People often ask me what sort of readings I would suggest, outside of my blog.  There is a list over at “FAQs”, but I’d also like to mention a new book that was recommended by Ambrose Evans-Pritchard in The Telegraph:

Yet three heavyweight books now lay the blame squarely on the Fed: the ‘Great Recession’ by Robert Hetzel, a top insider at the Richmond Fed; ‘Money in a Free Society’ by Tim Congdon from International Monetary Research; and ‘Boom and Bust Banking: The Causes and Cures of the Great Recession’ by David Beckworth from Western Kentucky University.

I’ve discussed the Hetzel and Congdon books (and recommend Hetzel’s especially highly) but haven’t discussed the new book edited by David Beckworth.  It’s your one-stop shopping for the views of Lawrence H. White, David Beckworth, Diego Espinosa, Christopher Crowe, Jeffrey Hummel, Bill Woolsey, Nick Rowe, Josh Hendrickson, William White, Laurence Kotlikoff and George Selgin. I also have a chapter in the book.

Most economists seem to think China invests too much.  In previous posts I’ve argued that if China wants to consume more, they first need to invest more.  If they want more restaurant meals and vacations, they must first build more restaurants, hotels, airports and train stations.  If they want more health and education, they must build more schools and hospitals.  If they want more housing services, they must build more housing.  Free Exchange just published a piece that offers an odd perspective on this issue:

Others are less convinced about Hayekian risk. Francis Cheung of CLSA, a broker, argues that China suffers from excess capacity in some parts of infrastructure, but not all. Cities like Beijing and Shenzhen are congested, faring worse on IBM’s “commuter pain” index than Delhi or Nairobi (see left-hand chart). That would suggest China has scope to invest in Shenzhen’s metro, one of the projects announced last week. Infrastructure demand will eventually catch up with supply, Mr Cheung concludes, as long as infrastructure spending remains disciplined.

Moreover, investment that adds little to a society’s stock of productive assets is not necessarily malinvestment. Michael Buchanan and Yin Zhang of Goldman Sachs say that some Chinese investment is best seen as “quasi-consumption”. In this category they place things like earthquake-proof schools and more comfortable metro lines. Instead of adding to the economy’s productive capacity, these assets provide a flow of services (such as reassurance to parents and relaxed travel) directly to consumers. In this respect they are more akin to consumer durables, like washing machines or cars, than to iron-ore mines or steel plants.

As a rough gauge of the size of quasi-consumption, the Goldman economists add up China’s investment in house building and “social infrastructure”, such as utilities, transport, water conservation, education and health care. Reclassifying this spending as consumption would increase China’s household consumption to 53% of GDP last year, compared with only 35% in the official statistics (see right-hand chart).

I’m not quite sure how the Goldman economists reached this conclusion.  Perhaps it was as follows:

1.  Everyone knows that China invests too much.

2.  Common sense says that certain Chinese investments are desirable.

3.  Hence those desirable investments must be consumption, not investment.

Investment is the construction of capital goods.  Period, end of story. Capital goods are highly durable assets, such as subways, airports, apartment buildings, hospitals, schools, etc.  Factories are also capital goods, although they tend to be less durable (at least in America) than the other items that I listed.

An economic “miracle economy” is simply an economy that has been horribly mismanaged by the government, before the miracle occurs. This mismanagement causes their GDP to be far below potential.  With somewhat more sensible government policies (but not necessarily sensible in an absolute sense) the country will engage in a period of catch-up growth.  Fast growth tells us almost nothing about the effectiveness of the current government; it tells us that the previous government was incompetent.  When fast catch-up growth occurs, the level of investment will be necessarily high, because one must first build the capital goods required to produce developed country levels of consumption.  This theory has several implications:

1.  During the 2020s it’s quite possible that North Korea will grow at a faster rate than any other country in history (outside of small countries whose data is distorted by huge natural resource discoveries.)  That’s because its GDP per person is probably farther below potential than any other country in history.  If it does set a record, no other country will ever surpass its record.  North Korea is the last of its kind.  Other poor countries are poor for much more complex (and hence hard to overcome) reasons that North Korea is poor.  Vietnam is probably most similar, then Cuba.

