More Capital Per Worker Makes Workers More Productive

 

In a recent blog post, I wrote:

Aside for non-economists: Why would reductions in income tax rates on corporations and on high-income individuals even be expected, at a theoretical level, to increase real wages? By increasing the incentive to invest in capital. The greater the capital to labor ratio, the higher are real wages.

Commenter Robert asked:

Could someone expand on this a bit for me? Does investing in capital, mean investing in capital goods (i.e., land, machinery, tools, etc)? I don’t understand why that would necessarily lead to higher real wages.

Commenter Laron gave a nice succinct answer:

The capital goods like machinery increase labor’s productivity, which increases wages. Others can chime in with more detail or to correct me tho.

Here’s what the article on “Capital Gains Taxes” in The Concise Encyclopedia of Economics says about the issue:

Between 1900 and 2000, real wages in the United States quintupled from around fifteen cents an hour (worth three dollars in 2000 dollars) to more than fifteen dollars an hour. In other words, a worker in 2000 earned as much, adjusted for inflation, in twelve minutes as a worker in 1900 earned in an hour. That surge in the living standard of the American worker is explained, in part, by the increase in capital over that period. The main reason U.S. farmers and manufacturing workers are more productive, and their real wages higher, than those of most other industrial nations is that America has one of the highest ratios of capital to worker in the world. Even Americans working in the service sector are highly paid relative to workers in other nations as a result of the capital they work with. In their textbook, Nobel laureate Paul Samuelson and William D. Nordhaus noted: “Because each worker has more capital to work with, his or her marginal product rises. Therefore, the competitive real wage rises as workers become worth more to capitalists and meet with spirited bidding up of their market wage rates.” The capital-to-labor ratio explains roughly 95 percent of the fluctuation in wages over the past forty years. When the ratio rises, wages rise; when the ratio stays constant, wages stagnate.

The quintupling in the above is certainly an underestimate because the Consumer Price Index, used to adjust for inflation, overstates inflation.

A way to think about it is with a person on a desert island catching fish. If he does it with his bare hands, he can catch, say 2 fish a day, enough to keep from starving. But if he fashions a stick that can spear the fish, he can catch, say 4 fish a day. So that one piece of capital, the spear, has doubled his productivity. His real wage has doubled.

Then Robert followed up:

Thanks Laron. That was kind of what I was assuming was meant in the quote. I don’t know if I fully trust a business to return higher productivity back to workers in the form of higher salaries, but I can see how and why that could happen.

Here’s why it would happen. A worker becomes more productive, not just with his current employer but also with other potential employers. So if an employer does not pay the employee an increased wage for increased productivity, another employer will offer more than the current employer. That will happen until the marginal revenue product (the marginal revenue produced by the employee’s marginal product) equals the wage.

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Three Economists Walk Into a Discussion, Part 1

On September 15, the Stanford Institute for Economic Policy had a virtual discussion about both Covid-19 and the views of the two major presidential candidates. The moderator was Gopi Shah Goda of SIEPR and the two interviewees were Kevin Hassett, who had been chairman of the Council of Economic Advisers under President Trump and Austan Goolsbee, who had had the same job under President Obama.

I watched it live.

I’ll hit some highlights and make some comments. This is Part 1.

At 4;24, Goda asks: “What are the right economic policies to provide relief to those whose livelihoods have been adversely affected by the pandemic and stimulate the economy? How much spending should we do in the short run on Covid relief issues like extended and extra unemployment and stimulus payments?”

She started with Kevin, and I got my first big disappointment. Notice that she asked two questions. Kevin, though, answered only the second. He gave a big number for spending and didn’t mention any other means of relief: deregulating, letting people work in occupations without having to get a license, allowing restaurants to sell food, allowing restaurants to open, getting the FDA to allow people to use home tests for the coronavirus.

And his number for additional federal spending was big: $1.5 to 2.5 trillion.

Goolsbee’s answer was what I would have predicted: lots more federal spending and a big bailout of state and local government.

14:50: Kevin defines classical liberals like me out of the discussion with “I don’t think there’s anyone who thinks there shouldn’t be state and local aid.”

