Archive for October 2019


If you are actually concerned about China

Some people worry that China is a rising military threat, and support trade and investment restrictions for that reason. But the trade war will have only a tiny impact on China’s development.

If we actually wanted to slow the rise of China, then we’d take in 100 million highly talented Chinese immigrants. Consider the following survey:

Hundreds of millions of Chinese want to emigrate, and the feeling is especially strong among the more affluent. So why don’t we take those skilled people, and by doing so dramatically boost our economy and military potential, while weakening China?

Unfortunately, our nationalists have been trying to reduce immigration from China, thereby weakening America and strengthening China. Trump would call them “traitors”, that is, if Trump himself were not one of them.

PS. I’m with Congress, and thus I’m far tougher on China than Trump, who is a fan of authoritarianism:

U.S. lawmakers harshly criticized China’s Communist Party, drawing a sharp contrast with President Donald Trump’s congratulatory message to counterpart Xi Jinping on the People’s Republic’s 70th anniversary.

We should mourn the 70th anniversary of the Chinese Communist Revolution.

If you are actually concerned about inequality

A number of pundits and politicians are suddenly advocating wealth taxes as a way of reducing inequality. But there is a much better way of doing so—progressive consumption taxes.

In the past, some have argued that progressive consumption taxes are fine in theory, but hard to administer. They might be easy to evade. But the same is true of wealth taxes.

We should not make the perfect the enemy of the good. For most people, a wage tax is essentially identical to a consumption tax, at least over their lifetime. Alternatively, most people could simply pay an income tax with unlimited 401k contribution and withdrawal privileges. That’s also effectively a consumption tax.

It is more difficult to deal with the self-employed, where the line between wage and capital income is blurry. In my view, all income from the firm where you work should be viewed as wage income. But investments should be fully expensed.

Most proposed wealth taxes only apply to the very wealthy, an implicit acknowledgment of their complexity. Each year, you’d have to value people’s stocks, bonds, art, businesses, houses, yachts, jets, stamp collections, Bitcoins, Ferraris, and many other assets. And does Taylor Swift’s human capital count? If not, why not? And if you are going to have a system that complex, where you need intrusive audits of each person’s wealth, then why would you want to tax wealth when consumption taxes are superior?

For instance, consider a wealth tax on a $100 million Hollywood mansion. That mansion also provides a flow of services that can easily addressed with a consumption tax. In contrast, a $100 million portfolio of Treasury bonds does not provide any consumption value, and thus the interest ought not be taxed.

Yes, there are grey areas with consumption taxes, but there are just as many grey areas with wealth taxes. So why advocate an inefficient wealth tax that favors current consumption over future consumption? That makes no sense.

PS.  Greg Mankiw points out that Warren’s proposal has a marriage penalty whereas Sanders’ proposal has a marriage bonus.

Strange respect for central banks

In the past, I’ve argued that our overly respectful view of central bankers has led us to misdiagnose recessions. Indeed it has led us to distort macroeconomic theory.

In basic macro theory the path of NGDP is determined by monetary policy. Recessions occur when NGDP growth falls suddenly and unexpectedly. Thus it seems logical to assume that whenever there’s a demand side recession it is the Fed’s fault.

The profession greatly respects people like Bernanke, Yellen and Draghi, as they should. These are talented central bankers. But we should not let that well deserved respect influence the way we think the macroeconomy works. Unfortunately, that’s exactly what we do.

The Economist recently did a long article on the mystery of low inflation.  Overall it’s a good article, well worth reading.  But there are a few problem areas.  Here’s one:

Later in the decade, amid low unemployment rates, monetary policymakers became more attuned to the risk of overheating. It would be odd, however, to explain low inflation by appealing solely to deliberate choices on the part of central banks, when they themselves profess to be confused by inflation’s quiescence.