2.  During this super growth spurt, North Korea will invest at an extremely high rate, perhaps even higher than in China.  If it is able to maintain a fairly high level of consumption, it will be through imports, not domestic production of consumer goods.  It’s not clear that China has this option.

PS.  For the purposes of this post, I define “potential” as the steady state per capita GDP level (as a fraction of US GDP/person) achievable with a new and moderately competent central government.  I’m claiming that a group of technocrats put in charge of the central government in North Korea could achieve higher growth than the same government in Afghanistan.  I’m not assuming identical economic policies, as it’s more difficult to implement policies in some countries than others.  Governability is endogenous.

PPS.  My North Korea prediction is based on the assumption that economic reform will occur.  If it doesn’t, then obviously growth will be less impressive.

This post won’t describe my preferred tax regime.  Rather I’ll describe two reforms that would greatly improve economic welfare and leave the distribution of taxes almost unchanged.  Both parties should support the plan, although I doubt either actually would.

1.  Remove all income tax loopholes.  All of them.  Reduce tax rates enough so that each income decile pays the same amount as before.

2.  Eliminate all capital taxes for people with less that $100,000 in capital income.  I.e. on the first $100,000 of passive capital income. Make up the lost revenue (which would be surprisingly little) by modestly raising the Medicare payroll tax on those making more than the Social Security cut-off point (roughly $110,000/year.)  The tax cut would mostly benefit the affluent, but some benefits would go to those making less than $110,000 in wage income.  All of the tax increase would fall on the affluent.  The net effect would probably be to make the system a tiny bit more progressive.

The combined effects of both plans would reduce MTRs for everyone. More importantly, the net effect of these two changes would be that 99% of non-self-employed people would not have to file income tax forms.  The IRS would simply withhold the appropriate amount of wage and salary income, and that would be the end of it.  For those lucky people (like me!) the income tax would become essentially identical to the payroll tax, except with a more complex rate structure.

This would cause huge numbers of tax-preparers to lose their jobs, freeing up labor for other more useful jobs like gardening and cleaning swimming pools.  Also more dog psychologists.  It would end my dread of the month of April.  It would boost capital formation, for reasons Matt Yglesias discusses in this post.  It would also be much fairer, as high savers are currently taxed at much higher rates that spenders with equal lifetime wage incomes (for reasons Yglesias hints at in the preceding post.)

Most people with capital incomes below $100,000 work for a living.  The big hedge fund guys would still have to fight it out with the IRS.  Is their income a return of capital, or on services rendered?

But please, leave me out of that fight.  There’s no reason for the IRS to bother the rest of us.

PS.  I don’t have time today to blog on monetary policy, but I’d point you to some excellent David Glasner posts (here and here), criticizing the hard money folks.  And Brad DeLong pushes back against an unusually weak argument by John Taylor and Phil Gramm.

Gillian Tett has this to say about Richard’s Fisher’s latest speech:

Or as Richard Fisher, head of the Dallas Fed, observed in a powerful speech on Wednesday (which cited the Duke survey): “Nobody on the [Fed] committee”‰.”‰.”‰.”‰really knows what is holding back the economy. Nobody really knows what will work to get the economy back on course. The very people we wish to stoke consumption and final demand by creating jobs and expanding business fixed investment are not responding to our [Fed] policy initiatives as well as theory might suggest.”

.   .   .

The crucial problem, as Fisher noted with such unusual clarity this week, is that the psychology of this is still so uncertain. With anything between $2,000bn and $4,000bn of unused liquidity now swirling around the US financial system (depending on how you measure it), consumers and CFOs alike can sense that monetary policy is becoming less effective. And yet, the more the Fed announces unconventional moves, the more stock market investors appear to demand additional drama. With every new round of QE, expectations and fears are being ratcheted up, in equal measure.

That is not reassuring in any sense. Anyone who feels tempted to start celebrating the recent share price rally, in other words, would do well to read Fisher’s bold speech – and then take a long, deep breath.

