Just give people money!

2015-11-05 PNRJ core principles, critique of neoclassical economics, development economics, public policy abolish poverty, altruism, basic income, cash transfer, inequality, justice, Maslow, Nelson Mandela, Permanent Fund Dividend, poverty, redistribution, self-interest, wealth

JDN 2457332 EDT 17:02.

Today is the Fifth of November, on which a bunch of people who liked a Hollywood movie start posting images in support of a fanatical religious terrorist in his plot to destroy democracy in the United Kingdom a few centuries ago. It’s really weird, but I’m not particularly interested in that.

Instead I’d like to talk about the solution to poverty, which we’ve known for a long time—in fact, it’s completely obvious—and yet have somehow failed to carry out. Many people doubt that it even works, not based on the empirical evidence, but because it just feels like it can’t be right, like it’s so obvious that surely it was tried and didn’t work and that’s why we moved on to other things. When you first tell a kindergartner that there are poor people in the world, that child will very likely ask: “Why don’t we just give them some money?”

Why not indeed?

Formally this is called a “direct cash transfer”, and it comes in many different variants, but basically they run along a continuum from unconditional—we just give it to everybody, no questions asked—to more and more conditional—you have to be below a certain income, or above a certain age, or have kids, or show up at our work program, or take a drug test, etc. The EU has a nice little fact sheet about the different types of cash transfer programs in use.

Actually, I’d argue that at the very far extreme is government salaries—the government will pay you $40,000 per year, provided that you teach high school every weekday. We don’t really think of that as a “conditional cash transfer” because it involves you providing a useful service (and is therefore more like an ordinary, private-sector salary), but many of the conditions imposed on cash transfers actually have this sort of character—we want people to do things that we think are useful to society, in order to justify us giving them the money. It really seems to be a continuum, from just giving money to everyone, to giving money to some people based on them doing certain things, to specifically hiring people to do something.

Social programs in different countries can be found at different places on this continuum. In the United States, our programs are extremely conditional, and also the total amount we give out is relatively small. In Europe, programs are not as conditional—though still conditional—and they give out more. And sure enough, after-tax poverty in Europe is considerably lower, even though before-tax poverty is about the same.

In fact, the most common way to make transfers conditional is to make them “in-kind”; instead of giving you money, we give you something—healthcare, housing, food. Sometimes this makes sense; actually I think for healthcare it makes the most sense, because price signals don’t work in a market as urgent and inelastic as healthcare (that is, you don’t shop around for an emergency room—in fact, people don’t even really shop around for a family doctor). But often it’s simply a condition we impose for political reasons; we don’t want those “lazy freeloaders” to do anything else with the money that we wouldn’t like, such as buying alcohol or gambling. Even poor people in India buy into this sort of reasoning. Nevermind that they generally don’t do that, or that they could just shift away spending they would otherwise be making (warning: technical economics paper within) to do those things anyway—it’s the principle of the thing.

Direct cash transfers not only work—they work about as well as the best things we’ve tried. Spending on cash transfers is about as cost-effective as spending on medical aid and malaria nets.

Other than in experiments (the largest of which I’m aware of was a town in Canada, unless you count Alaska’s Permanent Fund Dividend, which is unconditional but quite small), we have never really tried implementing a fully unconditional cash transfer system. “Too expensive” is usually the complaint, and it would indeed be relatively expensive (probably greater than all of what we currently spend on Social Security and Medicare, which are two of our biggest government budget items). Implementing a program with a cost on the order of $2 trillion per year is surely not something to be done lightly. But it would have one quite substantial benefit: It would eliminate poverty in the United States immediately and forever.

This is why I really like the “abolish poverty” movement; we must recognize that at our current level of economic development, poverty is no longer a natural state, a complex problem to solve. It is a policy decision that we are making. We are saying, as a society, that we would rather continue to have poverty than spend that $2 trillion per year, about 12% of our $17.4 trillion GDP. We are saying that we’d rather have people who are homeless and starving than lose 12 cents of every dollar we make. (To be fair, if we include the dynamic economic impact of this tax-and-transfer system it might actually turn out to be more than that; but it could in fact be less—the increased spending would boost the economy, just as the increased taxes would restrain it—and seems very unlikely to be more than 20% of GDP.)

For most of human history—and in most countries today—that is not the case. India could not abolish poverty immediately by a single tax policy; nor could China. Probably not Brazil either. Maybe Greece could do it, but then again maybe not. But Germany could; the United Kingdom could; France could; and we could in the United States. We have enough wealth now that with a moderate increase in government spending we could create an economic floor below which no person could fall. It is incumbent upon us at the very least to justify why we don’t.

I have heard it said that poverty is not a natural condition, but the result of human action. Even Nelson Mandela endorsed this view. This is false, actually. In general, poverty is the natural condition of all life forms on Earth (and probably all life forms in the universe). Natural selection evolves us toward fitting as many gene-packages into the environment as possible, not toward maximizing the happiness of the sentient beings those gene-packages may happen to be. To a first approximation, all life forms suffer in poverty.

We live at a unique time in human history; for no more than the last century—and perhaps not even that—we have actually had so much wealth that we could eliminate poverty by choice. For hundreds of thousands of years human beings toiled in poverty because there was no such choice. Perhaps good policy in Greece could end poverty today, but it couldn’t have during the reign of Pericles. Good policy in Italy could end poverty now, but not when Caesar was emperor. Good policy in the United Kingdom could easily end poverty immediately, but even under Queen Victoria that wasn’t feasible.

Maybe that’s why we aren’t doing it? Our cultural memory was forged in a time decades or centuries ago, before we had this much wealth to work with. We speak of “end world hunger” in the same breath as “cure cancer” or “conquer death”, a great dream that has always been impossible and perhaps still is—but in fact we should speak of it in the same breath as “split the atom” and “land on the Moon”, seminal achievements that our civilization is now capable of thanks to economic and technological revolution.

Capitalism also seems to have a certain momentum to it; once you implement a market economy that maximizes wealth by harnessing self-interest, people seem to forget that we are fundamentally altruistic beings. I may never forget that economist who sent me an email with “altruism” in scare quotes, as though it was foolish (or at best imprecise) to say that human beings care about one another. But in fact we are the most altruistic species on Earth, without question, in a sense so formal and scientific it can literally be measured quantitatively.

There are real advantages to harnessing self-interest—not least, I know my own interests considerably better than I know yours, no matter who you are—and that is part of how we have achieved this great level of wealth (though personally I think science, democracy, and the empowerment of women are the far greater causes of our prosperity). But we must not let it forget us why we wanted to have wealth in the first place: Not to concentrate power in a handful of individuals who will pass it on to their heirs; not to “maximize work incentives”; not to give us the fanciest technological gadgets. The reason we wanted to have wealth was so that we could finally free ourselves from the endless toil that was our lot by birth and that of all other beings—to let us finally live, instead of merely survive. There is a peak to Maslow’s pyramid, and we could stand there now, together; but we must find the will to give up that 12 cents of every dollar.

How about we listen to the Nobel Laureate when we set our taxes?

2015-10-252017-10-08 PNRJ core principles, financial fraud, inequality, macroeconomics, public policy Apple, Bernie Sanders, Bill Clinton, capital, capital gains, Center for American Progress, corporate welfare, debt, debt crisis, deficit, externalities, finance, fiscal policy, Henry George, high-frequency trading, income tax, Jon Stewart, Krugman, Marco Rubio, multiplier, Obama, progressive taxation, puppies and rainbows, reform, sales tax, Stiglitz, subsidy, tax expenditure, taxation, Tim Cook, unemployment, VAT, voodoo economics

JDN 2457321 EDT 11:20

I know I’m going out on a limb here, but I think it would generally be a good thing if we based our tax system on the advice of Nobel Laureate economists. Joseph Stiglitz wrote a tax policy paper for the Roosevelt Institution last year that describes in detail how our tax system could be reformed to simultaneously restore economic growth, reduce income inequality, promote environmental sustainability, and in the long run even balance the budget. What’s more, he did the math (I suppose Nobel Laureate economists are known for that), and it looks like his plan would actually work.

The plan is good enough that I think it’s worth going through in some detail.

He opens by reminding us that our “debt crisis” is of our own making, the result of politicians (and voters) who don’t understand economics:

“But we should be clear that these crises – which have resulted in a government shutdown and a near default on the national debt – are not economic but political. The U.S. is not like Greece, unable to borrow to fund its debt and deficit. Indeed, the U.S. has been borrowing at negative real interest rates.”

Stiglitz pulls no punches against bad policies, and isn’t afraid to single out conservatives:

“We also show that some of the so-called reforms that conservatives propose would be counterproductive – they could simultaneously reduce growth and economic welfare and increase unemployment and inequality. It would be better to have no reform than these reforms.”

A lot of the news media keep trying to paint Bernie Sanders as a far-left radical candidate (like this article in Politico calling his hometown the “People’s Republic of Burlington”), because he says things like this: “in recent years, over 99 percent of all new income generated in the economy has gone to the top 1 percent.”

But the following statement was not said by Bernie Sanders, it was said by Joseph Stiglitz, who I will remind you one last time is a world-renowned Nobel Laureate economist:

“The weaknesses in the labor market are reflected in low wages and stagnating incomes. That helps explain why 95 percent of the increase in incomes in the three years after the recovery officially began went to the upper 1 percent. For most Americans, there has been no recovery.”

It was also Stiglitz who said this:

“The American Dream is, in reality, a myth. The U.S. has some of the worst inequality across generations (social mobility) among wealthy nations. The life prospects of a young American are more dependent on the income and education of his parents than in other advanced countries.”

