Monthly Archives: April 2013

Economists are often conflicted about the relationship between their discipline and human nature. Standard theory is stuffed with assumptions that rival those of a geocentric universe. Indeed, analytic rigor still remains a deeply ingrained tradition of modern economics. Hopeful researchers are warned not to snub mathematical courses. And correctly so, it’s difficult to read through many a paper without a sound understanding of calculus and linear algebra.

Yet, Tyler Cowen writes in the New York Times that economics has a deeply egalitarian, even human, tradition. But no consensus here, Brad DeLong comments that morality and economics are inherently split, and Paul Krugman agrees. And there’s so much more where this comes from. Noah Smith has a string of blog posts lambasting the dynamic stochastic general equilibrium and utility curves, crowned with a prod at Cowen: Markets in Almost Nothing.

But there’s one statistic that is so human it removes any doubt that economists are deeply concerned about the human essence of growth. GDP might be the king on the chessboard, but unemployment rate is queen. We have to wonder why this statistic matters at all. As we know, production is the function of labor, capital, and land. During a recession, disemployment effects hurt all three, as workers are laid off, factories shut down, and land untended. In standard models, there’s little qualitatively different between the three.

But imagine talking about the unemployment rate of capital. Given five factories, ten screwdrivers, and fifteen tractors, if one of each is put in disuse do we face a 10% unemployment rate? Laughably, perhaps. But a screwdriver isn’t nearly as valuable as a tractor, let alone a factory. In labor market unemployment, however, we treat the unemployment of a farmer interchangeably with that of an engineer.

The real measure of recession and economic conversation should be the output gap. It accepts that not all men are created equal. But, economists everywhere worry about the unemployment effects of minimum wage (wrongly so, perhaps) and austerity (rightly so?). Theoretically, unemployment should be measured in value – this would even remove the need to consider underemployment. But it’s not, and economists are responsible.

And, because unemployment rate is designed atop of human constructs, economists should also be careful to let it serve as a key indicator within a model. Certain economists often speak of the non-accelerating inflation rate of unemployment (NAIRU), which posits that below a certain level of unemployment price levels will become too unstable to tolerate. This fundamentally assumes there’s something special about the number of people unemployed, rather than the total value of that employment. (The Phillips Curve, similarly, can’t convey any real truths about our economy. Its continued irrelevance due to falling labor share of GDP reflects its greatest flaw, unemployment rate doesn’t mean much).

We rarely hear these economists talk about the over-employment of capital in similar terms. (A 10% unemployment of capital by unit not value, anyone?) This also means that, at least without a minimum wage, there is no such thing as natural unemployment. We take it a priori that a human employed is better than a machine employed and, to the extent that capital can be replaced with labor, during periods of human unemployment the same wages paid on capital can be used to employ humans (granted, this might be peanuts).

This is a highly contrived example but does serve the point that there can’t be a magical rate of unemployment at which inflation suddenly takes off. This little ramble of a post, I hope, shows the very human side of economics. It’s surprising that a discipline so sterile of analytical models is as profoundly infected with egalitarian spirit as suggested by the prevalence of unemployment rate. We would know that economics was really the clammy, divorced subject so many make it out to be if headlines were crammed with talk of the output gap.

For now, we’re safe.

Edit: When the Paul duo associates itself with the neo-Confederates at the Ludwig von Mises Institute, it’s hard not to accuse them of racism. But I don’t think this interview is an instance as such, and that’s the point of this post.

Brad DeLong takes us to Ian Millhiser on Rand Paul’s recent interview. The interview is seething with a dedication to states’ rights and “localism” but is not, ultimately, racist as Millhiser suggests with this picture:


The thrust of Paul argument is captured in the sentiment of private property rights:

You had to ask me the “but.” I don’t like the idea of telling private business owners—I abhor racism. I think it’s a bad business decision to exclude anybody from your restaurant—but, at the same time, I do believe in private ownership. But I absolutely think there should be no discrimination in anything that gets any public funding, and that’s most of what I think the Civil Rights Act was about in my mind.


This is the hard part about believing in freedom—is, if you believe in the First Amendment, for example—you have too, for example, most good defenders of the First Amendment will believe in abhorrent groups standing up and saying awful things […] It’s the same way with other behaviors. In a free society, we will tolerate boorish people, who have abhorrent behavior.

