Archive for March 2013


The third way

Paul Krugman expresses frustration that “austerians” keep using bad arguments:

[We Keynesians are] not always and everywhere against fiscal consolidation; give me the right economic circumstances and I’ll turn at least modestly deficit hawk. We are, instead, against austerity when the interest rate is against the zero lower bound, because when the economy is in a liquidity trap the contractionary effects of fiscal tightening can’t be offset by monetary expansion.

I don’t agree that monetary policy is out of ammunition at the zero bound, and if you read the entire post it seems even Krugman doesn’t think the ECB is out of ammunition:

Let me venture a guess: it may have a fair bit to do with the ECB’s narrow mandate. In America, the Fed explicitly had a dual mandate, which charges it with achieving full employment as well as price stability; this makes it natural to consider the difference being at the zero lower bound makes. In Britain, for whatever reason, the BOE has proved willing to tolerate above-target inflation for a while, and public policy debate does tend to focus on what the BOE can do to offset austerity. But in Europe, the ECB just doesn’t talk about its responsibility to stabilize the real economy, and how the liquidity trap in the European core may be compromising its ability to do so.

Nor is it just failure to talk; let’s not forget that the ECB actually raised rates in 2011, despite high unemployment, and has consistently refused to cut rates even as Europe slides deeper into double-dip recession “” and as Europe as a whole moves ever deeper into fiscal austerity.

So what I’m arguing, I guess, is that the EC obtuseness on fiscal policy is derived in part from the broader European obtuseness on monetary policy. Still, it’s quite a remarkable thing: we’re five years into this crisis, and key European policy makers still talk as if they were unaware of the central argument their critics have been making from day one.

I strongly agree with all these points:

1.  The ECB has the wrong target (inflation only.)

2.  The ECB raised rates in 2011.

3.  The ECB “has consistently refused to cut rates even as Europe slides ever deeper into double-dip recession”

What I don’t understand is how the inflation-targeting ECB wouldn’t simply offset any additional fiscal stimulus, or at least the demand-side effects of additional stimulus.  Nor do I understand how a central bank that refuses to cut rates could be said to be out of ammunition.  Are PIIGS bond yields at zero?  And even if rates were at zero, is the ECB out of paper and ink?

Yesterday he did a post on a similar issue:

So, start with our big problem, which is mass unemployment. Basic supply and demand analysis says that things like that aren’t supposed to happen: prices are supposed to rise or fall to clear markets. So what’s with this apparent massive and persistent excess supply of labor?

In general, market disequilibrium is a sign of prices out of whack; and most people commenting on our mess accept the notion that one or more prices are for some reason not adjusting. The big divide comes over the question of which price is wrong.

As I see it, the whole structural/classical/Austrian/supply-side/whatever side of this debate basically believes that the problem lies in the labor market. (I know, the Austrians will deny it “” but it doesn’t matter what you say about their position, any comprehensible statement leads to angry claims that you don’t understand their depths). For some reason, they would argue, wages are too high given the demand for labor. Some of them accept the notion that it’s because of downward nominal wage rigidity; more, I think, believe that workers are being encouraged to hold out for unsustainable wages by moocher-friendly programs like food stamps, unemployment benefits, disability insurance, and whatever.

As regular readers know, I find this prima facie absurd “” it’s essentially the claim that soup kitchens caused the Great Depression. But let’s stick with the economic logic for now.

Notice that Krugman doesn’t address the sticky price wage argument at all.  To be fair, lots of conservatives make the “disincentive to work” argument, but it’s certainly not the only justification for believing wages might be at the wrong level to clear the labor market.  Then he switches to an interest rate argument, without explaining what’s wrong with the sticky wage theory:

So what’s the alternative view? It’s basically the notion that the interest rate is wrong “” that given the overhang of debt and other factors depressing private demand, real interest rates would have to be deeply negative to match desired saving with desired investment at full employment. And real rates can’t go that negative because expected inflation is low and nominal rates can’t go below zero: we’re in a liquidity trap.

