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Monthly Archives: May 2013

Perhaps one of my less orthodox beliefs is that we should have let Wall Street fail in 2007. Of course, the Bush-Obama administrations would be loth to let this happen, but I think there’s good reason to believe the just policy (as this self-evidently is) would not also create mass unemployment. And in an age where commenters inevitably spew hot air about “structural reform”, bank failure would set the stage for the most important adjustments in over a century.

James Tobin, Nobel Laureate and a little bit of an economic hero to me, once said “the linking of deposit money and commercial banking is an accident of history”. This has deep implications for our (broken) monetary transmission mechanism which is predicated on our weak financial system.

Weak, you say? America has the the world’s deepest credit market, but it thrives off well-documented subsidies encouraging debt and moral hazard through:

  • The implicit TBTF guarantee.
  • Deposit insurance.
  • Interest rate tax deductions.

By a free marketer’s own definition, Wall Street can not be efficient. And 2007 showed us that which can not, is not. Now, before you accuse me of sounding like an Austrian, note that what I’m suggesting would only work under strong state intervention, done right. Here’s all we need:

  • A federal employment guarantee program (a special form of the rare creature known as “fiscal stimulus”).
  • FedEx – or the Federal Reserve credit card!
  • FedEx Business

Now, let’s be clear about a few things. The government is a bad choice for an employer or a bank. (Aside from bureaucrats, local services, etc). But while the financial system stabilizes, aggregate demand will crash, employment will plummet, and credit will crunch. Then government ought to double up as the lender and borrower of last resort.

As spending crashes, employment guarantee programs (which can be coordinated with private enterprise via an “employee auction” market – which I will outline in a later post) should stimulate demand. Here comes your national credit card, with limits and interest rates set by the Fed. This will allow the Fed to increase limits and reduce rates during a credit crunch, thereby sidestepping the private banking system. During normal times the limit would either be absurdly low, or rates obscenely high allowing private banks to compete fairly for market share.

This is a piggyback on Miles Kimball’s Federal Line of Credit. My amendment would be a special loan for small businesses and startups that can’t easily sell corporate debt. This requires an unfortunate level of government bureaucracy, and in most times private banks would be much more efficient. But we’re trying to stabilize demand, here, without handing out money to bankers.

There’s a non-zero chance we won’t ever have to do something so nutty again. Once the government reneges it’s “implicit promise” to bailout “systematically important” banks, executives and shareholders will no longer expect relief, and will raise equity and deleverage appropriately. Matthew Klein and John Aziz have argued along these lines, but I’d add this wouldn’t just reform a risky practices on Wall Street, but challenge the very way we approach monetary policy, which is today tethered to the credit system.

Establishment of a central consumer banking network will allow the Fed to increase demand in a fair and just manner. And to the extent future recessions don’t threaten a credit crunch, open market operations will suffice. But our “exotic” quantitative easing policy has certainly benefitted the rich, asset-owning class than the still intolerably high number of unemployed.

In the near-term this would be more expensive. Government employment guarantee programs won’t be cheap (though wait for my post on the employment auction market which should substantially lower costs and increase efficiency), and will require sustained deficits. But if we credibly commit to irresponsibility – as they say – and let a government finance program take us through the lows of bank failure, the emergent credit system will be more efficient, effective, and morally just.

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Short answer is, no. Long answer is, well, maybe: depending on what you call “hawkish”.

In a tour of essays since Excelgate, both Reinhart and Rogoff have been (finally) flaunting their dovish credentials: Reinhart telling us austerity is a disaster or Rogoff telling us that “austerity is not the only solution to a debt problem”. Or, perhaps most curiously, Rogoff calling for substantially more inflation:

One of us [Rogoff] attracted considerable fire for suggesting moderately elevated  inflation (say, 4-6 per cent for a few years) at the outset of the crisis.  However, a once-in-75-year crisis is precisely the time when central banks  should expend some credibility to take the edge off public and private debts,  and to accelerate the process bringing down the real price of housing and real  estate.

Structural reform always has to be part of the mix. In the US, for example, the bipartisan blueprint of the Simpson-Bowles commission had some very  promising ideas for simplifying the tax codes.

Now the second paragraph is obviously just fluff. It’s not vogue to write an op-ed without talking about “structural reform” and “simplifying the tax code”. It’s kinda like the chorus all Serious People must add to their argument to sound well-balanced.

