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The Europe Issue

June 3, 2014
the Economy: Home and the World
24 Comments

Update: Mark Schieritz writes in the comments:

Thanks for reporting on my interview! I believe however you are confusing my role as a journalist conducting an interview with my own view on things. I do believe that the ECB should act more forcefully and I have said that on numerous occasions (e.g. on my blog http://blog.zeit.de/herdentrieb). When interviewing officials however it is my duty to challenge there actions and as I write for a German audience it is my duty to challenge them from a German perspective. Peter Praet has enough rooms to defend himself.

(I think that’s fair. As I told him, I think this only further implicates the European elite by serving a certain “German perspective” that requires such a deep prior that any and all monetary stimulus is always and everywhere evil. And while journalists are responsible for their audience, they are also beholden to the truth: and at least given what I know the perspective peddled in this interview is an unfair representation of reality. To a layman reading the interview, the tone is dominated not necessarily by the clarity of Praet’s thought, but the forceful austerity of Schieritz’ question.

In any case, read this post and substitute “elite” for “Mark”.

That said, since I believe this was originally written in German, I cede some things are lost in translation. But where are the elite “challenging the actions” of Jens Weidmann?)

—

It’s no secret that the European Union is collapsing under the weight of its own bind. The political situation across the continent looks not unlike what it did before a great war more than fifty years ago and, relatedly, the economy doesn’t look better. John Oliver lambasted the fascist politics that are taking over the union last Sunday. While it may be hard for many Americans, including Oliver, to understand why Europe hates its elite so much, you need look no further than the austerity complex at Die Zie, described on Wikipedia as:

 well-regarded for its journalistic quality. With a circulation of 504,072 for the second half of 2012and an estimated readership of slightly above 2 million, it is the most widely read German weekly newspaper […] The paper is considered to be highbrow. Its political direction is centrist and social-liberal, but has oscillated a number of times between slightly left-leaning and slightly right-leaning.

The most widely read weekly paper, it might be to Germany what Thomas Friedman is to the Beltway elite. Enter our protagonist, Mark Schieritz, in conversation with Peter Praet of the ECB in what may be the most spectacularly absurd interview of the year.

For context, inflation in Germany rolled in this month below its own low expectations at a barely-discernable-from-deflation 0.5% (consensus was 0.7%). Investors around the world are on the edge of their seats for the ECB meeting this Thursday when Draghi is widely-expected to announce Europe’s first round of quantitative easing.

Mark starts the interview curious that the ECB isn’t hiking rates because “business activity is picking up in Europe”. When Praet accurately notes that inflation is well-below target – that, indeed, 0.7 is less than 2 – he wonders whether that is “a little formalistic”. This defines the psychology of establishment economic thought across the pond: not only a requirement that the stipulations of rules-based policy themselves be hawkish, i.e. “close to, but below 2%”, but that even when we are far from meeting that goal, following rules are merely “formalistic”.

In the German mind, the one and only purpose of monetary policy must be further pain and austerity.

When told that persistently below-target inflation would harm the ECB’s credibility, Mark notes that many “experts’ expect inflation to soon again rise of its own accord. This statement is a great window into the minds of the European elite, motivating the idea that inflation is something that exists of its own accord, outside of monetary authority. This is not surprising for a country scarred by years of hyperinflation when, indeed, political and fiscal theories of the price level dominated. In most times, however, inflation is “everywhere and always a monetary phenomenon”. European policymakers for some reason believe supply, not demand, is the problem (how else would inflation come “of its own accord”). Of course, there is debate among sensible people about whether the central bank can do this in a liquidity trap, except journalists at Die Zeit have nowhere near the level of economic sophistication to actually understand that debate.

The story gets worse. When Praet gives Mark the canonical reasons for which low inflation is deadly he concludes that we cannot “allow inflation to be too low for too long”. You would think that even if people had subjective contention on what constitutes “too low” and “too long”, they would agree that given their own reference, inflation should not fall below that threshold.

Not so for Mark who wonders “why would that be dangerous?” In fact, the German elites want inflation to be too low for too long. And, unfortunately, this is probably not a logical paradox. The core elite know that austere policy is terrible for Europe as a whole. Indeed, what ignorant fools like Jens Wiedmann want is inflation that is devastatingly low for Europe and Spain, but just enough to keep the uninformed but vengeful German electorate appeased.

The interview has not climaxed yet. Praet makes a very sensible claim that inflation is an insurance policy and goes on to note that it is necessary to facilitate economic adjustment. Since Mark has not read an economics textbook, he is yet again left wondering why. He disagrees with Praet’s correct answer about external devaluation noting that

Prices and wages in den crisis countries had risen far too rapidly over many years. The low rate of inflation helps companies there to regain competitiveness vis-à-vis rivals in the north. Why do you want to counter that?

And here, for the first time, I think Praet gets it wrong. (You can see the whole interview below). Since European trade is such an important part of peripheral growth – indeed Germany maintained a surplus only by exporting its savings to weaker countries – what matters isn’t the absolute rate of inflation of Europe as a whole so much as the relative rate of inflation between the periphery and the core. While higher inflation in general would help reduce the real burden of debt, what we need is higher inflation in the core to make peripheral labor more competitive. It makes one whole hell of a lot more sense for Germany to tolerate slightly above-trend inflation for a few years instead of forcing Greek to deflate.

Then there’s some nonsense about low rates hurting savers which is a dumb, but forgivable, mistake before we get to the most remarkable statement in economic journalism:

If the banks have to pay penalty interest [negative rates], you may well be making loans dearer. What happens then?

In the eyes of the European elite, the cost of borrowing increases when interest rates decrease! There is a perverse world in which this makes emotional, though not logical sense, and that is from the perspective of a saver for whom making a loan is more expensive at a lower rate. Of course, that is not what the English means, nor is it economically valuable information even were it to be so, but it gives us a gory insight into how European policymakers think.

Then there’s some huffing and puffing about low interest rates causing a “property price bubble in Germany” – when, no less, I wouldn’t trust Mark to monitor soap bubbles, let alone one of the world’s largest economies. It’s interesting to note that he is both worried about “dearer loans” and bubbles, which are almost mutually exclusive.