Tyler Cowen linked to a WaPo article showing that the GOP is likely to cave on taxes after the election.  And what do they get in return?

But if Obama wins, the GOP would have no leverage “” political or procedural “” to force him to abandon his pledge to raise taxes on family income over $250,000, according to senior Republicans in the House and the Senate.

So they are beginning to contemplate a compromise that would let taxes go up in exchange for Democratic concessions on GOP priorities.

At the very least, that would mean protecting the Pentagon from the budget ax, which is set to whack $55 billion out of national security accounts next year. But it could also mean major changes to Medicare, which many Republicans said could quickly become the new front in the partisan battle over the budget.

“I hope, obviously, the status quo doesn’t prevail” on Nov. 6. “But if things stay as they are, and all the players are generally the same .”‰.”‰. finding a responsible reform for Medicare is the secret to unleashing very productive talks that would put in place a balanced solution to our fiscal problems,” said Sen. Bob Corker (R-Tenn.). “If you deal with the Medicare issue, then Republicans are far more open to looking at revenues.”

Difficult details would have to be hammered out. And any compromise would face head winds in the House, where a large bloc of GOP freshmen opposed new taxes during a messy fight to raise the federal debt limit last summer.

Many say they that are still not ready to agree to higher taxes and that they will press to maintain tax rates for families at all income levels no matter who wins the White House.

“As long as we have control of the House, I’m going to be really surprised if we capitulate on what’s essentially a core fundamental of conservative orthodoxy,” said Rep. Trey Gowdy (R-S.C.).

So the GOP will cave and allow tax increases, and in return they’ll get a Obama promise to raise federal spending by $55 billion.  That’s just great.   I know it’s defense, and how can we expect to defend our country with a military budget that’s only as big as the next 20 countries combined?  And then there’s that “Medicare concession.”  Memo to the GOP; Obama already wants to cut Medicare, it’s part of the health reform bill.  Indeed hasn’t the GOP been warning about Medicare cuts?  The Dems know that if they don’t reduce the rapid growth of Medicare, they’ll have no money for all those other Democratic goals (child care, infrastructure, medical subsides for the uninsured, higher teacher salaries, etc.)

And Rep. Trey Gowdy reminds me of Mill’s comment about the “stupid party.”  Do the House Republicans not even realize that taxes will rise next year, regardless of whether the GOP “capitulates” or not?  The Bush tax cuts are scheduled to expire.  Try negotiating that point with Obama after he’s just won the final election of his life.  Are the GOP Congressmen going to threaten to hold their breath until their face turns blue?  Obama will let the tax cuts expire and immediately propose re-instating them for everyone making under $200,000.  And the GOP will do what?

Last year I argued that the GOP was making a big mistake by not showing a willingness to negotiate with Obama on the budget.  Let’s review the facts:

1.  Obama was very anxious to negotiate, as he wanted to run for re-election on the claim that he’d been able to get beyond the old partisan divides in Washington.  After all, he’d promised to do so back in 2008.  He knew that a grand agreement would undercut the GOP argument on the economy.  And he has the foreign policy issue wrapped up.

2.  If the GOP had gone all in for Simpson-Bowles, they would have had to give a little ground on tax increases, but they would have gotten major tax reform.  Lower rates on income taxes in exchange for far fewer loopholes.  Isn’t that what Romney claims to want?   (Except the tax revenue increase, which he only wants secretly.)  And also spending cuts.

3.  By going all in for Simpson-Bowles, the GOP would have been seen as “bi-partisan” and all those centrist DC reporters that Krugman hates would have swooned over the party.  Especially if Obama held out and refused to negotiate.  Ryan would be seen as a hero.  Instead centrist reporters now (correctly) see the GOP as a rigid ideological party in hock to the Tea Party.  And that image will cause them to lose the independents, and lose the November election.

Compromise was the right thing to do.  Instead the GOP tried to destroy Obama, regardless of how badly it hurt the country.  Now they are about to lose everything.  And they’ll end up with a far inferior policy mix to what they could have negotiated in 2011.

What a stupid party.

PS.  I guess this post contradicts my previous post, where I claimed not to have “strong views” on either party.