Asymmetrical Information

From the desk of Jane Galt:

I heart Will Wilkinson

Why? You ask. Because he writes pieces like this: the piece that I would have written, if I were as smart and talented as Mr Wilkinson is . . .

The law of demand is a bitter pill for defenders of labor market price controls. Noted economic theorist Matt Yglesias has grown weary of appeals to “Economics 101″ in the minimum wage debate. “After all,” Yglesias writes, “there’s a reason they offer more economics classes and you don’t get your degree after taking just one.” His American Prospect colleague Ezra Klein says of the law of demand that “It’s a good guideline, but it’s got no end of exceptions.” The minimum wage, of course, is one those exceptions.

They’re both right in general, if not about the minimum wage in particular. There are more economics classes, and they do teach exceptions. However, let’s not imagine that there is some advanced economic class in which you learn that the law of demand is false. (Well, no doubt there is somewhere. There is contradiction-friendly “paraconsistent logic,” after all.)

To use Yglesias’s misapplied example, Econ 101 principles do not stand to higher-level economics in the way that Newtonian physics stands to relativity and quantum machanics: as a useful, but literally false, simplification of reality. Economic laws are not strict laws of nature, codifying ineluctable relationships of necessity, and they do not pretend to be. So counterexamples are not ipso facto falsifying, and the law of demand is never replaced with a better, more empirically adequate, law. The law of demand is very, very empirically adequate as it is: It captures a ubiquitous regularity of human behavior that is abundantly comfirmed every moment of every day, and without which there would be no science of economics.

But it is just a regularity, like people flinching involuntarily when they hear a sudden, loud sound. It doesn’t have to happen, but it’s pretty surprising when it doesn’t. (”Is he deaf? Paralyzed?”) And when it doesn’t, there’s need for some special explanation.

Economic laws, like the principles of all the “special sciences,” are ceteris paribus generalizations: generalizations that are true other things being equal. Econ 101 lays out the basic laws and explains what follows from them ceteris paribus. Later, students learn about cases when other things are not equal — when there are exceptions to the generalization. So, it is always possible to argue that the law of demand does not apply in this or that kind of circumstance. A certain necessary auxiliary condition, which is almost always present, may be absent in a certain kind of case, causing the regularity to break down. But then, in order to predict an exception to the regular pattern, you need to cite the absence of the relevant auxiliary condition (e.g., “He can’t hear; that’s why he didn’t flinch”). I hope Yglesias is not also tired of Philosophy of Science 101.

Now, let’s note two things. First, you will be utterly hopeless in reliably identifying exceptions to a ceteris paribus law when you never grasped its logic in the first place. Exhortations to mind your Econ 101 generally aren’t exhortations to stop being so darn advanced. They are exhortations to actually comprehend the principles upon which advancement depends. And, second, the fact that a law is ceteris paribus does not mean you can deny its applicability whenever you want to. Political convenience tends not to be an appropriate auxiliary condition. You can’t wave your hands and just hope that a good argument is in some upper-level textbook you haven’t read.

I can understand why liberals get frustrated with conservatives citing "basic economics". In fact, things that make intuitive sense sometimes aren't true, because your intuition is wrong, or (more commonly), because there are other basic factors, which also make complete intuitive sense, that you have overlooked. A long time ago, on a website far, far away, I tried to explain this in relation to the conservative economic intuition that if you cut people's taxes, they will work harder:

. . . there are tradeoffs involved in decisions to save or work: every dollar saved is a dollar you can't consume now. And every hour worked is an hour of leisure lost.

When people are making tradeoffs between two goods, economists commonly analyze it from the point of view of two effects: the income effect, which is the effect on your demand for a good of a change in your income, and the substitution effect, which is the effect on your demand for a good in the change of the relative prices of the good and it's substitutes.

Breathe deeply. The bleeding from the ears stops after a little while.

Seriously, it's not that hard to understand. Think of a good -- say Ramen Noodles. The income effect on this good is negative: as your income goes up, your demand for Ramen goes down.

The substitution effect is also easy to understand: if McD's is having a 99 cent Big Mac special, you shelf the cup o' noodles and head out for some mystery meat.

Got it? Great. So let's look at . . . a cut in marginal rates.

. . . the cut in marginal rates effectively increases your income. The income effect on demand for leisure v. work is unambiguous: as they feel richer, people want to work less and play more.

The substitution effect is also easy to comprehend. The tax cut just effectively raised your hourly rate. Leisure is therefore more expensive. Say you were taking home $10 an hour, but now you're getting $12. Every extra hour you decide to play instead of work is costing you more money. The marginal hours, the ones you spent watching shows you don't really like on Saturday afternoon, or arguing with your boyfriend about whose turn it was to get the car washed, might have been worth $10 but just aren't worth $12. So you work more.

. . . arguments about the effect of marginal tax cuts on the economy thus hinge on a debate over whether the income effect or the substitution effect is larger. That debate is still raging, and it's a post for another day. Suffice it to say that Bush's economists think that the substitution effect outweighs the income effect, so that cutting marginal rates will grow the economy.

Conservatives who argue the unambiguous case that people work harder when they're taxed less are overlooking a big, easily intuitive factor: when people have more money, they can afford to take more time off. (They're often overlooking another factor: most people don't have that much discretion about how much they work. This is the factor most often cited by liberals opposing tax cuts, but they too get it wrong, by forgetting that there are lots of marginal cases who do decide how much they work. A new rule or regulation doesn't have to effect every single person in the country--or the relevant market--to have an effect.)

That's very irritating, particularly since it's often exponentially harder to explain situations using multiple intuitions, even if the intuitions themselves are simple, than it is to explain them using only one. Witness the above explanation of income and substitution effects, which I think I've boiled down pretty concisely, versus: "if people get to keep more of their paychecks, they'll work harder." Truth be told, the tendency of conservatives to proclaim that their various deeply beliefs about things like property rights and hard work are not value judgements, but "Scientifically Proven! Using Economics!" sets my teeth on edge too.

But, then, liberals engage in the same sort of irritating single-intuition mongering: "Capital gains tax cuts primarily benefit the rich" . . . because, you know, taxing capital has absolutely no effect on the rest of us. We don't consume goods or services that are produced using capital, do we? After all, capital is icky--I certainly don't want any of that nasty capital in my double-frazzleberry mocha latte. I buy certified capital-free goods!

The economists who signed petitions in 2004 endorsing Kerry were, by and large, liberals who wanted a liberal president because, well, they're liberals. This is very understandable. But then they had to go and dress it up as some sort of super-scientific judgement that they'd made, not because they're liberals, but because they had Special Economic Insight that allowed them to divine a deep, universal truth which pointed to John Kerry as the superior presidential candidate. This was no more impressive than conservatives arguing that the wisdom of George Bush's tax cuts had been handed down from the divine Economist-in-Chief to Art Laffer on a pair of golden tablets. It seems to me that conservatives are more prone to this sort of economic philosphizing than liberals, but it is by no means a unipartisan vice.

More telling, though, is Will Wilkinson's point: just because economics often tells a more complicated story than political sound-bytes would suggest, doesn't mean that simple stories are always wrong. Lots and lots of simple stories are right. Rent control not only destroys the housing stock, but also eventually redistributes available housing from the poor to connected middle-class insiders, often government/non-profit employees, or to wealthy people who can afford "key fees" and the like. Confiscatory taxation produces black markets. High inflation produces high interest rates. When interest rates go up, the prices of bonds and housing go down.

Price ceilings and floors are among the most well documented economic phenomenon out there. The results are intuitively obvious: if you set the price of something below market level, there will soon be none of that thing left, and if you set its price above the market level, you will end up with a glut. These things are utterly predictible. When such regulations are proposed, they are, in fact, predicted. And with depressing regularity, the predictions come true.