The sad part is how Praet ends the interview, discussing more accommodative policy:

That possibility, too, was discussed. But I believe that such purchases would only be made if business activity and inflation develop along lines that are significantly worse than expected.

Even if you don’t believe QE works, and there may be good reasons to hold this belief, it is scary that officials don’t think they need it. Apparently “business activity and inflation” – nonexistent as they are – have not yet reached levels “significantly worse than expected”.

Paul Krugman is right – the Germans are masters that want the beatings to continue until morale improves. I’m not fan of fascism or nutty right-wing racism, but lets hope these asshats get thrown out of office and soon.

Addendum: In the sleepy haze that I wrote this post, I forgot to mention an important point. Among smart commentators in the US, the ECB is viewed largely as an archaically-tight institution, governed by bad economics and a misunderstanding of monetary policy. That isn’t true, the ECB is damned by a cultural and emotional – not economic – unwillingness to follow the right policy. The German elite couldn’t give a shit about the logical validity of their argument, indeed Schiertz hates inflation not for any monetary reason, but as a presupposition to his worldview.

Read the whole interview:

Mr Praet, business activity is picking up in Europe. Hasn’t it become time to prepare increases in interest rates – rather than to ease monetary policy further, as the European Central Bank (ECB) indicated rather clearly last week?

That would not be in line with our mandate. The ECB is required to keep the value of money stable. We understand this to mean an inflation rate of close to, but below, 2% over the medium term. Incidentally, this definition dates back to Otmar Issing …

… formerly chief economist of the Bundesbank and your predecessor in office …

… The rate of inflation in the euro area currently stands at 0.7%. Such a small increase in prices cannot be regarded as satisfactory over the medium term if we want to attain what we have announced.

That is formalistic.

Why formalistic? What is at stake is credibility, an issue of great importance for a central bank. People must be able to rely on our keeping the annual rate of inflation at close to, but below, 2%.That is important for them to take business decisions. That is why we cannot allow inflation to deviate lastingly from our designated target figure, irrespective of whether to the upside or the downside.

Many experts, however, expect inflation to soon again rise of its own accord.

We are assuming that prices will increase only gradually. According to our current projections – new ones will be presented in June – it is only at the end of 2016 that inflation will approach the mark of 2%. And what we have observed recently are rather surprises to the downside, which means that inflation has tended to be slightly lower than expected over the past few months. The longer this increase in inflation is delayed, the greater is the risk of a change in inflation expectations. This would cause firms and households to take very low inflation rates for granted, and to behave accordingly. That is why we cannot allow inflation to remain too low for too long.

Why would that be dangerous?

There is no central bank that would aim for an inflation rate of zero over the medium term – not even the Bundesbank has done so in the past. Normally, the goal of monetary policy is to have a moderate rate of inflation. This could be regarded as a margin of safety to avoid the risk of deflation, which would have grave repercussions for growth and employment. In a monetary union, moderate inflation would also facilitate necessary economic adjustment.

Why?

If there is a need to adjust wage and salary levels, it is an accepted fact that wage cuts are difficult to push through, while wage moderation could well be achieved. Expressed in a simplified manner, moderate inflation thus ensures that wages and salaries fall in real terms even when they remain nominally unchanged.

Prices and wages in den crisis countries had risen far too rapidly over many years. The low rate of inflation helps companies there to regain competitiveness vis-à-vis rivals in the north. Why do you want to counter that?

It is true that there were adverse developments of this kind. In the meantime, however, most of the countries concerned have made significant progress in adjusting prices, and the adjustment process will continue. What we want to prevent, however, is that this turns into a lasting change in inflation expectations for the euro area.

The President of the ECB has indicated that the Governing Council might take action at its next meeting in June. What precisely could you do?

We are preparing a number of measures. We might again lend banks money over an extended period of time, possibly subject to certain conditions. We could also lower interest rates still further. Even the combined use of several monetary policy instruments is conceivable.

As things stand today, when banks deposit surplus funds at the central bank, they receive no interest. The ECB would thus have to impose penalties in future.

Negative interest rates on deposits are a possible part of a package of measures.

That was attempted in Denmark, with a rather mixed outcome, so that the central bank there put an end to the experiment.

The situation is not comparable. The negative interest rates helped mitigate the appreciation of the Danish kroner. In the prevailing environment of low euro area inflation, any appreciation of the currency there is problematic for the whole area because a strong euro would make imports cheaper and push inflation down even further.

Paris will be glad to hear that. France has long urged the ECB to take action against the appreciation of the euro.

Various governments are calling for a number of different measures. We as the central bank are independent and will not be influenced by such demands. Moreover, our focus is not on weakening the euro in order to help exporters in Europe. We are interested, first and foremost, in the impact of the exchange rate on inflation.

You are nevertheless entering uncharted territory.

Doing nothing would also pose risks. We are currently observing that demand for loans is gradually picking up again. For the recovery in economic activity, it is extremely important that the banks actually satisfy that demand.

The ECB’s low interest rates are already proving to be detrimental for all savers. Interest rate cuts would exacerbate the problem.

I have a great deal of understanding for the concerns of savers – my money, too, lies in the bank. We must, however, resolve the crisis now. That will also be to the benefit of savers because interest rates would then rise again in future. It may well seem paradoxical, but a further easing of monetary policy in the prevailing environment could help in this respect.

If the banks have to pay penalty interest, you may well be making loans dearer. What happens then?

Given the orders of magnitude we have been discussing, I do not expect that to occur.

That said, experts are warning that the low interest rates could give rise to a property price bubble in Germany.

Low interest rates are an incentive to seek alternatives to classic savings books or time deposits at banks. However, that may certainly not lead to speculative excesses.

You intend to reduce interest rates nonetheless!

In the case of Germany, there is no justification to speak of a general property price bubble, even though prices have risen rather sharply in individual market segments, such as those for popular locations in a number of major cities. In the event of problems in a specific country, it would be the responsibility of the competent national authorities – in Germany, the Bundesbank and the Federal Financial Supervisory Authority – to take appropriate countermeasures and, for instance, to compel banks to be more cautious in extending credit. That having been said, we must see the euro area as a whole – and property prices are continuing to fall in a many of the countries there.

