Monthly Archives: May 2013

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?

Update: Brad DeLong here notes that there’s a bit of a straw man argument that liberals don’t care about the skills-based gap. To the extent that I am a liberal, I definitely think he is right 😉 

Timothy Noah has a new post at the New York Times arguing that the 1 percent are only half the problem. Of course, my first reaction is that their share of the problem is even more disproportionately allocated than their share of the income! Snark aside, I’m not sure organized labor is the solution to America’s “skills-based gap”. Here’s Noah:

The decline of labor unions is […] important. At one time union membership was highly effective at reducing or eliminating the wage gap between college and high school graduates. That’s much less true today. Only about 7 percent of the private-sector labor force is covered by union contracts, about the same proportion as before the New Deal. Six decades ago it was nearly 40 percent.

The decline of labor unions is what connects the skills-based gap to the 1 percent-based gap. Although conservatives often insist that the 1 percent’s richesse doesn’t come out of the pockets of the 99 percent, that assertion ignores the fact that labor’s share of gross domestic product is shrinking while capital’s share is growing. Since 1979, except for a brief period during the tech boom of the late 1990s, labor’s share of corporate income has fallen. Pension funds have blurred somewhat the venerable distinction between capital and labor. But that’s easy to exaggerate, since only about one-sixth of all households own stocks whose value exceeds $7,000. According to the left-leaning Economic Policy Institute, the G.D.P. shift from labor to capital explains fully one-third of the 1 percent’s run-up in its share of national income. It couldn’t have happened if private-sector unionism had remained strong.

Now, for the record, I think strong and healthy union membership is a good, countervailing force to the power imbalance between employer and employee (particularly in scaled, factory environments). However, it’s not the answer to our economic woes. I’m a left-leaning liberal: but a lot of this sounds more like high rhetoric than a realistic assessment of history. See the emphasized, why on earth should the wage gap between college students and high school grads be smaller

As technology advances, and capital becomes an efficient replacement for labor, we would expect – unions or not – college graduates to earn more. As America develops, adjusts to a globalized world, and realizes its competitive advantage in “knowledge” products, are we really surprised that the relative wages of a programmer is growing faster than those of a bus driver? And – as left-leaning liberals – have not those of Noah’s ilk been calling for more education this whole time? Isn’t Noah blowing away the strongest argument for government-subsidized education, especially of the poor? And without education, where on earth will the poor we care so much about find social mobility?

Most importantly, why do we think this is a bad thing, the idea that college pays? Noah squarely places a good part of the blame on the financiers and corporate executives in the 1%, but he doesn’t go far enough. When he talks about America’s “mass affluent” and the growing gap between the top 10% and middle 20% he ignores a few things:

  • The lions share of income in the top 10% (his baseline is incomes $100k or so and up) goes to its top 1%.
  • By targeting the broadly educated elite, the burden of taxation is shifted from rent-earning executives to scientists, engineers, programmers, as well as  main street lawyers and bankers. We actually want more of these people, and there’s pretty good reason to believe STEMers are woefully underpaid.
  • I’d much rather the college premium be higher and more people graduate, especially if it means fairer wages for engineers.

Further, from a distributive standpoint, incomes allocated to the 1% are significantly more important than anyone else. I would much rather the marginal tax dollar be derived from a rent-seeking executive than a run-of-the-mill college graduate. This is a false dichotomy, but helps underscore my disagreement with Noah. A mass labor movement with the simplistic goal of narrowing the college grad/non grad gap is sure to bring the former down rather than the latter up. A mass labor movement, without any aid from strong, protectionist government policy, will result in greater unemployment. At a time when companies are finally reshoring operations, it would be wrong to petrify America’s labor market. 

Of course, the United States could implement strong industrial policy with full employment as a key goal, but not without dismantling the free trade system we built. After Bretton Woods, a good part of American foreign policy was creating an international system (indeed led by the United States) conducive to free trade. 

I’m not really a proponent of the right-to-work laws that are plaguing this country, either. After all, nothing seems more coercive than the government forcing firms to provide non-union contracts. But as we move towards a far more “knowledge-based” economy, for wont of a better term, I really don’t see union-building as a way to edge inequality.

From a social perspective, the lives of the mass affluent are far closer to the middle-class than the 1%. Sure, they might have more books at home, more savings, a higher priority on education, but the qualitative differences rise at much higher incomes. Mansions on Long Beach should be of more concern.

