Saturday, April 9, 2016

More On Economists In Silicon Valley

This article entitled “Economists Adding Up At Amazon.com, Microsoft, Google” appeared on the website Investors Business Daily.

Why Is Macro So Hard? Repeating the Bad News but Not the Good

Humans are weird. We like to hear bad news, particularly if it’s about others, or if we can use it to gain sympathy for ourselves without actually getting hurt.

In macroeconomics, this means that you will be exposed to less news stories about the economy when it is doing well, and more when it is doing poorly.

We are currently towards the end of a weak expansion, maybe around a peak. This is prime time for bad news plus the same bad news.

Three months back, the news was that forecasting models were indicating that the economy was that the economy might be peaking soon (we discussed this here and here). Now the news is that real GDP growth for the first quarter of 2016 is going to come in around zero (the linked article is required reading). If you think about it, they mean the same thing.

The closely watched Atlanta Fed GDPNow model now shows first-quarter growth tracking at 0.1 percent, compared to a 0.4 percent estimate earlier in the week.

Do note that I’m not saying that both of these items are not news. Instead, what I am saying is that “evidence that we’re peaking and evidence that we peaked” is covered more than “evidence that we’re not peaking and evidence that we did not peak”. But, given the fact that the economy tends to be in expansion about three times as much as it’s in contraction, we should actually hear more about the latter.

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One problem with cyclical industries is that they overproduce and then have to pull back production and draw down their inventories. Some are of the view that the first quarter was a pull back, and that this is a good sign for the second quarter:

The JPMorgan economists, however, say there may be light at the end of the tunnel.

"While 1Q is adding up to be a clear disappointment relative to expectations from a few weeks ago, it now looks like the inventory correction was largely completed by the start of the second quarter, which is a favorable development for growth in that period. We now think that real inventories increased $54bn saar in 1Q, a rate that is likely to be sustainable moving forward," wrote JPMorgan economist Daniel Silver, in a note.

Sunday, April 3, 2016

Journalists Are Often Lousy Economists

Most of what people learn about the economy comes from journalists. Fair enough. But things get stickier when it’s about economics rather than the economy.

For students moving on to careers in FIRE, reading what journalists write is essential, but parsing whether or not the journalists theories make sense is even more so.

Tim Worstall spotted this one in one of Britain’s largest newspapers (not required, but fairly easy reading). It starts out with a discussion of the poor decision of newly rich investors from India getting burned buying worn out old companies from their former colonial parent.

But, towards the end, it turns into a clueless analysis of the trilemma (you know, the thing that China is having so much trouble with this past year):

In contrast to my early years as a financial journalist, when sterling crises were two a penny [note: sterling is a pet name the British have for their currency], nobody much cares about the current account deficit these days. Yet news last week that it reached a jaw-dropping 7pc in the final quarter of last year was enough to make even the most sanguine of observers sit up and take notice.

I’m going to continue with the quote, but here’s an aside about the paragraph coming next. I have touched on this in class: this sort of claim is like saying you’re amazing because you set a new world record just this morning for the number of breakfasts you’ve eaten in your lifetime.

It’s a profoundly alarming spectacle, but both the UK budget and the current account deficits seem get markedly worse with each passing, post war, economic cycle. These latest ones are by far the deepest yet.

That they are in any way tolerable is I suppose down to the much more sophisticated nature of global capital markets, which makes funding them a lot easier than it was. But this in turn may make the country even more vulnerable to a sudden stop, or to any loss of international confidence in the economy’s underlying solvency. Eventually there will be a shock, triggered possibly by Brexit, which will manifest itself in a deep devaluation and possibly a consequent, precipitous rise in interest rates.

A current account deficit of such magnitude would normally be an indicator of an economy which is seriously overheating, sucking in imports for lack of available domestic capacity. Yet inflation is at virtually zero …

Worstall correctly points out that the reason the U.K. used to have sterling crises all the time was from bad management of the trilemma.

[It’s] because we don’t have either fixed currency rates nor dirty floats. You can manage two of three, just about: currency rates, interest rates and trade balances. You cannot manage three of three. For the third is the tool that must be used to manage the other two.

But if you’re not trying to manage currency rates then you can leave the trade balance alone.

