Real Well-being, Mis-measured

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I was surprised by the results of this IGM Forum poll. Agree or disagree with

The 9% cumulative increase in real US median household income since 1980 substantially understates how much better off people in the median American household are now economically, compared with 35 years ago.

The great majority agreed with the statement. My remarks.

1. When I first saw the question, I expected a sharp split. I figure there is a lot of “mood affiliation” with the view that the middle class is suffering.

2. It could be that economists are so well off that they have no sense of what life is like for the median household. They feel intuitively that median well-being is somewhere in between what the statistics show and their own well-being.

3. If you read through the response, the most common reasons for agreeing with the statement are improvements in health and in (the consumers’ surplus from) smart phones and such.

Amateur Hour?

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What would Jonathan Rauch say about this?

Barack Obama’s ambitions to pass sweeping new free trade agreements with Asia and Europe fell at the first hurdle on Tuesday as Senate Democrats put concerns about US manufacturing jobs ahead of arguments that the deals would boost global economic growth.

It is possible, of course, that in the end the bill will pass. This could just be stage-management on the part of various parties who want to embarrass the President and/or make side deals.

Universal Savings Accounts

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Chris Edwards point out that Canada and Britain have expanded theirs.

Let’s look at Canada first. Prime Minister Stephen Harper’s government implemented Tax-Free Savings Accounts (TFSAs) in 2009, and they are creating a broad-based savings revolution north or the border.

Britain’s Individual Savings Accounts (ISAs) are just as impressive as the Canadian accounts. All UK residents can put up to 15,240 pounds (about $23,000) per year of after-tax money into ISAs. ISA earnings grow tax-free and can be withdrawn at any time for any reason with no taxes or penalties. Like TFSAs, ISAs enshrine in the tax code the principle that saving for all reasons is important, not just for reasons favored by governments.

Taming the Financial Sector

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Luigi Zingales writes,

there is precious little evidence that shows the positive role of other forms of financial development, particularly important in the United States: equity market, junk bond market, option and future markets, interest rate swaps, etc.

Found by Timothy Taylor.

Many financial practices are designed to evade regulations or optimize with respect to them. If regulators had not been so laggard in removing the interest rate ceilings on bank deposits, we might never have seen money market funds. If interstate banking had not been so restricted in the 1960s and 1970s, then there would have been no need for a mortgage securities market. If there were fewer short-sale restrictions and looser margin requirements in the stock market, then futures and options in the stock market might not have been created. My guess is that if you were to examine why firms use junk bonds rather than equity finance, you would find a regulatory story there as well.

Back in the early 1990s, someone coined the expression, “The Internet interprets censorship as damage and routes around it.” Financial markets attempt to do the same with regulation.

Jonathan Rauch Hearts John Boehner

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Rauch has a new e-book (free, at least as of the other day, when I downloaded it) called Political Realism. He argues that progressive political reforms have had adverse unintended consequences. In particular, they have made life more difficult for John Boehner.

Rauch relies on a distinction between professional and amateur politicians, a distinction for which he credits James John Q. Wilson. The pros just want to stay in power, and they will compromise on principles in order to keep it. The amateurs are ideologues.

Rauch argues that seemingly well-intentioned reforms have weakened political parties and thereby strengthened the amateurs. The reforms include attempts to require transparency in government, to restrict campaign finance, to curb earmarks, and to give ordinary voters more power to choose candidates via primaries.

The major unintended consequence of these reforms has been polarization and gridlock. Because the professionals are no longer free to manage the political process, government has become ineffective. Rauch argues that we should dial back the reforms that weaken the party pros and instead think in terms of reforms that strengthen them.

If you believe, as Rauch does, that the professionals would govern more effectively if given more slack, then his argument goes through. However, I am not sure that I buy into that assumption.

I can see one issue–entitlement reform–on which a compromise among professionals could have beneficial effects. But the unsustainable system of entitlements was built by those very professionals whom Rauch extols. My cynical take is that the professionals are good at compromising on the use of other people’s money, most especially when the other people are too young to vote or not even yet born.

