time, "players'' adopted an egalitarian attitude when distributing the wealth in what study co-author and University of California, San Diego, political scientist James Fowler calls the "Robin Hood effect."

                                                            "People want to give rewards to the lowest [paid] member of the group and take away from the highest [paid] member of the group," he says. "I think that we were surprised by the magnitude of the punishment." Nearly 70 percent of the players reduced someone else's income at least once, and three quarters of them gave up a little to help someone in a weaker position. The behavior was consistent across all five trials...

                                                            "These egalitarian impulses that we have are stronger than we previously realized," Fowler says. He notes that in previous studies, in which participants contributed to a shared fund, the ones who gave the least to the community pool were penalized most often. Those studies, however, were not able to determine whether participants were handing out punishments because of resentment over others' wealth or because they felt they were being cheated. In the current study, personal wealth was an isolated variable and cooperation among the group was removed... "What we show is that anger and annoyance towards people who earn more,'' Fowler says, "cause [participants] to punish nearly as much as they do in public goods games."

                                                            "The egalitarian impulse is one of the reasons why we exhibit more cooperation than other species," he adds. "[We are] more likely to punish people that don't cooperate, even when it's not in our best interest."

                                                            Ernst Fehr, a professor at ... the University of Zurich in Switzerland, says the study shows that a combination of altruistic and egalitarian motives prompts us to punish free riders. "The current results," he says, "are also interesting in view of the anthropological evidence from many small-scale societies that indicates food sharing has been widespread, and that these small-scale societies developed a kind of mini–welfare state that redistributes income through food sharing regardless of hunting success."

                                                            One question is whether the magnitude of the response would change if participants believed that people earned the wealth (and hence deserve it) rather than just benefiting from the luck of the draw. The perception people have about the source of the inequality may matter.

                                                              Posted by on Wednesday, April 11, 2007 at 12:32 PM in Economics, Income Distribution | Permalink  TrackBack (0)  Comments (5) 

                                                              Brad DeLong: How Supply-Side Economics Trickled Down...

                                                              Brad DeLong follows up on the conversation on supply-side economics, in particular what we knew at the end of the 1970s and in the early to mid 1980s and what constituted Keynesian policy during that time period:

                                                              How Supply-Side Economics Trickled Down..., by Brad DeLong: Bruce Bartlett's piece on supply-side economics:

                                                              How Supply-Side Economics Trickled Down - New York Times: AS one who was present at the creation of "supply-side economics" back in the 1970s, I think it is long past time that the phrase be put to rest. It did its job, creating a new consensus among economists on how to look at the national economy. But today it has become a frequently misleading and meaningless buzzword that gets in the way of good economic policy...

                                                              sparked an interesting and useful debate at Mark Thoma's Economist's View (which I previously noted).

                                                              After thinking about it, I want to weigh in again--on the side of Bruce Bartlett as opposed to Paul Krugman. It's not that Paul says anything wrong about what he and his MIT colleagues thought at the end of the 1970s, but IMHO he underestimates the intellectual gulf between Cambridge and Washington.

                                                              There are two issues here--stabilization policy and growth policy.

                                                              On stabilization policy, Bartlett says that the Keynesians around 1980 believed that full employment should be produced via fiscal policy--spending increases and tax cuts, preferably spending increases, to boost aggregate demand--and that inflation should be controlled via incomes policy--jawboning unions to restrain wages and businesses to keep a lid on prices, tax penalties for price increases, excess-profits and other taxes to provide incentives to keep wages and prices close to previous nominal anchors, and the threat and perhaps the reality of wage and price controls. Monetary policy, Bartlett says they said, was next to useless in controlling aggregate demand. And the principal effect of fiscal policy was not its impact on the supply side--on incentives to work and invest--but its demand-side impact on the volume of spending.

                                                              Krugman protests that what he and his Keynesian colleagues at MIT taught around 1980 was very different from Bartlett's parody of modern Keynesianism. MIT's Robert Solow had argued for JFK in the early 1960s that a good fiscal policy needed to pay at least as much attention to the supply side as the demand side. And certainly those teaching macroeconomics at MIT at the end of the 1970s--Stan Fischer, Rudi Dorbusch, and company--placed enormous stress on the power of monetary policy to affect aggregate demand, shape expectations, and control inflation. All this is true. And yet, and yet...

                                                              Matthew Shapiro of the University of Michigan perhaps puts it best. He went to Yale as an undergraduate in the late 1970s and to MIT as a graduate student in the early 1980s. He says (roughly, this is my memory and not verbatim):

                                                              At Yale in the 1970s, I was taught that the Chicago School was bad and wrong because they believed that monetary policy had powerful effects on production and unemployment. Then I get to MIT in the early 1980s and was taught that the Chicago School was bad adn wrong because they believed that monetary policy did not have powerful effects on production and unemployment.

                                                              The second Chicago School was made up of the rational expectations revolutionaries of the late 1970s. The first Chicago School was that of Milton Friedman's monetarists who thought that controlling inflation was simple: don't use open market operations to expand the money supply. They were opposed by Old Keynesians who thought that monetary restraint was ineffective, by those who thought that monetary restraint was too effective (i.e., would cause too much unemployment), and by those (like Arthur Burns) who thought monetary restraint was impossible (i.e., that the Congress would never allow the Federal Reserve to stop inflation by generating a recession the size of 1982). My take on this story is found in J. Bradford DeLong (1997), "America's Peacetime Inflation"; and J. Bradford DeLong (2000), "The Triumph? of Monetarism". The first Chicago School by and large won the day, and Paul Krugman takes their substantial victory as natural and inevitable, and it did indeed seem that way from MIT in 1980, but not from the trenches of the Joint Economic Committee where Bruce Bartlett wallowed in the political trench-warfare mud in the late 1970s. So it seems to me that Bruce is more right than Paul.

                                                              I'm less sure that Bruce Bartlett was on the side of the angels on growth policy. I was taught that one sought to have cyclical deficits in recessions, but a budget in balance or surplus on average over the business cycle, so that the mix of policy tended toward a tight fiscal-easy money configuration that would produce high investment and rapid wage, output, and productivity growth, and one paid attention to high marginal tax rates and the deadweight losses they caused. Nothing that Bruce would disagree with there. And certainly I am on Bruce's side against those who focused exclusively on how high marginal tax rates were a good thing because they improved the distribution of income, and those who focused exclusively on fiscal policy as a manager of aggregate demand.

                                                              But in practice... it seemed to me that Bruce's political masters like Jack Kemp were excessively eager to throw the "budget in balance or surplus on average over the business cycle," and that the eager embrace of deficits and their crowding-out of investment did more harm than the focus on reducing marginal tax rates did good. We can argue about that, however.

                                                              A good deal of the problem is that there were so many factions. On the left side, there was the Solow tight fiscal-easy money tradition; the Musgrave progressive-redistributive-tax-system tradition; the vulgar Keynesians who never met a deficit or a price control they didn't like; the New Keynesian faction to which Krugman belongs, and others. On the right side, there were Bruce Bartlett and company; the neoconservatives who wanted rhetoric but didn't care about getting economic policy right; those who were loyal to Reagan whatever Reagan would decide but had no clue about policy; David Stockman who hoped that cutting taxes now would produce a wave of revulsion against deficits that would enable him to cut spending later; the Buchanan-Niskanen "we are betrayed" faction that protested against the embrace of deficit spending by the Republicans; and the "starve the beast" faction. "What the supply-siders thought" depends very much on who is included in the charmed circle, and when. And the same applies to "What the Keynesians thought."

                                                              I entered graduate school in 1980 so let me try to contribute by giving a brief outline of what I was taught. I was not at a top 20 school - far from it - and maybe the gulf between Pullman, Washington and Washington, D.C. wasn't as large as the gulf between Cambridge and Washington. But perhaps that doesn't matter when it comes to policy in Washington versus what was known in the academic community, and as Brad notes, there was quite a lot of variety across graduate programs in terms of what was emphasized.

                                                              Though it started with a pretty traditional IS-LM framework with some AD-AS thrown in, by the end of my time in graduate school in the mid 1980s the New Classical model was the dominant paradigm. Much of the game was to try and punch holes in the result that comes out of the New Classical framework that only unanticipated money can affect real variables like output and employment.

                                                              This assault came on both theoretical and empirical fronts. Mishkin, for example, had published a paper in the early 1980s that challenged work by Barro and others from the later 1970s supporting the New Classical model and its implication that only surprise money matters. On the theoretical front, the old Keynesian model which had been criticized for, among other things, lacking microeconomic foundations and lacking rational expectations, was being reconstructed into the New Keynesian model. This model would eventually overcome theoretical objections that plagued the older Keynesian model, and it would also do a better job of explaining the magnitude and persistence of business cycles and other features of the macroeconomic data. We learned some about Real Business Cycle models - but for the most part that work went on elsewhere and would surface later as a more general opposing model to New Keynesian framework. But we were certainly made aware of it, e.g. arguments about reverse causality to explain statistical money income correlations. I'd say the same about growth theory - we did the Solow-Swan basics, but very little beyond that. Stabilization policy was the main issue we worried about at the time.

                                                              Did money matter? I thought it did, that's what my dissertation was all about, theoretical and empirical reasons to doubt the New Classical model result that expected money does not affect output, but the issue simply was not settled at that time. We now accept, for the most part, that the Fed can affect real interest rates and also affect the real economy, but at the time there was a very strong split within the profession on this issue. It wasn't until later that a more general belief that anticipated monetary policy was a potentially useful stabilization tool surfaced in the profession. It's sometimes surprising to me today how complete the conversion on that issue has been, though it's certainly not 100%.

                                                              So, no, it wasn't generally agreed that money mattered, i.e. that money was a useful policy tool for stabilizing the real economy. But the Keynesian economics I learned at the time, which was in the implicit and explicit labor contracting framework for the most part due to who taught the courses, did say that money mattered. In fact, since the point was to challenge the New Classical result that money did not matter, the focus was mostly on monetary policy. As for fiscal policy, the Keynesian model we talked about - beyond the simple IS-LM version we learned at first - paid very little attention to fiscal policy, though certainly challenges such as Barro's "Are Bonds Net Wealth" were part of the conversation. Thus, within the beginnings of the New Keynesian framework that I learned, how changes in monetary policy affected the real economy was the primary focus.

                                                                Posted by on Wednesday, April 11, 2007 at 12:15 AM in Economics, Macroeconomics, Monetary Policy | Permalink  TrackBack (0)  Comments (46) 

                                                                A Plan to End the Insurgency and Rebuild Iraq

                                                                Economist Laurence Kotlikoff of Boston University has a plan to save Iraq:

                                                                Enlisting Iraqis to rebuild their country, by Laurence J. Kotlikoff, Commentary, Boston Globe: Four years, more than 26,600 American casualties, more than 100,00 Iraqi casualties, 2 million refugees, and $410 billion later, large parts of Iraq and a vast majority of Iraqis are stuck in an unmitigated hell, with no end in sight. The routine massacres of scores of innocent people, the bombings of schools, hospitals, mosques, and universities, the grizzly tortures, and now the gas attacks and use of children as bomb delivery systems are resulting in the mutual assured destruction of the Iraqi people.

                                                                If Iraqis are engaged in competitive genocide, the United States is engaged in staticide -- the maintenance of a suicidal status quo. The United States has not committed and will never commit enough troops to achieve security given its tactics.