In this country, we have reached the point where policies supported by the analysis of world-renowned economists is considered far-left radicalism, while the “mainstream conservative” view is a system of tax policy that is based on pure fantasy, which has been called “puppies and rainbows” by serious policy analysts and “voodoo economics” by yet another Nobel Laureate economist. A lot of very smart people don’t understand what’s happening in our political system, and want “both sides” to be “equally wrong”, but that is simply not the case: Basic facts of not just social science (e.g. Keynesian monetary policy), but indeed natural science (evolutionary biology, anthropogenic climate change) are now considered “political controversies” because the right wing doesn’t want to believe them.

But let’s get back to the actual tax plan Stiglitz is proposing. He is in favor of raising some taxes and lowering others, spending more on some things and less on other things. His basic strategy is actually quite simple: Raise taxes with low multipliers and cut taxes with high multipliers. Raise spending with high multipliers and cut spending with low multipliers.

“While in general taxes take money out of the system, and therefore have a deflationary bias, some taxes have a larger multiplier than others, i.e. lead to a greater reduction in aggregate demand per dollar of revenue raised. Taxes on the rich and superrich, who save a large fraction of their income, have the least adverse effect on aggregate demand. Taxes on lower income individuals have the most adverse effect on aggregate demand.”

In other words, by making the tax system more progressive, we can directly stimulate economic growth while still increasing the amount of tax revenue we raise. And of course we have plenty of other moral and economic reasons to prefer progressive taxation.

Stiglitz tears apart the “job creator” myth:

“It is important to dispel a misunderstanding that one often hears from advocates of lower taxes for the rich and corporations, which contends that the rich are the job producers, and anything that reduces their income will reduce their ability and incentive to create jobs. First, at the current time, it is not lack of funds that is holding back investment. It is not even a weak and dysfunctional financial sector. America’s large corporations are sitting on more than $2 trillion in cash. What is holding back investment, especially by large corporations, is the lack of demand for their products.”

Stiglitz talks about two principles of taxation to follow:

First is the Generalized Henry George Principle, that we should focus taxes on things that are inelastic, meaning their supply isn’t likely to change much with the introduction of a tax. Henry George favored taxing land, which is quite inelastic indeed. The reason we do this is to reduce the economic distortions created by a tax; the goal is to collect revenue without changing the number of real products that are bought and sold. We need to raise revenue and we want to redistribute income, but we want to do it without creating unnecessary inefficiencies in the rest of the economy.

Second is the Generalized Polluter Pays Principle, that we should tax things that have negative externalities—effects on other people that are harmful. When a transaction causes harm to others who were not party to the transaction, we should tax that transaction in an amount equal to the harm that it would cause, and then use that revenue to offset the damage. In effect, if you hurt someone else, you should have to pay to clean up your own mess. This makes obvious moral sense, but it also makes good economic sense; taxing externalities can improve economic efficiency and actually make everyone better off. The obvious example is again pollution (the original Polluter Pays Principle), but there are plenty of other examples as well.

Stiglitz of course supports taxes on pollution and carbon emissions, which really should be a no-brainer. They aren’t just good for the environment, they would directly increase economic efficiency. The only reason we don’t have comprehensive pollution taxes (or something similar like cap-and-trade) is again the political pressure of right-wing interests.

Stiglitz focuses in particular on the externalities of the financial system, the boom-and-bust cycle of bubble, crisis, crash that has characterized so much of our banking system for generations. With a few exceptions, almost every major economic crisis has been preceded by some sort of breakdown of the financial system (and typically widespread fraud by the way). It is not much exaggeration to say that without Wall Street there would be no depressions. Externalities don’t get a whole lot bigger than that.

Stiglitz proposes a system of financial transaction taxes that are designed to create incentives against the most predatory practices in finance, especially the high-frequency trading in which computer algorithms steal money from the rest of the economy thousands of times per second. Even a 0.01% tax on each financial transaction would probably be enough to eliminate this particular activity.

He also suggests the implementation of “bonus taxes” which disincentivize paying bonuses, which could basically be as simple as removing the deductions placed during the Clinton administration (in a few years are we going to have to say “the first Clinton administration”?) that exempt “performance-based pay” from most forms of income tax. All pay is performance-based, or supposed to be. There should be no special exemption for bonuses and stock options.

Stiglitz also proposes a “bank rescue fund” which would be something like an expansion of the FDIC insurance that banks are already required to have, but designed as catastrophe insurance for the whole macroeconomy. Instead of needing bailed out from general government funds, banks would only be bailed out from a pool of insurance funds they paid in themselves. This could work, but honestly I think I’d rather reduce the moral hazard even more by saying that we will never again bail out banks directly, but instead bail out consumers and real businesses. This would probably save banks anyway (most people don’t default on debts if they can afford to pay them), and if it doesn’t, I don’t see why we should care. The only reason banks exist is to support the real economy; if we can support the real economy without them, they deserve to die. That basic fact seems to have been lost somewhere along the way, and we keep talking about how to save or stabilize the financial system as if it were valuable unto itself.

Stiglitz also proposes much stricter regulations on credit cards, which would require them to charge much lower transaction fees and also pay a portion of their transaction revenue in taxes. I think it’s fair to ask whether we need credit cards at all, or if there’s some alternative banking system that would allow people to make consumer purchases without paying 20% annual interest. (It seems like there ought to be, doesn’t it?)

Next Stiglitz gets to his proposal to reform the corporate income tax. Like many of us, he is sick of corporations like Apple and GE with ten and eleven-figure profits paying little or no taxes by exploiting a variety of loopholes. He points out some of the more egregious ones, like the “step up of basis at death” which allows inherited capital to avoid taxation (personally, I think both morally and economically the optimal inheritance tax rate is 100%!), as well as the various loopholes on offshore accounting which allow corporations to design and sell their products in the US, even manufacture them here, and pay taxes as if all their work were done in the Cayman Islands. He also points out that the argument that corporate taxes disincentivize investment is ridiculous, because most investment is financed by corporate bonds which are tax-deductible.

Stiglitz departs from most other economists in that he actually proposes raising the corporate tax rate itself. Most economists favor cutting the rate on paper, then closing the loopholes to ensure that the new rate is actually paid. Stiglitz says this is not enough, and we must both close the loopholes and increase the rate.

I’m actually not sure I agree with him on this; the incidence of corporate taxes is not very well-understood, and I think there’s a legitimate worry that taxing Apple will make iPhones more expensive without actually taking any money from Tim Cook. I think it would be better to get rid of the corporate tax entirely and then dramatically raise the marginal rates on personal income, including not only labor income but also all forms of capital income. Instead of taxing Apple hoping it will pass through to Tim Cook, I say we just tax Tim Cook. Directly tax his $4 million salary and $70 million in stock options.

Stiglitz does have an interesting proposal to introduce “rent-seeking” taxes that specifically apply to corporations which exercise monopoly or oligopoly power. If you can actually get this to work, it’s very clever; you could actually create a market incentive for corporations to support their own competition—and not in the sense of collusion but in the sense of actually trying to seek out more competitive markets in order to avoid the monopoly tax. Unfortunately, Stiglitz is a little vague on how we’d actually pull that off.

One thing I do agree with Stiglitz on is the use of refundable tax credits to support real investment. Instead of this weird business about not taxing dividends and capital gains in the hope that maybe somehow this will support real investment, we actually give tax credits specifically to companies that build factories or hire more workers.

Stiglitz also does a good job of elucidating the concept of “corporate welfare”, officially called “tax expenditures”, in which subsidies for corporations are basically hidden in the tax code as rebates or deductions. This is actually what Obama was talking about when he said “spending in the tax code”, (he did not invent the concept of tax expenditures), but since he didn’t explain himself well even Jon Stewart accused him of Orwellian Newspeak. Economically a refundable tax rebate of $10,000 is exactly the same thing as a subsidy of $10,000. There are some practical and psychological differences, but there are no real economic differences. If you’re still confused about tax expenditures, the Center for American Progress has a good policy memo on the subject.

Stiglitz also has some changes to make to the personal income tax, all of which I think are spot-on. First we increase the marginal rates, particularly at the very top. Next we equalize rates on all forms of income, including capital income. Next, we remove most, if not all, of the deductions that allow people to avoid paying the rate it says on paper. Finally, we dramatically simplify the tax code so that the majority of people can file a simplified return which basically just says, “This is my income. This is the tax rate for that income. This is what I owe.” You wouldn’t have to worry about itemizing your student loans or mortgage payments or whatever else; just tally up your income and look up your rate. As he points out, this would save a lot of people a lot of stress and also remove a lot of economic distortions.

He talks about how we can phase out the mortgage-interest deduction in particular, because it’s clearly inefficient and regressive but it’s politically popular and dropping it suddenly could lead to another crisis in housing prices.

Stiglitz has a deorbit for anyone who thinks capital income should not be taxed:

“There is, moreover, no justification for taxing those who work hard to earn a living at a higher rate than those who derive their income from speculation.”

By equalizing rates on labor and capital income, he estimates we could raise an additional $130 billion per year—just shy of what it would take to end world hunger. (Actually some estimates say it would be more than enough, others that it would be about half what we need. It’s definitely in the ballpark, however.)

Stiglitz actually proposes making a full deduction of gross household income at $100,000, meaning that the vast majority of Americans would pay no income tax at all. This is where he begins to lose me, because it necessarily means we aren’t going to raise enough revenue by income taxes alone.

He proposes to make up the shortfall by introducing a value-added tax, a VAT. I have to admit a lot of countries have these (including most of Europe) and seem to do all right with them; but I never understood why they are so popular among economists. They are basically sales taxes, and it’s very hard to make any kind of sales tax meaningfully progressive. In fact, they are typically regressive, because rich people spend a smaller proportion of their income than poor people do. Unless we specifically want to disincentivize buying things (and a depression is not the time to do that!), I don’t see why we would want to switch to a sales tax.