If you ask me, the single most consequential political act of my lifetime is likely to be President Obama’s decision to throw the Bowles-Simpson recommendations under the bus. That may have destroyed the last chance to prevent a budget train wreck. Yet Rauch believes that Obama is one of the good guys, a professional able to compromise.

Obama’s professionalism, according to Rauch, is illustrated by the way that health care reform involved compromising with various interests. But if Obamacare is your poster child for professional politics, you are not going to convince me to jump on board the Rauch bandwagon.

As you can tell, my feelings about the book are mixed. I think that the main points are insightful. I see those as

1. Professional politicians are better able to compromise if amateur ideologues are less influential.

2. Progressive reforms have worked to empower amateur ideologues.

However, I do not share Rauch’s optimism for what the professionals might accomplish if they had their way.

Uncertainty and the Sources of Profit

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From The Economic Way of Thinking, eleventh edition, by Paul Heyne and others, p. 195:

Profit arises from uncertainty. In the absence of uncertainty, any differences between expected revenue and expected total cost would be competed away and profits would become zero.

That sounds to me like too strong a generalization. Some remarks.

1. It shows the influence of Frank Knight. But would Knight have bought such a strong statement?

2. Economists, including the authors, point out that profits as reported by business include opportunity cost, particularly the opportunity cost of capital. Economic profit is less.

3. Elsewhere, the authors want to insist, reasonably enough, that taxes are paid by individuals, even when those taxes are called corporate income taxes. I would think that consistency would require insisting that profits accrue to individuals, even when they are called corporate profits. But if all profits accrue to individuals, then I do not see how we can separate economic rent from opportunity cost. Maybe Bill Gates made a lot of money from Microsoft because he happens to have a very high opportunity cost. OK, that sounds absurd, but still, he has a higher opportunity cost than someone with less drive and ability starting a software business.

4. Talking about the profits earned by shareholders is tricky. In the portfolio theory of modern finance, there should be no excess return from taking diversifiable risk. Unless I know something that everyone else doesn’t, I will earn on average a lower return by buying shares in a particular stock than by buying shares in the market portfolio. (I think this point tends to cut against point 3 above.)

5. How do patents fit into the story? Firms obtain patents in order to protect profits. Are patents simply government-chartered monopolies, leading to artificial rents? Or are patents a return on investment in research and development? In the latter case, perhaps one would say that if the outcome of research and development were certain, then profits from those activities would become zero.

6. It seems to me that there are other sources of market power that are defensible. I am not talking about defensible in a moral sense, but defensible in the sense that they will not be competed away. For example, there is reputation. If my insurance company has a reputation for being sound, then potential competitors will find it difficult to persuade my customers to switch. Another example is network effects. Wal-Mart has a lot of customers because it has cheap prices. Because it has a lot of customers, it is in a strong bargaining position with suppliers, so it can keep its prices cheap. But if a lot of companies try to create network effects, and some succeed and some fail, is this another case of profit emerging out of uncertainty?

Going back to the quoted paragraph, I think that it is either false or uninteresting. If we do not stretch our definition of uncertainty, then it is false. Alternatively, suppose that we make it true by arguing that profit from investment in intellectual property, reputation, network effects, and so on is only due to the uncertainty involved in such investment. A forced tautology of that sort is not interesting.

Vinod Khosla Talks His Book

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He writes,

Just in the Khosla Ventures portfolio alone, entrepreneurs already are trying to use machine learning technologies to replace human judgment in many areas including farm workers, warehouse workers, hamburger flippers, legal researchers, financial investment intermediaries, some areas of a cardiologist’s functions, ear-nose-throat (ENT) specialists, psychiatrists and many others.

I have omitted links to the companies to which he refers.

The rest of the essay argues, rather repetitively, that technology is becoming increasingly a substitute for, rather than a complement to, human labor. It strikes me as a nod toward Robin Hanson’s view of the future, although Khosla thinks that human brain emulation need not play a part.