In the case of the minimum wage, there is a decent argument that within the relatively small margins at which our nation's various levels of government tinker with it, the effect on employment is too small to be picked out of noisy economic data in which hundreds of variables are constantly changing. There is also the kind of complicated argument that Mr Yglesias is fond of, which is ably outlined by Mr Wilkinson:

The most popular principled explanation for the failure of minimum wage increases to create unemployment is a story about monopsony conditions for low-wage labor, i.e., imperfectly competitive labor market conditions in which there is a single buyer of low-wage labor (or a colluding band of buyers), that is able to set wages that workers have little choice but to accept. A simple model (Econ 101, even!) shows that under such conditions, an increase in the minimum wage, within a certain range, could even increase employment and raise efficiency.

It is not, to be sure, a very good argument: it is very hard to see how thousands of minimum-wage paying establishments, most of them engaged in cutthroat competition with the other mwp establishments, and all of them plagued by high turnover costs, could be engaging in the sort of collusion implied by monopsony. Proponents of this theory, such as Card and Krueger (the authors of the most famous study arguing that the minimum wage doesn't decrease employment), offer a lovely, complicated story about search costs and so forth, but this is patently unconvincing. Unless you are in a very, very economically depressed area, it's hard to see how the search costs in the minimum-wage market could fall more heavily on the workers than on the employers, who have to not only find workers, but also train them. The workers, meanwhile, can easily find out who's hiring just by driving down the main highway, or taking a stroll through the local mall. And they get paid during the difficult training period. A much more parsimonious explanation is that Card & Krueger screwed up . . . and indeed, when you look at payroll records, rather than a telephone survey, you get the result predicted by our simplistic Econ 101 model: employment went down.

That's not to say that there aren't any economists who think that the minimum wage is a good thing; there are. But as Mr Wilkinson points out, that's not the consensus view. And if you're a liberal who likes to defer to the consensus on things like supply side tax cuts, you cannot then turn around and declare that your other pet policies are okay because some economist, somewhere believes that it's a good idea. I mean, if you've ever been to the annual meeting of the American Economics Association, you'll know that there is nothing so nutty that some economist, somewhere, can't be found to endorse it.

Nor, when you propose to violate the consensus, can you escape your obligation to explain why you think this will work by grandly proclaiming that "Economics is complicated". I mean, physics is complicated--so complicated that I nevere actually took any--but as a general rule v = v₀ + at just the same.

From the desk of Winterspeak:

The Harvard Paradox

Greg Mankiw notes that Harvard scores lowest in student satisfaction *and* enjoys the highest yield (% of students admitted who attend) of any leading American university. How can the same institution be so desirable and so disliked at the same time?

Ideas:
1) Students go in with insanely high expectations that are then crushed. So, everyone admitted accepts, but they expect so much that the experience can only go down hill.

2) Parents pressure students to go to Harvard, so they go there *but* attending the school is a miserable experience.

3) In the eternal question -- do prestigious schools produce high-achieving students, or do high-achieving students select prestigious schools to signal their ability with the school doing little to nothing to actually help them develop -- Harvard comes out high in the "rubber stamp" end of the spectrum. If you believe that prestigious schools both 1) educate students and 2) signal intelligence, then the most prestigious school (Harvard) is likely to be heavy on the 2 and can therefore slack off on the 1. Certainly Larry Summer's goal was to improve the quality of the undergraduate education, which suggests 1 has some room for improvement.

4) Harvard students are just a miserable, ungrateful lot, who would moan and whine no matter where they went.

5) You need to be cutthroat competitive to get into Harvard, and then you find youself surrounded by other cutthroat competitive people, and you all make each other's lives a living hell.

6) To get into Harvard you need to focus on studying, not partying. Once you're in there, you find yourself surrounded by other people who don't know how to party. So you all study, and that's no fun.

Whatever the reason(s), I'm confident that If student dissatisfaction at Harvard becomes widely known, it will have zero impact on its yield. Given how inelastic demand is, any rational supplier would cut investment in the product, and shift it to things that make them happy, like ivory backscratchers.

From the desk of Jane Galt:

Markets in measurement

There are many sources of bad statistics in the world, but few as fertile as the rolling green (but well-fortified) hills of the abortion debate. Remember how Bush made abortions go up? Or the thinly researched (though intuitively appealing) proposition that sex ed reduces abortion rates? Perhaps my personal favorite is the "legalizing abortion doesn't make it any more frequent" argument, beloved of feminists (including ones I respect greatly), but hard to swallow--its proponents are essentially arguing that every single woman in America knew where to get an illegal abortion, and was willing to break the law to do so, prior to 1973. Steven Levitt--a very smart economist, a super-amazing writer, and a guy who's spent a lot of time looking at figures on conceptions and births, also disputes it, with what seem to be some very compelling figures:

In the first year after Roe v. Wade, some 750,000 women had abortions in the United States (representing one abortion for every four live births). By 1980, the number of abortions had reached 1.6 million (one for every 2.25 live births), where it levelled off. . .

To be sure, the legalization of abortion in America had myriad consequences. Infanticide fell dramatically. So did shotgun marriages, as well as the number of babies put up for adoption (which has led to the boom in adoptions of foreign babies). Conceptions rose by nearly 30 percent, but births actually fell by 6 percent, indicating that many women were using abortion as a method of birth control, a crude and drastic sort of insurance policy.

Note that this is simply a prelude to establishing his thesis that legalizing abortion caused the crime rate to fall--an assertion that the feminists of my acquaintance have been rather happy with. Of course, it's only true if legalizing abortion caused the abortion rate to rise--which his data indicate they did. One of the problems with Amp's data is that it's not cohort-adjusted--we get the birthrate, but not the number of women of childbearing age in the population. And even his data show a sharpish drop in 1971 (the year after large states like NYC and California made abortion legal) and another sizeable one in 1973 (in January of which year, the Supreme Court handed down its decision in Roe v. Wade.)

My own investigation indicates that the "abortions didn't increase" assertion traces back to a paper that estimated the rate of illegal abortions at somewhere between 200,000 and 1.2 million per annum. (Note that if Levitt is right, this latter figure is certainly too high, as the number of abortions post-Roe was only 750K.) Some enterprising researcher took the upper bound, compared it to today's abortion rate, and concluded that abortions hadn't increased--a ludicrous assertion for many reasons. First, obviously, because the correct statement is "abortions have increased somewhere between slightly and 7-fold". And second, because today's abortion figure is not the same as the abortion figure around the time of Roe, as Levitt's figures show--nor would we expect them to be, if only because of population growth.

Not that feminists are the only source of lousy abortion statistics--far from it. Recently I've been looking at estimates of how often the Pill (or emergency contraception) prevents a fertilized egg from implanting in the womb. Dreadful, dreadful, dreadful stuff. The correct answer is: "beats me". But that's not the answer pro-life groups give. They're certain it's a big, bad number--even though they admittedly have very little handle on the smaller numbers that go into it.

How often do low dose pills (the most common ones) permit breakthrough ovulation? Oh, somewhere between 2-20%.

How often does the effect of progestin on cervical mucus prevent the egg from being fertilised? Well, I don't know for sure--but it's definitely between usually and never. (in that link's defense, they did use some real, actual scientific evidence showing that a whole lot of sperm make it through the thickened cervical mucus in rabbits, which does give pause.)

How many users of the pill are sexually active? Couldn't tell ya.

How many of them are fertile, and having sex with fertile partners? No idea.

With this paltry evidence, pro-life groups don't say "best not risk it"--they treat dispensing birth control as the equivalent of a war crime.

To be fair, you also get a huge number of pro-choicers adamantly denying that the pill or EC ever work by preventing implantation, an assertion for which they have exactly as little data as their opponents.

Now, data on this sort of thing is hard to get. But it's not impossible to get; how come we don't have any?

