Tuesday, November 29, 2011
Monday, November 28, 2011
From 2001-2007, in the face of cuts in marginal taxes, we saw tax revenues surge by 30%, while the deficit was reduced by 61% from 2004-2007.
A visualization of the changes in tax revenue and deficits during the 1980's (after sharp drops in marginal tax rates) as well as the more recent period from 2003-2007
"The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks", by Christina Romer and David Romer. http://ideas.repec.org/p/nbr/nberwo/13264.html
Finds that a $1 decrease in taxes may lead to a $3 increase in GDP.
Lindsey, Lawrence B. 1987. "Individual Taxpayer Response to Taxcuts, 1982-1984." J. of Public Economics 33 (July) 173-206
Found elasticity of taxable income by income category to be .728 for income > $50k, 1.023 for >$100k, 1.413 for >$250k, and 2.0 for > $1 million. Also derived the tax revenue responses to reductions in marginal taxes for those earning more than $200k / yr. Revenues increased by 19% in 1982, 35% in 1983, 56% in 1984.
Other work indicates a negative effect of tax rates on economic growth and stimulus.
"Did Stimulus Dollars Hire the Unemployed?: Answers to Questions About the American Recovery and Reinvestment Act," by Garett Jones and Daniel Rothschild. Mercatus Center, August 30, 2011 Also featured on EconTalk with Russ Roberts.
Much of the empirical work related to the size of spending multipliers has been completed by Valerie Ramey. (see also her EconTalk Podcast discussion of her work with economist Russ Roberts)
Valerie Ramey. Quarterly Journal of Economics, February 2011.
Abstract: Standard vector autoregression (VAR) identification methods find that government spending raises consumption and real wages; the Ramey–Shapiro narrative approach finds the opposite. I show that a key difference in the approaches is the timing. Both professional forecasts and the narrative approach shocks Granger-cause the VAR shocks, implying that these shocks are missing the timing of the news. Motivated by the importance of measuring anticipations, I use a narrative method to construct richer government spending news variables from 1939 to 2008. The implied government spending multipliers range from 0.6 to 1.2
Abstract:This paper asks whether increases in government spending stimulate private activity, in the form of either private spending or private employment. The first part of the paper studies private spending. Using a variety of identification methods and samples, I find that in most cases private spending falls significantly in response to an increase in government spending. These results imply that the average GDP multiplier lies below unity. In order to determine whether concurrent increases in tax rates dampen the spending multiplier, I use two different methods to adjust for tax effects. Neither method suggests perceptible effects of current tax rate changes on the spending multiplier. In the second part of the paper, I explore the effects of government spending on labor markets. I find that increases in government spending lower unemployment. However, most specifications and samples imply that virtually all of the effect is through an increase in government employment, not private employment. I thus conclude that on balance government spending does not appear to stimulate private activity.
Can Government Purchases Stimulate the Economy? by Valerie Ramey. June 14, 2011. Prepared for the Journal of Economic Literature Forum on the Multiplier.
Conclusion: The U.S. aggregate multiplier for a temporary, deficit financed increase in government purchases (that enter separately in the utility function and have no direct effect on private sector production functions) is probably between 0.8and 1.5. Reasonable people can argue, however, that the data do not reject 0.5 or 2.
Edward C. Prescott,Adviser Research Department Federal Reserve Bank of Minneapolis
Federal Reserve Bank of Minneapolis Quarterly Review
Winter 1999, vol. 23, no. 1, pp. 25–31
Abstract: There are two striking aspects of the recovery from the Great Depression in the United States: the recovery was very weak, and real wages in several sectors rose significantly above trend. These data contrast sharply with neoclassical theory, which predicts a strong recovery with low real wages. We evaluate the contribution to the persistence of the Depression of New Deal cartelization policies designed to limit competition and increase labor bargaining power. We develop a model of the bargaining process between labor and firms that occurred with these policies and embed that model within a multisector dynamic general equilibrium model. We find that New Deal cartelization policies are an important factor in accounting for the failure of the economy to recover back to trend.