I don’t usually talk about the stock market. For good reason, I don’t know much about it. In fact, since I started blogging this January, I don’t think I’ve mentioned stock prices as a financial phenomenon even once. But it’s as if we’re experiencing a bubble in bubble-speak. Gillian Tett, in the Financial Times, warns us about financial instability and bubbles. Brad DeLong and Paul Krugman both remind us that market fundamentals are strong, and price-to-earnings is nothing like it was in 1999. Of course some people are wondering why this is the case:

Wait – with lower interest rates, the question should be why hasn’t the price to earnings ratio increased? 

So it looks it looks like market predictions are as vogue as ever. So before I start let’s just note a few obvious characteristics of today’s market:

The short term yields – more or less the Fed’s prerogative – are not significantly lower than the natural rate. That is, yield spread between 30-yr and 1-yr Treasuries is just not unnaturally high. Quite simply, this means investors expect 1-yr yields to be low in the foreseeable future. (This is quite a long time, as far as markets are concerned). But I don’t think anyone expects prolonged QE either. This means real factors like a global savings glut, shortage of safe assets, and dare I say confidence in American government have kept our yields low, in real terms.

There’s a darker side to things. A low yield premium on long-term bonds means investors aren’t expecting any serious boom in employment over the next decade, but why would they. This has been one of the weakest recoveries – take a look at this simple graph I made plotting output gap by months after the trough:


Crappy. I know. Now what do we know about stock markets. In the short-run, there’s generally little correlation between returns and economic growth:


But over the long-run, the S&P 500 has always moved in tandem with consumer confidence. And in the United States, where consumer spending accounts for roughly 70% of GDP, this isn’t surprising. But it’s clear that long-run growth expectations are meek (otherwise yield premiums would be higher). The economics behind this is clear, higher rates imply:

  • Lower trade deficits
  • More business investment and borrowing
  • Healthier bank lending
  • Higher tax revenues (because outside of a liquidity trap, government borrowing does crowd out private investment) implying higher incomes.

Therefore the next ten years will basically be a mean reversion on crazy returns. When EconoSpeak asks whether the market is undervalued with regard to the price/earnings ratio, it’s looking at the wrong part of the equation:

In other words, with higher earnings and lower interest rates, shouldn’t stock prices be even higher?

The “higher earnings” are illusory. The Federal Reserve has effectively brought future returns into the present. That means P/E will rise as relative profits fall. If profits don’t fall relative to prices, then I’ve seriously misunderstood the basic structure of our economy. And I’m not suggesting a causal relationship or anything, but here’s a graph that took me aback:


Profits and public debt – as a % of GDP – track each other pretty well, eh? 

If we are to believe there’s a structural factor that correlates the two, as American debt stabilizes we would expect – at least in a naive interpretation as for P(A|B)=P(A&B)/P(B) – profits to level off. 

That seems to further the case that quantitative easing has just allowed investors to realize future profits today. It doesn’t at all advance the idea that stocks are overvalued or, worse, there’s an imminent bubble.

Of course, the strongest evidence that fundamentals are strong is that no one is predicting Dow 36,000. 

Jay Goltz warns us in the New York Times that Amazon is keeping prices artificially low today  to gain market share:

Why would a company choose to operate without a profit? Because it wants to provide great value? Check. Because it wants everyone to love the brand? Check. Because it wants to gain market share? Check. Because it wants to put everyone else out of business, so that it can one day flick a switch to raise prices and make a fortune? CHECK!

Don’t believe me? Well, here is Jeff Bezos of Amazon, explaining why making a profit isn’t important. Of course, he doesn’t say he’s planning to raise prices after he puts a lot of people out of business, but let me translate something for you: Gaining market share by not taking a profit makes the most sense if you are planning to raise prices later when you have less competition.

That’s probably one of the most natural explanations of NASDAQ:AMZN, but I think Matt Yglesias is right:

And maybe it is. But it’s hard to see how that plan would work. Part of the genius of the Internet is that it makes it much easier for brands to directly market their wares to people. It’s easy to see how Amazon might put K-Mart out of business, but the only way for them to put Samsung out of business would be to actually manufacture mobile phones and televisions. And if Amazon ever starts trying to charge outrageous markups on Samsung’s products, people would just buy directly from Samsung. Amazon would probably be more efficient at delivering things quickly, but then any price premium Amazon charges would be in effect an upcharge for fast delivery not a monopoly rent. And most of the time delivery speed just isn’t that big a deal. 

