Unpacking the Decoupling Tautology

A couple of weeks ago, Lane Kenworthy asked, "Is Decoupling Real?" I've got another question: "is decoupling a tautology?" Laneworthy was referring to the gap between median family income and per capita GDP in the U.S. Along much the same lines is the chart below produced by the Economic Policy Institute's State of Working America, which compares median family income and productivity growth.

The Sandwichman is concerned with another kind of decoupling -- the much touted decoupling of energy consumption from GDP growth that technological optimists like Amory Lovins promote as the solution to environmental impact and resource exhaustion problems. Relative decoupling of energy consumption per dollar of GDP is a well established fact. What is in dispute is whether that can be translated into absolute decoupling through imminent technological breakthroughs.

The short answer is: it can't. The slightly longer answer is it can't because even the relative decoupling that has occurred over the last 39 years is questionable. Oh, there's no doubt that energy consumption per dollar of GDP has fallen; what's questionable is the composition and distribution of that growing GDP.

Even at the aggregate level, there is the question of the increasing proportion of economic activity that needs to be devoted to repairing the damage done by previous economic activity -- cleaning up toxic spills, recovering from extreme weather events, etc. This is what Stefano Bartolini referred to as negative externalities growth and Roefie Hueting called asymmetric entering. This is a kind of decoupling of GDP increase from any meaningful notion of expanded or improved utility. It is just running faster on a treadmill.

But that's not all. There is also the question of distribution and even the possibility that the growing gap between GDP growth and median incomes is a structural imperative. Now, by "structural imperative" I don't mean something that can't be changed -- only something that isn't going to be budged by moralistic pronouncements about fairness. To show what I mean by structural imperative, I would like to share a composite chart that integrates the data from the EPI productivity and median income chart above and data comparing the energy intensity of GDP to the energy intensity per hour of work. I have added an inverted productivity series (black dotted line) for reasons that will become clear as the narrative unfolds.

Sources: U.S. Bureau of Labor Statistics, Energy Information Agency, U.S. Census Bureau

The first thing that becomes clear from this chart is that productivity, median income and the energy intensity per hour worked tracked each other closely from 1949 to 1973. The latter year was chosen as the index year because energy intensity per hour of work peaked in that year. After 1973, energy intensity per hour of work declined for about ten years and then remained virtually flat up to the present. Productivity and Median Income diverge after 1973.

The inverted productivity series now presents a clue as to what exactly is being "decoupled" in all this decoupling. With productivity defined as GDP per hour worked, inverted productivity is hours worked per unit of GDP. Before 1973, inverted productivity appears as simply the mirror image of productivity, median income and energy intensity per hour worked. After 1973, though, it tracks energy intensity of GDP, while the stable energy intensity of hours worked can be understood as the axis around which productivity and energy intensity of GDP rotate and reflect one another. For all intents and purposes, then, one could say that "energy intensity of GDP" is a statistical tautology, which itself, prior to 1973, performed as the axis around which productivity growth translated into steady gains in median income.

Correlation does not imply causation. Sometimes, however, it reveals a hidden tautology. Hours, energy consumption, income and GDP are inputs and outputs of an economic system that transforms some of those into some of these. The inputs don't cause the outputs any more that cattle "cause" beef, they're just different names for the same thing in a different state.

The indexes I have plotted in the graph are ratios between inputs and outputs (productivity and energy intensity of GDP) or inputs and other inputs (hours of work and energy consumption). Median family income can be thought of as a circular ratio of inputs and outputs in which both income and the family can be viewed alternatively as either outputs or inputs -- income provides sustenance for the family; the family supplies labor to industry in return for income and so on.

Ratios between inputs do not wholly determine ratios between outputs or between inputs and outputs. Policies do that. But the quantities of outputs are constrained by the quantities of inputs. It is thus necessary when examining the energy intensity of GDP, for example, to ask what is happening with the other inputs and the other outputs.

In closing, I would like to present a third chart that compares the growth of population, labor force, employment and hours worked in the U.S. from 1950 to 2009.

When I initially chose employment as the numerator of an alternative index, I was aware that there was a rough coincidence with total population and thus would be similar to a per capita energy consumption index but would smooth out some of the cyclical variations. Aggregate hours of work presumably performs this smoothing function even more precisely. For the last fifty years, though, the growth in employment, labor force and aggregate hours has been steeper than population growth, with hours reaching a peak in 2000 of nearly 30% more per capita than in 1961. Employment as a percentage of total population peaked in 2008, even though labor force participation peaked in 2000 because the later ratio considers only the population 16 years and older.

Follow the Honey

There is lots of buzz (sorry) about a pair of just-published articles that provide further evidence that the colony collapse disorder, which is decimating bee populations around the world, can be at least partially attributed to neonicotinoids, one of the most widely used of pesticides. There has been a lot of controversy around this class of agents, and they are banned or restricted in much of Europe—but not in the US. In the writeup in this morning’s New York Times, after a brief summary of the new research, we get this paragraph:

Outside experts were divided about the importance of the two new studies. Some favored the honeybee study over the bumblebee study, while others felt the opposite was true. Environmentalists say that both studies support their view that the insecticides should be banned. And a scientist for Bayer CropScience, the leading maker of neonicotinoids, cast doubt on both studies, for what other scientists said were legitimate reasons.

There followed comments from four of these outside experts. One is from the main producer of neonicotinoids; he thinks the studies are flawed. Another is from the US Department of Agriculture, who thinks the studies shift the weight of research against the pesticide. The other two, both from academia, were evenly balanced, one finding the studies persuasive, the other not.

In other words, the article is a he-said, she-said about pesticides and colony collapse, which relieves the author from having to express his own judgment. Worse, there is no indication whether either or both of the academics have received funding from pesticide manufacturers. Research in entomology and ecotoxicity is expensive, and much of it is funded by industry. Being on the receiving end of pesticide dollars does not invalidate a scholar’s argument, but it is certainly relevant information for nonspecialists who want to know who to believe.

This is an interesting topic for me, because economics has the same problem: a lot of academic, not to mention think tank, economic researchers are funded by business interests with a stake in what their research shows. They present their views to the general public, but rarely with a disclosure of their own interests: the Inside Job problem.

I have two recommendations. First, there should be a public registry, for bee researchers and economists alike, that records any substantial funding they may have received from private individuals or organizations. Journalists should be able to look up this information online and include it in their reports. Professional organizations, like the AEA, should iron out the details and monitor compliance.

Second, journalists have to graduate from the duelling quote game. The only alternative is to write stories that explain, in terms that the public can understand, what the substantive issues are in scholarly disputes, and why some experts go one way and others go another. If a journalist does not have the expertise to do this herself, she should outsource the work to a panel of experts. Their job is not to take sides but to explain, as clearly as possible, what the root basis of the disagreement is, so that readers can understand the points on which the argument turns. In this scenario the job of the journalist is to put together the panel and use her writing skills to make their analysis clear to nonspecialists.

Year by year, more of the issues that democracy has to deal with are technical in nature. Journalism is the indispensable intermediary between arcane knowledge and popular debate. The job isn’t being done very well right now.

EU, How About a Public Option for Mobile Phone Users?

The EU has chosen to continue its system of price controls on mobile phone roaming and internet services.  Isn’t there a simpler way?  Why not create an EU-wide public enterprise to provide connectivity under the condition that it cover its cost of capital, and then let private firms compete with it?  If they can overwhelm the public entity with a great burst of innovation, fine.  If not, too bad.  Doesn’t this make more economic sense than trying to micromanage the price structure?

A Puzzler on Statistical Risk and Fundamental Uncertainty

Let’s compare two situations. In situation A there will be a coin toss. The coin is known with complete certainty to be fair. The odds are obviously .5 that it will come up heads and .5 that it will be tails.


