Why Is Eastern Europe Poorer?

Eastern Europe is generally poorer than Western Europe. This is a problem in an age of common migration because the educated and talented are migrating from Eastern to Western Europe. There’s a brain drain.

New research shows that this goes back about 1,000 years.

When you go back that far, you need to use to use a proxy for human capital. Keywood and Baten use “elite numeracy”. What they record is the frequency with which different countries were capable of recording the date of the birth of the child who later become the ruler. This is an indicator of understanding that some numbers will become important later on and needs to be recorded now.

What they found was that before 1000 A.D., elite numeracy was about the same across Europe (and probably not very good). But after that, and until about 1800 A.D., Western Europe took a large and sustained lead in elite numeracy. They then show that this divergence was related to military threats. In short, leaders in Eastern Europe were scared, and put their money into defense of, rather than education of, their elites.

The macroeconomic patterns we see in the world today may be very old indeed.

Inequality

We have some techniques for measuring the degree of inequality. For example, use of the Gini coefficient is becoming quite widespread. This is useful for thinking about whether the distribution of something is more unequal or less unequal than some other distribution. It isn’t perfect, but it’s a start.

Unfortunately, our mental heuristics† for assessing inequality have not caught up. On the face of it, equality corresponds to a single value of the Gini coefficient, zero, while inequality applies to all other values greater than zero and less than or equal to one (the coefficient is defined over 0 to 1). The thing is, these are point estimates. So, the probability of any distribution’s Gini coefficient hitting any value exactly is … zero. In some sense, we’re never likely to find equality (which is a fairly useful property if you like to complain about the pervasiveness of inequality).

In economic situations the typical heuristic is that the world we observe is too unequal because there are monetary/political/legal/social/cultural forces that have pushed us away from equality, and are capable of sustaining distance between how unequal things are and how equal we’d like them to be.

Now, let me modify that third paragraph with the implication of the second paragraph to get:

In economic situations a more realistic heuristic is that the world we observe is too unequal because there are monetary/political/social/cultural forces that have pushed us away from some more natural level of inequality, and are capable of sustaining distance between how unequal things are and how unequal we can reasonable expect them to be. [I’ve emphasized the modifications between the two paragraphs].

My point in this is that we can still be concerned about inequality while we go and explore the world for how much inequality is actually OK. That’s a premise that lots of people haven’t really considered, but it’s essential for things like, say music, where the inequality of tastes is what makes it worthwhile.

So, where to start? How about with “A Comparison of Wealth Inequality In Humans and Non-Humans”. The paper is behind a paywall, but this is excerpted from the abstract:

In many societies, the statistical distribution of wealth takes a characteristic form: unimodal, skewed to the right, and fat-tailed. …  we present the first description of inequality in material resources in an animal population … the shell distribution for the [hermit] crabs strongly resembles the characteristic form of wealth distribution in human groups. The amount of inequality in the crabs is more than that in some small-scale human groups but less than that in nations. We argue that the shell distribution in the crabs is not simply generated by biological factors such as survival and growth of either crabs or gastropods. Instead, the strong resemblance in the human and hermit crab distributions suggests that comparable factors, not dependent upon culture or social institutions, could shape the patterns of inequality in both groups. …  We also propose that inequality in hermit crabs could provide a baseline for examining human inequality.

For those of you that don’t know, hermit crab exoskeletons are not very serious defensive shells, so they move into harder shells of other creatures that have died. The crabs ability to grow is based on finding a shell that is big enough for them to grow into, but small enough for them to still maneuver. Since mollusks do not stop growing as they age, a hermit crab may go through several shells in its lifetime. Basically, their success as individuals is based on finding natural resources and using them in a rivalrous and excludable manner. And they result is inequality.

Sounds a lot like humans … except that there aren’t monetary/political/legal/social/cultural forces making it happen. This suggests that equality is not the null hypothesis we should be using for assessing human affairs.‡

† Heuristic is a good college level word that you should look up.

‡ Kurt Vonnegut’s short story “Harrison Bergeron” is a satirical look at what might happen if we did.

New Macro Dataset

This morning the BEA released the first county-level GDP data for the U.S. Here’s the news release, and here’s where to find all the numbers.

Annual data is provided for four years, 2015-18.