I certainly do understand this argument, but I find it frustrating how he seems to slide seamlessly from one issue to a completely separate issue.  The first tissue is; “Why do nominal shocks have real effects?”  And I think sticky wages are a pretty reasonable answer.  The second question is: “Why did the Fed allow a large negative nominal shock to occur?”  And the zero lower bound is certainly a plausible theory of Fed Fail.  As readers know I think the zero bound is not truly a “trap;” the Fed can reflate by setting a higher NGDP growth target and committing to buy as much debt is is required to equate market expectations with the target.  Nonetheless, I agree that the actual behavior of the Fed was almost certainly at least somewhat restrained by their queasiness over adopting aggressive unconventional policies.  So the zero lower bound matters in that sense.  But this is wrong:

There are strong policy implications of these two views. If you think the problem is that wages are too high, your solution is that we need to meaner to workers “” cut off their unemployment insurance, make them hungry by cutting off food stamps, so they have no alternative to do whatever it takes to get jobs, and wages fall.

No, if wages are too high, and wages are sticky, then the solution is to raise NGDP.  I favor straight monetary stimulus, but if that won’t work then even a helicopter drop would be preferable to waiting years for wage cuts to restore equilibrium.  You can believe wage stickiness is the root cause of unemployment, and also favor the sort of AD stimulus that Krugman would regard as “progressive.”

At times Krugman seems to suggest there are only two views; his view and that of the right wing crazies.  Of course there are heterodox views on both sides (some leftists also oppose the Fed’s “easy money” policy.)  And there are (monetarist) supporters of monetary stimulus who see sticky wages as the root cause of cyclical unemployment.

I also take exception to this claim:

Oh, and one more thing: no, you can’t say “Well, there may be truth to both views”. Either the economy is supply-constrained or it’s demand-constrained. Of course even the most ardent demand-siders will admit that there are supply constraints in there somewhere, that if we had an economic boom we would, after some period of time, enter a regime where printing money is inflationary and government borrowing drive up interest rates. But not here, not now.

I certainly agree that demand has been the biggest problem since 2008.  But I see no reason why both the AD and SRAS curves can’t shift left at the same time.  And if they do, the drop in employment would be even greater than if only the AD curve had shifted left.

There’s more to life than old-style Keynesian stimulus and austerianism.  In the first post I linked to Krugman expressed frustration that people weren’t paying attention to his views:

So do the austerians reject this argument? No “” they basically fail even to acknowledge that it exists.

As a market monetarist, I know how he feels.

PS.  Just so the post doesn’t seem like a mindless anti-Krugman rant, let me add that I do agree with Krugman’s view that the recent David Stockman column was a sort of mindless rant.  And I’m an expert on rants.   🙂

Putting a smiley face on the Chinese Communist Party

I won’t enjoy writing this post, but a recent defense of the Chinese government annoyed me on just about every level possible:

The world’s largest country and second largest economy has no tradition whatsoever of liberal democracy, says Zhang WeiWei, and many reasons for being wary of adversarial western political systems. He explains why Chinese see their own model as best suited to China’s needs.

In the subsequent article he doesn’t provide a shred of evidence that the Chinese people see their model as best suited to China’s needs.  Not one.  History is littered with dictators who thought they were popular, until rejected in elections (Pinochet, Ortega, etc.)  Here’s Zhang Weiwei:

China is often portrayed in the Western media as beset with social and political crises, awaiting only a colourful revolution to make it a liberal democracy. But China’s recent 18th Party Congress clearly demonstrated that this isn’t on the cards, and instead suggests that the country has found its own way to success, officially called “socialism with Chinese characteristics.”

Does he think China will develop its economy?  If so, then what other country failed to adopt national elections after becoming a highly productive economy?  (And no, extracting oil from the ground is not “highly productive,” it’s simply selling off one’s capital stock.)  He seems to think China has a bright future, yet doesn’t explain how China will avoid the iron law of democracy; when you get rich, educated, and productive, voters will want a say in governance.

1. Common sense. China’s population is larger than those of North America, Europe, Russia and Japan combined, and has no tradition whatsoever of liberal democracy and memories are still fresh of the devastating breakup of the Soviet Union.

Three misleading statements in one sentence:

1.  India has almost the same population as China, and is democratic.

2.  There is not a single liberal democracy on the face of the Earth that had a history of liberal democracy before it first became a liberal democracy.  Most (except Greece) had no history of democracy of any kind.  So this proves nothing.