In situation B there will also be a coin toss, but in this case we have no information whatever regarding the fairness of the coin. It could be rigged to always come up heads or tails, or it could be biased toward one or the other, or only in windy weather, or who knows. We don’t. What are the odds? With only two possible outcomes and no reason to expect either to be more likely than the other, it is still .5 and .5.

And that’s the puzzler. Does it really make no difference at all whether we know the true odds? From a decision point of view, are situations A and B effectively the same?

Although this is a greatly stripped-down puzzle, it contains the core of the risk vs uncertainty problem. Consider the typical problem faced by a firm of whether to make an investment. There are many possible outcomes of this investment, and its profitability will be affected by events we may not even conceive of in the present—the so-called unknown unknowns. Nevertheless, if the firm has a hurdle rate of return, its decision will boil down to whether it thinks the expected return is above or below the bar. In situation A it is able to calculate an expected rate of return with full confidence, in situation B with partial, and perhaps very little, confidence. Again, from a decision perspective, is there any reason for the confidence of the expectation to matter? Note that, in the absence of relevant information in situation B, there is no reason to expect the variance of the ROI to be greater or less than in situation A.

Did I mention that this is a tremendously important topic not only in macroeconomics, but also in areas of micro like the justification for the precautionary principle?

Is there a literature that frames the problem this way? I haven’t seen it, and I would be very happy if someone could lead me to it and allow me to achieve enlightenment, since this puzzle has kept me awake off an on for years.  (But I have chipped away at it and even published a paper on it a while back...)

If The Supremes Say No To Obamneycare, Then Go To Single Payer

So, the US Supreme Court seems likely to reject the individual mandate in Obamneycare, which would bring down the entire Affordable Care Act, even though the individual mandate was cooked up by the Heritage Foundation and was long the favored Republican plan, emphasizing using private insurance companies and individual responsibility not to be freeloaders on the system.

So, if the Supremes say no, just do what Teddy Kennedy proposed: expand Medicare to the entire population. This takes care of it, and we can get rid of Medicaid as well, which is increasingly an insufferable burden on the hard pressed state budgets (reminder that last year it was state and local governments that were laying people off to balance their budgets, the main source of rising unemployment in the US economy). So, go to single payer, which was better all along anyway.

Time To Lock The Gun Nuts Up In The Looney Bin

US society has been caving and kowtowing to the NRA for some time now, with Dems terrified to stand up to them over anything. Guns in bars, churches, schools, you name it, and then the obnoxious and insane "Stand Your Ground" laws that have been widely passed. We have now seen the fruits of this in Florida where it is not just the awful Martin-Zimmerman case, but a tripling of these sorts of homicides. The old manipulations of data by sock puppet John Lott are no longer able to cover up the truth: encouraging wider availability of guns leads to more people getting killed by them. Time to lock the lying gun nuts into the looney bin.

Debt, Income and Aggregate Demand: Scoring Krugman vs Keen

Not having learned from my earlier foray into MMT-land, I’m at it again, sucked into a debate between Paul Krugman and Steve Keen over how to think about debt, money and macroeconomics. It is remarkable that these questions could still be unresolved after eons of economic theorizing; this stuff is not very complicated, after all. Someone has to be right, but who?

Keen argues that mainstream economics is wedded to a false conception of what banks are and how they operate. According to conventional wisdom, people who earn more than they spend puts their savings into banks, and the banks turn around and lend this money to others who wish to spend more than they earn. The result is a wash: banks are simply intermediaries who play a role in the distribution of financial resources but not in their quantity. This view recognizes that money is created through the process of credit creation, but (1) the total volume of new money is given by the money multiplier and therefore reflects choices made by the central bank (M is exogenous), and (2) the amount of money in circulation influences aggregate demand via its impact on interest rates—beyond this, more money just raises the price level. For more detail, consult IS-LM.

Keen says this is all wrong. Banks don’t lend because someone has deposited, they lend because they have found a profitable lending opportunity. In the aggregate, credit creation is also deposit creation, since a portion of the new money eventually finds its way back into the banks, and banks borrow and lend between one another to meet their reserve requirements. But it is lending that leads, not saving. This is seen is a refutation of the “loanable funds” doctrine. Meanwhile, financial resources acquired through borrowing support the demand for goods and services just as effectively as income; thus aggregate demand is a function of the sum of the two, and not just income alone. Unfortunately, to add Minsky into the equation, people and businesses do not borrow only to purchase newly produced goods (including investment goods), but also to speculate on existing assets, thus bidding up their price. Borrowing in this fashion is inherently a Ponzi activity in the aggregate, and the perception of rising asset values in good times paves the way for a wave of insolvencies in the bust.

To sort this out, it may help to be a bit schematic. Let us say that there are three time periods of arbitrary length, and let’s tell two stories. The first is the orthodox (O) story: See, a guy walks into a bank and…..deposits some money, say $100, into his account. That’s period 1. In period 2 the bank lends $90 of this new-found cash to individual #2, taking care to hang on to a required 10% to meet its reserve requirements. In period 3 our borrower spends the money on something, generating income for individual 3. We could go on, but you get the point. This story can be found in any introductory textbook you might care to (or be required to) read. The upshot is that, at the end of period 3 there is $90 in new money, created by lending, and $90 in new income as well, accounted for by individual #3. Individual #1 is a creditor to the tune of $90, individual #2 is a $90 debtor, and the bank is simply an intermediary, with both its asset and liability columns up $100. (Assets: $90 in loans, $10 in reserves. Liabilities: $100 in deposits.)

So what might be the Heterodox (H) story? In period 1, a guy walks into a bank and….asks for a $90 loan. The loan officer figures the default risk is covered by the interest rate, so she extends it. In period 2, the borrower buys something from individual #2, which was the purpose for going into debt. In period 3, individual #2 deposits some of this new revenue in the bank. It happens that period 3 is also designated as a point at which the bank must meet its required reserve ratio. It could be that they will have extra reserves to lend out, or that they will have to borrow from some other bank that has reserves to spare. One way or another, they settle up. What is the result? There is $90 in new money, $90 in new income, one individual is a $90 creditor, another is a $90 debtor, and the bank’s books are balanced.

So the H story is beginning to look a lot like the O story. This should not surprise us, since mainstream theory comes close to endorsing Keen’s pronouncement that “aggregate demand is income plus the change in debt” (italics in the original). You can see this directly in the national income accounts: the sum of expenditures is equal to the sum of income plus net saving or dissaving. Obviously there can be net saving or dissaving only in an open economy with a current account imbalance. The reason I use the word “close” is that this identity holds for expenditures, but expenditures equal aggregate (desired) demand only in equilibrium. In textbooks you see this with some variables having an asterisk (equilibrium) and others not.

Is this a tempest in a teapot? I’m inclined to say, partly yes, but not entirely. I think it does matter, perhaps a lot, what sequence these three activities—borrowing, spending, and saving—occur in. A world in which investment and growth are driven by perceived profit opportunities is different from one in which they are the passive result of prior decisions to not spend. The first is a Keynesian, and also a Schumpeterian, world; the second is the world of monetary orthodoxy. Similarly, money really is more endogenous in the H world, since financial commitments are, in general, made first, and then monetary authorities have to deal with how much to accommodate them, especially if the banking sector finds itself spread thin. (I have a similar view of how trade and international finance work: first people decide how much they wish to import or export, and then holders of currencies have to figure out how to manage the accumulations and decumulations of foreign exchange.)  Same dance, same partners, but it matters who leads.

So in the end I think there is a real and important difference, but I don’t think it shows up at the level of accounting. For what it’s worth, I will be at the Berlin conference that Steve is speaking at, and I look forward to meeting him. I doubt I will get involved in any brouhaha over this, since I’m basically a micro guy, and I just want to figure this out to reduce my general level of confusion.