Surprisingly, I think Paul is correct about everything. Except the distinction between private and public property. The State has the same right to proscribe certain practices – such as discrimination or cruelty – as it does to levy any form of taxation. An Obama soundbite, “you didn’t build that”, understanding the sentiment that every business can succeed only through a melange of government support and subsidy: of education, of law and, maybe most importantly, of contract.

Oh and the network is so much more complicated than that. Local businesses (and Coke) receive greater demand through government transfers for the poor. Tax breaks for small companies realign incentives to their benefit. I can name a million reasons why a local shop exists because of, and only because of, a government.

And this doesn’t mean, literally, that “you didn’t build it”. It doesn’t undermine private enterprise. Indeed, at its best, it only kindles such entrepreneurial spirits. But that’s a different story. When Rand Paul cedes that public resources have no place in discriminating against black or white, he must tacitly cede whichever position he holds on local, privately “owned”, entities.

“Owned” because property is derived from the State. This is a controversial logic for the libertarians who see private property antecedent to the State which is (in its only legitimate form) a collective action of the holders thereof. This is similar to the classically liberal attitude towards property, John Locke:

believed that ownership of property is created by the application of labour. In addition, he believed property precedes government and government cannot “dispose of the estates of the subjects arbitrarily.

However, for Rand Paul’s beliefs on abortion to be internally consistent, he must accept a Benthamite interpretation of property rights. Only when private property is delegated by the State, and exists solely under its existence thereof, can pro-life policy exist. The right of full agency on a women’s womb is retained by the State.

This further compounds his confusion regarding the Civil Rights Act. Since property rights are ultimately mediated through the State, it would be improper for a free society to grant the right of cruelty and discrimination to property “owners”. In this sense, by holding the deed to a restaurant, I have many rights. I have the right to block involuntary seizure or unwarranted search by the State. I have the right to bake pizzas. These are my rights as a citizen of the United States. But until unless the government condones discrimination itself, I do not have the right to discriminate unfairly.

Because Republicans are so fond of slippery-slope arguments (remember? if you legalize same-sex marriage men are going to get married to pigs, or something), I’m going to make one here. The strong form of Rand Paul’s argument suggests that I have the ultimate right to do what I will on my property. (In other words, he mistakenly applies Lockean values of liberalism). This would mean owners could kill, maim, torture, and steal those who enter their property.

Of course, the libertarian argument might go that if the market learned of such cruel acts, the shop would be snubbed until it modified its practices. In the mean time, I’m happy to live in post-1964 America, run by Kenyan, anti-market, socialist (has anyone heard of Chained CPI?), Muslims.

So Rand Paul isn’t racist, just wrong. If he had a more open approach to abortion, he could even have an internally consistent ideology supporting a crippled version of the Civil Rights Act. Millhiser doesn’t seem to think Paul’s ideology is compatible with a free society. It is, just not our free society.

Matt Yglesias has some thoughts on the (complicated) virtues of a consumption tax:

The great egalitarian political philosopher John Rawls wrote that he preferred the idea of a consumption tax to an income tax “since it imposes a levy according to how much a person takes out of the common store of goods and not according to how much he contributes.”

The idea of a consumption tax sounds beautiful and, on the surface, it’s moral virtues are clear. The economic argument rests on the belief that such a tax promotes saving and investment which is, in the long-run, better.

Granted this is true, the argument behind such a tax still requires some work. And this is also assuming that the tax is implemented in a progressive fashion. Otherwise, there might be perverse consequences. Let’s think of value in a closed economy (or the world as whole). Economic output is, of course: Consumption (C) + Investment (I) + Government Purchases (G).

Let’s further divide this as: C + I + Government Consumption (GC) + Government Investment (GI). The lines here really aren’t clear, especially with things like education. When government subsidizes education there’s both consumption (“an end in and of itself”) as well as investment (“as a means to an end”).

There’s nothing inherently valuable about education, except its promise of increased future consumption. Consumption is the only activity from which we derive any value, we just hope that with solid investment our future consumption would compound exponentially against the nominal amount deferred. But herein lies the problem.

Rawls, in his argument of a consumption tax, thinks “it imposes a levy according to how much a person takes out of the common store of goods and not according to how much he contributes.” He makes the mistake of believing there is something ipso facto valuable about “contribution”. This is wrong. The value of production is predicated on consumption. There’s an artistic (if Marxist) sense in which there’s dignity and value in the process of contribution itself. (anyway, I would, impersonally, argue that this is a form of consumption).