3.  China is nothing like the Soviet Union.  China is 92% Han, and the vast majority of the non-Han are politically stable minorities who are well integrated into majority Han provinces.  Perhaps 2% of China’s population lives in areas that might become separatist.  Democratic India is far more diverse.

I’m sure you could go back 3 years and find “experts” on Burma assuring us that the government would never allow elections, and that Burma had no history of liberal democracy.  Yes, China is “special”, but then so is every other country (except Canada of course.)

Going further back, China’s more recent history saw chaos and wars, and on average from 1840 to 1978 a major upheaval every seven or eight years. So the Chinese fear of chaos is based on common sense and its collective memory, with very real fears that the country might well become ungovernable if it were to adopt the adversarial Western political system.

Yes and how many of those atrocities occurred under “liberal democracy,” and how many under autocratic governments like the Chinese Communist Party, which Zhang WeiWei believes should be entrusted with China’s governance?

And leaving China aside for a moment, not even the European Union as the birthplace of liberal democracy and with only one third of China’s population yet find it’s unable to afford its own liberal democracy model. If it chooses to retain popular elections as a way of selecting its top leaders, the EU may well end up facing chaos or even disintegration.

Let’s put aside the fact that Europe’s problems are trivial compared to the problems faced by China.  This is still a bit rich given that the Europe’s most serious problems are concentrated in the eurozone, a region that (like China) has decided to turn its governance over to unelected Mandarins.

Having myself travelled to over 100 countries, most of them developing ones, I cannot recall a single case of successful modernisation through liberal democracy, and there’s no better example illustrating this than the huge gap between India and China: both countries started at a similar level of development six decades ago, and today China’s GDP is four times greater and life expectancy 10 years longer.

How often do we hear this phony argument?  Once again, India is the most democratic country on the Indian subcontinent, and the most successful economically.  China is the least democratic economy that is ethnically Chinese, and is dramatically poorer than all the others (Singapore, Taiwan, Hong Kong.)  Comparing China and India is about as sensible as comparing Norway and Turkmenistan.

China has arguably performed better than most liberal democracies over the past three decades, especially in those domains that are of greatest concern to most Chinese.

Only in the sense that any statement is “arguable.”

And China has also performed better than all the transitional democracies combined, because the Chinese economy has grown 18-fold since 1979. Eastern Europe, for example, albeit from a very different starting point, has seen its collective economy only double in size.

That’s right, after the Chinese Communist Party made China poorer than India, poorer than Sub-Saharan Africa, so poor that 30 million of its citizens starved to death, it was able to grow faster than Eastern Europe, which was already a middle income region.

As well as performing better than many developed countries, China now has a huge ‘developed region’ with a population of about 300m, about the same population as the U.S., and in many ways it matches the developed countries in overall prosperity and life expectancy. China’s first-tier cities like Shanghai are today able to compete with New York or London, while its ‘developed region’ is engaged in a dynamic and mutually beneficial interaction with the rest of China – China’s ’emerging region’. This mutually reinforcing interaction explains to a large extent why China is able to rise so fast.

Yes, China has made lots of progress, but only after it began making its political and economic system more like that of those failed “liberal democracies,” as even Zhang WeiWei admits:

5. The China model. The economic successes of the China model have attracted global attention, but the model’s political and institutional ramifications have received comparatively little notice, perhaps for ideological reasons. Without much fanfare, Beijing has introduced significant reforms into its political governance and has established a system of what can be called ”selection plus election”: competent leaders are selected on the basis of performance and popular support through a vigorous process of screening, opinion surveys, internal evaluations and various small-scale elections.

So we are to believe that moving part way to liberal democracy has helped reverse the disasters of extreme autocracy, but moving further in that direction would somehow make China worse off?  Maybe, but where is the evidence?

In line with the Confucian tradition of meritocratic governance, Beijing practices – not always successfully – meritocracy across the whole political stratum. Performance criteria for poverty eradication, job creation, local economic and social development and, increasingly, a cleaner environment are key factors in the promotion of local officials. China’s dramatic rise over the past three decades has been inseparable from this meritocratic political model. Leaving aside sensational official corruption scandals and other social ills, China’s governance, like the Chinese economy, remains resilient and robust.