Federal Reserve Bank of Minneapolis Quarterly Review
Winter 1999, vol. 23, no. 1, pp. 2–24
Abstract: Can neoclassical theory account for the Great Depression in the United States— both the downturn in output between 1929 and 1933 and the recovery between 1934 and 1939? Yes and no. Given the large real and monetary shocks to the U.S. economy during 1929–33, neoclassical theory does predict a long, deep downturn. However, theory predicts a much different recovery from this downturn than actually occurred. Given the period’s sharp increases in total factor productivity and the money supply and the elimination of deflation and bank failures, theory predicts an extremely rapid recovery that returns output to trend around 1936. In sharp contrast, real output remained between 25 and 30 percent below trend through the late 1930s.We conclude that a new shock is needed to account for the Depression’s weak recovery. A likely culprit is New Deal policies toward monopoly and the distribution of income.
ABSTRACT: Relying on standard measures of macroeconomic performance, historians and economists believe that “war prosperity” prevailed in the United States during World War II. This belief is ill-founded, because it does not recognize that the United States had a command economy during the war. From 1942 to 1946 some macroeconomic performance measures are statistically inaccurate; others are conceptually inappropriate. A better grounded interpretation is that during the war the economy was a huge arsenal in which the well-being of consumers deteriorated. After the war genuine prosperity returned for the first time since 1929.
The Enterprising Americans: A Business History of the United States
BY JOHN CHAMBERLAIN 1963
"the magnitude of the response of U.S. business to the war is in itself refutation of the thesis that in the thirties businessmen simply sat on their hands…it simply would not have been able to produce the new type of goods when the war button was pressed"
While it was true that total investment was low, investment opportunities were proliferant. He points out the infinite number of industries ready to bust out with thier innovations, including such leaders as du Pont, Dow Chemical, American Cyanamid, and Monsanto that many in the ag industry would be familiar with. During this time GE was ready to go with flourescent lighting and Kodak with color photography and commercial air travel was in the making.
But these great ideas were suppressed and kept on the back burner under the massive interventions of Roosevelt's expanding government.
"Businessmen came to ask themselves whether Roosevelt really understood a system where the hope of profit sparks expansion and investment. Or did he believe simply in centralizing decision and authority in boards and "planners" along the Potomac?"
"Valerie Ramey of the University of California, San Diego talks with EconTalk host Russ Roberts about the effect of government spending on output and employment. Ramey's own work exploits the exogenous nature of wartime spending. She finds a multiplier between .8 and 1.2. (A multiplier of 1 means that GDP goes up by the amount of spending--there is neither stimulus nor crowding out.) She also discusses a survey looking at a wide range of estimates by others and finds that the estimates range from .5 to 2.0. Along the way, she discusses the effects of taxes as well. The conversation concludes with a discussion of the imprecision of multiplier estimates and the contributions of recent Nobel Laureates Thomas Sargent and Christopher Sims."
The references that link from this podcast are very good as well.
Tuesday, October 18, 2011
1) Reducing corruption in the legal system
2) Increasing reliance on market forces
3) Increasing foreign investment
4) Encouraging trade with other countries
5) Increasing the percentage of GDP devoted to savings
In this post, I attempt to integrate many of these concepts.
While the data show that income inequality is not as severe as often portrayed in the media, and that the U.S. has one of the most progressive tax systems in the world, income inequality still exists in the U.S. We know that some degree of income inequality is necessary and desirable (giving us for instance innovations that lead to increased standards of living for the masses). But what are the consequences of unequal distributions of income and wealth?
We can see that negative consequences result if wealthy powerful interests (including high income individuals, wealthy individuals, or corporate interests) are able to utilize the political apparatus to their benefit at the expense of the rest of society. Here in essence we have the specter of rent seeking. Rent seeking, or using the political apparatus to obtain special privileges or benefits ('rents') from government, diverts resources away from innovations and productive investment. It also creates a winner take all or dog eat dog environment (similar to a prisoner's dilemma or Nash equilibrium) that incentivizes everyone to participate (either on the offense to seek 'rents' or on the defense to prevent some law or restriction on activity).
Economic research (Hernando De Soto, The Mystery of Capital; Lane & Tornell, The voracity effect, American Economic Review 1999) indicates that weak political institutions in the presence of powerful special interests are related to stagnant economic growth. How can we design institutions to minimize the prevalence of rent seeking behavior?
When we look at current issues related to the economy, such as bailouts, corporate influence on the political process, and concentrations of power and wealth, we see that these issues arise from the intersection powerful governments and corporations.