                                                                Many Americans and Iraqis suspect that the presence of US soliders is making the security situation worse and exacerbating whatever carnage our inevitable departure will engender. This is why the majority of both Americans and Iraqis think it's time for the United States to withdraw.

                                                                In the meantime, the Iraqi government should implement a policy that will put an end to its Armageddon.

                                                                The Iraqi government should institute a draft of all Iraqi men between the ages of 18 and 35. This is the demographic most responsible for the violence. The removal of these 3 million men from the cities and countryside to army barracks would likely bring an immediate end to Iraq's horrific nightmare. Any men older than 35 suspected of involvement in terrorist or insurgent acts would also be enlisted...

                                                                The role of the enlarged Iraqi army would not involve bearing arms or training in the use of arms. Rather the role would be to reconstruct the country. All army units would be assigned specific reconstruction tasks and be jointly commanded by a Shia, a Sunni, and a Kurd who would make unanimous decisions. If any threesome can't agree, they would be replaced by a threesome that can.

                                                                Inductees would be taught the skills needed for their assigned reconstruction tasks..., and learn respect for diversity and human rights. They would be paid well, by the United States, for their national service. Annual per capita income in Iraq is now roughly $3,000. ...

                                                                Were the United States to pay 3 million Iraqi soldiers $10,000 yearly, the bill would be $30 billion. This is a small amount relative to the savings it would accrue from leaving the country. It would also make service in the Iraqi army highly desirable...

                                                                Eventually, the country's oil revenue would be used to cover these premium payments to Iraqi soldiers and provide a precedent for distributing oil revenues directly to Iraqis -- something that is long overdue and would eliminate much of the basis for the sectarian violence. ...

                                                                Instituting a draft is hardly a radical proposal. Scores of countries, including many in the region, have compulsory military service.

                                                                Enlisting young Iraqi men to rebuild their country would permit Iraqi children to attend school in safety, let the country rebuild its infrastructure, and let Iraqi women and older men work, shop, and pray in peace. And it would let the US military leave Iraq with a real sense of mission accomplished.

                                                                  Posted by on Wednesday, April 11, 2007 at 12:10 AM in Economics, Iraq and Afghanistan | Permalink  TrackBack (1)  Comments (83) 

                                                                  Robert Samuelson: Boomer Boomerang

                                                                  Once again, Robert Samuelson lumps all the social insurance programs together and foresees a dire future, in this case generational warfare. But as Dean Baker continually and correctly reminds us, Social Security is not the problem, and the programs themselves are not to blame - Medicare is not the cause of the growth in costs for health care:

                                                                  The Washington Post ... complained about ... "the coming crisis in Social Security and Medicare." The non-partisan Congressional Budget Office's most recent projections show that Social Security can pay all scheduled benefits, with no changes whatsoever, until 2046, and roughly 75 percent of scheduled benefits for many decades after that date, even if no changes are ever made. ...

                                                                  The Medicare story of course boils down to projections of exploding health care costs. If the health care system is not fixed, then "fixing" Medicare is irrelevant. We can zero out the program, but exploding health care costs would still devastate the economy. If the health care system is fixed, so that costs in the U.S. are in line with health care costs in other wealthy countries, then Medicare would be easily affordable. ...

                                                                  I think the last point is too often missed - it's not the Medicare program, it's the growth in health costs that is the source of the dire projections for rising budget deficits.

                                                                  Nevertheless, here's Robert Samuelson complaining about the budget pressures from the Social Security, Medicare and Medicaid programs and the generational divide it will bring about:

                                                                  Boomer Boomerang, by Robert J. Samuelson, Commentary, Washington Post: Cassandra Devine knows how to solve the coming "entitlements" crisis, preordained when the 77 million baby boomers begin hitting 65 in 2011: Pay retirees to kill themselves, a program she calls "transitioning." Volunteers could receive a lavish vacation beforehand ("a farewell honeymoon"), courtesy of the government, and their heirs would be spared the estate tax. If only 20 percent of boomers select suicide before the age of 70, she says, "Social Security, Medicare, Medicaid will be solvent. End of crisis."

                                                                  Okay, Devine is a 29-year-old fictional blogger in Christopher Buckley's satirical novel "Boomsday." Infuriated at the injustices awaiting her generation, she becomes an instant media celebrity with a gift for incendiary rhetoric. "Someone my age will have to spend their entire life paying unfair taxes, just so the Boomers can hit the golf course at sixty-two and drink gin and tonics until they're ninety," she tells one TV reporter. ...

                                                                  First, a generational backlash is inevitable. ...[T]he idea that younger workers will meekly bear the huge tax increases needed to pay all boomers' promised benefits is delusional. The increases are too steep, and too many boomers -- fairly wealthy and healthy -- will seem undeserving.

                                                                  Consider: In 2007, Social Security, Medicare and Medicaid constitute 44 percent of the $2.7 trillion federal budget. To pay all future benefits could ... easily require tax increases of 30 to 50 percent by 2030. ...

                                                                  Second, boomers will want even more benefits...: closing the "doughnut hole" -- a gap of coverage -- in Medicare's drug benefit; more lenient tax treatment for retirement accounts; more payments for nursing homes.

                                                                  Out in front will be the 38-million-member AARP, the nation's most powerful interest group. In the past four years, notes National Journal, it's spent $88 million on lobbying. ... AARP's new public relations campaign (slogan: "Divided We Fail") misleadingly aims to project an unselfish and high-minded image. In practice, it means AARP will support higher government spending for all age groups, which (of course) will increase taxes further for tomorrow's workers.

                                                                  For example, AARP urges the expansion of SCHIP, a program of health insurance for poor children that, ironically, illustrates the nation's twisted priorities. In 2007, SCHIP will cost $5.7 billion; Social Security and Medicare, $1 trillion. Well, maybe SCHIP should be expanded, but only if -- a test of AARP's real commitment -- cuts in Social Security and Medicare benefits pay for the expansion. A doubling of SCHIP would require cuts of about one half of 1 percent.

                                                                  Social Security and Medicare are an essential part of the social fabric. ... But the vast benefits -- paid too early and too indiscriminately -- have become disconnected from genuine need. Unless the two are reconnected, these successful programs will tear at the social fabric. It is unfair to blame only baby boomers for not acting preemptively... Still, boomers deserve special disapproval.

                                                                  "Baby Boomers," says Buckley's Devine, "made self-indulgence a virtue." Sure, that's a stereotype, but for opinion leaders and politicians, it is uncomfortably accurate. Consider Newsweek. It has a regular feature, "The Boomer Files," that celebrates boomer musicians, comedians, sports heroes and TV series. It discusses how boomers are "redefining the 'golden years' " -- but not a peep about the costs for their children.

                                                                  I was born in late 1945 and count myself a part of this failure. In our careless self-absorption, we are committing a political and economic crime against our children and perhaps -- when they awaken to their victimization -- even ourselves.

                                                                  He says:

                                                                  Well, maybe SCHIP should be expanded, but only if -- a test of AARP's real commitment -- cuts in Social Security and Medicare benefits pay for the expansion.

                                                                  Why does the expansion of SCHIP have to be paid for by reducing Social Security and Medicare as some test of AARP's commitment to children? I don't see that, there are plenty of other places to get the money. The program cost $5.7 billion in 2007. How much revenue was lost from tax cuts? Lots, no matter what the Lafferites try to tell you. The "twisted priority" is that there any poor children at all without health insurance.

                                                                    Posted by on Wednesday, April 11, 2007 at 12:06 AM in Economics, Health Care, Social Insurance, Social Security | Permalink  TrackBack (0)  Comments (14) 

                                                                    Tuesday, April 10, 2007

                                                                    Martin Wolf: How to Promote Employment while Protecting the Low-Paid

                                                                    Martin Wolf is worried that if we don't do a better job of protecting workers displaced by globalization and of sharing the gains from globalization more broadly, the global trading system will fail to live up to its potential:

                                                                    How to promote employment while protecting the low-paid, by Martin Wolf, Commentary, Financial Times: There are two particularly significant facts about labour markets of the high-income countries over the past two to three decades: globalisation and declining shares of labour income in gross domestic product.

                                                                    How are these phenomena related? What are the policy implications? The answers to these questions may well determine whether the backlash against globalisation...

                                                                    The subject is the focus of a background chapter to the latest World Economic Outlook from the International Monetary Fund. It reaches four chief conclusions.

                                                                    First, the globally engaged labour force has quadrupled over the past two decades, with the greatest impact coming from trade, not immigration.

                                                                    Second, the shares of labour income in GDP have declined markedly across the high-income countries over this period.

                                                                    Third, globalisation is among the causes of the declining share of labour income in GDP. But technology has been more important.

                                                                    Finally, countries that have lowered the cost of labour to business and improved labour-market flexibility have generally experienced smaller declines in labour-income shares. ...

                                                                    [W]hat are the policy conclusions? The ... most striking conclusion of this analysis has been the benefits of policies that promote employment. Insisting on high real wages for what, in consequence, become non-existent jobs is counter-productive. While incomes can be sustained through transfers, subsidised idleness is soul- destroying. French voters, please note.

                                                                    The right policy, then, is to promote employment while augmenting the incomes of the low-paid or at least sharply reducing the taxation of labour. It is also to promote the highest quality of basic education across the labour force and provide good opportunities for motivated workers to upgrade their skills.

                                                                    The right policy is to combine openness to trade with a politically acceptable sharing of the gains in high-income countries. The challenge is huge. But it is one at which we cannot afford to fail.

                                                                      Posted by on Tuesday, April 10, 2007 at 06:18 PM in Economics, International Trade, Social Insurance | Permalink  TrackBack (0)  Comments (7) 

                                                                      Robert Reich: The Real Scandal of Student Loans

                                                                      Robert Reich wonders why the government provides loan guarantees and subsidies to banks and other lenders so that they can make profitable student loans when direct provision of the loans by government is cheaper:

                                                                      The Real Scandal of Student Loans, by Robert Reich: The emerging scandal over student loans – and financial aid administrators that have cozy relationships with lenders – is only the tip of a scandalous iceberg.

                                                                      Consider: The Federal government subsidizes college loans in two different ways, giving colleges and universities the option of which way to go.

                                                                      The first way is for the federal government to lend students the money directly. ... The alternative is for the federal government to subsidize student loans indirectly by guaranteeing banks and other private lenders that if a student doesn’t repay the loan, the government will. The government also gives banks and private lenders additional subsidies to ensure they get a profitable return on any student loan they make.

                                                                      Obviously, this second alternative is a great deal for ... lenders. Hey, a guaranteed return on a no-risk loan! But it’s a lousy deal for American taxpayers. According to a study by the Center for American Progress, taxpayers pay about $7 more for every $100 lent by the private lenders than they do on direct government loans.

                                                                      That amounts to billions of taxpayer dollars each year ... that could be saved if the direct loan program was the only program. Billions of savings that could be put, for example, into Pell Grants for needy students.

                                                                      So here’s the multi-billion-dollar question. Why does the federal government continue to provide colleges and universities the option of going with the more expensive program when the government can offer direct loans more cheaply? Why is it that some fifteen years after the direct student loan program was first established, more than three-quarters of student loans still come through the more expensive system?

                                                                      Let me hazard a guess. Because the banks and other private lenders have enormous political clout in Washington. They also have clout within colleges and universities.

                                                                      This is the real scandal of student loans, and it’s got to stop. There’s no good reason for the federal government to waste taxpayer money by subsidizing banks and other private lenders when government direct loans are cheaper.