In class, and in this blog, with respect to China I described the trilemma as comprising exchange rates, monetary policy, and capital flows. These are just different aspects of the “currency rates, interest rates and trade balances” listed above.

The U.K. learned the hard way that you can’t control all three. The Chinese are still learning.

And do not forget that new government officials tend to forget lessons like this, and have to relearn them periodically.

Sunday, March 20, 2016

Economists Get Real About Measuring Inequality

Inequality is exceptionally hard to measure: you need lots of data, on lots of different people, in lots of different circumstances, and then a bunch of high level tools to figure it out.

Politicians, bureaucrats, and advocates claims about inequality should probably be dismissed out of hand as not credible.

Having said that, it doesn’t take a rocket scientist to recognize that there’s some.

There’s four big easy ideas, right at the top of the list, that should be grasped by every student at this level.

1)

Income and wealth are not the same. Income is a flow, wealth is a stock. Economists know a lot more about income, because it’s in everyone’s paychecks, and the government keeps tabs on most of us. Economists know a lot less about wealth because it’s harder to value (for example, what your car is actually worth isn’t known until someone buys it from you).

But, what you know about your neighbors is mostly about wealth. You don’t see their paychecks. You don’t know all their sources of income. But their wealth is sitting right there in front of you.

So, we worry about what is mostly wealth inequality, and then politicians, bureaucrats and advocates do bait and switch and tell us they can fix that by going after income. And they do.

2)

What we really want to be more equal is consumption not income (both are flows). We could get a lot less income inequality if we went and punished people for working long hours … you know … go watch more TV or we’ll get the IRS after you. But we don’t do that because it’s dumb. We could also get less income inequality by making sure the poor worked more … you know … no TV for you until you put in more hours. Somehow our society seems to think this one is a little better, but I don’t always agree with it.

Think about it, who bugs you more, the rich person who eats in fancy restaurants, or the rich person who eats at home? It’s not their income that bugs us, it’s what they do with it.

This means we need to be concerned about consumption inequality. So, politicians, bureaucrats, and advocates … focus instead on income. Learn to ask them why. The answers aren’t pretty.

3)

A lot of inequality is between young and old. Some of the poorest zip codes in the country are located in … college towns (because of the low income of most students). Do note that I do not want to diminish the areas of real poverty, I just want to point out that the data isn’t what we think it is. And, a lot of the rich live in coastal Florida, south Texas, Arizona, and southern California. Hmmm … the places that attract retirees.

But the old vote. So the response of politicians, bureaucrats, and advocates has been to shelter a lot of their income (which is often lower because the house is paid off and the kids are done with college anyway) from redistribution. One of the biggest sources of consumption for the old is … Medicare.

BTW: our fiscal problems with Medicare are much larger than those with Social Security (even though that gets more press). The reason is that Medicare is open ended during any given month for senior, while their Social Security checks have known and stable values.

4)

We already do a lot to reduce inequality. We can debate about whether that’s enough or not, but we can’t deny that we’re trying.

This means that if we want to assess whether inequality is getting better or worse, we have to do it after taxes have been collected, and redistributed at transfer payments.

That’s sensible. The only reason to not do that would be that you really don’t want to know the answer.

So what do our politicians, bureaucrats, and advocates do? Base almost all of their discussion and policy prescriptions on pre-tax, pre-transfer, income.

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All of that was a preface. There’s a new paper out that does a better job at this. It’s entitled “U.S. Inequality, Fiscal Progressivity, and Work Disincentives: An Intragenerational Accounting ”, and it’s by Alan J. Auerbach Laurence J. Kotlikoff Darryl R. Koehler. It's part of the NBER Working Paper Series: a lot of papers by top economists appear their first before they come out in a formal journal publication.

These guys are not conservatives/Republicans. A more accessible discussion appeared in The New Republic (a liberal/progressive magazine). It’s entitled “We’ve Been Measuring Income Inequality All Wrong” and it’s required.

Let me note that none of this is surprising to economists. It’s just a big job, and holy cow am I glad someone else did the work so that I just have to read it.

Here’s their big findings.

1)

First, spending inequality—what we should really care about—is far smaller than wealth inequality. This is true no matter the age cohort you consider.