Former Chancellor Levy Says Profs Should Work More

OK, I am steamed. It is bad enough when someone is misrepresenting facts, but when they add hypocrisy on top of it, this is really annoying. This is the case with the latest push for bashing faculty, in this case calling for increased teaching loads without any salary increases, all supposedly to reign in rising tuition costs. I fully agree that rising tuition costs are a serious problem in US colleges and universities, but the problem has much more to do with rising spending on administrators and staff than faculty, and this latest blast from David C. Levy, former Chancellor of "New School University" (back to being the New School of Social Research now) in the Sunday Outlook section of the Washington Post, "Do Professors Work Enough?" is the worst, with its focus on faculty and no mention whatsoever of his fellow administrators and other spongers.

So, he provides no evidence of falling faculty workloads (and none exists because they have not), but wants people teaching four course loads to go to five course loads in teaching oriented schools and to teach during the summers as well, apparently on a mandatory basis, whether or not students want to attend during summers. In short, he wants to turn our colleges into high schools. A sentence that shows how weirdly fixated he is follows: "Since faculty salaries make up the largest single cost in virtually all college and university budgets (39 percent at Montgomery College), think what it would mean if the public got full value for these dollars." Yeah, wow, just think of it. Here I thought he was going to trot out something like 70%, and instead we get 39%. So, what is the other 61% being used for? Obviously administrators, staff, books, and maybe sports (at my uni the highest paid individuals are the basketball coach and football coach, even though the athletic program is not a net money earner, which is true for all but about 20 schools in the US). As it is, one could fire a quarter of the faculty at Montgomery, increase the teaching load of the rest by a third, and manage to reduce tuition by, wait for it, 8%! Wow.

So, let us get at what is the real problem, completely ignored by this former high level university administrator. According to the New York Times of 12/5/11, during the decade 1999/2000-2009/2010, salaries for presidents at the 50 wealthiest universities rose 75%, while professorial salaries rose 14%, http://www.nytimes.com/2011/12/05/education/increase-iin-pay-for-presidents-at-private-colleges.html .

Nor is this just a matter of the salaries going up for people like Levy way more than for faculty, it is that the numbers of these parasites has also risen dramatically relative to faculty across the board (so that the 39% figure is not all that surprising, although we tend to think that faculty are doing most of the educating at colleges and universities, not the administrators and staff). So, between 1975 and 2005, while total spending on higher ed roughly tripled in constant dollar terms, student-faculty ratios remained about constant at 15-16, administrator-student ratios went from 84 to 68 and staff-student ratios went from 50 to 21. From 1998 to 2008, while faculty spending rose 22%, admin and staff spending rose 36%. From 1965 to 2005, while the number of faculty rose from 446,830 to 675,000, the numbers of administrators and staff rose from 268,952 to 756,405, http://www.washingtonmonthly.com/magazine/septemberoctober_2011/features/administrators_ate_my_tuition031641.php .

Really, I do not know if this guy Levy, now supposedly president of something called "the education group at Cambridge information group," is as seriously ignorant of these facts as he appears to be, or if he is just supremely hypocritical in ignoring the explosion of spending for his type of person in the higher education firmament. But, the push going on for putting faculty in their place by people like this is simply despicable. I must grant that Levy disavows such advocacy by "the political right [who] have been associated with anti-labor and anti-intellectual values," but this looks pretty empty given that earlier in his piece he singles out the "advent of collective bargaining in higher education" in the early 1970s as a main soure of the supposedly rising salaries of the supposedly wickedly lazy faculty he condemns.

I shall conclude with one more source on the bottom line statistics here, which puts to shame his jibe about collective bargaining. These come from the National Center for Education Statistics as reported by Mark Perry at http://mperry.blogspot.com/2009/08/college-tuition-increases-and-faculty.html . So, between 1978 and 2007, while tuitions rose 7.9% per year, faculty salaries rose just barely faster than inflation, 4.5% per year against the CPI at 4.1% per year. Somehow Levy never bothered to notice or cite such numbers in his ridiculous screed. I sincerely hope we do not see too much more of this sort of drivel from this sort of person.

Greg Mankiw Admits a Political Operative Into the Pigou Club

Via Greg comes some odd piece by Jim McTague:

President Obama habitually made the superhero boast, especially in regard to his energy policies. Consequently, now that pump prices have topped $4 in many parts of the country, he finds himself tangled in his cape, with his approval ratings several points below the crucial 50% deemed necessary for re-election. This is a campaign crisis for the president, which is why he is focusing so much of his time on it, including two solid days last week. Obama's mistake was to advertise himself as a hi-tech guru with the added, superhuman ability to manipulate market forces to create a green-energy utopia where batteries, algae and solar cells would replace climate unfriendly fossil fuels like coal and gasoline. His lengthy litany of powers included the ability to raise the cost of these dirty fuels to reduce their pricing advantage over renewable energy. He harped that this was desirable and necessary. The political imprinting worked better than our president ever imagined. Now that gasoline prices are pinching pocketbooks, the public expects Obama to exercise his superpowers and manipulate prices lower. Protestations by Obama that market forces beyond his control are setting the prices are greeted with disdain rather than sympathy.

McTague does go onto to praise Greg:

Harvard University economist Greg Mankiw, currently an advisor to GOP presidential hopeful Mitt Romney, has long been an advocate of a $1-per-gallon gas-tax hike phased in over 10 years (Romney won't countenance the tax). Absent the tax, politicians resort to crazy, Obama-like schemes to achieve the same end of reducing our dependence on foreign oil supplies. MANKIW PRESCIENTLY STATED during a 2006 interview conducted by CNBC's Larry Kudlow that the alternative to a simple gas tax is "an energy policy that looks like it was created in the Kremlin." "An alternative in Washington to gas taxes," he said, "is very heavy-handed regulation that's extraordinarily intrusive and not particularly effective. Things like CAFE standards"—the fuel-efficiency rules that auto manufacturers are required to follow—"and biofuel mandates are tremendously regulatory. The gas tax is really the least invasive way of getting toward our energy goals." In an Oct. 20, 2006, op-ed piece in The Wall Street Journal, Mankiw said higher gasoline taxes would be the least invasive way to reduce pollution and highway congestion. The tax would encourage manufacturers to make fuel-efficient cars and eliminate the need for bureaucratic mandates. Mankiw estimated in his 2006 article that tax revenue would amount to $100 billion a year, which could be used to lower the deficit.

OK – a little credit may have been due this silly op-ed for noting that Romney has not endorsed Mankiw’s tax except for the claim by McTague that “oil men don't have a knee-jerk opposition to such a tax”. McTague also seems to have missed this account of how Romney used to support the same eco-friendly positions that McTague ridicules.

To be honest – I had no idea who Jim McTague was until I found this:

I have little respect for journalists like Larry Kudlow and Jim Mctague who are merely right wing, Republican, political operatives masquerading as financial journalists. Since they are mere mouth pieces for industry groups, and self interested big business, who knows what financial incentives they receive? I have more respect for prostitutes, at least they’re upfront about what they do.

My only problem with this last blog post is that it claimed Kudlow used to be an economist.

Cochrane Confuses Keynesian and the Laugher Crowd

Noahpinion catches John Cochrane making a little sense:

Austerity isn't working in Europe. Greece is collapsing, Italy and Spain’s output is declining, and even Germany and the U.K. are slowing down. In addition to its direct economic costs, these “austerity” programs aren't even swiftly closing budget gaps. As incomes decline, tax revenue drops, and it is harder to cut spending. A downward spiral looms.

Alas, Cochrane switches to his usual rant criticizing fiscal stimulus, which Noah ably takes down. But let’s focus on this:

Economists have been arguing about whether this “multiplier” is more or less than one; five is beyond any reported estimate. Keynesians made fun of “supply siders” in the 1980s, who made similar claims for tax cuts. At least those cuts had incentives on their side, which stimulus doesn't.

Mark Thoma had a similar concern. I wish Cochrane had read this post and how Mark resolved his concern:

The people making the claim about government spending are careful to note that it only applies to very depressed economies

Art Laffer was claiming that tax cuts pay for themselves even if the economy were at full employment and even if the Federal Reserve was setting interest rates well above zero. In case, Cochrane does not realize that interest rates today are a far cry from what they were during the 1980’s, here’s a graph of Treasury bill rates.