And, quite successfully, Rogoff masks just how radical his original proposal is. It’s not the magnitude of “elevated [4-6 per cent] inflation” per se, rather the reason thereof. Left-leaning commenters, such as myself, have argued for more aggressive inflationary policies, but as a means to an end:

  • In a liquidity trap, cash hoarding can put us in a deflationary spiral (Keynesian).
  • Inflation, through the “hot potato effect”, increases money velocity and NGDP hence. (Market Monetarist).
  • Wages (and prices, to a lesser extent) are sticky in the downward-direction and inflation is required for readjustment (Keynesian and Market Monetarist).
  • Inflation will decrease the market-clearing interest rate and hence allow savers to substitute lending for money holding and increase investment (Mundell-Tobin effect).

We might call this inflation as a necessary means to an end. But Rogoff wants central bankers to consider “the option of trying to achieve some modest deleveraging through moderate inflation of, say, 4 to 6 percent for several years”.

We call that inflation as an end in and of itself. That is scary. And far more radical than anything I’ve ever proposed. For one, I don’t understand how more inflation by itself will bring down the “real price of housing and real estate”. It always seemed to me investment in land was a hedge against inflationary pressures. In fact, through the Mundell-Tobin effect, cheap mortgages should increase real estate demand – as we’re seeing today (albeit with substantially less inflation).

Scott Sumner puts this well in a fantastic argument for nominal income targeting:

Ben Bernanke does not really want higher inflation; it would be more accurate to say that he wants more aggregate demand and expects such higher demand to result in somewhat higher inflation rates. Unfortunately, however, the Fed has chosen a language to communicate its intentions that is both deeply unpopular and profoundly misleading. Inflation targeting gives the public the wrong impression, and the resulting political reaction impedes the Fed’s ability to carry out its work.

However, that’s only the tip of this dangerous iceberg. Inflation for the sake of inflation is a partial default on our obligations (aside from social security and TIPS, of course). I think debt forgiveness is a remarkably important component of the new international finance system. But it is a signal of fiscal irresponsibility and recklessness, neither of which afflict America today.

Our debt-to-GDP ratio is historically high, but nothing unsurmountable, especially at the low cost of capital today. The next decade is relatively stable as far as deficits are concerned, and there’s no reason to believe we won’t implement the necessary adjustments come what may after 2023. For this reason, inflation as a cop out of our obligations will send the wrong message:

  • The Federal Reserve will loose credibility – that is, investors will forever think that we will inflate our way out of even tolerable debt burdens.
  • The Federal Reserve will loose perceived independence – that is, investors will forever think that the FOMC will accommodate idiotic deficits and fiscal irresponsibility. (If they partially default today, imagine the expected reaction to real recklessness!)
  • We will send savers the wrong message; inflation will cease to be a noble and necessary means to an end, but a counterproductive end by itself.

I actually don’t mind the distributional effects of inflation, by itself. Very few Americans save, and those that do at high levels should probably be taxed more. But I dislike the idea of incentivizing dissaving, especially as it becomes ever-evident that the poor can and should save more. America’s tax burden is rather low, which makes our debt eminently more solvable, and I would rather the distribution explicitly handled through a more progressive code (preferably a neo-Ricardian land value tax coupled with nationalizing oil & gas companies).

Notably, as a global reserve currency and store of value, devaluing the dollar for deleveraging’s sake is a terrible idea. Once the Federal Reserve looses credibility, the phantom bond vigilantes might materialize (I would be willing to take this bet, at low odds). This would impugn our ability to run high deficits for countercyclical stimulus come the next recession.

But I told you the short answer to the titular question is no. And that’s absolutely true. In fact, the pith of my argument against inflation is from deeply dovish roots: that is I don’t think our deficits are near intolerable. I think because the nominal average premium on long-run bonds is unprecedentedly low, the market is begging America to borrow more. If not for stimulus, for infrastructure and education. The only relevant arguments against any sort of deficit spending today is moral hazard.

I also support inflationary policy after considering DeLong and Summers (2012). If hysteresis contracts labor force and aggregate supply during disinflationary periods, the logical conclusion would be positive supply side effects of mildly higher inflation, even out of recession. (Indeed, the logic used therein derives from work by Larry Summers with regard to female entrance into labor markets during inflationary times). To this end, I would support the central bank dictating policy around the employment-population ratio, rather than unemployment rate.

Perhaps most flabbergastingly, why inflate so much when we can just target nominal spending? Your guess is as good as mine.

There seems to be a settled consensus among economists that carbon taxation is superior to cap-and-trade with support from Jeffery Sachs, Nobel Laureate Gary Becker, Exxonmobil CEO Rex Tillerson, Sierra Club director Carl Pope, and Pigou Club founder Greg Mankiw. Or these three IGM polls of the biggest hotshots in econ. Any frequenter of this blog would know that this has been my preferred position as well. But I’m pretty sure I was wrong – at least to the extent climate change is our primary goal. And revenue potential of carbon permits wouldn’t be that much worse, just a bit more volatile, especially on an infinite horizon.