In Federalist #10 the founders made it clear that in a free society that we would have an unequal distribution of income and wealth:
"From the protection of different and unequal faculties of acquiring property, the possession of different degrees and kinds of property immediately results; and from the influence of these on the sentiments and views of the respective proprietors, ensues a division of the society into different interests and parties."
They were also aware that this may lead to populust uprisings, calling for policies that could be detrimental to a free society:
"A rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project…we behold a republican remedy for the diseases most incident to republican government."
Their proposed solution was a government limited in its power to bestow privilege through constitutional restraint. Economist Thomas Sowell, in his essay, Judicial Activism Reconsidered, describes how limited constitutional government serves to protect minorities and individuals from concentrated power and special interests:
"The federal Constitution is "the supreme law of the land," not because it is more moral than state constitutions or state or federal legislative enactments, but because it represents a larger and more enduring majority. Minorities receive their constitutional rights from that enduring majority to which transient majorities bow, not from whatever abstract moral rights are imagined to exist as a brooding omnipresence in the sky."
Monday, October 10, 2011
Thursday, October 6, 2011
Here is some related insight from Russ Roberts post Stagnation or Mismeasurement at Cafe Hayek: (this was in 2007)
It is not just a question of the number of new goods and services–it is the pace of innovation within product categories and how much each of these makes it hard to measure prices with any accuracy....The iPod will be six years old next month. The newly released iPod Classic with 160 GB of memory is $50 cheaper than the original iPod, holds 40 TIMES more songs and also plays color videos and displays photos. It is smaller, lighter and has a better battery.
We can also add to that the iPhone, iPad, Apple TV .....etc.
"Bruce Meyer of the University of Chicago talks with EconTalk host Russ Roberts about the middle class, poverty, and inequality. Many economists and pundits argue that the middle class has made little or no economic progress over the last 30 years, that poverty rates are stagnant or rising, and that inequality has increased dramatically. Meyer, drawing on his research over the last ten years, argues that these conclusions are either false or misleading. He argues that standard measures of economic progress and inequality are based on faulty inflation data or a misplaced focus on pre-tax income instead of post-tax income or consumption. "
Some excerpts from Meyer's paper:
Consumption and Income Inequality in the U.S. Since the 1960s*
October 18, 2010
Bruce D. Meyer
University of Chicago and NBER
and James X. Sullivan
University of Notre Dame
Tuesday, October 4, 2011
See also: http://economicsprinciplesandapplications.blogspot.com/2011/05/tragedy-of-commons.html
The Coase Theorem
See also: http://economicsprinciplesandapplications.blogspot.com/2011/05/coase-theorem.html
Monday, October 3, 2011
Tuesday, September 27, 2011
The first 10 minutes of this podcast does a great job connecting the principles of microeconomics (primarily the knowledge problem) with issues in macroeconomic theory, primarily topics related to recessions and stimulus policies.
Tuesday, September 13, 2011
Saturday, September 10, 2011
See also Type II Error Bias and the Response to Hurricane Katrina and Type II Error Bias and the FDA or for the statistical concept of type II errors see here.
Tuesday, September 6, 2011
Government and the Economy in "The Aviator"by Dirk Mateer
Rent seeking, the political pursuit of gains that would not be earned engaging in the market process, is a common theme in many films. With clips from the acclaimed 2004 film “The Aviator,” the discussion of rent seeking can be broadened to include the related concept of regulatory capture. After Pan Am leader Juan Trippe (played by Alec Baldwin) is unable to convince TWA’s Howard Hughes (portrayed by Leonardo DiCaprio) not to offer competing flights across the Atlantic, Trippe turns to Senator Owen Brewster (played by Alan Alda) to introduce a Civil Aviation Bill that would hamper TWA’s ability to compete with Pan Am. The clips illustrate the gains, in this case campaign contributions, prestigious committee chairmanship, and personal travel, that politicians can receive from pushing rent seeking legislation such as that favoring Pan Am.