If the Chinese model is really so great, why does China have 60,000 riots every year?  Where is that “stability” that Zhang WeiWei refers to?  Why has the government allowed SOEs to block needed environmental reforms?  And why does the government feel it must lie to Chinese school children, and cover up the true history of Mao, the true history of the Communist Party?  And why claim that the problem is “sensational official corruption scandals?”  Isn’t the real problem that there aren’t enough “scandals?”  That most corruption is being covered up?  Is it “meritocratic governance” that allows those Chinese government officials, earning government salaries, to suddenly become billionaires?

China has learnt much from the West, and will continue to do so to its own benefit. It may now be time for the West, to use Deng Xiaoping’s famous phrase, to “emancipate the mind” and learn a bit more about, or even from, Chinese ideas and practices.

The West has much more to learn from Singapore, a tiny country of 5.5 million with a government recently re-elected with 60% of the vote, than it does from China’s 80 million-member Communist party.

Zhang Weiwei is professor of international relations at Fudan University, Shanghai, and the author of China’s recent best-seller “the China Wave: Rise of a Civilizational State”. He worked as English interpreter for Deng Xiaoping and other Chinese leaders in the mid-1980s.

I don’t doubt that the Chinese model works well for Zhang Weiwei, who lives in a relatively affluent city that is being built by “foreign workers” who are exploited for their labor.  Of course they aren’t really foreign, but they might as well be, as they are not even allowed to live in the city that they are building for the benefit of people like Zhang Weiwei.

PS.  Commenters; yes this post is 100% consistent with all my other China posts—thanks for asking.

HT:  Tyler Cowen.

Zuckerberg’s $1,000,000,000 consumption tax payment

When you study economics you find out that lots of things average people believe just aren’t so.  You learn that inflation is caused by monetary stimulus, not an overheating economy or monopolistic pricing.  You learn that imports from China (or automation or immigration) don’t cause our unemployment rate to rise.  You learn that an economy can’t run both a current account deficit and a capital account deficit.  I e. it can’t import lots more goods than it exports, and simultaneously outsource lots of jobs with overseas investments exceeding foreign investments flowing in.  You learn that legal mandates banning service fees on X, or requiring employee benefit Y, or rent controls, generally hurt the people they are designed to help.

You learn that the fiscal multiplier is roughly zero . . . oops, that’s still a few years away.

And you learn that a wage tax is identical to a consumption tax.  I’ve given up trying to explain why, hopefully someone in the comment section will fill in for me.  In any case, we now have Mark Zuckerberg paying over a billion dollars in consumption tax for 2012:

Facebook’s stock market debut left founder and CEO Mark Zuckerberg with a paper fortune currently valued at $13 billion — and a 2012 tax bill of around $1.1 billion.

Zuckerberg’s whopping tax hit stems from his move last May to increase his stake in Facebook. On the day of Facebook’s initial public offering, Zuckerberg exercised a stock option and purchased 60 million Facebook shares at a “strike price” of 6 cents each.

Even if those shares are never sold, the IRS treats them as ordinary income at the time the options are exercised. The rationale is that such options are a form of compensation, just like regular wages.

A few observations.  Commenters sometimes tell me that a wage tax won’t work, because all the rich guys will disguise wage income as capital income.  Actually, it’s really easy to tax wage income if the government is determined to do so.  Simply put the burden of proof on the income earner to show that the “capital income” is not disguised wage income.  The IRS could greatly simply the lives of 98% of us by making the assumption that capital income earned from sources where the individual is not employed are actually capital income.

If there are currently loopholes in areas such as hedge funds, it’s because Congress wants there to be loopholes in areas such as hedge funds.  The only thing standing between us as a radically simplified, radically more efficient, progressive consumption tax is a corrupt and/or ignorant Congress.

Both parties should declare a ceasefire in 2013, and replace both the personal and corporate incomes taxes with an equally large and equally progressive payroll tax (which taxes both wages and benefits.)  Then in 2014 they can return to battling over how big and how progressive that payroll tax should be.