The GMP (Gross Metropolitan Product) data series will be discontinued. Now you can slice and dice that at the county level if you don’t like the official definitions of metro areas. I do wish the data, as released, had filters for the metro areas.

What trivia did I spot?

• There appear to be 3,112 county entries. This does not match up with the number of counties in the U.S. Still trying to figure out what’s missing.
• There are some entries for independent cities and combination entities (independent cities and their surrounding counties) from Virginia. This makes the undercount above more severe. Again, not a biggie, but I have to figure it out.
• My own small county in rural, southwestern Utah, has a GCP of $1,500M (larger than about 2 dozen countries).
• The smallest county is Issaquena in Mississippi with a GCP of just over $18M.
• The largest is Los Angeles (County) at $711,000M. Its’ just a tad smaller than Pennsylvania, and larger than 44 states.
• New York County, basically Manhattan, has a GCP of $600,000M. I was surprised at how large that is relative to the other boroughs of New York: Kings County (Brooklyn) and Queens are about $85,000M. The Bronx and Staten Island are far smaller. Nassau and Suffolk in the suburbs is about the same size.
• Salt Lake County, where I once lived, which is about half the metropolitan area comes in at $81,000M
• Orleans Parish, where I once lived, it down to $23,000M. It’s not even the largest parish in the state anymore. Even with the surrounding parishes added in, New Orleans is now far smaller than Utah’s Wastach Front.
• Erie County, New York, where I grew up, comes in at $51,600M.
• I also lived for two years in Tuscaloosa County, Alabama. It’s at $8,600M

Infographic: The World’s Money and Markets

This is good but not great. (All my comments are up here because the image is so large, here is the original in its own web page with comments). I have 3 big complaints. There’s also a fourth group of stuff to love because we don’t often see it elsewhere.

• There’s some crossover between different categories, so some things are double-counted. Some examples are:
• Several of the “Biggest Companies” biggest shareholders are listed in the “50 Richest People”.
• The “Fed’s Balance Sheet” includes the USA sub-category under “Currency”. And BTW: which side of the Fed’s balance sheet is shown there, or is it both (or do the visualizers not have that straight in their own heads?)
• There’s some mixing of stocks and flows. For example:
• The category “50 Richest People” (in the world) is followed by “California’s GDP”. But the former is a stock and the latter is a flow. A way to think about this is that they are related by a rate of return. Assume that’s 10%/year to make things simple. Thus, the flow of income coming of the wealth of the 50 richest people is about 2 blocks. When compared to the flow of California’s GDP of 26 blocks (yes, there’s a mistake in the chart there) it doesn’t look so big. Even better, California’s flow of GDP is generated by a stock of wealth that’s 10 times as big, so an appropriate comparison is the 19 blocks for the “50 Richest People” to the 260 blocks of wealth in California.
• But that comparison is insightful because the size of the sub-category “United States” under “Stock Markets” is only 73 blocks. Figure about 10 of those are in California. So somehow, California has 260 blocks of wealth of which just 10 are the market’s net worth of corporations. This tells us that most of what is productive in our world is not in corporations, which begs the question of why on earth so many politicians are so concerned with limiting them.
• They need to be careful about what are assets, what the liabilities are, and what net worth (the difference between the two) is. For example:
• They only have some portions of assets listed (e.g., “Gold”, “Currency”) but then they show a much more inclusive and comprehensive “Global Debt” category. This makes debt look too large.
• They also show capitalization of “Stock Markets” which is a net figure. What are the assets and liabilities associated with that?
• The same thing goes for derivatives. They talk about the zero-sum nature of most of those, but they don’t actually show it.
• This is a good example of the “balanced reporting” and “what passes for expertise” problems from my Why Is Macro So Hard lectures. In the sidebar about derivatives, they quote Dr. Richard Sandor (why does he get a title if it isn’t important to the position he takes?), Warren Buffet, and Jeff Greene. So what you have there is a guy who markets derivatives, a guy who’s rich mostly from non-derivatives, and a guy who got rich from derivatives. Any expertise there on the history of derivatives, why we have them, or why they’re useful??
• Most people who are buggy about money being backed by something think it has to be gold (in Fort Knox!!). The sub-category “Central Banks & IMF” shows how small that component actually is.

Courtesy of: Visual Capitalist, via Newmark’s Door.