Well, nobody wants to provide it, that's why. Pharmaceutical companies manufacturing birth control sure don't want a study indicating that taking the pill causes fertilized embryos to slip the womb, since that would limit the market for their products. They don't have to do such studies--so why do it?

Now, a number of my liberal readers are no doubt rubbing their hands right now, saying "See! We can't leave research in the hands of private companies! The profit motive distorts it."

Um . . . yeah. So where are all the government studies on the numbers of abortions, the reasons women have them, the biochemical effects of hormonal contraception?

Why, we don't have them, do we? Because the government sure as hell doesn't want to put out a study that will make millions of women at least think twice about their so-easy, so-convenient, so-effective birth control. Why, they'd be storming Capitol Hill with pitchforks!

Lesson: when information markets fail, those failures are often hard to correct through government action, because the consumers who don't want certain data are also the voters who would rather not hear it. I don't know how we do correct those failures, but a good start is acknowleging that we have met the enemy, and he is us.

From the desk of Jane Galt:

Four spouses good, two spouses better?

Tyler Cowen takes a brave stand against polygamy on economic grounds:

How about the trade-off between quality and quantity of children? A genetically talented father with many wives will likely maximize the quantity of children rather than their quality. This has a long-run negative externality, especially if you believe in the Lucas-Uzawa models of economic growth, or some approximation thereof. You would rather be in a society with fewer but more talented people. Switzerland rather than India. The loser is not the wives but rather the next generation of children. A piece in the February JPE also notes that the children may substitute for savings and thus polygamy can stunt capital formation; I take this as another version of the same argument.

The bottom line? We should encourage family structures that spur human capital formation. Polygamy does not do the trick. Comments are open...

Let me offer my own, strictly non-economic viewpoint: human nature being what it is, polygamy is only a stable social institution as long as one gender is pretty radically oppressed. Otherwise, jealousy and competition between spouses for resources, particularly by mothers for their children, will destroy the family.

From the desk of Mindles H. Dreck:

Barista-elasticity

Once More Into the Breach argues as follows:

The most common argument for a progressive tax rate is "The wealthy must pay their fair share." , or "Those who can best afford to should accept the greatest burden.". The first argument bastardizes the meaning of the word fair. In an equitable society it is not fair that one person has to accept a higher rate than another. If this were an acceptable meaning for the word than retailers could charge different prices to different people. In both statements defending a progressive tax could also defend such a case for retailers.

Retailers do exactly that all the time. Understanding that requesting a balance sheet or a precise measurement of price elasticity of demand at purchase, they use other techniques to sniff out customers who are willing to pay more. Tim Harford describes this eloquently in his book "The Undercover Economist". He provides examples, from supermarkets to Starbucks, of providers charging much higher prices for merchandise when the production cost difference is negligible. The most illuminating example is the Starbucks menu (p.35):

Hot Chocolate-$2.20
Cappucino-$2.55
Caffe Mocha-$2.75
White Chocolate Mocha-$3.20
20 Oz Cappucino-$3.40

Harford eloquently sums up targeted pricing:

Every single product on the menu above costs Starbucks almost the same to produce, down to the odd nickel or two.....Starbucks doesn't have a way to identify lavish customers perfectly, so it invites them to hang themselves with a choice of luxurious ropes.

He also describes retailer slotting strategies to achieve the same objective (is the organic produce next to the regular produce, or elsewhere?) and the airlines' tendency to make coach unbearable so the first class passengers feel like they got something for their overpriced ticket (or frequent flyer loyalty).

I'm a defender of a relatively flat marginal tax rate (but along the lines of the Jane Galt tax plan), there are some problems with the idea of government pursuing sensitivity-targeted pricing schemes, and Into The Breach has a point about the abstract concept of 'equity'. However, the private sector is already implementing progressive pricing. The difference is that they substitute immediate price sensitivity for the ability to pay, since assessing the ability to pay is impractical in a retail setting. The correlation between price sensitivity and means may exist in many cases, but is far from perfect.*

UPDATE: Bolded emphasis added in the sentence above for people just not getting it in the comments. There are circumstances where ability to pay is considered more directly in a retail setting, such as senior and student discounts. Also, the point of the Starbucks menu is not that they charge a lot (When you consider the real estate it isn't so much, and the real estate and labor dominate the costs), it's that they earn very different margins from different customers, and are able to do so with a targeted pricing scheme designed to find and match the price sensitivity of the customer (Harford's "variety of luxurious ropes").

*I once knew a centimillionaire who bought all his pants at the thrift shop for $5 or less.  In fact, high price sensitivity is often a good way to accumulate assets as well as run a business. Warren Buffet's suits and Bill Gates' (former) aversion to private jets are other cases in point.

From the desk of Jane Galt:

Adverse news for adverse selection

Alex Tabarrok has a marvellous post up on adverse selection. As he puts it, the central insight of adverse selection ". . . is simple enough for your friends to understand but profound enough for them to be impressed at your learning. so it's a hard story not to tell!"

Unfortunately, he argues, besides being elegant and important, the central insight behind adverse selection is also not true--at least not in many of the contexts in which it is used.

The basic idea of adverse selection is that in certain markets, all or most of the relevant information is known by one party, but unobtainable (at least cost-effectively) by the other. When you are selling your car, you know whether it is a good car, or a piece of crap that breaks down every two miles. But you have no incentive to tell prospective buyers this. So the information that the buyer gets--"this car is completely reliable!"--is the same whether the car is a lemon, or a mechanical dreamboat.

Buyers, knowing this, will discount the price they are willing to pay by the probability of getting a lemon. But if you are a car seller, why sell a good car at a hefty discount because of some other dishonest schmuck out there? Sellers with very good cars will exit the market, leaving only the relatively poor cars. But soon buyers will demand a steeper discount, because the probability of getting a lemon has gone up. The process is iterative; sellers with relatively good cars will exit the market, making the average quality even poorer, which will cause buyers to demand an even bigger market.

The theory of adverse selection is a favourite of national health care advocates, and has to my mind been one of the more convincing arguments in their arsenal (though not convincing enough to get me to endorse their plans). They argue that as sick people drive up the cost of health insurance, healthy people will decide not to buy insurance. This will increase the average cost of the people left in the pool, which will cause insurers to raise rates, which will cause more healthy people to drop their insurance, which will increase the average cost of the people left in the pool . . .

It makes intuitive sense, yet it is, as Mr Tabarrok says, profound. Just not true:

The facts of the matter, however, are that adverse selection is not an important part of the market for automobiles (trucks), or of auto, life insurance or health insurance (on the latter see below).

One reason adverse selection may not be that important in practice is because buyers and sellers use testing and certification to remove the most important information asymmetries.  You can buy a decent used car, for example just get it inspected or certified.  Only if such adjustments are illegal, or in some other way not allowed, will adverse selection become important.

Second, the asymmetry may run in favor of the sellers.  Do I really know more about my own life expectancy than an insurance firm that has access to sophisticated actuarial models?  And, assuming that I do have extra information is it all that important?  After all "the race is not to the swift, nor the battle to the strong, neither yet bread to the wise... but time and chance happen to them all."  Or, more prosaically, the signal is near irrelevant when the signal to noise ratio is high. 

Third, propitious selection can be more important than adverse selection.  What sort of person buys a lot of life insurance?  Is it people who expect to die soon?  Or is it the sort of person who is so worried about not leaving their family in trouble that not only do they buy life insurance they also buckle their safety belt and eat healthy?  The price of life insurance falls the more you buy so evidently insurance companies believe it is the latter.

Everyone talks about adverse selection in the market for health insurance but in fact non-group policies in these markets are not relatively expensive and not hard to get.  The national average annual premium for reasonably generous coverage for a single person is just $2,268.

Sure, that's a lot of money but the point is that it's not a lot relative to what an employed person and their employer would pay for similar coverage in the group market.  There is no evidence for an adverse-selection death spiral in the market for health insurance.  That's not surprising because non-group health insurance is medically underwitten (i.e. medical inspections just like car inspections).  Most people are accepted a few are not.  Only in states that require insurance companies to accept all or most buyers are rates high relative to the group market (rates in New Jersey, an outlier, are almost three times as high as the national average.)

