Sunday, 2 June 2013

Insiders, Political Economy and The Reset

Tyler Cowen has a reminder for us:
It is a common observation that nominal wages are sticky but let’s not forget that real wages are often sticky too (and in fact nominal stickiness tends to matter much more when accompanied by real stickiness, but that is a point for another day.)  That means many labor market changes will be slow to manifest themselves in the real world.  Furthermore you often will see them first for new jobs, for the young, and for new labor market entrants (usually but not always the young)...Fear the reset.  The world will continue to produce much more value, and much more gdp, but who will capture that value is already changing dramatically and will continue to do so.
The consequence of real wage stickiness is that changes in the position of labour might be slow to manifest themselves, leading to a painful ‘reset’ where insiders lose their cushy priviliges.

Isn’t this a good thing? We don’t look at the examples of Greece and Italy, wring our hands and say, ‘Oh, if only the labour market was more heavily regulated and there were more insiders who could protect themselves from economic disruption.’* We see rather that labour markets are not flexible enough – and I think we’re right in that observation.

Similarly, the fact that insiders got health insurance and the outsiders didn’t was the exact problem that Obamacare sought to solve. Companies offering less generous plans or leaving their employees to buy coverage on exchanges was the intention of the legislation. The goal was to move healthcare away from the corporate-centric model, because that model doesn’t control costs properly and screws over anyone with a pre-existing condition.

The classical view, therefore, would be to say the reset is great! Move resources to productive activities! Cut unemployment! Increase efficiency! Bryan Caplan wants the reset and he wants it now.

But Cowen offers a reason why real wage flexibility might be a bad thing – the declining labour share of income. There’s a lot of discussion of a future in which the labour share of income is minimal, but maybe the problem of the deteriorating position of labour relative to other factors of production is worse than we think. If change is only taking place gradually, at the expense of a population of outsiders which grows only slowly while a shrinking but substantial fraction of insiders remain insulated, then the rate of change of labour share of income is sticky and there could be lots more negative distributional consequences on the way.

The argument goes thus: maybe the current system isn’t economically efficient, but it’s better at keeping what resources there are in the hands of the workers. Neoliberal wonks don’t like insider-dependent ways of helping the poor, like unions or the minimum wage, because they’re economically inefficient. They tend to argue for dismantling these kinds of protections in favour of better policies like tax credits.

The problem is that insider-centric policies have a political constituency, and the wonks’ policies don’t. Unions lobby for more union power. Big corporations which already pay above minimum wage like to make life harder for the competition. On the other hand, no-one wants to pay extra taxes in order to fund the EITC, or capital endowments. Therefore, it may be that pareto-efficient labour market flexibility is impossible, because once the protections are dismantled there’s no political constituency for helping the poor. With rising inequality, the political clout of the rich can only increase, helping them to entrench themselves as a new class of insiders, while ensuring that the poor are left out in the cold –  they lose the suboptimal redistributive policies that were helping them before, but don’t gain any optimal redistribution in return.

There’s a compelling case that this is exactly what’s been happening in recent years.
Resets show up more quickly in some sectors than others, most of all they come quickly when buyers and sellers have only sporadic and perhaps even anonymous contact with each other.  In other words, the reset comes more slowly for the mistress than for the street prostitute.  And when you see youth losing relative ground in labor markets, that is another signal that you should be worrying about resets.
Cowen’s ‘reset’ argument also casts the problem of labour market bifurcation in a wholly new light. The last few decades of economic growth have been much kinder to academics than they have to burger-flippers. But maybe what we’re really seeing is that there are more insiders at the high-skilled end of the labour market, who are better equipped to forestall their inevitable reset.

This is obviously true in some sectors. Cowen uses the great example of tenured professors, but you can look at public employees like teachers, or credentialist cartels run by doctors and lawyers. Maybe it’s not a coincidence that these have been the sectors most resistant to productivity growth. The ‘Great Stagnation’ hypothesis assumes that the reason developments in technology haven’t made much difference to retail or healthcare or transportation productivity is that we haven’t found ways to make tech work in these industries (yet). But perhaps the real reason is that there are powerful upper-middle-class insiders holding back MOOCs and Watson and Uber and tooth whitening. Part of the reason insiders are able to entrench themselves is low turnover and this is true of firms as well as individuals. A large fraction of productivity growth comes from low-productivity firms going out of business and resources being reallocated to high-productivity firms.

After all, it’s not obvious that there has been a wholesale deterioration of labour’s position in many of the ‘flexible’ sectors, and tech is a great example of this. It still provides lots of upper-middle-class jobs** and if wages aren’t soaring that’s not because the surplus is being appropriated by corporations but because it’s being taken by a) new entrants to that labour market and b) consumers.

Of course, maybe the causality goes in the other direction. Maybe tech is a ‘flexible’ sector because there’s lots of disruptive innovation going on in that industry. Maybe academics still have tenure because MOOCs haven’t really got off the ground yet, rather than the other way around. Maybe doctors can run their cartels because medical productivity growth is so slow.

If that’s the case, though, we should still celebrate the deteriorating position of insiders because it would mean productivity growth. Maybe insiders are dwindling because there is no Great Stagnation and prosperity is just around the corner.

*This might provide a useful window into the sometimes impenetrable thinking of people who use the word neoliberal a lot.

**(and might provide a lot more of them if insiders would let more people live in San Francisco)

Wednesday, 22 May 2013

Lessons from Apple's Tax Avoidance


The scandal of the day is that Apple has been using a hostof tricks and loopholes in order to avoid paying tax on its enormous global profits. Naturally, everyone’s using this as a chance to draw their own preferred policy conclusions. Matt Yglesias is hardly alone in suggesting that it’s the US corporate tax code that’s the problem. But it’s hard to see a future in which the US tax code isn’t a problem – and that’s an important fact to consider when taking a step back and looking at corporation tax more broadly.

The government needs money to pay for roads, police, schools, hospitals and pensions. That money has got to come from somewhere, and as a democratic society we have to make decisions about how much of that money should come from the rich relative to the poor. We also have to make decisions about how to actually collect that money.