                                                                        Posted by on Tuesday, April 10, 2007 at 06:17 PM in Economics, Market Failure, Universities | Permalink  TrackBack (0)  Comments (18) 

                                                                        Health Care: The U.S. versus Europe

                                                                        Jonathan Cohn of the New Republic says European single-payer systems provide better health care than the U.S. system:

                                                                        What Jacques Chirac could teach us about health care, Comparative Advantage, by Jonathan Cohn, TNR Online: ...Michael Tanner, of the Cato Institute, wrote recently. "While one sympathizes with Elizabeth Edwards and wishes her well, it's important to note that the national health care system her husband has taken this opportunity to propose would be disastrous to thousands of Americans who suffer from cancer and other diseases." ...

                                                                        [T]his argument--that countries with universal coverage ration care and limit investment in new medical technology ... has been around for a while. ... Harry Truman's opponents warned of European-style rationing when he proposed creating universal coverage in the 1940s; Bill Clinton's opponents did the same in the 1990s.

                                                                        It's a potent argument politically. Americans certainly don't like the idea of losing their health insurance... But they're also spooked by the prospect that they might not be able to get the best, most advanced life-saving care if faced with a deadly disease. That's particularly true for more affluent Americans, for whom the threat of losing insurance coverage seems remote...

                                                                        But is it actually true that universal coverage results in worse care? That's a very different story from the one that conservatives tell. Let's start with what we know for sure. Relative to other highly advanced countries, the United States lags well behind the leaders when it comes to infant mortality, overall life expectancy, and life expectancy at 65. ...

                                                                        Critics argue that measuring infant mortality and life expectancy is too crude, since whether a newborn dies or how long somebody ends up living may have as much to do with outside conditions like poverty, environment, and lifestyle as they do with the quality of medical care. ... That's why the scholars ... prefer to look at some more finely tuned calculations: "potential years of life lost" or "disability adjusted life years." ... But, ... on these measures, too, the United States is decidedly mediocre compared to Japan and the more advanced countries in Europe.

                                                                        Conservatives insist that even these, more finely adjusted measures still can't adequately account for outside influences like poverty or environment. As such, they say, ... you need to look at health care-specific factors--like the amount of high-tech technology here versus there. In universal health care systems, the government inevitably exercises more control over health care spending. This is a big reason why all the other systems cost less--and, if you believe the critics, why people in those other systems get less.

                                                                        It sounds perfectly reasonable in theory. But the facts don't back it up. Look at Japan. It has universal health care. It also has more CT scanners and MRIs, per person, than the United States. It's true that the European countries tend to have less technology (although Germany and Switzerland appear to be comparable or at least very close.) But their citizens get more of something else...: Face time with doctors and time in hospitals. ...

                                                                        Truth be told, if there's an objection to relying on this sort of data, it's that they measure inputs and not outputs. Who's to say that more technology--or more days in the hospital--really does amount to better medical care? A lot of experts would argue that sometimes the opposite is true. And they would have a point.

                                                                        That leaves one place to look: The results of people who actually get sick. This is where the conservative argument about American superiority seems most persuasive--because, in a few cases, it actually has some merit. Cannon, Gratzer, Tanner, and others have all seized on the survival rates for cancers--particularly breast cancer and prostate cancer. In those two cases, Americans diagnosed with those diseases are significantly more likely to live than Europeans diagnosed with them.

                                                                        But before leaping to the conclusion that this proves the overall superiority of American health care ... you have to consider a slew of caveats. ... It's possible that, even accounting for such [caveats], the United States still has better treatment for breast and prostate cancer. But, even if that were true, it's hard to read the data as indictment of universal health care when the U.S. survival rate on other ailments isn't so superior. The Swedes are more likely than Americans to survive a diagnosis of cervical, ovarian, or skin cancer; the French are more likely to survive stomach cancer, Hodgkins disease, and non-Hodgkins lymphoma. Aussies, Brits, and Canadians do better on liver and kidney transplants.

                                                                        All of this comes with an important cautionary note: Measuring the outcomes of medical care is an imperfect science at best... It's difficult to make a ironclad case that any one system is better than another. But the fact that countries with universal health care routinely outperform the United States on many fronts--and that, overall, their citizens end up healthier--ought to be enough, at least, to discredit the argument that universal care leads to worse care.

                                                                        And that, in turn, ought to tip the scales of debate, since not even conservatives dispute the one clear advantage other countries have over us: You don't see their citizens choosing between prescriptions and groceries, or declaring bankruptcy, because of medical bills. As John Edwards put it when he announced his health care plan, "It doesn't have to be that way."...

                                                                        One note. Two main arguments against universal care are that waiting lines are too long and that medical technology lags behind the U.S. The article rebuts the waiting time claim, and when you see a doctor in Europe, it sounds like they actually have time to listen to their patients rather than cutting costs by cutting you off when you try to talk.

                                                                        On the other argument, that the use of technology lags behind the U.S., differences in technology may not be due to a superior U.S. system, but instead due to over-investment in technology caused by doctor's financial links to equipment makers. That is, even if we observe more equipment in the U.S., that does not mean the U.S. is more efficient or better, it could reflect a costly misallocation of health care resources in the U.S. with too much going to equipment and not enough flowing to other areas. This is the point that just looking at inputs does not tell us much about outcomes or efficiency. See "Drugs, Devices, and Doctors."

                                                                        Ezra Klein comments on the reaction of the National Review's Jonah Goldberg to the article:

                                                                        Throne-Kissers, by Ezra Klein: I've spent a bit of time this morning puzzling over the meaning of a pretty opaque Jonah Goldberg post. ... In it, he responds to Jon Cohn's smart article on the successes of the French health care system ... by trenchantly asserting that, "[m]aybe, just maybe, France and Denmark can handle the systems they have because they have long traditions of sucking-up to the state and throne. Marty Lipset wrote stacks of books on how Canadians and Americans have different forms of government because the Royalist, throne-kissing, swine left America for Canada during the Revolutionary War and that's why they don't mind big government, switched to the metric system when ordered and will wait on line like good little subjects....maybe, just maybe, the reason America doesn't have a sprawling European welfare state is that America isn't Europe. And, unlike some of our liberal friends, Americans don't want to be Europeans."

                                                                        My first thought is that that's a very serious, thoughtful, argument which has never been made in such detail or with such care. I smell a book contract! My second thought was: Huh? I'm not sure exactly what Goldberg thinks he's responding to, but it isn't anything Cohn or I wrote. For instance, apply his argument to Cohn's point on health care systems and it falls apart. America has multiple health care systems, some government-run, some privately administered. In every case, Americans -- who presumably aren't the "throne-kissing swine" of Goldberg's fevered imagination --report higher levels of satisfaction in the public programs. ... Even the poor, who largely rely on Medicaid, free clinics, and the like are at 41 percent, higher than those of us in private care. Butwaitthere'smore!

                                                                        The only truly socialized system in America is the Veteran's Health Administration. And surveys repeatedly and routinely find that they too are more satisfied with their care than those left in the private market. And anxious as I am to hear Jonah explain how our nation's veterans are just a bunch of toady throne-kissers, I'm not exactly holding my breath. So this one's back to you, Jonah: If America's culture renders us completely unsuitable for public health care systems, how come the vast numbers of Americans currently in public health systems seem so happy about it?

                                                                        Update: Jason Furman of the Hamilton Project has a proposal I'm not all that excited about. He advocates having patients share more of the cost of medical care in order to reign in costs. It would be tied to income so that the wealthy would pay more than the poor with households paying up to 7.5% of their income before full coverage kicks in. See "A New Prescription to Curb Health-Care Spending, by Laura Meckler, WSJ Washington Wire."

                                                                        Update 2: Ezra Klein adds:

                                                                        Why Are We Here?, By Ezra Klein: A commenter takes issue with Jonah's historical  contention that Americans reject generous social welfare states because we're a country comprised of refugees from monarchies who hate expansive safety nets:

                                                                        Does this kid know ANYTHING about American immigration patterns?

                                                                        I find it especially laughable to think the potato famine Irish immigrants were fleeing a welfare state... Yeah, that's EXACTLY why starving Irish came to America--they took offense at the too-generous welfare policies of the English!

                                                                        Likewise, I'm rolling at the suggestion that millions of African Americans chose America over Europe and Africa because they didn't want to be mollycoddled by a state that invested in their welfare.

                                                                        And let's not forget the Eastern Europeans who flooded in during the late 1800's and early 1900's, terrified that they would be forced to live under the generous welfare policies of nations like Poland and tsarist Russia. ...

                                                                        [W]hat an idiot. Yeah, that's the defining historical difference between Europe and the US--generous welfare states.

                                                                        Update: See Henry at Crooked Timber for more on this and, to try to salvage something worthwhile, an intelligent discussion of the role of culture in politics.

                                                                          Posted by on Tuesday, April 10, 2007 at 11:12 AM in Economics, Health Care, Policy | Permalink  TrackBack (0)  Comments (32) 

                                                                          Monday, April 09, 2007

                                                                          "A Boldly Redesigned Guest-Worker Program"

                                                                          That's a "Boldly Redesigned Program," not "Badly  Redesigned Program," which is the point. Gordon Hanson weighs guest worker programs against illegal immigration and concludes that "from a purely economic perspective, illegal immigration is arguably preferable to legal immigration." For this reason, he believes that any guest worker program must mimic the positive economic aspects of illegal immigration or it will be unlikely to slow the flow of illegal workers into the U.S.:

                                                                          Free Markets Need Free People, by Gordon H. Hanson, Commentary, WSJ: If there is one point of consensus in the fraught politics of immigration, it is that illegal immigration is bad. Yesterday, President Bush voiced his support for tough enforcement at the U.S.-Mexico border and called on Congress to resolve the status of the 12 million illegal immigrants now in the country. Last week, Rep. Tom Tancredo (R., Colo.) entered the presidential race, promising to make resentment of illegal immigrants a major campaign issue. And yet, from a purely economic perspective, illegal immigration is arguably preferable to legal immigration. Because Congress and the president refuse to see this, further reform this year could make a bad situation worse.

                                                                          Illegal immigration is persistent because it has a strong economic rationale. Low-skilled workers are increasingly scarce in the U.S. while they are still abundant in Mexico, Central America and elsewhere. ...[I]mpeding illegal immigration, without creating other avenues for legal entry, would conflict with market forces that push labor from low-wage countries to the high-wage U.S. labor market. ...

                                                                          Illegal immigration responds to economic signals in ways that legal immigration does not. Illegal migrants tend to arrive in larger numbers when the U.S. economy is booming and move to regions where job growth is strong. Legal immigration, in contrast, is subject to bureaucratic delays... The lengthy visa application process requires employers to plan their hiring far in advance. Once here, guest workers cannot easily move between jobs, limiting their benefit to the U.S. economy. ...

                                                                          Congress should redesign temporary immigration from the ground up. Successful reform would have to mimic current beneficial aspects of illegal immigration. Employers would have to be able to hire the types of workers they desire, when they desire. One way to achieve this would be for the Department of Homeland Security to sanction the creation of global temp agencies...

                                                                          Matching foreign workers to U.S. employers efficiently would require flexibility in the number of guest workers admitted -- and one way to make the number of visas sensitive to market signals would be to auction the right to hire a guest worker to U.S. employers. The auction price for visas that clears the market would reflect the supply of and demand for foreign guest workers. An increase in the auction price signals the need to expand the number of visas; a decline in the price indicates that the number of visas could be reduced.