There’s a word for this. Normally, when economist and journalist types talk about market health, they’ll use “perfect competition” and, by extension, number of firms, as a good baseline. In fact, the idea of “many firms” is so inculcated in the economic psyche that we’re loth to consider welfare efficiency by any other measure. Indeed Google returns 252,000,000 hits for “perfect competition” against a measly 555,000 for the much more appropriate “contestable market” – defined by The Economist as:

A market in which an inefficient firm, or one earning excess profits, is likely to be driven out by a more efficient or less profitable rival. A market can be contestable even if it is dominated by a single firm, which appears to enjoy a MONOPOLY with MARKET POWER, and the new entrant exists only as potential COMPETITION (see ANTITRUST).

In other words monopolistic rents are moderated by the threat of potential competition. As the Google hit numbers will tell you, this idea just hasn’t gained that much traction. But digital economics are very different. Internet monopolies are usually determined more by network effects (a la Facebook) more than real, physical barriers to entry. The obvious exceptions might be massively-scaled cloud storage etc. Even Paul Krugman missed this distinction regarding Google Reader. That’s why this little bit from Goltz really misses the mark:

If this competition with giant Internet companies seems like some kind of Brave New World, it’s really not. It’s pretty much the same strategy the robber barons employed in the 19th century. Today’s combination of tax avoidance and profit delay enjoyed by the Web retailers has made it very difficult for some local retailers. But is the end near?

In fact, it’s actually nothing like robber barons in the 19th century. For one, while Amazon is clearly the king of online retail, direct sales, as Yglesias notes, play an important role. But more importantly, Amazon’s appeal comes from rich, and reliable, system of product review it provides. Yeah Amazon Prime is great; the web infrastructure too. But do we really think consumers will let Bezos charge any real markups when Yelp is right next… click?

Furthermore, any markups can be so easily exploited by instant arbitrageurs that rents cannot exist for long. Price information spreads so rapidly that consumers will flock to other sites, or direct retail itself, the second they find any noticeable increase in price levels. iTunes reviewers have, on more than one occasion, saved me of $9.99 by pointing readers to legal ways of watching a movie free. Anecdotal, but powerful.

Goltz ends with what sounds like a guilt trip:

And if you are a customer, please think twice before you use the services of a local retailer without any intention of buying. We all may pay a hefty price for your “savings.” Empty storefronts don’t help a neighborhood.

Then again, the Times signs him off as:

Jay Goltz owns five small businesses in Chicago.

Okay, cheap shot! But I couldn’t resist… This is like a cry against efficiency and consumer surplus. For one, by selling in a public space using institutions funded by the American taxpayer, we have a right to cordially browse goods. And it’s not as if “local” stores don’t benefit from the likes of Amazon. Local shops need inputs, too, and I’m quite confident the long-run supply side effects of online retailing has brought that price down, allowing said shop to earn a greater margin on each product.

And think about the reviews! When a retailer is thinking about long-term inventories, it would be absurd if he or she didn’t use the rich information available on Amazon to better serve the local client base.

And if local businesses price their goods so fairly after all, implying a high level of competition, standard micro tells us that if Amazon were to raise prices too high, they’d just pop back into existence. Because if barriers to entry and exit aren’t low, then they’ve been earning rents this whole time, and are just upset that big, bad Amazon is making things fair. And if they are, well, Amazon can’t do much to keep them out.

Of course it’s a mix of both. Which is why we gotta think in terms of contestability. Yglesias is very correct: an evil Amazon will not stay in power for long. Network effects are rapidly eroded (see this), which forces digital “monopolies” to operate under the constant threat of competition.

My two robot posts are unfortunately long. So here’s a quick glimpse on my thoughts. This isn’t necessarily meant to be a standalone post, so if you want more details check out Kevin Drum’s comments here, as well as my response.

A note, I don’t think Drum is nearly as pessimistic as a few of the commenters I’m responding to. But I think the import of my point remains.

A comment I left on Brad DeLong’s blog to the many dissenters:

I’ve tried to address the criticism within most of the comments here:

The gist is as follows:

1. If the “masses” are to be “starved” then the rich must find a way to employ most of the capital and land in a way that is profitable *without* producing goods of mass production. It is difficult to believe this is realistic, there just aren’t enough “rich” ipso facto. But, if the rich hoard all the capital…

2. The “masses” are no longer “replaced”. The argument rests on the assumption that somehow their daily jobs doing things that help the average man have been replaced by robots. But if your saying goods and services consumed by the average American won’t exist that – after all – is the contention above, then there will be an arising demand for labor creating such things. This has to happen. In other words you will find a non-robotic economy divorced from the rich.

