Great Questions of Economics
Arnold Kling
Applying Introductory Economics Every Day

Archive of posts 301-310 of GQE

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The latest issue of Technology Review has a cover story that is filled with anti-market paranoia. The thesis of the article is that Detroit knows how to make automobiles with much higher gas mileage, but the corporate devils are keeping the technology off of the market.

All in all, there is no shortage of technology available and almost ready for the auto industry to adopt. And yet, SUVs still get an average of only 21 mpg. Asked why, General Motors’ Indra cites familiar industry arguments: innovations are too expensive; new components add weight, negating benefits. He says also that weight reduction—which, according to the DiCicco study, accounts for nearly one-third of the formula for boosting mileage—cuts into safety. That’s the argument the industry used as part of its lobbying blitz to kill tougher fuel-efficiency legislation last March.

My guess is that much of the rigidity of the car industry today is due to the weight of existing regulations. If the problem is slow adoption of technology, I doubt that more regulation is the solution.

Most economists would say that you should set an appropriate tax on gasoline (raise the tax if you want to discourage consumption) and let the market determine automobile technology.

Discussion Question. If technology for improving gas mileage were readily available and economical, what incentives would lead manufacturers to introduce it?

Income Distribution or Consumption Distribution?

'Jane Galt' reacts to the latest Paul Krugman salvo.

I quite agree with a lot of it. It's been obvious to me for quite some time that the level of many CEO salaries was based less on their personal acumen, and more on their ability to build a captive board that ratified insane stock options.

She makes an important point, which is that we should look at inequality in terms of consumption rather than income. She argues that by this measure, inequality has decreased:

Has the qualitative life experience of the rich really increased, while the poor stayed stagnant? Since the 50's? 60's? 70's? I would argue it's the reverse. The head of GM's life is not, qualitatively, much better than that of the head of GM in the 50's. The poor, on the other hand, have more space, better food, more and better clothes, color televisions, VCR's, automobiles. . . items that were beyond the wildest dreams of the poor in the 1950's. The numbers may have diverged, but I would argue that the quality of life is converging.

Well, I don't know whether Larry Ellison ever succeeded in buying a MiG jet fighter, but that might qualify as an upgrade over what CEO's had in the 70's. Still, the point is well taken. The improvement in living standards seems proportionately higher at the low end of the income distribution than at the high end. I wrote about this in Ideological Anachronisms, of which Krugman's piece is an example.

Discussion Question. Which would you rather have, the lifestyle of someone in the top 10 percent of the income distribution in 1970, or someone in the middle of the income distribution today?

Moore's Law and the Economics of Crime

One theme of the economics of crime is that the deterrent effect of laws depends on the probability of enforcement. In The Trackable Society, I argue that improvements in technology could raise the probability of getting caught committing minor crimes, such as speeding.

In theory, perfect enforcement of speed limits would cause everyone to obey the speed limit. But that would be such a radical development that I doubt that it is desirable. If speeding is widespread, it is very likely that it is efficient from both the individual and social perspective. In fact, we probably want the vast majority of speeding violations to be overlooked.

Discussion Question. There is much popular resistance to using surveillance technology to enforce laws. How much of that resistance is due to the fact that the laws themselves are too intrusive?

Poverty and Terrorism

How strong is the connection between poverty and terrorism? Economists Alan Krueger and Jitka Maleckova analyzed a variety of data, including statistics on members of Hezbollah and public opinion polls in the Gaza Strip and the West Bank. They concluded that

economic conditions and education are largely unrelated to participation in, and support for, terrorism.

Eliminating poverty is a laudable goal. Eradicating terrorism is a laudable goal. However, they are not the same goal.

Discussion Question. Why do many people assume that poverty and terrorism are connected?

Krugman on Inequality

Is the increase in inequality as adverse for the lower and middle income groups as Paul Krugman claims? To view the actual data, go here (and scroll down to the second table, which adjusts income for inflation). The Census Bureau reports, you decide.

Krugman pre-emptively delegitimizes any who would view the data as something other than alarming.

The concerted effort to deny that inequality is increasing is itself a symptom of the growing influence of our emerging plutocracy...politically motivated smoke screens...the ideas that were taken up by business schools, that led to nice speaking and consulting fees...

In other words, anyone who would dispute Krugman must have been influenced by the malefactors of great wealth. Only the great Paul Krugman remains incorruptible and honest.

In my view, it is difficult to dispute that the rich are getting richer. However, it is equally difficult to dispute that the poor are getting richer. For example, W. Michael Cox and Richard Alm in Myths of Rich and Poor have pointed out that in spite of the rise in inequality a poor household in the 1990's was more likely than an average household in the 1970's to have a washing machine, clothes dryer, dishwasher, refrigerator, stove, color television, personal computer, or telephone.

Cox and Alm see the improvement in the lives of the poor as a sign that the glass of economic growth is half full. Krugman sees the even-larger increases in incomes of the rich as a sign that the glass is half empty. I see the case for treating income inequality as a national crisis as being almost entirely empty.