In the event of your indeed cutting interest rates in June, will there be a broad majority in favour thereof in the ECB’s management?

We had a very good discussion at our meeting last week, both with respect to the assessment of the current situation and with regard to the conclusions to be drawn.

Controversial, by contrast, are bond purchases of the kind undertaken by the US Federal Reserve.

That possibility, too, was discussed. But I believe that such purchases would only be made if business activity and inflation develop along lines that are significantly worse than expected.

 

The Sharing Economy is Great – Don’t Listen to the Naysayers

May 29, 2014
the Economy: Home and the World
12 Comments

I agree with Dean Baker most of the time, but find his oddly strong distaste for the “sharing economy” puzzling. The focus of his concern is the regulatory limbo under which many of the services in question (Uber, Airbnb, etc.) operate, and the taxes for which they are responsible.

Understanding the purpose of consumer regulation is in order. For one, most occupational licensing is a way to keep the rich richer, whether we’re talking about millionaire medics or medallion-owners. That is not to abdicate all purpose of sensible regulation. I think we are all happier knowing that the FDA ensures the safety of our drugs and that airlines are required to comply with a slew of safety features. 

But sometimes these regulations get onerous, and plain absurd. Baker worries about the safety of someone renting a house without facing a number of meaningless regulations:

Hotels are regularly inspected to ensure that they are not fire traps and that they don’t pose other risks for visitors. Airbnb hosts face no such inspections – and their neighbors in condo, co-ops or apartment buildings may think they have the right not to be living next door to a hotel (which is one reason that cities have zoning restrictions).

The argument he seems to be making is that these houses are safe for millions of people to live in for many days of a year, but not safe enough for a temporary visitor for a few days while the owner is gone; he similarly wants to argue that Uber cars are safe enough for the many that drive in them on a daily basis for a full-time job, but not for a temporary passenger!

It is fair to argue that perhaps the new era sharing services harm the old guard unfairly as they are beholden to a higher standard of regulatory oversight. The column then should have been militating against the many useless regulations that brings about a need for this sort of service in the first place. 

Consumers would not be using the wildly popular sites apps such as Uber and Airbnb is they were repeatedly unsafe.

In fact, their existence is a shining example of the failure that is the American regulatory system: over-regulate things that should be left alone (food trucks, marriages, and private property) and ignore the toxic weapons ready to blow up (guns and money markets, mostly). 

The irritating part of his post is the disdain towards the “scam-facilitators” and “rip offs” in the sharing story. It is peculiar for a liberal economist to think so. UberX is used by students and immigrants looking for flexible ways to facilitate a comfortable living in an era of stagnant wages. And it’s really bad economics to assume that these services don’t increase taxes. Even if no direct taxes are paid (and despite what the article would suggest, this is plain false) it gives a lot more spending power to those likely to spend it which, through the multiplier, is a key driver of local taxes in the urban areas where these services thrive.

Many of the more specific worries in this post are also highly improbable:

Others in the economy will lose by bearing an additional tax burden or being forced to live next to an apartment unit with a never-ending parade of noisy visitors, just to cite two examples.

In apartments where people have paid for a level of guaranteed quiet and comfort – usually fancier places with doormen and apartment associations – this behavior would not be tolerated. In the case that these safeguards do not exist, if the neighbors are actually loud and disruptive to an illegal extent, it is in the neighbor’s power to stop. If not, well you don’t get what you don’t pay for. That’s the moral part. More practically, the reason this matters in a hotel is that the whole building is filled with a constantly moving bunch of people. In the number of times I’ve stayed in an Airbnb, not only have I not hosted rowdy parties, I have not run into tenants on my way up and down. 

I would be happy to bet Baker, and anyone else, that were these services to vanish, tax revenues would fall.

The article boils down to just a number of platitudes:

If these services are still viable when operating on a level playing field they will be providing real value to the economy. As it stands, they are hugely rewarding a small number of people for finding a creative way to cheat the system.

Where is the evidence for this, I don’t see a single number. 

But what I do know is that while these services may be valued in the billions for its founders, the real value comes not just from convenience to the customer, but giving poorer people an easy way to supplement their income. It is beyond me how Baker feels bad for a millionaire with a medallion that finally has to more than grumble at this customer but not the many immigrants and lower-income Americans employed many hours a week because of this service.

The final moral victory of the sharing economy is something Baker touches on, but dismisses in one paragraph:

The good thing about the sharing economy is that it facilitates the use of underutilized resources. There are millions of people with houses or apartments that have rooms sitting empty, and Airbnb allows them to profit from these empty rooms while allowing guests a place to stay at prices that are often far less than those charged by hotels. […] Other services allow for items to be used productively that would otherwise be gathering dust.

What a waste it is for a city to loose the value of empty apartments and unused cars. Surely in an economy where we can share more consumer durables is also one where we need produce fewer consumer durables: and thereby emit fewer greenhouse gases. The alternative to a sharing economy is a non-sharing economy: and any kindergarten teacher will tell you this is a bad idea.

So yes, if you think Uber and Airbnb get an unfair advantage by all means write about it. But ask Bill DeBlasio to get rid of archaic and stupid regulations rather than take away the livelihood and lifeblood of the thousands reliant on a better system. 

Inequality Will Resurrect Concorde

May 24, 2014
the Economy: Home and the World
3 Comments

There’s a series of posts by Stephen Smith pondering Concorde’s premature death:

@MarketUrbanism: Isn’t it kinda crazy that there used to be regularly-scheduled supersonic passenger flight, but there no longer is?

@MarketUrbanism: Can’t think of any other instance where we made a huge leap in technology like that and then gave it up.

@MarketUrbanism: It’s a shame the Concorde didn’t live to see the rise of Dubai. I bet Emirates could’ve kept it afloat.

It’s a little tragic, really. Almost two decades ago you could travel between New York and London in under three hours. Today that figure is almost three times as high (no help from our friends at the TSA). Concorde had a number of problems, including noise and carbon pollution. These were or could be largely addressed. The chief problem was economic.