Mitt Romney got a lot of stick for his infamous comment that ‘corporations are people’ and yet he and his detractors were actually making much the same point. Apple is not a person, and as such it can’t pay taxes. When the government taxes Apple it doesn’t take money away from Apple the corporation. It takes money away from Apple’s shareholders, who own those profits.*

This makes corporation tax a roundabout way of taxing rich people. Another way to tax rich people would be to take money from them directly. The appeal of corporate taxation as a way of getting at rich people’s money is that, if it’s not too distortionary, it might be easier to do and harder to avoid than if we tried to tax rich people directly. Clearly, though, the Apple fiasco suggests that, in a globalised world, it’s really really hard to squeeze money out of corporations. And Yglesias' followup echoes Derek Thompson in hitting the nail on the head – we’re never going to be able to effectively tax corporations. So what’s the point in doing it if it would be easier just to go straight after the rich people?

Sidenote: There is one side benefit of corporate over individual taxation – individual taxes apply only to people living in your country, whereas corporation tax allows the government to get revenue from rich foreigners’ investments as well. If your aim is to squeeze the most money out of foreign shareholders, though, the best strategy is to set your corporate rate low, Ireland-style, so that lots of foreigners redirect their corporate tax liabilities to your country.

*To make things simpler, I’m going to make the heroically generous assumption that the incidence of corporate taxation falls entirely on shareholders and not on workers etc.

Monday, 20 May 2013

Immigration Tariffs vs. Auctions, or Becker vs. Peri


Ashok Rao has a new post laying out a proposal for an immigration permit auction, as suggested by prominent immigration economist Geovanni Peri. This is a great idea, and it would definitely be a major improvement for public policy, especially if the number of visas auctioned was substantially higher than current immigration levels.

That said, it isn't the only way you could do market-based immigration policy. One alternative would be to have an immigration tariff, as advocated by Gary Becker. Instead of auctioning a fixed number of permits, the government would sell as many permits as demanded at a fixed price. The benefits of this kind of system are broadly the same as the benefits of an auction Ashok describes in his post. However, there are a few subtle differences that for me suggest a tariff might be a better way to go.

The first reason to prefer a tariff is that it means the market is more responsive to shifts in supply and demand. In a boom, more people want to come to the country and the economy ‘wants’ more immigrants. In a recession, the opposite is true. Using the auction system, the same number of people come – all that changes is the price. Under a tariff regime, on the other hand, the number of migrants is free to fluctuate according to the needs of the economy. This is true on a micro as well as a macro level.  If a new computing technology creates a sudden need for hordes of Indian programmers, or demand for immigrant builders goes up following a huge natural disaster, then the policy responds by allowing more immigrants. Yes, the government could adjust the number of auctioned permits according to economic circumstances, but it is better that changes in the number of migrants be market-driven, rather than decided by bureaucratic assessments of ‘need.’

Having a fixed tariff price, or at least a planned price schedule, also gives a level of certainty to the market. If I live in Mexico and my family is saving up to buy my way into the USA, I want to know how much I’m going to need to squirrel away. With an auction, the price will vary from year to year, perhaps dramatically, and there will be no guarantee that my savings will prove sufficient to get me a permit this year, or even next year. Tariffs solve this problem.

A criticism of immigration tariffs are that it is difficult to know how many people will come. If permits are auctioned, then the government knows what the level of immigration will be. There will be no concerns about a ‘flood’ of immigrants driving up house prices, overwhelming public services and so forth. Under a tariff system, things are much murkier – immigration is very difficult to forecast, as the UK government found to its embarrassment in the mid-noughties. However, that might serve as a feature and not a bug. It’s difficult for a politician to stand up and say that he wants millions upon millions of immigrants to be allowed in every year. It might be easier to sell to the public the policy of letting in anyone who coughs up £20000, even though the two policies might be equivalent. Voters are also reassured that every immigrant who arrives will ‘pay their way,’ whereas under an auction system there is the possibility (however unlikely) that the price will fall very low, creating the fear that people might get in ‘for free.’

A final, practical point is that tariffs would be far easier to administrate. It’s obviously feasible to design a working auction system, but it would be complicated. There’s a lot of room for the government to screw up, and there would almost certainly be teething problems to start with. It might also be simpler to verify the buyer’s identity and administer a background check under a tariff system.

Ultimately, I think the parallel with international trade holds – tariffs are better than quotas. An immigration tariff would be more sensitive to the needs of the market, less bureaucratic, in some ways more predictable, and maybe even more politically palatable than an auction system.

Thursday, 9 May 2013

Why not everyone should pay into the system


There’s an idea going around that it’s a bad thing when poor people don’t pay taxes. This has manifested itself in the infamous Mitt Romney ‘47%’ gaffe and also in the debate here in the UK about contributory benefits, the personal allowance and whether people should be getting benefits out of a system they haven’t paid into. The central argument is that, if you don’t pay taxes, you’re going to want to increase the provision of public services – all public services – because you get a share of whatever scant benefits there might be from the increase, and you don’t have to pay for any of it.

There are a couple of standard objections to this view. One is that poor people do pay a lot of taxes, in the form of social insurance contributions, consumption taxes and so on. Another says that, even if people don’t pay taxes one year, they might pay taxes the next; certainly, many of the 47% has paid income tax recently, and might again soon. There’s also a related life-cycle issue – many people not paying taxes are retirees or students, who have paid or will pay taxes at some other time in their life.

Then there's the argument that social insurance is just that - insurance - and just like with, say, home insurance, if some people get back much more than they paid in, it's a feature rather than a bug.

I’m going to explore a few other objections, though.

Firstly, it confuses average and marginal costs and benefits. If I’m going to vote for more spending, the cost to me of that spending isn’t the taxes I already pay – it’s the extra tax I’d pay to finance that spending. I might not pay any tax now, but if the government increases spending, it might pay for that by lowering tax thresholds so that I will pay tax in the future, or raise one of the kinds of taxes that I do pay, like VAT. Whether or not I pay taxes now has little to do with whether or not I will pay the cost of a rise in spending.

