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No End to the Nation-State, Thanks.

October 13, 2013
the Economy: Home and the World
16 Comments

I came across a Parag Khanna editorial in the New York Times that starts of documenting the CIA’s “Alternative Worlds” scenario – one of which is a so-called “non-state world” – and culminates in some kind of weird romance about the Silk Road days of yore when prosperous traders were the lifeblood of the Arabian Peninsula.

I need to make two quick points, one positive and the other normative. Khanna’s principal charge is that this “non-state world” is already here. The emergence of special economic zones, Dubai, and Hong Kong as centers of international commerce somehow hark the end of the international system as we know it:

A quick scan across the world reveals that where growth and innovation have been most successful, a hybrid public-private, domestic-foreign nexus lies beneath the miracle. These aren’t states; they’re “para-states” — or, in one common parlance, “special economic zones.”

Across Africa, the Middle East and Asia, hundreds of such zones have sprung up in recent decades. In 1980, Shenzhen became China’s first; now they blanket China, which has become the world’s second largest economy.

The Arab world has more than 300 of them, though more than half are concentrated in one city: Dubai. Beginning with Jebel Ali Free Zone, which is today one of the world’s largest and most efficient ports, and now encompasses finance, media, education, health care and logistics, Dubai is as much a dense set of internationally regulated commercial hubs as it is the most populous emirate of a sovereign Arab federation.

This complex layering of territorial, legal and commercial authority goes hand in hand with the second great political trend of the age: devolution.

In the face of rapid urbanization, every city, state or province wants to call its own shots. And they can, as nations depend on their largest cities more than the reverse.

Mayor Michael R. Bloomberg of New York City is fond of saying, “I don’t listen to Washington much.” But it’s clear that Washington listens to him. The same is true for mayors elsewhere in the world, which is why at least eight former mayors are now heads of state.

Scotland and Wales in Britain, the Basque Country and Catalonia in Spain, British Columbia in Canada, Western Australia and just about every Indian state — all are places seeking maximum fiscal and policy autonomy from their national capitals.

There’s a good argument that as urbanization proceeds and technology improves, cities ought to have more autonomy in local decisions. But that’s hardly true right now. Mayor Bloomberg can say whatever the hell he wants but, as it happens, he has to listen to Washington. It is the American people from the Dakotas and Carolinas that signed into law Dodd-Frank, which will regulate New York City’s largest and most important export. It was a Federal Judge that ruled against stop-and-frisk, and Bloomberg wasn’t even able to strongarm the state judiciary when it came to his ban on Sugary drinks.

If there’s one city-within-a-nation that has the political and economic clout, it’s New York City. If there’s one man to exploit that, it’s Bloomberg. And it’s not really worked out all too much in his favor. Indeed, since the death of Benjamin Strong, economic power has shifted from New York City to Washington, where the most important financial and economic decisions are made. And as shitty as the government in DC may be, they represent the people of the United States, not New York.

Let’s take the more surprising example of India, which as far cry from “autonomous cities”. Take a look at this McKinsey report (which, as far as they go, is pretty good) on India’s Urban Awaking. One of the clearest detriments to progress in urban India is the abject disempowerment of the urban voter. Few Indian cities – aside from New Delhi, which is its own state – have a more-than-ceremonial mayor. City politics are dominated by the Chief Minister of encompassing state. That means local action in Chennai is dominated by the mess-of-a-women that is Jayalalitha. And it’s no better in the more “advanced” cities of Bombay or Bangalore. Local politics is slave to rural concerns.

The money is in the cities, but the votes are in the country. National pro-urban policies are in complete disrepair, while India’s urban taxpayers fund the world’s largest welfare program for the villagers. It’s a good program as far as redistribution goes, but horrible in its effect on the productivity and progress – modern commerce – about which Khanna speaks. Not only does it come with the inefficiencies of taxes in general, but it engenders a culture of demechanization as the Indian government wants to guarantee maximum employment in the shittiest jobs as far as they are in the country.

A city-state? I think not.

And sure, there will always be a Dubai, Singapore, or Hong Kong. But as far as commerce go, the whole of the United States doesn’t do too badly. We’re the most economically free country, save two Asian city-states with a population less than New York City, and that counts for something. Power is also concentrated at the national level. As far as international politics go, who even cares what the Sheiks in Dubai want? It’s all about Obama, Putin, Assad, and Jinping. These are people who derive their powers from a national electorate.

But there’s a deeper, more normative problem, with Khanna’s assessment:

The Arab world will not be resurrected to its old glory until its map is redrawn to resemble a collection of autonomous national oases linked by Silk Roads of commerce. Ethnic, linguistic and sectarian communities may continue to press for independence, and no doubt the Palestinians and Kurds deserve it.

And yet more fragmentation and division, even new sovereign states, are a crucial step in a longer process toward building transnational stability among neighbors.

The classical world is gone. And thank god for it. It’s not like being born anywhere in Arabia is great today, but it is infinitely better than it was when Islamic culture ruled the world. It’s too easy to think about the “more cultured” days of our classical past.

At a more analytical level, nation states are key to economic mobility and prosperity. Think about what Dubai, Singapore, and Hong Kong represent – other than a gleaming success story of Khanna’s brave new world. They represent inequality and exclusivity. They represent don’t represent talent as much as wasted talent. Indeed, each of them almost solely represents all that was wrong with the world in 2008. Finance is key to a modern economy, and no one is going to deny it. But it would be a brutal joke to say that the kind of nonsense exported from these “modern city-states” is anything like what America (and, ugh, Britain) once did. It’s a joke to assume the real innovation comes from real estate in Dubai instead of modern ways to improve livelihoods in the heart of India and Africa (not the urban fringes thereof).

Within a nation state, because of fiscal union, someone can dream of settling in the country, but also making it to Manhattan. What kind of dream does Dubai represent in the world – other than young American grads that want a consulting gig for two years so they can party a little harder.

The Three Contradictions of Niall Ferguson

October 6, 2013
the Economy: Home and the World
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Brad Delong tries to detangle Niall Ferguson’s most recent blatherings. I’m in sleepy Rochester, Minnesota (under less than desirable circumstances, but celebratory nonetheless) and, like always, Ferguson gives me the chance to write something fun. On the bright side, Ferguson’s article is a rare example of pundits updating their priors. Only, in this case, it’s within the same piece of writing.

To understand the contradictions within this article, one must first understand Ferguson’s pathological relationship with free markets, his intellectual heroes, and aggregate demand. We begin:

What’s so seductive about the efficient markets hypothesis is that it applies nine years out of ten. A lot of the time it works. But when it stops working, you blow up. Much of the time it looks like you’re in the Bell Curve, and then something happens that your model tells you will happen only once in a million years, but which history tells you happens about once every 50 years.