What I would watch for over the next 15 years are developments that enable humans to evolve more rapidly, in order to compete with machines. Note that the cover story of the latest MIT technology review says (a bit prematurely) We Can Now Engineer the Human Race.

Co-ordinated Specialization

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I have been thinking about the problem of teaching emergent economics. A commenter suggested The Economic Way of Thinking, so I got the eleventh edition. Paul Heyne started the franchise, and this edition, from 2006, adds as co-authors Peter Boettke and David Prychitko. It is quite good. It is certainly an improvement over the Samuelson tradition in which the market is a machine, technocrats are its repairmen, and economists write the repair manual.

The authors write (p. 16-17)

The economic way of thinking was developed by social theorists largely to explain how order and cooperation emerge from the apparently uncoordinated interactions of individuals pursuing their own interests in substantial ignorance of the interests of those with whom they are cooperating. Economics is a theory of choice and its unintended consequences.

The fundamental assumption of the economic way of thinking is that all social phenomena emerge from the actions and interactions of individuals who are choosing in response to expected benefits and costs to themselves.

I prefer something more Smithian and less Misesian. I would be inclined to start with something like this:

The most striking economic feature of modern society is that we can consume the products and services requiring millions of tasks while performing only a few tasks ourselves. Obviously, this requires some form of coordinated specialization. How can this coordination take place? Consider three possible extremes.

1. Decentralized decisions, but with no prices and profits. People just spontaneously decide on their own what would be most useful to society.

2. Centralized decisions, made by an expert planning bureau.

3. Decentralized decisions, guided by prices and profits, and regulated by competition.

The problem with (1) is that you will get imbalances. Suppose that getting milk to urban consumers requires both dairy farmers and truck drivers. If too many people would rather be truck drivers than dairy farmers, then there won’t be enough milk to transport. If too many people would rather be dairy farmers, then the milk will spoil on the farms. More generally, the jobs that no one wants to do will tend to go undone. Computer programmers will all work on video game hacks, not on inventory control systems. Basically, (1) only works when there are very few tasks to be divided among a small number of people who all get along.

Top-down planning is widely used in the economy. I think of corporations and non-profit organizations as operating this way. But as planning organizations increase in their scope of activities, prolems arise. When central planners draw up their plans, they do not know true costs. Part of the reason for their lack of knowledge is that all costs are opportunity costs, and opportunity cost has a subjective component. Moreover, central planners are not well positioned to gauge alternatives to the status quo. How can a remote planner know whether a factory will be managed more efficiently by Jane than by John?

In a complex economy, these knowledge problems are better solved by competition under a price system with profit incentives.

Returning to Heyne-Boettke-Pryhitko, I would prefer not to put as much emphasis on the methodological dogma that people choose in response to expected benefits and costs. Instead, I prefer to emphasize the question of how a society can operate with each individual performing a few tasks while consuming the products of vast multitude of tasks.

I am not saying that one can do away with the dogma. Offhand, I do not see how to get to “all costs are opportunity costs” without invoking it at some point. But I want to be up-front that the dogma has philosophical consequences.

Predict the Impact on Inequality

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The WSJ reports,

Basically, the long-time “gap” between the fertility of educated versus less-educated mothers—more educated mothers have fewer kids—is closing.

This could help explain what’s happening with statistics on marriage and fertility. Data from the Centers for Disease Control & Prevention earlier this year showed that married U.S. women are having more children, while unmarried women are having less.

John Goodman on Health Care Reform

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His latest book is now available.

Offering a fixed-sum tax credit for its purchase (in place of tax exemptions for employer-provided insurance and tax deductions for the self-employed and for Obamacare subsidies in the exchanges) would eliminate the perverse incentives in the current system and allow people to make their own choices between health
insurance and other goods and services without financial penalty.

Harry Truman said, “I never gave ’em hell. I just told the truth and they thought it was hell.”

Goodman applies economic logic to health care, and people think it’s hell.