Is The West Shooting Itself In The Foot With Iran Oil Sanctions?

Juan Cole describes a translation from a questionable web source, Javan, of the Iranian Revolutionary Guards, who claim there was a summit of intel analysts from the US (CIA), Israel (Mossad), UK (MI6), Germany (BND), and France (DSGE) on March 20 in Stockholm in which they supposedly discussed how Iran has gained $3 billion in revenues from the higher oil prices due to the sanctions against Iran, which supposedly have failed to reduce Iran's oil sales all that much, and of course are hurting the western oil-importing countries, http://www.juancole.com/2012/03/western-intelligence-analysts-worry-that-iran-sanctions-are-hurting-west-irgc.html .

One must suspect that even if the reported meeting took place and that the claims about what has been reported are at least somewhat accurate, that this may be a report intended to understate damage to the Iranian economy and an effort to discourage the sanctions. The issue seems to be Iranian inflation, which has almost certainly accelerated due to the substantial devaluation of the Iranian rial that has happened since the sanctions began being imposed. Indeed, the translation does not deny that this is the case. Rather it says that this does not matter politically or stategically in that the March 2 Majlis election has already passed with pro-Khamenei supporters winning solidly and with the Iranian public supposedly convinced that the increased inflation is strictly due to domestic causes. Even if they are not so convinced, there is reason to believe that the response of the Iranian public, even those critical of the government, is to be angry at outsiders for imposing the sanctions, with much past evidence to support such a view.

Another matter in the translation is that there was reportedly a split at the meeting, with the European nations criticizing the US and Israel, with the German BND being particularly incensed over the negative impact of rising oil prices induced by the sanctions. Supposedly it was decided that the UK should engage in an expanded propaganda effort in Iran to convince their public that the higher inflation there is caused by the sanctions (as if this will do much).

What should be noted here is that even if the report is seriously flawed, this fits in with an ongong theme of intel agencies in western countries being far less enamored of and supportive of the vigorous anti-nuclear-Iran efforts being pushed by most of the media and politicians. In the US, a solid majority believes Iran is actively pursuing a nuclear weapons program, even though all 16 US intel agencies in the latest NIE on this subject agree that Iran is not actively pursuing nuclear weapons (although it may be pursuing a potential capability to pursue them). Less reported than the NIE report is the fact that Israeli Mossad completely agrees with this assessment as well, even though the disjuncture with Israeli politicians is much greater than is the case currently in the US, with the Israeli leaders pushing for an attack, even against public opinion in Israel, which may be more negative on that than public opinion in the US.

Although it is possible that this report is simply bogus propaganda from the Iranians (and that no such meeting in Stockholm occurred or had very different results than reported), it remains that like most sanctions programs this one is probably not as damaging as many think and certainly does have a damaging feedback on the oil-importing countries still struggling to come out of the depths of the past recession, with these sanctions basically pointlessly directed at a nonexistent nuclear weapons program (and Iran's actual nuclear activities completely legal under the Nuclear Non-Proliferation Treaty of which it is a party).

Bankers Who Can’t Live Without Multi-Million Salaries

J.P. Morgan was a bit sloppy in their salary offer to Kai Herbert:

The original contract said Herbert’s annual pay would be 24 million rand ($3.1 million). JPMorgan blamed the mistake on a typographical error and said the figure should have been 2.4 million rand, according to court documents.

Herbert is now suing after he realized that he’d make a mere $300,000 a year. As the attorney for J. P. Morgan noted:

How can you possibly suggest that they would pay you so much money for an executive director level job?

This strange story alludes to this lawsuit:

More than 100 bankers claim Commerzbank AG broke a pledge by Dresdner Bank, which it bought in 2009, to set aside about $516 million for bonuses and are asking a U.K. court this week to order that they be paid. In the trial, scheduled to begin Jan. 25 in London, the former Dresdner bankers seek about 50 million euros ($64.5 million), with individual payouts of as much as 2 million euros ... Commerzbank bought Dresdner in January 2009, even though it was forced to seek an 18.2 billion-euro bailout from Germany during the credit crunch. A month after the deal was struck, Blessing had to defend the acquisition when Dresdner posted a full-year loss of $8 billion.

During the Great Recession, these bankers insist they are entitled to 7-figure compensation!

The Lovins Paradox: "this old canard"

Amory Lovins has responded to David Owen's commentary at the New York Times on "Efficiency’s Promise: Too Good to Be True." In his Times comment, Lovins cites his complete response at the Rocky Mountain Institute blog, wherein he asserts: "There is a very large professional literature on energy rebound, refreshed about every decade as someone rediscovers and popularizes this old canard."

Now, "this old canard" -- the Jevons Paradox -- is based explicitly on an even older canard the Sandwichman has dubbed the "Rasbotham rebound", the truism opposite to the so-called lump-of-labor fallacy. Although he may not be aware of it, in trivializing the Jevons Paradox, Lovins is implicitly trivializing the Rasbotham rebound as well. So, in effect (as many economists would claim) he is embracing the lump-of-labor fallacy. You cannot categorically reject both the Jevons Paradox and the lump-of-labor fallacy because the two are diametrically opposing principles. If "A" is absolutely false, then "B" is absolutely true. However is "B" is absolutely false, then "A" is absolutely true.

There is, however, a third possibility, which is that both "A" and "B" are only conditionally true. They are true in some circumstances but false in others. In that case, their relative importance vis a vis each other can only be gauged in context. It is not sufficient to find circumstances where "A" is true and other circumstances where "B" is false. One must examine the relationship between "A" and "B" in a given circumstance. Or -- to bring it back to the language of energy efficiency, energy consumption and employment -- one must look specifically at the energy intensity of employment, not the energy intensity of GDP or the micro-level effects of energy efficient light bulbs on the demand for lighting.

The Lovins Paradox thus can be stated as: even if Amory Lovins is right about the Jevons Paradox (or rebound effect) being an "old canard", the implications for energy consumption are troubling because of the intricate linkage between energy consumption and employment. In other words, dispensing with the rebound still leaves us with what David Owen calls The Conundrum (see video embedded below). The following chart compares the energy intensity of GDP in the U.S. with the energy intensity of employment (energy consumption per worker). The green line shows the index Lovins likes to cite, energy intensity of GDP from 1949 to 2009. The blue line shows energy intensity of employment in the U.S. for the same period. The red line shows the energy intensity of the labor force (because employment data is not available) for the world from 1980 to 2006.

Sources: World Bank, U.S. Bureau of Labor Statistics, U.S. Energy Information Agency

World energy intensity of employment in 2006 was around five percent higher in 2006 than it was in 1980. This is not an improvement, not even a relative improvement.

Bankrupt Rhetoric

I woke up this morning to Paul Ryan, describing his budget proposal, as quoted in the New York Times: “This is about putting an end to empty promises from a bankrupt government.”

Bankrupt government?  Let’s consider this more closely.  The normal meaning of bankrupt is negative net worth, as when your liabilities exceed your assets.  By this standard, the US government is hardly bankrupt, since it has enormous hard assets and an even larger soft one, the legal right to tax the income, transactions and property of all individuals and organizations subject to US law.  We should all be so bankrupt!

So I guess Ryan is not using the normal business meaning of the word.  Perhaps for him bankrupt means having negative earnings over some period of time.  Here is the federal government’s fiscal record since 1929:

So during what periods has the federal government been “bankrupt”?  During every year when outlays exceeded revenues?  That would include nearly all of modern history since the 1960s.  Or when the fiscal deficit exceeded, say, 5% of GDP?  That’s a smaller time frame—basically the past few years since the financial crisis hit and WWII.  But if the government is bankrupt now, how bankrupt was it in the days of FDR and the struggle against Germany and Japan?  And what does it mean to be bankrupt if the US could be really, really bankrupt in the 1940s and then bounce back to fiscal health almost immediately as soon as the troops came home?