Equally, the myth of the squeezed middle (more on this later) allows many people to argue for ‘free’ benefits – not because the middle class doesn’t pay taxes, but because at the margin any tax rise is going to fall on the rich. This is obvious in the USA, where the Democrats are pushing for higher taxes on the rich and only on the rich, and consequently the alternative of spending cuts looks comparatively unpalatable.*

Secondly, the simple fact of whether or not I’ve paid into the system doesn’t really matter that much. If I paid £1 in income tax last year, it’s not going to make me dramatically more averse to increased spending than if I didn’t pay anything. As a result, even if the tax rate paid by the poor was important, the 47% statistic would still be meaningless. What’s important is the average tax rate paid by the poor. And that becomes an argument against any and all redistribution, which no-one** advocates (even flat-tax advocates think that benefits should be progressive).

Thirdly, while people are self-interested voters at the margin, on average they are actually quite civic-minded. Bryan Caplan's excellent articleThe Myth of the Rational Voter, was widely derided for calling voters idiots, but one of the interesting things it pointed out is that voters don't tend to vote for the things that will be best for them. People vote for farm subsidies not because they benefit them but because they (mistakenly) think that it will be good for society. Equally, even if poor people not paying tax had a marginal effect on how likely they were to vote for extra benefits, it wouldn't be the only or even the most important deciding factor. They might still vote against it if they thought that was what was best for society.

Summary: if anyone ever tries to argue that taxing the poor is vital for preserving democracy, tell them they're an idiot.

*This argument is starting to look a bit politically slanted. Of course, from a Rawlsian/utilitarian perspective, if you can get benefits to the poor and middle class solely by taxing the rich, maybe that’s a great thing.
**Apologies to any anarcho-capitalists I may have offended by this statement. I love you really.

Wednesday, 1 May 2013

The Pope Is Right – Bangladeshis Are Slaves


The new Pope has come out and called the conditions of Bangladeshi workers like the 400 tragically killed in a building collapse last week ‘slave labour,’ and he’s right.*

Let's be clear. He’s not right because ‘not paying a fair wage’ and ‘only looking to make a profit’ are things that ‘go against God.’ Here, I’m firmly on the side of Matt Yglesias’ posts on the subject (which were widely criticised). Essentially, there’s a tradeoff between work safety and employment/wages. As Bangladeshis get more productive, they’re going to work less, and they’re going to be willing to give up some of their rising wages in order to make their workplaces safer. This will happen, just like it happened in the UK in the 19th and early 20th century, and just like it happened in China over the past couple of decades. Until it does, we should be wary of imposing higher labour standards, because poor Bangladeshis probably prefer long hours and unsafe conditions to reduced wages. Once Bangladeshis get richer and more productive, working conditions will improve – and government legislation will likely follow the improvement in conditions rather than lead it.

Rather, the Pope is right because the Bangladeshis are slaves in another way. Or, more accurately, they’re serfs. Back in the days when the Pope had significant lands and armies, Europe was ruled by feudal lords. Peasants working on the land weren’t slaves – the lords didn’t own them – but there were tight legal restrictions on their freedom to move to the next farm over. That meant lords didn’t have to compete for labour – you couldn’t just work for someone else who offered better wages and conditions, which meant there was little incentive for your current lord to offer you better wages and conditions. It hurt the economy, too, as people were unable to work where they would be most productive.
Of course, serfdom is complete anathema today. It’s obvious to everyone that the feudal system was destructive and immoral. Nothing like that could ever happen now. Right?
Imagine that there are a large number of corporations who would love to hire Bangladeshi workers at fair wages and with good conditions. If the Bangladeshi employers wanted to keep their workers, they would have to pay higher wages and provide better working conditions.

This isn't just a hypothetical. These companies do exist. Sadly, however, they’re mostly based in North America and Europe. There are legal restrictions on where Bangladeshis are allowed to live and work which prevent them from working for said companies, stifling competition. That's what makes the Bangladeshi's willing to accept the bad wages and working conditions - they have no alternative. As long as serfdom is allowed to persist, the serfs won’t have much chance of earning a fair wage in a safe environment.

On the other hand, feudalism long ago ceased to exist. So maybe there’s some hope that things will improve.

*It’s worth noting that the building itself was illegal under existing Bangladeshi law. Like the Pope, I’m going to focus more on wider issues of labour exploitation in Bangladesh.

Sunday, 17 March 2013

Kuehn on Immigration

The always interesting Daniel Kuehn has a thought-provoking post on immigration:
1. It's a really bad idea to give high skill immigrants a leg up in the immigration process. It's market planning that we would balk at if we did it for foreign investment or foreign trade but for some reason it's palatable for foreign flows in labor. We do not have high skill labor shortages and decades of research has shown that. The high skill immigration programs are often exploitative of workers. Science and engineering market failures are principally on the demand side, not the supply side. Plus it simply goes against our values. If we went all-in for an Australian or Canadian style points system program we might as well just remove the "huddled masses yearning to breathe free" plaque from the Statue of Liberty.
There’s something to this argument if you see immigration through the lens of comparative advantage, as this Bryan Caplan post does. We gain from trade when we trade things we are relatively better at making for things that other people are relatively better than making. But of course certain goods and in particular many services are much harder to trade across borders – that’s one reason why the gains of immigration are so high in the first place. So from this perspective, we don’t want to be letting in people who can produce the things we’re just as good at producing – academics and computer scientists. We want to let in the people who are low-skilled, because their opportunity cost of producing low-wage services is much lower than ours, so there can be huge gains from trade.

That’s fine as far as it goes. But there are a bunch of other good reasons why you’d want to promote high-skilled immigration. For one thing, one of the biggest benefits of freer immigration are agglomeration economies. When people cluster together, they all get a lot more productive. There are reasons to think that these effects are more important for high-skilled workers. If you’re a waiter, your productivity is not really affected that much by the number and quality of the other waiters around you. But if you’re a scientist or an entrepreneur, then you do gain a lot from getting to work with and share ideas with a larger population of other scientists and entrepreneurs. I don’t have any hard evidence to hand, but anecdotally the ‘place premium’ is higher for higher skilled workers, for this reason. Moving a physics PhD from Somalia to California raises their productivity more than it would an unskilled worker’s.