Some Theory of Wealth Taxation

Mirlees is the basis for a lot of how economists think about taxation (he won a Nobel Prize for this body of work in 1996). Famously, while he was a supporter of the Labour Party in the UK, and generally what we would now call progressive, he believed his own results on taxes. Namely that most forms of corporate or capital taxation were a bad idea, and that rates are best kept at zero.

Of course, that doesn’t work politically in most places.

Kocherlakota published an article in 2003 in Econometrica expanding on Mirlees work. It’s one of the basic theoretical papers in taxation.

He set up a model with the following features:

• Agents have skills that determine their income.
• Agents can save, and can finance consumption out of wealth if needed.
• Skills evolve through time with persistence, sometimes getting worse; but you’re self-insured to the extent that you saved something.
• The government is interested in providing a social safety net to the income-poor by taxing the wealth-rich, and redistributing the proceeds as income to the needy.

In this framework, what would the optimal wealth tax look like? The answer is anything but what politicians commonly propose.

• The expected tax rate that an agent expects now on the wealth they may have in the future … should be zero.
• The gross amount of total tax revenue collected on wealth … should always be zero.
• But, the actual tax rate that an agent should face on their wealth once they accumulate it … should be decreasing in their consumption.
• The dispersion of tax rates on wealth between the wealth-rich and wealth-poor should be bigger if the government is bigger.

If you told that to anyone in D.C. (or any other capital) they’d think you were nuts. It means the wealthy should be subsidized, and the not-so-wealthy should be taxed. Further, that should be accentuated when the government is bigger (as they pretty much all have done over the last century).

Economists anger people by pointing out unintended consequences. And there’s a doozy in the framework established by that first set of bullet points (which honestly seemed pretty plausible when you first read it, right?).

It turns out that the dominating effect comes from people who are wealthy now, and who suffer a negative skill shock in the future, so their income drops. Their optimal choice is to … stop working completely … collect the government’s welfare support … and keep their nest egg relatively untouched.

Does this sound like any seniors you know? Wealth rich, income poor, choosing not to work because they have relatively more aches and pains than other seniors, and receiving checks from the government?

Before you complain, let’s look at how an optimal wealth tax might differ from the one’s we have or might have. Current wealth taxes (and those proposed) simply take a percentage of wealth. What Kocherlakota is saying is that you can and should take a fraction of wealth, provided that you adjust that for current income; you take more from someone with low income because they might be a slacker, and you take less from those with high income because you know they’re probably supporting the government more with the high income taxes they pay.

Do note that we already do something like this in certain situations. For example, many welfare programs have asset tests. No one likes this, but in practice this is what is happening when an old person with a home needs to go into a nursing home, and the government requires that the home be sold and the proceeds used up before they’ll start covering the cost of the nursing home. In short, if you self-insured, the wealth tax rate should function to make sure that you use your self-insurance when it’s needed.

The paper is not required. It appeared in Econometrica, which is one of the toughest journals. And the author, Narayana Kocherlakota, has been a top macro theorist at theory-heavy schools for most of his career. By all means check it out, but don’t make yourself feel bad just because you’d need years of math and theory classes to get it all (when all boiled down, the model is 58 equations and 58 unknowns).

Some Politics of Wealth Taxation

Taxing wealth seems to be on the policy table in this U.S. election cycle. This is arguably the most serious move in this direction in about 70 years.

Of course, we already do have some forms of wealth taxation. Owners of real estate pay property taxes. Estate taxes claim a portion of large inheritances. And capital gains on assets are taxed when the gains are realized at sale.

The proposals this year, made by candidates Sanders and Warren, are far broader. They are analogous to property taxes, in that they will be paid on some guess of value (since the value of an asset is only an estimate until it actually changes hands). However, the base for the taxes is widened to most assets. There is some question about tangible vs intangible assets: stocks owned will be a lot easier to value than say, a copyright or patent.

Wealth taxes have been tried in a number of places, primarily in western Europe. And the history of the last few decades has been that they’ve been slowly dissassembled as impractical, unworkable, and not capable of raising that much revenue.