There are problems in the health insurance market, including a lack of long term insurance, job lock and the inequity of affordability, but adverse selection is not one of them.

That pretty thoroughly undercuts any support I might have had for nationalised health care.

You are cruel! my critics will say. No, not really. It is true that I now have good health insurance, but I was also against nationalised health care when I did not have health insurance, whih I could not afford thanks to New York's practice of "community rating"; i.e. forcing health insurance companies to sell insurance to anyone who can breathe and sign a check. The reason that I am against nationalised health care is that I think the market is the primary vehicle for medical innovation, and I do not want to see the government become the monopoly purchaser that destroys that market. Believing as I do, if I supported nationalised health care I would be privileging the needs of those who are undertreated now, over those who have diseases that we could cure in the future. Since there are more of the latter than the former, this does not seem to me to be a reasonable moral choice, though I am sure that there is more than one left-wing moral philosopher out there who would like to explain to me why I am wrong.

From the desk of Winterspeak:

Best chair for the money?

I find myself working from home more often these days and realize I need a new office chair. My current chair was priced right ($0 -- found it on a curb in Chicago) but it has poor ergonomics -- and my back and wrists are paying the price.

So what chair to get? The famous Aeron (and its less famous little sister Mirra) are freakishly expensive (around $800 and $600 respectively). I can get a new chair from Staples for $200 or pick up a used one from Craigslist for $20.

However -- Aerons and Mirras do not seem to depreciate -- their used prices seem to be exactly the same as their new prices. The Staples chair, however, is sure to lose 90% of its value ($180) as soon as I take it out the door. If the expensive chairs are more durable as well, they could infact end up being cheaper than the Staples chair.

But it seems ludicrous to shell out $600 for a simple chair when I can get one for 30 times cheaper.

Slate has an old article where it tested various office chairs and it ended up liking the $400 Lets B. I cannot make up my mind whether this is a sensible compromise or if it's the worst of both worlds. A quick eBay and craigslist scan does not turn this chair up so I don't know if its selling used for $40 or $399. Since it lacks the cachet of the Aeron, it may be a great buy used, but a waste of money new.

From the desk of Jane Galt:

Collective action

Brad DeLong points to this LA TImes article about New Orleans, which paints the decision to rebuild as a collective action problem:

What Bush said would be one of the largest public reconstruction efforts ever is becoming a private affair, leaving the tough choices to residents as their risks increase. Laurie Vignaud faces a double dilemma: If she rebuilds her wrecked ranch house at 1249 Granada Drive in the great suburban expanse south of Lake Pontchartrain, will her neighbors do the same? And even if they do, will that guarantee their Gentilly neighborhood does not end up an isolated pocket in a diminished, post-Katrina New Orleans?

Nothing in Vignaud's 46 years, not even her job as affordable housing vice president with Hibernia Bank, the region's biggest financial institution, prepared her for this problem. From her relocated offices in Houston, she recently confessed, "It's scary. I don't know when I'll ever go home." Double dilemmas abound in this deeply damaged city, and represent considerably more than the start of the slog back from disaster. Lost amid continued talk of billions in federal aid is the fact that most homeowners and businesses are being left to make the toughest calls on their own. Lost is that New Orleans' recovery -- which President Bush once suggested would be one of the largest public reconstruction efforts the world had ever seen -- is quickly becoming a private market affair.

"My constituents have pretty much concluded that it's up to us to put our neighborhood back together and get on with our lives," said Republican city council member Jay Batt, who represents the Lakeview neighborhood just west of Vignaud's. To market advocates, this is the way it should be. Rugged individuals settled the American West in the 19th century and can resettle the Crescent City in the 21st. But the risks that individual New Orleanians must shoulder in such an on-your-own recovery appear staggeringly large.

"There is no market solution to New Orleans," said Thomas C. Schelling of the University of Maryland, who won this year's Nobel Memorial Prize in Economic Sciences for his analysis of the complicated bargaining behavior that underpins everything from simple sales to nuclear confrontations. "It essentially is a problem of coordinating expectations," Schelling said of the task that Vignaud and her neighbors must grapple with. "If we all expect each other to come back, we will. If we don't, we won't. But achieving this coordination in the circumstances of New Orleans,'' he said, "seems impossible."

To me, it seems clear that there is a real potential for a market failure: if everyone wants to rebuild New Orleans, but doesn't because they are afraid their neighbours won't, then everyone is on net worse off. (At least in New Orleans. The American taxpayers who are expected to continue to protect a floodplain from, well, flooding, at enormous expense are probably better off. I will not attempt to calculate which utility is greater.)

But the implied solution--government action--seems to me to hold at least as much potential for market failure. If the majority of people don't want to move back to a crime-ridden and corrupt small city on a hurricane-prone flood plain, but the federal government goes ahead and rebuilds it anyway, it will have decreased the utility of those forced to move back, and wasted a stunning amount of taxpayer money on a suboptimal solution. I see no good way to distinguish whether the government or the market is more likely to produce suboptimal results, so my instinct is to default to the non-coercive system.

From the desk of Winterspeak:

Why does this deficit matter?

In this smackdown between Tyler Cowen and Max, Max raises the common Democrat/left wing concern that the current Federal budget deficit is too high and that taxes must be raised (or, as he prefers, "tax cuts repealed") to narrow that deficit. To be fair, the Republic/right wing has its share of budget hawks too--folks who are aghast at how rising spending and lower taxes during Bush II have increased the federal deficit.

Even Jane Galt has argued on this blog that "starving the Beast" by running deficits does not seem to have curbed spending, so now it's time to try something new.

Suppose, though, that Bush listens to his critics and hikes up tax rates tomorrow to shrink the budget deficit to zero. This transfer of money from individuals to the government would destory value through deadweight loss, and this value destruction would reduce consumption and investment in the US. This would be Bad.

This Badness would not be outweighed by the traditional Goodness from small budget deficits -- namely lower interest rates. The US short term rate is currently being actively increased by the Fed because I assume they think it is too low now and possibly feeding into a dangerous real estate bubble. The long term rate is arguably too low as well as Asian central banks take money from their people and give it to the US.

In an environment where rates are too low, I see no benefit in reducing economic growth to reduce rates further. In the future this situation will change and that will be the time to cut the deficit through higher taxes or lower spending. At that moment, lower rates will be a blessing, not a problem.

But now is not that moment. I am going to be deliberately provocative and argue that it is fiscally irresponsible to not run deficits when foreigners are handing you free money. I would prefer it if the US were spending that money more wisely (and I'm talking more here about homeowners and real estate than the government), but to refuse a stranger's $100 is as irresponsible as forgetting $100 on the subway.

Cheney was surely too blase when he said "deficits don't matter", but they certainly don't seem to matter right now as interest rates, and inflation, remain remarkably low. There is surely a time for deficit reduction, and that time is later.

Update Many comments -- I'll make a quick response to some of the common themes here.

Firstly, government debt is similar to personal debt in many ways but different in one critical one -- government debt can be rolled over into the far future in a way personal debt cannot. If I lend someone a $1M to be paid back in 100 years, I actually don't care about the principal since in NPV terms its essentially zero -- but I do care very much about interest payments. This is why the ability to finance debt (and therefore the interest rate) is more important than the actual size of the debt outstanding. While many commentors in the thread don't seem to have confidence that the US can make good its obligations, there are clearly lots of people who do -- as evidenced by the extremely low rates interest rates they ask for to in exchange for buying the debt.

Since governments can roll debt over for as long as they exist, they essentially never need to pay debt back -- they just need to make their interest obligations (whatever those might be) -- and can keep rolling the debt over.