At the end of the paper Stiglitz talks about the vital difference between short-term spending cuts and long-term fiscal sustainability:

“Thus, policies that promote output and employment today also contribute to future growth – particularly if they lead to more investment. Thus, austerity measures that take the form of cutbacks in spending on infrastructure, technology, or education not only weaken the economy today, but weaken it in the future, both directly (through the obvious impacts, for example, on the capital stock) but also indirectly, through the diminution in human capital that arises out of employment or educational experience. […] Mindless “deficit fetishism” is likely to be counterproductive. It will weaken the economy and prove counterproductive to raising revenues because the main reason that we are in our current fiscal position is the weak economy.”

It amazes me how many people fail to grasp this. No one would say that paying for college is fiscally irresponsible, because we know that all that student debt will be repaid by your increased productivity and income later on; yet somehow people still think that government subsidies for education are fiscally irresponsible. No one would say that it is a waste of money for a research lab to buy new equipment in order to have a better chance at making new discoveries, yet somehow people still think it is a waste of money for the government to fund research. The most legitimate form of this argument is “crowding-out”, the notion that the increased government spending will be matched by an equal or greater decrease in private spending; but the evidence shows that many public goods—like education, research, and infrastructure—are currently underfunded, and if there is any crowding-out, it is much smaller than the gain produced by the government investment. Crowding-out is theoretically possible but empirically rare.

Above all, now is not the time to fret about deficits. Now is the time to fret about unemployment. We need to get more people working; we need to create jobs for those who are already seeking them, better jobs for those who have them but want more, and opportunities for people who have given up searching for work to keep trying. To do that, we need spending, and we will probably need deficits. That’s all right; once the economy is restored to full capacity then we can adjust our spending to balance the budget (or we may not even need to, if we devise taxes correctly).

Of course, I fear that most of these policies will fall upon deaf ears; but Stiglitz calls us to action:

“We can reform our tax system in ways that will strengthen the economy today, address current economic and social problems, and strengthen our economy for the future. The economic agenda is clear. The question is, will the vested interests which have played such a large role in creating the current distorted system continue to prevail? Do we have the political will to create a tax system that is fair and serves the interests of all Americans?”

Why being a scientist means confronting your own ignorance

2015-10-212015-10-21 PNRJ core principles confirmation bias, falsification, ignorance, knowing, knowledge, Popper, science, stupidity, The Armor of Truth

I read an essay today arguing that scientists should be stupid. Or more precisely, ignorant. Or even more precisely, they should recognize their ignorance when all others ignore and turn away.

What does it feel like to be wrong?

It doesn’t feel like anything. Most people are wrong most of the time without realizing it. (Explained brilliantly in this TED talk.)

What does it feel like to be proven wrong, to find out you were confused or ignorant?

It hurts, a great deal. And most people flinch away from this. They would rather continue being wrong than experience the feeling of being proven wrong.

But being proven wrong is the only way to become less wrong. Being proven ignorant is the only way to truly attain knowledge.

I once heard someone characterize the scientific temperament as “being comfortable not knowing”. No, no, no! Just the opposite, in fact. The unscientific temperament is being comfortable not knowing, being fine with your infinite ignorance as long as you can go about your day. The scientific temperament is being so deeply uncomfortable not knowing that it overrides the discomfort everyone feels when their beliefs are proven wrong. It is to have a drive to actually know—not to think you know, not to feel as if you know, not to assume you know and never think about it, but to actually know—that is so strong it pushes you through all the pain and doubt and confusion of actually trying to find out.

An analogy I like to use is The Armor of Truth. Suppose you were presented with a piece of armor, The Armor of Truth, which is claimed to be indestructible. You will have the chance to wear this armor into battle; if it is indeed indestructible, you will be invincible and will surely prevail. But what if it isn’t? What if it has some weakness you aren’t aware of? Then it could fail and you could die.

How would you go about determining whether The Armor of Truth is really what it is claimed to be? Would you test it with things you expect it to survive? Would you brush it with feathers, pour glasses of water on it, poke it with your finger? Would you seek to confirm your belief in its indestructibility? (As confirmation bias would have you do?) No, you would test it with things you expect to destroy it; you’d hit it with everything you have. You’re fire machine guns at it, drop bombs on it, pour acid on it, place it in a nuclear testing site. You’d do everything you possibly could to falsify your belief in the armor’s indestructibility. And only when you failed, only after you had tried everything you could think of to destroy the armor and it remained undented and unscratched, would you begin to believe that it is truly indestructible. (Popper was exaggerating when he said all science is based on falsification; but he was not exaggerating very much.)

Science is The Armor of Truth, and we wear it into battle—but now the analogy begins to break down, for our beliefs are within us, they are part of us. We’d like to be able to point the machineguns at armor far away from us, but instead it is as if we are forced to wear the armor as the guns are fired. When a break in the armor is found and a bullet passes through—a belief we dearly held is proven false—it hurts us, and we wish we could find another way to test it. But we can’t; and if we fail to test it now, it will only endanger us later—confront a false belief with reality enough and it will eventually fail. A scientist is someone who accepts this and wears the armor bravely as the test guns blaze.

Being a scientist means confronting your own ignorance: Not accepting it, but also not ignoring it; confronting it. Facing it down. Conquering it. Destroying it.

What if employees were considered assets?

2015-10-142015-10-12 PNRJ core principles, public policy accounting, asset, capital, credit, debit, equity, labor, liability, nonzero-sum, Robert Reich, wealth, zero-sum

JDN 2457308 EDT 15:31

Robert Reich has an interesting proposal to change the way we think about labor and capital:
“First, are workers assets to be developed or are they costs to be cut?” “Employers treat replaceable workers as costs to be cut, not as assets to be developed.”

This ultimately comes down to a fundamental question of how our accounting rules work: Workers are not considered assets, but wages are considered liabilities.

I don’t want to bore you with the details of accounting (accounting is often thought of as similar to economics, but really it’s the opposite of economics: Whereas economics is empirical, interesting, and fundamentally nonzero-sum, accounting is arbitrary, tedious, and zero-sum by construction), but I think it’s worth discussing the difference between how capital and labor are accounted.

By construction, every credit must come with a debit, no matter how arbitrary this may seem.

We start with an equation:

Assets + Expenses = Equity + Liabilities + Income

When purchasing a piece of capital, you credit the equity account with the capital you just bought, increasing it, then debit the expense account, increasing it as well. Because the capital is valued at the price at which you bought it, the increase in equity exactly balances the increase in expenses, and your assets, liabilities, and income do not change.

But when hiring a worker, you still debit the expense account, but now you credit the liabilities account, increasing it as well. So instead of increasing your equity, which is a good thing, you increase your liabilities, which is a bad thing.

This is why corporate executives are always on the lookout for ways to “cut labor costs”; they conceive of wages as simply outgoing money that doesn’t do anything useful, and therefore something to cut in order to increase profits.

Reich is basically suggesting that we start treating workers as equity, the same as we do with capital; and then corporate executives would be thinking in terms of making a “capital gain” by investing in their workers to increase their “value”.

The problem with this scheme is that it would really only make sense if corporations owned their workers—and I think we all know why that is not a good idea. The reason capital can be counted in the equity account is that capital can be sold off as a source of income; you don’t need to think of yourself as making a sort of “capital gain”; you can make, you know, actual capital gains.

I think actually the deeper problem here is that there is something wrong with accounting in general.

By its very nature, accounting is zero-sum. At best, this allows an error-checking mechanism wherein we can see if the two sides of the equation balance. But at worst, it makes us forget the point of economics.

While an individual may buy a capital asset on speculation, hoping to sell it for a higher price later, that isn’t what capital is for. At an aggregate level, speculation and arbitrage cannot increase real wealth; all they can do is move it around.

The reason we want to have capital is that it makes things—that the value of goods produced by a machine can far exceed the cost to produce that machine. It is in this way that capital—and indeed capitalism—creates real wealth.

Likewise, that is why we use labor—to make things. Labor is worthwhile because—and insofar as—the cost of the effort is less than the benefit of the outcome. Whether you are a baker, an author, a neurosurgeon, or an auto worker, the reason your job is worth doing is that the harm to you from doing it is smaller than the benefit to others from having it done. Indeed, the market mechanism is supposed to be structured so that by transferring wealth to you (i.e., paying you money), we make it so that both you and the people who buy your services are better off.

But accounting methods as we know them make no allowance for this; no matter what you do, the figures always balance. If you end up with more, someone else ends up with less. Since a worker is better off with a wage than they were before, we infer that a corporation must be worse off because it paid that wage. Since a corporation makes a profit selling a good, we infer that a consumer must be worse off because they paid for that purchase. We track the price of everything and understand the value of nothing.

There are two ways of pricing a capital asset: The cost to make it, or the value you get from it. Those two prices are only equal if markets are perfectly efficient, and even then they are only equal at the margin—the last factory built is worth what it can make, but every other factory built before that is worth more. It is that difference which creates real wealth—so assuming that they are the same basically defeats the purpose.

I don’t think we can do away with accounting; we need some way to keep track of where money goes, and we want that system to have built-in mechanisms to reduce rates of error and fraud. Double-entry bookkeeping certainly doesn’t make error and fraud disappear, but it at least does provide some protection against them, which we would lose if we removed the requirement that accounts must balance.

But somehow we need to restructure our metrics so that they give some sense of what economics is really about—not moving around a fixed amount of wealth, but making more wealth. Accounting for employees as assets wouldn’t solve that problem—but it might be a start, I guess?