Key to Ferguson’s intellectual framework are mathematically efficient markets, or at least the program prescribed thereof. His hagiographic pieces on Reagan, Thatcher and supply-side reform in general derive from work by the likes of Robert Barro in the context of Ricardian Equivalence or crowding out. Niall Ferguson is a free marketer, but also a Jeffersonian in the image of producerist currents. That is, the bankers, lawyers, and special interests within the government manipulate power against the common man.

But the ultimate implication of efficient markets is embodied in its eponymous hypothesis: the price is always right. Ferguson can live with this “nine times out of ten”. More accurately, this hypothesis (arguably) vindicates Ferguson’s world view nine times out of ten.

But today, the markets are not telling us the United States of America will default on its debt. Not now, nor ever in the future. Today the markets are not telling us that Washington “is playing Russian Roulette with our creditworthiness”. And suddenly, markets are wrong. Suddenly, Sir Niall Ferguson the first is better than the market at evaluating its own signals. This flies in the face of his own ideology.

Capitalizing on his Jeffersonian credo, he tries to blame the Fed on manipulating the market:

So long as the Federal Reserve continues with the policies of near-zero interest rates and quantitative easing, the gun will likely continue to fire blanks. After all, Fed purchases of Treasurys, if continued at their current level until the end of the year, will account for three quarters of new government borrowing.

But in the world of efficient markets – the world in which Ricardian Equivalence, crowding out, and real business cycles too reside – the Federal Reserve cannot trick investors. Indeed, if the market believed we were spending recklessly – sustained only by a massive balance sheet expansion on part of the central bank – eventually inflationary expectations would become unanchored precipitating a rapid rise – not fall – in Treasury yields.

Here emerges the next in Niall Ferguson’s theory. On the one hand, he heaps praise on Milton Friedman and his “skepticism towards government and faith in individual rationality”. And yet, he disregards a key implication of this theory:

Low interest rates are generally a sign that money has been tight, as in Japan; high interest rates, that money has been easy.

But this would fly in the face of Ferguson’s position on monetary policy.

Niall Ferguson could rightly – or at least arguably – take the position that government spending is less efficient than the private sector and hence we should avoid expectations of a future increase in tax rates. Niall Ferguson could express disdain at the ideology of a large government, quite independent from its economic effect, in libertarian spirit. But instead he insists that fiscal crisis is nigh. But this contradicts Ferguson’s every belief in the efficient market.

Niall Ferguson’s two contradictions fold into an ultimate third: a contradiction between aggregate demand and aggregate supply. On the one hand, Ferguson is a fervent supply-sider with a saintly view of the Thatcher and Reagan reforms. On the other, he believes supply matters not at all:

Only a fantasist can seriously believe “this is not a crisis.” […] Net interest payments on the federal debt are around 8% of revenues. But under the CBO’s extended baseline scenario, that share could rise to 20% by 2026, 30% by 2049, and 40% by 2072. By 2088, the last date for which the CBO now offers projections, interest payments would—absent any changes in current policy—absorb just under half of all tax revenues. That is another way of saying that policy is unsustainable.

Someone who believes in the importance of aggregate supply cannot reasonably speak of predictions into the  year two thousand and eighty eight ( = 2088). Someone who believes in the importance of aggregate supply (or, indeed, the efficient market hypothesis) cannot possibly imagine the growth of gross domestic product can be predicted in any sensible fashion by the Congressional Budget Office.

But perhaps Ferguson’s 2010 column – “Today’s Keynesians Have Learned Nothing” – explains everything:

When Franklin Roosevelt became president in 1933, the deficit was already running at 4.7 per cent of GDP. It rose to a peak of 5.6 per cent in 1934. The federal debt burden rose only slightly – from 40 to 45 per cent of GDP – prior to the outbreak of the second world war. It was the war that saw the US (and all the other combatants) embark on fiscal expansions of the sort we have seen since 2007. So what we are witnessing today has less to do with the 1930s than with the 1940s: it is world war finance without the war.

You see, high deficits are okay in times of war, but not of peace. Markets are efficient nine times out of ten, but not when millions are out job in which case bond yields are too low, because… well… because. Aggregate supply is important when it’s used to justify tax cuts and low public spending, but not when we can predict the infinite future like certain Scottish Sages.

As I have documented in detail before, Niall Ferguson’s grand theory is devoted to a time of big government, but of a different kind. He yearns for the day when big governments taxed the poor to finance colonial adventures and fought with each other for glory and nothing else. Indeed, as he’s written before, he yearns for the day when “Britannia bestrode the globe”.

We today owe our intellectual and humanitarian heritage to Franklin Roosevelt. Not because he vindicated principles of easy money or public finance. Not because he vindicated principles of modern liberalism. But – for the first time in the history of our nation and all nations – he demonstrated that government can exist for the great benefit of the many at the minor cost of the few. For almost a century both political parties have lived by this end, if disagreeing on the means.

There is an ideology that accommodates the worst of efficient markets, supply side economics, and neoliberal economists like Milton Friedman. It is called right wing hackery, with Niall Ferguson as its high priest.

The Paradoxes of Perfect Policy

September 18, 2013
the Economy: Home and the World
1 Comment

So what if I told you the more expansionary monetary policy is, the smaller the Fed’s expected balance sheet will be. And, more curiously, the smaller the Fed’s expected balance sheet will be, the more expansionary current policy will become. These two forces build off each other into perfectly expansive monetary policy. Let me explain why.

Consider two policies. In one, the Fed continues to buy n dollars of Treasuries and mortgage backed securities each month until its expected loss – at any arbitrary sensitivity to deviation from its dual mandate – is minimized. In the other, the Fed continues to buy n dollars of assets each month but, at the end of the year if its target is missed, n becomes kn. This continues ad infinitum.

You would be mistaken to think these policies are functionally equivalent even in the first year. Even though the monetary base would be the same at month 12 under both, inflation would be higher and unemployment lower under the second. Markets know that if the Fed misses its target, purchases will increase substantially in pace next year, which would drive money demand down in the latter months of the year after it becomes clear the Fed’s mandate is missed.

Of course, since deviation from the Fed’s target is falling more rapidly under the latter policy, the expected time of exit from monetary stimulus is also smaller. If k is large enough, markets would expect the Fed to “taper” purchases before the end of year one.

Hence the expected size of the Fed’s balance sheet is smaller under the more aggressive policy, for some parameters k and n.

This deals with almost all the “negative” aspects of quantitative easing suggested by other critics. When more is less, its safer to do more. The scarcity of safe assets, as many worry, would be significantly lower if the Fed’s balance sheet was smaller. Therefore we should be talking about increasing the extent of purchases to the level where people expect a taper because of too much inflation. It’s like walking in a circle.