Regardless, we measure contribution in terms of its dollar value, not by unit. Ten light-bulbs are not as valuable as two MacBooks. If I’m giving to society a useless good, I’m contributing nothing at all. Therefore, there’s nothing specifically “better” – in the moral sense he argues – about taxing outflow over inflow. Of course, the way his words are framed, one pictures a common pot from which people freely take, but any such consumption is financed only by earned value from previous contribution. So there’s also a cyclical sense in which the distinction between production and consumption is vague.

Scott Sumner has some nice remarks on this column here, but this bit caught by eye:

I absolutely do not assume the economy is at full employment when advocating consumption taxes.  And “financial saving” is a meaningless term, so I won’t comment on that.  Saving is saving; it is defined in all the textbooks as the funds that go into investment.

If you buy my argument that there’s nothing by the fact better about investment (only that it can increase future consumption more than the amount by which it defers present value, or that there are positive returns) then this will be tough to accept, without qualification. Vanishingly low interest rates imply that investors don’t believe there are many worthwhile interest rates. Which is why companies and rich people are sitting on piles of cash. If the rate of return is low, it would be better to employ the resources to finance present consumption, especially for the needy. Indeed, smart spending on roads or education would both direct these funds toward future returns, but also serve as valuable consumption today.

Taxing capital might serve a bad precedent (but why, then, are some people okay with inflation – just an implicit tax), but I think it could be valuable if constitutionally capped to a certain proportion of government revenue. Any serious disincentives to save would be mitigated by ensuring the tax only applies to extremely large levels of cash.

This would also incentivize corporations like Apple to find productive venues of investment, as savings would earn a negative return (above a very, very high level). This is inefficient in the classical sense that Apple is not investing because there are no good investments to make. But in times of recession, which is usually when individuals or corporations find themselves sitting on cash, it might be an effective way to spur employment. Edit: Sumner notes that I haven’t defined my terms very clearly. And because income equals output, savings and investment really are the same thing. When I talk about taxing capital I mean highly liquid assets, as are many corporate cash piles, incentivizing investment in riskier and less-liquid projects. Like a factory. Or huge R&D endeavor.

And, really, this is no different than the Fed aggressively using government mandate to keep interest rates down.

Don’t get me wrong, I think a consumption/payroll tax is a much better system than what we have today. America needs to save more, and not just in the economic sense. Larger savings provides a sense of security which would better allow us to tolerate frictional unemployment. It also has the huge benefit of being ridiculously simple. The real immorality of our income taxation, as anyone who’s met a tax lawyer knows, is its complexity.

Noah Smith has some thoughts about a “world without macroeconomists” – a spin-off from a Twitter discussion a few days ago:

So does this mean that macro research is useless for policymaking? No! Not at all!! Because here’s an interesting thing about policymaking: No matter who advises the policymakers, policy is going to get made. That includes economic policy. So if there were no academic and Fed macroeconomists around to advise policymakers, who would policymakers listen to on economic matters?

This is the key point from his post, economists exist because they fill a critical gap in human knowledge. I should note that I don’t, in the least, qualify his definition of an economist:

Of course, the definition of “economist” is fuzzy; if you make a chart of past GDP growth rates on your home computer just for fun, does that make you an “economist”? So I’ll assume that “economist” means “academic economists, or economists working at government research institutes.” In other words, paid econ researchers.

I’m much closer to the dork that plugs in GDP data on my home computer, but I’ll give a shot at my thoughts anyway. For one (it’s just “Turtles all the way down”, skip below if you’re not interested), I don’t believe a “world without” conversations have much salience. Everything exists for a reason – some underlying cause within our worldview. An economist might say that I believe their profession is endogenous to our world. It’s like asking what the world would exist without Christianity. People act like it came from the Heavens and was exogenous to human events. However, a particular thread of action, however complex brought rise to these events.

We can’t hope to understand what these were but the discussion we’re about to have is entirely unreasonable. Consider Christianity:

  1. Say a particular world “State”, A, gives rise to Christian foundations.
  2. Say A is biconditional with the origins of Christianity
  3. To assume a world without Christianity would be to assume a world that never hit state A.
  4. But we know state existed. So the tenor of our question is ultimately reduced to “Imagine a world that never achieved state A”. 
  5. But we know that, because A did, indeed, occur – some other arbitrary State S gave rise to A.
  6. You can see where this is going. As Stephen Hawking might say, it’s turtles all the way down.