Evan Soltas aptly states the biggest problem with taxation (albeit reaching the conclusion that  a carbon futures market is the optimal solution):

There’s just one problem. Nobody knows how big carbon’s negative externality — if any — really is. Richard Tol, an economist at the University of Sussex and an expert on carbon-tax research, has compiled 588 estimates of this number from 75 different studies. In an e-mail he tells me that the interquartile range (which excludes the most extreme estimates) is approximately -$25 to $325 per metric ton of carbon (a negative number means a positive externality).

It’s well-acknowledged that estimating externalities is not easy. But here’s what we do know: eclipsing 2º C above preindustrial levels will be disastrous. Right now, we’re on track to a 6º C world. The World Bank doubts it can fulfill it’s mandate in anything more than a 4º C world. But scientists also know, with good probability, if we stabilize carbon at 400 parts per million (ppm) 2º C world. (And we’ve recently breached this limit, for the first time in history).

In the long-run, we also know approximately how many permits we can issue to be 50% certain that we won’t breach this threshold. (Ensure carbon emissions peak no later than 2016). That is, if there existed sufficient international will, we could solve global warming today, with great certainty, under a cap-and-trade regime.

But externalities are more complicated. What is the difference between the marginal social cost and the marginal private cost of carbon? It’s extremely tough placing a dollar value on the environment. We can more effectively calculate the public health cost thereof, but this will certainly undershoot any hope of averting tail risks with regard to climate change. The Clean Air Act handles most of that, without really touching carbon. That’s why I’m actually peeved that this ever passed – it’s kind of like removing ethyl mercaptan from your propane gas. What kind of an idiot would do that? Carbon, like natural gas, is the invisible and odorless gas that’s killing us.

So naturally, because we have no idea what the hell carbon “costs”, politicians will be unable to price it highly enough. Remember, we have a Congress where a rough half (Democrats included) don’t believe in climate change. And because any suggested tax has to be arbitrary, it will fall on the conservative side. In the future, as economic growth continues increasing demand for carbon-intensive activities will be met with both increased revenue and emissions.

In microeconomics, textbooks often cite an example of two factories polluting in a common river. In this far less complex system, the per-unit social cost can be determined, and internalized. And hence taxation will not be arbitrary. This is the most important point, politically if not economically.

If Congress can commit to averting climate change, we can non-arbitrarily argue the maximum acceptable number of permits for n-degree climate change. The insight here is that what’s keeping us from significant legislation isn’t the extent of political will, but the lack of will itself. Once we “make a move” – whether it be through taxation or cap/trade – it’s likely we’ll do the best we can with reasonable exceptions. Every major reform confirms this bias.

So it’s crucial we get the fundamentals right. Now, there are certain conditions under which taxation is superior. There’s been some fascinating work in carbon capture and storage. This can either be on-site (like at a coal factory) or, more complicatedly, from atmospheric air itself. Under current regulation, plants around the world think this is too expensive, because the technology is very nascent. But if scientists develop viable carbon capturing techniques, the government can very reasonable price each ton emitted at the cost of recapturing from the air.

The not-so-obvious implication of this argument is that carbon taxation is effectively revenue-neutral. If the government has to deploy a large-scale program to recapture emissions, all earned revenue is – by accounting identity – consumed.

A few notes on the very novel solution Soltas suggests:

Nicolaus Tideman and Florenz Plassmann, economics professors at Virginia Tech and SUNY Binghamton respectively, have an ingenious solution. In a paper published in 2010, they say polluters should be made to buy a special 30-year, zero-interest bond from the government for every unit of pollution they emit. The government would set the principal at a reasonable upper-limit estimate of the per-unit cost of pollution. The bond’s redemption value, though, would be set in the future. Bondholders would receive what is left of the principal after subtracting the actual cost of the pollution as determined by an independent agency at the bond’s maturity.

Investors could trade the securities in a secondary market, creating a prediction market for the cost of emissions. Investors who think the bond market is overestimating future costs will buy the bonds. Those who think the market is underestimating the costs will sell them.

“If you’re going to deal efficiently with pollution, it’s appropriate to put an incentive on people to economize,” Tideman said in an interview. “But you’ve got to get the price right. Experience tells us that the best way to get information about the future is a futures market. Our proposal adapts a futures market to address climate change.”