But the expansionary nature of this is greater still. Paul Krugman, and most Keynesians, correctly worry that expansionary policy isn’t determined by the size of the Fed’s current balance sheet, but expectations of the terminal money base. That is, because Krugman among others believe markets believe the Fed will vacuum money out of the system in the future, there’s a de facto floor on money demand.

Let’s say the Fed can’t really change expectations of its long run “sensibilities” (tolerance of inflation, etc.) without regime change. (This is a point deeply felt in the work of Christina Romer who should be our next chairwomen of the Federal Reserve). That’s not a perfectly true statement, and the expectations channel of monetary policy is still intact, but it still poses an important “drag” on the efficacy of monetary policy. This implies the market would expect a contraction in future money base proportional with the size of the balance sheet. However, if the expected balance sheet at the end of stimulus is smaller, so too is the expectation of future tightness.

So I don’ t think people like Krugman get it all right when they write that quantitative easing works only through signals of “willingness to be easy”. That’s part of it, but more aggressive quantitative easing not only signals a “willingness” on side of the Fed, but more bullish expectations on part of the market that the Fed won’t tighten, not because it doesn’t want to, but because  it doesn’t have to.

In fact, there’s a sweet spot where if k is high enough, markets won’t expect any contraction in money base at all, because the period of expansion would cause inflation so quickly that the Fed can slowly exit its stimulus program without a bloated balance sheet at all.

Because tapering quantitative easing won’t end it completely, there’s a good chance the Fed’s balance sheet is going to end up far larger than it needs to be. It’s about time for the hawks to call for aggressive easing.

Money vs. Mechanics

September 12, 2013
the Economy: Home and the World
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A surprising number of people tell me that quantitative easing is deflationary. Their reasons and political affiliations are diverse but, a comment like this left on Scott Sumner’s blog, captures that sentiment well:

Why would investors be convinced of inflation? Mortgage rates going down and longer term rates going down as a result of QE might not be enough to make people confident at all. Maybe prices go down instead of up because of lower interest costs. The private sector may want to deleverage so lower rates might not help at all.

Economics is all about identifying the “perverse consequences” of straightforward policy. So it’s also remarkably easy to contrive an example where something like quantitative easing – through various effects, expectations, etcetera – ends up making “prices go down instead of up because of lower interest costs”. Normally you’d argue back with empirical evidence to the contrary. 

But that quantitative easing can be inflationary isn’t even about economics. It’s about physics. 

All wealth, including the Fed’s balance sheet, is a claim on future returns from land, labor, and capital. Therefore, when the Fed purchases assets, it is increasing its claim on future output, denominated in some nominal aggregate. As the Fed continues its purchases, literally only two things can happen: we get inflation, or violate the Laws of Physics. 

Imagine that quantitative easing is not inflationary and the rate at which the Fed’s balance sheet grows exceeds the income deflator. Not too long from now, the Fed’s claim on future income will exceed what is physically and scientifically possible under standard physical laws.

The real value of the Fed’s claim on future activity is limited by inflation. And since we can’t violate physics, it stands to reason that quantitative easing must cause inflation. Think about it this way. Imagine the government cut every existing tax and met its obligations by printing money. Either we get inflation, thereby foiling the plan, or we find a way to finance the world’s biggest army, most extensive insurer, most expensive healthcare system, and strictest jailor with pieces of paper. 

Or, as Scott Sumner puts it, prices will either increase, or the Fed will own the universe. I honestly prefer the latter. 

The Economy’s Not a Rock, and Paper Isn’t Killing It

September 11, 2013
the Economy: Home and the World
20 Comments

Matt Yglesias writes that paper money kills economies because it institutes an effective lower bound on interest rates, the primary instrument of monetary policy. People like Miles Kimball have long argued that the “zero lower bound” and, hence, liquidity trap is basically a “policy choice” – a consequence of our cash economy. That is to say, under an electronic money system, we can easily implement negative nominal interest rates, giving monetary policy infinite power at all times.

The best way to think about this is imagine we all had dollar bills whose purchasing power was proportional to the length of the note, and the government can change the rate at which the note evaporates at will. If the rate of paper evaporation is increased, money demand will fall as consumers and investors across the world will throw cash for goods, services, and assets propping up a rapid recovery. In fact, the government doesn’t even have to increase the rate of evaporation, as long as it merely announces a credible intention to do so in the future.

But central banks can’t credibly announce the coming of negative interest rates, not the least because it isn’t physically possible in our current paradigm. Does that mean paper money is killing the economy…? I think not, for several reasons. Primarily, paper electronic money would be a superior choice to current monetary policy (and I, personally, have no animus towards accepting the future. Note that I’ve always hated carrying around cash, and don’t even have a wallet, so I love my electronic money, also known as Visa. But a lot of people use cash, and this would distributionally hurt them the most). But what we might call “conventionally unconventional” policies of quantitative easing are not out of steam.

Even Paul Krugman, the high priest of “monetary policy probably can’t gain traction in a liquidity trap”, agrees this has nothing to do with economic constraints of monetary policy as much as the conservatism of the central banking profession. That is to say, no one believes the central bank is sufficiently radical. In which case, we ask, what exactly is the point of militating for the abolishment of paper money – which is a far more radical experiment altogether?

Kimball – and maybe Yglesias – might argue that bringing it to the front of economic dialogue will make it easier for future crises to be handled effectively. But that would suppose getting rid of paper money is somehow fundamentally better than other unconventional options – given central banks were the right level of radical. We must make this stipulation because it makes no sense comparing a world where we are too timid to follow the policies proposed by Scott Sumner or Paul Krugman, but crazy enough to burn away paper.

And this contention is questionable at best. For example, even with negative interest rates, the central bank would need to set some sort of policy target. A lot of bloggers and forward-thinking economists like the idea of a nominal income target. I think Paul Krugman prefers a 4% inflation target (I don’t really know). If the latter – a higher inflation target – was the “optimal” solution between the two, then electronic money is most likely superior. The only point of a higher inflation target is to vastly reduce the risk of future recessions driving the equilibrium interest rate to the point of liquidity trap (and maybe reducing the effect of wage rigidities, but nominal targeting would accomplish this as well), and there’s some evidence that this is not optimal. (Edit: though still far, far better than current policy).

For reasons noted here, I don’t think a higher inflation target is superior to nominal income level targeting. In this case, it’s worth wondering whether negative interest rates really add a whole lot to the monetary policy arsenal, again, provided, markets didn’t think the central bank was skittish about its policies. The answer, I expect, is a probable “no” for reasons listed below:

  • A nominal income target works as much through expectations of action as much as action. So once such a regime is credibly instituted, money velocity is unlikely to fall as much as it did even during a pretty serious crash. This doesn’t require lower interest rates.
  • A proper quantitative easing plan can very easily provide above expectations with adequate firepower. What would such a plan look like? A symmetric Evans Rule. That is, for every month that the Federal Reserve misses its nominal income target, the scale of asset purchases are increased by some percent n. The exponential growth here would immediately convince investors that inflation is coming, stabilizing nominal income growth.