15:10: Austan gets it right: There are a great number of people who are opposing state and local aid.

17:10: Austan has a funny line that riffs on the old can opener joke: “This is not just ‘assume we have a can opener; let’s assume we have the greatest of all can openers.’” Then he says that you wouldn’t want to use the price system to allocate the vaccine.

23:43: Goda asks about the differences between the two candidates’ tax policies.

24:20: Austan says that Biden wants to raise taxes on high-income people and on corporations. What’s important, he says, is what the money is used for. If the added revenue were used to provide universal child care, that would be very pro-growth, says Austan.

But wait. This is not a discussion between politicians. This is a discussion between economists. What’s the market failure that would justify government provision of child care? Austan doesn’t  even mention one. If my wife and I, when we were younger, had wanted to hire child care so she could work, we would have compared her after-tax income to our net-of-child-care-tax-credit cost of hiring child care. I showed in a piece in the Journal of Policy Analysis and Management in the late 1980s that the structure of the tax credit at the time could be seen as a way of offsetting the distorting high marginal tax rate of the second earner, typically the women. But Austan isn’t making that argument; in fact, for high earners, he wants an even higher marginal tax rate. Moreover, various changes in the tax law have been the tax credit much less pro-growth.

At about the 25:00 point, they get into a real substantive discussion about what happened to real wages and real family incomes after the tax cut. They literally disagreed about what the numbers were. Austan said that the effects of the tax cut on real median family incomes were disappointing. Kevin said that in a debate with Austan in Philadelphia a few years earlier, he had predicted that real median family income would rise by $4,000 and that the data that just came in (which were pre-pandemic), the number was actually a $4,900 gain. Kevin also pointed out that over 6 million people had moved out of poverty, the biggest drop since the War on Poverty had begun under LBJ. Kevin also pointed out that he had predicted that income inequality would fall as a result of the 2017 tax cut and that it had fallen.

Aside for non-economists: Why would reductions in income tax rates on corporations and on high-income individuals even be expected, at a theoretical level, to increase real wages? By increasing the incentive to invest in capital. The greater the capital to labor ratio, the higher are real wages.

29:10: Kevin catches Austan’s characterization of the proposed Biden tax hike as an increase in taxes on billionaires. Kevin points out that it would apply to people making over $400K annually. He then expresses optimism that Biden will hold off on raising marginal tax rates, due to the state of the economy.

31:00: Here is where Austan gives numbers on increases in real median family income that differ dramatically from Kevin’s data.

Aside:  As a viewer, I was able to type a question on line and I did. We learned near the end from Goda that a number of viewers had asked a similar question and it was this: “You two are disagreeing on actual facts; show us your sources.” I asked Mark Duggan, the SIEPR director, for the source and he sent me the link to the Census data that Kevin had cited. Kevin turned out to be right about the large growth in median family income of families, including black and Hispanic families. I’m still scratching my head about what data Austan had in mind.

32:00: Kevin says that growth in median real family income in the first 3 years of Trump vastly exceeded any 3-year period under Obama.

32:10: Goda lays out the deficit issue nicely and asks about the two candidates’ plans.

In Part 2, I’ll cover the rest of the discussion.

 

 

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Mazzucato and “Climate Lockdowns”

“In the near future, the world may need to resort to lockdowns again — this time to tackle a climate emergency.” Certainly, Mariana Mazzucato has a taste for striking words. In her latest column for Project Syndicate, Mazzucato argues that

Shifting Arctic ice, raging wildfires in western US states and elsewhere, and methane leaks in the North Sea are all warning signs that we are approaching a tipping point on climate change when protecting the future of civilization will require dramatic interventions.

 

This is the scenario Mazzucato works with. What are the odds it will come by? When could that happen? What are the events that may trigger it? Mazzucato seems to assume that this is almost inevitable if things “go on” as they did in the past, namely if we continue to have economic growth dependent on fossil fuel. Still, more than a scenario this looks like the background story of the movie “Interstellar”: in that movie, a team of scientists was (treacherously) contriving to send some humans up in space in order to perpetuate humanity. Here we have Mazzucato suggesting governments should work to “limit private-vehicle use, ban consumption of red meat, and impose extreme energy-saving measures, while fossil-fuel companies would have to stop drilling.”