And if the US government is bankrupt today, how come it can raise money at approximately a zero real interest rate?

And on a philosophical level, how does Ryan measure the financial health of government when its purpose is not to make itself rich but to support the prosperity of everyone else?

My translation of the way Ryan uses the word “bankrupt” would be “I want to scare everyone about the current fiscal deficit, and the best way to do it is to use a business-sounding term that has no meaning at all in this situation and hope that the public, and especially the journalists, are too dumb to notice.” 

What Did He Say?

The Los Angeles Times has an article about a campaign to get Pete Seeger, now a vibrant 92 years old, back on the Billboard charts.  (Hat tip An Overgrown Path.)  Toward the end I stumbled onto

Arlo Guthrie, at a tour stop in Oklahoma City, Okla., last week on his way to a centennial concert salute to his father, said he had recently invited Seeger, with whom he toured on and off for three decades, to join him for a show, but Seeger declined. 

“Pete said, ‘Arlo, I can’t play as well as I used to play, and I can’t sing as well as I used to sing,’” Guthrie told the audience. “I said, ‘Pete, have you taken a look at your audience lately? They can’t hear as well as they used to hear!’”

The Post-Privacy Era Has Already Begun

You don’t have time to read this long, sober report on the National Security Agency’s program to capture and analyze all data on planet earth, but you should anyway.  The author is James Bamford, the generally recognized authority on the US intelligence establishment.  Thanks to Naked Capitalism for linking this.

Neoliberalism Hits a Speedbump?

The Wall Street Journal has an interesting article today, which begins, " More Asian governments are pressing businesses to hike wages as a way to prevent outbreaks of labor unrest, raising the specter of higher manufacturing costs for global companies -- and the products they sell world-wide."

The problem is that people in Asia lack the necessary naiveté to make capitalism work efficiently; i.e. to maximize exploitation.

"Political leaders say they have little choice but to act, as voters grow savvier about wage gains" elsewhere, which they can research on the Internet. Recent protests by low-income workers in places like Indonesia and Thailand have added to pressure on governments to raise wages."

"There is a genuine feeling that the low-wage segments [of Asia's population] haven't made much progress in recent years" as the gap between rich and poor has widened in some areas, said Edward Teather, an economist at UBS in Singapore."

What is wrong with Americans that they can be bamboozled to think that the current neoliberal policies are constructive of anything more than more of the same?


James Hookway, Patrick Barta, and Dana Mattioli. 2012. "China's Wage Hikes Ripple Across Asia." Wall Street Journal (13 March).

http://online.wsj.com/article/SB10001424052702304450004577279111724105828.html?mod=ITP_pageone_0

MMT Redux

I knew if I stuck my hat on a pole above the trenches, the MMT missiles would come flying.  Specifically, I hear two general arguments whizzing over my head:

1. Loans are not made out of reserves, silly!  Loans are simply made, and if the bank finds itself short of reserves at the end of the day it borrows them from the overnight market.  Lending and the quantity of reserves at any moment in time are decoupled.

2. The CB targets an overnight interest rate.  If an over- or undersupply of reserves puts pressure on that rate, the CB injects or soaks up reserves to maintain its peg.  Implication: the Treasury can borrow as much as it pleases, as long as the CB purchases whatever proportion of the bond issuance it needs in order to maintain its peg.  Notional measurements of “the money supply” have no independent significance.

Responses:

1. It is a fair criticism to say that textbook presentations of fractional reserve banking, including my own, are counterfactual; convenient exposition is, in this case, at odds with observed reality.  It should be borne in mind, however, that the money multiplier model, like conventional supply-and-demand models, operates at an aggregate level and is not truly microfounded.  (In S&D, prices are supposed to equilibrate in a perfectly competitive model, in spite of the definition of perfect competition as a state in which no agent has the ability to influence the market price.)  The money multiplier really specifies a limit at which further loans need to be backed by an infusion of new reserves.  (The MM has been getting fuzzier of late due to changes in financial institutions and instruments, not to mention international capital flows, but we’ll leave that aside.)  If banks were always fully lent, the CB would have sole control over “the” money supply through control over the monetary base: that would be one corner solution.  But banks are not fully lent at all times.  If banks were never fully lent, the CB would have no influence at all on monetary aggregates except through its ability to stimulate or discourage lending, but this is another implausible corner solution.  I take the middle road.

2. If the CB targets a nominal interest rate, it runs the risk of the following scenario: increased borrowing by the Treasury increases inflationary expectations, which reduce the real interest rate, perhaps even below zero.  This leads to ever-reduced lending standards and overheating (including bubblish activity), validating those expectations, disastrously.  Or the CB can target a real rate, but if inflationary expectations rise it is compelled to increase its nominal peg, dumping an increasing share of bonds on the market.  This looks like, and is, contractionary monetary policy.  The notion that a CB can passively accommodate any and all fiscal deficits strikes me as very strange.  To put it differently, there are two dubious corner solutions, one in which any exercise of fiscal expansion is completely vitiated by offsetting changes in inflation, and another in which there are no such changes.  I’ll take the old fashioned Keynesian view that the proportion of fiscal expansion absorbed by inflation roughly increases as the output gap decreases, a sensible—and empirically validated—middle position.

The Difficult Concept of a Global Market

According to poll results published in today’s New York Times,

Over all, 54 percent of poll respondents believed that a president can do a lot to control gas prices, as opposed to 36 percent who believe they are beyond a president’s control.

It appears that a majority of those polled have difficulty with the concept that prices in a global market are set globally.  I’m not surprised, because variations on the same mental hurdle show up in discussions of whether it matters if we import oil from country A or country B, or if oil prices are quoted in dollars or euros.

Since the first and most important step in teaching is deconstructing erroneous priors, I hope those whose job it is to teach economics will address these misunderstandings as explicitly as possible.  Take time to find out what students think about how the global oil market works before launching into your prepared explanation.  Drill down to the underlying assumptions and hold them up for scrutiny.  Minute for minute, time spent on unlearning false knowledge is far more valuable than time spent on developing a more sophisticated grasp of the better stuff.

It was also help enormously if media outlets like the Times would make it clear that there are right and wrong answers to questions like the president’s control over gas prices.

Peter Diamond On The Slow Recovery Of Employment

I have just returned from the Eastern Economic Association meetings held in Boston over the weekend. Peter Diamond delivered the main plenary lecture on Saturday evening (2/10/12) on "Markets with Search Frictions." While I disagree with some things he said (He thinks the "natural rate" equals "NAIRU" [and that these are both meaningful concepts], and as always wants to "fix" social security, but these were not his main topics), he mostly gave a wise and knowledgeable presentation about the search model of unemployment, going back into its routes and noting many of its limitations and problems, as well as how it is useful, reminding everyone in the audience what fools those in the Senate are who think he is not qualified to serve on the Board of Governors of the Fed.

One general point he made that I had not really thought about, although once pointed out it is obvious, is that labor markets are seriously different from textbook supply and demand models in that there is never a really clearcut equilibrium. There are always vacancies, hence some "excess demand," and some official unemployoment, hence some "excess supply." All the imposed definitions of labor market equilibrium are thus arbitrary.

The most interesting remark to me came in reply to a question from the audience. He had stated in his main talk that "the matching mechanism has broken down during the recent recession." He was asked to elaborate. Drawing on research by Davis, Haltiwanger, and others, he broke it down to the micro sectoral level, although saying that more is going on than just that. But at that level, different sectors have different hiring rates. The one with the most rapid hiring rates is the one with the least hiring, construction. Some with slow hiring rates include education, health, and government. Not all of those latter are growing that much, but health is certainly one of the most rapidly growing. So, quite aside from broader macro issues (including possibly reduced mobility from underwater mortgages, although some studies claim this is not a factor), this sectoral pattern of how the recession has hit has slowed down the hiring/rehiring portion of the matching mechanism.