The only reason we would need negative interest rates under a nominal income target is if quantitative easing was somehow less welfare efficient than negative interest rates. This is likely to be the case if the central bank was forced to inject liquidity via the purchase of many private assets. However, with government debt levels where they are, this is not a significant concern, and can always be fixed with the issuance of higher maturity debt.

Another contention might be that it is easier to implement a “rules based” rather than “discretionary” monetary policy with the ability to vary interest rates below zero. While there is a sense that quantitative easing is discretionary, that only has to do with the conservative nature of the Federal Reserve, and there’s no reason why following a Taylor Rule when rates exceed zero, and an “exponential growth of asset purchases” when rates fall below zero is any more discretionary. It’s just as algorithmic, but with one extra condition. Die hard monetarists even want to institute a “nominal income prediction market” which would remove the discretionary element of maintaining the rule entirely.

Michael Woodford or Paul Krugman’s preferred monetary policy – “credibly promising to be irresponsible” – might be better achieved under negative interest rates but, even then, that’s not a clear conclusion. If central banks can’t credibly commit to keep interest rates at zero for a long time due to institutional conservatism, I’m not sure how we could a) abolish paper money, and b) credibly convince the market that we’ll bring them below zero for long enough. That the Bank of Japan increased interest rates whenever the economy was just about to recover is an example of this difficulty.

Anyway, if Bernanke could somehow promise that interest rates will be zero on January 01, 2017 there’s a very good chance we’d hit escape velocity from the liquidity trap. And that’s a less radical promise than getting rid of paper money altogether. (Can you imagine what Austrians and their ilk who dominate America’s policy minds on both sides of the aisle would say about NEGATIVE interest rates?) By the time we reach a political consensus that paper money is archaic, we’ll have a far better monetary policy to begin with by virtue of the fact that it is less radical. (Not to mention the fact that in modern markets simply holding a foreign currency won’t be a bad choice, either).

I sometimes feel arguments for a negative interest rate are substituted in place of arguments for a better policy target. But the latter is the important debate, and the former is only a tool to achieve the latter. If an optimal target necessitated negative interest rates, I’d be writing about them every day. But I’ve yet to see an argument why a nominal income level target requires negative interest rates. Importantly, the central bank can technically levy a penalty on excess reserves which has the same benefits.

Paper money is killing the economy, but so is central bank conservatism. The former is just a symptom, the latter a disease.

The Limits of Free Contract

September 9, 2013
the Economy: Home and the World
4 Comments

Economics and liberal philosophy intersect on the question of liberty. The economist might argue that minimum wage laws reduce welfare by banning Pareto dominant transactions between two agents that would make each better off without leaving anyone else for the worse. The philosopher might argue that it is our freedom to work for whichever wage rate we command: surely volunteerism should not be banned?

A similar and more resonant argument emerges in the market for sex: banning it is not just illiberal, but destroys value created in a transaction that makes both solicitor and prostitute the worse off without bettering anyone else, so long as the activity is private and unseen. This is an overwhelmingly popular argument among intellectuals, left and right, but faces severe limits. Indeed, much of the argument falls prey to what we might call the fallacy of marginalism or confusing marginal benefit with average benefit.

I am not arguing that prostitution should be illegal, per se, but want to provide a framework that will be more amenable to modern liberals and libertarians than the moralistic nonsense offered by social conservatives and can hopefully extend that reasoning to more salient topics like minimum wage, immigration control, and other illiberal regulation.

First, let’s state the philosophical argument, or what Kaushik Basu calls the “principle of free contract”, 

which asserts that when two or more consenting adults agree to a contract or an exchange that has no negative externalities on uninvolved individuals, then government has no reason to intervene and prohibit such a transaction. This principle is the product of two more fundamental ideas: the Pareto principle and consumer sovereignty. The Pareto principle asserts that if a change is such that at least one party is better off and others are no worse off, then that change is desirable. Consumer sovereignty asserts that each (adult) individual is the arbiter of that individual’s own welfare.

(I have not read this particular Basu paper, but enjoy his phrase and definition of free contract from his book Beyond the Invisible Hand – a book I read a long time ago, which inspired my love for economics.)

Therefore, if we aggregate over all such transactions, welfare and social good is maximized if and only if humans are free to contract. For this reason, economists are far less critical of moneylending at obscene – “usurious” – interest rates. But once we consider social norms the principle of free contract (PFC) is on substantially weaker footing.

Let’s use an example of prostitution to see how. Using a story from a TV favorite, The West Wing, imagine a young women paying her law school tuition through weekend prostitution. There is nothing morally repulsive about this scenario by itself, and it is a commendably efficient way to earn good money on a law student’s (presumably) busy schedule. To make the logical structure of the argument a little more transparent, let’s suppose Laurie – the prostitute – was actually using the money not to get through law school, but for LSAT prep to get into law school. This is not structurally different, but more intuitively forceful.

Laurie is now better off and ready to crack any exam and interview thrown at her as a result of elite prep classes affordable only to the few. However, seats at the top law schools are effectively zero sum: Laurie’s acceptance translates almost directly into her colleague’s rejection. This makes the application pool just a little more competitive on the margin. Now imagine a girl who just barely made it into law school without prep classes and, like Laurie, can neither afford to pay for elite classes or work in a normal job to finance resulting loans.

This girl, and everyone like her, will now be rejected because they only just made it. They would each all make it were they to also engage in a low time, high reward activity like prostitution. This argument continues: in the real world only several times because markets are not perfect, but theoretically ad infinitum.

Eventually, everything would be okay if all concerned were morally okay with prostitution. But Laurie is, let’s say, atheist – all of her compatriots that are practicing Catholics, Muslims, or just were morally uncertain about prostitution would be left behind. We know that within a capitalist system that those who do not work hard are left behind, and that is its greatest strength. But the assumption that contracts do not carry externalities is violated when others – to maintain the same standard of living – are compelled to do something that is against their moral code.

This argument can be terribly abused. I can stipulate it is against my moral code to work more than ten hours a week, and hence the government should ban everyone from doing so. That would be dumb, economically and morally, because most people do not hold this view.

But this is a more tenuous argument relative to prostitution. How many parents would say they are okay with their children participating in sex markets – with full and total consent – so that everyone else is better off, as liberal economic theory stipulates. My guess would be very few.

The side effect of free contract is forced homogeneity of the most aggressive principles.

In the sense of a “Protestant work ethic” that can be good, even great, by making once lazy and poor countries rich and prosperous – to summarize the nuances of economic history in five words!