3. Further, the idea that “robots” can be kept away from “most” people is also difficult to believe. Software is naturally explosive and diffuses rapidly. Information doesn’t want to be kept secret. And, under the utopian (dystopian?) assumptions made by my critics, 3D printing will obviate the need for real “hardware”. That is, software is prior to everything. Therefore most people cannot be restricted from the “robo revolution”.

4. Hence, I find the whole “oh the rich people will keep it all to themselves” argument not just unlikely, but fundamentally allergic to the way technology works.

5. Robin Hanson corresponds via email noting that the limiting constraint is use of land and natural resources. If this is somehow monopolized, then we face a different future. To this my reactions are as follows:

This is why I support huge and strong Ricardian taxes on land, oil, gas, etc.

Go back to point (1) It seems odd to me that the rich can find a way of employing all American land in a profitable way that benefits only them. Sure they will hog the beachfront property, but I don’t really care if your Malibu vacation is affordable or not. Most habitable land can’t be “taken” by the rich in a way that benefits only them. They are not large enough in number, ipso facto. So it will be used for things that benefit most people, even if for a profit. This is how self-interest is supposed to work.

6. Disemployment can happen either in labor units, or in hours. I think if it happens at all, the latter is vastly preferable and more likely. Robots mean overworked lower class parents can spend more quality time with their kids, sleeping, taking a break. And did I mention not working two jobs?

7. The anti-robot narrative is deeply Anglocentric. Much of the working conditions in the global south – creating goods for American consumption – are absolutely dismal. The same conditions these people would any other day protest against. That is p(worrying about robots | protesting Nike shoes) > p(worrying about robots | standard American). Robots would let the ten year old boy in Bihar go to school instead of work to put food on his mother’s table.

Tyler Cowen does. Surprisingly, I think I agree. But with a few, important, caveats.

My first reaction to the rapidly falling deficit was disappointment that we hadn’t done more. I, after all, have been arguing that we need more short-term stimulus, now. And in the spirit of DeLong and Summers (2012), I even believed our tight policies were self-defeating.

Now, there’s no reason to believe this is not the case. We can’t, after all, test against a non-existent counterfactual. But the Keynesian reaction to recent numbers exposes a certain illogic with regard to falsifiability.

If I think austerity today is self-defeating – and I did – then my measure of bad policy should have been an above trend deficit update; that is we’re doing worse than we thought. But, evidently, my measure of bad policy has been a below trend deficit update. Full faith in the idea of self-defeating austerity and my reaction to the deficit numbers are logically inconsistent.

This is probably my fault. I’m not saying all Keynesians thought the same, but it is quite easy to think so. Either I didn’t believe what I thought I did, or held logically inconsistent priors. Perhaps a mix of both.

However, as I said, there are some big caveats. DeLong and Summers have a fairly solid theory of self-financing stimuli. An important part of the argument is existence of hysteresis effects, wherein labor shocks are permanent (and we see this with the horrible long-term employment situation and crappy Beveridge Curve).

Here’s a crucial point. At the margin, perhaps austerity doesn’t increase deficits. The healthy position right now meant our stimulus was eminently sustainable. It means DeLong and Summers are probably right in the idea of it all. That is, deficits aren’t that much higher than they might have been.

I don’t think the CBO has the capacity to measure this in any effective manner. A weaker labor force will have costs that we may not even realize at the moment. To be fair, the mathematics behind the argument also assume something we cannot know – a flip side of the same coin.

A stipulation is that a lot of the good news is coming from a flattening healthcare cost curve, that a healthier long run aggregate supply. This is entirely divorced from Keynesian theory, and hence can’t be used by austerians.

Ultimately, this is a question of meta-rationality. I’m not willing to update my beliefs about austerity, at least not with this news. We needed more, and we needed it for longer. But I do cede that my beliefs and reaction thereof were internally inconsistent. Further, the argument for self-financing may not be as strong as we once thought it might be. And even if it is, it seems very difficult to falsify.

The idea of self-defeating austerity seems so natural to me, now. But I now have to decide whether I think the deficit is bad news, I do, or whether I maintain my old beliefs. But ultimately, I think the spirit of DeLong and Summers is vindicated. To the same extent austerity didn’t cause deficits, our stimulus packages didn’t send long-term deficits through the roof. That means we’ve tolerated unemployment and bad growth for no particular reason.  More to come soon: this is an important conversation.

Abenomics, move over.