Outgoing president, Duncan Foley, also gave an excellent talk on physical limits to growth related to climate and energy, but, I shall not comment on that at length here and now (title, "Dilemmas of Economic Growth"), other than to say I largely agreed with it and he showed some very interesting statistics on various things that I had not seen before.

Why Larry Kotlikoff Is Not Getting My Vote for President

An economist is running for President with this opening:

Our country is at a critical juncture. Twenty-nine million Americans are out of work or underemployed. For most of those with jobs, real wage growth is a distant memory. Younger Americans are searching for the American dream and finding no-help-wanted signs. And millions of retirees are reeling from massive losses they've taken on their homes and life savings. The few doing well are doing very well, with income and wealth growing more unequal over time.

With such an outstanding diagnosis of the big economic issues, what progressive economist wouldn’t get behind his candidacy? Well this one - after I read his various “purple” plans, which all seem to be about austerity designed to eliminate what he claims is a long-term fiscal gap in excess of $200 trillion.

I’ll concede that we likely need a balanced approach of long-term spending reductions and more tax revenues and his proposal to have a progressive consumption tax is intriguing. Note, however, that extra revenues amounts to only 15 percent of his proposed long-term austerity, whereas Social Security is supposed to make up about 25 percent of the shortfall. This is from someone who correctly notes that retirees have lost much of their life savings while the elite are doing very well. Now putting 60 percent of the burden on health care reforms might sound right – but his website is short on specifics of how he chooses to accomplish this goal.

But none of this constitutes the main reason I’m not voting for Dr. Kotlikoff. The main reason goes to his point that we are far below full employment. So why does his campaign focus on austerity? We might as well be voting for Mitch McConnell for President.

Running on MMT

I’m going to regret this, but here is a short reaction to the Modern Monetary Theory (MMT) uprising, occasioned by reading (after some hesitation) Philip Pilkington’s MMT-inspired attack on IS-LM models over at Naked Capitalism.

1. I agree with the fundamental complaint MMTers have about the LM curve: it assumes a fixed money supply, so that changes in the speculative demand for money (due to i) have to be offset by changes in the transaction demand (due to Y): hence the upward slope.  (The slope is flat during a liquidity trap.)  But the money supply is not fixed; it has a substantial endogenous component.  Note the word “substantial”.

2. But MMT jumps from one corner solution to another.  After rejecting the implausible notion that the money supply is fixed, always at a level determined by the money multiplier times the monetary base, it leaps to the equally implausible notion that the monetary base is completely decoupled from the money supply.  On this view, infusions or withdrawals of liquidity by the central bank influence only interest rates, and the banking system alters its credit creation to meet money demand at the policy-determined price.  Thus the volume of economic activity need have no bearing at all on interest rates; the central bank has a completely free hand.  Do I have this right?

My view is that corner solutions are usually wrong; at least they should be regarded with fierce skepticism.  It would take a lot to convince me that monetary aggregates are completely decoupled from central bank liquidity provision, just as I doubt they can be controlled by monetary policy.  Surely there are limits to credit creation, which we see in a raw form during those episodes in which reserve requirements are reset.  What’s wrong with saying that the money supply is jointly created by the central bank and the private sector as the latter responds to perceived lending (and other asset acquisition) opportunities?

(Note: this post is about just one issue in IS-LM modeling.  There are others, but I am saving them for a day when there is really nothing better to do.)

Libertarians for Social Democracy

Sign up Alex Tabarrok.  He has an excellent piece in the latest Chronicle of Higher Education extolling the apprenticeship systems of Germany, Finland, the Netherlands, Denmark, etc.  As well he should: they offer students from all class backgrounds a real opportunity to earn a middle class income, and they are central to the ability of these countries to maintain high standards of living in an even more open economic environment (Europe) than the one the US has to contend with.

Just one thing though.  What makes these apprenticeships so valuable for the students?  And why are employers willing to pay more for well-trained employees than dumbing down the jobs for minimum wages or simply outsourcing as much as possible?  Each country is different, but they all share part of two answers—labor market regulation and stakeholder corporate governance.  The first of these is especially crucial to mass apprenticeship: to maintain demand for high-end labor, there need to be rules mandating employment rights, credentials and, especially, unions.  To minimize outsourcing, labor and the community need a strong voice in corporate management.  In addition, the whole system is nurtured and nudged with multifarious forms of public subsidy.

To put it simply, if you want the social democratic educational strategy, you’re going to need a social democracy to go along with it.  I’m happy to have Alex on board.

Incidentally, how about this for a political platform: no high school graduate left behind.  There should be a public pledge, backed by dollars and ambitious programming, that every student who graduates from high school in America is guaranteed the opportunity to either earn a college degree or get placed in a job that pays a middle class wage.  All access barriers to education, training and apprenticeship ought to be removed, with students enjoying these benefits as a matter of right.  As long as a kid puts in the effort, public responsibility does not end until he or she has a solid foot in the door.  This is a universal deal, for everyone.

Ethical Conduct for Economists?

Is it an oxymoron?

The first group of papers has been posted for the online WEA conference, Economics in Society: the Ethical Dimension, among them Crisis, Credit and Credulity: the incredible circulation of a counterfeit idea by Tom Walker (AKA Sandwichman):

Abstract: Even as the first warning signs of the global credit crisis were emerging in 2008, the IMF published a working paper that sought to analyze the youth employment effects of early retirement schemes in Belgium but ignored the historical context of those policies as part of the response to an earlier crisis – the "steel crisis" of the 1970s and 80s. Instead, the authors dwelt on a dubious but well-worn fallacy claim that advocates of early retirement policies believe there is a "fixed amount of work to be done", a "lump of labor." In the context of the astonishing history of the fallacy claim, what might seem a questionable paradigm choice for the paper's authors constitutes an inexcusable ethical lapse for the economics profession. Not only is the fallacy claim notoriously unsubstantiated, it originated as a propagandist's forgery and gained currency as a viciously partisan polemic against trade unions. Subsequent textbook versions of the fallacy claim may have toned down the vitriolic rhetoric but their ad hoc rationalizations neglect to offer any substitute for the original's fabricated evidence for the alleged belief. Financial credit depends on trust and today that foundation of trust extends to the scientific knowledge and technical analysis of experts. What does the enduring credulity of economists toward a demonstrably counterfeit fallacy claim suggest about the prospects for the economics profession to confront and remedy its ethical failures?

Meanwhile, the Sandwichman has compiled a list of economists, journalists and a few politicians over the past decade or so who have invoked the fraudulent fallacy claim, either in unvarnished credulity or with malice aforethought:

Peter Antonioni, David Autor, Ryan Avent, Martin Neil Baily, James Banks, Bruce Bartlett, Andrew Biggs, Matthew Bishop, Olivier Blanchard, Walter Block, Richard Blundell, Tito Boeri, Axel Börsch-Supan, Antoine Bozio, Samuel Brittan, Michael Burda, Pierre Cahuc, Laura Carstensen, Philip Coggan, Peter Coy, Diane Coyle, Andrew Coyne, Bruno Crepon, Clive Crook, Ed Crooks, Michael Cuneo, Reginald Dale, Jaap de Koning, Klaas de Vos, Werner Eichhorst, Carl Emmerson, Marcello Estevão, Sean Flynn, Thomas Friedman, Ed Glaeser, Robert Gordon, Jonathan Grubel, Matthew Hancock, Alister Heath, Ruth Hubbard, Jennifer Hunt, Will Hutton, Richard Jackman, Juan Jimeno, Alain Jousten, Adriaan Kalwij, Arie Kapteyn, Laurence Katz, Joshua Katz, Achim Kemmerling, Jacob Funk Kirkegaard, Dylan Kissane, Francis Kramarz, Paul Krugman, Simon Kuper, Jason Kuznicki, Oliver Landmann, Richard Layard, Ruth Lea, Mathieu Lefebvre, Melanie Luhrmann, Landis Mackellar, John Macnicol, Bill McBride, Francois Melese, Giles Merritt, John Micklethwait, Kevin Milligan, Jack Mintz, Casey Mulligan, John Munro, Stephen Nickell, Kristian Niemetz, Gilles Paquet, Jamie Peck, Sergio Perlman, Pierre Pestieau, Christopher Rhoads, Matt Ridley, Nick Rowe, Filipa Sá, Gilles Saint-Paul, Xavier Sala-i-Martin, Thorsten Schank, Amity Shlaes, John Shoven, Robert Simmons, Hans-Werner Sinn, Dennis Snower, Guy Standing, Nigel Stanley, Will Straw, Timothy Taylor, Marian Tupy, Ernst van Koesveld, Matthias Weiss, Niels Westergaard-Nielsen, Alan Wheatley, Charles Wheelan, David Willetts, David Wise, Tim Worstall, Asghar Zaidi, Jeffrey Zax, Klaus Zimmermann, Andre Zylberberg