The macroeconomist might say that both marginal and average welfare increase under free contract. Certainly if, between two convenience stores, the one owned by a hardworking immigrant stays open twenty-four hours, and the other closes at eight, competition will buoy per capita GDP, providing an illusion of a richer society. In reality, the microeconomist will reply, total utility – which is the cause of contention – is a tradeoff between work (dollars) and leisure. The higher GDP of the harder working country may not reflect a similarly higher utility if the value of leisure is high.

In fact, working hours are the clearest example of capitalism homogenizing the aggressive behaviors of hard work. This is most evident in the comparison of two similar economic structures – the United States and Europe – where the former is far richer by per capita GDP and works far harder whereas the latter is riddled with required vacations and regulated work hours. The United States being the more capitalist if the two, work ethic diffuses more rapidly from those innately or morally predisposed to such and those compelled into such through competition. But GDP does not account for the value of reading Shakespeare alone or watching NFL with your friends.

We can make this argument within the neoclassical structure as well by reconsidering the definition of “free”. If we no longer assume that the existence of choice implies the void of compulsion, it becomes clear that most contracts may not be free. For example, if I am providing my family a lifestyle commensurate with an income of $50,000 a year, and an immigrant moves and undercuts my prices, I can either choose to work the same hours for less income. But social commitments and a responsibility to family will encourage me to sacrifice leisure instead. Then, we may say, externalities exist to every contract making the idea of aggregated free contract a red herring in the case for liberalism.

Undercutting my personal wage rate is formally the same as working harder: indeed, if I choose to work for $4 instead of $8, hourly, I must spend twice as much time to maintain the same lifestyle.

This line of argument not only challenges the economic assumption that free contract is everywhere and always superior but also redefines the frame of a philosopher’s case for liberty. That is, under social obligations, am I really free to work less in the face of competition?

Ultimately, it is unlikely this argument can – or even should – change the mind of economists for most things. I, myself, am not convinced, but rather outlining what started out as a Devil’s Advocate case against prostitution or drug legality. In any case, for issues of social importance like prostitution, it bears (I think) significantly on the idea of externalities from the economic and social, rather than physical, outcomes of a contract. By definition, these are largely removed from standard economic analysis, but still follow similar principles of welfare and utility maximization.

I have touched, but not discussed, some philosophical pondering for another day. For one, what exactly constitutes “freedom”? This question has compelling implications, particularly so in markets for organs, surrogate mothers, and even plain, old, work.

How Not to Make an Argument

September 8, 2013
the Economy: Home and the World
4 Comments

Jeffrey Dorfman, somehow a professor at the University of Georgia, has the scoop in Forbes India. Normally, it’s not even worth writing about articles that are misleading and profoundly confused. But when it comes from someone of supposed repute making the worst possible argument a rejoinder can be important. I’m writing this post as much for the pro-Austerians as the pro-Keynesians. It would be smart for the anti-stimulus crowd to disavow the worst arguments made to their effect, like this from Dorfman.

First, I ask the Forbes editors, how they used literally the same title for two, entirely different articles:

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(Both are bad; the latter is infinitely superior to the former. And what’s with the asymmetric punctuation?)

Of course, when an article starts with a moral, economic, social, political, and philosophical absolute like “Government spending cannot generate economic growth” we already know a train wreck is en route. No meta-rational person could possibly write something so absolute. (Frequent readers know that I don’t discount supply-side factors at all, and have written about their recent importance contra singly-demand side theories). More refined believers of Say’s Law sometimes criticize Keynesians for misrepresenting the idea as simply as “supply creates its own demand”. (David Glasner, by the way, has some of the best analysis of Say’s Law in a sensible context). But here’s Dorfman claiming the Keynesian caricature:

You cannot buy a product unless somebody has manufactured it and is ready to sell. If supply is unchanged, an increase of demand results in bidding among buyers and higher prices. More demand without more supply does no good. Therefore, economic policy should focus on the supply side, encouraging businesses to invest and create.

Several things here confuse me. I was taught that aggregate nominal demand is the sum of consumption, investment, and government purchases. It would seem to me that “encouraging businesses to invest” would then constitute “aggregate demand”. Was I taught wrong? More likely, “encouraging businesses to invest” – as demand side a phenomenon as that may be – is just code for tax cuts and deregulation. (The former of which, by the way, is stimulus spending!)

More importantly, unless one rejects wage rigidity completely and absolutely “higher prices” are exactly what the economy needs. Then again it is entirely possible the writer believes that “aggregate supply is always an everywhere a vertical phenomenon”.

And then comes the kicker:

The only problem with these arguments is that all the purported facts are misstated. In reality, few countries in Europe have reduced government spending. For those that have, growth is generally better than it is in countries that have continued to expand government spending.

Data on 30 European countries from Eurostat, the official statistics agency of the EU, show that only eight countries cut government spending between 2008 and 2012. Of the eight, only Iceland and Ireland faced significant outside pressure to impose austerity. The others are Bulgaria, Latvia, Lithuania, Hungary, Poland and Romania.

Many countries that have purportedly tried austerity and failed are not on the above list. Greece, Spain, Italy and Portugal increased state spending. Italy is the only one of those four whose hike in government spending (4.1 percent) is below the EU average of 4.9 percent over 2008-2012. Greece (8.3 percent), Spain (13.3 percent) and Portugal (5.8 percent) were more profligate than the average European government.

Aside from the fact that austerity must be measured on potential output – as elusive a statistic as that may be – it’s inane to write that there was no outside pressure for spending cuts. Here’s a nice (graphically, tragic otherwise) diagram from Reuters for Greece:

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“Agreed with the EU, ECB, and IMF”, by the way, should be interpreted as “outside pressure”. A smart “real” indicator for austerity would be public sector disemployment. And that’s been tried across the pond here in the United States, by the way, not to any great avail. (Of course, the titling of this article suggests I do not share the same definition of “try” and its derivatives).

We continue:

Eurostat also contains data on GDP growth rates from 2008 to 2011 (2012 data are not ready for all countries). In terms of GDP growth only two of the eight countries that practised austerity were below average: Iceland and Ireland. Iceland had a meltdown of its banking system, so it is a special case. Ireland had a big real estate bubble that popped, causing a bank crisis and enormous government deficits. Both were among countries with the severest recessions.

This is called making exceptions when your theory fails. Of course, more than eight countries practiced austerity and this makes no sense to begin with since countries that practiced austerity might have stronger fundamentals – like the United Kingdom compared to Greece. And, since the author is from Georgia, I wonder which other country had a “meltdown of its banking system” and “a big real estate bubble that popped” thereby “causing a bank crisis and enormous government deficits”. But this line of argument would suggest Dorfman agrees that random correlations do not suggest causation.