The scissors of supply and demand

2015-10-032015-10-03 PNRJ core principles, public policy business cycle, conservative, demand, demand-side, immortality, liberal, Marshall, policy, Say's Law, supply, supply-side, unemployment

JDN 2457299 EDT 17:03

In recent posts I talked about demand and then I talked about supply. Now it’s time to talk about both at once–which is where the real magic happens. Alfred Marshall famously compared supply and demand to the lower and upper blades of a pair of scissors:

We might as reasonably dispute whether it is the upper or the under blade of a pair of scissors that cuts a piece of paper, as whether value is governed by utility or cost of production. It is true that when one blade is held still, and the cutting is effected by moving the other, we may say with careless brevity that the cutting is done by the second; but the statement is not strictly accurate, and is to be excused only so long as it claims to be merely a popular and not a strictly scientific account of what happens.

~Alfred Marshall, Principles of Economics

Before Marshall, it was actually rather common to debate whether prices are determined by supply or by demand. Actually there seems to be a certain branch of Marxists today who insist upon the “labor theory of value” that seems to rest upon a similar sort of confusion, basically saying that the real value of something is entirely determined by its cost of supply. If the value of something were strictly determined by the labor put into making it, there would be literally no reason to ever make anything. If the value you get from a good is precisely equal to the labor put into it, there is no net benefit to ever making any goods. At most, embodying labor in a product might allow you to transfer labor from one person to another; but there would be no such thing as real economic growth. In order to have real economic growth, products must end up being worth more than what it cost to make them—that is, their value of demand must exceed their cost of supply.

Toward the other end of the political spectrum, we have “Say’s Law”, which says that “supply creates its own demand”; that is, that there is never any such thing as too much or too little overall demand in an economy, because supplying a good automatically makes that good available to trade for something else. I hate to even call it a “law” because isn’t even like the Pirate Code; it’s not even useful as a guideline, it’s just flat wrong. There is absolutely no reason that making something would make someone else want to buy it from you. You can make all sorts of things that nobody wants to buy; the possibilities are endless, really. Balls of lint dusted with powdered sugar, broken ballpoint pens dipped in motor oil, burnt-out lightbulbs covered in melted Swiss cheese. It’s possible that someone might want to buy such bizarre items (call them “postmodernist found art” or something), but there clearly isn’t a large market for such goods, even if you should decide to manufacture thousands of them. Even in an aggregate sense, there’s also no particular reason to think that we can’t have an economy where millions of products pile up on shelves because no one can afford to buy them; indeed, that’s basically what happens in a recession.

In fact, the converse, “demand creates its own supply”, is considerably closer to true. It’s still not strictly true—centuries of searching for the elixir of immortality have failed to produce it, though modern genetic engineering just might finally succeed where all else has failed. (After all, every new technology is impossible… until it isn’t.) But in the long run, this converse law (it doesn’t have a name so far as I know) does contain an important grain of truth: If people want something badly enough, they will spend enormous resources in order to find a way to get it. If you know that a lot of people want something that no one is supplying, it behooves you to find a way to provide it—it might just make you a billionaire. Over centuries of technological advancement, humanity has found ways to provide many goods and services that were previously thought impossible, and one of the central benefits of a capitalist economy is that it provides powerful economic incentives for entrepreneurs to innovate and find ways to provide goods that people have always wanted but never had. Yet, even so, it isn’t true that demand creates its own supply—certainly not in the short run.

Neither supply or demand on its own does much of anything. You can have insatiable demand for something nobody can supply (the aforementioned elixir of immortality), and it still won’t be sold. You can have endless supply of something nobody demands (vacuum?), and it will remain worthless. It’s only when you have both supply and demand that a market becomes possible.

One of the central insights of modern economics is that prices and quantities in a capitalist market are determined simultaneously by supply and demand. In general, both supply and demand are constantly changing in response to events in the world, and thus the prices and quantities of goods shift from one equilibrium to another. In order to predict exactly how they will shift, we would need to know how both supply and demand have changed.

As Marshall alludes to in the above quotation, in some cases we can take either supply or demand as fixed and then the other one is what matters; but these are only special cases. In general, both supply and demand are subject to the winds of changing markets, and we need to keep track of both at once. If that sounds really difficult, that’s because it is—most of what economists do in the real world ultimately amounts to finding ways to distinguish supply effects from demand effects in various situations. Even most statistical methods in econometrics were basically designed as means of separating out demand-related causes from supply-related causes.

A lot of policy questions ultimately depend upon whether supply or demand is the dominant factor: If the business cycle is primarily driven by changes in demand, it makes sense to use monetary and fiscal policy to stabilize the economy (short version: it is, and it does). If it were instead driven by supply (“supply-side economics”), it would instead be better to make structural changes that reduce costs of production. (Why is this obviously wrong? Because there weren’t sudden increases in production costs in 2008—but there was a sudden collapse of consumer buying power. Maybe the 1973 recession can be explained by a sudden increase in oil prices, but there was no such supply shock in 2008.) If the labor market is primarily driven by demand, we need to find ways to get business to hire more people; but if it’s primarily driven by supply, we need to find ways to get people to get off their butts and try to find work. (Again, I think it’s pretty obvious that the former is true, not the latter—since at least 2000 there have never been as many job openings in the US as there were unemployed people.)

In the above policy questions the liberal view is the demand-side and the conservative view is the supply-side, but that need not be the case. Regarding renewable energy, for example, the more liberal view is that lots of people would want to buy electric cars and solar panels, if they were made available, but they aren’t—we are supply-constrained. The more conservative view is that the reason they aren’t selling more is that nobody particularly wants them and trying to force them on us is a fool’s errand—we are demand-constrained. Likewise when it comes to banking, liberals generally think that the reason there isn’t more credit is that banks refuse to supply loans, while conservatives (particularly from the banks themselves) usually argue that it’s because people aren’t willing to take the risk of taking out more loans.

The point, however, is that a lot of policy debates ultimately hinge upon the question of whether demand or supply is more important in driving a particular market—and since sometimes they are both important, sometimes the policy solution requires a combination of different approaches. One of the advantages of quantitative economic analysis is that we can determine exactly how much the costs and benefits of each policy option will be, and thereby choose the one that is most cost-effective.

In this way, “supply or demand?” is a lot like “nature or nurture?”; the answer is always “both”, but there are times when one factor or the other is more important for the policy question at hand.

How (not) to talk about the defense budget

2015-09-30 PNRJ core principles, public policy budget, CIA, college, defense, education, Facebook, healthcare, Lee Camp, Medicare, meme, military, SIPRI, Social Security, spending, UNDP

JDN 2457927 EDT 20:20.

This week on Facebook I ran into a couple of memes about the defense budget that I thought were worth addressing. While the core message that the United States spends too much on the military is sound, these particular memes are so massively misleading that I think it would be irresponsible to let them go unanswered.

First of all, this graph is outdated; it appears to be from about five years ago. If you use nominal figures for just direct military spending, the budget has been cut from just under $700 billion (what this figure looks like) in 2010 to only about $600 billion today. If you include verterans’ benefits, again nominally, we haven’t been below $700 billion since 2007; today we are now above $800 billion. I think the most meaningful measure is actually military spending as percent of GDP, on which we’ve cut military spending from its peak of 4.7% of GDP in 2010 to 3.5% of GDP today.

It’s also a terrible way to draw a graph; using images instead of bars may be visually appealing, but it undermines the most important aspect of a bar graph, which is that you can easily visually compare relative magnitudes.

But the most important reason why this graph is misleading is that it uses only the so-called “discretionary budget”, which includes almost all military spending but only a small fraction of spending on healthcare and social services. This creates a wildly inflated sense of how much we spend on the military relatively to other priorities.

In particular, we’re excluding Medicare and Social Security, which are on the “mandatory budget”; each of these alone is comparable to total military spending. Here’s a very nice table of all US government spending broken down by category.

Let’s just look at federal spending for now. Including veterans’ benefits, we currently spend $814 billion per year on defense. On Social Security, we spend $959 billion. On healthcare, we spend $1,018 billion per year, of which $536 billion is Medicare.

We also spend $376 billion on social welfare programs and unemployment, along with $149 billion on education, $229 billion servicing the national debt, and $214 billion on everything else (such as police, transportation, and administration).

I’ve made you a graph that accurately reflects these relative quantities:

As you can see, the military is one of our major budget items, but the largest categories are actually pensions (i.e. Social Security) and healthcare (i.e. Medicare and Medicaid).

Given the right year and properly adjusted bars on the graph, the meme may strictly be accurate about the discretionary budget, but it gives an extremely distorted sense of our overall government spending.

The next meme is even worse:

Again the figures aren’t strictly wrong if you use the right year, but we’re only looking at the federal discretionary budget. Since basically all military spending is federal and discretionary, but most education spending is mandatory and done at the state and local level, this is an even more misleading picture.

Total annual US military spending (including veteran benefits) is about $815 billion.
Total US education spending (at all levels) is about $922 billion.

Here’s an accurate graph of total US government spending at all levels:

That is, we spend more on education than we do on the military, and dramatically more on healthcare.

However, the United States clearly does spend far too much on the military and probably too little on education; the proper comparison to make is to other countries.

Most other First World Countries spend dramatically more on education than they do on the military.

France, for example, spends about $160 billion per year on education, but only about $53 billion per year on the military—and France is actually a relatively militaristic country, with the 6th-highest total military spending in the world.

Germany spends about $172 billion per year on education, but only about about $44 billion on the military.

In absolute figures, the United States overwhelms all other countries in the world—we spend as much as at least the next 10 combined.