Kevin Drum isn’t as optimistic about the massive capital-biased technological change that robots promise:

Nor is it enough. Even if we can immerse ourselves in the web all we want for low cost, we still need to eat, clothe ourselves, live somewhere, and so forth. Until our future robot paradise arrives, this is a big deal. If you lose your job to a robot, your net economic position is going to be sharply worse than it used to be.

Drum doesn’t buy my argument that this structural change will almost-definitely be a good thing. At least not in the short-run. I want to clarify my last point, which I’ve clearly obscured, vis-a-vis the emphasized text. If mass labor is no longer needed to produce most goods and services (an assumption I doubt – but that later), there is definitely reason to believe in disemployment effects. But my point wasn’t about unemployment, per se, but standard of living. A rise in total output will allow much sharper redistribution of income.

Long ago, J.S. Mill noted that the humanitarians of the day needn’t criticize the Smithian free market in its “natural” tendencies. Because production was an economic question, and distribution was political. Of course, he ignored the intimate link between the two. If high-earners are taxed at sufficiently high rates, they will definitely be disincentivized at the margin.

But to the extent Drum’s suppositions are true – i.e. that robots replace most wage labor – production has, largely, been solved. (Drum’s whole point is there isn’t much work to be done in “running” the robots, material production will be on auto-pilot). The vast amounts of capital income would lend themselves to more redistribution, and I doubt that standard of living would fall much at all. Remember, the capitalists who own all the robots won’t have any profits without a huge and growing consumer base. Falling cost of production implies increase in supply, and hence more surplus –  consumers included. I cannot emphasize this point enough – without healthy consumption, robots are useless. I’ve read comments that the rich would “use” the robots “for themselves”. This is highly unlikely for a plethora of reasons but, if it comes to pass, will mean everyone else can create their own, relatively labor-intensive economy. Problem (kinda) solved. Capitalists paying huge sums for fixed quantities, like land, make a new Ricardian tax program a perfect choice.

This is tangential to the main point, because I don’t think we’ll face severe disemployment effects at all. For all the talk about “offshoring” to China, the American labor market adjusted remarkably well over the Clinton and early Bush years. The post-industrial apocalypse that is Detroit aside, the current crisis isn’t, at least not directly, one of structural unemployment.

On that note, this whole argument has been framed in an unfortunately Western point of view. Most wage labor across this world is treated in dismal conditions. They don’t want to work, but have no other way to put food on the table (or on the mud floor, as it might be). Just calculate, how many slaves do you have? I have 29. In a robotic world, that will be nil. I know there are many poor women across India who would rather put their ten year-old son in school than on the hot field as a brutally-treated farmhand.

Drum seems to think that in our robotic future, the demand for (most) labor will vanish:

I very much doubt [that millions will enter the ‘thinking classes’]. The vast majority of humans have neither the skills nor the desire for this. Rao may be right about “millions,” but that represents just a tiny fraction of the human race. What about the rest of us?

I was probably a bit idealistic about the future being “a cornucopia of thought, refinement, ideology, and science”. As I noted, if incorrectly applied, such jobs are by definition restricted to the smartest who, by definition are few. But an important part of the argument remains. Many people today who feel financial pressures either drop out of the educational system early, or undertake a purely vocational education, against their will. And this isn’t a bunch of intellectual snootballing either – I’m more than happy if people turn to “lower” pleasures (this was in the spirit of Mill, after all!)

But in the future we’ll see more youngsters confident enough to study english, philosophy, or the lab sciences. Noah Smith’s argument against all non-econ PhDs will become a nonstarter. Kids who want to pursue their time as “starving artists” will have all the means to do so. I think Drum underestimates the huge demand for the more “thinking” pursuits of life we’d see if the whole world – billions not millions – was educated.

As Tyler Cowen linked to, earlier today, a Master’s in Computer Science from one of the best universities is now available for $7,000. TotalThis is a story about how not even the most exclusive admission committees can keep the gate closed on learning itself.

And there’s another narrative here. The huge increase in material wellbeing (unequal as it might be) will itself create demand for all kinds of new things we can’t even imagine. Here’s one prediction. As a % of total employment, the sex industry will grow relatively rapidly. Because no robot can replace, how to put it.. a beautiful woman.

And this pattern carries across. We’ll have more people watching plays at the local theatre, and spending time with their grandparents. Or tending to a garden. Michael Pollen will no longer be chastised as a sexist pig.

