Why does free speech matter? Channeling John Stuart Mill.

5 Dec

The assault on free speech seems to be growing. Millennials seem ok with limitations on “offensive” speech (http://www.pewresearch.org/…/40-of-millennials-ok-with-lim…/). Millennials also seem skeptical of democracy (https://www.washingtonpost.com/…/yes-millennials-really-a…/…). Forget the millennial angle. Let’s think about the connection between limiting speech and dying democracy. Can these phenomena be related? John Stuart Mill may have an answer.

Mill writes that free speech is important for three reasons. First, it may silence a true opinion. Second, engaging with false opinions help holders of true opinions get a better sense for why their opinion is correct. Indeed this is the basis of science – there can be no science without falsifiability. Last, different opinions may have different elements of the same truth; engaging with these different opinions helps people a clearer picture of the truth. In any case, as long as we believe that all individuals are equally capable of thought (if fallible) everyone’s opinion has value. Hearing out even mistaken opinions gives such thoughtful individuals an opportunity to learn. Thus, free speech helps people toward a realization of truth.

However, free speech has cultural effects as well. Engaging in free speech and keeping the space open for dissenting opinions generates a culture of fallibility. This reduces the risk of people forcing a wrong opinion on others. Moreover, free speech allows people to learn, thus allowing humanity to better respond to changes in their social, cultural, economic, political, and geographic environment. Free speech also vets opinions and therefore creates a systematic way to confer legitimacy on opinions, a process also known as science! This legitimacy has important implications for the legal fictions that govern the relationships between individuals (or society).

For example, the constitution is fiction; a mere piece of paper. The effectiveness of constitutional rule of law therefore depends on whether people believe that the constitution is legitimate. Free speech creates the environment for conferring this legitimacy through the three reasons stated above. Thus, free speech is the heart of democratic rule of law. Given this connection, when people do not believe in free speech they have no reason to believe in the legitimacy of constitutional democracy.

So what? A recent study by Basuchoudhary, Bang, David and Sen (“Predicting Conflict” forthcoming 2018 email: basuchoudharya[at]vmi.edu for more information) suggest that lack of institutional transparency and credibility are one of the biggest predictors of civil conflict. In short, the cultural institutions that allow free speech and confer legitimacy on governance institutions (albeit defined in a very constricted way for statistical analysis) are what is keeping humanity away from perpetual conflict. This should be of interest to everyone as we sip our $7 chai lattes.

Are the Trump tax cuts justified?

5 Dec

There are two reasons to cut taxes. Keynesian tax cuts prime economic growth by increasing consumer spending power. This requires that government spending remain at current or increasing levels, thus expanding the budget deficit. Current estimates suggest that the proposed tax cuts will increase this deficit by more than a trillion dollars. GOP leaders are channeling Keynes to say that the economy will grow by enough to reduce the deficit in the unforeseeable future.

However, government borrows to finance deficits. If the promised economic growth happens, continued deficits require the government to compete with private investors for loans. This raises interest rates and therefore reduces investment and economic growth. Thus, cutting taxes when the economy is growing is a bad idea – unless the country as a whole can borrow cheaply from foreigners. But that caveat REQUIRES a capital account surplus and therefore a trade deficit. Thus, a Keynesian tax cut designed to “grow” the economy out of a deficit will have precisely the opposite effect if enacted when the economy is booming. It therefore seems to be a bad time for a Keynesian tax cut given that President Trump and the GOP are taking credit for a booming economy AND have signaled a desire to cut our current capital account surplus by reducing the trade deficit.

Alternatively, the GOP could plausibly justify tax cuts (and has in a more principled past) as a way to reduce government’s ability to transfer wealth from one group to another. This approach requires government spending to be cut as well since the purpose is to let the private sector be the engine of economic growth. This approach therefore reduces the size of the budget deficit. That ain’t happening!

The GOP’s tax cut justifications make no economic sense. The GOP has no economic credibility left.

Can tax cuts increase economic growth?