Using figures from the Stockholm International Peace Research Institute (SIPRI), the US spends $610 billion of the world’s total $1,776 billion, meaning that over a third of the world’s military spending is by the United States.

This is a graph of the top 15 largest military budgets in the world.

One of these things is not like the other ones…

It probably makes the most sense to compare military spending as a portion of GDP, which makes the US no longer an outlier worldwide, but still very high by First World standards:

If we do want to compare military spending to other forms of spending, I think we should do that in international perspective as well. Here is a graph of education spending versus military spending as a portion of GDP, in several First World countries (military from SIPRI and the CIA, and education from the UNDP):

Our education spending is about average (though somehow we do it so inefficiently that we don’t provide college for free, unlike Germany, France, Finland, Sweden, or Norway), but our military spending is by far the highest.

How about a meme about that?

Elasticity and the Law of Supply

2015-09-262015-09-26 PNRJ core principles, public policy capital, Denmark, elasticity, housing, investment, land tax, Law of Supply, long-run, nuclear power, oil, property tax, real estate, rent control, short-run, Singapore, solar power, supply

JDN 2457292 EDT 16:16.

Today’s post is kind of a mirror image of the previous post earlier this week; I was talking about demand before, and now I’m talking about supply. (In the next post, I’ll talk about how the two work together to determine the actual price of goods.)

Just as there is an elasticity of demand which describes how rapidly the quantity demanded changes with changes in price, likewise there is an elasticity of supply which describes how much the quantity supplied changes with changes in price.

The elasticity of supply is defined as the proportional change in quantity supplied divided by the proportional change in price; so for example if the number of cars produced increases 10% when the price of cars increases by 5%, the elasticity of supply of cars would be 10%/5% = 2.

Goods that have high elasticity of supply will rapidly flood the market if the price increases even a small amount; goods that have low elasticity of supply will sell at about the same rate as ever even if the price increases dramatically.

Generally, the more initial investment of capital a good requires, the lower its elasticity of supply is going to be.

If most of the cost of production is in the actual marginal cost of producing each new gizmo, then elasticity of supply will be high, because it’s easy to produce more or produce less as the market changes.

But if most of the cost is in building machines or inventing technologies or training employees which already has to be done in order to make any at all, while the cost of each individual gizmo is unimportant, the elasticity of supply will be low, because there’s no sense letting all that capital you invested go to waste.
We can see these differences in action by comparing different sources of electric power.

Photovoltaic solar power has a high elasticity of supply, because building new solar panels is cheap and fast. As the price of solar energy fluctuates, the amount of solar panel produced changes rapidly. Technically this is actually a “fixed capital” cost, but it’s so modular that you can install as little or as much solar power capacity as you like, which makes it behave a lot more like a variable cost than a fixed cost. As a result, a 1% increase in the price paid for solar power increases the amount supplied by a whopping 2.7%, a supply elasticity of 2.7.

Oil has a moderate elasticity of supply, because finding new oil reserves is expensive but feasible. A lot of oil in the US is produced by small wells; 18% of US oil is produced by wells that put out less than 10 barrels per day. Those small wells can be turned on and off as the price of oil changes, and new ones can be built if it becomes profitable. As a result, investment in oil production is very strongly correlated with oil prices. Still, overall production of oil changes only moderate amounts; in the US it had been steadily decreasing since 1970 until very recently when new technologies and weakened regulations resulted in a rapid increase to near-1970s levels. We sort of did hit peak oil; but it’s never quite that simple.

Nuclear fission has a very low elasticity of supply, because building a nuclear reactor is extremely expensive and requires highly advanced expertise. Buil ding a nuclear power plant costs upward of $35 billion. Once a reactor is built, the cost of generating more power is relatively trivial; three-fourths of the cost a nuclear power plant will ever pay is paid simply to build it (or to pay back the debt incurred by doing so). Even if the price of uranium plummets or the price of oil skyrockets, it would take a long time before more nuclear power plants would be built in response.

Elasticity of supply is generally a lot larger in the long run than in the short run. Over a period of a few days or months, many types of production can’t be changed significantly. If you have a corn field, you grow as much corn as you can this season; even if the price rose substantially you couldn’t actually grow any more than your field will allow. But over a period of a year to a few years, most types of production can be changed; continuing with the corn example, you could buy new land to plant corn next season.

The Law of Supply is actually a lot closer to a true law than the Law of Demand. A negative elasticity of supply is almost unheard of; at worst elasticity of supply can sometimes drop close to zero. It really is true that elasticity of supply is almost always positive.

Land has an elasticity near zero; it’s extremely expensive (albeit not impossible; Singapore does it rather frequently) to actually create new land. As a result there’s really no good reason to ever raise the price of land; higher land prices don’t incentivize new production, they just transfer wealth to landowners. That’s why a land tax is such a good idea; it would transfer some of that wealth away from landowners and let us use it for public goods like infrastructure or research, or even just give it to the poor. A few countries actually have tried this; oddly enough, they include Singapore and Denmark, two of the few places in the world where the elasticity of land supply is appreciably above zero!

Real estate in general (which is what most property taxes are imposed on) is much trickier: In the short run it seems to have a very low elasticity, because building new houses or buildings takes a lot of time and money. But in the long run it actually has a high elasticity of supply, because there is a lot of profit to be made in building new structures if you can fund projects 10 or 15 years out. The short-run elasticity is something like 0.2, meaning a 1% increase in price only yields a 0.2% increase in supply; but the long-run elasticity may be as high as 8, meaning that a 1% increase in price yields an 8% increase in supply. This is why property taxes and rent controls seem like a really good idea at the time but actually probably have the effect of making housing more expensive. The economics of real estate has a number of fundamental differences from the economics of most other goods.

Many important policy questions ultimately hinge upon the elasticity of supply: If elasticity is high, then taxing or regulating something is likely to cause large distortions of the economy, while if elasticity is low, taxes and regulations can be used to support public goods or redistribute wealth without significant distortion to the economy. On the other hand, if elasticity is high, markets generally function well on their own, while if elasticity is low, prices can get far out of whack. As a general rule of thumb, government intervention in markets is most useful and most necessary when elasticity is low.

Elasticity and the Law of Demand

2015-09-23 PNRJ core principles, critique of neoclassical economics Daraprim, demand, elasticity, finance, Giffen, Law of Demand, monopoly, Pirate Code, speculation, Veblen

JDN 2457289 EDT 21:04

This will be the second post in my new bite-size format, the first one that’s in the middle of the week.

I’ve alluded previously to the subject of demand elasticity, but I think it’s worth explaining in a little more detail. The basic concept is fairly straightforward: Demand is more elastic when the amount that people want to buy changes a large amount for a small change in price. The opposite is inelastic.

Apples are a relatively elastic good. If the price of apples goes up, people buy fewer apples. Maybe they buy other fruit instead, such as oranges or bananas; or maybe they give up on fruit and eat something else, like rice.

Salt is an extremely inelastic good. No matter what the price of salt is, at least within the range it has been for the last few centuries, people are going to continue to buy pretty much the same amount of salt. (In ancient times salt was actually expensive enough that people couldn’t afford enough of it, which was particularly harmful in desert regions. Mark Kulansky’s book Salt on this subject is surprisingly compelling, given the topic.)
Specifically, the elasticity is equal to the proportional change in quantity demanded, divided by the proportional change in price.

For example, if the price of gas rises from $2 per gallon to $3 per gallon, that’s a 50% increase. If the quantity of gas purchase then falls from 100 billion gallons to 90 billion gallons, that’s a 10% decrease. If increasing the price by 50% decreased the quantity demanded by 10%, that would be a demand elasticity of -10%/50% = -1/5 = -0.2

In practice, measuring elasticity is more complicated than that, because supply and demand are both changing at the same time; so when we see a price change and a quantity change, it isn’t always clear how much of each change is due to supply and how much is due to demand. Sophisticated econometric techniques have been developed to try to separate these two effects (in future posts I plan to explain the basics of some of these techniques), but it’s difficult and not always successful.

In general, markets function better when supply and demand are more elastic. When shifts in price trigger large shifts in quantity, this creates pressure on the price to remain at a fixed level rather than jumping up and down. This in turn means that the market will generally be predictable and stable.

It’s also much harder to make monopoly profits in a market with elastic demand; even if you do have a monopoly, if demand is highly elastic then raising the price won’t make you any money, because whatever you gain in selling each gizmo for more, you’ll lose in selling fewer gizmos. In fact, the profit margin for a monopoly is inversely proportional to the elasticity of demand.

Markets do not function well when supply and demand are highly inelastic. Monopolies can become very powerful and result in very large losses of human welfare. A particularly vivid example of this was in the news recently, when a company named Turing purchased the rights to a drug called Daraprim used primarily by AIDS patients, then hiked the price from $13.50 to $750. This made enough people mad that the CEO has since promised to bring it back down, though he hasn’t said how far.

That price change was only possible because Daraprim has highly inelastic demand—if you’ve got AIDS, you’re going to take AIDS medicine, as much as prescribed, provided only that it doesn’t drive you completely bankrupt. (Not an unreasonable fear, as medical costs are the leading cause of bankruptcy in the United States.) This raised price probably would bankrupt a few people, but for the most part it wouldn’t affect the amount of drug sold; it would just funnel a huge amount of money from AIDS patients to the company. This is probably part of why it made people so mad; that and there would probably be a few people who died because they couldn’t afford this new expensive medication.

Imagine if a company had tried to pull the same stunt for a more elastic good, like apples. “CEO buys up all apple farms, raises price of apples from $2 per pound to $100 per pound.” What’s going to happen then? People are not going to buy any apples. Perhaps a handful of the most die-hard apple lovers still would, but the rest of us are going to meet our fruit needs elsewhere.