                                                                          Perhaps the most important provision of any new visa program would be to allow guest workers to move between jobs in the United States. Without mobility between employers, guest workers would lack the attractiveness of illegal laborers. They would also be exposed to abuse by unscrupulous bosses. One way to facilitate mobility for guest workers would be to allow existing visa holders to apply for new job postings [at the global temp agencies]... Guest workers could move ... as economic conditions change.

                                                                          Making immigration more responsive to the market would not be easy to implement, either administratively or politically. However, absent a boldly redesigned guest-worker program, temporary legal immigrants would be unlikely to displace illegal labor. In the Immigration Reform and Control Act of 1986, Congress voted to increase enforcement against the hiring of illegals without creating a mechanism for the continued inflow of legal, low-skilled labor. Under steady pressure from business, the government ultimately gutted or redirected IRCA's major enforcement provisions. ...

                                                                          As Congress again wrestles with immigration reform, one would hope that it will pay heed to the failures of the past by creating a framework that allows for the dynamic participation of legal immigrant workers in the U.S. economy. Otherwise, the U.S. is likely to find itself with even larger illegal populations in the very near future. [This op-ed is adapted from a new study published by the Council on Foreign Relations]

                                                                            Posted by on Monday, April 9, 2007 at 09:36 PM in Economics, Policy, Unemployment | Permalink  TrackBack (0)  Comments (53) 

                                                                            Which Euler Equation?

                                                                            One of Leonhard Euler's equations is below, but it's far from the only one (how many Euler equations are there anyway?). However, for reasons explained at the end, many people believe this was his most "beautiful" equation, and one of the most beautiful equations of all-time. Here's a brief history of Euler's life and achievements:

                                                                            The Countless Achievements of a Math Master, by David Brown Washington Post: ...In 1988, the journal Mathematical Intelligencer asked its readers to list the most beautiful equations in mathematics. Of the top five, [Leonhard] Euler, who was born in Basel, Switzerland, 300 years ago next Sunday, discovered three of them, including No. 1:

                                                                            eiπ + 1 = 0.

                                                                            ...In 2004, Physics World put the same question to its readers. Of the top 20 equations, Euler had two. The one listed above, known as "Euler's equation," was second only to James Clerk Maxwell's equations describing electromagnetism...

                                                                            Continue reading "Which Euler Equation?" »

                                                                              Posted by on Monday, April 9, 2007 at 07:47 PM in Economics, Science | Permalink  TrackBack (0)  Comments (7) 

                                                                              Explicit Inflation Targets and Anchored Expectations

                                                                              The Fed has been discussing whether to adopt an explicit inflation target, something Ben Bernanke favors, and this has brought about an active debate within the Fed and elsewhere about the virtues of inflation targeting generally, and explicit inflation targeting in particular. With explicit inflation targeting the central bank announces a target inflation range, the measure of inflation it will use to assess price pressures, how much time it will allow to bring inflation within the target range, and so on. As noted, presently the U.S. does not announce its target, but many other central banks do.

                                                                              One argument for explicit inflation targeting is that it helps to anchor inflation expectations, more so than with an implicit target like the U.S. uses. However, Alan Greenspan and others argue that there is also a cost to committing to an inflation target, loss of flexibility when large unexpected events hit the economy. Since the Fed has been able to control inflation without an explicit target, they argue there is little to be gained in terms of anchoring expectations from moving to explicit targets.

                                                                              There are two responses to this. First, as Bernanke and others have argued, flexibility can be built into a targeting regime so the costs are not as large as claimed.

                                                                              But what about the benefits? The second response is that the benefits may not be as small as many have argued. This paper exploits cross-countries differences in whether inflation targets are explicitly announced to examine whether explicit targets lead to more firmly anchored inflation expectations. The paper finds evidence that explicit inflation targeting does help to to anchor expectations, i.e. that there are benefits to announcing a target, even for a country like the U.S. with a strong and credible inflation fighting record over the last few decades:

                                                                              Inflation Targeting and the Anchoring of Inflation Expectations in the Western Hemisphere, by Refet S. Gürkaynak, Andrew T. Levin, Andrew N. Marder, and Eric T. Swanson, FRBSF Economic Review 2007: [This article is reprinted from the conference volume Series on Central Banking, Analysis, and Economic Policies X: Monetary Policy under Inflation Targeting, eds. Frederic Mishkin and Klaus Schmidt-Hebbel. Santiago, Chile: Central Bank of Chile, 2007.]  Abstract We investigate the extent to which long-run inflation expectations are well anchored in three Western Hemisphere countries—Canada, Chile, and the United States—using a high-frequency event-study analysis. Specifically, we use daily data on far-ahead forward inflation compensation—the difference between forward rates on nominal and inflation-indexed bonds—as an indicator of financial market perceptions of inflation risk and the expected level of inflation at long horizons. For the United States, we find that far-ahead forward inflation compensation has reacted significantly to macroeconomic data releases, suggesting that long-run inflation expectations have not been completely anchored. In contrast, the Canadian inflation compensation data have exhibited significantly less sensitivity to Canadian and U.S. macroeconomic news, suggesting that inflation targeting in Canada has helped to anchor long-run inflation expectations in that country. Finally, while the requisite data for Chile are available for only a limited sample period (2002–2005), our results are consistent with the hypothesis that inflation targeting in Chile has helped anchor long-run inflation expectations in that country as well.

                                                                              Continue reading "Explicit Inflation Targets and Anchored Expectations" »

                                                                                Posted by on Monday, April 9, 2007 at 02:07 PM in Academic Papers, Economics, Inflation, Monetary Policy | Permalink  TrackBack (0)  Comments (2) 

                                                                                Paul Krugman: Sweet Little Lies

                                                                                Paul Krugman explains the power of the "Little Lie":

                                                                                Sweet Little Lies, by Paul Krugman, Commentary, NY Times: Four years into a war fought to eliminate a nonexistent threat, we all have renewed appreciation for the power of the Big Lie: people tend to believe false official claims about big issues, because they can’t picture their leaders being dishonest about such things.

                                                                                But there’s another political lesson I don’t think has sunk in: the power of the Little Lie — the small accusation invented out of thin air, followed by another, and another, and another. Little Lies aren’t meant to have staying power. Instead, they create a sort of background hum, a sense that the person ... must have done something wrong. ...

                                                                                Before 9/11, ... the right-wing noise machine mainly relied on little lies. And now it has returned to its roots.

                                                                                The Clinton years were a parade of fake scandals: Whitewater, Troopergate, Travelgate, Filegate, Christmas-card-gate..., there were false claims that Clinton staff members trashed the White House on their way out.

                                                                                Each pseudoscandal got headlines, air time and finger-wagging from the talking heads. The eventual discovery in each case that there was no there there ... received far less attention. The effect was to make an administration that was, in fact, pretty honest and well run ... seem mired in scandal.

                                                                                Even in the post-9/11 environment, little lies never went away. In particular, promoting little lies seems to have been one of the main things U.S. attorneys, as loyal Bushies, were expected to do. For example, David Iglesias, the U.S. Attorney in New Mexico, appears to have been fired because he wouldn’t bring unwarranted charges of voter fraud.

                                                                                ...[I]n Wisconsin, ... the Bush-appointed U.S. attorney prosecuted the state’s purchasing supervisor over charges that a court recently dismissed after just 26 minutes of oral testimony, with one judge calling the evidence “beyond thin.” But by then the accusations had done their job: the unjustly accused official had served almost four months in prison, and the case figured prominently in attack ads alleging corruption in the Democratic governor’s administration.

                                                                                This is the context in which you need to see the wild swings Republicans have been taking at Nancy Pelosi.

                                                                                First, there were claims that the speaker of the House had demanded a lavish plane for her trips back to California. One Republican leader denounced her “arrogance of extravagance” — then, when it became clear that the whole story was bogus, admitted that he had never had any evidence.

                                                                                Now there’s Ms. Pelosi’s fact-finding trip to Syria, which Dick Cheney denounced as “bad behavior” — unlike the visit to Syria by three Republican congressmen a few days earlier, or Newt Gingrich’s trip to China when he was speaker. ...

                                                                                [T]he hysterical reaction to her trip is part of a political strategy, aided and abetted by news organizations that give little lies their time in the sun.

                                                                                Fox News, which is a partisan operation in all but name, plays a crucial role in the Little Lie strategy... But Fox has had plenty of help... For example, CNN ran a segment about Ms. Pelosi’s trip titled “Talking to Terrorists.”

                                                                                The G.O.P.’s reversion to the Little Lie technique is a symptom of political weakness, of a party reduced to trivial smears because it has nothing else to offer. But the technique will remain effective — and the U.S. political scene will remain ugly — as long as many people in the news media keep playing along.

                                                                                Previous (4/6) column: Paul Krugman: Children Versus Insurers
                                                                                Next (4/13) column: Paul Krugman: For God’s Sake

                                                                                  Posted by on Monday, April 9, 2007 at 12:15 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (90) 

                                                                                  Sunday, April 08, 2007

                                                                                  Kenneth Rogoff: Policy Paralysis

                                                                                  Kenneth Rogoff says problems associated with financial market liberalization during the 1990s brought about an irrational fear of relaxing capital market controls in developing countries, and this fear of liberalization is preventing developing countries from realizing their growth potential. Though he acknowledges it will be controversial, he believes developing countries should be encouraged to pursue greater capital market liberalization because "Weak financial systems in emerging markets are a major obstacle to balanced development. They are also a big factor behind the global trade imbalances":

                                                                                  As the IMF meets, policy paralysis is continuing, by Kenneth Rogoff, Project Syndicate: Financial globalization is exploding. Yet, as the world's leading finance ministers and central bankers convene in Washington this month for the semi-annual International Monetary Fund (IMF) board meetings, policy paralysis continues. There is simply no agreement on how to address glaring problems such as America's increasingly fragile trade deficit, or financial dysfunction in a number of emerging markets.

                                                                                  This paralysis has three layers. First, rich countries are deeply reluctant to embrace any collective plan that might impinge on their own domestic policy maneuvers. The United States is the worst offender. US Treasury secretaries ... lecture their foreign colleagues on America's economic perfection, and why every country should seek to emulate it. Never mind that this logic is now in danger of unraveling along with the US housing market; Treasury Secretary Hank Paulson will stick to it. But the fact that the US looks set to borrow almost $900 billion this year from the rest of the world is hardly a sign of US strength and foreign weakness.

                                                                                  It is difficult to summarize the cacophony of European voices so succinctly. ... Europeans generally agree that their societies produce the best lifestyles, even if their economies are less efficient than America's in a Darwinian sense. Thus, European finance ministers, too, will not be keen to admit any need for major policy changes to deal with risks from financial globalization.

                                                                                  The Japanese typically try to keep quiet. As huge winners from globalization, they want to avoid criticism of their ... policies, which arguably remain considerably more protectionist than those of their rich-country counterparts. And they certainly don't want to be pressed to apologize for holding hostage over $800 billion in foreign currency reserves, acquired to resist yen appreciation.

                                                                                  Developing countries are also at fault. Too many policymakers still believe that externally imposed opening to international capital flows was the main culprit behind the financial crises of the 1990s - a view that unfortunately is lent some intellectual respectability by a small number of left-leaning academics.