That the private sector can cope with such a challenge is a hypothesis Mazzucato does not even consider. Such a sad scenario cannot possibly be affected by human ingenuity, at least if supported by private shareholders.

Mazzucato’s piece is simply an exercise in “never letting a good crisis go waste”. She maintains that Covid-19 is “itself a consequence of environmental degradation: one recent study dubbed it the disease of the Anthropocene.” Moreover, she says, “climate change will exacerbate the social and economic problems highlighted by the pandemic. These include governments’ diminishing capacity to address public-health crises, the private sector’s limited ability to withstand sustained economic disruption, and pervasive social inequality.”

The key sentence in the article is: “These shortcomings reflect the distorted values underlying our priorities.”

Virtually all problems, in Mazzucato’s worldview, reflect the fact the priorities in the world of production are attuned to people’s demands. In a capitalist system, there are no other “values underlying our priorities” than the perceived necessities of people which become demand for goods and services.

This is the essence of Mazzucato’s view:

Addressing this triple crisis requires reorienting corporate governance, finance, policy, and energy systems toward a green economic transformation. To achieve this, three obstacles must be removed: business that is shareholder-driven instead of stakeholder-driven, finance that is used in inadequate and inappropriate ways, and government that is based on outdated economic thinking and faulty assumptions. Corporate governance must now reflect stakeholders’ needs instead of shareholders’ whims. Building an inclusive, sustainable economy depends on productive cooperation among the public and private sectors and civil society.

This nicely summarizes the evolution of Mazzucato’s views, from her first to her second book. In her first book, she advocates an “entrepreneurial state”. In the second she does call for going beyond capitalism founded upon “shareholder value”. I think this makes sense. If the state is going to fund or sponsor innovative companies, they will nonetheless have to compete in a world of private business seeking positive profits — and that may show either the virtues of government-led capitalism or its weaknesses. So, why not allow both the government and the private sector reject the profit motive, which means the traditional metrics of success and failure too?

Note that in Mazzucato’s piece there are no words of concern for low-income countries, where relatively more “polluting” technologies may be the only ones available, let alone economical, for the time being.

I think this piece is very useful. It perfectly epitomizes an attitude which is spreading in some intellectual quarters: use the Covid19 crisis to make some changes permanent, hoping for a world in which people travel less, trade less, rely more on the government. Those on the other side of the debate should take any available opportunity to emphasize that the quarrel is not between those who want to use government capital to satisfy people’s needs, and those who want to use private capital to satisfy people needs: but between those who want the economy to serve the needs of the people, and those who want the economy to supply those goods and services some rulers believe the people should consume.

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Branko Milanovic on Holiday Inn

Don Boudreaux, over at CafeHayek, has been posting about his debate with Branko Milanovic over whether middle class stagnation is a myth. I have some thoughts to add to that debate. I’ll do so at the end. But reading Milanovic’s comments reminded me of something he wrote in 1996 that I challenged in an article co-authored with my then colleague Robert McNab and my former student from Hungary Tamas Rozsas. The article is “The Hidden Inequality in Socialism,” The Independent Review, Winter 2005.

Here’s that segment of the article:

Referring to the effect of subsidies on essential items and to the quality of vacation homes for the top party brass, Milanovic argues that these privileges would not have altered measured income inequality to a great extent. He claims that others exaggerated the value of these privileges: “Elite privileges were exaggerated both by |the] indigenous population, because of the secrecy in which privileges were held, and by overly credulous Western analysts. In effect [as] anybody who has visited vacation homes previously kept strictly off-limits for all but the top Party brass can testify, their level of comfort and service is below that of an average Holiday Inn” (1996, 200). However, in dismissing the value of a vacation home by comparing it unfavorably to a Holiday Inn, Milanovic is, wittingly or not, implicitly appealing to Western standards. Although few middle-class Americans will regard a Holiday Inn as a luxury hotel, Americans are not the relevant group here; eastern Europeans are. In the mid-1970s, living space per person in the Soviet Union was approximately only 120 square feet (W. S. Smith 1973, 405, as cited in Pejovich 1979, 55). Every room at a Holiday Inn has its own bathroom, whereas in the early 1970s approximately half of all Soviet housing lacked running water or plumbing, and much of the other half shared bathroom facilities with other families (Pejovich 1979, 55-56). For almost anyone in the eastern European socialist countries, a Holiday Inn would have been the height of luxury. To “translate” Milanovic’s statement for Western ears, it would need to read something like this: “In effect, as anybody who has visited vacation homes previously kept strictly off-limits for all but the top Party brass can testify, their level of comfort and service is below that of an average Hyatt.” In other words, access to a vacation home of high quality by socialist standards for a couple weeks each year free of charge constituted a substantial perquisite for those with political connections, and it would have been widely envied by those without it.

Milanovic might have made the following more telling and accurate criticism of the idea that vacation homes increased the inequality of incomes. Not just the politically connected had access to such vacation homes. Rather, even those not so connected could get such access if they did what the authorities wanted them to do: refrained from criticizing communism, refused to support many of the victims of communism, showed up at work, and so forth. In other words, access to vacation homes, like so many other perquisites under communism, was a means of creating loyalty to the regime and cementing workers into the system.

Now to my criticism some of Milanovic’s recent claims. Don Boudreaux has handled it well but I want to add my own thought.

Here’s Milanovic’s statement:

But has real income of the American middle class gone down? Professor Boudreaux thinks it has not. To prove that, he engages into a doubly absurd exercise. He compares income of today’s middle-class Americans with income of the middle-class Americans 40 years ago using the goods that were inexistent 40 years ago. Indeed by that peculiar metric they are better off. It would suffice that one American out of perhaps 100 million middle-class American owns a smart phone today to obtain Professor Boudreaux’s result: since nobody had it 40 years ago, the growth rate of such income would be infinite.
If we equally one-sidedly, but somewhat less absurdly, make a comparison in terms of individual goods or services that existed then and now, like health care, education, and housing, we would find the very opposite result. This is why, if we want to engage into such comparisons, we use Consumer Price Index which includes all goods and services. When we do so and compare real incomes at different percentiles of U.S. income distribution, we get the result shown below. Over the thirty-year period U.S. middle class income has cumulatively increased by between 20 and 30 percent, which on an annual basis gives a rate of growth between 0.6% and 0.9%. This is hardly satisfactory and is especially galling when we compare middle-class growth with that of the top 5 percent, or even better with the top 1-percenters, whose incomes have increased by more than 80% (cumulatively).

Notice the first two sentences:

But has real income of the American middle class gone down? Professor Boudreaux thinks it has not.

That’s correct. That’s what Boudreaux does think. But here’s  something else interesting: Milanovic agrees with him. In the second paragraph, Milanovic writes:

Over the thirty-year period U.S. middle class income has cumulatively increased by between 20 and 30 percent, which on an annual basis gives a rate of growth between 0.6% and 0.9%.

In short, the real income of the middle class has risen, not fallen.

What about Milanovic’s point that looking today at only smart phones gives a biased viewpoint? He’s right. And contrary to what I had thought when I first read Milanovic’s statement too quickly, he admits that having access to a smart phone now does, all other things equal, increase one’s real income, possibly by a lot. But Milanovic’s point is that all else is not equal. In particular, health care, education, and housing have all become more expensive. Of course, in each case, other than education (hmmm: which entity provides most of that?) quality has clearly gone up. So then we have to dig into details.

That’s why Milanovic wants to use the CPI, because it includes a wide spectrum of goods.

Don Boudreaux catches the problem, citing the Boskin Commission report of 1996. The CPI overstates inflation.