5 Dec

The current “debate” about tax cuts (actually, there appears to be more hand waving than debate but my parents taught me the virtue of politeness!) revolves around a central assertion: Tax cuts will spur economic and job growth. This assertion is based on the assumption that corporate and income tax cuts (many small businesses pay income rather than corporate taxes) will be reinvested into the economy spurring job growth. This is not entirely clear (https://www.bloomberg.com/news/articles/2017-11-29/trump-s-tax-promises-undercut-by-ceo-plans-to-reward-investors) but let us for the moment assume it will indeed happen.[1]

When businesses reinvest their capital, business grows and demand for labor goes up. Basic microeconomics does support this position. More capital increases labor productivity. Therefore, for a given supply of labor wages go up. Given the current tight labor market, this may indeed be the case. However, life is seldom static. The wage increase relative to the price of capital implies that new investment is likely to be capital intensive rather than labor intensive. This process actually exacerbates the current trend toward robots and away from labor. Thus, it is unclear if these tax cuts will increase job growth dramatically. In any case, these, fewer, new jobs will tend to benefit the sort of labor that can run robots and write algorithms. People with older/no skills will be left out in the cold. Such a scenario may create a permanent unemployable underclass if e.g. schools are unable to pick up the training slack.

The corporate tax cuts have other effects as well – particularly if these cuts lead to companies moving their tax headquarters back to the United States. This move will show up as a capital account surplus in the United States international balance of payments. This influx of foreign money increases the demand for USD and leads to an appreciation of the dollar relative to other currencies. The more expensive dollar makes our exports more expensive and our imports less expensive – thus increasing the trade deficit. This is not a problem per se but I have to scratch my head at the Trump administration’s inconsistency in pushing for a tax cut designed to increase the trade deficit when they want to reduce the trade deficit. To reiterate though, I do not think a trade deficit is a bad thing because foreign lenders MUST finance it. Therefore, it keeps interest rates low as well.  That can help future growth. Alternatively, if the US increased tariff/non-tariff barriers to cut the trade deficit the capital account surplus would have to go down – i.e. businesses would not bring capital into the country. This of course would cut off some of the growth benefits of the corporate tax cut.

Bottom line effects:

  1. If the corporate tax cuts lead to capital reinvestment (and this is a big if) then labor productivity and wages will rise. This will lead to economic growth. However, job growth may not happen since firms will substitute labor with cheaper capital.
  2. Jobs will be skewed toward specific skills. This will continue the current process toward jobs with specific skills and away from low-skilled/old-skill jobs.
  3. Any attempt to lower the trade deficit will reduce the growth potential of the tax cuts.

[1] The income tax cuts are temporary. This may actually increase the incentive to pay out dividends which may then be taxed at lower income tax rates today rather than wait to be taxed at a higher rate I the future.

Can’t repeal economics — health insurance

1 Mar

How does health insurance work? Individuals (or an organization on behalf of the individual) pay a premium to a company. If the individual falls sick the insurance company pays for health care. Sounds simple, but what is the insurance company’s business model here?

Healthy people pay premiums. That is the insurance companies revenue stream. When they fall sick the insurance company pays for healthcare — that is (along with administrative expenses) the insurance companies costs. Profits = Revenues – costs. The insurance company has an incentive to keep costs low and revenues high.

Notice that for the insurance business model to work healthy people are necessary as a revenue source. But what sort of person would prefer not to buy insurance? Well healthy people of course because they don’t think they need it. By the same token sick people would want insurance. This dynamic is not good for the insurance companies bottom line. That is why insurance companies would like to charge more for older people or sicker people (for example those with preexisting conditions) though ideally it would be best to not have these high risk categories on their rolls at all.

