Asymmetrical Information

I am all for raising taxes on the rich, but I think you're right. It's hard to see how it would do anything significant to reduce the account deficit.

For instance, if taxes on the poor are reduced, won't they just use part of the money to buy more goods produced in China?

The coefficient of 0.4 was based on earlier work, using data up to 2003, and time-averaged observations, and fixed effects specification. In our newer paper [pdf], Hiro Ito and I report a range of estimates from 0.95 to 0.485. Consider a point estimate of 0.4 (which is bracketed by our estimates.) What this means is that a one percentage point shift in the medium term budget balance in an industrial country (using the IMF classification) induces a 0.40 shift in the medium term current account imbalance. The 0.485 estimate comes from the fixed effects regression where we measure medium term values using a Hodrick-Prescott filter; a Baxter-King band-pass filter would yield similar coefficient estimates.

Because we are examining medium term balances, one cannot take the current value and apply the coefficients mechanically to current observed values. Rather one would like to apply them to the cyclically adjusted series. Rather than working through these, however, let me just observe that a 0.40 coefficient is not too unreasonable. First, between 2000 and 2005, one saw a roughly 4.3 ppt. swing in the Federal budget balance. This implies a 2.2 ppt deterioration in the current account. The actual deterioration was ... 2.2 ppt. (Data sourced from pages 1, 34, 36 of the August Economic Indicators jointly published by CEA and JEC; GDP and Federal figures on a NIPA basis, current account numbers on a balance of payments basis.)

Further, I would note that 0.40 is an entirely plausible number based upon my reading of the OECD's Interlink macroeconometric model, and discussions I've had with people familiar with Macroeconomic Advisers' WUMM. As I have stressed elsewhere, some of the low elasticities reported in the press are based upon calibrated dynamic stochastic general equilibrium models; while calibrated to "match the data", they differ in spirit from macroeconometric models and reduced form emprical estimates I'm relying upon.

So while you are right, a retrenchment back to a pre-Bush fiscal stance would not eliminate the current account deficit, this was not the point I was making. In point of fact, I have stated [pdf] repeatedly that fiscal retrenchment alone would not solve the problem. But it is a key in reducing the CA deficit; falling oil prices will also help, as will deflation of the housing market, and of course increased Rmb flexibility. My point is that the Administration has focused almost solely on this last issue; perhaps that will change.

For those who want to read more about the various models -- from a variety of competing viewpoints -- I sugest they read the papers presented at this conference.

From reading the comments on Mankiw's blog entry, I would suggest that you are not missing anything.

As for the current account deficit, I would point out that Americans pay cash for the goods we import. It is up to the foreigners to find the appropriate things to buy with those dollars. They can either buy some of our output or buy some of our assets- real and financial. If the U.S. government cuts the growth of the federal debt, then that should cause a shift in where those dollars go. Will it raise the ratio devoted to U.S output rather than assets? I am not sure I see a reason that it necessarily would.

I think that they're referring to % of GDP, so an elimination of a 2% budget deficit would lead to a (2% * 0.4 = 0.8% of GDP) reduction in the current account deficit. So that would be about a $104 billion reduction in the current account deficit, for a reduction in the fiscal deficit of $260 billion, since 260 * 0.4 = 104. At least that's how I read it; I could be wrong myself.

Middle class people pay higher taxes than poor people and rich people.
When the balance of payments renormalizes, the poor people will get jobs working in the smelters and mines and factories in the flyover, and become middle class and pay more in taxes both as a percentage and in total than when they were poor.
This money will come from the rich people paying more for made in America stuff than they do now for imported stuff. They will fall into the middle class and pay more in taxes than the dividends and capital gains (twenty to zero percent, averaging nine percent, depending on how long the money is held) that they pay now.
Mostly that's because they will sell their stuff and pay twenty percent capital gains instead of holding it till death and paying zero percent because of the stepped up basis for their heirs.
The formerly poor people will by their stocks and property (I assume bonds will be inflated away) as investments with the money they will be making.

You're just being silly Jane. You're confusing values and tactics. Taxing the rich is, to many, a value. Its not a means to the end of obtaining more tax revenue, its an end in itself. The justifications for doing so may vary, and different ones spring up from time to time, but if they are logically or empirically discredited they will just grab at any new justification that comes along. Its been going on for a long time now. I don't think it will end anytime soon.

Its just another Solution in Search of a Problem. If the problem turns out to defective, you just go looking for another one.

Hey, wkwillis, great thinking. Could you please do a further post with actual numbers?