Tideman’s and Plassmann’s insight is that policymakers don’t know the actual future costs of pollution and don’t need to guess. Their market would determine the actual liability of most polluters, except for those who chose to hold the bonds to maturity. This solution uses the ability of prediction markets to synthesize a price from disorganized, disconnected bits of knowledge.

It is ingenious indeed, but not ideal. The independent agency in question will have the same problem government has in pricing carbon (that is it will be underpriced, by political nature), though it benefits future correction from a prediction market. But the whole premise derives from the ability of investors to reasonably deduce what future costs might be. There’s good reason to believe climate change poses serious tail risks, which makes this a pretty futile effort. Reason is, understanding climate science requires a lot of expert knowledge. An effective futures market assumes that said experts are not so risk-averse as to avoid the market to maximize the discounted present value of their profits.

Irrationality may not be a big deal in gold futures because level of expertise isn’t as significant a barrier, and those with the most valuable information aren’t as risk-averse (they will probably be investing on behalf of a bank). The whole idea of prediction markets seems to fall apart if a select few won’t fully divulge information onto the market (that is, maximize their profits without any consideration of risk). Maybe if Al Roth put his mind to it, he’d design a market that fixes this failure. But, until he does, I must hold back my endorsement for Tideman and Plassmann, except perhaps for the most creative solution.

Or perhaps J.K. Rowling ought to write a new book on codfish and the environment…

P.S. Some interesting thoughts from the comment section. Evan Soltas says:

Ashok, something you should read — and the most convincing argument I’ve seen for cap-and-trade — comes from an old article called “Prices vs. Quantities.” http://www.jstor.org/stable/2296698. Weitzman’s reasoning is that at the point where the costs are both uncertain and highly nonlinear with quantity, you can minimize the deadweight loss with a quota rather than a tax. Note that the optimal carbon level is just as hard of a cost-benefits question as a carbon tax. And I think tax wins big points over cap-and-trade when you get into the nitty-gritty of it. If you do cap-and-trade for big firms only, that’s a distortion, and it doesn’t solve the whole issue; cap-and-trade for all firms would be a logistical nightmare. Much easier just to collect tax at the point of production!

Martin Weitzman is one of the most interesting environmental economists (you should check this scary article with a silver lining). Soltas’ point got me wondering, and I’m starting to think climate change is a fantastic real-world manifestation of the Ellsberg Paradox. Me:

Going through [Weitzman’s model] itself, climate change strikes me as the rather perfect example of uncertain costs. And it is at least ethical in the sense of accepting the social discount rate. It really seems like the real-life approximation of the Ellsberg Paradox. (And the Knightian uncertainty thereof is what makes pricing, and to a lesser extent futures, a challenging task). This suggests we should act on this sooner-than-later (even disregarding the scientific benefits of doing so).

And if we do anything at all, it seems it would be easier to legislate command by quantity than by price. I’ve thought a bit about the logistical issue, and wonder if a robust trading regime would spawn several large financial organizations that mediate allocation of permits to smaller firms. Perhaps allowing them to “borrow” a permit today and pay for it later.

The distortion then, of course, is rents earned by said organizations!

Reihan Salam asks me to consider the cost of my revenue-positive immigration plan. In other words, the $750 billion dollars isn’t coming out of thin air. I wrongly took this for granted earlier, but on second thought it brings a fresh perspective to this argument. The explicit costs will clearly fall on the firms and local governments which choose to purchase permits to “import” (for wont of a better word) employees.

I also noted this might create a downward pressure on immigrant wages, which can be considered a “tax” as well:

It’s crucial to note that the burden of permit financing would fall on both employers and employees, depending on elasticities of demand and supply. The dearer the permits, other things equal, the less a potential employer is willing to pay for the same level of output, realized as a lower wage. This can be thought of as a migrant financing his own permit.

Let’s consider a firm operating in an imperfect labor market – as most inevitably are. If the market rate for a permit at a given time is $n, the only immigrants who will be hired are those for whom employers expect the discounted value of all future earnings to be greater than n. For these workers, the costs are explicit $10,000 each. Consumer surplus here is represented by (NPV – n).

The more important welfare loss derives from the implicit cost expropriated on firms that want to hire workers whose NPV is less than the market value of permits. That is governmental intervention prevents an otherwise profitable transaction. In this sense, welfare loss will be roughly proportional to the ratio of firm demand for immigrants to the number of permits supplied on the open market by the government.

This isn’t a mathematically rigorous statement, rather an intuitive heuristic. If demand for migrant workers falls, the permit price on the open market will drop, resulting in fewer excluded transactions. Same logic on the denominator, wherein government can increase the supply to cut permit costs.