He who gives credit to the calumny before he has investigated the truth is equally implicated. -- Herodotus

More on Mankiw’s Defense of the Carried Interest Loophole

My take on what Greg wrote is here. It seems Alec MacGillis made the same point much more forcefully finishing with this gem:

If Mankiw is so bothered by the carpenter’s fate after the closing of the carried interest loophole, then he should be pushing for the equalization of the tax rate for investments and earned income.

But Alec does one better by finding a 2007 Mankiw oped that advocated closing this loophole. But give Greg a break as he is advising someone who flip flops on just about everything!

Macro and Micro: The Case of Balance Sheet Recessions

To continue some random thoughts about the role of microeconomics in macro, consider the notion of a balance sheet recession.  Like most others who came to see this as an essential ingredient of the current crisis, my route was via the financial balances framework—for instance, the Wynne Godley version.  I saw the problem in aggregate/net terms: the US household sector in the mid 00's was running up unsustainable debt loads, especially through the medium of the housing bubble.

This is a purely macroeconomic perspective, and one can go a long way with it.  Nevertheless, one can go even further by filling out some of the microeconomic aspects.

One that has attracted a lot of attention is the role of inequality between households.  This takes us from net to gross balances: the accumulation of large debts among some households adds fragility and eventually drag to the system notwithstanding the net wealth accumulation of other households.  The inequality/debt nexus has been examined at a purely macro level, but to dig further we would need to disentangle the threads: which households in particular are going into hock, what motivates them to do this, how are collateral constraints imposed or lifted, etc.  Even with statistical controls, aggregate analysis can only point to association, not causal pathways.

But there are other micro aspects to household balances that are worth exploring.  Some that occur to me are:

1. How can we call the turn?  Through what channels do debtors come to revise downward or upward their reference point for when debt is “too much”?  Most debtors, after all, do not experience default.  What persuades them to shift from debt accumulation to deleveraging?  And what persuades them that they have paid down enough debt and can begin borrowing again?

2. Related to the first question, is the tendency toward overshooting symmetrical?  That is, we know debtors tend to overshoot on the way up, leading to the fabled Wiley Coyote moment.  Is there also a tendency to pay down beyond the level needed for debt sustainability?  If so, there might be interventions that could moderate the contractionary impetus of balance sheet recessions without impinging on needed adjustment.

3. For policy purposes, and here we enter the realm of the Lucas Critique, we should want to know the extent to which household perceptions of actual and desired leverage are intertemporal: do people think about their financial situation only in its immediate state, or do they incorporate some notion of permanent income?  If the latter, do temporary fiscal infusions provide less perceived balance sheet relief than the raw numbers would suggest?  Are these effects of different magnitude for different households?  Note that these questions are entirely empirical and can’t be addressed through armchair speculation, no matter how many clever wrinkles one adds to a textbook intertemporal optimization model.

What I hope this example demonstrates is that it is possible to see a large role for microeconomic research in macroeconomics without making metaphysical claims about foundations or demanding ritual obeisance to general equilibrium.  In fact, freeing macro from these constraints is also freeing micro.

Can You Say Sonnenschein?......I knew you could

What bothers me about the current discussion on the relative merits of micro-founded versus non-micro-founded macro is the crazy idea that RBC/DSGE models are micro-founded. These are representative agent models, people! They are micro-founded models of a macroeconomy consisting of one agent, and so we should by all means use them whenever we come across such an economy, and good luck with that. Unfortunately, the macroeconomy we'd like to understand has many agents. And any attempt to apply general equilibrium analysis to such an economy is faced with an insurmountable problem. Hugo Sonnenshein showed conclusively that aggregate excess demand functions, aggregated from "well-behaved" individual excess demand functions, can behave any way you like - arbitrarily. Just sayin'.

The Real Problem with Microfoundations

Suppose you lived in a world in which there were two branches of economics, micro and macro.  Microeconomics in this world is rigorous, precise, honed over many decades of increasingly sophisticated analysis, and confirmed in almost every empirical test.  It is axiomatic, its propositions invested with mathematic certainty.  It has proved its worth in one application after another.  Macroeconomics, alas, is everything micro isn’t.  The axiomatic structure is missing; much theoretical work is essentially ad hoc.  Data are thinner and models are at risk of failing the first out-of-sample challenge.  Even outright embarrassment is a continuing problem: leading macroeconomists often make predictions that are not simply wrong, but profoundly, cosmically wrong.  It’s a crap shoot.

If this were your world, wouldn’t you want to base your macro on micro to the fullest possible extent?  Bend and squeeze the good, rigorous stuff as far as you can, so you could minimize the use of the dubious macro ad hocery?

I think something like this is in the back of the minds of most macroeconomists.  Optimization models, general equilibrium----these are things we know to be right and true, so the more we can use them to generate macro models, the more solid our ground.  Arguments with more apparent technical content that are sometimes trotted out don’t really change the situation.  Take the Lucas Critique: we need to take into account how people’s behavioral patterns will change in response to changes in policy.  This is certainly true, but it is another matter entirely to put your faith in models of optimizing individuals (or clone armies) as the vehicle for understanding behavioral shifts.  Whatever the purpose, If I believed in micro they way most economists do, I would be for microfoundations too.

Here’s the rub, though: micro is just as squishy, in its own way, as macro.  The axiomatic architecture has nothing to do with science, elegant as it may appear to those who have devoted years of their life to mastering it.  Yes, micro is absolutely internally consistent.  So what?

Optimization is a formal technique, something you can do with a sufficiently specified utility mapping and choice set, but it is not descriptive of the actual behavior of individuals or organizations.  Equilibrium can be identified in models constructed by economists, but there are few real-world markets in which stationarity is observed for very long.  (Disequilibrium dynamics are observed, but adjustment is the ill-behaved child of microeconomics, the one who smashes the furniture and is sent to bed early so that proper equilibrium conditions can hold forth.)  General equilibrium theory in particular is a dead-end project, useful only for establishing the myriad ways real world economies are incapable of achieving such timeless bliss.  Their welfare properties do not even hold asymptotically: getting closer to a an equilibrium state (achieving equimarginal conditions in more markets) does not guarantee Pareto superiority over positions further away.  And of course, the convenient construct of a representative agent has no justification whatsoever in microeconomic analysis.

Textbook micro should not be a basis for pre-certifying real micro modeling and empirical work, much less macro.  In fact, economics does not offer any specifically “scientific” concept or method around which we should be compelled to standardize, which leaves us with no substitute for thinking through every significant problem from the ground up.  Consider this not a loss but a gain.  With less a priori baggage, macroeconomics might develop the habit of pruning in the face of disconfirmation, treating Type I error with the seriousness real scientific work demands.  Hell, there can even be lots of serviceable micro within macro, but it will be empirically grounded and institutionally specific—finance, corporate investment, markets in real estate and consumer durables, stuff like that, populated by humans and not rational cyborgs.