He, surprise, does not:

As further evidence, the correlation between government spending growth and GDP growth is negative (–0.14) for these 30 European countries, meaning they move oppositely—higher government spending growth leads to lower GDP growth. If Keynesians were correct—that government spending increased growth—the correlation would be positive.

I actually wasn’t planning on writing this post until I read this paragraph. This was written by an economics PhD who teaches America’s tuition-paying students. And we’re talking about the University of Georgia, a taxpayer funded, research university. For one, citing a slope without a relevant r squared or a regression without a p value should be illegal. But slightly deeper statistical analysis isn’t even my point. Even if Dorfman doesn’t agree, were he to be making the best possible case against stimulus, would it not be worth at least noting the possibility that countries that engaged in deeper austerity had stronger fundamentals? That countries which couldn’t as rapidly curtail deficits had structural differences that makes said observation entirely useless?

Or, more importantly and subtly, while everyone (actually, read the article and scratch that) knows that “correlation does not imply causation”, few people really, intuitively accept that causation doesn’t imply correlation. I’ve discussed this in some more detail previously, but there is no reason to accept that Keynesians would only be right if “the correlation [was] positive”. By the way, to challenge your priors, check out Australia, which weathered the recession far better than any other country, and its government spending.

But, hey:

The Europe-wide negative correlation between government-spending growth and GDP growth, combined with the fact that three of the four countries with the best GDP growth tried austerity, suggests that austerity has some empirical support in Europe. This brief look at the data is not enough to prove austerity works, but it certainly has not been the widespread failure Keynesians claim.

A “Europe-wide negative correlation”, of course, is filler talk since it makes no sense to regress statistics randomly across a complex system that is the European economy. For example, the United States “tried austerity” and did way better than many European economies. Does this mean sequestration worked? Not really – just that hiking interest rates in the depth of a recession is really dumb. Not to mention the extremely small sample size.

If only economic zombie theories were as small in number as the extent of the data sets used thereof.

I’m sorry. Is Forbes trying to laugh at its Indian audience?

Inequality: Then and Now (Short Note)

September 6, 2013
the Economy: Home and the World
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The latter half of the 20th century was a great time for American liberalism. Our big, but more or less market oriented, government – for the first time – used public policy as a means of substantially curbing inequality across the country. The story of postwar America was of the middle-class autoworker living a good life.

There are economic reasons to doubt that we’re reaching a crescendo in the era of increased polarization: skill-biased technological change being key among them. But the more pressing issue is social, political and, unfortunately, broadly unmentioned. Perhaps the ferment in economic structure due to automotive and other technology played an important role in creating the new middle-class.

However, it is indisputable that Roosevelt, Truman, and Eisenhower era policies of very high taxes and public spending played an even more important role. Most Americans today cannot comprehend the extent to which the Federal Government was involved with economic life just two generations ago.

In a democratic society, this implied incredible political will to create progressive institutions. I have little doubt that if we wanted to, policy could cure inequality with a broad enough mandate – like that given to Roosevelt.

But this obscures something important. The Great Recession might have been the worst economic event in American history since the Great Depression. But it wasn’t the Great Depression. Living standards for the median and poor in America might be at their relative minimum since the Great Depression. But not their absolute minimum.

To understand the difference between then and now, citing GDP per capita is just not enough, because the mean blurs tail skews. In 1933, the average income for the bottom 90% was less than $7,000 dollars. In other words the average Chinese (who is very poor, by the way) lives much better today than most Americans did then.

The political will in a democratic society to vote to eat, be clothed, and provide for your children is very strong.

The equivalent figure today is over $30,000. Sure the rich today are unimaginably wealthier – but that doesn’t change the evaporation of fundamental want.

This is to say that we may never again see the political will from the country as a whole necessary to employ policy to curb inequality. This is to say that the Kuznets Curve for inequality in democracies might well be bimodal.

Should You Support High-Speed Rail?

September 5, 2013
the Economy: Home and the World
6 Comments

Probably not. A commenter recently got upset with me for saying:

Don’t subsidize long-distance rail (unless it’s Hyperloop). I don’t, unlike many other progressive wonk types, have any passion for really nice, high-speed transport between urban hubs. That’s a lie I personally do, but I depart from liberal ideology that it’s a social benefit. Think about it, the people who most intensely travel the Northeast Corridor – or between San Francisco and Los Angeles – are affluent professionals that take many more flights than the average American, are more likely the fly in environmentally-shitty business class setups, and all around typify the East Coast Elite Liberal stereotype. That it’s treated as some sort of environmentalist’s dream is a joke. (In fact, a 100% tax on business class, 200% tax on first class, and 50% tax on all economy flights after your first two in a year is a great idea).

He (or she) noted:

About rail: the population you observe is a selected sample. With rail, more people are likely to transport themselves; how do you account for this? The answer is far trickier than what you make it out to be.

I think this criticism is very fair. I made a rather blanket generalization from anecdotal evidence and it is possible, even probable, that my sample is itself highly biased. (For example, though I think the government should be helping many people, I personally do not know anyone that should fall into this category). Maybe the Northeast Regional is a lifesaver for much of America’s poor and lower-middle and I’ve misjudged the program completely.

So I decided to do a bit of research. But first, let me state the theoretical reasons why high-speed rail should never be at the top of a liberal’s agenda. By “theoretical” I do not mean abstruse mathematics or Euler Equations, but simple logic. Let me also say this is an important post, personally, because it marks a rather strong shift from my previous prior that we should encourage massive spending on high-speed rail across the country. I have some good things to say about rail, and I’ll get to that in the end, but I’ll first outline the case against.

Sometimes anecdotes can be generalized – especially those of broad economic judgement – and, as it happens, this weekend is a good time for me to write this post. I’m planning a trip from Philadelphia to Princeton tomorrow evening and I have two good options: a local connector via Trenton or Amtrak’s Northeast Regional. The former takes roughly four times as long (two hours to Amtrak’s half), requires a connection, but comes about $50 dollars cheaper.

There’s no reason for me – or most of America – to take the Amtrak. And that’s the problem with the high-speed emphasis of the conversation. Time is money but, for most of us, it isn’t much. Moreover, with smartphones, books, and sufficiently comfortable seats, the extra hour isn’t even time wasted as it once may have been. Of course, for America’s liberal, particularly coastal, elite – it is. Daily readers of the New York Times earn way more than most people, and their fodder, like Tom Friedman, work and play in circles where than hour is worth a lot of money.

This, by itself, doesn’t mean high-speed rail is ineffective. For example, slower speeds aren’t too bad for relatively short distances – say between Philadelphia and Princeton – but become a pain when we’re talking transnational services. Wouldn’t it be nice to get from Brooklyn to the Beltway in thirty?