By this point it’s clear that the real price of permit auctioning is the cost of closed borders. Standard economic theory tells us that open immigration is the Kaldor-Hicks efficient solution, and any regulation thereof will inflict deadweight losses. At this point, it’s worth comparing (if briefly) my proposal to our current solution.

The deadweight loss comes from the difference between employer demand for migrants and actual cleared licenses. But there are two, huge benefits of auctioning n permits rather than allocating the same number on a first-come-first-serve basis as we do today:

  1. The deadweight loss is lower because auctions will almost definitely command a higher quality of immigrant. If firm A wants to bring a highly profitable doctor, and B a similarly “skilled” professional whose just not as competent, the former will be willing to pay more on the open market. This information cannot be captured in any other way. (Nobel Laureate Al Roth has written about how good auction design compels market participants to divulge useful information).
  2. Even if the deadweight loss is equal, in my revenue-positive proposal, at least the government captures some of it. In today’s system, all is lost. I suppose more surplus is captured by firms who “make it first” or have large systems that can maneuver government bureaucracy efficiently (like, say, Google).

In fact, there’s a Schumpetrian superiority to permit auctions – over our current system or even the better Canadian “points” program. Byzantine systems requiring “proof of need” etc. give an unfair advantage to large and established players. Startups, the blood of American innovation, are discriminated in the present system. The Canadians and Australians will face a similar problem, if to a much lesser extent. Therefore, the burden of argument is on those who would rather surplus be captured by monopolistic corporations rather than the government.

Though this isn’t the point of my post, I want to conclude with some notes on Reihan Salam’s last remark (which I can’t seem to find, now), which echoed the idea that either of us could design a policy much better than status quo, but that political deliberation makes that impossible.

I don’t think he’s being fatalistic here – he has argued for the Canadian option – but that’s what makes this interesting. It’s hard to argue the American system doesn’t cater to vested interests with regard to immigration. However, what are the “loopholes” really, of the Canadian system? It’s a very transparent, skills-oriented, rubric which cannot be “gamed” in any meaningful way – at least not to my knowledge.

As far as American policy goes, why is my (or whatever his preferred choice is) solution “idealistic” whereas Canada’s is somehow more politically sound? I say this because I’m rather surprised at the paucity of “creative conservatives” arguing for an auction-oriented approach to immigration. I really believe if this idea finds more traction, it’s at least as realistic as a point system. Indeed, both Reihan and I worry more about native wages than overall welfare gain – a topic which puts me at odds with many liberals like Matt Yglesias and deserves a post of its own – and I think few ideas command the “most valuable” immigrants as the quantity-regulated open market.

America’s war on drugs is a tragic story. Barbaric “three strike” policies have bloated our prisons. Martial policies have put disadvantaged minorities in jail for smoking weed. As you probably know, we lead the world not just in innovation, but also incarceration.

And that’s just the tip of this iceberg. It costs twice America’s median income to jail an inmate for a year – and the opportunity cost is infinitely higher. From a forever-crippled labor force to poor, (surely black), children without fathers, it’s clear we’re not waging a war on poverty, but one on the impoverished.

But the real farce is we don’t have to abdicate our resolve for a drug-free youth in order to make our system fair. There’s little chance anyone will listen to me because, as we learn from the great state of Pennsylvania – the ironic home of our “Liberty” bell – jailing innocent kids is a profit-making business. 

Short of the civil libertarian revolution this country desperately needs, there are smaller steps we can take that may be amenable to the conservative parts of our legislatures – national and local.

The game theoretic solution to this war comes from former chief advisor to the Indian government, Kaushik Basu. Years ago, he controversially suggested that for a certain class of “petty corruption”, only the act of taking a corruption be made illegal. I’ve explained the beautiful logic behind this idea before:

In the spirit of Basu’s best writing, the idea behind this proposal is game theoretic in nature. India is famous for its corrupt political culture. Of course, foreigners sense this from the carefully coordinated heists like the 2G Scam. But most bribery isn’t that sexy, nor is it coordinated. It’s the undignified bribes a commoner must pay to the police officer, or water man. The gift to expedite regulatory approval. (In my case the bribe to bring our American-born Dachshund, Lego, into India without the murder of a quarantine India requires).  Basu’s argument is as follows:

  1. In a “harassment” situation, the bribe giver is humiliated and is eager to bring the taker to justice.
  2. Under today’s punitive laws he, too, is a criminal and hence must keep quiet. The taker knows this to be the case and hence does not fear punishment – especially as this information is restricted to the two involved parties.
  3. If the government were to a) legalize the act of giving a bribe and b) incentivize citizens to report illicit activity the dominant strategy for the citizen would be to report the bribe regardless.