Tickets sold at a premium to standard first class, sometimes upwards of $10,000. In fact, the first class market was so thin that Air France (along with British Airways, the airline that flew Concorde) usually booked the flight commercially in only one direction, and chartered the way back to maximize profit. That was the structural issue. However, between a crash on one of the chartered flights and the post-9/11 crash in air traffic, it was clear that this technological marvel wasn’t profitable.

Take a brief history airplanes. The Concorde’s pilot flight was merely weeks after that of another 20th century marvel, the Boeing 747. The heyday of both were the three decades between 1970 and 2000. This was a period that realized huge gains in mass consumer purchasing power, deregulation of the airline industry, and an Anglo-American (upper) middle class ever ready to explore a previously unaffordable world. And the vehicle for this job was the 747.

Of course, inequality was increasing over this period, but not until the 2000s did it reach Gilded Age levels.

And that damned the Concorde. Part of running a luxurious service is consistent demand. The ideal clientele for Concorde is something akin to British Airway’s “Club World London City” – a business class only jet between JFK and Heathrow. And running twice-daily with only 32 seats, it’s as much a disaster to the environment as the Concorde.

But Concorde could never run that frequently, not with that price tag.

The problem wasn’t that Concorde cost between six and ten thousand dollars. It was that the people who could afford that back then, but not a full-time business jet, were too small in number. But what we’ve seen since the ’80s is a rapid growth in an affluent-elite: managing elite at corporations not rich enough to fly privately. More importantly, the affluent-elite have globalized around the world, with incredible (and consistent) demand to fly comfortably to and from Hong Kong, Shanghai, Dubai, Mumbai, and other international centers of new wealth.

This is why Etihad has something called a “residence” for its A380 flights between Abu Dhabi and London, priced over $20,000 each way. And if you think this is a little beyond the reach of the standard, top-business elite, look at the boom in “super” business-class arrangements that cost threefold what worked even a decade ago – a world where flatbed seats and French cuisine are considered necessary among a select, exceptionally-disconnected few.

More than anything, this is a reaction to inequality, and increasingly globalized inequality. Of course all these toys of the kinda-but-not-super rich fly on the coattails of a coach flying mass – but as the London City shuttle and massive growth in luxury travel in general tells us, it won’t be long before airlines realize a demand for scaled, exclusive travel. And when that day comes, a newer cousin of Concorde will be waiting.

 

Are Student Loans Holding Back Housing?

May 21, 2014
the Economy: Home and the World
6 Comments

A lot of people seem pretty sure that student loans are behind a slow economy. Elizabeth Warren got there first. Then Vox posted a few charts confirming that, yes, those with student debt are less likely to own homes. Today I read that Larry Summers and Joe Stiglitz endorse this idea. Rick Rieder from BlackRock agrees. 

Let me play devil’s advocate.

The facts are clear – home ownership among those with student loan debt is decreasing much quicker than for those without.

Image

It is difficult to reach the conclusion, at least from this chart alone, that student loan debt decreases home ownership. For one, both lines are following the same trend over the same period of time, only one has a steeper slope since the financial crisis. Except this isn’t surprising, student debt is correlated with debt which is poison over a period of deflation (or lower than expected inflation). It is not unique to students.

But more importantly, those jumping at the correlation between student loans and home ownership over a few years of data are not paying enough attention to large, structural shifts in economic geography over the past fifty years. For nearly a century, suburban growth eclipsed urban. Millenials, the fraught group in question, are changing that. Two-thirds of young graduates now want to move to cities for a better job, compared to a fraction not too long ago. Not to mention the more than 80% that are willing to move to any city if needed.

Dad is no longer a company man, nor mom a housewife. Rather, graduates are likely to vie for shorter commitments focused on training and, in a number of cases, with a higher probability of relocation in the future. Not to mention the logistical, locational difficulty of maintaining a dual-income family (specifically outside of urban centers).

And that’s the demand side. Jobs that cater to college graduates are slowly disappearing from middle America toward coastal centers that capitalize on economies of scale and network effects. Vox notes that the age at which graduates first purchase a house is becoming later. True, but not necessarily relative to household formation itself – something happening later across the country driven by graduates. (Not to mention, as a commenter on Twitter mentions, the increasing necessity of a post-Baccalaureate degree).

Here’s the thing about those with “student debt” – they are much more likely to be “students” than those “without student debt”. In the latter group, you either don’t have a degree – in which case none of the above qualifications apply – or you’re wealthy enough to go through college without any debt. Neither is a representative group.

The bottom line is students increasingly want to live in areas where homeownership is unaffordable. (And it’s not like twenty-somethings even should be able to afford a place in New York City). There is increasing evidence that homeownership is probably not the best investment for many people. The returns on real estate are dwarfed by the stock market, and other carefully-orchestrated investment plans, especially without the (clearly excessive) boom years of the past decade. Maybe millenials are paying more attention and making smarter investments.

Of course, jubilees are almost always a good thing (and it’s not clear that lower rates as Elizabeth Warren wants, would even achieve lower debt – it may just encourage poorer people, or those who otherwise would not have, to borrow more). Deleveraging, especially in a time of low inflation, will improve the economy through simple wealth effects and encourage capital formation via higher savings rate (and perhaps investment in domestic equity).

But it does not strike me as a particularly equitable, or necessarily economically-optimal, use of our budget to help those who were, are, or would-be students. Or, in other words, near the top of the income distribution. An expansion of the EITC with the same money would be more equitable, more directly encourage job creation, and give more bang for the buck.

Of course, the best thing for debtors and the economy would be a inflation above expectations.

 

Declining Consumption and Secular Stagnation

May 20, 2014
the Economy: Home and the World
4 Comments

Brad DeLong notes that lack of consumption is not especially responsible for currently low levels of aggregate demand. I am not so sanguine. At first approximation, this is hardly surprising. There is some truth to the Austrian principle that recessions arise from a decline  in investment during the boom. (There are many flaws to this theory, not the least that spending on consumption goods increases only in relative, not absolute, terms). Since most consumers smooth their spending over time, to the extent liquidity is not a problem (and it was), what happened is exactly what you would expect.