Older Americans are covered under government run Medicare since they add to insurance companies costs. Before ACA insurance companies could refuse coverage to people with preexisting conditions. Now they cant. Healthy people therefore cross subsidize people with preexisting conditions and as a result high risk people have a lower premium than they would otherwise have while healthy people have a higher premium. This is a risk pool and left alone it is not stable. Healthy people are paying more than they want to so they quit buying insurance. This reduces revenues and profits for insurance companies. So they raise premiums. This makes more healthy people leave. And the insurance company goes out of business. Healthy people are needed to cover expenses for sick people and a little bit more. But for everyone — both sick and healthy — to be covered healthy people have to be “incentivized” to buy insurance. In any case, any policy to add more people to insurance rolls implies that sicker people are more likely to apply while healthy people will not. This unraveling of the risk pool destroys the insurance business model. The only way to get around that is to “incentivize” healthy people to join the insured ranks.

The ACA does that by penalizing people who do not have health insurance. The various replacement plans floating around seem to want to give tax credits for those who join. They are essentially the same thing. Consider someone who has to pay a $1 penalty if she does not buy insurance. That $1 of her money she does not have — a penalty she can avoid by buying health care. Now consider the $1 tax credit. If she does not buy the insurance she loses $1 of her own money as taxes — a penalty she can avoid by buying insurance!

Can’t repeal economics. Sigh!

“Border Adjustments” Tariffs Whatever

19 Feb

I do not understand why Mr. Trump and his GOP want to raise taxes on the American people.

Mr. Trump wants to hike import tariffs. His congressional Republican lackeys call it a “border adjustment.” Either way this tax will make goods and services more expensive for American consumers while their touted “benefits” are murky.

For example, a fall in the trade deficit is touted as one such “benefit”. However, this fall will ALWAYS be balanced by a fall in foreign capital investment in the US. Thats just how national income accounting works. Well that’s also fewer American jobs.

Another effect might be a devaluation of the US dollar because of a fall in demand for US assets. That makes our exports more competitive while making imports more expensive. Since many of the goods we make in the US have foreign inputs the net effect of all of this on American jobs and wages is murky.  Moreover, a fall in demand for US assets like T bills puts upward pressure on interest rates. Higher interest rates translate into less US capital investment and fewer American jobs. These higher interest rates could be neutralized by asset purchases by the Fed. But that could end up being inflationary.

Supporters of the “Border adjustment” claim that any inequity in the border adjustment will be negated by a rise in the value of the dollar. Well thats not so certain given the possibility I raise above. In fact anyone who claims they know exactly what will happen to exchange rates is at best wildly optimistic!

Advocates also keep talking about the border adjustment as “trade neutral”. Thats a lie. The whole argument for the border adjustment is that it helps import substitute and export industries while penalizing American businesses which use imported inputs. In fact even advocates say that prices of all goods will rise (see https://taxfoundation.org/understanding-house-gop-border-adjustment/). Which of course it would! In other words it is a tax on the American people.

Of course, US tariff increases will be matched by other countries. This trade war will impoverish everyone.

Not so long ago Republicans understood that government intervention in business decisions was a bad idea because the economy is complicated. As a result, policies have complex and often unintended effects. This was one argument for small government that did not promote grandiose policies with ever cascading unintended consequences. Republicans need to remember that idea. Executive orders or even legislation cannot repeal economics.

How about a flat destination based corporate income tax without any border adjustment? That would encourage American businesses to relocate to the US. It would increase demand for American goods and American workers. And all without the inevitable price hikes from so called “border adjustments.”

Political Economy of Trump’s “jobs” policy — A scenario.

17 Nov

President elect Trump says he wishes to “Prioritize the jobs, wages and security of the American people” (https://www.donaldjtrump.com/policies/immigration). But what would his restrictive immigration policy do for jobs? The question is complex but the most obvious analysis suggests that it would not help unskilled workers or workers with outdated skills.

Let’s start in the labor market. Immigration restrictions will reduce the supply of labor. That should raise wages for American workers. However, that wage rise will also impact how American businesses hire workers. A higher wage might make labor relatively more expensive than capital. Businesses would then substitute capital for labor where they can. Such substitutions may be harder in agriculture (machines have a harder time picking fruit without bruising them) than in say automobile manufacturing (already quite capital intensive). Nevertheless that kind of substitution would be incentivized by the rise in the price of labor relative to capital. Of course, these higher wage jobs would also require specific skills since employers will pay higher wages only to more productive workers. Thus workers with low or outdated skills may continue to be unemployed.

