Steven Landsburg. Is He Crazy?

I don’t think he is. I enjoyed his book, “The Big Questions”, and I even made a set of desktop images for him, which (if you’d like) I can send you the full sized images and you can use them for free if you enjoy them (p.s. I also do design work)!

In any case, his recent post has gotten play from Alex Tabarrok, Brad DeLong, and tonight, Noah Smith.

The only thing I find wrong is the fact that you can’t do economics from accounting identities. If you could, then Steven’s basic model would be correct, as a matter of arithmetic, and a matter of reality. To my mind, that is where you stop.

Start with GDP: Y = C + G + I + Nx. I think we can probably disregard Nx to make the model easier. In this case, consumption is constant, as the assumption is that our idle millionaire consumes zero at $84 million, and you can’t consume less than zero (even when dead!). In this case, we’ll hold C constant at $100. Now say G is currently 0, but the government sees a nice pile of money, maybe $84 million, sitting around in a bank account. Well, that money isn’t just sitting there, S (savings) is related to I in our GDP model! So assuming a quick 1:1 relationship between S and I, what the government is doing, in order consume $84 is reducing investment by $84. Assuming there is some sort of relationship between I and C, than in future periods, C will have to be reduced by a cumulative total of $84.

Of course, none of that is literally true. As I (and Noah) said before, doing economics from accounting identities leads to patently absurd conclusions. There are no concrete relationships between savings and investment. They are both dependent variables. Neither is there a concrete relationship between I and C. Both depend on other economic variables, as well. But, zero-sum accounting would get you this result.

But I think there is a deeper fallacy that Landsburg’s experiment falls into, and that is the myth of government as consumer. It is very common to hear in right-wing (usually non-economist) circles that the private sector produces wealth, and that the government produces nothing, it only consumes wealth that is generated in the private sector. The fact is that the state produces the exact same amount of wealth as the market. That is none at all.

The fact is people produce wealth, and people consume wealth. The state and the market are simply institutions which people have arranged to coordinate production and consumption. The socialist calculation debate was not regarding how the state stole wealth from the market, it was regarding the limitations of the state as an institution for coordinating economic activity. Corporations in-and-of themselves do not produce any wealth, either. The organization of a corporation is wealth enhancing, but that is only to the point that it is more efficient than other such arrangements that bring people together to produce and consume.

Per James Buchanan’s excellent analysis [JSTOR] of the political economy, the (tax and spend*) state is largely concerned with providing club goods, that is: goods that are largely non-rival, and at least partially non-excludable. So to assume away transaction costs, deadweight loss, and the like…in this simple model, a society is choosing to purchase some goods as the “club of everyone”, instead of as individuals. Consumption increases when the government steals “idle millionaire’s” money, and doesn’t decrease at all (assuming no effect on I, or rather, that he government’s investment produced a form of capital to substitute for direct savings) because the types of goods provided by the “club of everyone” wouldn’t necessarily be purchased by the individual, but individuals are (presumably) wealthier for having them.

Brad DeLong is actually correct (and this fallacy is what he is pointing out in his post, although he doesn’t explicitly state it). “We” are the state. Arnold Kling is also correct, “lose the we”…the catch is that he just wants a different arrangement of the provision of club goods. Kling is re-stating Milton Friedman’s sentiment when he said (paraphrasing), “I’ve never seen a tax cut I didn’t like”. Friedman was stating a preference for institutional arrangements, not a statement about consumption.

Note: This isn’t an argument that allows the government to run roughshod over “idle millions” sitting around. Our capital stock does determine investment in the long run. Savings do have a role in the economy. In a hypothetical situation, if the government can get a higher ROI from stealing a millionaire’s money from under his mattress, then society is richer. But if not; if the government simply determines that government mattresses are where money goes, society is no worse off, and if the government consumes goods or invests the money in a ridiculous fashion, then society is worse off.

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*I specifically point to the tax and spend state because the “tax to finance regulations” state is a completely different animal. And so you can see how you can get mislead by simple accounting identities!

Corroboration!

A while ago, I made a post which argued for reverse causality in the search for the source of the US’ widening income inequality. In that post, I made this point:

What is it that European countries do? Massive income redistribution. That may seem superficial, but it’s the answer that I’m most happy with. It has long been known to network theorists that competitive networks (with a return to scale to node connection) are characterized by power law distributions. This is a natural phenomenon; it happens in the blogosphere, the financial markets, in sports, and it happens in economies as a whole. Left to its own devices, it is inevitable that such networks will evolve an shockingly large disparity between the best-performing actors, and the mean actor.