… The poorest are able to spend far more than their wealth would imply …

The fact that spending inequality is dramatically smaller than wealth inequality results from our highly progressive fiscal system, as well as the fact that labor income is distributed more equally than wealth.

2)

… U.S. fiscal policy acts as a serious disincentive to work longer hours or harder for more pay.

3)

Our standard means of judging whether a household is rich or poor is based on current income. But this classification can produce huge mistakes.

… Nearly a third of the people we identified as middle income are being mis-classified as either richer or poorer.

And what are their policy recommendations?

Raising taxes and benefits as Democrats advocate will, unless existing tax and benefit systems are properly reformed, come at the cost of even larger work disincentives. Lowering taxes as Republicans advocate—presumably funding this with benefit cuts—will improve work incentives but may exacerbate spending inequality unless the benefit cuts disproportionately hit the rich.

Wednesday, March 16, 2016

Just to be Fair - Let's Beat Up Trump's Proposals Too

Unlike the other candidates, Trump’s proposals are backed up with very few specifics. In some sense, serious critics have very little tinder to start their fires.

By far the biggest of Trump’s proposals is a series of tax reforms that amount to very large tax cuts.

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A problem of sorts with Republican proposals over the last few decades has been a ridiculous sales pitch — supporters are sold a story that tax cuts will “pay for themselves” when even conservative economists can’t support any conclusion even close to that. All of these proposals (or actions in the case of Bush II’s tax cuts) amount to back door plans to increase government borrowing to offset reduced tax revenue.

Yes, there is something called a Laffer curve which says that cutting rates when they are already low will reduce tax revenue. That makes sense. It also says that if cutting rates when they are already high will increase tax revenue. That also makes sense: it’s because the tax rate is a discouragement, and cutting it creates more taxable economic activity. That’s the theory. The empirical evidence is that almost all tax rates are way below the level where behavior would switch. There are some exceptions, usually involving taxes on one-time purchases or sales of assets. But for most taxes most of the time, you should assume that cutting rates will cut revenue. Unfortunately, Republican politicians have bought wholesale into the part of the argument they like (that cutting tax rates raises tax revenue) and ignored the evidence that this result is just not common at all.

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What Republicans should pay more attention to is something called Ricardian equivalence (this is related to a newer result in finance known as the Modigliani-Miller theorem). The evidence is that how governments finance themselves — either through taxes or borrowing — is Ricardian equivalent. This means it doesn’t matter, and also the corrolary that the size of the deficit doesn’t matter.

When people first hear of Ricardian equivalence the think it sounds crazy. Let me explain why it’s not. The way the government pays for the stuff it provides is either with taxes or with borrowing. What Ricardian equivalence says that when evaluating a program, how it’s paid for doesn’t make any difference to its effectiveness. When you put it that way, it makes a lot of sense.

A useful analogy is buying vegetables or illegal drugs. Let’s presume the first is good for you, and the second one is bad. For the government, tax revenue is their income, and deficits are their borrowing. So the analogous choice for a person is whether to pay for something out of cash you received as income, or to charge it. Would you ever tell someone that vegetables are less good for you if you charge them? Or would you tell someone that illegal drugs are less harmful if you pay for them with cash? Of course not. If that analogy works for you, then it shouldn’t make a difference whether a government program is financed by tax revenues or deficit borrowing.

That’s actually a useful thing if you’re predisposed to liking smaller government. Because it says that all you really ought to think about is not how big or how small the government budget, deficit, debt, or taxes are … but just whether the program the money is being spent for is a good one or not. I think a lot of the public would benefit from thinking that way.

But honestly, I don’t think anyone involved in government likes smaller government. So, while Republicans say they want smaller government, when they’re in power they seem to be pretty good at making it bigger. For example, a Republican President and Republican-dominated Congress passed passed Medicare Part D (providing subsidization for seniors to afford pharmaceuticals). That’s a fairly liberal/progressive program to be added by the people who claim they want smaller government. Oh … and in case you had any doubts … they were paying for wars in Iraq and Afghanistan at the same time.

So Republicans cover their tracks by saying they want to cut taxes. And for a lot of people, reducing the pain of government taxes is hard to differentiate from reducing the size of government.