This is a really verbose way of saying that there was some intellectual gap that necessitated the formation of economics as an academic discipline. This gap, considering the preponderance of mainstream economics across academia, still exists today. So rather than answering the question a “world without economists”, it might be easier to wonder what would happen if all living economists suddenly died. Sad, I know.

Let’s consider why rich central banks were granted powerful independence in the postwar era. Fairly long-sighted governments understood that they would propagate boom-and-bust cycles coincident with national elections knowing full-well that budgets would not be passed on economic virtue but political necessity. This would emphasize increased spending and decreased taxes.

While neither of the above sound so bad in our austerity-saturated world today, economists know that aggregate supply isn’t always flat, and such stimulus can overheat an economy creating all kinds of problems. The drive to divorce central banking from politics is at the heart of why economics “deserves to be”, if you will.

Think about administering the United States of America: a set of over 300 million people earning about $50,000 a head. That’s $15 trillion, an unimaginable sum of money. A few people might say that we should let the pure and hot “free market” allocate capital in an efficient way. (Most) economists will tell us this isn’t particularly bright.

This leaves some need for central allocation of goods. Sure, not to the same extent a Marx would have imagined, but certainly a far cry from purely classical liberalism. This necessitates a bureaucracy responsible for economic administration. This entity can either be dictated by political whims or guided, if fallibly, by those who “understand” the allocation of scarce resources. (In some sense, all economists believe in central allocation, without which their profession is useless).

Naysayers will be quick to harp that we don’t need “economists” for this job. Smart lawyers and scientists could do the trick. But Richard Feynman’s thoughts on physics apply to economics, too: “If you think you understand quantum mechanics, you don’t”.

Just like quantum mechanists tell us it might be possible to build a computer that solves intractable problems in polynomial time, or transport photons economics has taught us that some very unintuitive principles are true:

  1. Currency does not (and should not) need to be “backed” by anything. The gold and silver standards were highly intuitive to humans, brilliant scientists and technocrats included. Currency as only paper sounds, to anyone before the past century of economic innovation, ridiculous.
  2. Deficits are not a bad thing. This is, again, a very counterintuitive notion.
  3. Nominal shocks can have real effects. (Just printing more money today can increase economic output).
  4. No honest man can beat the market. 

Try telling a Roman that replacing his bullion-backed currency with fiat money would actually help his economy. The idea that printing paper can, in certain circumstances, make us live better is beautifully counterintuitive.

Indeed, some annoying goldbugs are known to criticize Krugman or Bernanke by saying something nutty like “Ask a three year old how printing paper can make us richer. We need to get back to first principles”. Good economics does not have easily perceptible principles.

This is why Keynes’ General Theory was such a landmark work. It destroyed any semblance of intuitive understanding in economics, thereby converting it into a mature discipline.

We also take too much economic data for granted. The silent, apolitical, econometricians that staff the American government have collected such rich and high-quality data of economic trends across the world. Just browse through the wealth of information our FRED database contains.

Imagine the intellectual and bureaucratic infrastructure needed to calculate gross output, employment, or capital investment? The marriage of economics and statistics has generated some of the most valuable data in the world. Available for free. These are silent economists telling us what is. While the normative dominates op-eds in time of crisis, it is the positive that makes the economics discipline profound.

Estimating the entrepreneurial activity of 7 billion people is tantamount of measuring grand physical constants like the mass of this Earth or Newton’s Gravitational Constant. Economics is very much a science, in this sense. We commentators take this huge collection of macro-level data on an unimaginable scale to be granted. But the machine behind this is just about as intricate as any scientific endeavor.

And all this is ignoring the intellectual fertility economics has provided for philosophy, politics, and law. From Locke’s Two Treatises to Smith’s Wealth of Nations economics has underpinned political thought. The advent of sophisticated economic thinking is coincident with some of the richest works of political value including, yes, the Declaration of Independence itself.

And this doesn’t even begin to touch the kind of work done by the likes of Esther Duflo who tells us which policies, specifically, work in the direst of areas.

All this makes me sound like a cheerleader for the discipline. That I am certainly not. Recent computational advances have made me hopeful that economics of my generation will be far more effective at making the world a better place than the useless analytical models of the past.