A bus is driving from Los Angeles to Vegas.  At some point the bus goes off course, and ends up in the Mojave Desert, 20 miles from I-15.  The bus driver’s labor union points out that this is a skilled driver.  “It would be odd to attribute the location of the bus to choices made by the bus driver.  More likely, an electromagnetic pulse from outer space affected the bus’s navigation system.”  How would that excuse work?

Think about it.  The Fed raised rates 9 times.  Each rate increase was done with the intention of preventing inflation from overshooting the Fed’s 2% target.  They relied on a flawed Phillips Curve model that predicted that low unemployment would cause high inflation.

Yes, “they themselves profess to be confused”.  I’m sure the errant bus driver was also confused.  But is this any reason to absolve them from making bad decisions?  Why wouldn’t you blame low inflation on the choices of the central bank?

Not all central banks have trouble hitting their 2% inflation target.  In the UK, inflation has averaged 2.06% over the past decade.  If you insist on excluding the last three years (when inflation was boosted by the Brexit depreciation of the pound), it’s 1.97%.  If you take the past 20 years, it’s 2.02%.

The Economist piece also has a long discussion of how supply side factors might have played a role in low rates of measured inflation.  Unfortunately, the evidence suggests that this is wrong.  Technological innovations such as the “Amazon effect” can only reduce inflation to the extent that they boost productivity growth.  But productivity growth has been slower since 2004.  Thus the data do not provide even a necessary condition for considering the hypothesis that productivity gains (or any other supply side factors, such as trade with China) is holding down inflation.  James Pethokoukis has a cute tweet:

PS.  Even if technological progress were rapid, it would not hold down measured inflation, due to monetary offset.  At best, it might reduce actual inflation if the rate of progress were underestimated.

PPS.  The article ends up endorsing NGDP targeting, and there are other good parts as well.

HT:  David Beckworth

The American war on China just jumped the shark.

Here’s the New York Times:

For nearly a year, the Bureau of Industry and Security, a division in the Commerce Department, has been working to identify emerging technologies that, if shared, could pose a security threat to the United States. 

The restrictions aim to head off new security threats. For instance, 3D printers could create weapons on the battlefield, making it unnecessary to ship arms. Artificial intelligence can decode encryptions that previously could not be cracked. Robots could provide surveillance from space, while organelles could build tissue for soldiers injured in war.

AI I can sort of understand (although I do not agree with an export ban.) But do I even have to explain how utterly insane the rest of that is? If we have a war with China its outcome will not depend on whether or not China has “robots” in space (they already have spy satellites), or whether the Chinese have 3D printers on the battlefield. Which battlefield? Taiwan? And medical advances are now a security threat because they can treat injured soldiers? Is this an Onion parody?

Of course none of this will work:

Past efforts to regulate technologies provide a cautionary tale. In the late 1990s, the United States placed tight restrictions on exporting satellite technology in an effort to protect an industry deemed vital to national security.

The effort backfired. Wary of restrictions that could cripple their ability to ship products overseas, companies like Boeing, Maxar Technologies and Lockheed Martin moved satellite manufacturing overseas. According to a report by the Commerce Department, companies said the controls eroded American competitiveness in the industry and led to $1 billion to $2 billion of lost opportunities from 2009 to 2012.

PS. The lunacy in DC gets worse every day. Soon after the Trump chief of staff announced to a stunned press conference that there was indeed a “quid pro quo” (as if anyone who wasn’t moron didn’t already know that), the claim was confirmed by Bill Tayler, a radical left-wing extremist picked by Mike Pompeo. And after all of that, the Trump administration has gone back to denying any quid pro quo. Huh?

We’ve always known that Trump believes that laws only apply to little people, but it’s still nice to get him on record:

“I’m in charge of the Hatch Act,” Mr Trump reportedly snapped at chief of staff Mick Mulvaney, when he was told that bringing his Cabinet to the rally could raise issues. . . .

The report on Mr Trump’s views towards the Hatch Act come just after Mr Trump mocked the US Constitution’s emoluments clause, which prohibits federal office holders from accepting gifts from foreign sources.