Unfortunately, to the extent this stagnation is secular, we can’t ignore consumption. Take a stylized accelerator model which says that I/Y_r = (K/Y)g_r, where I/Y and K/Y are the investment and capital stock to potential income ratio respectively and g is the potential growth rate. Let’s state secular stagnation as the state where an economy is (for the foreseeable future) demand constrained and g as a function of r drops by some constant amount. (That is, the real interest rate necessary to maintain some level of growth is lower than it used to be).

So, for whatever reason, when the long-run potential growth of the economy falls, firms are not as driven to invest in future profits and therefore the level of investment has to fall. This must either be accompanied by a corresponding increase in consumption or decrease in total income.

The question we should be answering then isn’t whether consumption has increased as a share of GDP, but whether it has increased enough given a lower potential growth rate. Even under generous assumptions, this is probably not the case:

Image

The growth in consumption as a share of GDP – which we will generously define as 1 – max_t(C)/min_t(C) – is just over 18%. Over the same period, real income grew by an average of 3.2%. Taking this as the former potential, and 2% as the new normal g has fallen by around 60%. Even with an optimistic assumption that the economy will grow at 2.5%, the fall in potential g still outweighs the increase in consumption. (This is all under the assumption that K/Y has and will remain fairly constant. Piketty says no. I don’t buy that this will be significant enough to outweigh everything else, but that is for another post). 

This is, of course, a simplistic assumption. The accelerator model is naturally stylized and investment may not fall nearly as much as suggested. Increased consumption of capital (“wear and tear”) may be one such reason, though that seems ever unlikely in an economy increasingly-oriented towards investments in intellectual property and information rather than coal mines. So if it is not the case that increasing consumption is necessary to maintain a certain level of income, it is certainly interesting to see the assumptions and model under which that is so.

The United States is simultaneously too much like China, and not enough like China. On the one hand, falling potential growth in both countries necessitate a decreasing reliance on private investment. On the other hand, unlike China, there is much the United States can and should do to increase public investment in green technology, basic research, and stronger infrastructure. 

More Notes on Inequality of Wealth

May 10, 2014
the Economy: Home and the World
3 Comments

I’ve been thinking a bit about why wealth inequality really doesn’t matter – but I think the argument is a little more nuanced than I presented. In particular, what I wrote yesterday is concerned largely with the positive, but in reality this debate is intimately connected with normative action. In the wake of Piketty’s book (which I have not finished) a number of people are talking about taxes on global capital.

I don’t have a very strong opinion on that (other than a negative gut reaction). But there are things we can do closer to home – appealing to both conservatives and liberals – that would be more feasible and possibly more effective. In this debate we are faced with a slurry of terms that are sometimes used to describe the same underlying phenomenon but are each different: wealth, capital, returns on capital, and capital share of income.

While I am unconvinced that just the inequality of net worth (“wealth”) really does much harm to a nation’s socioeconomic fiber – indeed I think concentrated wealth is probably a necessary consequence of capitalism – it is clear that skill-biased technological change, and what that portend’s for labor’s share, is probably an important concern (if nothing else in the discussion of income inequality itself).

And here’s the problem. Government programs, the way they are currently structured, are largely to blame for gaping disparities like this:

Image

(Before I go on, it is worthwhile noting this picture, yet again, confirms my previous point that wealth inequality per se isn’t increasing and was never a problem).

What we see isn’t surprising. The bottom 90% of Americans are basically excluded from the stock market – the most important source of long-run returns for pretty much everyone else. What’s striking here is that this inequality is far worse than inequality of wealth itself. So not only do the rich own more capital, they own the best capital.

To some extent this is unavoidable. Rich, well-connected elite have far better access to the best investment opportunities like secondary private markets and hedge funds that provide alpha. (Chances are if a hedge fund is doing well accounting for management fees, they don’t want you as a client). But the people that benefit from this are the extremely wealthy percent of a percent not even demarcated above, not simply affluent Americans who are still extremely well-represented in stock markets as a whole.

And the reason for this? Perhaps poor government policy.

The real wealth of most Americans is their claim on social security in the future. Social security has been an incredible source of, well, security for many citizens and pretty much the reason many are not in poverty today. But the Social Security Trust, which actually handles all of this money, is basically forcing you to invest in low-return government debt.

This becomes a source of inequality as social security as a portion of total implied wealth (here defined as your claim on future GDP) is far higher for the bottom 95% of Americans, who can barely save, than anybody else. On the other hand, for people that actually manage to save (even if just a little bit) the stock market is a source of real, long-term prosperity.

Furthermore, misguided government programs encouraging homeownership – something many economists have come to agree isn’t a good thing for poorer people – once again distorts private investment choices to relatively low-return stores of wealth like residential real estate. When the productivity growth is coming from financial, informational, and social capital, what value is owning a home in Podunk, Missouri?

Again, mortgages are the primary – and possibly only – source of explicit wealth for middle-class Americans.

Many conservative economists have reached the conclusion that we should probably privatize social security. As a purely financial matter, I am inclined to agree – the justification for our current program is fully predicated on the dangerous assumption that government bonds are the best long-term investment when, in fact, Vanguard Target Retirement 2045 is the way to go.

In fact, what we need is something akin to a Sovereign Wealth Fund that allocates payroll tax receipts in a more productive way. This should have great appeal to conservatives as well as liberals. For conservatives, it frees an immense source of domestic equity away from relatively inefficient projects furnished by the national government to more entrepreneurial and productive ventures in private markets. Indeed the cost of capital (in normal times) would probably fall. For liberals, it is the most logical extension of the welfare state, designed in a way complementary, not opposed, to modern capitalism.

This would solve what I see is the heart of the problem Ezra Klein and others are getting to when they worry about wealth inequality. It isn’t the disparity of wealth itself (which is background noise), but the changing structure of the returns. It is a tragedy that over the past thirty years, the stock distribution was so much more skewed than wealth distribution.

The government is ultimately a bank that can print its own money. What it should be doing is guaranteeing a minimum return in future receipts, as it does today, as well as investing in the option for more explosive growth. If the stock market performs so poorly as to not provide the returns necessary for to meet the obligation (and there’s a very low chance this would happen over the long run) the government can always finance the difference with a deficit. In fact, since returns would be far higher, chances are in a financially-driven recession, the increase in deficits would be lower.