                                                                                  Never mind that most of the crises could have been avoided, or  at least substantially mitigated, if governments had let their currencies float against the dollar, rather than adopting rigid exchange-rate pegs. Instead, the bogeyman of financial globalization is used as an excuse for continuing to coddle inefficient and monopolistic domestic financial systems. The inability of backward domestic financial systems to allocate investment efficiently is a big factor pushing funds out of poor countries and into the US.

                                                                                  Last but not least, the IMF ... ought to be providing more leadership. ... Unfortunately, the IMF is paralyzed by ... internal governance problems, the biggest of which is the lack of a sensible way to recalculate the voting shares of countries as their relative influence in the global economy evolves. In particular, a radical increase in the weight of Asia's vote is urgently needed.

                                                                                  What, then, should ministers do when they gather in Washington? First, there is the long-standing litany of policy responses needed to deal with the global trade imbalances. These include greater fiscal discipline in the US, greater reliance on domestic demand in both Europe and Asia, and more flexible exchange rates in Asia.

                                                                                  But it is time to go further and begin to lobby aggressively for faster financial liberalization in the developing world. ... [B]ad memories of the IMF's first, premature attempt to promote long-term capital market liberalization remain an obstacle today..., coming as it did in the middle of the 1990s Asian financial crisis... But it is now time to revisit the idea... Weak financial systems in emerging markets are a major obstacle to balanced development. They are also a big factor behind the global trade imbalances.

                                                                                  Pushing for greater capital market liberalization after the debacle of the 1990's will be controversial. But the core of the idea ... is right... In the absence of better mechanisms for capital allocation, global growth in this century will slow down a lot sooner than it should. ...

                                                                                    Posted by on Sunday, April 8, 2007 at 01:11 PM in Economics, International Finance | Permalink  TrackBack (0)  Comments (11) 

                                                                                    Exorcising the Ghosts of 1994

                                                                                    Learning from Clinton's mistakes on health care reform:

                                                                                    This time, we want healthcare reform, by Ezra Klein, Commentary, LA Times: ...What a difference a decade makes. It wasn't so long ago that President Clinton's proposed [health care] reforms suffered a catastrophic defeat at the hands of moneyed interests and Republican opportunists, setting the stage for the Democratic Party's historic losses in the 1994 midterm elections. It was an enormous blow to ... the Democratic Party...

                                                                                    Such traumas leave scars, and for years afterward, Democrats ... shied away from fully reengaging the healthcare debate, even as the country's healthcare system continued its slow deterioration.

                                                                                    But the ghosts of 1994 have been largely exorcised from the Democratic psyche, and today, even the most hardened cynics are allowing themselves moments of hope. ... If Democrats are going to ... finally succeed, though, they are going to have to learn the lessons that 1994's failure can teach...

                                                                                    Everything that could go wrong did; everything that could be handled wrong was. Clinton decided to pursue the passage of NAFTA before healthcare reform, exhausting and angering his liberal allies (such as organized labor) immediately before he would most need their support and strength.

                                                                                    The initiative was placed under the control of Hillary Rodham Clinton and Ira Magaziner, whose primary health policy credentials came from a report on medical spending he'd written for the state of Rhode Island. Neither had the political experience to safely shepherd a reform of this magnitude, and it showed in their procedural missteps, which involved creating more than 30 closed-door task forces with more than 600 members but little to no representation from industry stakeholders such as the insurance industry or healthcare providers.

                                                                                    Worse, the Clinton administration was completely incoherent on how to handle those industry stakeholders and other interested parties, and thus it was unprepared to repel the all-out assault they mounted on the plan. ... There's a lot of money sloshing around, and quite a bit of profit to protect.

                                                                                    So, the first question for would-be reformers is how you handle the insurance industry, the pharmaceutical industry, the for-profit-hospital lobby and the businesses that don't want to begin offering comprehensive healthcare for their employees. And here, there is a choice to be made: Do you run over the industry interests that impede reform ..., or do you resign yourself to their involvement and invite them to the table?

                                                                                    In a classic worst-of-both-worlds compromise, Magaziner and Hillary Clinton did not initially include industry representatives in the process, but then constructed a plan whose famed complexity sprang mostly from their attempts to retain a place for these groups. Thus, they expected a certain degree of buy-in from the medical-industrial complex and were blindsided by the ferocious opposition they actually faced. Worse, their proposal didn't allow them to effectively counter the opposition. ...

                                                                                    And at the same time as the Clinton administration was floundering before the attacks ... (the insurance industry alone spent $50 million in ads, lobbying and organizing), the structural pressures pushing toward reform began to ease. As healthcare writer Matthew Holt has persuasively argued, President Clinton's initial mandate came in the context of the 1991-92 recession ... that left the middle class feeling particularly insecure...

                                                                                    But amid the lengthy dithering of the Clinton/Magaziner policy process, the recession lifted, the economy improved, the public's anxieties eased... Moreover, the promise of implementing managed care left the right with an alternative policy to organize around, one that didn't require government intervention or obvious turbulence.

                                                                                    Today, of course, it's clear that managed care has failed. After cost growth was effectively arrested in the mid-1990s, patients rebelled against being managed, and insurers decided that passing on the costs ... was less trouble than holding them down. Moreover, ... anxieties over spending growth and the precariousness of coverage ... are now constant companions, even in periods of economic expansion. ...

                                                                                    That may be why a recent New York Times/CBS poll found that 90% of Americans said they thought that the healthcare system needed either "fundamental changes" or to be "completely rebuilt." The last time the poll recorded such desire for reform was in January 1994. Indeed, according to the poll, 62% report themselves willing to pay higher taxes for universal coverage.

                                                                                    Such numbers have appeared before, and efforts at reform have failed before. There are differences this time, though. No change-minded president would be so naive about industry opposition, or slow to propose a plan, or secretive about its creation. The pressures that eased after the 1990-91 recession are now enduring.

                                                                                    The progressive coalition is much more mature and effective ..., and it aches to engage ... in a debate about how to best run the American healthcare system. Most telling of all, the American people regret passing up the Clinton plan. A 2005 ... poll found that 53% of respondents ... believe that they'd be better off had the Clinton plan passed, while only 28% believe that they'd be worse off. It may be that ghosts of the Clinton plan's failure have ceased scaring Democratic politicians and begun haunting voters, leaving them afraid not of change but of its absence.

                                                                                    Will it happen, or is reform politically impossible? If business comes solidly aboard I think there's a chance even if the medical industrial complex fights the effort vigorously. In any case, reform will depend upon the ability of the next president to build an effective coalition, a difficult task since serious reform will come at someone's expense and hence bring strong opposition from some groups.

                                                                                    There are signs that firms are realizing participating in reform is better than potentially having it forced upon them, so it's partly a matter of the type of reform business is willing to support and whether that will lead to a unified reform effort, or the splintered politics of the past that has blocked substantial change.

                                                                                    If anyone cares to weigh in, I'd be curious to hear how you see the current slate of presidential candidates in this regard, i.e. their ability to design an effective health care reform plan, and to forge the necessary coalition to put it into place, or any other thoughts you might have on the more general topic of what will be required to bring about major health care reform.

                                                                                      Posted by on Sunday, April 8, 2007 at 02:34 AM in Economics, Health Care, Policy, Politics | Permalink  TrackBack (0)  Comments (37) 

                                                                                      Saturday, April 07, 2007

                                                                                      Jeffrey Sachs: "The Difference between Mr. Easterly and Myself is that I'm Actually Trying to Get Something Done"

                                                                                      An Easterly lesson? A post not too long ago, "Africa's Poverty Trap" gave William Easterly's views on development in Africa, including negative comments about the work of Jeffery Sachs. In this interview, Jefferey Sachs responds to Easterly's general criticisms of his work, and he comments on the contributions of William Easterly to the African development effort:

                                                                                      Lunch with the FT: Jeffrey Sachs, by Chris Giles, Financial Times (free): I am due to meet Jeffrey Sachs in his choice of restaurant... Sachs is in London to deliver the first of five BBC Reith Lectures, a sought-after honour for academics. The lectures give a chance to talk to a worldwide radio audience. "[The lecture] is unique as a global discussion. It's hard to think of another way to reach such a wide audience," Sachs says... Referring to the BBC, he says: "They quote a 100 million audience - rather more than that, a 150 million audience." Then he asks me if I know how many people will listen. I haven't a clue, I admit, but tell him that the audience figure might need an "up to" added before the numbers. ...

                                                                                      Audience size clearly matters to Sachs. His website says he is "widely considered to be the leading international economic adviser of his generation", and his mission is to solve the problems of poverty, disease, global warming and globalisation. Although his current views are highly controversial, he knows that the bigger the audience, the bigger the impact. ... He campaigns for a better world, and is certain he knows how to get one. ...

                                                                                      I want to talk first about his role in advising governments on economic reforms in Latin America and eastern Europe. There was a time, particularly in the late 1980s and early 1990s, when no self-respecting government of a middle-income or ex-communist country would instigate a reform programme without Sachs's advice. So, ... I rather blunder into my first question: "Looking at the countries you advised in the early 1990s, those countries are not now doing very well, are they?"

                                                                                      "Oh, no. That's not right," he retorts. ... We embark on a tour of the world's economies, starting in Latin America. ... Latin America is doing much better than is often thought, he argues: "I'm optimistic about Brazil. And if you look at a map, being optimistic about Brazil takes you a long way to being optimistic about the whole of Latin America. I don't lose huge sleep over Latin America - it's at peace, it's not riven by terrorism, it's democratic and it has made huge strides in human development. What have been hugely unequal and divided societies are becoming slowly more equal, and even very deep ethnic and racial divisions are being ameliorated through democratic politics."

                                                                                      The same cannot be said about Russia, I say. Sachs replies by telling me how Poland was a case of successful reform, which has now led to a normal country embraced within the European Union. How did it achieve success? "The essence of what they wanted to do was right, it was based on sound fundamentals. What I tried to do was to add the economics to go around it." ...

                                                                                      I bring the subject round to Russia again. "I advised Russia for two years from December 1991 to January 1994," Sachs says defensively. "It was an extremely frustrating period for me." The problem, he says, was not that good ideas were tried and failed, but that neither the US nor the powerful elites in Russia wanted to try sensible economic reforms. The US, he says, failed because it wanted a weak Russia, while the Kremlin's corrupt efforts to stop the communists' re-emergence in the mid 1990s led to the transfer of the Russian state's assets into the hands of a tiny elite.

                                                                                      "When I watch all of this now," Sachs says, "it is the ... triumph of politics over economics." He is warming to a theme that forms the backbone of his thinking on almost every issue - good economic solutions will work if only politics doesn't get in the way...

                                                                                      The theme continues as we move on to talking about poverty in Africa. This has been the focus of his more recent work. Immediately, he shows his anger at those who claim aid fails because Africa remains desperately poor, even after some $2,300bn of aid - the figure comes from Professor William Easterly of New York University. Sachs manages a masterly dismissal; he calculates the amount as only $16 per poor person per year over the past 60 years. "I see the number and say, well, that's a pretty modest sum. The rest of the world sees the same number and says that's a horrendous failure that's nearly bankrupted us."

                                                                                      Worse, Sachs thinks that Easterly's criticisms of aid are having an impact on giving. "The difference between Mr Easterly and myself is that I'm actually trying to get something done practically... But I know that since he has launched this tirade, it makes it harder to do." He insists that for $16 a person a year, aid has "done extremely well". ...