In other words, the asymmetric punishment changes the Nash equilibrium away from officials requiring a bribe. Corrupt officials will stop asking for side payment in fear of being prosecuted in the future.

It’s easy to see how this can be adapted to America’s drug trade. The real culprits are almost always the dealers (large-scale, violent ones, not high school kids) who notoriously give free goods to potential customers to exploit addiction. Today, the FBI spends millions on sting operations to deliver evidence “beyond any reasonable doubt” against producers and dealers while wasting their richest resource, the addicts themselves.

Unfortunately, the impoverished citizens afflicted by the system are loth to speak up and report dealers for two reasons:

  1. They have an addiction, or need to distribute the promised stuff to their friends.
  2. They’re scared of being arrested.

Imagine our law amended such that:

  • Dealing (but not possession of any quantity or “probable” cause) remains absolutely illegal, punishable by whatever cruel and unusual shit the government can think of (and our government, unfortunately, is quite imaginative nowadays). You can also exempt middlemen who are reselling what they get wholesale from violent dealers. (And they, in turn, become the “moles”).
  • Purchasing and consuming all drugs (including crack and heroin) are legalized on private property. (Obviously I think we should go pure libertarian on pot…)
  • Those who correctly tip the Feds regarding a drug dealer are paid $1000 plus 2% of the civic asset forfeiture. 

Anyone with an intuitive sense of game theory can understand the huge potential from this small change. Before, users were scared to “rat” their dealer. Now, not only are they confident (because it’s explicitly legal), but have a financial incentive to work with the system.

But this isn’t even the intended effect. Drug dealers will no longer want to ply openly, because they can no longer be confident that their customer will be loyal. In fact, there’s a great chance that he won’t be. Game theorists would say that users can credibly threaten to take legal action, resulting in a subgame perfect equilibrium where drug dealers no longer operate.

Quite astonishingly, there’s good empirical evidence that this might work. A team of researchers led by Klaus Abbink, Lata Gangadharan, Utteeyo Dasgupta, and Tarun Jain tested Dr. Basu’s idea with middle-class Hyderabadi students. Of course, the situation (paying a bribe), was very different, but the game theoretic application is identical. To that end, they found that employing asymmetric penalties made customers far more willing to report corrupt officials, and said officials were far less willing to offer a bribe.

An analogous policy gives both a substantial increase in quality information for the government, and a severe decrease in drug sales across the country. No one’s denying the vast differences between Basu’s idea for India, and this adaption for America. But it is incumbent on a government that is ever-keen on stripping poor men of their liberty to at least pilot a program that will achieve the same end goal more effectively, without devastating inner city communities or minorities.

This post isn’t about the economic, social, and cultural cost of our war on drugs – that’s blatantly obvious to anyone that’s not an idiot. Rather, I hope I’ve given you a framework to think about a very real problem – drug trade and addiction – in a way that’s cheaper, more effective, and preserves the liberties enshrined in the American constitution.

 

Theo Clifford has a thoughtful reply to my recent post calling for immigration on the open market:

That said, it isn’t the only way you could do market-based immigration policy. One alternative would be to have an immigration tariff, as advocated by Gary Becker. Instead of auctioning a fixed number of permits, the government would sell as many permits as demanded at a fixed price. The benefits of this kind of system are broadly the same as the benefits of an auction Ashok describes in his post. However, there are a few subtle differences that for me suggest a tariff might be a better way to go.

Now, before we go on, let’s note that standard econ theory would tell us the optimal policy is an infinite number of monthly permits, or a tariff priced at nothing – at which point the two systems would converge into open borders. Before I go through Theo’s argument, it’s important to note that in a government-controlled industry, we can control either price (and let quantity float by demand) or quantity (and let price float by demand).

When it comes to immigration – people – I assert that the latter is wildly more preferable. On what basis do we price immigration? It’s tough to come up with a non-arbitrary algorithm to achieve this. Immigrants, after all, are not “externalities” to be priced and taxed. On the other hand, it’s eminently possible to create a non-arbirary framework through which the number of immigrants are controlled.

A country like the United States may decide that it wants to target an n% labor force growth rate annually. Based on native fertility rate, the monthly auction can be sized to hit this target. Similarly, European countries with below-replacement fertility can target constant population. Therefore the comparison to international trade isn’t fair:

Ultimately, I think the parallel with international trade holds – tariffs are better than quotas. An immigration tariff would be more sensitive to the needs of the market, less bureaucratic, in some ways more predictable, and maybe even more politically palatable than an auction system.