This is probably not enough, but does more to solve inequality than a meaninglessly small increase in capital gains taxes would accomplish. More importantly, it achieves this without further harming private interests, and yet greatly increases capital redistribution. It would also unleash an incredible amount of capital for the investment the private sector desperately needs.

Here’s the short and sweet argument for privatized, but guaranteed, security. Rich people should give poor people equity in their companies rather than taxes to the government to solve issues of capital return disparity. The only role government should play is effectively guaranteeing a minimum return, in other words purchasing a barrier put on the S&P in the event valuations fall below what is promised. That is cheaper, more efficient, and the principle we ought to work on.

Some Myths of the Economics of Climate Change

March 11, 2014
the Economy: Home and the World
13 Comments

Tyler Cowen links to a brief, frank symposium on the economics of climate change. Many of the responses, particularly from Lomborg and Tabarrok are fascinating. But, unfortunately, there are a few big myths about the economics of climate change that seem so obviously true but are dangerously false. Take Otaviano Canuto, Senior Advisor to the World Bank, for example:

The economist’s solution to climate change can be summarized in a single statement: “get the prices right!” This means taxing fossil fuels proportionately to the amount of carbon they release, in order to correct the problem that corresponding negative spillovers of their use are not reflected in their market prices. Incentives in favor of more climate-friendly technological innovations would also be reinforced. Subsidies to these innovations, as well as to avoid deforestation would also help, as potential benefits of these mitigating factors would in turn become appropriately embedded in their reduced costs.

First of all, one would imagine that the World Bank could put its money where its mouth is and stop flying its officials in first class on taxpayer dime. Second of all, “taxing fossil fuels proportionately to the amount of carbon they release” is only enough under the assumption that the revenues will be spent on undoing the damage of the initial emission. (There are a few exceptions to this which I’ll get to later). If Canuto noted this as a start he would be on sound economic footing, but like so many in this debate he misses a nuance in the way externalities work.

To see why imagine the effect of a $25/ton tax on carbon. We know this would increase gas prices by just over 25 cents. If $25 was the “spillover cost” of carbon, the climate would be robust to large increases in drilling efficiency. But let’s say there’s a breakthrough in refinery technology and a substantial increase in available petrol, putting a strong downward pressure on costs such that the tax becomes a majority of the price itself. Would the carbon tax be enough in this case? Well, it depends what you’re doing with it. A good, if brute, measure of spillover may be the cost of recapture. Therefore, the tax is enough if and only if the government is spending the money on a large scale recapture program undoing the ills of the initial emission. Otherwise, the decrease in costs of production would increase supply and hence emissions beyond a sustainable level.

It is always useful to consider various parametric limits in assessing the validity of one’s claim. In doing so we discover hidden assumptions that never make their way to public consciousness. Textbook economics is tricky. Whether a spillover is intimately connected with your definition of social costs and the implications for your revenue thereof.

Of course, this assumes that the socially optimal level of carbon is effectively zero. In fact, there is a carrying capacity and the optimal level, economically speaking, probably exceeds this carrying capacity. The initial capacity emerges from the Earth’s innate ability to absorb emissions along with uncertainty that more is always worse. That the optimal capacity exceeds this level is a result of a positive discount rate along with the fact that future generations – due to improvements in technology – will be richer than us. Therefore, under perfect generational smoothing, we endow our children with superior technology and a shittier earth.

But neither of these change the fundamental premise that pricing carbon “at its cost” will hardly ever be enough (unless, as other more intuitive commenters noted, green technology becomes competitive in its own right). For one, the last sentence in the previous paragraph should make uncomfortable your moral sensibilities – for axiomatic reasons. More importantly, the economic models that are needed to quantify such ambiguous statements are really crappy.

As Robin Harding writes in the Financial Times, economic models of climate change fail the limit test with flying colors. Standard models suggest output would only be reduced by half for warming over twenty degrees Celsius in magnitude. To get some perspective, the rest of the academic community is freaking out about an increase of two degrees. Therefore, by the rule of seventy, our kids will be better off than us if the Earth warms twenty degrees and we grow at a measly 2% a year. You would be right to laugh.

Of all the answers that actually say something of substance, Larry Summers has the one that I find most practically challenging. I think he misjudges the political landscape of the United States. Cap-and-trade failed in 2009 – truly a “moment of great opportunity” – not because of deep forces against its passage but primarily because the Obama administration decided socialized healthcare was its priority and secondarily because of the Massachusetts mistake that is Scott Walker. Permit trading has something a carbon tax does not. That is, it’s not a tax. In America, that gets you very far. It’s why second best alternatives like banning incandescent bulbs or regulating fuel efficiency work, but simple taxes do not.

But I think he misses one more thing. Practically, we are more likely to have a system that both subsidizes and taxes carbon before we have one that does neither. Yes, we should phase out fossil fuel subsidies and tax breaks. This is a bit like the problem with sugar subsidies. Mancur Olson’s The Logic of Collective Action is a must-read for this. Oil subsidies have very low average costs but remarkable concentrated benefits that make “big energy” a powerful lobby in both parties. Big energy will also loose more from a repeal of our most inefficient subsidies than it will from a broad based carbon tax. Therefore, one is distinctively easier to fight. In fact, big business in general may yield to a carbon tax if they know a larger decrease in subsidies is not immediately to follow. Poor Americans loose out on this one but it is hard to argue that subsidy without tax is better than subsidy with tax.

Therefore while Summers is unimpeachable in his economic logic, public choice concerns dominate. Here’s to the second best.

Permit trading has many benefits a tariff does not. For one, we are far better at estimating the effect of carbon than calculating its price (and, as noted above, we would not use the revenues from a carbon tax appropriately to begin with). But more importantly, it isn’t a tax, and it isn’t as “leaky”. A relatively important component of a broad carbon tax at the level we need it (probably around $100 to the ton) is subsidizing the poor. Under a carbon tax, this ends up undoing part of the tax and is counterproductive. On the other hand, under a permit trading system, the government can guarantee a fixed number of permits to each household from its initial “stock” which would simply increase the cost of luxury carbon.