But here’s something more. As the Report points out, and as Boskin has laid out in “Consumer Price Indexes,” his entry in The Concise Encyclopedia of Economics, there’s a particular problem with new items. Coincidentally, Boskin mentions the cell phone. He writes:

Finally, an additional bias results from the difficulty of adjusting fully for quality change and the introduction of new products. In the U.S. CPI, for example, VCRs, microwave ovens, and personal computers were included a decade or more after they had penetrated the market, by which time their prices had already fallen 80 percent or more. Cellular telephones were not included in the U.S. CPI until 1998.

In short, the introduction of new products does contribute to the CPI’s overstating of inflation. And it contributes substantially. Boskin writes:

The CPI currently overstates inflation by 0.8–0.9 percentage points: 0.3–0.4 points are attributable to failing to account for substitution among goods; 0.1 for failing to account for substitution among retail outlets; and 0.4 for failing to account for new products. Thus, the first 0.8 or 0.9 percentage points of measured CPI inflation is not really inflation at all. This may seem small, but the bias, if left uncorrected for, say, twenty years, would cause the change in the cost of living to be overstated by 22 percent.

Therefore, middle-class income has increased even more than Milanovic admits.

 

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Post-Pandemic Optimism from Joel Mokyr

These days optimism is rarer than before. So it is uplifting to read an historian such as Joel Mokyr writing that “at the end of the day, the post-pandemic economy may not be all that different from what we had in 2019, and insofar that it is different, not all changes will necessarily be bad”.

Mokyr’s reasons for optimism are rooted in the fact that modern economic growth is rooted more in advances in science and technology than on the engine of “Smithian growth”, which is, basically: commerce, though the two things are obviously connected (difficult to imagine technology advances to be independent from the knowledge and even the casual opportunities created by increased contact and thus specialization, as Matt Ridley explains in How Innovation Works).

The problem with Smithian growth is that the institutions that sustain it are very fragile. Markets depend on “peaceful politics, trust and cooperative institutions”.

A shock, whether war or a virus, can wipe those out in just days. We have experienced this in our lifetimes: A major terrorist attack or a pandemic can disrupt markets in a matter of weeks and bring the infinitely complicated machinery of international markets to a grinding halt. In August 1914, with the outbreak of hostilities in Europe, the entire system based on the gold standard and the institutions that supported international specialization and exchange collapsed. It took many years for the system to recover, and it could be argued that not until the 1950s did the world return to the kind of proto-globalization that had taken place in the decades before 1914.

For Mokyr, the fact that modern economic growth is  “based on more productive technology and the science that underlies it” makes it more resilient. Different than trust, “knowledge, once acquired, cannot be easily reverse”. And science and technology informs our societies so profoundly that, in the wake of the pandemic, they have been widely mobilised for the fight against COVID19.

Mokyr also points out that a more science-oriented mentality and, more generally, the experience of change should make us better understand flexibility. “Leaders of our business and technology community would be wise to keep sight of the flexibility and adaptability of our economy, as unemployment soars and businesses small and large in the service sector face bankruptcy.” Alas, this wise advice tends to collide with the urges of politics, as leaders in the political world are, particularly as anxiety mounts, in the need of providing impressions of safety, very often regardless of the costs.

This article by Mokyr, which I summarised without giving it justice, is well worth reading.

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Are the old opposed to progress?

The Economist has an interesting article (focused on UK politics), which suggests that the answer is yes. I’m less sure, but the article is full of interesting tidbits.  Here’s how it begins:

Clive thinks immigration has overwhelmed the health service. Pat says her town is swamped by new housing. Elizabeth voted for Brexit, but doesn’t want a trade deal with America, “especially the pharmaceutical side of it, Trump and his chickens.” So did Kathleen, but she now thinks a no-deal exit will mean shortages of groceries and medicines. “I’m prepared to do without stuff,” she says.

They are part of a focus group organised by NatCen, a social-research institute, studying “affluent eurosceptics”, a Conservative-leaning middle-class tribe. Nearly half the group is over retirement age. They lament their children’s europhilia, their grandchildren’s idleness and the decline of Britain’s industrial prowess. Yet the thread that links their views is a preference for policies that harm growth, and an aversion to those which boost it. . . .