Regulation | 2003| Summer
"From the claims of opponents of the new biotechnology, it would be easy to conclude that the biotech industry has vigorously fought government efforts to regulate its products. But in fact, the industry has been anything but a consistent opponent of extensive, and even unnecessary, regulation. It has lobbied for protectionism of various sorts — including public policy that makes regulatory costs excessive – and in the process has forsaken science and common sense. Since the 1980s, large biotech companies like Monsanto, Ciba-Geigy (now Syngenta), and Pioneer Hi-Bred International (now owned by DuPont), along with their trade associations, have actively and aggressively lobbied in favor of certain major regulatory or legislative initiatives that often are more restrictive even than those sought by regulators themselves. The industry’s goal is ostensibly to placate anti-biotech activists"
Regulation 1996 No 4
"There is no reason to expect environmental regulations to be immune from the economic pressures that create rent seeking in other contexts. In fact, by their very nature, environmental regulations are conducive to rent seeking, for in the environmental context, both regulated firms and "public interest" representatives stand to gain from reductions in output and the creation of barriers to entry. Regulated firms and public interest groups may not always agree on the nature and design of specific regulatory programs, but they often share a common interest."
But as the legislation’s chances improve, corporations, environmentalists and other interest groups have worked to put their imprint on the bill. The Center for Public Integrity said its review of Senate disclosure records showed that more than 880 businesses and interest groups have registered to lobby on climate change in the first quarter of 2009 — up more than 14 percent over the same time last year.
The groups include coal companies, investment banks, wind and solar firms, state governments, auditing firms and technology companies that might be part of the proposed trading system for carbon. An item inserted at the behest of Rep. John D. Dingell (D-Mich.) would give the auto industry $1.4 billion worth of extra allowances starting in 2012 when the cap-and-trade system takes effect, according to an estimate by the Union of Concerned Scientists.
Monday, September 5, 2011
September 12, 2011
8:00 pm - 9:30 pm
Grise Hall 235(special thanks to the BB&T Center For the Study of Capitalism at WKU).
The lesson of September 11 is not that government should plan better and not that a Republican president plans better or worse than a Democrat president. The lesson of 9/11 is that central planning doesn't work and that government should not get in the way of our planning. " LINK
"I prefer true but imperfect knowledge, even if it leaves much indetermined and unpredictable, to a pretence of exact knowledge" - F.A. Hayek
"The financial crisis invalidated a naïve notion of "efficient markets," but the most sophisticated version is still viable. Whereas the invalidated version holds that markets never err and always adjust instantaneously, the sophisticated version, associated with the ideas of Adam Smith and F. A. Hayek, holds that markets mobilize individuals to realize gains from trade and to innovate and thereby produce generalized prosperity."
"In the 1940s, Hayek warned his fellow economists of the misleading standards of perfect competition and static efficiency in assessing the market economy. As he wrote in Individualism and Economic Order, "[T]hese adjustments are probably never 'perfect' in the sense which the economist conceives them in his equilibrium analysis. But I fear that our theoretical habits of approaching the problem with the assumption of more or less perfect knowledge on the part of almost everyone has made us somewhat blind to the true function of the price mechanism and led us to apply rather misleading standards in judging its efficiency" (1948, 87)"
"The great free market economic thinkers from Adam Smith to F. A. Hayek never argued that individuals were hyper-rational actors possessed with full and complete information, operating in perfectly competitive markets.... Efficient markets are an outcome of a process of discovery, learning, and adjustment, not an assumption going into the analysis."
A basic application of climate economics:
What economists must do is take consensus science into account, and approximate what the price of carbon should be to limit economic damages from CO2. This level will be achieved where the marginal cost of reducing carbon emissions is equal to the benefits of decreased damages from climate change in the future.
Nordhaus ( Using the DICE-2007 model, and based on the science of the IPCC Fourth Assessment Report) prices carbon at about $30/ ton, with the average person in the US generating about 5tons/yr, for a total of about $150/year, or .09 /gallon of gas and .01/kwh for electricity. However, the Stern Proposal(proposed by another economist in the U.K) estimates the damage from global warming to be closer to $300/ton carbon for the next two decades. In this case we are looking at increasing gas prices by about $1.20/gallon. (read more)
Carbon taxes and the climate change knowledge problem
The idea of pricing carbon is that given the assumption that CO2 production has a negative impact on climate change and so many goods and services are carbon intensive, if we can put a price on carbon (paid by corporations that trade carbon permits or a carbon tax) to capture the value of the negative externality, this will 'trickle down' to the mirco level, such that when you buy an ice cream cone, gasoline, or a pencil, the impact of your choice on the climate will be captured in the price you pay for it. This is the climate change knowledge problem. We have to get the initial price of CO2 correct so that the 'trickle down' economics works at the micro level and we ward off catastrophic climate change.