A President Trump has also promised higher infrastructure spending. So that will also spur the growth of construction and construction jobs. But here too higher wages (increase in the demand for labor) will also require higher productivity. In short these jobs will require specific skills since these jobs will be part of a capital intensive production process. Once again, folks with low or outdated skills may not see the benefit they hoped for.

In fact President elect Trump’s  desire to reduce the trade deficit could further complicate matters. Reducing the trade deficit through high tariff barriers would of course have long term negative effects on innovation and growth. But even in the short term a reduction in the trade deficit would imply a reduction in foreign investment into the US and foreign lending in the US’s capital account. Keep in mind the US’s national accounts have to balance so a reduction in the trade deficit will also result in a reduction in the capital account surplus. This process will be correlated with a stronger dollar and higher US interest rates. This also suggests less investment in the future, lower exports, and generally a higher cost of capital.

To conclude, as both wages and the cost of capital rise in a US protected from both foreign workers and foreign capital, US economic growth and power will diminish in the medium to long term. Of course, the reader will note that there are many moving parts to this scenario. It assumes for example that other countries will not react to US policy changes or that there will be no internal changes in the skill distribution in the US. Nevertheless, the analysis above is pretty straightforward and seems loaded against unskilled workers or workers with outdated skills.


Why Nations Fail

9 Feb

I recently wrote a review of Acemoglu and Robinson’s newest book “Why Nations Fail.” The review is available behind a pay wall for the journal Public Choice (here). But here’s the gist:

Why Nation’s Fail is an ambitious and worthwhile attempt to understand the origins of power, prosperity, and poverty. It provides a succinct narrative for how institutions may diverge. The many examples that show this divergence are entertaining and informative. However, Acemoglu and Robinson’s unwillingness to incorporate the well-established toolkit of public choice economics hobbles their analytical narrative. Ultimately, they fail to make their case – and make no mistake it is an important case to make – because they ignore the individual and they ignore history.

The impact of Republican intransigence on passing the budget and raising the debt ceiling

4 Oct

It should come as no surprise that our country finds itself in yet another internecine squabble regarding questions about how much to, or maybe even if we should, fund governmental operations.  It is a source of national embarrassment that the United States hasn’t passed a full slate of Appropriation Bills since Fiscal Year (FY) 2008.  Looking back to FY 1977, there have been 17 funding gaps of at least one day or more (Congressional Research Service). The funding gap in Fiscal Year 1997 was, until now, the most highly publicized funding gap.  In FY 1997, the U.S. Government shut down from 15 December 1996 until 6 January 1997.  While our current shutdown commands the attention of the vast majority of the press, the effects of a shutdown are mostly temporary; they do not extend much past the lost productivity of government workers. There may be very real impacts in specific sectors of the economy. Closed national parks may affects tourism related businesses, closed Headstart facilities would affect the working poor, and closed licensing authorities may affect whether businesses get certain permits or not. However, this could be balanced against the economic activity created by people who substitute their vacation dollars away from national parks or by depending on friends and family for daycare. Moreover, the impact of the shutdown will begin to be felt – even in these sorts of affected sectors – only if the shutdown drags on. Thus, it is hard for us to get overly excited about another crisis of artificial proportions.