From the perspective of American welfare, which Kuehn thinks is what we should focus on, there are also benefits from high-skilled immigration. An influx of very low skilled immigrants would increase local inequality, with its attendant costs – lower civic trust, worse social cohesion and so on. Higher-skilled immigrants are more likely to assimilate more quickly into American society. Obviously the higher immigrants’ incomes, the larger the fiscal benefits, meaning a lower tax burden on current Americans. And given diminishing marginal utility of income, we should be more worried about wage suppression of low-skilled native workers than the high-skilled.

Of course, there are other reasons to accept the low-skilled in. They themselves are likely to experience a bigger improvement in their living standards than a high-skilled person would. And the costs of filtering out the high-skilled from the low-skilled are probably quite high, leading to an expensive and bureaucratic system that ends up deterring all potential immigrants from applying. So a mixed bag of immigrants is probably more desirable.
2. Illegal immigrants are exactly who we want here and occasional amnesty is not that bad of a policy. Most people insist they love immigrants but want them to be here legally and talk about how illegal immigration is unfair to people who wait in line to be legal immigrants. But being an illegal immigrant reveals important information about the immigrant: these people really want to be here. They want to be here so much they will take personal risks to avoid the wait. They also like American society more than they like Congress or the federal bureaucracy. That doesn't seem like that bad of a perspective to have. People will also sometimes talk about how amnesty is bad because it sends mixed signals and it will indicate that our commitment to immigration enforcement isn't credible. But amnesty legitimates the immigrants who have revealed this important information about themselves in the decision to come over illegally. Of course there are a lot of problems with illegal immigration, even for the immigrant themselves. They obviously don't get to live fulfilling lives while their status is in that kind of limbo. So I'm not necessarily advocating restricting immigration flows just to get a crop of dedicated illegals. What I'm saying is that people need to think about the self-selection implied by illegal immigration and realize that those are exactly the sort of people we want as fellow citizens. How many natives would go to such length to get into the United States?

Again, to some extent I agree with this – self-selection is an important part of why immigrants are so great for the country and the economy. But that’s true of any kind of immigration. The kind of people who are desirable enough employees for companies to subject themselves to the H1-B visa process are going to be the ‘best’ immigrants. The kind of people who would scrimp and save in order to pay an immigration tariff would be the ‘best’ immigrants. Even under completely open borders, the kind of people who would be willing to uproot themselves and their families in search of a better life would be the ‘best’ immigrants.

And illegal immigration is obviously horribly inefficient. Mexican ‘coyotes’ could be doing something much more productive. So could document forgers. The immigrants would be able to do their jobs a lot better if they could work on the books.

More than that, though, the strategy of illegal immigration followed by amnesty as a backdoor way of increasing immigration is counterproductive. It marginalises immigrants, makes voters less empathetic towards them – and if the majority of voters don’t think you’re ‘like me’ then the law is not going to treat you well. A sense that the law is being flouted doesn’t endear people to more immigration. If immigrants were permitted to come legally then they would assimilate much better into society, be more likely to speak English and probably people would feel better about letting them in.

Now, I know Daniel isn’t suggesting that this is a first-best policy, and I agree with him that we could do a lot worse than periodic amnesty for large numbers of illegal immigrants. But that’s hardly a ringing endorsement for the policy.

3. The population that should benefit from immigration policy is a moving target. You hear two different things on this issue. First, the Bryan Caplan types think that we should maximize global welfare. I think this is obviously wrong. When we get together to form a government we do it to satisfy our own needs and internalize our own externalities. The world should have no expectation of free riding on our collective action. That doesn't mean we don't care about the world when we make policy - it's only to say that the social welfare of the world should only enter policymaking to the extent that American citizens value the social welfare of the world. So policy should be made to maximize the welfare of Americans. This is fine for most policy, except immigration. When it comes to immigration the very question of which population has standing in these decisions is a moving target because the whole policy debate is about who is and is not an American! Now it's possible there's a stochastically dominant policy that will be preferred no matter what the population of "Americans" that we decide on is, but that's not guaranteed. The question of whose utility we are maximizing and what immigration policy should be is self-referential. What I draw from that is that we shouldn't stake too much on thinking about a specific population that we're trying to help. We should rely on other decision rules and principles. The Bryan Caplan types should stop talking about what's best for the world and the rest of the country besides the Bryan Caplan types should stop talking about what's best for Americans.
As a Bryan Caplan type, I have a good counterargument to this, which is that the world is not free-riding on our collective action. Freedom of movement is not something we graciously allow, it’s something we gratuitously restrict. When we restrict immigration, we are killing, not letting die. We are chaining Julio to the tree. And it’s pretty obvious that we shouldn’t be allowed to do whatever we want to foreign people if it makes the ‘master race’ better off.

I do think it’s a tough question to think about. If we admit that we’re trying to maximise the welfare of Americans, that naturally leads to the question – which Americans? Do the children of potential immigrants, who would be citizens, count? Schools in the USA are a lot better than in Mexico. How much more weight should we assign to low-income Americans’ wages as opposed to high-income?

So Kuehn decides that we shouldn’t assess the policy on utilitarian grounds at all. But then if we don’t think about policy based on whether it would increase welfare, what do we decide based on? If we see freedom of migration as a natural right, then it would be unjust to restrict immigration even if it did substantially decrease global welfare – but it’s clear that Kuehn doesn’t take this view. So what criteria is he using to evaluate immigration policy?

Ultimately, I think the answer to this has to be a Pareto-efficient immigration policy. Because the benefits of immigration are so large, we could easily design the policy in a way that increased everyone’s welfare. Then we wouldn’t have to care so much about which groups’ welfare we should be thinking about.