Whaa asks "isn't the biggest (and indisputable) benefit of not running deficits that you don't have to pay all that money back later on?" The answer is no -- governments get that for free just by being governments. They never need to pay back principal, only interest, and whether or not that's a good idea depends on the rate. The link between the rate and the total indebtedness depends on the demands of lenders, and currently they are being very indulgent towards the US.

I have no doubt that in the future creditors will demand higher interest rates and at that point the budget deficit will have to be reduced. But that is exactly why not running deficits now is fiscally irresponsible. People are not going to be giving out free money forever -- might as well get it while you can.

Questions about the size of government, efficacy of various government programs, and public vs private investment are all interesting but tangential to the argument that when lenders are offering their cash too cheap, one should take extra.

From the desk of Jane Galt:

How does education increase earnings?

I'm less sanguine than Winterspeak that education actually increases skills in a productive way. Of course, I was an English major, and if there's any course of study less designed to make you employable, it isn't given in the Ivy League*. But in general, I'd say that very few of my classmates taking a liberal arts course learned anything useful that couldn't be gotten out of a six week course on business writing. Eingineering and science majors, yes, but not the liberal arts majors--who are the majority of our nation's college graduates.

So why do we both sending people to college?

In my opinion, it's very much a signalling mechanism: employers do not value what you learned in school, but they do value knowing that you have the middle class background, the willingness to delay gratification, and the intelligence necessary to complete a degree. For many people, college also provides a social network that helps them later in life. And it may allow them to mature enough to make them worth more than minimum wage.

If what we learned in college were really important, we would expect to see income correlated with the quality of the school. And indeed it is--but if you look at people who were admitted to a highly selective school, but chose to attend a less prestigious one (presumably for money reasons) they earn no less than the students who matriculated at the more highly regarded school. Thus, I think in general, the educational benefits of college are probably pretty trivial compared to the social and signalling benefits.

This is not necessarily inefficient for our society. Education may have non-economic benefits. And the signalling mechanism could well be more efficient than employing legions of unproductive high school graduates. Plus, college students get a lot of utility out of being irresponsible morons for four years. Or was that just me?

Funnily enough, I am now employed in the only job which has ever required the skills I learned in school--and I'm in a job that almost no business school graduates go into. On the other hand, my classmates on average seem to use very few of the skills they learned. Go figure.

*The joke when I was graduating college ran something like this:

Q: What did the English major say to the Engineering major after they graduated?

A: You want fries with that?

Sadly true.

From the desk of Winterspeak:

Returns to Education

Kash over at Angry Bear had the nerve to say that education increases earnings. The data on this is pretty clear -- he includes an excellent chart showing that those with just a high school degree earned a median income of $26K in 2003 compared to those with some professional degree, who earned $82K. He also notes that:

This reward to education has grown over time. For example, a Census Bureau summary of major economic trends in the US over the past half century reported that the median income of workers with at least a Bachelor’s degree was only 35% higher than those with only a HS diploma in 1963. By 1997 that premium had risen to 88%. And in 2003 the earnings gain from having at least 4 years of college was over 100% of a HS graduate’s earnings, according to the data cited above.

His commentators get really mad, arguing that higher education is mere credentialism and that these higher wages are not due to any additional skill that higher education signals or produces, but that society rewards people based solely on which bits of paper they have, not what they can actually do.

Although there is certainly some credentialism in higher education, I don't buy the argument that it runs rampant in an economy as competitive as the US's. A country that is comfortable outsourcing work to poorer parts of the world clearly cares, at least a little, about what people can do, and not just where they graduated from.

I would also add that the falling expected wages of a high school diploma have also greatly reduced the cost of a college education. While college tuition has outpaced inflation for several decades, the gap between what a HS diploma holder and college degree holder can hope to earn has widened dramatically. The opportunity cost of going to college is now much lower than it used to be, both in foregone wages while in school and in the wages you would have earned had you not gone to school at all.

The question is whether or not the reduced opportunity cost of getting a college degree makes up for the increase in the cost of the degree itself, making college more of a bargain today than it was in the past. I'm too lazy to calculate it all out, but if anyone wants to take a swing at things in the comments, they are welcome.

From the desk of Winterspeak:

Elasticity of Bankruptcy

The US government recently passed a new, tougher, personal bankruptcy law that makes it harder to escape repaying your debt. Those for the change argued that current bankruptcy provisions were being abused, resulting in more filings and higher interest rates for the rest of us. Those against the change argued that nobody chooses to become bankrupt -- it just happens through bad luck -- and increasing the penalty is needlessly punitive.

Just before the law passed, the number of bankruptcy filings rose sharply. Now that the law is in place, the number of bankrupcies filed has fallen by 90%.

The spike in bankrupcies was clearly people rushing to file before the tougher regulations took hold, and the lull after is due to 1) fewer people filing (not worth it) and 2) fewer people to file (they all filed last month). Both of these support the idea that bankruptcy is a calculated and timed decision, and that changes to the benefits around filing for bankruptcy would impact whether or not people did so.

If bankruptcy was primarily driven by unforseeable bad luck that left people with no choice, individuals would not be able to be as strategic about filing as they have been.

From the desk of Winterspeak:

Psychology and Markets

Standard classical economics is modeled on forward looking, rational utility maximizers. By definition then, classical economics struggles to explain bubbles and funks, periods of irrationally high or irrationally low asset prices that correct themselves with a *pop*.

Part of the problem is that it is very difficult to know whether a price is right or not. For example, I thought Google was totally overpriced when it IPOd at $100, and its quadrupled in the 14 months since then. It is currently trading at a P/E of 90, which is really really high. It seems even more overpriced to me now but had I shorted it back in '04 I would have lost my shirt.

At least with Google people can fantasize about them launching brilliant new highly profitable products, but what captures the imagination to justify the crazy run-up we've seen in real estate prices? What magical thing is going to happen in the future that justifies a doubling of price in five years?

Seperating out real, informed predictions about the future, from short-term speculative greed and risk taking, from genuine sentimental fantasy is very difficult, and maybe a fools errand. But the individual that does some math and declared an asset overvalued is not ignoring psychology, he is considering it directly.

I've written extensively about housing (here, here, here) and the fact that I think it is currently in a bubble, so I very much enjoyed this post by Prof. Piggington:

I suppose that one could note my emphasis on data and assume I am some sort of impassive misanthrope whose only glimmer of pleasure comes from long nights spent manipulating my beloved database tables as my long-suffering wife looks resignedly on in aching loneliness. Our hypothetical reader believes that such a person—perhaps our reader now pauses to wonder whether such a joyless automaton can even be considered a person at all—could never understand the role that psychology and emotion play in buying a home.

There is but one purpose served by all those fun-filled charts and graphs in the Bubble Primer (the series of articles in which I lay out my case that San Diego housing is both way overpriced and at risk for a steep correction). That purpose is to use the process of elimination to zero in on the causes of the home price runup. One by one, we look at the actual numbers and see that none of the usual suspects—population, housing stock, income, rates, nice weather—can explain the magnitude of San Diego's recent home price growth. And when you rule out all those potential demographic and economic causes, only one thing remains: psychology.

The psychology, to be specific, of a speculative financial mania.

Standard economic theory says that systematic mispricing (which is what a bubble is) presents a free profit opportunity and so can be arbitraged away. But the illiquidity of housing, plus the difficulty of shorting, or hedging, strongly limits the ability to arbitrage mispricings. What can one do in a housing bubble except wait it out if one does not own, and sell and rent if one does?

Robert Shiller, whom I met at Chicago, has some very interesting ideas our financial instruments that are actually useful to individuals, and one of them is indices and futures on residential housing. Not only are these more liquid instruments amenable to short positions (bets that prices will decline) but they will also let people who do not yet own a house, and want to be longer on real estate but don't actually want an entire house, to buy some fractional ownership.