I don’t think the sterile mathematics of analytic economics has added any value. (Finance is a different story, underpinned by probability and statistics: far more effective tools than the rigid models found in its parent discipline of economics). I don’t think we’re any the better for having a “dynamic stochastic general equilibrium”. I think utility curves are nonsense. I think the idea of perfectly transitive ordered preferences equally ridiculous.

I also don’t like Noah’s comparison with the past history of “other” scientific disciplines:

However, here’s an interesting thing about research, and about science: Past discovery is no guide to future discovery. Chemists were basically a joke for centuries before they stumbled on a few key principles, and rapidly turned into the most reliable discovery-factories in all of science. Biologists had an even longer history of uselessness before they became incredibly useful thanks to new technologies. So someday, macroeconomists might learn how to forecast the economy extremely well. We really just don’t know. A breakthrough in forecasting power would yield huge payoffs to society.

For one, he doesn’t include physicists. Either because he was trained as one (?) or because they were just too damn good. More importantly, just because “past discovery” (or, in this case, lack thereof) doesn’t mean anything about what might happen in the future. This is his point, but using his logic we might also justify homeopathy and astrology for having some “future” breakthrough. But even chemists and biologists don’t deserve to be included in the intellectual mess that is so much of economics. Economists disguise their work under the pretense of some “scientific method” that is “falsifiable”. But if something goes wrong they point to flawed agents in the real world, as Unlearning Economics points out:

I’m actually not entirely happy with this argument, because it implies that the economy would behave ‘well’ if everyone behaved according to economist’s ideals. All too often this can mean economists end up disparaging real people for not conforming to their theories, as Giles Saint-Paul did in his defence of economics post-crisis. The fact is that even if the world did behave according to the (impossible) neoclassical ‘ideal’, there would still be problems, such as business cycles, due to emergent properties of individually optimal behaviour. In any case, economists should be wary of the as if argument even without accepting my crazy heterodox position.

Sometimes arguing against a mainstream economist is like arguing god doesn’t exist. You can’t prove them wrong because their assumptions aren’t testable. (Except with modern behavioral empirics which disproves so much previously believed crap).

All said and done, we might think economists are nuts. But just think about all the crap people thought about money and finance before they came around. It’s just about as ridiculous as believing the world is flat. As I’ve said before, I’m all for expensive computational projects that would save the discipline from its mathematico-analytical backwash, to real, high-quality science.

Noah Smith makes a pretty strong case for industrial policy (in the South Korean sense):

In any case, back to the master narrative: Real national wealth does not come from theft. It comes from reorganizing society into a more productive form. As South Korea did. As Japan did before that. As Mexico is hopefully doing right now. The nations of the Global South were late to the industrialization party, but I think they are finally here.

We both agree that “manufacturing-export capitalism” plays a large role in educating the masses into productive employment. We don’t need to go so far as South Korea, or even Mexico, to see this. There was a time, not so long ago, when Detroit was the Venice of the 20th Century, leading the world in per capita income and wealth generation. You might say that the city-state of Detroit efficiently brought its people into gainful employment creating completely new model of development.

But I think it’s pretty simplistic to suggest that something like that will come close to working. As Noah sees it, South Korea grew predominantly with export of cheap goods, becoming basically as rich as Japan is today:

How did South Korea pull off that trick?

Well, no one knows exactly what worked and what didn’t; all we see is the overall result. But in general, South Korea followed a blueprint outlined by America, Germany, and Japan. That blueprint is called, for lack of a better term, “manufacturing-export capitalism”. We don’t really know what countries can do to get rich, but the really successful ones all seem to do something that looks like “manufacturing-export capitalism”. And it’s basically what Mexico is doing right now.

But the world has changed – dramatically – since. South Korea basically hit the jackpot of growth between 1970 and 1990:


There are two points to take from this graph. First, South Korea had remarkably robust growth for the last quarter of the 20th Century. Second, South Korean growth was hugely dependent on the American economy. Aside from the Asian Crisis in the 1990s, the only severe declines in growth happen during American recessions (see the grey columns). 

The “Tiger” economies grew during a time when rich countries (basically America) were willing and able to absorb the cheap manufacturing exports from Asia. There are two dynamics that afforded South Korea its “miracle”. For one, America had pretty solid growth of 3-4% through that period of time. Though dwarfed by Korea’s growth rate, Americans not only were richer to begin with, but the real growth itself was higher:


This graph basically shows the factor by which total American growth outdid South Korea. This figure, roughly, estimates the extent to which America can run a trade deficit to finance international growth. All said and done, because America was so rich in the 20th Century, it didn’t need huge growth rates to import like crazy. The only blip in the graph is, of course, the 1980s recession. 