The correct price for carbon will balance the marginal cost of reducing carbon emissions with benefits of decreased damages from climate change in the future. As Armstrong points out, there are few scientific forecasts related to these future damages. And technological change allows us to continually respond the volatile effects of climate change. Advances in biotechnology are allowing us to produce more climate resilient crops, all the while reducing our carbon footprint in agriculture. How can we incorporate this knowledge into our calculus? When it comes to the costs of reducing carbon emissions, it isn't any easier. What are the opportunity costs of resources invested in emissions mitigation (voluntarily vs. those mandated or incentivised by government administered prices for carbon)?
From the Capitalism Today Blog at Western Kentucky University there was recently adiscussion regarding macroeconomic equilibrium and the difficulties of knowing the micro-level equilibrium for something (seemingly) as simple as ice cream:
"They act as if not only there is equilibrium, but that they know where it is. If anyone knows exactly how many ice cream cones the US needs to produce tomorrow, please raise your hands. What no hands? No one can know the "appropriate" amount of ice cream cone production for today let alone for tomorrow. The $15 trillion US economy makes a lot more than just ice cream cones."
Some will agree that planners are no match for markets in determining prices and quantities, but because we currently have no established property rights to the atmosphere there is no 'price' for carbon. As such, there are going to be consequences if we do nothing, and the next best solution is an attempt, even if not perfect, to price carbon because it is not considered in market transactions.
Is that really the next best solution and is it true that the price mechanism totally ignores CO2?
What is carbon really? 'Carbon' in an economy manifests itself in how we heat and cool our homes, how we manufacture goods and services, how we respond to emergencies, how we travel and transport goods, how we store and retrieve information. Leonard E. Read's essay I, Pencil demonstrates the complexity involved in an economy that thrives on disaggregated information and processes with numerous feedback loops and interactions. In a complex society, carbon is no different, and while it may not be explicitly and directly priced, it is hard to believe that its role is not part of the pool of knowledge characterized by the partial bits of information held by all individuals in society.
In fact, while politicians and special interests argue over the politically optimal arrangement of regulatory protections and subsidies to 'combat climate change' markets have responded in much more meaningful ways without any bureaucratically administered price of carbon or cap on CO2.
As Dr. Don Boudreaux of George Mason University points out in a recent piece in the Wall Street Journal, in response to climate alarmists' connecting violent storms and climate change (and obviously calling for centralized solutons to combat it): (read more)
"...because of modern industrial and technological advances—radar, stronger yet lighter building materials, more reliable electronic warning devices, and longer-lasting packaged foods—we are better protected from nature's fury today than at any other time in human history."
Perhaps the innovations in green technologies in agriculture provide the greatest example of mitigating climate change:
Total decreases in carbon dioxide as a result of using biotech crops was equivalent to removing 6 million cars from the road in 2007. The carbon footprint for a gallon of milk produced in 2007 was only 37 percent of that produced in 1944. For every 1 million cows, the reduction in global warming potential from rBST supplemented cows is equivalent to removing 400K cars from the roadways or planting 300 million trees. The use of grain and pharmaceutical technology in beef production has resulted in a nearly 40 percent reduction in greenhouse gases (GHGs) per pound of beef compared to grass feeding. Intensive agriculture has actually has a mitigating effect on climate change with a reduction of 68 kgC (249 kgCO2e) emissions relative to 1961 technology. (read more)
We are not really sure how to price carbon, and what we observe in all of these instances is that despite the absence of a centrally planned price or quantity of carbon, people are making choices that optimize its use or production. Because we don't have the knowledge to price carbon, we don't know that the resources expended in 1) lobbying lawmakers to tweak the proposed rules and regulations 2) mitigating the costs of a centrally planned price or quantity, would not have higher valued uses mitigating climate change in other ways (like investment in green technologies like biotech). The best approach for dealing with climate change or any environmental problem is to develop resilient market based economies that are able to invest in the technology necessary to adapt to ever changing resource constraints.