Since everyone needs to live somewhere, I argue that we are born into this world short housing and buying a house merely moves us to neutral. You need to buy "extra" house (more house than you need) or a second house to actually be long real estate and profit from price appreciation. I would recommend that all young people put their savings into residential futures upon graduation -- people should have a diversified portfolio and we enter this world naked, screaming, and very short housing.

From the desk of Jane Galt:

The perils of economic education

From the Wall Street Journal.

From the desk of Jane Galt:

In praise of price gouging

I should have known it was coming. This morning on the news, the anchor was talking to a man who had written a book on oil, yet seemed singularly uninformed about oil economics or even basic oil information (he claimed that prices had spiked "seven or eight dollars" before the storm hit, information which is true but not useful since, AFAIK, most of that spike happened before Katrina was even a gleam in the weather forecaster's eye. Then the two of them got themselves into a nice lather about gasoline price gouging.

Well, let me stand up for price-gougers everywhere. Thank you, brothers, for helping out in an emergency.

"Helping out?" you cry. "Do you realize how much I paid for gas this morning?" Why, yes, I do, and thank you too for doing your part to make sure that gasoline goes where it's needed most.

But let me explain.

Katrina has taken out the LOOP (Louisiana Offshore Oil Port), which ships about 1 million barrels per day (bpd) of oil to the mainland. (It's not permanently damaged, but it's not operating). It's shuttered 9 refineries in the Gulf Coast, and 20 more are operating at reduced capacity because of supply shortfalls. That means that more than 10% of the nation's refining capacity has been taken offline. A similar amount of America's crude oil production has been shut down, and it is yet unknown how much damage has been done to drilling rigs and the underwater pipes that carry oil to refiners.

The refining problems are particularly difficult because refineries have already been going flat out to keep up with summer driving demand. The upshot is, there is no longer enough gasoline to go around at the prices that were prevailing before Katrina got hit. Refiners are already rationing supplies to some wholesalers.

If you cap the price (as some people are making noises about), rationing will take the form of queuing: people will have to wait in long lines for gasoline. This sounds just fine to some activists and academics, apparently ones with a lot of time on their hands. The rest of us, who do not think it would be fun to live in the Soviet Union, recognize that, painful as it may be, prices are in general a better way to allocate scarce resources than lines.

But it hurts! I hear you moan. "What about my Labor Day driving?" Let me translate. What you're really saying when you say "I don't want to pay more for gas" is "I don't want to either use less gas, or use less of anything else". But as a society, we have to use less gas. You, or someone else, is going to have to consume less of the stuff, because we have less than we used to. If you don't want to be one of the people using less gas, then you have to be one of the people using less of everything else. Thus will the market pretty efficiently strip out driving by those who value it least.

Or to put it another way, "Yes, of course it hurts. If it didn't hurt, no one would stop driving."

But high prices don't just make people want to drive less; they make people want to supply more. European refiners are already talking about shipping gasoline here, though I don't know how it will get here before the temporary easing of air quality standards ends on September 15th (many US regions and even cities have special requirements for gasoline additives--this is one of the things that makes our refining infrastructure so inefficient). Even if that doesn't work, with local air quality standards relaxed, prices can act to push gasoline around the country to where it's needed most--like to the areas devastated by Katrina where people need gasoline, diesel and kerosene to help them get back on their feet. Prices of everything rise after a disaster, and a good thing too, since that encourages people and material to flood into the damaged area, where they're needed most. When well-meaning politicians impose "anti-gouging" laws, they slow the flow of resources to repair the damage.

So let's all do our part by grinning and bearing higher oil prices, and remembering to be nice to our friendly neighbourhood price gougers. But you don't need to thank them; after all, they're just doing their job.

From the desk of Jane Galt:

Economics jokes

I was told this one the other night:

Three econometricians go hunting, and spot a large deer. The first econometrician fires, but his shot goes three feet wide to the left. The second econometrician fires, but also misses, by three feet to the right. The third econometrician starts jumping up and down, shouting "We got it! We got it!"

From the desk of Jane Galt:

Holy cow!

Economics in One Easy Lesson, which is, like, the best popular book on economics ever, is online. If you haven't read it, trot over there right now, you lucky dog, you.

From the desk of Jane Galt:

Broken Windows Redux

Every time there's a big disaster, some idiot trots out our old friend The Broken Window Fallacy. The Broken Window Fallacy is the distressingly common belief that some destructive act, such as, say, breaking windows, is good for the economy, because look at all the work we just created for the glassmaker! This ignores, of course, the things we could have spent the money on, if we weren't busy repairing all those broken windows.

Different River takes on the inevitable application of this idiotic theory to the Tsunami. Here's what I wrote about the equally moronic notion that the 2003 blackout was good for the economy.

Update I think part, although by all means not all, of the confusion stems from the common journalistic belief that if something increases GDP, it is necessarily "good for the economy". While I'd argue that this is generally true, GDP is of course an imperfect measure.

The problem with natural disasters is that since GDP measures only flows, rather than stocks, it picks up, say, the uptick in economic activity that comes with rebuilding after a bad hurricane, but does not measure all the wealth that was destroyed when the hurricane roared through. So even though, on balance, the hurricane was a negative thing, our main economic statistic, GDP, will portray it as a positive.

This would not be a problem, of course, if most journalists had more than a cursory knowlege of economics.

From the desk of Jane Galt:

Stupidest thing yet heard about the blackout

"This will stimulate the economy -- think of all the money people will make cleaning up after the blackout!"

That was a talking head on some radio show I listened to for about three minutes before hurling the radio across the room in sheer horror at the

a) rampant partisan silliness
b) stunning technological ignorance
c) egregious economic illiteracy

of the guests, all of whom seemed to have been picked because they knew nothing about anything relevant to a discussion of power blackouts, hated George Bush, and had low, slow, mellifluous voices. From the general tone of things, one would have thought that George Bush had snuck out of the White House and snipped the power lines in two with a pair of pinking shears, just to be spiteful.

But hey, partisan silliness is what radio is for. (Apparently.) It's the economic illiteracy that really sets my hair on fire. I've heard versions of this same illogical trope from many people. Environmentalists arguing that expensive new environmental regulations create wealth because, gee, look at all the new jobs we got making catalytic converters!* Big government types arguing that pouring money down a rathole on their pet project isn't really a waste of money, because now we've increased GDP by however much we've spent on rathole operators and expensive rathole pouring machines designed by 100% American engineering talent. Hawks who argued that the war in Iraq was just the medicine to cure our ailing economy, because, well, look how well World War II turned out!

No, no, and no.

Wait, that's too timid. NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO NO!!!!!!!!!!!!!!!!!!!!!!!!

Except in rare economic conditions, which may or may not exist depending on which school of economics you follow, and which we certainly aren't enjoying right now, spending money on wasteful projects like, say, shutting down everything in the Northeast, does not increase GDP. On the contrary, it decreases it.

As Henry Hazlitt, author of Economics in One Lesson, put it, if you carry this thought to its logical conclusion, one could theoretically put the economy through the roof by hiring millions of people to dig holes and then fill them up again.

But that's silly, you say; who will run the trains?

My friend, you have just discovered the concept of opportunity cost. Opportunity cost is the value (monetary and non-monetary) of the best alternative use of your time, money, or person.

The classic example: you have two job offers. One pays $120k (hey, why not? It's just an example.) The other pays $100k. The opportunity cost of taking the first offer is $100k -- the value of your best alternative. The opportunity cost of taking the second offer, conversely, is $120k. In other words, in this simplified example where all jobs are equal and none carry intangible benefits, the opportunity cost of taking the lower-paid job exceeds the value of the job. This tells us that, economically speaking, it's a bad deal and you shouldn't do it.

Governments and economies have opportunity costs too. If they are doing something with their capital and labor, it comes at the expense of doing something else. A government with a fixed budget must choose how much army, social work, public library, and so forth it wants to have, because in this world of limited resources, it cannot have as much of everything as it would like. More library means less social work or soldiery.