For most goods most of the time, elasticity of demand is negative, meaning that as price increases, quantity demanded decreases. This is in fact called the Law of Demand; but as I’ve said, “laws” in economics are like the Pirate Code: They’re really more what you’d call “guidelines”.
There are three major exceptions to the Law of Demand. The first one is the one most economists talk about, and it almost never happens. The second one is talked about occasionally, and it’s quite common. The third one is almost never talked about, and yet it is by far the most common and one of the central driving forces in modern capitalism.
The exception that we usually talk about in economics is called the Giffen Effect. A Giffen good is a good that’s so cheap and such a bare necessity that when it becomes more expensive, you won’t be able to buy less of it; instead you’ll buy more of it, and buy less of other things with your reduced income.

It’s very hard to come up with empirical examples of Giffen goods, but it’s an easy theoretical argument to make. Suppose you’re buying grapes for a party, and you know you need 4 bags of grapes. You have $10 to spend. Suppose there are green grapes selling for $1 per bag and red grapes selling for $4 per bag, and suppose you like red grapes better. With your $10, you can buy 2 bags of green grapes and 2 bags of red grapes, and that’s the 4 bags you need. But now suppose that the price of green grapes rises to $2 per bag. In order to afford 4 bags of grapes, you now need to buy 3 bags of green grapes and only 1 bag of red grapes. Even though it was the price of green grapes that rose, you ended up buying more green grapes. In this scenario, green grapes are a Giffen good.

The exception that is talked about occasionally and occurs a lot in real life is the Veblen Effect. Whereas a Giffen good is a very cheap bare necessity, a Veblen good is a very expensive pure luxury.

The whole point of buying a Veblen good is to prove that you can. You don’t buy a Ferrari because a Ferrari is a particularly nice automobile (a Prius is probably better, and a Tesla certainly is); you buy a Ferrari to show off that you’re so rich you can buy a Ferrari.

On my previous post, jenszorn asked: “Much of consumer behavior is irrational by your standards. But people often like to spend money just for the sake of spending and for showing off. Why else does a Rolex carry a price tag for $10,000 for a Rolex watch when a $100 Seiko keeps better time and requires far less maintenance?” Veblen goods! It’s not strictly true that Veblen goods are irrational; it can be in any particular individual’s best interest is served by buying Veblen goods in order to signal their status and reap the benefits of that higher status. However, it’s definitely true that Veblen goods are inefficient; because ostentatious displays of wealth are a zero-sum game (it’s not about what you have, it’s about what you have that others don’t), any resources spent on rich people proving how rich they are are resources that society could otherwise have used, say, feeding the poor, curing diseases, building infrastructure, or colonizing other planets.

Veblen goods can also result in a violation of the Law of Demand, because raising the price of a Veblen good like Ferraris or Rolexes can make them even better at showing off how rich you are, and therefore more appealing to the kind of person who buys them. Conversely, lowering the price might not result in any more being purchased, because they wouldn’t seem as impressive anymore. Currently a Ferrari costs about $250,000; if they reduced that figure to $100,000, there aren’t a lot of people who would suddenly find it affordable, but many people who currently buy Ferraris might switch to Bugattis or Lamborghinis instead. There are limits to this, of course: If the price of a Ferrari dropped to $2,000, people wouldn’t buy them to show off anymore; but the far larger effect would be the millions of people buying them because you can now get a perfectly good car for $2,000. Yes, I would sell my dear little Smart if it meant I could buy a Ferrari instead and save $8,000 at the same time.

But the third major exception to the Law of Demand is actually the most important one, yet it’s the one that economists hardly ever talk about: Speculation.

The most common reason why people would buy more of something that has gotten more expensive is that they expect it to continue getting more expensive, and then they will be able to sell what they bought at an even higher price and make a profit.

When the price of Apple stock goes up, do people stop buying Apple stock? On the contrary, they almost certainly start buying more—and then the price goes up even further still. If rising prices get self-fulfilling enough, you get an asset bubble; it grows and grows until one day it can’t, and then the bubble bursts and prices collapse again. This has happened hundreds of times in history, from the Tulip Mania to the Beanie Baby Bubble to the Dotcom Boom to the US Housing Crisis.

It isn’t necessarily irrational to participate in a bubble; some people must be irrational, but most people can buy above what they would be willing to pay by accurately predicting that they’ll find someone else who is willing to pay an even higher price later. It’s called Greater Fool Theory: The price I paid may be foolish, but I’ll find someone who is even more foolish to take it off my hands. But like Veblen goods, speculation goods are most definitely inefficient; nothing good comes from prices that rise and fall wildly out of sync with the real value of goods.

Speculation goods are all around us, from stocks to gold to real estate. Most speculation goods also serve some other function (though some, like gold, are really mostly just Veblen goods otherwise; actual useful applications of gold are extremely rare), but their speculative function often controls their price in a way that dominates all other considerations. There’s no real limit to how high or low the price can go for a speculation good; no longer tied to the real value of the good, it simply becomes a question of how much people decide to pay.

Indeed, speculation bubbles are one of the fundamental problems with capitalism as we know it; they are one of the chief causes of the boom-and-bust business cycle that has cost the world trillions of dollars and thousands of lives. Most of our financial industry is now dedicated to the trading of speculation goods, and finance is taking over a larger and larger section of our economy all the time. Many of the world’s best and brightest are being funneled into finance instead of genuinely productive industries; 15% of Harvard grads take a job in finance, and almost half did just before the crash. The vast majority of what goes on in our financial system is simply elaborations on speculation; very little real productivity ever enters into the equation.

In fact, as a general rule I think when we see a violation of the Law of Demand, we know that something is wrong in the economy. If there are Giffen goods, some people are too poor to buy what they really need. If there are Veblen goods, inequality is too large and people are wasting resources competing for status. And since there are always speculation goods, the history of capitalism has been a history of market instability.

Fortunately, elasticity of demand is usually negative: As the price goes up, people want to buy less. How much less is the elasticity.

Free trade, fair trade, or what?

2015-09-052015-09-05 PNRJ core principles, critique of neoclassical economics, development economics, public policy Adam Smith, Ayn Rand, comparative advantage, creative destruction, Democrat, fair trade, forced labor, free trade, gains from trade, globalization, HSBC, human rights, IKEA, iPad, Kohlberg, Korea, Krugman, loss aversion, politics, poverty, protectionism, Republican, Schumpeter, sweatshops, trade, trade policy

JDN 2457271 EDT 11:34.

As I mentioned in an earlier post, almost all economists are opposed to protectionism. In a survey of 264 AEA economists, 87% opposed tariffs to protect US workers against foreign competition.

(By the way, 58% said they usually vote Democrat and only 23% said they usually vote Republican. Given that economists are overwhelmingly middle-age rich White males—only 12% of tenured faculty economists are women and the median income of economists is over $90,000—that’s saying something. Dare I suggest it’s saying that Democrat economic policy is usually better?)

There are a large number of published research papers showing large positive effects of free trade agreements, such as this paper, and this paper, and this paper, and this paper. It’s hard to find any good papers showing any significant negative effects. This is probably why the consensus is so strong; the empirical evidence is overwhelming.

Yet protectionism is very popular among the general public. The majority of both Democrat and Republican voters believe that free trade agreements have harmed the United States. For decades, protectionism has always been the politically popular answer.

To be fair, it’s actually possible to think that free trade harms the US but still support free trade; actually there are some economists who argue that free trade has harmed the US, but has benefited other countries like China and India so much more that it is worth it, making free trade an act of global altruism and good will (for the opposite view, here’s a pretty good article about how “free trade” in principle is often mercantilism in practice, and by no means altruistic). As Krugman talks about, there is some evidence that income inequality in the First World has been exacerbated by globalization—but it’s clearly not the primary reason for rising inequality.

What’s going on here? Are economists ignoring the negative impacts of free trade because it doesn’t fit their elegant mathematical models? Is the general public ignorant of how trade actually works? Does the way free trade works, or its interaction with human psychology, inherently obscure its benefits while emphasizing its harms?

Yes. All of the above.

One of the central mistakes of neoclassical economics is the tendency to over-aggregate. Instead of looking at the impact on individuals, it’s much easier to look at the impact on aggregated abstractions like trade flows and GDP. To some extent this is inevitable—there are simply too many people in the world to keep track of them all. But we need to be aware of what welose when we aggregate, and we need to test the robustness of our theories by applying different models of aggregation (such as comparing “how does this affect Americans” with “how does this affect the First World middle class”).

It is absolutely unambiguous that free trade increases trade flows and GDP, and for small countries these benefits can be mind-bogglingly huge. A key part of the amazing success story of economic development that is Korea is that they dramatically increased their openness to global trade.

The reason for this is absolutely fundamental to economics, and in grasping it in 1776 Adam Smith basically founded the field: Voluntary trade benefits both parties.

As most economists would put it today, comparative advantage leads to Pareto-improving gains from trade. Or as I’d tend to put it, more succinctly yet just as thoroughly based in modern game theory: Trade is nonzero-sum.

When you sell a product to someone, it is because the money they’re offering you is worth more to you than the product—and because the product is worth more to them than the money. You each lose something you value less and gain something you value more—so you are both better off.

This mutual benefit occurs whether you are individuals, corporations, or nations. It’s a fundamental principle of economics that underlies the operation of markets at every scale.