To the extent neither of us are endorsing freely open borders – which would be the Kaldor-Hicks efficient solution – we accept that there are cultural constraints that dictate policy. Frankly, I don’t care how many tons of steel are imported each year, so long as my buildings are efficiently priced. But immigration is a whole different story – these are people you interact with. They will assimilate into your culture, to a large extent, but you into theirs. To abstract the migration of human families into human trade misses the very reason why neither of us advocate free borders (or perhaps he does, in which case a tariff is suboptimal).

But even beside that important point, I think a permit auction holds strong.

The first reason to prefer a tariff is that it means the market is more responsive to shifts in supply and demand. […] Using the auction system, the same number of people come – all that changes is the price. Under a tariff regime, on the other hand, the number of migrants is free to fluctuate according to the needs of the economy […] Yes, the government could adjust the number of auctioned permits according to economic circumstances, but it is better that changes in the number of migrants be market-driven, rather than decided by bureaucratic assessments of ‘need.

I think I’ve addressed most of my concerns with this claim above, i.e. that targeting price level is arbitrary whereas number is not. But even that aside, an auction is sufficiently robust to meet changes in demand. I’m not asking for a once-in-a-lifetime bonanza. The government would host an electronic auction monthly. Furthermore, state and local governments have the explicit right to petition for more permits to be floated on the market in response to acute changes in immigrant demand.

I would argue, too, that permit markets are far more conducive to deeper markets, by encouraging secondary and tertiary exchanges. A big part of my proposal piggybacks on the old, American, Jeffersonian ideal that states are in competition with each other – thereby bringing out the best in each. Michigan, as I noted, has shown a remarkable interest in immigrant labor. Under my proposal, it would be easy for Michigan to buy a block of permits and float them on an internal market open to Michigan’s only businesses. Theo’s proposal is quite similar to a permit market endorsed by Matt Yglesias, but I believe my employer-focused plan places greater emphasis on ensuring only the most valuable immigrants make are allowed. (Note I said “valuable” not “skilled”).

Another argument for tariffs is certainty of barriers to entry:

Having a fixed tariff price, or at least a planned price schedule, also gives a level of certainty to the market. If I live in Mexico and my family is saving up to buy my way into the USA, I want to know how much I’m going to need to squirrel away. With an auction, the price will vary from year to year, perhaps dramatically, and there will be no guarantee that my savings will prove sufficient to get me a permit this year, or even next year. Tariffs solve this problem.

Ask yourself this question. You’re the American president. You have to decide between providing some level of certainty to your own people about what their country will look like in a generation. Or you can provide certainty to some potential Mexican peanut farmer about how much he has to save to maybe make it.

But I’m not even convinced that prices will be so predictable in a tariff system. One of Theo’s main arguments was that the labor market can flexibly respond to changes in demand by allowing more people, but this is a double-edged sword. What if the price is too high, which would strangle innovation and economic growth? Can the government credibly promise business leaders it will keep it high? And what if the price is too low vis-a-vis nativist preferences, which are always in flux? Any sensible government would change the price according to national and business sentiment: but this removes any “predictability” to the whole thing.

Generally, for international trade, I’d support tariffs (if anything at all). But neither price nor quantity is arbitrarily defined. In labor, it makes a lot more sense to target a number than a price. The former can definitely be credibly sustained, with minor exceptions as per immediate request.

Auctioning permits gives the government far more control over its long-term demographic profile, which is ultimately the heart of all immigration debate. There’s a Cato post here that makes pretty much the same points as Theo, but ignores that there’s not something magically more “market” about controlling price than quantity. They (correctly) argue that America needs more immigration but then seem to assume that a tariff would not be overpriced relative to demand but an auction would be. I suppose the old joke about the economist on a stranded island assuming a can opener is appropriate.

Oh and by the way, if we’re extrapolating this debate, I wonder how the folks at Cato would feel about a tariff-based Sovereign debt system rather than an auction. There are scenarios where targeting price is better (international trade) and those where targeting quantity trumps (immigration). It would be wrong to equivocate two very different markets.

It’s not secret that America has a rusty immigration policy that’s costing us billions. Almost everyone seems to agree that we could use more talented doctors and engineers, presumably from India or China. There’s even considerable consensus that tolerating unskilled (mostly Latin American) workers has huge long-run benefits.

But there’s a pretty vocal contingent – left and right – that believes other things equal more unskilled workers are bad thing. Take Madeline Zavodny from the American Enterprise Institute, what we might take as a reasonable barometer of center-right market-oriented thinking:

The fact that these immigrants would receive more in benefits than they would pay in taxes if they legalize their status does not mean that the US should not have an earned legalization program — it means that the US should reform its government transfer programs.