Friday, 8 March 2013

NGDP Targeting and the Inflation Messaging Problem

Quite apart from the substantial economic benefits of NGDP level targeting, it has a messaging advantage. Targeting nominal incomes is quite a lot easier to explain to the public than targeting inflation. For example, imagine the following hypothetical news story:
CPI inflation fell to 1.8% last month according to latest statistics, providing consumers with a welcome dose of relief in the horrible economy. 
 There is hope that the ending of the squeeze on real incomes will boost consumers’ spending power and help get the recovery back underway. 
[Central bank economist] said the news was cause for celebration. “We knew our flexible inflation target was a good idea and this has been proved now that inflation is coming back under control.” 
[Pensioner lobby spokesman] was cautiously optimistic. “This is an optimistic ray of light for pensioners, many of whom are poor and who you should all feel sorry for. Now if only the bank would unwind its distortionary QE policies then prices would be lower for working people and there would be rainbows and unicorns for everyone.”
Under NGDP targeting, we instead get this:
Nominal income growth declined to 2% last quarter according to latest statistics, suggesting dismal prospects for the recovery. 
The continued fall in nominal incomes is likely to dim the prospects for the recovery. This suggests that the Bank of England should be considering more monetary easing, considering that nominal income is getting further and further away from where it ‘should be’ under the Bank’s level target. 
[Central bank economist] said that the Bank would not act. “Yes, nominal income growth is abysmal. But we think there are costs and risks to further action. I won’t explain what these costs and risks are, but suffice to say that we won’t be helping anyone.” 
[Pensioner lobby spokesman] saw no cause for alarm. “Yes, growth is weak. But forget working people – the real problem is rich pensioners who hold government bonds! The Bank should reduce nominal growth even further to help these people out.”

Wednesday, 6 March 2013

What to Do When You Can't Tax Wealth

Ezra Klein points out that wealth inequality really sucks:
There’s a strong case to be made that what we worry about when we worry about economic inequality makes much more sense in terms of wealth than income.Take social mobility. A family might be doing fine on the income scale but still living hand-to-mouth, with little left over to pay for the child’s SAT prep or college tuition. A family with wealth, on the other hand, can always liquidate some assets to invest in their child’s future, and they can do so without worrying that they won’t be able to pay next month’s mortgage.Political power works similarly. A young hedge funder who just got her first big bonus might show up in the top 1 percent of the income distribution. But she’s still paying down college loans and saving up for a house and waiting to see whether these incredible checks keep coming. She doesn’t have the security to be trying to purchase politicians.But someone in the top percentile of the wealth distribution? They’ve probably been very comfortable for a long time, and they know they have the resources to continue being very comfortable for a long time, and so they can make speculative investments in politicians.
 Ezra hits on the crux of the problem, which is that wealth inequality is more pernicious than income inequality because it reduces equality of opportunity. We want a society which is broadly meritocratic, where the smartest, most hardworking people who can do things people want done get paid the most. And one obstacle to that is wealth inequality.

The problem is that we can’t tax wealth, because taxing wealth is really hard and has deleterious economic effects. Essentially, while wealth inequality is bad, wealth itself is obviously good and we don’t want to discourage it. So we have to find some other way of dealing with the problem. The Economist magazine released a report a couple of months ago calling for a number of changes to mitigate inequality.

We could address inequality in quite a few ways, but I think the problem is that whatever your policy prescription is, we’re already doing it.

We could invest more money in education so that people who are smart can rise to the top whatever their background. But education spending has risen a lot over the last decade (especially in the UK), and it’s not clear that it’s had that much effect on equality or on outcomes.

We could encourage – or force – poor people to save. This would reduce inequality without having to take wealth away from any of the rich. But to some extent we already do this. People pay national insurance contributions (payroll taxes in the US) and that entitles them to certain benefits. So they’re essentially saving for their retirement (and getting a generous subsidy to do so) without it showing up as wealth. I think a semi-private forced saving model, Singapore-style, might make people better off – but transition is hard and it would probably be a political nonstarter.

So the outlook is pretty depressing. It doesn’t seem like there’s a lot more we can do. And indeed the evidence is that inequality is really, really, really intractable. But there are a few things we could do.

Perhaps the most promising is deregulating the planning process – making it easier to build stuff and in particular tall stuff in big cities. This would push down house prices, making it easier for poor people to get on the housing ladder. It would provide steady construction jobs, resisting the bifurcation of the labour market (or be done cheaply by immigrants, which would be good too).

Perhaps most importantly, it would mean more people could afford to live in dense, high-productivity cities. In the (excellent) HBO series Girls, in order to make it as a writer, Lena Dunham’s character has to spend time working as an intern – and she can only afford to live in New York because her parents help her pay her rent. This is one of the biggest problems caused by wealth inequality. Even education-sceptics will acknowledge that the skills and networks you acquire through on-the-job training and internships are valuable. But few people without deep-pocketed parents can currently afford to pay London’s exorbitant rents while working for very low pay or even for free in order to work towards getting a high-paid job. Perhaps if the South Bank looked a bit more like Manhattan it wouldn’t be so hard.

(Human) Capital Punishment


Economists talk a lot about why we shouldn’t tax capital gains. The essential idea is sound – you’ve earned your money, it’s been taxed once, and the market value of that cash is the same whether you consume it now or invest it, get interest, and consume more later. If you tax the returns to investment, you make saving less attractive than it should be, and consuming now more attractive than it should be, which leads to there not being enough investment.

Now, a few economists are more sympathetic to the idea of capital taxes. If elasticities are low – rich people will still save lots anyway – it might be a relatively painless way of reducing inequality and getting revenue. And giving a preferential tax rate to capital gives people an incentive to pretend their wages are really capital (see carried interest loophole, the – or the absurd lengths English football players go to). But overall the consensus in the economics profession is that taxing capital is a really bad idea.

This is fine as far as it goes. But you get the worst of both worlds if one kind of capital is taxed more than another kind. You get less investment, and investment gets shifted towards the kind of capital that gets taxed at lower rates. And there is one kind of capital that gets taxed at exactly the same rate as wages – human capital.