                                                                                      "People are dying in large numbers. The triumph of politics over economics is not that money is being lost in Africa, it is that money is not going in." He vehemently denies that big aid has been tried before and not worked, and challenges me to name studies proving him wrong, knowing full well that I can't.

                                                                                      We move on to talk about a specific project Sachs is currently involved in, Millennium Villages, where his ideas on fertilisers, malarial bed-nets and the like are tried on the ground. My less-than-ecstatic reaction to his reports of their success is clearly the same as that of many aid agencies. It instantly raises his hackles. I suggest there are many examples where success in pilots does not translate into something that can be replicated on a large scale... "I'm sorry," he is almost shouting now. "That, I disagree with completely. That's preposterous."

                                                                                      I ... counter that it is equally preposterous to insist they will work. "I know," he says, "but how do you actually do something in life? Do you list all the things that may go wrong and then decide we won't do it, or do you actually try?"

                                                                                      We talk about global warming. It's easily solvable, Sachs insists, because the costs of doing something about carbon emissions are exaggerated - so people will soon realise that they can cut carbon emissions without much pain. We talk about global trade - all the US has to do is offer an aid, trade and climate change deal to the rest of the world and a solution is within reach. We talk about US healthcare - within a few years, people will see sense and the uninsured will be covered, he predicts. ...

                                                                                      I wonder aloud whether economics really can solve these big global challenges. In Sachs's world, ... there is always an easy solution. I suggest vested interests, national differences and the fact that reforms tend to [have] winners and losers make issues rather more intractable than he believes. Bringing the subject full circle back to his lectures, he says: "The key word of all of these lectures is 'choice'. A generation has a choice, and we have choices we make collectively... We have some absolutely terrific opportunities... but we miss opportunities all the time. That's why it is really important to understand what these choices are - and that is what I'm trying to explain in these lectures." ...

                                                                                        Posted by on Saturday, April 7, 2007 at 09:00 PM in Economics | Permalink  TrackBack (0)  Comments (25) 

                                                                                        The Value of a Progressive Corporate Image

                                                                                        Would you buy coffee from a union-busting firm?:

                                                                                        Latte Laborers Take on a Latte-Liberal Business, by Daniel Gross, NY Times: On March 30, the National Labor Relations Board’s New York office delivered a stinging accusation against one of the city’s — and the nation’s — most popular retail outlets. The labor board charged that Starbucks ... committed 30 violations of law in ... trying to ward off union activity at four Manhattan outlets. This may be the latest salvo in a new kind of labor battle: union workers versus corporate do-gooders. ...

                                                                                        “The N.L.R.B.’s complaint illustrates that this is a company with a profound disrespect for workers’ rights,” said Daniel Gross (no relation), a union organizer who dished out frappuccinos and mocha lattes at Starbucks before being fired last August. ...

                                                                                        Starbucks strongly denies the charges, and says it will fight them in court. But Starbucks hasn’t suffered anything like the fate that has befallen Wal-Mart, another national chain known for its opposition to unions. ...

                                                                                        Judging by the lines at Starbucks stores in Manhattan, one of the most progressive and union-friendly towns in the country, the accusations of union-busting and poor pay may not matter a lot. New Yorkers will probably continue to queue up in the thousands for the privilege of shelling out $4 or so for a caffeine injection...

                                                                                        Activists are asking consumers to sign petitions and send e-mail messages protesting Starbucks’ practices. But they may have a hard time matching the success of the campaign against Wal-Mart.

                                                                                        One could chalk it up to the nature of the product Starbucks peddles. Many customers feel they simply can’t get their day started without a caffeine-laden beverage. But some powerful, far-reaching trends — like consumers’ viewing their spending choices as political expression — may also help explain why a company can maintain its assiduously polished progressive reputation while also bitterly fighting unions.

                                                                                        Do-goodism is an important component of Starbucks’ brand appeal. Starbucks is regarded as one of the most progressive members of the Fortune 500. It provides health care benefits and stock options to many part-time employees. It says it is committed to paying coffee growers in impoverished countries above-market prices for the beans. And its chief executive, Howard Schultz, called for universal health care coverage long before it became popular for corporate chieftains to do so. ...

                                                                                        The same holds true at Whole Foods. Like Starbucks, the organic foods supermarket maintains what it calls socially responsible sourcing guidelines and supports alternative energy. (In 2006, Whole Foods made what it says was the biggest corporate purchase of green power ever.)

                                                                                        Again, like Starbucks, it has a chief executive, John Mackey, who is hostile to organized labor. In 2003, he told Fortune magazine that unions are “highly unethical and self-interested.” And, like Starbucks, Whole Foods suffers no apparent consumer sanction as a result of its position. ...

                                                                                        Why? One explanation, of course, is that with each passing year, unions occupy a smaller space in our culture. In 2006, according to the Bureau of Labor Statistics, a mere 12 percent of employed wage and salary workers were members of unions, down from 20.1 percent in 1983. In 2006, only 7.4 percent of private-sector employees were union members. As a result, very few of the people who pop into Starbucks each day for a jolt of energy are members of unions themselves, or are related to union members.

                                                                                        A change in the nature of political activism may also explain any possible disconnect. Activism is increasingly taking the form of consumption. “People are interested in doing a little bit better by the planet while they’re shopping,” said Mark Whitaker, the former Newsweek editor who is publishing Sprig, a new Web site for environmentally conscious consumers.

                                                                                        To register their concern about global warming, people can petition their government. Or they can pay above-market prices for reliable, prestigious products that reduce emissions and save energy: a Prius instead of an S.U.V.; compact fluorescent light bulbs instead of incandescent bulbs; wind energy instead of coal-fired electricity.

                                                                                        By the same token, many people are willing to pay a premium for Starbucks coffee and Whole Foods vegetables in part because they swear by the products, and in part because the companies trumpet their “good corporate citizen credentials.” Whether the associates and team members who sell them $4 coffees and $7-per-pound heirloom tomatoes agree with that assessment may not matter.

                                                                                        Another potential explanation is that people do not believe unions are the best or even an effective way in the long-run for labor to increase its share of national output to the extent that they did in the past. Because people see less value from unions, they also see less value in penalizing firms who oppose unionization. See "Market Failure in Everything: The Labor Market Edition."

                                                                                          Posted by on Saturday, April 7, 2007 at 05:22 PM in Economics, Environment | Permalink  TrackBack (0)  Comments (9) 

                                                                                          What Did You Know, and When Did You Know It?

                                                                                          In the comments to my discussion of his NY Times article "How Supply-Side Economics Trickled Down," Bruce Bartlett says:

                                                                                          Interesting discussion. However, I think Mark misses the historical context of my analysis. In the 1970s, we were unaware of real business cycle theory or New Keynesian theory. We were confronting Old Keynesian theory. What Mark has basically done is take a current theoretical debate and superimposed it on the 1970s. That's fine if one's goal is to understand how the economy really worked in the 1970s or what the actual effects of policies taken at that time were. But as a matter of history, it is misleading. We didn't know any of this stuff because it didn't exist then. We were dealing with a far different situation in terms of what people knew about the economy (or thought they knew) and that's one reason why I believe that terms like "supply-side economics" have outlived their usefulness. The context in which the term had meaning no longer exists and therefore it has become a barrier to communication rather than a facilitator.

                                                                                          And, in another comment, he adds:

                                                                                          People need to keep in mind that this was not some purely theoretical debate taking place at some academic conference or in the pages of obscure journals. The people I was working with were members of Congress and their staffs and we were battling specific policies by putting forward specific policies of our own. Many people on both sides were unaware of the theoretical underpinnings because they were unstated, implicit. Part of the supply-side strategy was to make those assumptions explicit. I mention some of them in my article.

                                                                                          Paul Krugman then says:

                                                                                          Bruce Bartlett says this:

                                                                                          Among the beliefs held by the Keynesians of that era were these: budget deficits stimulate economic growth; the means by which the government raises revenue is essentially irrelevant economically; government spending and tax cuts affect the economy in exactly the same way through their impact on aggregate spending; personal savings is bad for economic growth; monetary policy is impotent; and inflation is caused by low unemployment, among other things.

                                                                                          Wow. You see, I was a grad student at MIT - the great Keynesian stronghold - in the 1970s, and this bears no resemblance to what was being taught.

                                                                                          In fact, I still have my copy of Dornbusch-Fischer, Macroeconomics, the 1978 edition - and it doesn't make any of those assertions. I'm particularly amazed by the "monetary policy is impotent" bit: no mainstream Keynesian in America believed that any time after, say, 1955. Dornbusch-Fischer is mainly *about* monetary policy, and how important it is.

                                                                                          Let me suggest that good economic doctrines don't have to be sold by misrepresenting what other doctrines say.

                                                                                          Continue reading "What Did You Know, and When Did You Know It?" »

                                                                                            Posted by on Saturday, April 7, 2007 at 10:53 AM in Economics, Macroeconomics, Policy | Permalink  TrackBack (0)  Comments (10) 

                                                                                            Church and State

                                                                                            This discusses John Ashcroft's "profound" changes to the Civil Rights Division of the Justice Department with the help of Monica Goodling and others:

                                                                                            Justice's Holy Hires, by Dahlia Lithwick, Commentary. Washington Post: Monica Goodling had a problem. As senior counsel to Attorney General Alberto R. Gonzales and Justice Department liaison to the White House, she no longer seemed to know what the truth was. ...

                                                                                            Continue reading "Church and State" »

                                                                                              Posted by on Saturday, April 7, 2007 at 10:16 AM in Economics, Politics, Religion | Permalink  TrackBack (0)  Comments (7) 

                                                                                              Friday, April 06, 2007

                                                                                              FRBSF: Will Fast Productivity Growth Persist?

                                                                                              John Fernald, David Thipphavong, and Bharat Trehan of the San Francisco Fed ask if the downward shift in productivity growth since mid-2004 is temporary or permanent:

                                                                                              Will Fast Productivity Growth Persist?, by John Fernald, David Thipphavong, and Bharat Trehan, Economic Letter, FRBSF: Strong productivity growth is essential for improving living standards and can have an important impact on economic policy, yet economists are far from being experts at predicting when the trend of productivity growth might shift. In the 1960s, productivity growth boomed, growing at an average annual rate of 2-1/2%. It weakened in the early 1970s, and for the next two decades or so averaged an annual growth rate of only about 1-1/4%. Then, in the mid-1990s, productivity growth boomed again, averaging about a 3% annual rate from the last quarter of 1995 through the middle of 2004. These shifts were not predicted and were generally not widely recognized until years after they occurred. Considering that, since the middle of 2004, productivity growth has averaged only about 1-1/2% per year, it may be time to ask whether this is just a "pause" in the boom that started in the mid-1990s or a shift back to the growth rates seen in the 1970s and 1980s. This Economic Letter begins to answer this question by focusing on the factors that underlay the most recent productivity boom and what they may portend for the future.

                                                                                              Information and communications technology and the productivity surge Technological innovation is often associated with productivity booms. The most obvious such innovations in recent decades have been in the production of information and communications technology (ICT), such as computers, software, communications equipment, and the like. But the channels for ICT to affect the overall economy are complex.

                                                                                              Economists identify three proximate or direct sources of higher labor productivity. First, workers have more and better capital to work with, also known as "capital deepening." Second, the workforce gains more education and skill. Third is total factor productivity, or TFP, a comprehensive term for everything not otherwise explained; the main reason TFP rises over time is innovation in products and processes.