Onward, a think-tank close to the government, reported last year that the old are especially hostile to the “drivers of prosperity in the modern liberal market economy”. They are more likely to agree with statements such as “globalisation has not benefited most people”, “jobs and wages have been made worse by technological change” and “more people living in cities has made society worse.”

On the other side, younger voters tend to be more supportive of socialism, which in my view is a profoundly anti-progress ideology.  Nonetheless, it is striking how older voters have recently shifted on a wide range of issues.  They’ve probably always been more reactionary on social issues such as interracial marriage, gay rights and drug legalization.  But they have also become more skeptical of trade and immigration, and more hostile to building new housing.  Some of this reflects the fact that Nimby policies disproportionately hurt younger voters.

In the UK, older voters favor spending on health care (and pensions) over education. According to The Economist, they seem to have had their way, as spending on health care has risen from 6% to 7% of GDP while spending on education fell from 6% to 4% of GDP. I’m actually not convinced that public education does much to spur growth, but I’m almost certain that additional spending on health care doesn’t boost growth.

Leadership in the UK’s Conservative Party seems more pro-growth than the rank and file.  Recall that Brexit was sold as a way of making the UK a sort of Singaporean free trading nation.  That doesn’t seem to be happening:

Mr Johnson’s plan to offset the costs of Brexit by making Britain a nimbler, globetrotting place is not popular among the old. A trade deal with America will require loosening food regulations, to which pensioners are particularly hostile. Mr Johnson calls himself a Sinophile, but his mps have pushed him into banning Huawei, a telecoms company, from Britain’s fifth-generation (5g) mobile network on security grounds. Older voters, unlike the young, overwhelmingly support the move even if it harms trade with Beijing.

Prime Minister Johnson also seems to have lost out on the housing front:

Mr Johnson’s reforms to the planning system, announced on August 6th, might have threatened their back gardens, but concessions to nimbies ensure that the green belt, which prevents prosperous towns and cities from expanding, remains protected.

In America, the GOP recently bowed to reality, and switched from being an anti-zoning party (at the national level) to a pro-zoning party.

As populations age all over the world, we can expect an increasingly geriatric politics:

Increasingly, Britain is governed in the interests of voters with an insatiable demand for health care and pensions, while a sluggish economy struggles to fund them. But it would take a brave Tory to make the grey voter pay more tax. “Everything I’ve got I’ve earned,” says Kathleen. “The generation under me just seems to expect everything to be given to them.”

That last comment reminds me of amusing signs at Tea Party rallies:

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Krugman and Growth Agnosticism

Back in 2004, Robert Lucas famously remarked: “Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution.”

Ten years later, Paul Krugman replied:

It’s fairly common for conservative economists to try and shout down any discussion of income distribution by claiming that distribution is a trivial matter compared with the huge gains from economic growth. For example, Robert Lucas:

Of the tendencies that are harmful to sound economics, the most seductive, and in my opinion the most poisonous, is to focus on questions of distribution.

The usual answer to this is to point out that we don’t actually know much about how to produce rapid economic growth — conservatives may think they know (low taxes and all that), but there is no evidence to back up their certainty. And on the other hand, we know how to make a big difference to income distribution, especially how to reduce extreme poverty. So why not work on what we know, as at least part of our economic strategy?

Krugman’s apparent embrace of this growth agnosticism is doubly puzzling.  After a lifetime of study, a brilliant Nobel laureate still lacks anything useful to say about fostering growth?  How is that even possible?

The puzzle amplifies, though, when you recall that Krugman has endorsed several specific policies with large, clear-cut growth effects.  Most notably:

1. Krugman strongly advocates housing deregulation.  The whole point of this literature is that housing regulation hasn’t merely made housing expensive; it has retarded economic growth by discouraging Americans from relocating to high-productivity regions of the country.  You could say, “This is only a level effect, not a growth effect,” but that’s a semantic quibble.  Regulation is now so strict that you could noticeably raise measured growth for decades with moderate deregulation.