Tethering freer borders to the “reform” of America’s safety net is not only counterproductive, but effective political suicide on our third rail. Not to mention study after study has shown immigrants will increase America’s tax base (satisfying conservatives) as well as working-class salaries (satisfying liberals).

No matter, there is a superior alternative that would definitely raise revenues, and attract the most valuable immigrants: permit auctions. Australia and Canada are both cited as having relatively robust “point based” immigration policies. However, the market is a far more efficient and fairer arbiter potential immigrant competence than a bureaucrat in government.

America’s first-come-first-serve (FCFS) system is even worse. I propose that the government should electronically auction some anticipated number of permits at the beginning of each month on a free market. Similar ideas have been floated by economists like Giovanni Peri at the University of California at Davis, but my idea would be quite a bit different:

  • There are no different classes of permits for “high” and “low” end workers. Skill is determined only by the market.
  • There is no price floor, the government can tighten labor supply by supplying fewer permits on the open market.
  • The auction would not be limited to firms – it would include individuals as well as local and state governments.
  • Would shift the focus to employers rather than more common residency permit auctions, like the ones Matt Yglesias discusses here. The idea behind this is to attract the most productive, not the richest, people – though you could say the spirit of our proposals is quite similar.

To the extent that we cannot tolerate purely open borders, a consistent permit auction is the most optimal choice. Right now, family members and bad FCFS policies don’t ensure that each immigrant we accept is better than all potential immigrants. That is far from Kaldor-Hicks efficient.

But if permits are auctioned on the open market, only the agents that will maximize the resultant marginal revenue product (MRP) receive clearance. Furthermore, this will end the need for the cruel government practice of tethering visas to employment, which certainly depresses wages in the lab sciences. Rather, employers themselves will sign contracts with foreigners only on the condition of sustained employment, thereby mitigating the risk of purchasing permits.

Left-leaning liberals like Dean Baker should also be pleased. While I believe his concern that immigration decrease native wages is false (studies actually show it has a 2-3% positive effect), my proposal deals with this in two ways:

  1. Especially with minimum wage laws in full-force, the MRP of high skilled workers is almost certainly higher than unskilled workers. The only other purveyors of such permits might be the North Carolina Growers Association which couldn’t find a single American to do the job. (Okay, I lied, they found seven).
  2. Consistent auctions would lend a steady stream of revenue which can be used to finance education and employment for the poorest Americans, who those like Baker claim to care the most about.

Furthermore, this is a great way to increase partnership between the Federal government and immigration-friendly states. Piggybacking on the spirit of regional visas from Adam Ozimek, state politicians should be given the right to petition the Federal government for an increase in the supply of permits. I do not endorse that they be traded on a separate exchange, which would too strongly favor public sector work. Rather, this is a means by which interested states (like Michigan) can bring down the permit cost. If states buy large quantities thereof, they me operate a secondary market within their state, to identify the most competent local businesses.

Here itself, we can observe the deep flexibility of this market-oriented proposal. Secondary and tertiary markets allow for a reallocation of permits in a far more efficient manner than centralized bureaucracy can ever dream of. Further, the high-skilled immigrant labor market will become rather more competitive when employer restrictions imposed by the government are removed, thereby enhancing regional mobility and hence overall welfare.

The revenue potential is not insignificant. Just at this moment, the United States has almost 150 million potential migrants. The United Kingdom is a laggard runner-up with a figure of 42 million. Assuming each permit floats at $5,000 – and this is conservative based on Peri’s work – the United States has a potential revenue of $750 billion. Indeed, a market-based immigration reform would further accelerate demand to become American.

It’s crucial to note that the burden of permit financing would fall on both employers and employees, depending on elasticities of demand and supply. The dearer the permits, other things equal, the less a potential employer is willing to pay for the same level of output, realized as a lower wage. This can be thought of as a migrant financing his own permit.

Therefore, if the USA manages to bring more people today – who will then want to bring their friends, families, and loved ones – a naturally captive demand for American visas will alleviate the employer’s share of the permit burden.

Most economists firmly believe that tax is an evil far kinder than bad regulation. The American bureaucracy is rusty, expensive, and highly detrimental to long run growth prospects. A market (ultimately) for citizenship would increase government revenues, per capita income, labor market flexibility, and innovation. Markets lend themselves to a devolution of regulation to state and local governments, which can then compete with each other as centers of immigrant activity.

To maximize growth in a time of debt immigration market reform is the clearest step. And can perhaps command bipartisan support. Market framework also helps us clarify foggy thoughts. Why do we regulate migration, anyway? Would anyone even dream of something as nutty as a “permit to innovate robots”? No! But why is immigration any different?