                                                                                              Continue reading "FRBSF: Will Fast Productivity Growth Persist?" »

                                                                                                Posted by on Friday, April 6, 2007 at 09:09 PM in Economics, Monetary Policy, Technology | Permalink  TrackBack (0)  Comments (18) 

                                                                                                Tim Duy's Fed Watch: Not Rate Cut News

                                                                                                Tim makes it clear that he is not a fan of the ADP report as he interprets the latest employment data:

                                                                                                Not Rate Cut News, by Tim Duy: If you traded on Wednesday’s ADP report, this is not exactly Good Friday for you. Please, please remember this the next time you feel the urge to pay to much attention to the ADP report. Yes, over time, I believe the ADP number will prove to be not significantly different from the BLS private NFP numbers (which begs the question of why we need two identical measures of the same thing in the first place). Indeed, I find the analysis of ADP’s payroll data to be academically intriguing. And the ADP report may even edge the market consensus in the right direction on occasion.

                                                                                                Yet still, even after the significant methodological improvements made after the December fiasco, when ADP is wrong, it is very wrong from a trading perspective. While the difference between the ADP read and the BLS read on private NFP is “only” 51k, the smallest drop in the bucket of the US labor pool, it can mean the world to the bond markets. And suppose that the BLS number is revised down to the ADP number. To be sure, this will be seen as a victory for the ADP report, but it doesn’t change the fact that you were on the wrong side of the trade today. Simply put, use the ADP number at your own risk, and expect to be blindsided on the first Friday of every month.

                                                                                                The employment report stands against the softer tone of much of the data. NFP rose by 180k, while the prior month was revised up to 113k. For the quarter, the average monthly gain was 152k. I know, if viewed in the light of the Clinton years, this is a disappointment. But the Fed thinks labor force growth is slowing, and consequently is looking for something closer to 100k to hold unemployment in place. Recent figures remain well above that mark; unemployment edged down to 4.4% in March.

                                                                                                In the details, the 56k gain in construction was surprising, but this is being written off as a rebound from February’s weather related decline. Manufacturing employment dropped; no surprise there. On a weak note, business and professional services lost 7k, largely on the decline in the employment services component (but not the temporary help component, which only slid by 800 jobs). Something to keep an eye on. Note also the consistent gains in computer systems designs, up 7.1k for the month and 62.9 for the year – interesting considering there is so much commentary about information technology jobs being sent overseas. And retail hiring is on the upswing – someone must be shopping, despite continue calls for a consumer collapse.

                                                                                                To be sure, we will soon be reminded by the bears that the employment report is the ultimate lagging indicator. I don’t dispute this point, but just look at the last five reads on GDP growth:

                                                                                                2005:Q4 2006:Q1 2006:Q1 2006:Q1 2006:Q1
                                                                                                1.8 5.6 2.6 2.0 2.5

                                                                                                With the exception of the 1Q06 GDP pop, you can’t exactly say that the slowdown is a new event, especially considering that no one believes that 1Q07 was anything special. If we are significantly below potential, I would have expected labor markets to be considerably softer by this point in the cycle. Not only are they not soft, but they are strong enough to generate wages gains – note that the 6 cent gain translates to an annual rate of 4.2%, which will hopefully be ahead of inflation. "Hopefully" meaning it might imply that we are shifting income from corporate profits to labor. Of course, the wage gains could be of the more inflationary variety…let’s not go there just yet.

                                                                                                Still, from a policy perspective, that gets us back to the productivity question (also raised by Jim Hamilton this morning). Note that aggregate hours worked rose at a 1.5% annualized rate for the first quarter – if GDP posts at 2%, you really can’t expect much good news on the productivity front. It was already clear that monetary policymakers believed that labor force growth was slowing. Multiple quarters of soft GDP growth – assuming 1Q07 is weak, 5 of the last 6 quarters will post at 2.6% or lower – combined with continued job growth and a declining unemployment rate, is going to put going to raise some serious questions on Constitution Avenue. Those looking for a rate cut on the back of weak growth should be looking closely at the possibility that relative to potential, growth is not that slow. The Fed will be. In this environment, some good news on inflation would be very welcome.

                                                                                                The risk of a recession is still out there, despite the employment numbers. All the things the bears say will happen may still happen. But the recession keeps being put off to the next quarter. Eventually it will happen. But timing is everything.

                                                                                                  Posted by on Friday, April 6, 2007 at 01:17 PM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (5) 

                                                                                                  Paul Krugman: Children Versus Insurers

                                                                                                  Since resources are limited and choices must be made, what types of health care programs should the government support?:

                                                                                                  Children Versus Insurers, by Paul Krugman, Commentary, NY Times: Consider the choice between two government programs.

                                                                                                  Program A would provide essential health care to the eight million uninsured children in this country.

                                                                                                  Program B would subsidize insurance companies, who would in turn spend much of the money on marketing and paperwork, and also siphon off a substantial fraction ... as profits. With what’s left, the insurers would provide additional benefits, over and above basic Medicare coverage, to some older Americans.

                                                                                                  Which program would you choose? If money is no object, you might go for both. But if you can only have one, it’s hard to see how anyone could, in good conscience, fail to choose Program A. I mean, even conservatives claim to believe in equal opportunity — and it’s hard to say that our society offers equal opportunity to children whose ... families can’t afford proper medical care.

                                                                                                  And here’s the thing: The question isn’t hypothetical..., but the choice between A and B is playing out right now.

                                                                                                  Program A is the proposal by Senator Hillary Clinton and Representative John Dingell to cover all children by expanding the highly successful State Children’s Health Insurance Program. To pay for that expansion, Democrats are talking about ... shutting down Program B, the huge subsidy to private insurance plans ... so-called Medicare Advantage plans — created by the 2003 Medicare Modernization Act. The numbers for that trade-off add up, with a little room to spare. ...

                                                                                                  Now, nobody is proposing that Medicare ban private plans — all that’s on the table is requiring that they compete with traditional Medicare ... on a fair basis. And that’s not what’s happening now. ...Medicare Advantage plans now cost taxpayers an average of 12 percent more per enrollee than traditional Medicare. Private fee-for-service plans, the fastest-growing type, cost 19 percent extra.

                                                                                                  [T]he Bush administration ... is adamantly opposed both to any attempt to expand the children’s health insurance program — in fact, the administration wants to cut its reach — and to any attempt to reduce Medicare Advantage payments.

                                                                                                  The official reasons given for this position are evasive and dishonest.

                                                                                                  Explaining the administration’s opposition to expanding the children’s program, Michael Leavitt, the secretary of health and human services, said the program “should not be the vehicle by which we insure every adult and every child in America.” But that isn’t what the Democrats are proposing.

                                                                                                  As for why the administration wants to keep subsidizing insurance companies, Mr. Leavitt says, “The president and I are for competition.” But nobody is against competition — it’s subsidized competition that’s the problem. Mr. Leavitt added that “the marketplace beats the government at controlling costs and delivering value” — but he’s not willing to put that assertion to the test by requiring that private insurers compete on a level playing field.

                                                                                                  Lately, both the insurance lobby and the administration have also started playing the race card, claiming that Medicare Advantage offers special benefits to the poor and to minority groups. ... But a new report from the Center on Budget and Policy Priorities thoroughly debunks these claims...

                                                                                                  Clearly, the real reasons for the administration’s position ... are ... political, having to do with the long-term battle over the future of the welfare state.

                                                                                                  But that’s a subject for another day. For now, the choice is between A and B — health care for children, or subsidies for insurance companies. Which will it be?

                                                                                                  Previous (4/2) column: Paul Krugman: Distract and Disenfranchise
                                                                                                  Next (4/9) column: Paul Krugman: Sweet Little Lies

                                                                                                    Posted by on Friday, April 6, 2007 at 12:15 AM in Economics, Health Care | Permalink  TrackBack (1)  Comments (24) 

                                                                                                    Bruce Bartlett: How Supply-Side Economics Trickled Down

                                                                                                    Bruce Bartlett says we're all supply-siders now, but as explained in some detail below, I don't fully agree:

                                                                                                    How Supply-Side Economics Trickled Down, by Bruce Bartlett, Commentary, NY Times: As one who was present at the creation of “supply-side economics” back in the 1970s, I think it is long past time that the phrase be put to rest. It did its job, creating a new consensus among economists on how to look at the national economy. But today it has become a frequently misleading and meaningless buzzword that gets in the way of good economic policy.

                                                                                                    Today, supply-side economics has become associated with an obsession for cutting taxes under any and all circumstances. No longer do its advocates in Congress and elsewhere confine themselves to cutting marginal tax rates — the tax on each additional dollar earned — as the original supply-siders did. Rather, they support even the most gimmicky, economically dubious tax cuts with the same intensity.

                                                                                                    The original supply-siders suggested that some tax cuts, under very special circumstances, might actually raise federal revenues. For example, cutting the capital gains tax rate might induce an unlocking effect that would cause more gains to be realized, thus causing more taxes to be paid on such gains even at a lower rate.

                                                                                                    But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue. Last year, President Bush said, “You cut taxes and the tax revenues increase.” Senator John McCain told National Review magazine last month that “tax cuts, starting with Kennedy, as we all know, increase revenues.” Last week, Steve Forbes endorsed Rudolph Giuliani for the White House, saying, “He’s seen the results of supply-side economics firsthand — higher revenues from lower taxes.”

                                                                                                    This is a simplification of what supply-side economics was all about, and it threatens to undermine the enormous gains that have been made in economic theory and policy over the last 30 years. Perhaps the best way of preventing that from happening is to kill the phrase “supply-side economics” and give it a decent burial.

                                                                                                    It’s important to remember that at the time supply-side economics came into being, Keynesian economics dominated macroeconomic thinking and economic policy in Washington. Among the beliefs held by the Keynesians of that era were these: budget deficits stimulate economic growth; the means by which the government raises revenue is essentially irrelevant economically; government spending and tax cuts affect the economy in exactly the same way through their impact on aggregate spending; personal savings is bad for economic growth; monetary policy is impotent; and inflation is caused by low unemployment, among other things.

                                                                                                    These beliefs led to many bad economic policies. In particular, they lay at the root of stagflation, that awful combination of high inflation and slow growth that bedeviled policy makers in the 1970s. Based on insights derived from the Nobel-winning economists Robert Mundell, Milton Friedman, James Buchanan and Friedrich Hayek, the supply-siders developed a new program based on tight money to stop inflation and cuts in marginal tax rates to stimulate growth.

                                                                                                    As the staff economist for Representative Jack Kemp, a Republican of New York, I helped devise the tax plan he co-sponsored with Senator William Roth, a Delaware Republican. Kemp-Roth was intended to bring down the top statutory federal income tax rate to 50 percent from 70 percent and the bottom rate to 10 percent from 14 percent. We modeled this proposal on the Kennedy-Johnson tax cut of 1964, which lowered the top rate to 70 percent from 91 percent and the bottom rate to 14 percent from 20 percent.

                                                                                                    We believed that our tax plan would stimulate the economy to such a degree that the federal government would not lose $1 of revenue for every $1 of tax cut. Studies of the 1964 tax cut showed that about a third of it was recouped, and we expected similar results. Thus, contrary to common belief, neither Jack Kemp nor William Roth nor Ronald Reagan ever said that there would be no revenue loss associated with an across-the-board cut in tax rates. We just thought it wouldn’t lose as much revenue as predicted by the standard revenue forecasting models, which were based on Keynesian principles.