How many rich people are there and how much money will they spend for mined, smelted and factoried stuff and all so as to raise all the poor into the middle class?

P.S.---

I was just being a smart-ass when I said you were silly. I have the highest respect for you and I truly meant no insult at all.

The New Zealand government is running a healthy budget surplus, and yet the current account deficit is only a little bit below 10% of GDP.

Current account deficits are weird, and possibly just a figment of statistical accounting.

Wouldn't putting more money in the hands of the poor tend to *worsen* the current account deficit? If it's true (as we are told) that the poor tend to spend their earnings while the rich save, then transferring wealth from rich to poor would tend to decrease savings and increase consumption, no?

One might want to redistribute for other reasons, of course, but closing the trade deficit seems to be a very bad reason to soak the rich and give the proceeds to the poor.

That's not how I read Chinn's analysis, either. As far as I can tell, he said that you'd need to reduce the budget deficit by $6-7 to reduce the current account deficit by $1, which means that completely eliminating the budget deficit would barely put a dent in the current account deficit. But it's not terribly clear to me, either.

It's also not clear to me what your question is. Could you clarify?

The current account deficit is artificial, and in an integrated global economy is essentially meaningless. It matters quite a lot when you have a non-integrated economy, such as for very poor countries that are essentially autarkies, or in very mercantilist situations. It also mattered quite alot back when we used specie currency, as one can see when you look at the history of money and gold flows between the US and Europe, the South and the Northeast, the Frontier and the Northeast... in terms of electronic fiat currencies this doesn't mean much.

Current account deficits only matter to our inner mercantilists, and are but one of our vestigial feelings about economics that "make sense" but don't actually work. The entire concern stems from a lack of comprehension of Ricardo's work and the gains of trade.

Eliminating the budget deficit (and heck the debt) is good in and of itself. Taxing the rich is always a bad idea, though it appeals to the envious nature of most people.

Jane,

The portion of the current account deficit that is "left" after we erase the budget deficit must be do to some market mechanism.

Either the foriegners are lending us more money because the United States is a great place to invest with higher returns than the rest of the world despite or high level of capital per capita.

Or American's have simply decided that they would personally rather trade consumption today for wealth tomorrow. This is a personal choice for each person and since (unlike the budge deficit) you are not responcible for paying their bill, what is it to you.

Or, the foreigners are foolishly inflating our cuurency in an effort to spur economic activity in their own country. This is foolish because it is unsustainable and the eventual correction will devestate their net worth.

An anology would be buying a stock you already own a lot of in an effort to keep the price up. It makes your balance sheets look good in the short term but over the long haul the eventual correction will wipe you out.

None of these possibilities are bad for the US as a whole and if you think that it is most likely the third then you probably suspect that once the congress stops proping up the demand for loanable funds China and other nations will see the foolishness of their self-Ponzi scheme and try to back out slowly.

Two issues here:

1) Why do left wing economists always propose increasing taxes on the "rich?" Why do teenage boys get erections? Same answer in both cases - any reason and no reason will do equally well.

2) Is the current account deficit (CAD) a problem? The empirical evidence suggests the answer is NO.

The CAD has been significantly in negative territory for pretty much my entire adult life - all 30+ years of it. It has been wailed about in print by professional economists this entire time. I recall a piece by someone in the early 80's in which it was pointed out that the then-current year's CAD was equal to the entire market value of all the agricultural land in Iowa. "What are we going to give the foreigners next year, now that we've had to give them Iowa?" was the rhetorical thrust.

Iowa, of course, is still where it was 25 years ago and the title has not changed hands.

What I think gets missed here is that the U.S. does not send money to cover the CAD, it sends government securities. These are not money, they are securities. They are bonds in a technical sense, but are functioning, to an important degree, as if they are equity shares in USA, Inc. with the interest paid standing in for a stock dividend. Foreigners are happy to take these because they are sound paper.

The U.S. economy has demonstrated that it is the only advanced industrial/service/informatic economy that can consistently deliver productivity growth and real GDP growth at rates not otherwise seen outside of developing economies that are much further down both the size and sophistication curves. No other large developed economies come close in either respect. Germany and France are moribund. Japan is only now emerging from a 15-year economic hibernation. Great Britain is doing passably well, but not as well as the U.S. and it's economy is, in any case, only a fraction as large.

The proof of this particular pudding is interest rates. If the U.S. were really the desperate profligate it is portrayed as by people like Stiglitz when wailing over the CAD, it would attract little capital and would need to pay dearly for it. It doesn't, in fact, have to do either.