Except that Ricardian equivalence means that to be in favor of cutting taxes without cutting spending is to also be in favor of more borrowing.

To go back to the analogy, the Democrats are saying “more vegetables for everyone, all the time, and the government will pay for it”. And the Republicans are saying “more vegetables for everyone, but just when we’re in power, and government will pay for it” … “oh … and … um … the vegetables will be better for you if we pay for them with a credit card”. Then the whole Laffer curve bit amounts to justifying the credit card purchases because you get points you can use to buy even more vegetables (when, really, we’re all supposed to know that the points are a way to take away the sting of spending your money, and not a worthwhile financial objective in and of themselves).

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Lastly, I think everyone should always, everywhere, be in favor of simplifying the tax code. Republicans tend to push this more than Democrats. That’s a good thing, but it’s hard to quantify how useful it is.

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This is all important because when the Republicans make concrete proposals, they’re usually about tax rates, and when Republicans are criticized the basis is often the amount of borrowing the government does. Ricardian equivalence should be part of that conversation, and it is at some levels, but not in common public discussion.

So, what can we say about Trump’s proposals?

Here’s a piece from The New York Times entitled "Analysts Question Viability of Deep Tax Cuts Proposed by Republican Candidates" from which I drew this chart:

16-02-22 NYT capture about Republican tax cut proposals

Most of the article is about the size of the projected cuts to tax revenue: “By most estimates of the outside groups, the costliest plan is Mr. Trump’s.”

Do note that The Times does make the Ricardian equivalence argument, but it doesn’t use that name:

“I believe by cutting taxes and simplifying the tax code, we will grow our economy and create more taxpayers rather than more taxes,” Senator Marco Rubio of Florida has said.

Tax policy groups agree generally, but only if the revenue losses are offset by budget savings that avoid piling up more debt that would be counterproductive to spurring the economy.

“The candidates need to present real specifics for how they would address our record levels of debt,” said Maya MacGuineas, the president of the bipartisan Committee for a Responsible Federal Budget.

“Massive tax cuts and few specifics for what spending to reduce will only make the challenges much worse,” she added. “And miraculous growth projections and ‘waste, fraud and abuse’ are just not credible solutions.”

Now, here’s a much larger analysis of all Trump’s proposals from the Committee for a Responsible Federal Budget, a bipartisan think tank. It’s pretty detailed, but if you parse it out, by far the biggest economic proposal of Trump’s it the tax cuts. So it’s fair to stay relatively focused on that.

Trump has also argued that he’d like to balance the government’s budget. Think about that: 1) the government budget is already in deficit (so it’s partially financed by borrowing), and 2) Trump wants to cut taxes (which will require even more borrowing), so 3) he’s implicitly stating that he wants to cut spending. Now that we’ve gotten to the heart of the matter, the useful question is by how much?

But … wait for it … Trump has also said there’s some categories of spending that he won’t cut. He wants more spending for veterans and immigration, so no cuts there. But he doesn’t want to cut anything for seniors, which takes Social Cecurity and Medicare off the table. And he won’t cut defense either. Here’s the chart:

http://fiscalfactcheck.crfb.org/app/uploads/2016/02/Trump-Cuts-4.png

The result is on the right: Trump is arguing for cutting 60-80% of everything else.

Of course, he can’t say that, because no one would vote for that.

And, I actually doubt that he means it. What politicians do is throw out policy proposals and hope that no one actually does the analysis I’ve just reported here.

Now, obviously, economic growth could make all of this possible. But the estimates are that Trump’s proposals would collectively require sustained real GDP growth rates of about 11% per year. Compare that with Sanders’ estimates assuming sustained real GDP growth rates of 5.3% per year to pay for his proposals.

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Paul Krugman, the Nobel Prize winning economist, who writes a column for The New York Times, is a solid Democrat/Progressive on the leftish side of their spectrum.

He’s written about how he’s conflicted about the Democrats proposals because they’re so disconnected from reality. (He says worse things about the Republicans) but his own Democrats are making him feel conflicted.

Anyway, he has a great metaphor about this. He says that Clinton is proposing to give voters a unicorn, and Sanders is proposing to give them a magic unicorn.