On a per capita bases, this graph bodes very well for South Korea. Once it hits one, it means both countries have the same total increase in welfare, but South Korea, obviously, distributes that across a much smaller base. It won’t be long before the graph converges at some below-zero point, indicating equal per capita growth rates. 

I totally agree that all growth isn’t “theft” or, as a fancy economist might say, after the colonial pillage, most countries like America, South Korea, and India have grown with “inclusive” rather than “extractive” institutions (this is a broader point, but speaks to the same sentiment, in my eye). But manufacturing isn’t the free lunch it once was, and Mexico isn’t a good example to the contrary.

Mexico shares a special physical and cultural relationship with the United States. It makes very strong political sense for America to keep Mexico sufficiently rich. While I would argue we benefitted tremendously from NAFTA, it can definitely be parsed as America willing to run large and unnecessary trade deficits to finance Mexican growth. Most poor countries don’t have the luxury of being America’s little brother. 

The picture in the 21st Century will be very different from that in the late 20th. There used to be a booming America financing the growth of a handful of people (forget countries, South Korea and the other Tigers are dwarfed by India and China). Today 50% of the world is “booming” and America is not. Last year, India – the “weak” BRIC – grew by $100 billion. If America grows at 3%, that would represent almost 25% of its total GDP. China grew by over a trillion dollars, or two times America’s total growth. Even if you dash China off as a relatively rich and booming economy (not to mention geopolitical giant), there are many countries like India eagerly waiting for the West to import their goods. But this is not happening.

Recently, China became the world’s biggest trading partner with a majority of countries, a position held by the United States for a long time. This isn’t too surprising to anyone. But, for the first time, trade between developing countries and developed countries (“developing-developed” trade) fell short of trade between developing countries (“developing-developing” trade).

These are all huge, qualitative factors that South Korea did not face during its ascent. And they are realities Mexico is largely shielded from due to its position. There are also fuzzier agents at play. The latter half of the 20th Century, the heyday of American dominance, was defined by a growing respect for free trade, banking, and capitalism. Today there are populist, anti-trade impulses in both major American parties, forget Europe. We’ve (wrongly) convinced ourselves that a trade deficit is a bad thing and political rhetoric frequently borders on currency protectionism.

As the rich world slouches from recession to stagnation, export-driven growth isn’t going to be the answer to the development India and its friends desperately need. The Fabian spirit of Nehruvian beginnings leaves India with a very strong domestic industry and its growth is sufficiently infused with both technological progress and domestic consumption. While China is the gold standard model child for growth today, India might offer a more sustainable alternative in principle (India has huge, non-structural – unless bad politics are structural – problems that need fixing). 

While I’m not advocating for import-substitution, I do believe there is a strong case to be made for mining new avenues of growth. For most countries this means: 

  1. Find alternatives for oil and coal. When we hit reach peak oil/coal/whatever, America and company will pay extraordinary prices for energy crowding out the poor world from natural resources. (Or forcing huge trade deficits that will definitely tempt a balance-of-payments crisis).
  2. Focus on a domestic services industry that requires literacy but not much more serious education.
  3. Don’t trade a good terms-of-trade for a weak currency.
  4. Target areas highly-specific industries and devote huge sums of research to develop a comparative advantage. For India, I believe thorium-powered nuclear research is a candidate. While the rich countries are the general choices for research and development. If poorer countries invest enough in very specific projects, they can develop a niche.

Development for the “Global South” isn’t looking apocalyptic. But South Korea, Mexico, and any other wild tigers are not the answer. 

Kindred Winecoff (via Brad DeLong) has some thoughts on inequality:

1. Global inequality, which was expanding from 1800-1975, and receding since (due primarily to China and India).

2. US inequality, which was declining from 1925-1980, but increasing since, in two ways:

2.a. The separation of the top 20% from the bottom 80%, partially as a function of college wage premium.

2.b. The separation of the top 0.1% from the rest of the top 20%, for reasons unexplained.

3. The rise of the top 1% globally — the development of a new international plutocracy — since… 1980 or so?

For reasons that escape me he does not link the three together. It seems an obvious thing to do. It’s what Oscar Landerretche (the other participant in the discussion) does, in the context of explaining outcomes in Chile. But he doesn’t do it.