Unfortunately, the usage of these services are almost exclusively beneficial to the somewhat upper middle class, if not only affluent. Flying JetBlue (as anyone not yet a millionaire should be doing, without whining) is, and in all likelihood will continue to be, a cheaper option. At this point, the high-speed rail activist points out that flying is shitty for the environment.

This is a concern that I sympathize with deeply. In fact, as Christie Aschwanden writes in Slate, the best thing you can do for the environment isn’t to become vegetarian, drive a Prius, or shop at Whole Foods but to stay within a hundred miles of your home and avoid flying to the extent possible.

But I am, and you should be, concerned about an argument to socially guarantee a rail service to clear the conscience of the rather select group that will use it. I would rather institute draconian airline fuel surcharges with annual exemptions. That is, most Americans barely fly, and when they do it’s probably for an important reason. Therefore, tax the first flight at 15%, and all subsequent flights in increasing intervals of 30%. Tax business class at 100% and first at 200%. Or something similarly aggressive.

As Aschwanden points out, telling an educated professional not to go to a conference or important business meeting is difficult. It’s why flying isn’t stigmatized like driving a hummer – it’s too important an action for the would-be stigmatizers. The tax system, in this case, is our friend.

And, by the way, some might say a “carbon tax will fix it all” but this isn’t the case for flying. Because the emissions are at a very sensitive part of the Earth’s atmosphere, the marginally emitted unit can be about four times as bad. More importantly, the worst part of a carbon tax is its regressive nature, and tilting the incidence to the wealthy is a good way to stem the welfare losses.

Ultimately, the data back my story up. The liberal argument for high-speed rail derives, primarily, from perceived environmental benefits, and subsidies for the poor. The environmental benefits can obviously be extracted in a more efficient manner (which the frequent fliers will hate, but so be it). But what of the poor? Well this is from a paper by Nevine Geroggi at the Center for Urban Transportation Research and Ram Pendyala at the Department for Civil and Environmental Engineering at the University of South Florida:

It was found that nearly half of the low income and elderly made no long-distance trips in the 1-year survey period. In addition, it was found that long-distance trips made by these groups were more likely to be undertaken by bus and geared towards social and personal business activities. The paper discusses the implications of these findings in the context of transportation service provision and policy formulation.

Now, half of the low income made no long-distance trips in the sampled year. Contrast that with the average of seven long-distance trips made by the “average” American. Of course, I scare quote “average” because statistically speaking average quantities do not reflect the median American. Since long-distane travel follows a power law relationship, the large handful of affluent (or busy working class) people making weekly trips heavily skews the picture.

Liberals generally talk about high-speed rail as a way of replacing airplane traffic, but the social welfare point of their argument somewhat more evaporates when you realize  air travel is used for business purposes at over twice the rate of all other transportation methods.

You’ll find even more important data here. Usage of intercity rail services is correlated positively with education and income, and very negatively with those who haven’t completed college. In fact, the correlation continues quite steeply not just at the “mildly affluent” income level of $100-150k but well beyond. If the conversation were limited to Amtrak, the divide would likely be even worse.

A subtly of the pro-rail argument is that we as a country should replace airplane traffic with more rail traffic, and use the government to achieve this outcome, rather than just use less airplane traffic to begin with. This wouldn’t bother most of America – which uses the interstate highway system to travel – but it certainly would cost the affluent. The conservative political establishment generally doesn’t seem to give a shit about the environment, so they don’t begin the argument at all. But that’s not much better than using the whole country’s purse for the betterment of a small group of people.

In fact, the liberal argument might be worse in that the fact that so many of us (unfortunately, I may not write “you”) even fly to begin with undermines our environmentalist credo. It’s like a watered down version of the joke where a Hollywood star drives a Prius to his private jet.

Note that while it is true that rail is environmentally healthier than using a car, it would be too expensive – and not socially efficient – to build high speed rail across all of the country. It would only be smart to link major commercial hubs – and this won’t help most people.

The driving assumption of this argument is that what does not help the poor should not be the government’s objective. That’s a dangerous line of thinking. In all likelihood, considering our record low interest rates and need to employ the unemployed, a large-scale project that doesn’t help the poor may not even be a bad idea. But I’m not convinced rail would help even the middle class as much as the affluent in general and select members of the middle or poor. We can expand two-year educational opportunities and make healthful eating options available to the poor; we can expand the EITC and cut payroll taxes. I do not see why we should build a railway given these tradeoffs.

If high-speed rail is such a great idea, it should be privately financed by those interested. My guess is America won’t get its own TGV even if we institute aggressive airplane taxes. And that in and of itself speaks to the meek social utility thereof.

A Remark on Ricardian Taxes

September 3, 2013
the Economy: Home and the World
15 Comments

A lot of people are skeptical of the idea that a Ricardian tax program on land and natural resources can finance the kind of government we need. I’ve outlined – in some detail – why this isn’t the case but some prominent voices, like Paul Krugman, disagree:

But [Henry George – late champion of land taxes – has] been out of favor for decades, especially in graduate schools. Economists are trained to ignore him. Paul Krugman came to Berlin in 2008, right when the subprime crisis had started to rumble, and I asked his opinion of Henry George. He squinted and tried to remember the name of the book. “Uh — Progress and Poverty I think is the [main text]?”

“That’s right.”

“Well, look. Believe it or not, urban economics models actually do suggest that Georgist taxation would be the right approach at least to finance city growth. But I would just say: I don’t think you can raise nearly enough money to run a modern welfare state by taxing land. It’s just not a big enough thing.”

The context was health care. “We’re having enough trouble trying to make sure we repeal the Bush tax cuts,” Krugman added, “and trying to shift to a completely different base of taxation is just not going to be on the table.”

When we’re talking about revenue positive tax reform, it’s useful to understand a) from what activity and b) from what individual the marginal tax dollar is generated. In a welfare maximizing system, the answer to (a) would probably be something very bad for the world like carbon and the answer to (b) would be Bill Gates. More generally, we should first tax activities that harm the world – like global warming – before we tax activities that help the world – like working. Similarly, we extracting a marginal dollar from the rich is vastly less welfare inefficient than doing so from the poor.

Most of the time, these guiding principles are in tension with each other. A tax on externality-generating activities – like a levy on gas, carbon, or natural gas – tend to disproportionately hit the poor. Likewise, a tax on the rich usually comes from what we would usually consider “good” – like returns on human or capital investment.

Land is a big exception*. Land – like almost any other store of value – is disproportionately owned by the rich. (Remember, land excludes value added property, so democratic ownership of houses across flyover country doesn’t make as big a difference as you might imagine). And while land isn’t “bad”, per se, because its ultimate supply is perfectly inelastic there is no welfare loss in its taxation (granted, there are no welfare gains either, unless it offsets an even worse tax).

(*Another notable exception might be congestion taxes in cities which fall on the people who take cabs or private cars instead of public transportation. In other words affluent tourists and the local elite).