Just because myself and Kevin Drum can’t predict the future demand for employment doesn’t mean it won’t exist. I don’t think most of the jobs today would have been predicted ten years ago, let alone fifty. I place incredibly stock in human ingenuity.

This just isn’t about the “long-run”. There are two ways about thinking about the immediate effects. Disemployment might be relatively prominent during “structural adjustment”, as an economist would say. But this doesn’t always have to be so painful. America became a service-based economy rather quickly. Also remember, at the hark of the industrial revolution Luddites were saying the same thing (and burning down buildings in the process). Drum can look retrospectively to analyze why they’re wrong and it’s different this time. But who is the say the future Kevin Drum won’t be saying the same thing!

And, in the meantime, unemployment can always take two forms: of bodies, or of hours. We have good reason to believe a good part of America is “overworked” – the same people that Drum thinks will be most hurt by this change. Moving to fewer working hours will allow working-class parents to spend more time with their kids and mothers to enjoy better maternity leave and benefits.

The smaller working-day will create more social interaction, perhaps at a local cafe. In fact, along with the sex business, I’d be bullish on fancy restaurants – in the future.

I hope I’ve made more clear the obscurities in my previous post. But I also want to get more specific. What does Drum think unemployment rates will look like over the next ten years? Fifteen? Fifty? What about labor force participation?

As for the former, I don’t think natural unemployment will ever hit more than 8%. (I don’t think it will get near, but I can see a few possibilities to the contrary). I think labor force will fall among the elderly – and I think this would be a damn good change. Working-age adults participation has been on secular decline, but I don’t think robot technology will do anything to put this fall on steroids. 

More specifically, over the next twenty years, I don’t expect participation to fall below 70%, adjusting for all hysteresis effects of low AD.

I do think Drum gets one thing absolutely right, robonomics has been given “surprisingly little attention among economists”. This will change. Because, if there’s one thing we liberals hate to admit, this is a supply-side revolution. We have to fundamentally reconsider what income is, and how it’s allocated. I think consumer surplus has already done a lot of that (I mean yeah, the Internet isn’t “free”, but it’s about as close as it gets. That’s pure surplus).

There is the more daunting question of work and dignity. As John Steinbeck beautifully put it during far worse times:

“The last clear definite function of men — muscles aching to work, minds aching to create beyond the single need — this is man. For man, unlike anything in the universe, grows beyond his work, walks up the stairs of his concepts, emerges ahead of his accomplishments. This you say is man — when theories change and crash man reaches, stumbles forward, painfully, mistakenly sometimes. This you may know when the bombs plummet out of the black planes on the marketplace, when prisoners are stuck like pigs, and the crushed bodies drain filthily in the dust. If the step were not being taken, if the stumbling forward ache were not alive, the bombs would not fall, the throats would not be cut. Fear the time when the bombs stop falling while the bombers live — for every bomb is proof that the spirit has not died. And fear the time when the strikes stop while the great owners live — for every little beaten strike is proof that the step is being taken. In this you can know — fear the time when manself will not suffer and die for a concept, for this one quality is the foundation of manself, in this one quality is man, distinctive in the universe.

Cutting words. But I wouldn’t doubt the creative capacity of Man. We’ll create movies, delve into the craziest depths of quantum mechanics, solve the question of P and NP, and “create beyond the single need”. We, after all, are human.

That doesn’t mean there won’t be inequality, or discontent. It won’t be the end of ideology, passion, or thinking. There will be an underclass: of who, what, and where I don’t know. History, after all, won’t be over.

But those in it will be a lot better off than they once were. And that’s why the future is a good place.

Update: Brad DeLong has aggregated many responses to this question. Most notably, Keynes himself:

I draw the conclusion that, assuming no important wars and no important increase in population, the economic problem may be solved, or be at least within sight of solution, within a hundred years. This means that the economic problem is not – if we look into the future – the permanent problem of the human race…. Thus for the first time since his creation man will be faced with his real, his permanent problem – how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well. The strenuous purposeful money-makers may carry all of us along with them into the lap of economic abundance. But it will be those peoples, who can keep alive, and cultivate into a fuller perfection, the art of life itself and do not sell themselves for the means of life, who will be able to enjoy the abundance when it comes… 

…Meanwhile there will be no harm in making mild preparations for our destiny, in encouraging, and experimenting in, the arts of life as well as the activities of purpose. But, chiefly, do not let us overestimate the importance of the economic problem, or sacrifice to its supposed necessities other matters of greater and more permanent significance.

My post – in other words – is almost a century too late.