Category: Economics

The Lesson of the Spoons

In a story beloved by economists it’s said that Milton Friedman was once visiting China when he was shocked to see that, instead of modern tractors and earth movers, thousands of workers were toiling away building a canal with shovels. He asked his host, a government bureaucrat, why more machines weren’t being used. The bureaucrat replied, “You don’t understand. This is a jobs program.” To which Milton responded, “Oh, I thought you were trying to build a canal. If it’s jobs you want, you should give these workers spoons, not shovels!”

A funny story but one I was reminded of by Greta van Susteren’s not so funny tweet.

Bear in mind that Van Susteren has 1.2 million followers and, according to Forbes, is the 94th most powerful woman in the world.

Of course, there is something odd about using advanced technology to do a job that could be done by millions of immigrants who would be quite happy for the work, but Van Susteren is also against immigration.

Is there anything to be said for banning automation in low-skilled work? Let’s be charitable and assume that there is a problem with not enough work for low-skill workers. It’s unlikely that the best way to address this problem is by banning improvements in productivity. Which sectors are to be artificially restrained and by how much? Should fast checkout workers be banned? Should we prevent customers from walking the aisles and filling their own shopping carts? Remember, self-selection of goods was also once an innovation. As Friedman pointed out, it’s all too easy to reduce productivity.

To the extent that low-skill workers can’t find work (i.e. ZMP workers) the appropriate policy is a wage subsidy as Nobelist Edmund Phelps has suggested (see also the MRU video and Oren Cass on wage subsidies). A wage subsidy is better targeted than the Luddite smashing of machines and because it doesn’t prevent productivity from growing it makes for greater wealth to support the subsidy.

*More from Less*

The author is Andrew McAfee and the subtitle is The Surprising Story of How We Learned to Prosper Using Fewer Resources — And What Happens Next.

I am a fan of Andrew’s work more generally, and most of all I am pleased to announce this is a book full of good economic reasoning.  From the publisher’s attachment:

How did we start getting more from less?  Largely because of two unlikely heroes: capitalism and technological progress.  As the book explains, capitalism’s relentless quest for profits is also an endless search for lower costs — after all, a penny saved is a penny earned — and natural resources cost money.  Tech progress gives companies countless opportunities to dematerialize: to use bits instead of atoms, and so consume fewer resources even as they grow.

I have yet to read my way through all of the book, and I will be reporting more on this.  I can assure you, however, that Andrew is not a denialist on the issues where worry really is called for.  Here is the Marc Andreessen blurb:

“In More from Less Andrew McAfee conclusively demonstrates how environmentalism requires more technology and capitalism, not less. Our modern technologies actually dematerialize our consumption, giving us higher human welfare with lower material inputs. This is an urgently needed and clear-eyed view of how to have our technological cake and eat it too.”

In any case, I wanted to bring this book to your attention as soon as possible.

How much would German stimulus raise the steady-state return on private capital?

I have been following a bunch of Twitter discussions around this topic, but I would like a firm estimate — if only your guesstimate — how much more German spending on infrastructure would boost general rates of return.  One side question is whether such a policy might drag Germany out of its current negative yield equilibrium.

There is (I think) general agreement on a few magnitudes, noting that the moving averages may be more relevant than last year’s numbers:

Government consumption in Germany is modestly below 20% of gdp.

Total government spending in Germany is modestly below 50% of gdp.

Germany could and should spend another 1% or 2% more of gdp boosting its infrastructure.

The current German unemployment rate is about 3%.

Germany runs large trade surpluses, relative to gdp, so the aggregate demand shortfall there cannot be biting too hard.

It would be good for the Eurozone as a whole if the ECB were to adopt a more expansionary monetary policy, at least under some conditions (so no need to reiterate that in the comments).

OK, so here is the thought experiment. Let’s say Germany spends 2% of gdp more a year on roads, better internet speed, upgrading airports — whatever is best.  And they do this each year for “as long as it takes.”

As we approach the new steady-state, how much higher is the private return on capital?  (And what is then the implied rate of return on fiscal policy?)

Note that the higher taxes, even if you postpone them through debt, will involve some deadweight loss and output restrictions sooner or later.

And what is the chance that brings Germany out of negative yield territory on its government securities?

Inquiring minds wish to know.