This is something that has disappointed me about the conversation regarding American inequality over the past few years more generally. (I’ve written about it before.) Folks like DeLong, Krugman, Cowen, and others think in global terms quite frequently. But when they seek to explain the Great Stagnation and the rise of inequality they concern themselves almost entirely with local explanations. I think such analyses are very likely to suffer from omitted variable bias.

Around the 43rd minute, DeLong takes a direct question about this from the audience. He answers it fairly well, but still downplays the role of the global economy in influencing outcomes in the US, favoring cultural explanations (e.g. explosion of CEO pay) and changes to marginal tax rates. He does not consider that these might be related to global dynamics either. If global forces eroded the bargaining power of American Labor, then maybe that’s why society has tolerated the enormous increase in executive pay. If global forces are pressuring American corporations through new competition, then maybe we’ve cut top-end taxation in an attempt to gain back some competitiveness.

This takes a highly simplistic view of inequality in the world. The reason you can’t just “link” the three together are captured in this one, little chart from Conceição and Ferreira:

ImageThe GINI Index is intuitive but ultimately handcuffed in how much it can tell us about the economy. Especially when we’re talking about the world. A far more robust measure is the so-called Theil Index. The math behind the measure (between 0 and 1) requires a fair understanding of information theory but the idea is lower index implies a higher economic “entropy”.

Your physics teacher might tell you that this is a bad thing but, economically, it’s a little more complex. As Boltzmann showed, entropy increases as predictability of an event decreases. This means the entropy of a fair coin is higher than a biased one. Similarly, in a very equal economy it is very difficult to distinguish between two earners based only on their income. Indeed in a perfectly equal society this is impossible. However, as society stratifies itself, knowledge of ones income conveys far more information (redundancy), thereby decreasing entropy.

Within a system, Theil makes it easy for econometricians to understand the amount of total inequality due to within-group inequality and across-group inequality. If this is a little hard to grasp, think about it this way. If the total differences in economic output remained constant between countries (that is, India is still poor and Norway rich) but income was equally distributed within each country the residual inequality would be the “across-country” inequality. The residual from the converse, where all countries remain as unequal as they were, but world economic output is distributed equally to countries (not people), represents the “within-country” inequality.

So what’s my point? While global inequality has been on the decline (because of, as DeLong notes, China and India) the inequality within Asia is about 27% more significant than it was in 1970. This means DeLong’s answer is pretty accurate. While the GINI shows a worrisome increase in American inequality over the past thirty years, its contribution to global inequality hovers around 9%.

There are strictly local factors that can be attributed to increases in American inequality. Sure, global competition puts a downward pressure on American wages but this comes from basic trade and, theory tells us, that this increases output for both parties. This means the American pie is growing (and, clearly, it has) and bad policies are inhibiting the necessary redistribution.

Winecoff also conveniently ignores that the median American worker has become exponentially more productive which would, in normal circumstances, imply higher wages. Alas, local factors have prevented this from happening.

DeLong is very smart in not extrapolating meaningless inferences from his simple observations. If what Winecoff asserts is correct, American worker bargaining power is undermined by a smaller between-country inequality but, relatively, it is the within-country inequality that has grown and, most significantly, in Asia.

American CEOs are earning 300x their median worker is nothing more than the fraying separation between Chief Executive and Chairman resulting in the extraction of severe rents. Lower marginal tax rates on the rent-earning minority have no effect on global competitiveness but explain pretty well the growing importance of within-country inequality.

Edit: Winecoff comments below:

So first of all, trade is not a “strictly local factor”. That’s my point. And what economic theory tells us is NOT that trade is redistributed equally; far from it. Comparatively advantaged sectors/factors benefit from trade, while comparatively disadvantaged sectors/factors suffer. What I’m suggesting is that the American comparative advantage changed post-1970 or so. Previously, it was advantaged in manufacturing, and post-GATT trade liberalization helped it exploit those advantages. Post-1970s or so, the collapse of Bretton Woods capital controls and pursuit of export-oriented industrialization efforts in Asia and elsewhere, the US comparative advantage shifted to finance and other high-capital output (e.g. information tech, pharma, etc.). These require smaller inputs of labor, so the share of national income going to labor declined. Hence: increasing domestic inequality in the US, without a concomitant rise in global inequality (since trade benefits all societies in aggregate).