2. Krugman has strongly advocated labor deregulation, at least in Europe and the Third World.  Again, the whole point of this literature is that labor regulation hasn’t merely made labor expensive; it has retarded economic growth by (a) keeping unemployment rates permanently high in many European countries, and (b) suppressing formal employment in many Third World countries.  While you can protest, “Moving French unemployment from 10% to 5% is a one-time gain, not a growth effect,” that’s semantics.  After labor deregulation, excess unemployment would still take many years to disappear; hence, measured growth would be markedly higher for years to come.

Furthermore…

3. While Krugman seems to oppose serious deregulation of immigration (for brow-furrowing reasons), he never questions the textbook logic showing that such deregulation would lead to massive increases in Gross World Product.  Indeed, the case for immigration deregulation is isomorphic to Krugman’s case for housing and labor deregulation: The status quo forces business to waste big golden opportunities.  The only difference is that estimates of the economic gains of immigration deregulation are much bigger.

What’s really going on?  Frankly, I think that Krugman’s growth agnosticism is just an act.  Intellectually, knows very well that governments could readily boost growth if they wanted to.  Emotionally, however, Krugman finds such reforms uninspiring.  Taking from the rich and giving to the poor is fun; freeing the rich and poor to cooperate for mutual benefit, not so much. Krugman thus reminds me of my friend and debate partner David Balan, of whom I’ve said:

Since my opponent is a serious thinker, I know that he actually agrees with much of what I’ve just told you.  So where does he go wrong?  Emphasis.  Yes, David favors allowing a lot more immigration and a lot more construction.  He grants that these policies will enrich society in general, and the poor in particular.  But none of this excites him.  Why not?  I’m no mind-reader, but my best guess is that David idolizes Big Government, and resents free markets.  So when he thinks about a grave social problem like poverty, he doesn’t want government to get out of the way and let the free market work its magic.  He wants government to heroically solve it with redistribution.  Even when he knows that government viciously victimizes the poor, he wants to hastily concede the point, then talk about redistribution at length.

On reflection, then, Lucas’ words are even deeper than they seem.  Focusing on questions of distribution doesn’t merely seduce and poison economic policy.  Focusing on questions of distribution seduces and poisons the minds of fine economists, too.

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Comments on Siegel’s Fewer, Richer, Greener

Last week, I was part of the Cato Institute’s book forum on Laurence Siegel’s Fewer, Richer, Greener: Prospects for Humanity in an Age of Abundance.  Here’s my commentary on the book.


1. Vast areas of agreement:

a. Until March, the world was getting richer at a marvelous pace. Absolute poverty has been disappearing before our eyes after ten thousand years of apparent permanence.

b. Conventional measures sharply understated the glorious reality, because the environment keeps getting cleaner and the quality of the goods keeps getting higher.

c. Like it or not, global population is leveling off.

2. Overarching complaint: Siegel is so excited to share his conclusions that he rushes through the arguments in their favor. When the arguments are strong, the rushing is harmless. When the arguments are weak, the rushing leads Siegel to embrace errors.

3. Error #1: Leveling off of population now is a good thing. Siegel has no argument for this other than to say that population growth can’t be a good thing forever. But this argument would have been just as true when global population was 8000, 8M, or 800M.

True, Simon dodged the question of when population would start to be a problem.  But he genuinely demonstrated vast neglected upsides of population – especially the effect on innovation.  Almost all innovation really does come from high-population areas – and this can hardly be a coincidence.  Furthermore, the main downsides of population – pollution and congestion – can be easily mitigated with pollution taxes and tolls, rather than fewer births.

Key point: Siegel presents no evidence that extra population has ceased to be a good thing overall yet, so why is he so happy about falling birthrates?  The world is still mostly uninhabited – you could fit the entire world’s population into the continental U.S. at the density of Los Angeles.  So why not hope for a world population of 20B, 50B, 100B, or even a T?  If this seems absurd, imagine how absurd multiplying humanity 25-fold would have seemed 1000 years ago.  Yet this “absurdity” turned out to be awesome.

4. Error #2: We should just live with (or even celebrate) declining birth rates. If you do the math (as I have in an earlier Cato Unbound piece), you’ll discover that large tax credits for births are the holy grail of tax policy: They more than pay for themselves in the long-run. We can reasonably expect a $10k per birth one-time tax credit to increase fertility enough to ultimately yield about $250k in net present value for the Treasury.  A fantastic deal!