But ultimately, economists need to step up on climate change. It is more than a textbook example of externalities and far more nuanced than many simple accounts make it to be. It is also far more harmful than many of their models suggest (consider the limits). Economic logic sometimes fails. It was, if I recall, Larry Summers who prevailed over Gore and Browner, convincing Bill Clinton not to follow a more aggressive reduction in carbon emissions wary of economic consequences. (Not a criticism of Summers – just one of his decisions).

Lomborg makes a lot of sense in the snippet of the linked symposium. Subsidizing basic research and hoping for the best is our only real option. But, in general, he doesn’t acknowledge scientific realities that clash with his optimism and occasional myopia. Indeed, climate change hurts the poor more than anyone and, when the water runs dry, probably more than anything else he worries about. But, even within his economic frame, an ideal, international, permit trading system would be the most beneficial. Think about what would happen if each of us were limited to some level of carbon output. The west would need far more than this limit, and poor Africans would need far less. Money is going to flow in one direction and, given the need for carbon in the west, would be enough to replace the inefficient foreign aid already in place. An international carbon marketplace is the ideal cash transfer – something economists should be killing for.

I believe in economics and, indeed, the value of economists. They are unfortunately neglected in important policy decisions which – independent of any political affiliation – may be cited as a cause for much hardship over the past thirty years. But if an astroid was about to crash into New York City, we wouldn’t ask economists to create a poorly-founded model of its costs. We would tell NASA to do whatever it can to save us. Economists need to stop telling us what the program for change should be, but rather identify the most efficient means of implementing a program scientists already deem necessary. Otherwise we’ll end up with nonsense like CAFE standards and Cash-for-Clunkers. Otherwise, we’ll end up with an absolute mess of leftism that is Greenpeace and organic, anti-GMO activism claim climate change for its own. Now that is scary.

National Product, Domestic Product, and Debt

February 28, 2014
the Economy: Home and the World
3 Comments
Earlier today Matt Yglesias borrowed a chart from Thomas Piketty’s new book noting that public assets remain above public debt. This chart actually underestimates the strength of our balance sheet.  A more striking image is the ratio of our gross national product (GNP) to our gross domestic product (GDP).
 
Image 
 
 
The left axis here is a pretty narrow range, so the dynamics aren’t as extreme as they first seem, but what you’re seeing is that the GDP-GNP ratio is at it’s highest pint in history and continues to rise. What does that mean? Remember from Econ 101 that the GNP = GDP + American income on foreign assets – foreign income on American assets. In essence, the ratio I’m graphing shows that over the past decade net inflows have grown substantially faster than GDP, despite the skyrocketing debt. (Since GNP/GDP = 1 + (net payments)/GDP In fact, you would expect precisely the opposite phenomenon, more so than ever before as our deficits are increasingly financed by foreign savings (interest payments to domestic pension funds cancel out). As Wikipedia recites basic economic wisdom:
 
Similarly, if a country becomes increasingly in debt, and spends large amounts of income servicing this debt this will be reflected in a decreased GNI but not a decreased GDP. Similarly, if a country sells off its resources to entities outside their country this will also be reflected over time in decreased GNI, but not decreased GDP. This would make the use of GDP more attractive for politicians in countries with increasing national debt and decreasing assets.,
 
It’s worthwhile asking yourself what exactly national debt represents – a claim on future income. This graph suggests that our claim on everybody else’s future income is way higher than their claim on our income. You should be scratching your head – why are emerging markets throwing money at us when the domestic return on capital is far more attractive? They are lending us really cheap credit so that we can recycle that to our firms which then invest in foreign equities earning a huge premium. That should sound pretty familiar to you, because it’s basically how Wall Street made all of its money. America, basically, is a huge hedge fund.
 
But for the Federal Government, this isn’t a problem. We can always roll over our debt since the dollar is sovereign. We can actually make some pretty insightful observations taking the perspective that the government is a big bank. We could theoretically sell our foreign assets to repurchase our own debt (or, since we don’t have a sovereign wealth fund, tax our citizens more, which is the same thing) which is less volatile than emerging market equities (and isn’t subject to any currency risk). But we’d then be short emerging market, which means we would pay the risk premium rather than earn it. 
 
The in-built short term volatility isn’t actually a big deal, either. In the long-run, equity indices are pretty well correlated with economic growth, and everybody else will grow faster than us on average. That leaves liquidity risk, but because the Federal Reserve exists even that is negligible. The currency implications of this are even more mind bending still. For most countries, a depreciation has a negative wealth effect – that is we can buy less on the international market than before in real terms. But the more our own inflows are denominated in foreign currencies, the less obvious this link becomes. That gives monetary policy more space as higher inflation would be a lot less detrimental for us than any other country.
 
People are happy to pay a premium for safety. We should be happy to earn that spread. 

Elephants and Economics

February 27, 2014
the Economy: Home and the World
12 Comments

One of the biggest skills I’ve gained writing an economics blog is dispassionate writing and thinking. Sure, we all have ideologies and spirit, but a common thread across good writing is relatively sterile analysis. For me, that means not writing about things that truly incite me (beyond an intellectual curiosity). Like the criminal justice system. Or elephants and their poachers.

But as Ferris Jabr writes, “to look an elephant in the face is to gaze upon genius”. It is abundantly clear to me that the problem is largely economic, and therefore something that I should at least try to blog about without expletive passion (of which there is plenty elsewhere). I hope more economists publicly and privately advocate market solutions to the poaching problem – because the government, unsurprisingly, lacks the necessary competence in basic market design and incentive formation.

Economics is a constructive field, and is therefore concerned with efficient means of building a market. The task at hand is efficiently destroying a market. That is very difficult. It’s not really possible argue whether a market is driven by supply or demand, but for reasons I’ll outline, it is fair to assume restricting demand should be the primary tactic.

African governments unfortunately lack the competence, wherewithal, and and will to fight monied (probably Chinese) interests in any meaningful way. The investment necessary in good law enforcement to prevent large poaching networks is something that Africa will not have for a long time. And, anyway, that money is better spent on education and infrastructure. African countries shouldn’t have to drain the public purse because of foreign demand that dwarves its national wealth. More importantly, the production function will remain cheap so long as poachers need to kill elephants to put food on their children’s plate. And who can blame them? Poaching wouldn’t be a problem if elephants roamed American prairies as they do African forests. But Africa is no America, and any real effort should start with demand.