Imagine you’re given £20000, and you’re given the option of investing that money in the stock market or spending it going back to school so that you can earn more from your labour in future. Any gains you get from your investment in stocks will be taxed like capital gains. But any gains you get from education will be taxed like wages, so you’ll probably pay more. And the progressive structure of the tax code makes this even worse because some of the ‘extra’ earnings might be taxed at an even higher rate than the rest of your income. So not only have the gains been taxed as wages but your overall average tax rate is higher than if you hadn’t invested in your education at all. The result of this is that people will invest too much in factories and machines, and not enough in education and training* - and the potential positive spillover effects of human capital only make the problem worse.

This is why we should listen to people like Scott Sumner when they caution us against the potential long-term effects of high marginal tax rates. Raising the top income tax rate might cause doctors today to work more, or it might cause them to work less, or it might cause them to dodge taxes. It might have a whole host of other effects. But one thing it does do is reduce the incentive for kids to put themselves through medical school in the future, because their investment in human capital is going to be taxed at a very high rate.

Of course, one way to fix the screwed-up nature of this system might be a shift towards greater consumption taxation, which might also solve someother problems. But how likely is that to happen?

*Of course, if you believe in the signaling model of education, then maybe this is a good thing.

Migration, Development, and Investing in Eastern Poland


Matt Yglesias has a pretty good answer prepared for the inevitable day when his psychotherapist asks why he didn’t invest in Eastern Poland – namely that conditional convergence (‘catch-up growth’) doesn’t happen within countries.
The theory he's appealing to here is "conditional convergence" and unfortunately it's dead wrong. Look around the world and you'll see that region-to-region convergence almost never happens. Mississippi is poorer than Massachusetts and has been for a long time. The same goes for Northern Italy and Southern Italy, or Scotland and England. East Germany hasn't caught up to West Germany since reunification despite massive public sector expenditure aimed at closing the gap. And the reason it doesn't happen, roughly speaking, is that people move. The economic opportunities are better in the richer part of the country and the most ambitious people from the poor part of the country move toward opportunity. They leave behind a population that's disproportionately composed of retired people, the less-ambitious segments of the native born population, and folks who've chosen to prioritize something in life other than big time professional success (bucolic country living, a strong sense of community, cheap land, whatever).
This is a good point. Northern England is a lot poorer than the South – and the problem has only been getting worse, not better, for the past 50 years. Matt provides a bunch of other similar examples, and suggests that this is because of economic migration. Cities have enormous agglomeration effects – prosperous regions are prosperous because lots of smart, hardworking people live there, which causes more people to move there in search of work, increasing the relative prosperity of those regions.

As someone who is sympathetic to the idea of open borders, I wonder about the extent to which this argument applies to immigration generally. Matt suggests that the reason why China hasn’t caught up with the UK is that ‘people can’t just pick up and move to London or New York or Tokyo.’ The flipside of this would be that, under open borders, there would be massive movement of people to very productive developed-world cities – and the convergence of China and India and Africa would suddenly stop.

I’m not sure this is true. It’s worth considering that the reasons for international income differences are different to the reasons for differences at the subnational level. One reason Eastern Poland is poor is because it’s further away from Germany, Poland’s main export market. Coastal China is the richest part of China largely because it’s, well, coastal. Lagos is poor, but Abuja is much poorer because it’s further inland in a region where road transport is unreliable and expensive.

One of the main drivers of international income differences are institutions. One of the reasons India is poorer than Poland is that India is very badly governed. Regulations enrich incumbents at the expense of everyone else. Contracts cannot be enforced because of the horribly bureaucratic legal system. Power and transportation infrastructure is bad. A lot of the government funds allocated to alleviating poverty are appropriated by corrupt officials. The rule of law is weak.

One of the main reasons India and China are getting much richer is that their institutions are improving, allowing the improvements in human capital and in technology deployment that lead to development. This is one of the reasons why China has grown faster than India has grown faster than Sub-Saharan Africa. But of course Eastern Poland is governed about as well as Western Poland. There isn’t room for Eastern Poland to develop relative to Western Poland by improving its government, because by and large they have the same government.*

The other point of course is that the income gap between China and the EU is a lot bigger than the difference between Eastern and Western Poland. And we wouldn’t be surprised if Chinese convergence to slow dramatically, or ground to a halt entirely, as Chinese per capita income gets to 70 or 80% of the level it is in the developed world.

One of the reasons for explosive Chinese growth has been in utilising technologies that it wasn’t using before. Companies eager to take advantage of cheap Chinese labour relative to the developing world have poured investment into building factories and deploying these technologies. As China develops, it no longer has the cheapest labour – but it has leapt up to the next rung on the development ladder, becoming the best in the world at producing goods like electronics. And already we are seeing China take the next step, along the path worn by South Korea and Japan before it – moving from producing to innovating. This post is brought to you by my laptop, courtesy of Lenovo. The worry is that if manufacturing moves to high productivity areas which now have quite cheap labour, then who is going to invest in bringing modern technology to developing? If there are no foreign manufacturers to attract, what incentive do local elites have to support good policies? And if this rung of the development ladder is missing then how can developing countries ever hope to reach the next one?

So would open borders halt development? Maybe. If lots of workers flocked to high-productivity areas, then wages would go down in those areas. In today’s world, companies sometimes pick the country with cheap labour and mediocre institutions over the one with expensive labour and good institutions – but in a world with open borders, they wouldn’t have to choose. And so there might not be that investment that pulls developing countries rapidly to the forefront of the 21st Century.

But on the other hand, one consequence of massive immigration is that land is going to become very expensive. We can think of this by comparing New York and Florida. Lots of companies find it beneficial to locate in New York, because there are lots of skilled workers there. Lots of skilled workers move to New York because that’s where the jobs are. This of course makes housing obscenely expensive in New York. So companies that don’t rely so much on agglomeration effects are going to move to areas where land is cheaper. And old people, who don’t benefit from being where the jobs are and don’t benefit from the trendy gastropubs, are also going to sell up and move to Florida. Another example of this happening is the exodus of British pensioners to Southern Spain, the land of sun, sea and a relatively low cost of living.

Similarly, in a scenario where there are open borders, workers are going to move to places where people are very productive. And that’s going to reduce (average) productivity in the areas they leave. But cheap land in the areas they leave is going to attract people who don’t really care about living in a very productive place. If the border between the USA and Mexico was open, lots of Mexicans would move to work in the States – but lots of American pensioners would buy beach condos in Mexico. Mexicans with low productivity, who cannot afford to live in big American cities, would be able to get jobs working for American pensioners.