Also: Housing deregulation.  City-dwellers have few kids because they’re so cramped for space, but this is largely a product of zoning and land-use policies that grossly inflate the price of housing, especially in the country’s most desirable areas.

5. Error #3: Becker’s economics of the family readily explains declining family size. Reality: Kids were never a good financial investment. As a business model, hiring able-bodied farmers makes far more sense than breeding helpless infants and waiting 15 years for help.  Yes, modern economies offer many extra opportunities for child-free fun, but they also drastically reduce the pain of child-rearing and offer many extra opportunities for family fun.  Why rising wealth causes falling birthrates is a fascinating question that social scientists have still failed to successfully answer.

 

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The 1918 Pandemic and Economic Freedom

One would think that, in the case of an economic shock such as a pandemic, a country’s economy would suffer less damage and recover more rapidly the greater its level of economic freedom and the more flexible the economy is. To the typical economist, this seems rather obvious in theory. But is it empirically confirmed?

Worse than the current Covid-19 pandemic, the influenza pandemic that started in 1918 infected half a billion individuals or one-third of the world population and killed 50 million.

In a recent paper “Economic Freedom and the Economic Consequences of the 1918 Pandemic” (SSRN, May 2020), two young economists, Vincent Geloso (King’s University College, Ontario) and Jamie Bologna Pavlik (Texas Tech University) provide an empirical confirmation that economic freedom dampened the effects of the 1918 pandemic. They analyze 20 countries where, over the period 1901 to 1929, estimates of economic freedom are available as well as data on deaths from the pandemic (and from WWII, to avoid this confounding factor). They regress the levels or growth of real GDP per capita on these variables. They admit that the small number of countries in the sample represent “the main downside of [their] approach.”

Economic freedom is measured by a long-term index (going back to 1850 in some cases) developed by Leandro Prados de la Escosura of the Universidad Carlos III in Madrid and similar to the contemporary Economic Freedom of the World Index by the Fraser Institute. In both cases, the score of economic freedom can run from zero to a maximum of 10.

Geloso and Bologna Pavlik’s econometric estimates are generally highly statistically significant, especially in their main specification. They show that

countries with higher levels of economic freedom suffered substantially less from the pandemic … [H]igher levels of economic freedom mitigate the effect of the crisis. In terms of magnitude, an extra point [on 10] of economic liberty offsets roughly 16% of the [economic] effect of an extra flu death per 100,000 persons.

Another very interesting, but not surprising, result is that it is general regulation and restrictions to international trade that interfered most with the maintenance and recovery of GDP per capita in the 1918 pandemic.

A longer version of the article will be published in Contemporary Economic Policy. The revised paper further shows that democracy had a much smaller effect than economic freedom in mitigating the economic impact of the pandemic.

Let me add that the importance of economic freedom in mitigating the impact of the 1918 pandemic suggests that the American economy (and most if not all other economies in the world) would have weathered Covid-19 much better if prices had not been controlled as they would have rationed quantity demanded (better than queues), incited producers to increase quantity supplied, and thus prevented shortages. In America, the majority of states have “price gouging” laws that prevent prices from increasing once an emergency is declared. At the federal level, the Defense Production Act, invoked by President Donald Trump on March 18, have also contributed to the shortages. I have a number of Econlog posts on this topic.

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Flintstones Without the Nice Tune

I just finished watching an excellent 45-minute discussion led by my Hoover colleague Scott Atlas. The two participants he questioned were Hoover colleagues Russ Roberts and Ayaan Hirsi Ali.

The topic was Hoover’s Human Prosperity Project and both had a lot of great insights and great lines.

Among the lines that stood out was one from Ali. If I remember correctly, she said it in the context of her story about growing up in Somalia and seeing her mother lining up for food for hours after Somalia went the socialist route under Siad Barre. She explained that whereas socialism is utopian and aims at nice goals like equality and prosperity for everyone, it ends up as “The Flintstones with the nice tune.”

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