So everyone who was spending time speculating about possible causes of the blackout, sitting in the park drinking beer, walking miles and miles to get home, or trying to find something to sleep on superior to the steps of the post office, was also not doing something else. Something that we, as a society, presumably feel is more valuable, since we will not pay them to do it ordinarily, and they generally don't take it upon themselves to go for eleven-mile hikes through the streets of Manhattan.

All the food that was spoiled will have to be replaced, which means that we'll spend resources on making food instead of something else we might like, like making the Jetsons-style videophones for which I have been waiting all my adult life. All the equipment that was broken will have to be fixed, which means some resource sacrifice by someone: repairmen who will have lost valuable leisure time, or utilities which will have less to spend on new power sources to make our electricity cleaner and cheaper, or companies which will do less of whatever it is they do in order to cover expensive repairs.

Just as in the examples above, where those arguing for their version of economic silliness look only at where the money is being spent -- not where it now isn't being spent, on things we might value much more than whatever it is they're urging. Their may always, of course, be independent reasons of social or political policy that we should spend money on their project -- but not because the mere act of spending the money is somehow a net gain to us all.

On a personal note, I've spent today redoing several hours of work that I did yesterday, and lost when the power went out. I'm not getting those hours back.

So the blackout is going to be bad for the economy. How bad? I couldn't guess. But with the first signs of a recovery just creeping into the data, this was absolutely the last thing we needed -- not, as these silly arguments would have it, the first.

* I know that there are other economic reasons to think about environmental regulations, such as negative externalities. I am not saying that there are no economic reasons to be an environmentalist; indeed, I believe many of the economic arguments for environmental action. But this argument in favor of environmental regulation is badly wrong.

From the desk of Jane Galt:

The Dangers of Data Mining

I want to have a little chat about an economic fallacy that one sees all over the place, from commentators both left and right: the idea that because some number was particularly good under the presidency of one's chosen political party, that this therefore means that their policies are correct. Specifically, they use this kind of data to claim that some thing of which they are in favor is good for the economy -- without reference to what that piece of data would have looked like absent their favored item.

This fallacy is extremely widespread. I will use one example apiece from left and right.

For a while, leftish bloggers were quite caught up in the notion that the correlation of good economic performance with Democratic presidencies had to be causal. Clinton was thus "good" for the economy.

But when you want to argue that a president is good for the economy, you cannot just point to the fact that the economy was good while he was president, QED.

Even the most policy wonkish can concede, surely, that there are some influences on the economy larger than that of the president. If green men from Mars had invaded during Clinton's presidency and razed the capital infrastructure to the ground, forcing us to return to subsistence farming with the attendant loss of life -- surely we would not blame Clinton for the entirety of the resulting 97% contraction of GDP, would we? We might argue that he should have prevented the invasion, or at least valiantly climbed into a fighter plane like Bill Pullman and at least try to chase them off, but we would not argue that better fiscal, monetary, or social policy would have averted the, er, recession.

Indeed, if you begin totalling up the outside influences, you quickly realize that they are much greater than the influences of fiscal and monetary policy, at least within the rather staid limits set by the American voting public. (Our staggering new budget deficit is a dainty 4% of GDP. The Argentinian government would have laughed such miserly sums off the playground during its heyday.)

If you want to claim Bill Clinton was good for the economy, you must first establish what the economy would have looked like without the benevolent policies you give him credit for. If we were due for a nice long internet bubble, Clinton's policies may have helped, hindered, or done little either way. But simply pointing out that GDP and tax revenues grew doesn't give us any clue as to which of the three is true.

Now, conservatives may be chortling. But you have your own wing-nuts to contend with, my frosty friends. Like the fellow I saw the other day trying to refute the standard macroeconomic belief that if you raise budget deficits, you decrease national savings, and thus investment, and thus future productivity gains. His argument? In the 1980's the budget deficit increased but interest rates went down.

Well, yes, they did. But that might have had a little something to do with the fact that the government abruptly halted its massive inflation of the money supply. In fact, if you see how neatly falling interest rates dovetailed with Volcker's aggressive monetary targeting, it becomes obvious that by far the largest influence was the Fed's war on inflation.

It is thus insufficient to point out that interest rates were dropping. This tells us nothing about the effect of the budget deficit on interest rates, which is generally, IMHO, relatively trivial. We can only figure out that effect by first determining how much interest rates would have fallen in a neutral environment, and then analyzing whether the budget deficits measurably added to it.

But how do I do that, I hear you cry. Why, it is difficult, my little chickadees; that is why people have to get PhD's and things. It is so difficult, in fact, that when you see a blogger who has claimed to prove some grand theory, such as the superior economic performance of their political party, or the ability of budget surpluses to generate astonishing rates of growth, using only numbers they can find on the internet in fifteen minutes or less, you should be very, very suspicious.

From the desk of Mindles H. Dreck:

Games With National Accounts

There have been a number of lengthy posts in the blogosphere over the last few months that attempt to prove one or the other point of view about the effects of taxation and fiscal policy by graphically presenting national accounts data. Many of them have made elementary errors (some that surprised me, given the source) that I have wanted to describe, but for time or lack of esprit de blog combativeness, I haven't. Also, I suppose it's good to see people yanking out the data and making what they can from it as opposed to thinking you need some kind of macro-econ license before driving the information superhighway to bea/bls.gov.

However, you might look at this rant to see many of these mistakes in one convenient place. (as the title of the blog suggests, the author usually comments on other topics).

So here's a start on a checklist:

1. Don't forget to use REAL growth figures so you don't wind up touting the inflationary Carter years as the sine qua non of economic growth. That one always makes me laugh.
   
2. When comparing GDP across time, don't forget that real GDP is bounded by workforce growth and productivity growth and is therefore difficult to compare across periods where workforce growth varied dramatically. Consider how this rule, in combination with the first, might change your conclusions , or at least challenge your confirmation bias. I've seen several assertions about growth or productivity droughts that just aren't born out under proper measurement.
   
3. When presenting dollars or price levels, or anything that compounds over time, use a logarithmic scale. Otherwise, the same percentage change looks larger in the more recent part of the time series (the graph linked immediately above violates that rule, I'm afraid).*
   
4. Don't equate a change in revenues/expenditures as a percent of GDP with a decrease in absolute revenues/expenditures For those of you trying to disprove supply-siders, Laffer doesn't fall that easily. See Nordhaus for better arguments.
   
5. Don't claim that giving money to the government stimulates the economy and yet, in the same breath, say letting rich people keep their money doesn't.
   
6. For your surviving data series, please don't forget that correlation isn't causation. I ran a correlation the other day on individual income taxes as a % of GDP vs. Real GDP growth since 1941. It's negative 22%. Does that prove supply-siders right? Of course not. Apply the same statistical caveats to the data you are mining.
   
7. Understand the more subtle implications of national accounts, and test your forecasts against them. The first thing you learn in Macro is that national output is the sum of private sector output, government and net exports (Y=C+I+G+X). This isn't a theory, its an accounting identity, how one computes GDP. It follows that the private sector (business and individual) surplus or deficit, plus government's deficit or surplus, plus net imported investment, all expressed as a percentage of GDP must equal zero. Up through 2000, the private sector ran enormous deficits - about triple the long-term average at -6% of GDP. Both business and consumers were dissavers. Government ran a surplus and we certainly imported foreign capital, so these two parts of the identity were positive. Businesses have made a sharp retrenchment, and consumers have followed suit, although much more slowly (thank goodness for that). One of the following two things HAD to accompany this: the government goes into deficit, and/or the FX situation reverses by way of massive dollar depreciation or a complete reversal in trade.