Jeffrey Hummel on the Fed

Jeff Hummel has an excellent review of Ben Bernanke’s new book in the WSJ:

Mr. Bernanke credits targeted bailouts, starting in December 2007, with providing liquidity almost exclusively to solvent institutions with good collateral. Yet as his graphs demonstrate and his words fail to emphasize, for almost a year Fed sales of Treasury securities offset these injections. In doing so, the Fed was most definitely not acting like a traditional lender of last resort, which calms panics by increasing total liquidity, but was instead merely shifting savings into targeted institutions from other sectors of the economy. As many market monetarists have maintained, Mr. Bernanke’s crisis response was far too tight at the outset. Then, when Mr. Bernanke, running out of Treasurys to sell, finally orchestrated an unprecedented increase in the monetary base in October 2008, he partly offset the impact by paying interest on bank reserves, thus discouraging bank lending.


A note on tax progressivity and tax reform

Thoughtful conservatives:

Yes, I’ll support sensible anti-global warming policies, as long as it’s a carbon tax, and as long as it’s revenue neutral.

Thoughtful progressives:

Yes, I’ll support moving toward taxing consumption, as long as it’s as progressive as the current tax regime.

Environmentalists get annoyed by conservatives putting up preconditions that are unlikely to be met in reality.  I get frustrated by the fact that our measures of tax progressivity are flawed on so many levels that it will be impossible for a consumption tax to look equally progressive, even if it is equally progressive.

Over the next decade or so I’ll make a fairly steady upper-middle class income from teaching in a college.  Then I’ll suddenly be “rich” when I sell my house, and earn a vast capital gain.  (I bought the house in 1991, and it’s a two family.)  If we replaced the current income tax regime with a progressive payroll tax that hit me equally hard over that decade, the new tax regime would look far more regressive, even if (by assumption) it was equally progressive.  That’s true for all sorts of reasons:

1.  My capital gain was already taxed once as wage income before I invested the funds, and should not be taxed again.

2.  Even if real capital gains should be taxed, I get taxed on nominal gains.

3.  The actual gains occurred in small amounts over many years, I’m just paying the entire amount at the point of sale.  Nothing objective about my economic “class” changed the year I sold that house and bought a new (retirement) house of equal value.

For all these reasons the income tax looks vastly more progressive than it really is.  And for all those reasons (and many others) progressives will see any “progressive consumption tax” proposal as coming up woefully short, when compared to the current tax regime, even if it is equally progressive using proper inequality metrics–i.e. in terms of consumption.  The official tax data will show someone making a couple hundred thousand dollars in capital income (when I sell out), and only paying tax on wage income.

This makes me very pessimistic about the prospects for meaningful tax reform.

And as for effective anti-global warming measures—not happening.

From tax reform to monetary policy to environmental policy, far more of our policy failures are due to cognitive illusions (as opposed to special interest groups) than is generally acknowledged.

PS.  The recent Obama tax increase gave me an incentive to let my rental unit lie empty for 2 years.  Taxes don’t just cause workers to become unemployed, they cause capital to become unemployed.

PPS.  I just noticed this excellent comment by Matt Yglasias:

The fact remains that if you tax rich golfers’ income and give the money to poor people, you increase the sum total of felicity in the world. If you find a way to collect the same amount of money from rich golfers but do it primarily by taxing rich golfers’ consumption, then you do an even better job. When you think about physical disabilities this becomes particularly clear. We try to help out people who are blind or who lost a leg in Iraq or who are born with a congenital heart weakness not because providing such assistance accords with a principle of merit, but precisely because people who lack “merit” in the field of seeing or walking or not dying as a child due to heart failure are the people who need help. But lots of people suffer from less visible problems, be it a genetic weakness for alcoholism or the below-average intelligence that afflicts exactly 50 percent of the population. Those people should have great lives, too. But a very egalitarian society in which everyone enjoys a high standard of living is almost certainly going to have become that way precisely because it doesn’t strive to turn the remorseless meritocracy of the PGA tour into a model for society.

BTW, it’s really easy to tax the consumption of rich golfers without taxing their income—just put a progressive payroll tax in place, and consider golf winnings to be wage income.

PPPS.  Commenter Steve sent me a Bloomberg radio interview of Thomas Moore and Erik Larsson from the Bentley Fed Challenge team (which took second place in the national competition) and also one of the two coaches, Aaron Jackson.