Monthly Archives: December 2012

A Solution Exists…I Can Quit Any Time

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Tyler Cowen writes,

Unfortunately, longer-lasting solutions require coordinated agreement among many euro-zone nations and, possibly, the broader European Union. That would include significant debt write-offs (as the International Monetary Fund is suggesting), quick moves toward better-integrated European banking institutions, and a general agreement that the European Central Bank unconditionally support troubled debt securities without trying to manipulate home governments’ policies.

I would say that a longer-lasting solution has to include adopting sustainable fiscal policies. Read the whole column. Another excerpt:

Unfortunately, the relevant governments — and their citizens — still don’t seem close to accepting the onerous financial burdens they need to face. And when those burdens are unjust to mostly innocent voters, no matter whose particular story you endorse, acceptance becomes that much tougher.

Still, we shouldn’t forget that a solution exists.

Meanwhile, back in the United States, Jonah Goldberg writes,

You could confiscate 100 percent of income over $1 million, and it would cover about a third of the deficit (and crush the economy in the process). You’d still have to deal with spending, particularly entitlement spending.

But the Democrats want to do . . . nothing. Or at least that’s the position they seemed to be taking this week.

I want to caution readers not to commit the Fundamental Attribution Error. That is, do not attribute the current political strife and apparent short-termism to the personalities of politicians. Instead, these characteristics are structural defects of a system without a hard constitutional brake against deficit spending. Absent an effective constitutional brake, deficit spending is like smoking. In theory, the politicians can quit at any time. In practice, in many cases we end up with cancer.

That is the import of Lenders and Spenders, an essay that I expect I will be linking to regularly. The point of that essay is that debt crises are easy to slide into and very difficult to get out of.

At the end of the second World War, the United States was fortunate in that (a) running deficits in peacetime was still taboo and (b) Social Security was running surpluses that the politicians had not yet put their hands on, because it was considered a separate account. Unfortunately, both of those taboos went away in the 1960s, when Keynesianism became orthodox and President Lyndon Johnson got his hands on the Social Security surpluses by changing to a “unified budget”.

Eventually, some smokers get cancer. And some deficit-spending countries succumb to the fiscal equivalent. I used to think that Europe was going to get there before the United States, because I thought that in this country we had a stronger political will to restrain deficit spending.

I am starting to change my position. The mainstream views in the United States on deficit spending now lie somewhere in between, “We can quit at any time, but now is not the time” and “We never have to quit.”

Have a nice day.

The Keynesian Fixation

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Zachary Goldfarb presents a series of charts and concludes,

Put it all together and household debt has weighed on the economy in a way many people don’t appreciate, but there seems to be progress toward addressing it.

Pointer from Mark Thoma.

In my view, Goldfarb is presenting symptoms and suggesting that they are causes. This is a characteristic of what I call the Keynesian fixation. Note that in macroeconomics the position that I criticize is the mainstream position. New readers should be aware that mine are outlier views.

To a Keynesian, economic activity consists of spending. Spending causes jobs, and jobs cause spending. When you look at economic data, that is your focus. Is spending going up or down? If it goes up, then we will have more jobs and more spending. If it goes down, then we will have fewer jobs and less spending.

The alternative approach that I propose is to look at economic activity as the formation of patterns of sustainable specialization and trade (PSST). As entrepreneurs create businesses that exploit comparative advantage and specialization, jobs and spending increase. When existing patterns of trade become unsustainable, jobs and spending decrease. See this paper and this paper.

For example, when hurricane Sandy hit New York, the Keynesian fixation was to look at the destruction in terms of how it would affect spending. Would people spend less, because of lost wealth? Or would they spend more, because of the need to rebuild? Mayor Bloomberg wanted to run the New York marathon less than a week after the hurricane hit, because he did not want the city to miss out on the all the spending that comes with the marathon.

My view is that what matters are the patterns of specialization and trade, which depend on the transportation infrastructure. I over-estimated the damage to that infrastructure, and so I thought that there could be significant long-term shifting of jobs out of Manhattan. However, if only a tiny portion of the transportation infrastructure suffered damage that could not be repaired in a couple of weeks, then the PSST story would say that employment in the area should not be affected.

To take another example, the “fiscal cliff” does not trouble me. If you hold the Keynesian fixation with spending, then it appears that a sharp reduction in government spending and/or increase in taxes will cause a recession. If you think in terms of PSST, it probably will make little or no difference. And, as I wrote two years ago,

Government spending plummeted by nearly two-thirds between 1945 and 1947, from $93 billion to $36.3 billion in nominal terms. If we used the “multiplier” of 1.5 for government spending that is favored by Obama administration economists, that $63.7 billion plunge should have caused GDP to fall by $95 billion, a 40 percent economic decline. In reality, GDP increased almost 10 percent during that period, from $223 billion in 1945 to $244.1 billion in 1947.

After the second World War, the U.S. economy easily created new patterns of specialization and trade. I think that one reason is that the war increased mobility, as soldiers met others from different parts of the country. Instead of remaining in their communities of birth, men moved in order to take advantage of new opportunities. Regardless of whether this was an important factor, it should be obvious that if we could cut government spending by 25 percent and thrive, then going over the fiscal “cliff” would be a non-event.

If I were assembling charts on the economic outlook, I would focus on secular factors: declining labor force participation among less-educated men, which indicates that new patterns of trade are reducing the value of their work; the increasing “tax” represented by the cost of providing health insurance to workers in large enterprises; the significant shift in the distribution of wealth toward Washington, DC, which makes secondary businesses such as restaurants and real estate services more profitable in the nation’s capital and less profitable elsewhere. Or consider the charts on household income and benefits from Gary D. Alexander, showing many categories of workers facing marginal tax rates of over 100 percent.

We should be trying to understand what is causing the breakdown in patterns of specialization and trade that prevailed at the end of the 1990s. We should be trying to understand what is impeding the formation of new patterns of specialization and trade today.

The Tax Deduction for Charitable Contributions

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Reihan Salam discusses some ideas for reforming the charitable deduction. In particular, why let rich people have all the fun? You could make it a credit rather than a deduction.

I need to think more about this whole issue. My initial inclination, years ago, was to take a very hard line against any attack on the charitable deduction. If you think about it in terms of government vs. the rest of civil society, then I prefer the other institutions of civil society.

More recently, however, I have begun to question the idea of assigning privileged status to non-profit organizations. I think of profitable organizations as sustainable and accountable for delivering results to customers. In contrast, non-profits are not sustainable (at least on a market basis) and are accountable only for making donors feel good.

Or consider General Motors. GM received a lot of money from the government in 2008, because it had become a non-profit. Should it have been eligible for charitable donations as well?

Many non-profits are no less dependent than GM on direct government support. They compete for government grants. Why is government largess bestowed on non-profits more ethical than the largess it bestows on profit-seeking enterprises?If a for-profit could turn a government grant into better results at lower cost than a non-profit, should the non-profit still get the grant?

When I get my thoughts sorted out, I will probably turn them into an essay.