A Weak Defense of a Low Tax Rate on Carried Interest

Mark Thoma links to two articles that should be read at the same time. First up is Greg Mankiw:

WHAT is carried interest? And why does it get the tax treatment it does? … If we are going to tax capital gains at a lower rate, one question necessarily arises: What is a capital gain, and how can we distinguish it from ordinary income? The answer seems simple. If you have a job, the money you are paid for your work is ordinary income. If you buy an asset at one time and sell it later for a higher price, the profit you made from holding it is a capital gain. But is it really that easy? Consider five examples, and see if you can identify what is ordinary income and what is a capital gain:

His fourth example was:

Dan is a real estate investor and a carpenter, but he is short of capital. He approaches his friend, Ms. Moneybags, and they become partners. Together, they buy a dilapidated house for $800,000 and sell it later for $1 million. She puts up the money, and he spends his weekends fixing up the house. They divide the $200,000 profit equally.

In his defense of the current treatment of carried interest, he writes:

This brings us to Dan and his partnership with Ms. Moneybags. The tax law treats this partnership as exactly equivalent to Carl’s situation. In this case, however, the $200,000 capital gain is divided into halves: some of it goes to Ms. Moneybags, who provided the cash, and some goes to Dan, who provided the sweat equity. Once again, nothing is treated as ordinary income. In some ways, this treatment makes sense. After all, Dan is doing half of what Carl did, so why should he have to pay a higher tax rate than Carl did on that half of his income?

As I read this question, my first thought was – maybe we should raise the tax rate on capital income to equal the tax rate on ordinary income. David Cay Johnston provides an interesting discussion of whether the proposed reduction in the corporate profit tax rates is really a reduction in the taxation of capital income or is indirectly a reduction in the tax burden on wages with this gem:

On the face of it, the AEI argument suggests workers should be joining the calls for Congress to cut corporate income tax rates. But, if the argument is correct, then workers should also be calling for cuts in their own income taxes and an end to reduced rates on dividends and capital gains.

EXACTLY!

Ongoing Confused US Discussion Of Internal Iranian Politics

Tomorrow is the Iranian parliamentary election that I have suggested might lead to lowering of tensions with possible renewed talks on the nuclear issue and a possible drop in the price of oil. Maybe, but before the election I want to note how garbled and misleading discussion in the US media of internal Iranian politics is and has been pretty much consistently. This generally arises from a combination of ignorance and a desire to have simple stories told about good guys vs bad guys. This has been going on basically since 1979.

So, the discussion has always been put in terms of "moderates," supposedly the good guys likelier to be more amenable to US policy interests, and "hardliners," supposedly the bad guys less likely to be so. In the years immediately following 1979, the focus seemed to be on economic policy attitudes. So, the "moderates" were the supposedly more pro-free market types while the "hardliners" were the supposedly more socialist types. Funny thing was that for what probably mattered in terms of attitudes to the US, the free market types based in the bazaars were much more hardline on theological issues compared to the socialists. Indeed, when the social reforming Khatami was surprisingly elected in 2001 over Rafsanjani, he brought back some of the pro-socialist types into economic policymaking over the more pro-free market types that the more socially and theologically conservative Rafsanjani had in place.

Now we come to today's discussion. One reads that the current race is between two sets of "arch-conservatives." However, one is viewed as more "moderate," the other less so. The supposedly more moderate group is led by President Ahmadinejad, whose supporters are currently a minority in the Majlis. The majority "hard(er)liners" are supposedly the supporters of Supreme Leader Khamene'i. Frankly, I think this is junk fed to dumb western media types by Ahmadinejad supporters.

After all, it is Ahmadinejad who is a Holocaust denier, not Khamene'i. The latter has called for the Israeli government to disappear, but he has never called for "eliminating Israel" as claimed by many commentators. Ahmadinejad is regularly identified as being more willing to negotiate with the US about nuclear weapons, but it is Khamene'i who has issued the fatwa against nuclear weapons.

We all worry that factions of the Revolutionary Guards are for nuclear weapons and that one of their hotheads will initiate an attack on US naval forces in the Persian Gulf. But it is Ahmadinejad who came out of the Revolutionary Guards, not Khamene'i, so frankly, this entire discussion has been an embarrassingly muddled mess.

Free Trade Ad Absurdam

The last thing a defender of free trade should want is to find herself on the same side as Jagdish Bhagwati.  Exactly because the arguments against laissez-faire on the international front are so strong, we need someone to remind us what is at risk when we mess with trade.  Too bad Bhagwati isn’t the guy.  In Defense of Globalization in particular was a big disappointment.  We tried using it in class to provide some friction to the alter-globalization voices, but students just tore it apart.

His latest screed in defense of trade orthodoxy comes on with the force of a handful of packing peanuts flung angrily into space.  Let’s look at his arguments.

“The first misconception is that exports create jobs, while imports do not....”  His rebuttal is that exporters often use imported parts, and shippers create jobs when they ship imports.  But what is the counterfactual here?  If he is opposing the idea that we should simply stop imports at the border and suffer without them, then he has a point.  His argument says nothing, however, against policies designed to replace imports with domestically produced products.  Moreover, it is absolutely the case that an import constitutes a leakage from a national macroeconomy, while an export constitutes an injection.  That’s not mercantilism, it’s basic accounting.

“Second, the credo “Trade, not aid” has given way to the mistaken belief that trade matters less than foreign assistance.”   Huh?  The problem with trying to manage trade flows is that it leads to an excess of foreign aid?  Where did he come up with this?  In reality, (1) rich countries have flagrantly failed to meet the aid targets enshrined in the Millennium Development Goals, and (2) it is the poorest countries, where current account deficits are structural and persistent, that the need for trade policy is most acute.  (Specifically, these countries need strategic investments, stakeholder-oriented pubic and private sector governance reforms and industrial policies to achieve external sustainability.)

“Third, many believe that manufactures deserve preferential support.”   Here Bhagwati makes the error of conflating a specific preference, for manufacturing, with a general preference for achieving approximate balance between imports and exports, whatever the sectors.  But let’s give him the benefit of assuming that a belief in the importance of manufacturing is more interventionist than, say, an exaggerated attachment to intellectual property protection.  What is his case against singling out manufacturing?  Simply that lots of famous people say you shouldn’t do this.  I’m not kidding: read the original.  There isn’t a single substantive point in his missive that considers the pro-manufacturing position and rebuts it.  Actually, manufacturing is important, not only for potentially high-productivity jobs but also for the kind of innovation that depends on bringing abstract ideas and hands-on skills together.  I’m writing this from Germany, and I can guarantee that preferential support for manufacturing is gospel over here, and that it works.

“Finally, the financial sector has come to be viewed as the bane of morality....The quasi-Marxist view that our morality stems from our economic position overlooks the moralizing role of family, religion, culture, and art.”  And now we get the ethical case: reject quasi-Marxism and pay no attention to the extraordinary concentration of wealth in a few hands.  In passing, we should note that he gets the Marx part absolutely backwards: Marx claimed repeatedly that ethical systems are relative to historical period and social position, and that one could not deduce the desirability of socialism from the ethical superiority of workers over capitalists.  (Granted, he did make lots of snide remarks about the rich, but he also spread his cynicism around to other classes.)  The main point, however, is that the ethics of plutocracy is almost orthogonal to debates over trade policy.  One can stuff finance back into a little box, with modest pay and privileges, and leave trade alone, or one can be a trade hawk and a finance dove.  This final argument isn’t an argument at all.

Face it, Bhagwati isn’t even listening.  He has no idea what the arguments are of those who worry about trade and social standards, or trade and ecological sustainability, or trade imbalances, inequality and the volatility of global finance.  He has written many clever papers based on a set of implausible assumptions (like trade always balancing at the margin), and he has no clue how to respond to those who question those assumptions.  My students, who think his priors are bonkers, found only incoherent bluster.