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!

Canada: A Real-World Liberaltarian Model?

Here is a chart of Federal revenue as a share of GDP in Canada, posted by Livio De Matteo, one of the newer bloggers at Worthwhile Canadian Initiative:

Many a contemporary American libertarian dreams of the day when US Federal spending is confined to ~15% of GDP. However, in the real world this happens in a country that has a fairly robust single-payer basic health care system*, early-childhood-on education initiatives (a previous Conservative government even passed a fairly robust school choice plan that was subsequently killed by a Liberal government after 2 years), and a generally higher level of simple transfers. Some transfers don’t make a whole lot of sense, and kind of get caught in backflips, but nevertheless, there it is. Canada seems to take in ~15% of GDP in taxes, although there is a fit about the budget deficit, which is measured in the happy-go-lucky millions.

I think this lends some credence to the notion that I know Matt Yglesias and Kevin Drum are partial to. That is, ‘largely release people from sources of grave uncertainty (like spells of unemployment, extreme health care and education bills, etc., which can be done at a relatively cheap cost), and sensible market reforms become much more popular’. I can see Canada leading the way in replacing their income tax with a revenue-neutral carbon tax.

But there is a chicken-and-egg story here, as noted by Joseph Heath**:

…it is important to observe that this lack of a correlation [between redistribution and long-term growth of GDP per-capita per Peter Linder’s work] does not show that economic theory is false, that incentives don’t matter, and that government cna do whatever it wants. The lesson to be learned is exactly the opposite. One of the major reasons that big-spending governments tend not to be penalized by the market is that, due to their very bigness, they need to operate more efficiently, and they need to work harder to get incentives right.

The US government, by contrast, has a tax code that is seemingly designed, from the ground up, to keep tax accountants and attorneys employed. Our institutional structure is to blame for most of this, but our relatively low individual tax rates (compared to other rich democracies) enable it.

This is an important story since we’re wading into a battle between spending cuts and raising revenue. As I think about the issue more, I notice that few of my complains come from the entitlement state at all, and the ones that do are about the structure of programs, not the programs themselves. In contrast, I have major complaints about the revenue side of government, and still more major complains about the regulatory side of government (at the local, state, and Federal levels). I think a lot of self-styled libertarians or people who lean that way feel the same way. I don’t think that utilitarian redistribution is a bad trade for some of my other goals (which would likely uncomfortably expose certain segments of the population to the cold whims of the marketplace). How about you?

Note: Provincial spending in Canada pushes government/gdp up to ~32% vs ~28% in the US.

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*With the option of pursuing private insurance above and beyond. Not my preferred plan, but it seems work on average.
**Filthy Lucre, pp57-61

Are the Owners of Capital Doing Better?

I have been puttering around with some of the arguments from The Great Stagnation. One line that stood out to me went something like this

If the capital isn’t doing any better and labor isn’t doing any better then where is all of this supposed innovation going?

My knee jerk reaction was what about human capital. However, I decided to see whether or not capital was doing any better. One of my favorite measures the return to capital is the national dividend yield. That is, what portion of national income is paid out to the holders of US stock.

I was actually a bit shocked at the result. I had assumed that the rise in retained earning would mask some of the “real returns” to capital and that perhaps some of innovation was being sent down the tubes by a corporate bureaucracy that spent profits on empire building rather than paying them out to shareholders.

Yet, dividends as a percent of GDP are rising. That is the owners of corporations are getting paid out an ever larger share of GDP.

Part of this is because corporate profits as a percent of GDP are rising but it looks like significantly more corporate profits are actually going out of the door.

Here is dividends as a percentage of after tax corporate profits

Maybe this is coming at the expense of small business owners. Lets add in proprietors profits

Interesting. Well that warrants looking at Proprietors’ Profits on their own.

The fall in proprietors’ income up until 1980 seems to be the dominant story, the rise in dividends the dominant story after 1980.

Basically less and less on the nations income was going towards business owners until 1980 when that turned around, both for small business owners and the owners of corporate capital.

This is not a story of the owners of capital doing worse. Indeed, it might even suggest that workers wages were being boosted by the decline in income going to the owners of capital.

An obvious question is – what about interest? I am not sure how to deal with that. On the one hand those are payments to capital but they seem of the kind most likely benefiting the median household. If a working class family was going to save typically that would have been in some interest bearing vehicle.

Plus we have problems with teasing out money demand and inflation fluctuations. Though off the cuff I am not exactly sure how to treat inflation when thinking about these variables. It seems like it ought to matter even when normalizing by GDP.

A high inflation economy is one where a larger fraction of nominal GDP is paid out to bond holders to compensate them for loss in purchasing power. This in theory should depress profits. However, should it depress dividends and proprietors income after capital adjustments? I am not sure.

Don’t Stop That Growing Feeling

Jim Hamilton has a nice breakdown on all the positive signs for US growth. I even have a new presentation I am giving titled “Don’t Be Lulled into Fall Sense of Despair” that basically argues that if things go as planned the US economy will be growing steadily and so will profits and tax revenues.

All that having been said my worry is that this will cause the Fed to back off of its aggressive stimulus policy. The Fed should stay the course with QE2 and consider QE3.

As I have mentioned before, we are conditioned to think of 3 – 4% growth as strong. However, that is in a world where there are few slack resources. This is not our world. Our world has plenty of idle resources.

6% growth is not unrealistic. I urge the Fed to push towards that goal. High profits and growing government revenues are great but we need to put people back to work.

The Mankiw Rule for example doesn’t call for raising the funds rate above zero until the (unemployment rate – core inflation) rate drops below 6. Right now we are still above 7.5

Indeed here is what the Mankiw Rule says the Fed Funds rate should be

We are still deep into negative territory meaning that we need additional monetary stimulus above and beyond a zero interest rate.

As a side note, I would love to claim that QE2 is behind this increased growth but that is premature. The timing is right on, but we need more evidence before we can claim intellectual victory.

A strange model of the economy

Can someone explain to me a model of an economy where this makes sense?

For the economy, a slower increase in the population raises concerns about American competitiveness. But it could actually be a good thing. A number of economists, including the Federal Reserve Chairman Ben Bernanke are worried about the lack of inflation and income growth in the United States. Fewer workers could drive up salaries. What’s more, fewer new Americans might help slow government spending. That may curtail the rising US federal debt, which many think will soon cause interest rates to jump and hold down US GDP growth. “At a time of fewer government resources, fewer new people might not be such a bad thing,” says New Hampshire’s Johnson.

This seems very wrong to me. For one thing we have an aging population who we are going to need to support, and the less working age population we have to support them the more of a burden they become. Like a pyramid scheme you can’t permanently improve this situation with faster and faster population growth, but you certainly can make the situation worse by decreasing the number of working people per retired person. In addition, lots of government spending, like defense spending, is non-rivalrous public goods so that a higher the population means a lower the per-capita cost. I’m very curious to hear how Kenneth Johnson, the “population expert” from which this claim comes, sees per-capita government spending decreasing. Or perhaps he is talking only about total spending, but why should that be a concern?

Likewise I find his claim that lower population growth will drive up salaries to be confusing. After all one man’s salary is another man’s price, which decreases his real wage. Perhaps he thinks there are basically two types of people: skilled and unskilled. And that what’s really happening is population growth is decreasing in the unskilled which will make them more scarce relative to the skilled, and thus able to command a higher wage. I don’t find this very believable, either empirically or as a model for our economy.

Can someone explain to me a model where decreasing population growth raises real wages and decreases per capita government spending? I do not mean to be dismissive of Professor Johnson or his claims, but I am at a loss here.