That mocking followed after Mr Trump was forced to choose a different site for the next G7 Summit, after he was condemned for choosing his own resort in Florida for the event.

L’état, c’est moi.

Rethinking recessions

Recently, there’s been a tendency for people to try to expand the definition of recessions. You see people talking about declines per capita GDP in Australia, or “manufacturing recessions” in various countries.

I’d like to see us go in the other direction, tightening the definition. In the past, I’ve discussed three “phony recessions” in Japan during the past nine years. In each case there was a brief period of negative RGDP growth, and then a rebound, with no increase in the unemployment rate. Because Japan has a rapidly falling population, its trend rate of RGDP growth is quite low. It doesn’t take much to drive them into a brief mild recession.  But it’s not really much of a “business cycle”.  Here’s the Japanese unemployment rate:

The smaller the economy, the more erratic is the rate of growth in RGDP, as individual sectors can have a bigger impact on the total.  Germany’s important manufacturing sector is currently in a slump, and it threatens to push Germany into a technical recession:

Germany’s central bank warned the country’s economy may have shrunk for its second consecutive three-month period, which would mean the eurozone’s biggest economy has entered its first recession in six years.

But does this actually matter?

The labour market has cooled in Germany recently, but unemployment continues to fall, the Bundesbank said. In September the number of people registered as unemployed fell by 10,000 from the previous month to 2.28m, its first fall in four months.

Does this look like a country in recession?

Keep in mind that manufacturing is a relatively small share of the economy in most developed countries, and a slump in capital-intensive manufacturing can affect output more than employment.

If storm clouds are gathering over trade, investment and manufacturing, they are not, however, seriously affecting households. Unemployment is at long-term lows in many advanced economies and with real incomes rising, consumer spending is preventing recessionary forces taking over.

The US unemployment rate fell to its lowest level in 50 years at 3.5 per cent in September; UK levels are at 45-year lows; and the eurozone rate of 7.4 per cent in August was the lowest for 11 years and within a whisker of the lowest rate since the single-currency area was created.

The recent problems at Boeing are a perfect example of the disconnect between output and employment.  The pause in the construction of 737s does have a discernible impact on US output, but does not have a noticeable impact on US employment.

BTW, this graph illustrates a point that I frequently make.  Even if the central bank undershoots its inflation target for an extended period of time, the unemployment rate will eventually fall back to the natural rate.  The ECB needs a much more expansionary policy, but primarily so that it can hit its inflation target.  The unemployment rate is already close to the natural rate (albeit still a bit above, as the European natural rate is trending downward.)

My suggestion is that we start defining the term ‘recession’ as a substantial rise in the unemployment rate.  For the US economy, a jump of one percentage point might work.  Using that criterion, all the recessions and non-recessions since WWII would be exactly the same.  In the US, there are no “debatable recessions”.  It’s always 100% clear as to whether we are in a recession or not.  (The lack of mini-recessions in the US is perhaps the most important unsolved mystery in macroeconomics.)

Going forward, however, the unemployment criterion might yield different results from the 2 quarters of falling RGDP criterion, or the more complex formula used by the NBER in the official recession dating decisions.  We already see mini-recessions in other countries.  (BTW, contrary to popular opinion, the NBER does not use 2 quarters of falling GDP.)  Let’s get ahead of the problem, and not change the definition only after an ambiguous situation shows up.  Do it now.

Prediction:  The world will see an increasing number of “phony recessions” in the 21st century—recessions with falling output but strong labor markets.  The Phillips Curve is now defunct; Okun’s Law is next.

PS.  I have a new piece at The Hill that actually praises the Fed for improving its monetary policy, and I suggest that this is why the current expansion is the longest in US history.  Of course with my luck you should now expect a recession within 12 months!  🙂

Seriously, I do say in the Hill piece that money continues to be too tight, and that recession risks remain elevated.  I see a roughly 30% risk of recession, which is too high.