The bigger issue associated with yet another game of brinksmanship played by two kids who can’t play nicely on the playground, is the issue of a possible link between this fight and the yet-to-be-had fight over raising the debt ceiling.  Even without the current intervention by the Federal Reserve, the United States dollar enjoys reserve currency status, which allows the U.S. to borrow at very low interest rates.  Certainly artificially low interest rates hurts U.S. savers, but it is a boon for the U.S. in terms of lessening the burden of servicing the fast-growing U.S. debt.  Now, though, we are quickly approaching the date when all extraordinary financial measures will be exhausted and the U.S. will default on its legal obligations.  This date is widely believed to be 17 Oct (side note – just approaching the debt-ceiling deadline in 2011 caused the U.S. to suffer a downgrade to its heretofore sterling credit rating; an actual default will potentially have long-lasting implications, as it will most likely raise borrowing costs substantially and it will make asset valuation harder because treasury bonds will not be risk free anymore), but the first large, default-inducing payment comes on the 1st of November when benefit checks are due.  Currently there are no indications that countries are actually worried about a default; in fact, the yield on the 10-year U.S. Treasury bond closed unchanged on the first day of the shutdown, which suggests there isn’t any panic selling as of yet.  But let’s do some back-of-the-envelope calculations to get an idea of what may transpire.  As of 31 August 2013 (latest data available from Treasurydirect.gov), there is $16.7 trillion of total U.S. Treasury securities outstanding.  The average interest rate now is 2.4 percent; this equals about $400 billion a year in interest payments.  Assuming that a simultaneous credit rating downgrade and a limited default causes a one percentage point increase in the average interest rate from 2.4 percent to 3.4 percent (a rate last seen in August 2009), interest payments will increase by $170 billion a year.  To put this in perspective, last year’s Fiscal Cliff deal is projected to raise $617 billion in new revenue over 10 years; all of this new revenue will be subsumed by increased interest payments in less than four years.

A less obvious but more pernicious consequence is the uncertainty that results from nearly five continuous years of partisan gridlock.  Businesses and individuals cannot plan if they do not know whether a law will exist or not. This puts a damper on economic activity and job creation. Moreover, to the extent larger businesses have more resources to deal with uncertainty, partisan bickering serves as a tax on small job creating businesses.

— Commentary provided by me and Jeff Smith.

Tenure: A meandering path to serfdom!

15 Mar

Tenure is part of the compensation package for college professors. However, college administrators view this as a privilege. In fact, the AAUP (effectively a professor’s union) tacitly agree because they make the case for tenure as an institution necessary for academic freedom with no connection to compensation.But let’s concentrate on the idea that tenure is about compensation. How should professors react when tenure is not part of a compensation package?

Consider what tenure does. It is part of a compensation package designed to reduce mobility. It is a barrier to exit in the college professor employment market. Thus it reduces bargaining power for the professoriate effectively by reducing any holdup costs. Professors cannot make a very credible threat to leave if they feel their working conditions are bad or wages are too low. This lack of credibility translates into reduced bargaining power when it comes to wages. This is, of course, a big reason behind the wage compression we see among professors relative to assistant professors. And if there is no way to bargain for higher wages or better working conditions why should the professoriate innovate? After all they cannot retain the fruits of their innovations. So what would happen if tenure went the way of Nineveh and Tyre?

The end of serfdom – similar to tenure insofar as it reduces the bargaining power of labor by restricting mobility – in medieval Europe may provide an object lesson. The reduction in the labor force wrought by the plague had differential impacts in Western and Eastern Europe. In Western Europe small institutional variations led to the end of serfdom as labor became more scarce. This jump started a secular increase in the share of output going to labor. Of course mobility and other institutional changes also promoted innovation and economic growth. In Eastern Europe, however, the problem of scarcity of labor was met with a strengthening of serfdom! The results are obvious and persist to this day.

In other words, removing tenure, like the end of serfdom, should increase the likelihood that the professoriate will innovate to keep themselves competitive and increase their wages. Of course there may be other problems based in agency theory. How will administrators gauge the productivity of the professoriate given the inherent information asymmetry that exists between the professoriate and college administrators? But that’s another post. Watch this space!

Gerrymandering and the failure of the US political market.

27 Jan

Acemoglu and Robinson in their book “Why Nations Fail” argue that Venice — the global superpower of its day — became a museum because inclusive institutions like the “commenda” were slowly replaced by extractive institutions which led to the “La Serrata.” Venice effectively became a hereditary aristocracy because the election system was rigged to favor incumbents and their families.  Congressional districts in the United States are often redrawn in a way that favors incumbents. Only people belonging to a certain “family”  — political party — can get elected from these districts. This restriction of political competition has echoes of Venice! So will the United States become a pretty museum? Probably not. But it may lose its economic superiority by ignoring inclusive founding principles.

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