Nonetheless there is a strong impetus for such taxes, largely driven by the research of Piketty, Saez, and Zucman. I don’t care to discuss those much in this post; suffice to say they have documented a large increase in the portion of wealth held by the richest people, across countries, going back about 40 years. Their worry is that societies did a good thing in reducing the portion of wealth held by the rich in the decades prior to that, and that the rich are using the political process to turn the tide in the other direction, and perhaps to re-cement their new gains into permanence. That is a separate issue from whether or not a tax on such gains is feasible.

For this post, I bring your attention to a recent paper by Glennerster entitled “Why was a wealth tax for the UK abandoned?: lessons for the policy process and tackling wealth inequality”. He discusses the UK experience in the 1970’s.

A couple notes about politics are in order. First, the UK has a parliamentary system. This would be analogous to a U.S. system if the Speaker of the House (Nancy Pelosi) was President, the Senate was far weaker, and the judicial system was not co-equal to the other branches. Second, the two largest political parties in the UK are more extreme than those in the U.S. The Conservative party is fairly close to the Republican party here, but the Labour party there is left of our Democratic party.

The backstory is that the Labour Party had contemplated a wealth tax for a long time. Through the 20th century, they had been disappointed with the revenue collected with high rates through an estate tax. Beginning in the 1950’s they started to discuss taxing wealth before death rather than at death. This came to a head in 1974 when the Labour Party included a wealth tax in the platform it used to successfully win the general election. Now they were in a position to enact the tax rather than crow about one, and that’s when the problems began.

Initial public complaints came from farmers, city-dwellers who owned country houses, and private art collections. This was followed by worries about international flights of capital (basically, the rich moving elsewhere). To some extent this was already happening in the UK, which required a bailout from the IMF in 1976 to stabilize the value of the pound.

N.B. The article does not mention this, but that was a topic of some interest in the U.K. in the 1970’s. This was the period when many rock musicians (e.g., members of The Beatles, The Rolling Stones, and Pink Floyd, David Bowie, the entire bands Jethro Tull and Bad Company, Tom Jones, Cat Stevens, Rod Stewart), movie stars (e.g., Roger Moore and Michael Caine), and television personalities (e.g. David Frost, and members of the Monty Python troupe) decamped (primarily to the U.S. and France) to avoid high income tax rates.

Ultimately the wealth tax proposal was not even brought to a vote. It died in committee meetings of presumable supporters. What went wrong? Glennerster quotes Denis Healey’s memoirs and synthesizes (Healey was analogous to Secretary of the Treasury in the UK during the 1970’s):

Denis Healey’s own reflective conclusion was that it was a mistake. ‘Another lesson was that you should never commit yourself in Opposition to new taxes unless you have a very good idea how they will operate in practice. We had committed ourselves to a Wealth Tax: but in five years I found it impossible to draft one which would yield enough revenue to be worth the administrative cost and political hassle.’ (Healey 1989, p404) It seems clear that the Labour Party never considered in any detail the administrative costs and practical complications involved in assessing individuals’ wealth on a regular basis. It was enough to say, as Labour Party Research Department papers did, that other countries levied such taxes so it must be possible. The several thousand civil servants needed, depending on the valuation level at which the tax began, the numerous regional offices required and the process of regular valuation that might fall on individuals came as a surprise to the politicians and, indeed, to the Treasury when it got to think about the question properly. [emphasis added]

…

One lesson to be drawn from the 1974 experience is that the administrative detail in taxation matters a lot. The idea still lacks detailed study. The second lesson is that tax changes that are likely to affect major sections of the population and the wider economy have to be widely debated before, rather than after, any party reaches power.

This is rather an amazing conclusion for the U.S. going into the 2020 election. As we saw in 2016, the unusual thing about U.S. presidential elections is the extent to which they can bring groups into the White House with little or no policy experience. The huge distinction is that in the UK almost everyone brought into power had policy experience, and not only could they not pull it off, but they abandoned the idea as unworkable.

Via Marginal Revolution.

Some Politics of Wealth Taxation

Taxing wealth seems to be on the policy table in this U.S. election cycle. This is arguably the most serious move in this direction in about 70 years.

Of course, we already do have some forms of wealth taxation. Owners of real estate pay property taxes. Estate taxes claim a portion of large inheritances. And capital gains on assets are taxed when the gains are realized at sale.

The proposals this year, made by candidates Sanders and Warren, are far broader. They are analogous to property taxes, in that they will be paid on some guess of value (since the value of an asset is only an estimate until it actually changes hands). However, the base for the taxes is widened to most assets. There is some question about tangible vs intangible assets: stocks owned will be a lot easier to value than say, a copyright or patent.