This would obviously have a huge effect on politics, not least the detrimental fiscal impact – Florida would not be in great shape if the federal US government wasn’t picking up the tab for Medicare. But large capital inflows from retirees moving, as well as remittances from productive workers in big cities, will lead to higher standards of living in developing countries. And competition among developing countries for tourists and retirees, as well as the larger community of skilled expats, is likely to ensure that developing-world institutions continue to improve.

Open borders have really interesting implications for development. People think a lot about the impact of poor people moving to rich countries, but perhaps not as much as they should about rich people moving to poor countries. Under open borders, GDP per head in the developed world is likely to be much higher, while it might be somewhat lower in the developing world because productive workers will move and over time the equilibrium will entrench itself. But that doesn’t mean everyone won’t be better off as a result.

But one thing is clear. If you do invest in Eastern Poland, you probably want to build golf courses, and not factories.

*It’s a bit different under a federal system – and indeed well-governed Indian states like Gujarat are catching up faster than the poorly-governed ones. But these differences are also less likely to drive convergence in the long term.

Monday, 4 March 2013

Tax in a Time of Robots


Ashok Rao has a post arguing for a wealth tax, pointing to the diminishing share of income that goes to labour and questioning the financing of government in a future where capital income is likely to be an even larger proportion of GDP than it is today.

I remember Adam Ozimek (I think?) saying that the left's policies would make a lot more sense if today's world was a lot more like the capital-dominated world we might end up in in the future – the world bloggers are talking about when they talk about ‘robots’. (A good list of links to this discussion is here) A wealth tax seems to make quite a bit more sense in this future, where income taxes aren't reliable and most people's wealth is inherited (because fewer people are earning wages and saving, relative to the size of the capital stock).

However, I don't think Ashok does enough to address the argument from economic theory that there are a lot of strong reasons to oppose a large wealth tax. Similarly to the points Evan Soltas raised in his post:
  • Capital taxes distort intertemporal consumption preferences. I don't think this is as big a problem as is often made out - how much more can a superrich person really consume if tax rates go up? - but it's definitely a concern.
  • Is it moral to disproportionately hurt savers? Yes, big savers are mostly the uberrich – but should we be encouraging the rich to spend all their money on yachts and Batcaves, rather than encouraging them to finance investment, or endow charities?
  • Capital taxes foster avoidance. It's really hard to collect all that money. People will stash their assets abroad, they'll hide cash, and at the very least you'll create a lot of jobs for tax lawyers. I'm pretty sure the literature suggests that the revenue-maximising top rate of capital taxation is a lot lower than for income taxes.
  • Not only will it be very unpopular, but even if you did succeed, there'd be all sorts of exemptions and caveats. Some of these would be desirable. Many would not be. All would increase complexity and implementation costs.
  • Capital taxes have other weird effects. They can distort the debt-equity tradeoff. They can bias rich people against inflation if the tax is not indexed to inflation, and if the experience of the last five years has taught us anything, it’s that rich people being biased against inflation is a very bad thing. How will the tax treat declining asset values? What will the effects of the tax be on the relative demand for different risk classes of assets?

I think we need to think about the fundamental problem, which is that ‘wages are falling as a share of income, therefore taxes are harder to collect,’ in a different way. If people save more, then that will mean a bigger allocation of the economic pie to capital, and less to labour. But that isn’t necessarily a bad thing.

The main problematic implication of this would be that it would become harder for governments to collect taxes on labour, because more of total income is interest on past labour, and less is the (taxable) current labour – i.e. wages.

But it’s a fundamental point that a wage tax raises the exact same amount of revenue as the equivalent consumption tax.

Imagine two doctors, A and B. Both of them earn £100000.

A pays a 50% wage tax. The government takes £50000 from him when he earns the money. He spends all of the remaining money straight away.

B pays a 100% consumption tax. He spends all of the money straight away. The government takes £50000 when he spends the money.

The two taxes are equivalent in this case.

Now imagine the case in which both A and B choose to invest all of their money at a risk-adjusted interest rate of 100% per decade. (Yes, that’s implausibly high, to make the maths easier).

Usually this sort of scenario is used to show that, because the net present values of £100000 and £200000 in ten years is the same, capital taxes are distortionary and hurt savers. Scott Sumner did so here.

I’m going to look at it a little bit differently, however.

A gives his £50000 to the government straight away, and saves the other half of his wages. He earns a return of 100% over the next decade and, ten years later, buys £100000 worth of goods.

B invests his whole £100000, and gets £200000 back in ten years. He spends it all, pays £100000 to the government in consumption taxes, and gets his £100000 worth of goods.
In Scenario A, the government gets £50000 in the first period. In Scenario B, the government gets £100000 after ten years.  The crucial point to remember here is that, because the risk-adjusted real interest rate is 100% per decade, the two are functionally equivalent. This point should also hold across time horizons.

If the state taxes wages, and the wage share of income is falling, it has too much income now, and not enough income later. But this is essentially a problem of consumption smoothing – and if anyone can do consumption smoothing, the government can.

So the government has two choices.

Either it can tax away wages now, invest that money, and later use it to pay the bills. This is what Miles Kimball has been plugging in his calls for a sovereign wealth fund and in our twitter discussion about capital taxes.

Or it can implement a consumption tax that allows people to save the money now, and the government will tax it away when they later spend the money. The USA would implement a VAT. European countries which already have one would raise theirs. A lot has been said about the various economic benefits of (progressive) consumption taxation, but this is an interesting angle on the idea that I haven’t seen discussed before.

I think consumption taxes generally trump the sovereign wealth fund idea (although they’re not necessarily incompatible – you could do a mixture of both). There are a few reasons for this.

Sovereign wealth funds may not be managed effectively. This is partly a problem of size. Norway’s sovereign wealth fund owns 1% of the global stock market. If the USA had a comparable fund, it would be enormous. Would it be able to find good places to invest that money? Even if there were good investment opportunities, it might be difficult for state-managed corporations to find them. There would be a powerful temptation to divert money to popular causes, such as ‘green’ industries or flagging auto companies.