Lane Kenworthy, who writes a lot about inequality issues, has a recent post on his blog (and a subsequent link to a longer article in a U of Arizona journal) which seems to corroborate the story I told above:

What about in an absolute sense? Would the incomes of low-end households have grown more rapidly in the absence of the top-heavy rise in inequality? If we look across the rich nations, it turns out that there is no relationship between changes in income inequality and changes in the absolute incomes of low-end households. The reason is that income growth for poor households has come almost entirely via increases in net government transfers, and the degree to which governments have increased transfers seems to have been unaffected by changes in income inequality.

I was probably subconsciously channeling my inner Kenworthy when I wrote the previous post, as I read his blog sporadically. If I had it my way, the discussion would break along three lines:

1. Wealth Inequality.
2. Income Inequality.
3. Consumption Inequality

And on three lines, we would be able to analyze poverty. What would be the value in this? We would more easily be able to define public policy on narrower grounds. For example, wealth distribution is always going to be sharply unequal. People with higher incomes relative to consumption will always be able to amass more wealth than lower income groups (wealth meaning savings + assets, wealth is something I think many people conflate with income). However, what is the best policy for addressing this aspect of the problem? Simple income transfers won’t work alone, we need to incentivize intergenerational savings among the poor. In that light, Social Security is not the most optimal program, as it discourages savings.

I tend to not really focus on income inequality, but it does feed into the more important aspect (in my view); consumption inequality. Are poor peoples’ consumption patterns keeping up with what we as a society would consider some measure of a “quality” standard of living? Are they able to afford necessities like electricity, HVAC, food, and medical care? If not, this is where we get to fiddle with income in my most preferred way (and the way which allowed other countries’ poor to keep up with growth): simple transfers. Look for efficiency on the supply side, but on the demand side, just augment income. This could be in the form of a universal deduction for income under a certain level, or cash or voucher transfers. It is relatively cheap and easy to structure these transfers in a way that incentivizes future-time orientation…indeed, that is what the Mexican organization Opportunidad does.

I realize that democracy is much messier than this, but it is something to work toward. The welfare state need not be cumbersome…indeed, the US is unique in the world in the inefficient ways it implements a patchwork system. Canadian Philosopher and pop-economics writer Joseph Heath has said that the US government gets away with it because we don’t redistribute a whole heckuva lot of income…but as that enterprise grows, we’ll inevitably have to address our abhorrent inefficiency issues.

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Addendum: Lane Kenworthy has also done some good work on the question of measuring poverty and material wellbeing, so check that out as well. Seems the real barrier to constructing a time series from this data is that it doesn’t go back far enough to create a reliable measure of wellbeing over time.

Education as consumption

Over at Econlog, Bill Dickens is trying to convince Bryan Caplan that signaling does not explain the majority of the value of higher education. Two of his reasons why education is productive is that is has a value as a consumption good, and as consumption capital:

2. Education is a consumption good. This should be self explanatory. At the margin school may be work, but infra-marginally at least some (if not most) people actually enjoy the reading, the lectures, the homework, etc.

3. Education is not just investment in work capital, its also an investment in consumption capital and social capital. I feel much more  at home in the world due to the fact I understand certain cultural references… The  shared culture produced by the education experience expands our common  language with a lot of meaning, and that produces huge network  externalities. Knowing history does help me do my job, but it is much  more important that it allows me to make analogies that will be  understood by acquaintances.

As an explanation for why people value college, this has some appeal. As an explanation for why college has a social value, I think it’s a pretty weak defense. Grant for a moment that it is entirely factually correct, is there any reason why this should be subsidized?

For the first thing this is a terribly regressive subsidy, primarily benefitting people with above average ability and wealth. Second, if the goal is to increase “social capital” for consumption purposes this is probably the least efficient way to do it. The money would be better spent subsidizing high-minded TV shows that make audiences more literate and cultures, or providing grants for creating and broadcasting informative documentaries or books that are catered towards people who normally wouldn’t watch them or read them. You would almost certainly generate more consumption capital and welfare by providing free subscriptions to the New Yorker ($40) for 175 households than a year in college ($7,020) for one person, and it would cost the exact same.

I’m not defending the signaling theory, Bill Dickens’ theory, or any other theory of education as a matter of fact. But proponents of more education investment should not look to Dickens’ criticisms of the signaling theory education, because even if he is right education is still way oversubsidized.