Wealth taxes have been tried in a number of places, primarily in western Europe. And the history of the last few decades has been that they’ve been slowly dissassembled as impractical, unworkable, and not capable of raising that much revenue.

Nonetheless there is a strong impetus for such taxes, largely driven by the research of Piketty, Saez, and Zucman. I don’t care to discuss those much in this post; suffice to say they have documented a large increase in the portion of wealth held by the richest people, across countries, going back about 40 years. Their worry is that societies did a good thing in reducing the portion of wealth held by the rich in the decades prior to that, and that the rich are using the political process to turn the tide in the other direction, and perhaps to re-cement their new gains into permanence. That is a separate issue from whether or not a tax on such gains is feasible.

For this post, I bring your attention to a recent paper by Glennerster entitled “Why was a wealth tax for the UK abandoned?: lessons for the policy process and tackling wealth inequality”. He discusses the UK experience in the 1970’s.

A couple notes about politics are in order. First, the UK has a parliamentary system. This would be analogous to a U.S. system if the Speaker of the House (Nancy Pelosi) was President, the Senate was far weaker, and the judicial system was not co-equal to the other branches. Second, the two largest political parties in the UK are more extreme than those in the U.S. The Conservative party is fairly close to the Republican party here, but the Labour party there is left of our Democratic party.

The backstory is that the Labour Party had contemplated a wealth tax for a long time. Through the 20th century, they had been disappointed with the revenue collected with high rates through an estate tax. Beginning in the 1950’s they started to discuss taxing wealth before death rather than at death. This came to a head in 1974 when the Labour Party included a wealth tax in the platform it used to successfully win the general election. Now they were in a position to enact the tax rather than crow about one, and that’s when the problems began.

Initial public complaints came from farmers, city-dwellers who owned country houses, and private art collections. This was followed by worries about international flights of capital (basically, the rich moving elsewhere). To some extent this was already happening in the UK, which required a bailout from the IMF in 1976 to stabilize the value of the pound.

N.B. The article does not mention this, but that was a topic of some interest in the U.K. in the 1970’s. This was the period when many rock musicians (e.g., members of The Beatles, The Rolling Stones, and Pink Floyd, David Bowie, the entire bands Jethro Tull and Bad Company, Tom Jones, Cat Stevens, Rod Stewart), movie stars (e.g., Roger Moore and Michael Caine), and television personalities (e.g. David Frost, and members of the Monty Python troupe) decamped (primarily to the U.S. and France) to avoid high income tax rates.

Ultimately the wealth tax proposal was not even brought to a vote. It died in committee meetings of presumable supporters. What went wrong? Glennerster quotes Denis Healey’s memoirs and synthesizes (Healey was analogous to Secretary of the Treasury in the UK during the 1970’s):

Denis Healey’s own reflective conclusion was that it was a mistake. ‘Another lesson was that you should never commit yourself in Opposition to new taxes unless you have a very good idea how they will operate in practice. We had committed ourselves to a Wealth Tax: but in five years I found it impossible to draft one which would yield enough revenue to be worth the administrative cost and political hassle.’ (Healey 1989, p404) It seems clear that the Labour Party never considered in any detail the administrative costs and practical complications involved in assessing individuals’ wealth on a regular basis. It was enough to say, as Labour Party Research Department papers did, that other countries levied such taxes so it must be possible. The several thousand civil servants needed, depending on the valuation level at which the tax began, the numerous regional offices required and the process of regular valuation that might fall on individuals came as a surprise to the politicians and, indeed, to the Treasury when it got to think about the question properly. [emphasis added]

…

One lesson to be drawn from the 1974 experience is that the administrative detail in taxation matters a lot. The idea still lacks detailed study. The second lesson is that tax changes that are likely to affect major sections of the population and the wider economy have to be widely debated before, rather than after, any party reaches power.

This is rather an amazing conclusion for the U.S. going into the 2020 election. As we saw in 2016, the unusual thing about U.S. presidential elections is the extent to which they can bring groups into the White House with little or no policy experience. The huge distinction is that in the UK almost everyone brought into power had policy experience, and not only could they not pull it off, but they abandoned the idea as unworkable.