Sovereign wealth funds would be difficult to accumulate. Government saving now to pay for spending later is extremely politically unpalatable. It would require huge government surpluses, perhaps of 10% of GDP or more, to finance future spending. Politicians – not to mention voters – would be quite aggrieved about this, when we have major problems today that we might be attending to. There would be the temptation to divert money to current spending at the expense of future spending, which is already a major problem in politics generally.

Consumption taxes are better than wage taxes in some other ways. Because you don’t have to have a distinction between wage and capital income – income is not taxed at all – there isn’t the incentive to reclassify wage income as capital income. This gets rid of a whole can of worms. Goodbye, carried-interest loophole.

Instead of saving money itself, the government tells people to take their money and invest it wherever they want, and spend it whenever they want – just with the knowledge that when they do spend that money the tax man will take his cut. This kind of implicit government saving solves quite a lot of the political problems associated with, for example, a sovereign wealth fund.

Moreover, it would appease Ashok and people like him by imposing a de facto wealth tax. People’s current wealth, accumulated under the old income tax system, would have incurred the old high rates of wage taxation when it was earned. When they spent it, it would also incur the new high rates of consumption taxation. So the rich get soaked.

But, crucially, they don’t get soaked in as distortionary a way as they would with a full-on wealth tax. Because the effective wealth tax is levied as part of tax reform, there is a credible commitment not to go back and impose another wealth levy. You can’t rebalance your system in favour of consumption taxes twice. It wouldn’t require assessment of people’s wealth, and it would be impossible to avoid. Further, because the wealth tax isn’t explicit, it would be easier to sell politically. And news of an impending rise in consumption taxation would stimulate spending now, hopefully jumpstarting the economy.

Ultimately, the government is going to need enough money to finance its operations and do some redistribution as well – especially in a future where inequality is potentially worse than it is now. I think wealth taxes are clearly unfeasible, and there are numerous practical objections to a sovereign wealth fund. A shift to greater consumption taxation would be more economically efficient – and it would also solve this problem.

Wednesday, 27 February 2013

The Case for NGDP Targeting

I have half a post plugging NGDP targeting over at Lib Dem Voice.

The Times is reporting that the Treasury is setting up an internal unit to look into the wisdom of revising the Bank of England’s ‘flexible’ 2% CPI inflation target. Mark Carney, the incoming Governor of the Bank who will replace Mervyn King in June, mentioned the merits of adopting NGDP (National Gross Domestic Product) level targeting in a speech last December, launching a frenzy of speculation. 
Considering the enormous effect expectations of future monetary policy changes have had in places such as Japan, it may be that the talk of NGDP targeting is partly behind the substantial rise in the FTSE and fall in the pound since around the New Year. Recently, however, both he and George Osborne have seemed to be rowing back on their support for their policy. Therefore, it’s worth reviewing – as the Treasury is – the case for listening to Vince Cable and targeting the level of nominal GDP instead of inflation. 
When discussing NGDP targeting, too often politicians and commentators see it as some kind of policy of ‘targeting growth.’ To clarify, NGDP targeting requires the Bank to make no assumptions about the rate of real output growth. A better way to think about it is targeting the amount of nominal spending in the economy. 
There are several advantages to targeting nominal spending as opposed to rises in the price level. Perhaps the most major reason is that NGDP is a better indicator of demand in the economy. If there are negative ‘shocks’ to the real economy – a rise in oil prices, say – then it will raise inflation, but that will not be an indicator that the economy is overheating. It would not be appropriate for the Bank of England to tighten monetary policy, reducing import prices by ensuring that people are too poor to afford them. Because a real shock would raise prices but reduce real growth, NGDP would be unaffected, allowing the central bank to ‘look through’ real shocks and avoid tightening monetary policy too much in response to sudden bursts of inflation that are outside their control. 
In 2008, for example, the Bank would have been able to see past commodity price rises and the realisation that perhaps we weren’t as productive as we thought we were, and realise that demand was collapsing. They might have prevented the banking crisis from becoming systemic and leaching through into the wider economy. 
Similarly, in the 1970s the Bank would have been able to see past the supply side effects of the oil crisis and see that accelerating NGDP growth was also pushing up prices and causing a wage-price spiral. The worst of stagflation might have been prevented. The story, of course, cuts both ways – if there are positive supply shocks, the Bank would avoid easing and overheating the economy. 
There’s a fairly strong case that in the early noughties, falling import prices thanks to cheap Chinese production and the strong pound led monetary policy to be too easy, pushing NGDP growth above trend and helping to inflate the housing bubble. NGDP targeting, then, isn’t just a recipe for monetary easing – it would promote stability at all points of the business cycle.
Another advantage of nominal GDP targeting is that it’s much easier to measure than inflation. Inflation requires you to estimate how much prices are rising by. There are several different measures, and all of them give wildly different results, each with wildly different implications for the required stance of monetary policy. The Consumer Price Index that the Bank currently targets is going to be 0.3% higher for the next three years because of the increase in tuition fees, which is not a rise in the price of higher education at all but rather a change in who pays for it. The VAT rise in 2011 created similar distortions that arguably caused the Bank to miss the derailing of the recovery. 
Measuring nominal spending is comparatively easy. Concerns about revisions to the data are overblown because headline NGDP growth would be only one of the factors affecting the Bank’s stance – inflation expectations, asset prices, unemployment and other indicators would also be used to estimate the future path of nominal GDP and therefore the appropriate policy stance. There are also ways of adapting the policy regime to compensate. 
The advantages of targeting NGDP rather than inflation are numerous and sceptics tend to overstate their case. It’s far easier for the government to tighten fiscal policy and deal with the deficit when monetary policy is co-operative; austerity may be hurting the economy right now, but there’s no reason why it has to be that way. Even absent level targeting, which I’ll address in a future post, nominal GDP is the key to a more stable monetary framework which would dramatically reduce the likelihood of future recessions.