I’m not denying any of this, in fact I pretty clearly noted above that trade in the last decade or so has accrued in the hands of a relative few. America’s competitive advantage doesn’t benefit the middle man, anymore. But this is not cause to throw our hands up and call it a day, because trade is “global”. There are plenty of things we can do at home. If America’s competitive advantage is exporting math/science know-how, then we can make it a lot easier for people from poorer families to get a STEM degree. If the Ivy League is our competitive advantage, we can take a lesson from this BPEA report and encourage low-income students to apply to top colleges.

In fact, over the past thirty years, as our competitive advantage shifted, we did precisely the opposite of what we ought to have done. It is hard to fight against a falling wage share of GDP. In fact, economically, this is probably a good thing. However, we should have fought hard against the growing inequality within wages themselves.

A side note: I have not “conveniently ignored” the fact that median productivity has increased exponentially. That is not an established fact. As far as I know there is no evidence that it has. Productivity statistics like those issued by the BLS are calculated on a per-worker (i.e. mean, not median) basis. Mean compensation has tracked productivity fairly well. It’s the median that stagnated, which is one definition of rising inequality: a separation of the mean from the median.

I don’t buy this. While the BLS statistics are average productivity the way to explain Winecoff’s argument would be that only the top 1-5% of American workers got better at their jobs. The median worker, with better capital, has gotten a lot more productive. The last 40 years also brought many women into the workforce. With a 100% increase in productive workers for most households, one would not expect such a stagnant increase in overall income.

In standard fashion, the Economist quips, Ben. And Then. It turns out, the rest of the article must be sarcastic as well:


This is, inadvertently, a Rorschach test. You should be – regardless of your persuasions – squirming that Christina Romer is excluded from this little elite list of potential chiefs of the world’s most important bank. You should wonder when competence and “Obama connection” are the factors of inclusion why the only administration don to actually get everything right is excluded from the list.

The list is constituted of very respectable names. Janet Yellen knows that that the Fed has a dual-mandate. Larry Summers has shown a growing desire to reform mainstream economics. We can be sure he’d consider fresh ideas like a nominal output target. Jeremy Stein provides one of the only coherent arguments against easy money. (I don’t agree with him, I think market expectations of a heating economy would take care of any insanely-risky behavior, but he’s about as brilliant a chance the monetary hawks have – and he probably does not even agree with them). Stan Fischer seems to have done wonders in Israel.

But it’s bordering on madness to exclude Romer from any serious list of potential candidates. Take this 2011 op-ed in the New York Times:

Mr. Bernanke needs to steal a page from the Volcker playbook. To forcefully tackle the unemployment problem, he needs to set a new policy framework — in this case, to begin targeting the path of nominal gross domestic product.

Nominal G.D.P. is just a technical term for the dollar value of everything we produce. It is total output (real G.D.P.) times the current prices we pay. Adopting this target would mean that the Fed is making a commitment to keep nominal G.D.P. on a sensible path.

More specifically, normal output growth for our economy is about 2 1/2 percent a year, and the Fed believes that 2 percent inflation is appropriate. So a reasonable target for nominal G.D.P. growth is around 4 1/2 percent.

Economic research showed years ago that targeting nominal G.D.P. has important advantages. But in the 1990s, many central banks adopted inflation targeting, a simpler alternative. As distress over the dismal state of the economy has grown, however, many economists have returned to the logic of targeting nominal G.D.P […]

Because it directly reflects the Fed’s two central concerns — price stability and real economic performance — nominal G.D.P. is a simple and sensible target for long after the economy recovers. This is very different from Mr. Volcker’s money target, which was abandoned after only a few years because of instability in the relationship between money growth and the Fed’s ultimate objectives.

Desperate times call for bold measures. Paul Volcker understood this in 1979. Franklin D. Roosevelt understood it in 1933. This is Ben Bernanke’s moment. He needs to seize it.

Infamous memos to Larry Summers during the depths of the Lesser Depression, as Brad DeLong now calls it, prove that Romer had a brilliant grip on America’s fiscal woes (read: she’s a Keynesian). That she acknowledges that the Fed has a dual-mandate (remember when Bernanke bragged about his fantastic inflation record) and is open to new thinking suggest she’s equally competent (that is to say, mind-blowingly brilliant) on monetary issues.

Most of the candidates the Economist outlined deserve to be on that list, but it looses its value without Christina Romer.