You probably shouldn’t believe either one of them. And you probably shouldn’t prefer the magic unicorn because … you’re never going to get any unicorn at all. And … oh my gosh … if Sanders’ numbers are supported by a math mistake, then it’s more like the Sanders is offering a unicorn that he says is magical because the unicorn already appeared to him and told him to say that.

The Ricardian equivalence argument implies that choosing between the Republicans is more innocuous: along the lines of each candidate is offering a differently colored unicorn. No doubt, Trump’s unicorn would be aggressively colored in bold hues of red and blue stripes, with white stars. And when Trump (or others) starts making outlandish claims about cutting taxes and balancing the budget and not cutting most spending … then their unicorn is far more magical than Sanders.

Tuesday, March 15, 2016

Towards a Measure of National Wealth

I’ve emphasized in class that we’d get better macroeconomic decision-making if spent more time looking at national wealth and less time looking at GDP.

Do note that this is not because we don’t have data on national wealth. But we do have is not as accurate as GDP, and no where near as commonly used.

Someone in class mentioned that Josh Price had talked about measuring national wealth in class. I talked to Josh, and he was referring to a paper entitled “Sustainability and the Measurement of Wealth” by Arrow, Dasgupta, Goulder, Mumfor, and Oleson.

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First a note about Ken Arrow. He’s huge in economics. He won a Nobel Prize. You usually win these when you are old for work you did in your 30’s. Arrow won his over 40 years ago for work he did in the 1950’s. This was mostly about how to generalize the idea of equilibrium from supply and demand, including the first proof that perfect competition is Pareto optimal (which is the basis for doing so much supply and demand in principles of micro).

Just because Arrow wrote it doesn’t make it great. But it’s a pretty good sign.

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The idea of the paper is that economic growth is sustainable (forever) if national wealth per capita is persistently increasing.

They look at 5 countries. Here’s what they find:

… Our results show that the United States, China, India and Brazil are currently meeting the sustainability criterion, although Brazil meets the requirement by a narrow margin. Venezuela fails to meet this requirement as a result of substantial depletion of natural capital and negative estimated TFP growth. In the United States and India, investments in human capital prove to be very important contributors to increases in per capita wealth; in China, investments in reproducible capital dominate. Accounting for improvements in health dramatically affects the estimates of changes in per capita wealth. We estimate the value of health capital to be more than twice as large as all other forms of capital combined.

Now, this isn’t weird to an econmist, but it might be something you haven’t thought about before. The biggest component of national wealth is the value of citizens themselves. Educate them and they’re worth more. Keep them healthy and they’re worth more. And young peoplle are worth more than old people because so much of their productivity is in the future rather than the past.

For example, I personally might earn the equivalent of $4,000,000 (in constant 2016 dollars) over my lifetime. So, in some sense, if we went back to 1985 we could have said that I was a piece of capital with a net present value to society of $4,000,000 (the value of my leisure might be half of that more added on top). Now compare that to the other capital I have: a house worth about $250,000, a $30K car, a retirement account, and some other stuff that’s just not as significant. In short, if we just count up the physical stuff we see, then we’re missing most of the wealth.

What this means is that the most important things that countries do is keep their populations alive for a long time, and keep them productive for a long time.

And if we want to find the wealthy countries around the globe, we need to look for the ones that are capable of nurtuing citizens through a lifetime of productive work, and putting them in a position where they can work when they are old (but don’t have to if they don’t want to).

Some Growth Isn’t Just Economic

Macroeconomists stress that real GDP is correlated with a lot of desirable non-economic outcomes.

I feel that sometimes non-economists don’t believe us when we say that.

Here’s an example from North and South Korea. After World War II this was the poorest place on Earth (or not far off of that).* Since then South Korea has displayed phenomenal growth, arguably the longest sustained high growth period of any country. On the other hand, North Korea has struggled, and even had periods of widespread famine.

There’s now been a formal study of a tidbit of data that economists have been talking about for a couple of decades: you can tell that the South is richer because its people are 1-3 inchest taller than those from North Korea. This is interesting because the Korean peninsula has a relatively homogenous population, with little historical colonization. So the only way to reasonably explain that difference is with better diet coming from a richer economy.

* Interestingly, South Korea was the poorer of the two. Most of the limited industriatlization before 1950 had taken place in the North.