Some people I’ve talked to don’t grasp the idea that land is inelastic. They tell me that companies will stop “improving” land for more productive use. It’s always surprising how confused people are about the idea of land. By definition land is unimproved. I don’t want to tax people who’ve built nice buildings on land or, for that matter, even deforested dense areas for efficient development (though I’d support anti-deforestation laws for entirely different reasons). That’s why property taxes are dumb.

But I want to disarm some misconceptions. When Paul Krugman says “Land is just not a big enough thing” he’s echoing a broadly held, and to some extent true, belief. In 1980, Paul Samuelson wrote:

Historically, pure land rent has become a declining fraction of GNP and NNP.

Ironically, 1980 was an important, if gradual, turning point:

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These figures – land rent share of income – are, for reasons I’ll get to later, quite a bit underestimated. But for now I’m more interested in the rate of change. After secular decline during the postwar expansion, land rents have increased not just in value, but in proportion, to the incomes of the wealthiest.

The biggest reason for this is, I think, the steep rise in inequality over the same time period. Conceptually, this is a pretty sensible argument. As mass affluence increases, as it did between 1940 and 1970, demand for consumer luxuries – like fridges, air conditioners, and garments – grows quickly. But as incomes of the median workers stagnate, while those of the rich grow precipitously you see a shift in demand to zero sum goods – or land.

Think about it, beachfront property, Manhattan penthouses overlooking Central Park, and second homes in Aspen have all increased rapidly in value in the Inequality Era. That’s because as the number of people who can afford luxury products has grown substantially, so too has the dollars chasing said land.

This is a pretty informative thought experiment. Land plays a big role in all of the products in the set of goods exclusively afforded to the affluent, and especially rich. While second homes and penthouses are a great example at the primary level, think about Ski Resort owners. If you want to Ski properly – that is on the Alps or in Colorado – those fake, manmade hills won’t cut it. You need a real mountain. The former is capital, and the latter is land. And boy do rich people love their Winter Chalets on the Swiss Alps.

Once you realize that land value is the most pristine of luxury goods – fake beaches are below the rich – the potential of land taxes becomes immediately apparent.

Now, you might be wondering after all this, if only 3-4% of the richest 1%’s income is land, there’s no way a total reform can include land values only. This is correct insofar as its ambiguity. The moral and logical extension of a land value tax would include similar levies on minerals, Internet domain names from common language words, and imputed rents from “middle America”. More importantly, there’s reason to believe this figure is understated, as discussed here. The last paragraph here is conspiratorial nonsense, but Fred Foldavary gives some pretty good reasons to believe that land rents are underestimated.

Part of the problem is because the United States pursued a program of broad home ownership – along with the fact that many affluent people own only one, expensive home without renting a second one out – so-called “imputed rents” become an important part of the picture. To calculate GDP, the government uses all kinds of tricks to estimate what you would have paid to live in your house had you not owned it. Even an average of $700 a month for everyone taxed at 50% yields a very significant sum. (Especially noting that the rich are easily paying the equivalent of $5,000 a month).

Granted, going back to the tradeoff between objectives of an optimal tax system, this would also “hit” many middle-class Americans.

There’s another critical point about taxing minerals. Many think about this from the point of profit from production without considering the consumer surplus from cheap consumption. That is, because most of us – especially the rich – would (if we had to) pay way, way, way more for a gallon of gas than we do, we’re rentiers each time we pay at the pump less than we would have. Because otherwise it would have been the company’s profit which is clearly rent.

Now, it’s important to note that a disproportionate amount of fossil fuel consumption should be attributed to the rich (just look at how much they fly, and in fancy business class configurations too!) That means their rent extraction from cheap fuel is orders of magnitude worse than the average American’s.

Note this argument has nothing to do with the environmentally-efficient price of carbon: we only note that minerals are a scarce, primary resource whose rents should be treated as land, and correct for the fact that most people would pay more for the average unit than we do. This is a very non-trivial point. Once you stipulate that not only the taxes, but consumer surplus, from minerals can be taxed under Ricardian principles, there is a gold mine of untapped tax revenue. Just look at the sales of America’s oil and gas sector. Along with land, and maybe a small levy on income earned above $1M we can finance a big government (25% G/GDP) with sensible tax policies.

Here we tease an important tension. A minerals tax (in reality what should be a carbon tax, but I’ll refrain from using that language here to divorce this conversation from environmental concerns) would disproportionately hurt the poor, as it is regressive, even if the rich disproportionately abuse the cheap fuel. This is a classic case where p(a|b) is very different from p(b|a). The best way to deal with this is to still heavily tax minerals – coal, oil, natural gas, etc. – but to provide a very progressive government spending system.

I want to summarize the most important part of this post as treating consumption of minerals as crucial a component of rents as profiting from the sale thereof. This adds another inefficiency beyond the environmental cost to even just innocently buying a gallon of gas. If we all used gas equally this wouldn’t be a problem, but we don’t, so our collective benefit should be socialized.

This is a particularly shocking problem if you think about how much the rich would actually pay for a gallon of gas (or unit of coal and natural gas burned if you’re of the Elon Musk class). For someone earning $500,000 a year or more, $20 a gallon would hardly seem like too high a reservation price. (After all, people in Europe earning well below that figure pay over half that). And what of air transport? This can’t be replaced with efficient, clean travel anytime soon.

The conversation on rents from land and minerals in this time of inequality has to begin. We might not be able to achieve all of our progressive goals with only a land value tax, but once we implement taxes on that principle the revenue is not trivial. Paul Krugman is unfortunately correct that this has all but disappeared from the Neoclassical, mainstream graduate schools. But I would expect the average consumer microeconomist to understand the rent from simple consumption better than anyone else. 

People like Paul Krugman can make this debate real in a matter of minutes. There is nothing utopian, idealistic, or useless about doing what Hal Varian’s Intermediate Microeconomics would tell you to do.

P.S. The name for this post comes, of course, from David Ricardo who first (or at least most prominently) advanced this argument:

It was from this difference in costs [between productive and unproductive land] that rent springs. For if the demand is high enough to warrant tilling the soil on the less productive farm, it will certainly be profitable to raise grain on the more productive farm. The greater the difference, the greater the rent. 

P.P.S. I plan to write some more on the evolution of economic thought regarding land. Some of the crispest writing on land rents comes from the classical greats like Ricardo or Henry George years after that. In any case, the modern arguments for land taxes usually come from the extremely utopian libertarian wing which makes a great argument but does alienate support from the “mainstream”. A lot of what Ricardo wrote doesn’t apply today, and mechanism of rent-seeking certainly manifests itself in subtler ways than before. But it is time to bring land and mineral taxes back into the heart of mainstream progressive discussion: something even the wonkiest seem hesitant to do.