Discussion Question. The Census Bureau data show that on an inflation-adjusted basis, households in the middle quintile of the income distribution today have the income level that the quintile above them enjoyed 30 years ago. How does this help make Krugman's case that we are losing the middle class?

The Elusive Quest for Growth

In an unusually long Web article, Hans H. J. Labohm surveys the problem of generating economic growth in underdeveloped countries. (In a recent book, William Easterly calls this The Elusive Quest for Growth.) Labohm covers many issues, which would make this a good introductory article to assign to students. In one section, he makes use of an index of corruption, which is

based on a survey by Transparency International on the perceptions of business people, academics and country analysts...

The richer a country, the less corruption and vice versa.

He summarizes current thinking.

It is an holistic framework, which offers objectives for macroeconomic policy and trade; the role of government, regulations and the fight against corruption, the creation of a social safety net, health care, education, infrastructure, environment, rural development, the promotion of private enterprise, and the creation of equal opportunities for women. Additionally, attention should be paid to the overarching problem of institutional reform.

In my view, these dry words do not match the challenge of underdeveloped countries. After reading Robert Kaplan's Eastward to Tartary, I came away with a picture of countries like Syria or Turkmenistan that was more immediate and frightening. Terms like "fight against corruption" or "infrastructure" do not begin to describe the issues of ethnic conflict and organized crime that plague such states.

Discussion Question. Should economists try to offer "holistic" advice, or should they restrict their policy recommendations to their areas of expertise, such as trade policy?

A Trend in Music Pricing?

Alan B. Krueger takes note of the sharp rise in the price of tickets for music concerts, and he examines various possible explanations.

I suspect the main reason is that the growing ability of fans to download music free from the Web — legally or illegally — has cut into artists' revenues. Millions of people have downloaded music from Napster, Morpheus and KaZaA — and bought fewer records as a result. Music sales are plummeting, putting downward pressure on artists' royalties.

In this environment, concerts take on a different meaning for artists and their managers. In pre-Napster days, concert prices were kept below their market rate to help sell albums, a complementary good. Now concert prices are set with an eye toward maximizing concert revenue.

Many economists believe that the music industry will have to change its revenue model, and that artists may grow to depend more on live concerts. However, I am skeptical that this is already happening to the extent that it explains the surge in concert prices. Ticket prices for professional basketball games also have shot up, and there is no Napster effect in basketball. I suspect that certain forms of popular entertainment are luxury goods, and the big increase in wealth in the late 1990's is what facilitated the rise in ticket prices.

Discussion Question. If popular entertainment is a luxury good, will the drop in stock market wealth help to curb ticket price increases?

Inequality, Institutions, and Growth

Why do some countries develop institutions conducive to growth (broad-based democracy), while others fail to do so? Stanley L. Engerman and Kenneth R. Sokoloff have an explanation.

we highlight the relevance of stark contrasts in the degree of inequality in wealth, human capital, and political power in accounting for how fundamental economic institutions evolved over time. We argue, moreover, that the roots of these disparities in the extent of inequality lay in differences in the initial factor endowments (dating back to the era of European colonization). We document -- through comparative studies of suffrage, public land, and schooling policies -- systematic patterns by which societies in the Americas that began with more extreme inequality or heterogeneity in the population were more likely to develop institutional structures that greatly advantaged members of elite classes (and disadvantaging the bulk of the population) by providing them with more political influence and access to economic opportunities.

Brad DeLong describes this as though it were all about temperate vs. tropical climates. From the abstract (I have not read the paper), it would seem to me that their analysis is more flexible than that.

Discussion Question How would a narrow base of land ownership and a narrowly-based government tend to reinforce one another?

Taxes and the Business Cycle

State and local governments cannot run deficits, so Alice Rivlin suggests that they would be better off with tax revenues that are insulated from the business cycle.

The fact that states collectively have become more dependent on the income taxation somewhat reduces the fear that their revenues will grow more slowly than GDP over the long run. The price, however, is the greater volatility of revenues over the business cycle...

Because consumption is more stable than income, a tax on consumption would be more stable than an income tax. However, Rivlin points out that because sales taxes tend to exempt services, which are a fast-growing sector of GDP, sales tax growth may tend to lag GDP growth. Also, income taxes tend to be more progressive.

Discussion Question. If it is good for the Federal government to run a deficit during a recession, then is it preferable for the government to use an income tax or a sales tax?

Margin of Safety

In What's Your Margin of Safety?, I write

[Benjamin] Graham's "margin of safety" plays the role in stock market valuation that economists usually assign to something called "the risk premium." However, this is a case of bad economic jargon driving out a useful practitioner's concept. There is no way for most economists, much less ordinary investors, to have intuition about what is a reasonable risk premium. But anyone can grasp the concept of a margin of safety.

Discussion Question. How sensitive is the estimate of the intrinsic value of stocks to the forecast for dividend growth? Does this sensitivity require a large margin of safety?