This is because - quite simply - the U.S. system works. Those of other large developed nations do not work nearly so well. There are political and cultural reasons for both of these circumstances, but the bottom line is that other nations - regardless of their own internal arrangements - see that the U.S. has worked, continues to work and will continue to work in the foreseeable future.

The U.S. economy - and the socio-political order that underpins it - is not only the best large bet for future, low-risk appreciation, it is the only one.

Eventhough I got my economics degree (bachelors) from Penn, which I hear is a good school, I think I must be crazy as to why I find the existence of the current account deficit perfectly explainable and obvious and theat my reasons don't seem to be held by economists.

It just seems to be a question of demography. Labor is next to worthless without capital and capital is absolutely worthless without labor. In the developed world, which country is the only one with a growing labor force that is projected to keep growing. The US. Even the countries whose labor forces are not currently declining are projected to decline starting in the near future. So where is the world's capital going to go. No mystery. If you import a lot of Mexicans to cut grass, you have to import a lawnmower for him too. Also, if one's labor force is expanding, so is your capacity for servicing debt, so that's not really a problem.

Why many academic economists, seem to think that if we cut the budget deficit the current account deficit, which is the flip of the capital flow is the real mystery, if you ask me.

Middle class people pay higher taxes than poor people and rich people.

No, rich people pay higher taxes, in dollar terms, than anybody. And it is dollar terms that matter. You can't buy a car with "a percentage of disposable income" -- they make you pay them in actual currency. :)

Let's put all of this in perspective.

Let's map the US economy into a family making $50k a year.

The US runs about (as a percentage of GDP):

30% net foreign debt
300% domestic assets
7% current accounts deficit
16% investment
84% consumption

How would our model family making $50k look with this:

$15,000 in debt
$150,000 in assets
$3500 in annual borrowing
$8000 in annual investing
$45500 in annual consumption

So tell me, does this look like a bankrupt family to you? The save and invest a net $4500 a year, they have net assets of $135k.
The really interesting question is, does this family make more on the $8k a year it saves than it pays on the $3500 it borrows. Let's look at that.

The US pays about 5% on for it's borrowing. So for our hypothetical family, That means the $3500 they borrow effectively subtracts $175 a year in interest from their income.
The US economy tends to grow in the long term at about 3% annually, which mapped into our hypothetical family can expect about an extra $1500 in income next year. So our hypothetical family can expect a net increase in available income next year of $1325.

When you really map the US GDP down to household spending, you get a clear picture of just how healthy it is.

If you beleive that our trade deficit is due to an overvalued dollar and that market forces are going to cause an adjustment, then the one way to cushion our economy is to take steps now to strenthen the dollar and reduce the trade deficit, by balancing the federal budget. That is we can decrease the amount of overvaluation with a sound fisal policy so adjustment will be slower and more orderly.

I'm surprised nobody has pointed out the national accounts identities, which one learns the first day in Macro Econ (and to which I refer in #7 here).

Private sector (business and individual) savings or deficit, plus government's deficit or surplus, plus net imported investment, all expressed as a percentage of GDP must equal zero. If the government deficit, which can be financed either by imported capital or private sector (individual and corporate) saving, goes to zero, then we will stop importing capital or stop saving in the private sector or some combination of the two.

Note that none of this tells you what direction GDP goes in, just the savings/dissavings within it.

I've made much reference to Woody Brock in prior comments on this subject. He has made some of his papers public. Have a look at the one on current account deficits.

^I think this is implicit in the conversation.

The "problem" is that the trade deficit exceeds the budget deficit. So, even if a decline in goverment dissaving as no negative effect on domestic saving we would still be in a hole to the foriegners.

The next question of course is, is that a good thing or a bad thing.

If foreign money is financing US investment then concievably its a good thing. The marginal product of our labor goes up when US investment increases even if we did none of the investing.

If it is financing US consumption then on one level its a bad things. However, its a bad thing primarily to the indivduals who are borrowing "too much" not to the nation as a whole.

However, I made the point some time ago that changes in the quality of work and life expectancy might result in making lifelong savings ineffecient.

Many people are apt to have the most income and the least expenses precisly at the same time - in their 60s. The house is paid off and the kids are gone but they are in the peak of their earning years.

Why should they save for 40-some working years just to be even richer when they are 60?

Great comments here, most enjoyable and unusually analytical, rather than emotional. Good to see this.