   I was surprised at how many people thought after 2000, the private sector could re-save and the budget could stay balanced (with the right President, of course). This could only have happened if the trade deficit disappeared simultaneously. The fact of the matter is that the near term government deficit was practically a given when the private sector deficit bubble of the '90s burst. Trying to resist it would have created a depression. For a good primer on the implications of the national accounts identities, particularly the lesser-of-two-evils deterioration in the fiscal balance in the post '90s environment, see Wynne Godley's 2001 analysis. He and Woody Brock have been pointing this out since 1999.
   

I'm sure there's more, and I'm sure you'll feel free to stick it, and me, in the comments.
_____
*Actually, Robert Shiller violated scale principals big time in Irrational Exuberance, even as he set new standards for the proper use of inflation-adjusted data. See figure 1.1 in the linked spreadsheet for a potpourri of double-axis deception. He needlessly compresses the right scale and fails to use logarithmic scaling. I would argue the ratio of the left to right scale should be the long-term average P/E of about 15. The top of the right scale would be about 120. Go ahead, you can do it yourself. Doesn't look as extreme, does it? His point, however, survives.

From the desk of Mindles H. Dreck:

Regimes

(this post has been substantially revised on March 12, 2003)

Reading Jane's recent post on housing valuation, I remembered I meant to put this page* up comparing the real change in value of various assets through three recent periods: 1949-1966, 1967-1981 and 1982 to 1999. These are periods S.E.D. identifies as "regimes" in which radically different expectations obtain for different asset classes.

Real estate just hasn't been anywhere near as frothy as stocks. Household real estate assets have grown about as fast (in real terms) from 1982 to the present as from 1967-1981, The difference in the 1982-1999 regime for stocks and bonds with prior eras is striking.

This doesn't mean real estate isn't in a bubble in certain parts of the country, but I think it suggests it won't re-price, in aggregate, nearly as aggressively as stocks have.

In the same publication, S.E.D. publishes an essay by Lawrence L. Kreicher of Omega Economics. Kreicher concludes that there is no national real estate bubble but there are certain urban areas that are at risk. Particularly interesting is an analysis of the ratio of housing prices to per capita income. He creates an index of this measure and scales it to average 100 over the 1980-2002 period (remember, income is growing). The national index rests at about 100 over the period. San Francisco rests at 140, and New York and Boston at about 120. Kreicher suggests that Robert Shiller, of Irrational Exuberance fame, has come to similar conclusions as well.

Kreicher's data omits the high end of the housing market (he is using conforming mortgage data), so it is fair to allow that extreme valuations may exist not only in geographic pockets but in high-priced real estate as well.

Speaking of "regimes", I have updated the logo to the left in order to gain approval from uberblogger Steven Den Beste.

*The source of the linked page, including the unusual spelling of cumulative, is S.E.D. inc.

From the desk of Mindles H. Dreck:

Economist Mouse Control

This is funny. Will I be accused of making disparaging remarks about economists? More importantly, do they have Ph.D.'s?

From the desk of Jane Galt:

What Are the Rich Getting Away With This Time?

What, my correspondants ask, is to keep evil rich people from taking advantage of the new dividend taxation scheme by forming corporations and taking all their income as untaxed dividends? Or setting up similar deals for managers? The subtext seems to be, "Bet you thought you could slip one by us regular folks, hmmm?" Well, you know me, Jeremiad Jane, Shill for the Military-Industrial Complex. I'm sure I'm going to disappoint the readers who thought they'd caught me pulling a fast one, but the answer, my dears, is "the tax code".

Before I explain myself further, I'd like to try to convince you of a proposition that is basically non-controversial in economics: that it doesn't matter whether you tax the employer or the employee; the employee still pays the tax.

Think of it this way: your boss has some amount of money he is willing to pay for your services. Any more than that, and he'll find someone else, or another way to accomplish the tasks he was willing to pay you for. Say that amount is $50K per year.

Now say that the government slaps a 10% tax on wages, payable by the employer. Say further that you are a crack negotiator who has extracted the maximum $50,000 he is willing to pay in salary bargaining. Does your boss go down to the money tree on the back lawn and pick another $5,000 to pay you with? Of course not. He fires you and hires someone cheaper. Or gets a machine to do the job. I had a nice email from a guy at a company making restaurant equipment a while back, saying that he could always tell when a state had raised its payroll taxes or its minimum wage -- there was a huge spike in purchases of labor-saving equipment from that state.

Salary negotiations basically go like this: your company has a maximum they will pay. You have a minimum you will accept. You settle on an amount somewhere in this range; exactly where depends on how good a negotiator you are.

Now add taxes into the equation. Say your boss is willing to pay a total of $50,000, and you're willing to accept a minimum of $40,000. Now, let's add a payroll tax of 10% into the picture. What does that mean? It means that the maximum you will actually get paid is $45,454. If you demand more than that, they will not hire you, because it will push their expense over $50,000.

Now let's imagine it's not a payroll tax, but an income tax of 10%. You'll get slightly less at the maximum: $45,000, rather than $45,454. But the difference is not large compared to the $4500 you lose to the tax. The effect of both taxes is to cap your after-tax salary around $4500 -- even though one tax is nominally imposed on the employer.

And that, my friend, is why companies can't just use the new dividend tax to make salaries to top managers tax free. When you look at a salary, you can't just look at the benefit to the employee; you also have to look at the cost to the corporation. And in this case, there's a big cost to paying salary in dividends instead of wages: salaries are tax deductible, but dividends are not.

Let's imagine again that the corporation is willing to pay a manager $50,000 net of taxes, and the manager is willing to take $40,000 net of taxes. Now, let's examine what happens under the two alternatives. We will assume, for the purposes of the excercise, that the manager is a real sharpie and squeezes every last dime out of his company.

Regular salary:

The company is willing to pay up to $76,923. Why? By paying that amount, the company saves $76,923 X 35% on its taxes: $26,923. That leaves them an after-tax cost of $50,000. Assuming an income tax burden of 20% (yes, this is NOT like real life), that leaves our manager a comfortable after-tax income of $61,538.

Salary paid as dividends:

Now, assume the company wants to pay the manager a nice tax free salary using some dodge to pay his salary as dividends. How much are they willing to pay? $50,000. Why? Because dividends aren't deductible. He gets it tax-free -- but he's worse off than under the regular salary scheme. Note that a dodge to get the employee his salary tax-free only really works when the employee's average income tax rate is higher than the corporate income tax. But that happens only at very, very high levels of taxation, and also, with the new phase-outs there won't be anyone in the country paying a higher rate than the corporate tax. So no one is going to pull that particular dodge.

The same goes double for rich people. Why would you dump your assets into a corporation for the pleasure of paying a 35% bite off every dollar if your marginal rate was lower than that?

There are corporate forms in which the company does not pay the corporate income tax, such as the partnership, the REIT, and the S-Corporation. However, those entities also do not benefit from deductible dividends. So while I'm sure that people would set up an entity to dodge their tax burdern if they could (and in fact, they do so all the time -- what do you think tax lawyers do all day?), this law is not going to help them accomplish their goal. It is going to shift capital distributions from stock repurchases, which were popular in an era of tax-advantaged capital gains, but it is not going to make it so they get to mint money without paying off Uncle Sam.

Next question?

From the desk of Jane Galt:

Stimulating Discussion

Kevin Drum complains that the Bush tax stimulus plan is only going to be stimulative for two years before causing a contraction in 2005.

But of course it is. If you believe in stimulus, all stimulus plans are eventually contractionary.

That is, unless they remove some sort of distortion in the economy -- like, just to pick an example out of nowhere, the differential treatment of capital gains and dividend income -- the basic idea of a stimulus plan is to borrow prosperity from the future.

Stimulus plans do not grow the economy. Everyone from Paul Krugman rightward generally agrees that the only way to grow the economy is either to increase the labor or capital input, or increase productivity. Except in rare cases such as the Keynsian Liquidity Trap, all you are doing is altering the