                                                                                                    Furthermore, our belief that we might get back a third of the revenue loss was always a long-run proposition. Even the most rabid supply-sider knew we would lose $1 of revenue for $1 of tax cut in the short term, because it took time for incentives to work and for people to change their behavior. ...

                                                                                                    Moreover, we were adamant that only permanent cuts in marginal tax rates would stimulate the economy. We thought that temporary tax cuts, tax rebates, tax credits and such were economically worthless, and we strongly opposed them.

                                                                                                    Today, hardly any economist believes what the Keynesians believed in the 1970s and most accept the basic ideas of supply-side economics — that incentives matter, that high tax rates are bad for growth, and that inflation is fundamentally a monetary phenomenon. Consequently, there is no longer any meaningful difference between supply-side economics and mainstream economics.

                                                                                                    There is no question in my mind that we never could have overcome the stagflation of the 1970s as quickly or with as little pain as we did without the supply-side idea. But supply-side economics has done its job, just as Keynesian economics did in the 1930s. Those who campaign as its champions are fighting a fight long won — and it is time for supply-side rhetoric to go, with its essential truths embodied in mainstream economics and its perversions discarded for good.

                                                                                                    As noted above, I don't fully agree, so let me cast this debate in a different framework where it's easier for me to highlight where we differ.

                                                                                                    Let's start with the following fairly standard picture of the evolution of GDP. The red line shows actual output cycling over time, and the blue line shows that natural rate of output which also varies over time:


                                                                                                    As depicted, the natural rate is subject to both permanent and temporary supply shocks causing growth to be uneven, but generally upward, and actual output is driven away from the natural rate by demand shocks. That is, the variation in the blue line is from supply-shocks, and the deviation of the red line from the blue line is from demand shocks.

                                                                                                    In general, there are two types of policies to consider. The first is the use of monetary and fiscal policy to stabilize the economy. The goal here is to use changes in the money supply, government spending, and taxes to manage aggregate demand and minimize the deviations of actual output from the natural rate of output. This is shown by the dotted red line in the following diagram which is closer, on average to the natural rate than the no-policy outcome shown as the solid red line:


                                                                                                    The second type of policy is growth policy. This is what many people mean when they use the term supply-side policy. The goal here is to increase the growth rate of output. This is shown by the upward rotation of the trajectory for the natural rate in the following diagram:


                                                                                                    The natural rate of output is determined by the growth of technology, the growth of the capital stock, and the growth of the labor force so policies to increase the growth rate of output are directed at these factors. Examples of supply-side policies are (not all have proven to be equally effective, or effective at all in some cases, and this is far from exhaustive) tax breaks for research and development (to increase technology), tax breaks for IRAs (to increase saving, investment, and the capital stock), tax cuts on capital gains and dividend  (to make capital markets more efficient and increase the capital stock), spending on education (to make labor more productive), reductions in marginal tax rates (so people will increase work effort), accelerated depreciation (to make investment cheaper and increase he capital stock), and reductions in estate taxes (so people will work harder to leave more for their heirs).

                                                                                                    Note also that it is the upward rotation in the supply-curve that generates the increase in taxes from supply side policies that you often hear about. The question, of course, is how much additional growth comes from a cut in taxes and here I agree to some extent with Bruce Bartlett. It depends upon the type of tax cuts that are enacted, some are more productive than others and hence some types of tax cuts generate more tax revenue than others. Whether the tax cut is permanent or temporary is also important.

                                                                                                    We'd disagree over the magnitude however. While some types of tax cuts can affect growth, the effect is nowhere near large enough to generate a 33% tax revenue recovery rate, not even close, and, in any case, all the low-hanging fruit has already been plucked, something that is often overlooked.

                                                                                                    That is not the end of our disagreement. Bartlett does not distinguish between various classes of models, between the short-run and long-run, or between stabilization and growth policy all of which are important distinctions so let me touch upon these issues.

                                                                                                    There are two predominant views of the source of fluctuations in output, Real Business Cycle models and New Keynesian models.

                                                                                                    Real Business Cycle (RBC) theorists believe that most if not all fluctuations in the economy are due to supply side shocks, aggregate demand shocks such as changes in the money supply, changes in taxes, and changes in government spending affect nominal variables such as prices but have little to do with changes in output over time (however,  government intervention does causes inefficiencies in these models so that less intervention is generally preferred to more). Thus, for RBC advocates, the red and blue lines lie nearly on top on one another because nearly all of the movement in output is due to supply shocks.

                                                                                                    Obviously, then, in these models demand management - monetary and fiscal policy - can stabilize prices (and hence increase efficiency), but demand management has little effect on output.

                                                                                                    Thus, since short-run demand management is ineffective in these models (and often counterproductive), all that's left is long-run growth policy and that's why people such as Bruce Bartlett, who have an RBC model in mind when thinking about policy, tend to focus on long-run, supply-side, growth enhancing policies.

                                                                                                    Let me turn next to Keynesians. My focus is on the New Keynesian (NK) school, but I should note that I don't agree with all of the characteristics Bartlett associates with Keynesians of the 1960s and 1970s, and I certainly don't agree with the claim made in the next paragraph that after the policy failures of the 1970s "the supply-siders developed a new program based on tight money to stop inflation and cuts in marginal tax rates to stimulate growth." A standard expectations augmented Phillips curve story does a much better job of explaining these events, and the interest rate targeting rules used from the early 1980s onward are not based upon RBC models. Most RBC models don't even include money as it plays not role in either the short-run or long-run.

                                                                                                    New Keynesians (NK) do not deny that shocks to aggregate supply can affect GDP nor that supply shocks can be large and important. However, New Keynesians also believe that aggregate demand shocks are important, i.e. that the difference between the blue and red lines is large.

                                                                                                    New Keynesians attempt to stabilize actual output around the natural rate as shown above. Why does NK policy tend to focus on demand shocks rather than supply shocks? The answer is that although it would be ideal if we could use supply-side polices to smooth short-run fluctuations in output arising from supply shocks, the reality is that we cannot do this. As Bartlett notes, supply-side polices are very blunt, slow-acting policies that can affect output in the long-run, but they are all but useless in dealing with short-run fluctuations in the economy (thus, RBC theorists tend to focus mainly long-run growth).

                                                                                                    Since supply cannot be managed in the short-run, that leaves demand management policies, i.e. monetary and fiscal policy. As we learned in the 1970s, demand side tools are not very effective instruments for offsetting supply-side shocks - trying to use demand side policy to offset supply shocks helped to generate the stagflation we saw at the time. We've learned since then, but practically we are still somewhat powerless to offset supply side shocks in the short-run - all we can do is manage demand to match changes in supply. That is, if a hurricane wipes out supply, we can use policy to reduce demand to match, but we can't do much to increase supply back to its initial level in the short-run.

                                                                                                    What we can do much more effectively, if you believe in NK models, is stabilize demand shocks through demand management policy. These policies are relatively simple conceptually, the trick is to manage demand so that upward and downward demand shocks are offset by appropriate changes in policy, but that is easier said than done. Still, we do appear to be able to reduce variation over time through both monetary policy in particular, and also through fiscal policy (e.g. through automatic stabilizers).

                                                                                                    The claim made by Bruce Bartlett that "there is no longer any meaningful difference between supply-side economics and mainstream economics" is not something I can agree with. There are big differences between the RBC and NK schools and big differences in the implications of the two schools for policy in the short-run. RBC advocates do not believe in short-run stabilization policy, their focus is solely on maximizing long-run output growth. NK theorists do not deny that robust economic growth is important, but they also believe that government can play a helpful role is smoothing short-run economic fluctuations.

                                                                                                    Why do Republicans tend to endorse the RBC framework? I believe in many cases that belief in the RBC model arises from an honest view that the evidence is most supportive of this class of models. But in other cases I believe it is an ideological marriage. The RBC model has two features that make it attractive.

                                                                                                    First, because it says short-run stabilization policy is ineffective, and that government intervention through either spending or taxes generates economic distortions, the RBC framework supports an approach where the role of government in the economy is minimized.

                                                                                                    Second, because the RBC framework allows for tax cuts to produce higher growth by reducing inefficiencies, and because it is then possible to argue that tax revenues might increase, it gives two reasons for supporting tax cuts - higher growth and less than a full loss of tax revenue, i.e. a dollar tax cut does not cost a dollar (or, for serious ideologues, the tax-cuts even pay for themselves).

                                                                                                    The NK model, on the other hand, supports active government intervention which is at odds with this ideology. In addition, because the focus in NK models is on stabilization of output around the natural rate, not on growth of the natural rate, tax-cuts do not have the dynamic long-run effects as in RBC models (though these can be added) and hence there is not as much ideological support for tax cuts in the NK framework.

                                                                                                    This is much too long already, but a few more things. We don't we know which type of shock is most important? If demand shocks play a substantial role, we should pay attention to the NK policy prescriptions, but if aggregate supply shocks are the primary force behind business cycles, we should abandon short-run stabilization and focus solely on long-run growth. We don't we just look at the empirical evidence and figure this out?

                                                                                                    The problem, essentially, is that we only have one time-series, GDP, and we want two things from it, supply shocks and demand shocks. Since we only have one piece of information and want two things from it, we must make an assumption of some sort. Under some assumptions, supply shocks appear predominant, but under others, demand shocks are the most important factor in business cycles. Because we have no way of knowing for sure which assumption is best, and because the econometric evidence changes as the assumptions change, we are left with uncertainty as to which type of shock matters most and hence which model we ought to prefer.

                                                                                                    There is much more to say about all of this, I haven't even mentioned New Classical models, but that will have to do for now. Summarizing, contrary to what is implied in Bruce Bartlett's commentary, there are two distinct schools in economics, the RBC school and the NK school, and they have very different policy implications. Not everyone will agree with this, and that is the point I suppose, but I would argue that the mainstream view today is the NK model, though the RBC school has strong advocates and has made important contributions to our thinking (the long-run incentives Bruce Bartlett mentions are a good example).

                                                                                                    So, here's where we agree. Both NK and RBC advocates see the long-run similarly. Both schools agree that demand side polices have little effect on long-run growth. Both agree that incentives matter, and that we should, of course, strive to enhance efficiency and long-run growth whenever possible. There is a difference in the two schools as to the strength of those incentives, but if that is all that is meant by supply-side polices, then fine, no problem, we're in agreement.

                                                                                                    But there is a big disagreement over the short-run. RBC adherents take a hands-off, free market approach. Their model tells them that government interference causes inefficiencies, and that there is nothing to be gained in return in terms of enhanced stability. NK adherents believe government should take an active role in stabilizing the economy and that is something that, contrary to what is implied above, has not changed since the 1960s and 1970s. The model used by the NK school is very different from the models we used then - and our approach to policy is similarly different - but the basic idea that government intervention can help to stabilize output and employment in the short-run is unaltered.

                                                                                                    Update: See comments by Bruce Bartlett and Paul Krugman.

                                                                                                    Update: More at Angry Bear, Political Animal, Ezra Klein, Angry Bear again, Division of Labour, and Tim Worstall. Update: Brad DeLong too. . Update: One more from Angry Bear. Update: Lawrance Lux comments. Update: Angry Bear with more. Update: Talk Left also.

                                                                                                    Update (4/11): Follow-up here.

                                                                                                      Posted by on Friday, April 6, 2007 at 12:06 AM in Economics, Macroeconomics, Policy | Permalink  TrackBack (4)  Comments (122)