A ban is the crucial first step, but easily circumvented (in the United States, for example, you can only purchase ivory that is at least a hundred years old – but how hard is it to forge the necessary documents), especially if the punishment isn’t commensurate with the potential reward.

Enforcement is also ridiculously expensive. Police officers and the DEA waste billions trying to stop people from smoking crack, but the results are a complete joke. Sure we don’t have the brightest people spending that money (to say the least), but enforcement costs are non-trivial, especially without a culture that supports the cause (If everyone was a murderer, police officers couldn’t do a thing about it).

Civilizing people is a long process. It took centuries for humans to see the moral flaws with slavery – a far more heinous crime – and the socioeconomic forces in emerging markets to flaunt wealth is strong; without a government that really cares it is unlikely we’ll get anywhere. So molding culture is out of the question (in the time period we have, which isn’t that long).

In contemplating a solution, I couldn’t but think of George Akerloff’s “A Market for Lemons”, one of the best pieces of economic intuition and analysis I’ve had the pleasure of reading. Without getting into the details, the import of his paper is that a market can break down  under a little information asymmetry.

Policymakers and conservationists need to stop auctioning horns and burning stockpiles of ivory, they need to create this asymmetry. And it’s not hard. By virtue of being a black market, there isn’t a good organized body that can consistently verify the quality of ivory in general. Sure, it’s easy to access, but ultimately there’s a lot of supply chain uncertainty.

There is a cheap way to exploit this. The government, or some general body that has access to tons of ivory, should douse (or credibly commit to dousing) the tusks with some sort of deadly poison, and sell the stuff across all markets. Granting some additional complexities, the black market could not differentiate between clean and lethal ivory, and buyers would refrain from buying all ivory in fear. The market would be paralyzed. It is analogous to Wall Street during a bank run, and probably stronger given that lives – and not just portfolios – are on the line. And it’s far cheaper than anything we’re trying to do now. (As a commenter notes, another smart method would be to flood the market with uncertainty of authenticity, but this is a lot harder to achieve, and possibly very expensive).

It sounds like a batshit crazy idea, and it probably is, but it’s not morally that much worse than what we have now (that is even completely ignoring the cruelty of purchasing ivory in the first place). The human suffering of the current system is immense, with many poor Africans threatened or bullied into poaching under the threat of death. Moreover, many African governments – in a Hail Mary effort to combat the Chinese economy – have draconian penalties for those caught poaching. I would only transfer that risk from producer to consumer, suggesting the trade, ethically, is weakly superior at least.

It is hard to imagine such a fragile market functioning with a competent organization trying to fool it. It wouldn’t even require governmental support (though may be illegal). If you’re a mess about the ethics of poisoning people, we can try the flu instead.

This is, like unemployment, a moral, social, and political problem. And, like unemployment, it has an economic solution. I don’t know if what I’ve outlined could actually work in practice (though I am somewhat confident that a well-thought out try, with the proper support, would make a difference). But I do know that without aligning incentives and goals we have no hope. It’s time for better ideas than burning stockpiles or auctioning hunts.

The Problem with Pessimism

February 19, 2014
the Economy: Home and the World
3 Comments

A number of people have commented on a new paper from Robert Gordon, professional pessimist. Many people have identified the specific issues with the logic in this essay. But I think it’s important to discuss a central problem with the very idea of Gordonesque gloom.

First, distinguish between positive and negative pessimism. If NASA were to tell us, with great confidence, that an astroid will strike Earth tomorrow there is no case for disdain. This is a scientific judgement and, at least philosophically, would be akin to standing in front of a speeding train and claiming that it won’t hit you. That is not the sort of pessimism that concerns us. But Gordon is making a much more powerful claim, a pessimism about what won’t happen – that our entrepreneurs cannot create another industrial revolution, that we’ve pretty much done the most we can with robots, and artificial intelligence is limited to the grocery store.

This requires a certain knowledge about the trend of technological progress and the economic value thereof. Gordon knows much more about the former than most and may well be the reigning expert on the latter. Unfortunately that doesn’t help us out. Because, believe it or not, most any of us can make this claim without any technical skill and little more than economic knowledge.

If you knew that some form of AI was going to revolutionize the world, and that building it is tractable, there’s a good chance it already exists or will be built relatively soon. Because that’s all you need to know to make a profit from basically nothing (patent the idea and rent the rights out when someone who can build it builds it). But it’s very rare that we make something from nothing so most of us, like Gordon, don’t see anything great about the future.

But that only means that me, you and Gordon don’t know what that invention will be, not that some arbitrary such invention won’t be. So Gordon is claiming that the space of all future invention is limited and the costs of finding the marginal source of technological growth are limited and, equivalently, that he knows the space of all future growth.

That’s a rather strong claim. He rather strongly asserts that the last three stagnant decades are a better indication than the last century. Choosing the postwar boom may be an outlier but, accordingly, so too would choosing a bad period like the past fifty years arbitrarily. By claiming that he understands growth will slow, Gordon implicitly declares that he understands the mechanics of future innovation. 

But that isn’t the case with optimism. As statisticians will tell you, proving a positive is possible. You an always say “something may exist that we can’t even comprehend” – how could you disprove that. It’s not objective, and you’re not going to make money off this belief but it just isn’t as philosophically flawed as a belief in perpetual stagnation.
 
Most discussion about our economic future – on the scale Gordon speaks – has been horribly wrong (read a certain John Maynard Keynes’ Economic Possibilities for our Grandchildren) and claiming that there won’t be a new digital revolution tomorrow (or even in the next decade) is trivial. In fact, a central tenet of efficient markets is that you can’t keep beating the market and those who do are probably just lucky. (If we had growth denominated bonds Gordon could literally beat the market). 
 
The probably here is key. Maybe you’re a financial trader and play golf with a certain Janet Yellen. Or maybe you heard about Steve Jobs’ cancer before anybody else. But here there’s a clear source of the insider information. 
 
Unfortunately you and me can’t be insiders with God.