Speaking of which: Where is that great economic genius thinker, Eduardo? Since his first post above, I guessed he'd have a lot more to enlighten us with, being the "brainwashed capitalist" that I am. I was expecting another communomics rebuttal dissertation explaining why we need to hang the rich, and become Mexico as fast as possible. Eduardo where are you? You do understand this stuff comprehensively, right?

I think Slocum and Mindles H. Dreck have the right idea here. Menzie Chinn’s analysis is largely irrelevant to Stiglitz’ proposal, because Stiglitz proposes to reduce the budget deficit but increase consumption at the same time. The Chinn results apply to deficit reduction alone. If you deliberately increase consumption by the same amount as you decrease government spending, and if there are no effects on output or domestic investment, you end up, necessarily, with exactly the same trade deficit. It’s not clear how, exactly, Stiglitz expects his proposal to reduce the trade deficit at all (as I discuss here).

But as for proposals that reduce the budget deficit in ways that actually would reduce the trade deficit, I think there’s another point that has to be made. Jane refers to the unified budget deficit. Given that, for example, the Social Security surplus is there for a good reason and if anything probably not big enough to cover eventual promised benefits, it might make more sense to refer to the primary budget deficit, which is much larger. If we got rid of the primary deficit, and if the savings passed one-for-one into the trade balance, most of the trade deficit would be eliminated. So in that sense the story is about budget deficits and not about foreigners insisting on lending us too much money.

In fact, if the government were forced to do actuarially correct accrual accounting, the annual accruals on the huge Medicare liabilities would really put the deficit into the stratosphere, and the budget deficit would be much bigger than the trade deficit. Wherefore it occurs to me that, perhaps the reason that households are not saving is that they expect the government to take care of their future needs in ways that it has promised but won’t be able to deliver.

blaquejaquesshellaques
Hey, it's okay if you don't believe me. It's hard to unlearn things.
Here is a back of the envelope calculation. It's as valid as one with the latest numbers because the numbers are bad. No kidding, we really don't know what's happening with the economy and even when we put in estimates they have to reissued each year. Look at the jobs creation numbers the Republicans put out and what they release later. Not allways downward revisions, either.

We have a balance of payment deficit of around 700 billion, give or take 100 billion. No kidding, we don't really know. We won't go into the whole dark capital thing, though you can google it if you want. Assume it is true, or will be next year or was last year. The trend line for balance of payments is down, down, down, for the last ten years and more. Clinton as well as Bush.
Now assume that most of the cost of anything is labor, or labor to build the factory, smelter, or mine. Capital intensive things are really construction labor intensive things.
So we have 80% of the 700 billion as labor cost. Assume that most of our imports are manufactured or resource goods. Crude, cars, clothes, coffee, and computers. That's a good rough estimate.
Those are the imports.
Coffee is not substitutable, except that we export countervailling food exports that can remove it from the equation. All the others are substitutable. We can build iron ore mines, steel mills, coal mines, synfuel plants, wafer fabs, textile mills, etc.
So we have a lot of construction and manufacturing jobs.
These jobs do not require four year degrees. They require high school diplomas and two year degrees. No kidding, working in a steel mill requires brains. Ditto wafer fabs. Clothing factories and coal mines, not so much.
So what is 80% of 700 billion? About 560 billion. What is the average wage in the US? About 40 thousand. So what happens when demand in the labor market goes up by 14 million? And half the illegal immigrants go home, adding another 6 million or more?
We have just added 10 percent to the labor demand. When OPEC cut world oil production 5% in 1973, prices went up 4 times.
Think about it.

What you are missing is why people invest in the American economy.

The risk vs reward. Low risk, reasonable reward.

Some economist think that tax rates over 20% produce tax avoidance not more tax revenue.

It is really strange to see so called libertarians who do not understand economics.

If a rip roaring economy doubles the income (real purchasing power) of the poor and the income of the rich 50X (with the middle class coming in at 5X) would that be a bad thing?

American high incomes are dependent on high capital invested per worker. I fail to see how highrer taxes on the rich will increase investment (and thus worker pay).

Libertarian socialism will work no better than any othter flavor of socialism.

. In the developed world, which country is the only one with a growing labor force that is projected to keep growing. The US.

I'm not sure if this is a relevant argument. The UK, Australia and NZ's labour forces are not projected to keep growing significantly, As Far As I Know, but these countries are also running substantial current account deficits.

For some reason, when Americans think about the current account deficit, they only seem to think about the American one. The whole thing gets a lot more puzzling and less worrying when you include the rest of the Anglo-Saxon world.

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