This is what I think most people don’t understand when they say they want to “stop sending jobs overseas”. If by that all you mean is ensuring that there aren’t incentives to offshore and outsource, that’s quite reasonable. Even some degree of incentive to keep businesses in the US might make sense, to avoid a race-to-the-bottom in global wages. But I get the sense that it is more than this, that people have a general notion that jobs are zero-sum and if we hire a million people in China that means a million people must lose their jobs in the US. This is not simply wrong, it is fundamentally wrong; it misses the entire point of economics. If there is one core principle that defines economics, I think it would be that the universe is nonzero-sum; gains for some can also be gains for others. There is not a fixed amount of stuff in the world that we distribute; we can make more stuff. Handled properly, a trade that results in a million people hired in China can mean an extra million people hired in the US.

Once you introduce a competitive market, things get more complicated, because there aren’t just winners—there are also losers. When you have competitors, someone can buy from them instead of you, and the two of them benefit, but you are harmed. By the standard methods of calculating benefits and harms (which admittedly leave much to be desired), we can show quite clearly that in general, on average, the benefits outweigh the harms.

But of course we don’t live “in general, on average”. Despite the overwhelming, unambiguous benefit to the economy as a whole, there is some evidence that free trade can produce a good deal of harm to specific individuals.

Suppose you live in the US and your job is to assemble iPads. You’re good at it, you like it, it pays pretty well. But now Apple says that they want to “reduce labor costs” (they are in fact doing nothing of the sort; to really reduce labor costs in a deep economic sense you’d have to make work easier, more productive, or more fun—the wage and the cost are fundamentally different things), so they outsource production to Foxconn in China, who pay wages 1/30 of what you were being paid.

The net result of this change to the economy as a whole is almost certainly positive—the price of iPads goes down, we all get to have iPads. (There’s a meme going around claiming that the price of an iPad would be almost $15,000 if it were made in the US; no, it would cost about $1000 even if our productivity were no higher and Apple could keep their current profit margin intact, both of which are clearly overestimates. But since it’s currently selling for about $500, that’s still a big difference.) Apple makes more profits, which is why they did it—and we do have to count that in our GDP. Most importantly, workers in China get employed in safe, high-skill jobs instead of working in coal mines, subsistence farming, or turning to drugs and prostitution. More stuff, more profits, better jobs for some of the world’s poorest workers. These are all good things, and overall they outweigh the harm of you losing your job.

Well, from a global perspective, anyway. I doubt they outweigh the harm from your perspective. You still lost a good job; you’re now unemployed, and may have skills so specific that they can’t be transferred to anything else. You’ll need to retrain, which means going back to school or else finding one of those rare far-sighted companies that actually trains their workers. Since the social welfare system in the US is such a quagmire of nonsensical programs, you may be ineligible for support, or eligible in theory and unable to actually get it in practice. (Recently I got a notice from Medicaid that I need to prove again that my income is sufficiently low. Apparently it’s because I got hired at a temporary web development gig, which paid me a whopping $700 over a few weeks—why, that’s almost the per-capita GDP of Ghana, so clearly I am a high-roller who doesn’t need help affording health insurance. I wonder how much they spend sending out these notices.)

If we had a basic income—I know I harp on this a lot, but seriously, it solves almost every economic problem you can think of—losing your job wouldn’t make you feel so desperate, and owning a share in GDP would mean that the rising tide actually would lift all boats. This might make free trade more popular.

But even with ideal policies (which we certainly do not have), the fact remains that human beings are loss-averse. We care more about losses than we do about gains. The pain you feel from losing $100 is about the same as the joy you feel from gaining $200. The pain you feel from losing your job is about twice as intense as the joy you feel from finding a new one.

Because of loss aversion, the constant churn of innovation and change, the “creative destruction” that Schumpeter considered the defining advantage of capitalism—well, it hurts. The constant change and uncertainty is painful, and we want to run away from it.

But the truth is, we can’t. There’s no way to stop the change in the global economy, and most of our attempts to insulate ourselves from it only end up hurting us more. This, I think, is the fundamental reason why protectionism is popular among the general public but not economists: The general public sees protectionism as a way of holding onto the past, while economists recognize that it is simply a way of damaging the future. That constant churning of people gaining and losing jobs isn’t a bug, it’s a feature—it’s the reason that capitalism is so efficient in the first place.

There are a few ways we can reduce the pain of this churning, but we need to focus on that—reducing the pain—rather than trying to stop the churning itself. We should provide social welfare programs that allow people to survive while they are unemployed. We should use active labor market policies to train new workers and match them with good jobs. We may even want to provide some sort of subsidy or incentive to companies that don’t outsource—a small one, to make sure they don’t do so needlessly, but not a large one, so they’ll still do it when it’s actually necessary.

But the one thing we must not do is stop creating jobs overseas. And yes, that is what we are doing, creating jobs. We are not sending jobs that already exist, we are creating new ones. In the short run we also destroy some jobs here, but if we do it right we can replace them—and usually we do okay.

If we stop creating jobs in India and China and around the world, millions of people will starve.

Yes, it is as stark as that. Millions of lives depend upon continued open trade. We in the United States are a manufacturing, technological and agricultural superpower—we could wall ourselves off from the world and only see a few percentage points shaved off of GDP. But a country like Nicaragua or Ghana or Vietnam doesn’t have that option; if they cut off trade, people start dying.

This is actually the main reason why our trade agreements are often so unfair; we are in by far the stronger bargaining position, so we can make them cut their tariffs on textiles even as we maintain our subsidies on agriculture. We are Mr. Bumble dishing out gruel and they are Oliver Twist begging for another bite.

We can’t afford to stop free trade. We can’t even afford to significantly slow it down. A global economy is the best hope we have for global peace and global prosperity.

That is not to say that we should leave trade completely unregulated; trade policy can and should be used to enforce human rights standards. That enormous asymmetry in bargaining power doesn’t have to be used to maximize profits; it can be used to advance human rights.

This is not as simple as saying we should never trade with nations that have bad human rights records, by the way. First of all that would require we cut off Saudi Arabia and China, which is totally unrealistic and would impoverish millions of people; second it doesn’t actually solve the problem. Instead we should use sanctions, tariffs, and trade agreements to provide incentives to improve human rights, rewarding governments that do and punishing governments that don’t. We could have a sliding tariff that decreases every time you show improvement in human rights standards. Think of it like behavioral reinforcement; reward good behavior and you’ll get more of it.

We do need to have sweatshops—but as Krugman has come around to realizing, we can make sweatshops safer. We can put pressure on other countries to treat their workers better, pay them more—and actually make the global economy more efficient, because right now their wages are held down below the efficient level by the power that corporations wield over them. We should not demand that they pay the same they would here in the First World—that’s totally unrealistic, given the difference in productivity—but we should demand that they pay what their workers actually deserve.

Similar incentives should apply to individual corporations, which these days are as powerful as some governments. For example, as part of a zero-tolerance program against forced labor, any company caught using or outsourcing to forced labor should have its profits garnished for damages and the executives who made the decision imprisoned. Sometimes #Scandinaviaisnotbetter; IKEA was involved in such outsourcing during the Cold War, and it is currently being litigated just how much they knew and what they could have done about it. If they knew and did nothing, some IKEA executive should be going to prison. If that seems extreme, let me remind you what they did: They used slaves.

My standard for penalizing human rights violations, whether by corporations or governments, is basically like this: Follow the decision-making up the chain of command, stopping only when the next-higher executive can clearly show to the preponderance of evidence that they were kept out of the loop. If no executive can provide sufficient evidence, the highest-ranking executive at the time the crime was committed will be held responsible. If you don’t want to be held responsible for crimes committed by people who work for you, it’s your responsibility to bring them to justice. Negligence in oversight will not be exonerating because you didn’t know; it will be incriminating because you should have. When your bank is caught laundering money for terrorists and drug lords, it isn’t enough to have your chief of compliance resign; he should be imprisoned—and if his superiors knew about it, so should they.

In fact maybe the focus should be on corporations, because we have the legal authority to do that. When dealing with other countries, there are United Nations rules and simply the de facto power of large trade flows and national standing armies. With Saudi Arabia or China, there’s a very real chance that they’ll simply tell us where we can shove it; but if we get that same kind of response from HSBC or Goldman Sachs (which, actually, we did), we can start taking out handcuffs (that, we did not do—but I think we should have).

We can also use consumer pressure to change the behavior of corporations, such as Fair Trade. There’s some debate about just how effective these things are, but the comparison that is often made between Fair Trade and tariffs is ridiculous; this is a change in consumer behavior, not a change in government policy. There is absolutely no loss of freedom. Choosing not to buy something does not constitute coercion against someone else. Maybe there are more efficient ways to spend money (like donating it directly to the best global development charities), but if you start going down that road you quickly turn into Peter Singer and start saying that wearing nicer shoes means you’re committing murder. By all means, let’s empirically study different methods of fighting poverty and focus on the ones that work best; but there’s a perverse smugness to criticisms of Fair Trade that says to me this isn’t actually about that at all. Instead, I think most people who criticize Fair Trade don’t support the idea of altruism at all—they’re far-right Randian libertarians who honestly believe that selfishness is the highest form of human morality. (It is in fact the second-lowest, according to Kohlberg.) Maybe it will turn out that Fair Trade is actually ineffective at fighting poverty, but it’s clear that an unregulated free market isn’t good at that either. Those aren’t the only options, and the best way to find out which methods work is to give them a try. Consumer pressure clearly can work in some cases, and it’s a low-cost zero-regulation solution. They say the road to Hell is paved with good intentions—but would you rather we have bad intentions instead?

By these two methods we could send a clear message to multinational corporations that if they want to do business in the US—and trust me, they do—they have to meet certain standards of human rights. This in turn will make those corporations put pressure on their suppliers, all the way down the supply chain, to uphold the standards lest they lose their contracts. With some companies upholding labor standards in Third World countries, others will be forced to, as workers refuse to work for companies that don’t. This could make life better for many millions of people.

But this whole plan only works on one condition: We need to have trade.

What is socialism?

2015-08-30 PNRJ core principles, public policy Adam Smith, Bernie Sanders, capitalism, climate change, consensus, Donald Trump, economic consensus, Economic Freedom Index, Heritage Foundation, minimum wage, politics, protectionism, Scandinaviaisbetter, social democracy, socialism

JDN 2457265 EDT 10:47

Last night I was having a political discussion with some friends (as I am wont to do), and it became a little heated, though never uncongenial. A key point of contention was the fact that Bernie Sanders is a socialist, and what exactly that entails.

One of my friends was arguing that this makes him far-left, and thus it is fair when the news media often likes to make a comparison between Sanders on the left and Trump on the right. Donald Trump is actually oddly liberal on some issues, but his attitudes on racial purity, nativism, military unilateralism, and virtually unlimited executive power are literally fascist. Even his “liberal” views are more like the kind of populism that fascists have often used to win support in the past: Don’t you hate being disenfranchised? Give me absolute power and I’ll fix everything for you! Don’t like how our democracy has become corrupt? Don’t worry, I’ll get rid of it! (The democracy, that is.) While he certainly doesn’t align well with the Republican Party platform, I think it’s quite fair to say that Donald Trump is a far-right candidate.

Bernie Sanders, however, is not a far-left candidate. He is a center-left candidate. His views are basically consonant with the Labour Party of the UK and the Social Democratic Party of Germany. He has spoken often about the Scandinavian model (because, well, #Scandinaviaisbetter—Denmark, Sweden, and Norway are some of the happiest places on Earth). When we talk about Bernie Sanders we aren’t talking about following Cuba and the Soviet Union; we’re talking about following Norway and Sweden. As Jon Stewart put it, he isn’t a “crazy-pants cuckoo bird” as some would have you think.

But he’s a socialist, right? Well… sort of—we have to be very clear what that means.

The word “socialism” has been used to mean many things; it has been a cover for genocidal fascism (“National Socialism”) and tyrannical Communism (“Union of Soviet Socialist Republics”). It has become a pejorative thrown at Social Security, Medicare, banking regulations—basically any policy left of Milton Friedman. So apparently it means something between Medicare and the Holocaust.

Social democracy is often classified as a form of socialism—but one can actually make a pretty compelling case that social democracy is not socialism, but in fact a form of capitalism.

If we want a simple, consistent definition of “socialism”, I think I would put it thus: Socialism is a system in which the majority of economic activity is directly controlled by the government. Most, if not all, industries are nationalized; production and distribution are handled by centrally-planned quotas instead of market supply and demand. Under this definition, the USSR, Venezuela, Cuba, and (at least until recently) China are socialist—and under this definition, socialism is a very bad idea. The best-case scenario is inefficiency; the worst-case scenario is mass murder.

Social democracy, the position that Bernie Sanders espouses (and I basically agree wit), is as follows: Social democracy is a system in which markets are taxed and regulated by a democratically-elected government to ensure that they promote general welfare, public goods are provided by the government, and transfer programs are used to reduce poverty and inequality.

Let’s also try to define “capitalism”: Capitalism is a system in which the majority of economic activity is handled by private sector markets.

Under the Scandinavian model, the majority of economic activity is handled by private sector markets, which are in turn regulated and taxed to promote the general welfare—that is, at least on these definitions, Scandinavia is both capitalist and social democratic.

In fact, so is the United States; while our taxes are lower and our regulations weaker, we still have substantial taxes and regulations. We do have transfer programs like WIC, SNAP, and Social Security that attempt to redistribute wealth and reduce poverty.

We could define “socialism” more broadly to mean any government intervention in the economy, in which case Bernie Sander is a socialist and so is… almost everyone else, including most economists.

The majority of the most eminent American economists are in favor of social democracy. I don’t intend this as an argument from authority, but rather to give a sense of the scientific consensus. The consensus in economics is by no means as strong as that in biology or physics (or climatology, ahem), but there is still broad agreement on many issues.

In a survey of 264 members of the American Economics Association [pdf link], 77% opposed government ownership of enterprise (14% mixed feelings, 8% favor) but 71% favored redistribution of wealth in some form (7% mixed feelings, 20% opposed). That’s social democracy is a nutshell. 67% favored public schools (14% mixed feelings, 17% opposed); 75% favored Keynesian monetary policy (12% mixed feelings, 12% opposed); 51% favored Keynesian fiscal policy (19% mixed feelings, 30% opposed). 58% opposed tighter immigration restrictions (16% mixed feelings, 25% opposed). 79% support anti-discrimination laws. 68% favor gun control.

The major departure from left-wing views that the majority of economists make is a near-universal opposition to protectionism, with 86.8% opposed, 7.6% with mixed feelings, and only 5.3% in favor. It seems I am not the only economist to cringe when politicians say they want to “stop sending jobs overseas”, which they do left and right. This view is quite popular; but the evidence says that it is wrong. Protectionism is not the answer; you make your trading partners poorer, they retaliate with their own protections, and you both end up worse off. We need open trade. I’ll save the details on why open trade is so important for a later post.

One issue that economists are very divided on right now is minimum wage; 47.3% favor minimum wage, 38.3% oppose it, and 14.4% have mixed feelings. This division likely reflects the ambiguity of empirical results on the employment effect of minimum wage, which have a wide margin of error but effect sizes that cluster around zero. Economists are also somewhat divided on military aid, with 36.8% in favor, 33% opposed, and 29.9% with mixed feelings. This I attribute more to the fact that military aid, like most military action, can be justified in principle but is typically unjustified in practice. And indeed perhaps “mixed feelings” is the most reasonable view to have on war and its instruments.

Since Bernie Sanders strongly supports raising minimum wage and some of his statements verge on protectionism, I do have to place him to the left of the economic consensus. A lot of economists would probably disagree on the particulars of his tax plans and such. But his core policies are entirely in line with that consensus, and being a social democrat is absolutely part of that. Compare this to the Republicans, who keep trying to out-crazy each other (apparently Scott Walker thinks we should not only build a wall against Mexico, but also against Canada?) and want policies that were abandoned decades ago by mainstream economists (like the gold standard, or a balanced-budget amendment), or simply would never be taken seriously by mainstream economists at all (the aforementioned border wall, eliminating all environmental regulation, or ending all transfer payments and social welfare programs). Even the things they supposedly agree on I’m not sure they do; when economists say they want “deregulation” Republicans seem to think that means “no rules at all” when in fact it’s supposed to mean “simple, transparent rules that can be tightly and fairly enforced”. (I think we need a new term for it, though there is a slogan I like: “Deregulate with a scalpel, not a chainsaw.”) Obama has done a very good job of deregulating in the sense that economists intend, and I think in general most economists view him positively as a leader who made the best of a bad situation.

In any case, the broad consensus of American economists (and I think most economists around the world) is that some form of capitalist social democracy is the best system we have so far. There is dispute about particular policies—how much should the tax rates be, should we tax income, consumption, real estate, capital, etc.; how large should the transfers be; what regulations should be added or removed—but the basic concept of a market economy with a government that taxes, transfers, and regulates is not in serious dispute.

Indeed, social democracy is the economic system of the free world.

Even using the conservative Heritage Foundation’s data, the correlation between tax burden and economic freedom—that’s economic freedom—is small but positive. (I’m excluding missing data, as well as Timor-Leste because it has a “tax burden” larger than its GDP due to weird accounting of its tourism-based economy, and North Korea because they lie to us and they theoretically have “zero taxes” but that’s clearly not true; the Heritage Foundation reports them as 100% taxes, but that’s also clearly not true either.) See for yourself:

Why is this? Do taxes automatically make you more free? No, they make you less free, because you have to pay for things you didn’t choose to buy (which I admit and the Heritage Foundation includes in their index). But taxes are how you manage a free economy. You need to control monetary policy somehow, which means adding and removing money. The way that social democracies do this is by spending on public goods and transfers to add money, and taxing income, consumption, or assets to remove money. Even if you tie your money to the gold standard, you still need to pay for public goods like military and police; and with a fixed money supply that means spending must be matched by taxes.

There are other ways to do this. You could be like Zimbabwe and print as much money as you feel like. You could be like Venezuela, and have government-owned industries form the majority of your economy. Or, actually, you could not do it; you could fail to manage your country’s economy and leave it wallowing in poverty, like Ghana. All of the countries I just listed have lower tax burdens than the United States.

Within the framework of social democracy, there are higher taxes so that spending and transfers can be higher, which means that more public goods are provided and poverty is lower, which means that real equality of opportunity and thus, real economic freedom, are higher. It’s not that raising taxes automatically makes people more free; rather, the kind of policies that make people more free tend to be the kind of social-democratic policies that involve relatively high taxes.

Worldwide, US is 12^th in terms of economic freedom and 62^nd in terms of tax burden. We currently stand at 24%. That’s quite low for a First World country, but still relatively high by world standards. The highest tax burden is in Eritrea at 50%; the lowest is in Kuwait at an astonishing 0.7% (I don’t even know how that’s possible). Neither is a really wonderful place to live (though Kuwait is better).

Indeed, if you restrict the sample to North America and Europe, the correlation basically disappears; all the countries are fairly free, all the taxes are fairly high, and within that the two aren’t very much related. (It’s been a long time since I’ve seen a trendline that flat, actually!)

Switzerland, Canada, and Denmark all have higher economic freedom scores than the United States, as well as higher tax burdens; but on the other hand, Greece, Spain, and Austria have higher tax burdens but lower freedom scores. All of them are variations on social democracy.

Is that socialism? I’m really not sure. Why does it matter, really?

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