Addendum: Keep in mind that most government projects these days are not direct output, rather they are inputs toward selling or producing further private sector outputs.  So you build a better road so more people can get to the store, and the journey of the supply trucks is easier too.  That means when the private sector activity shows constant returns to scale, while the greater output will be desirable, the private rate of return on those activities won’t be going up at all, not in the steady state.  So a big chunk of the government spending, while it may boost consumer surplus, won’t increase rates of return period.

According to this study (its p.8 source is official but I cannot verify “according to the author’s calculations”) the rate of return on private capital in Germany in 2013 was slightly below four percent.  But say you have a capital share of output at about fifty percent and a four percent yield on that.  Capital then is giving you an extra 2% a year of gdp, it would seem.  Say that by spending 2% of gdp on infrastructure you could double the rate of return on all that capital (which seems implausible to me I might add).  You are then spending about 2% of gdp a year to get…about 2% of gdp a year.  I am sure those are not the correct, exact numbers but…what is the better non-question-begging way to think about the problem?

Your best bet of course is to invoke project durability.  Say you spend 2% of gdp for seven years (Germany isn’t so quick at building things), and you get infrastructure that lasts say twenty years before needing another upgrade.  Years 8-20 it is pure bonanza (except the higher taxes may be kicking in then).  That is indeed why I think the spending is a good idea.  But that is hardly “stimulus.”  It is much closer to “we forgo valuable output for a bunch of years and much later people are better off with better roads and yes long-run growth is important.”

Of course that explains why the current government is less than enthusiastic to do this “stimulus.”  The Merkel government isn’t stupid, it simply has a limited time horizon, and it doesn’t assume that demand-side economics is a free lunch at three percent unemployment.

And by the way, that spending is not, over any time horizon, likely to actually double the private rate of return on capital.

Along the way, how are the negative yields supposed to disappear?  In year eight, when the net benefits finally kick in?  Reflected in the term structure now, for the arrival of year eight?  (Really?)  In the meantime, the German economy is modestly poorer.

If you disagree, please show your work.  No moralizing about austerity or surplus countries, please.  Show your work.

Why not more annuities?

From a reader in the know:

Annuities are often unappealing because they’re expensive, and they’re expensive because of the capital rules and market dynamics. Capital rules make it challenging for insurers to back annuities with anything but investment grade debt. Using a 50/50 A/BBB portfolio would require capital of about 5% of annuity premium. Additionally these products never sell without the intervention of a sales rep, who will require a commission of 3-10% depending on annuity type.

So now the insurer’s shareholders have committed 10% of premium and need to earn a return on that equity. If I target an ROE of 12% (common in the industry), I need to earn a net 120 bps of spread (and more to amortize the commission!). So in effect, the customer is paying to get a treasury yield or worse. It’s understandable why they may prefer to take their chances with more traditional investments.

Has the time come and passed for negative interest rates?

That is the topic of my latest Bloomberg column, here is one excerpt:

Step back and consider the cultural context. Germany is still scarred by the memories of two world wars, fascism, communism, deflation and hyperinflation: in general, huge instability. Since the end of World War II, however, personal savings and the banking system have been an oasis of predictability and a driver of growth. Many Germans treasure their frugality, perhaps excessively or irrationally, and it has become an important part of the narrative Germans tell themselves about the economic order they have built.

Now enter the ECB, in essence telling Germans (and others) that savings are a bad thing, to be taxed and penalized. The very word “negative,” as in “negative interest rate,” makes the policy hard to sell politically. The German word “Strafzinsen” refers to a penalty rate, but the root “Straf” also refers to punishment, and it was used effectively by Franz Kafka in his famous torture-laden short story “In the Penal Colony” (the German title is “In der Strafkolonie”). One German newspaper referred to the “final expropriation” of the German saver, noting that the ECB’s decision to deviate from its inflation target carries “grave consequences.”

More generally, a significant segment of the German population is upset or outraged by the policy. There is even a claim that the revenue from the negative interest payments will be used to finance other EU countries.

Most economists and central bankers view negative interest rates as an acceptable tool of macroeconomic management. Maybe so. But in an era when trust, including trust among nations, is much lower than previously thought, it probably isn’t a good idea to place a punishing new tax on the German national virtue of saving. Central bankers must also be sensitive to public relations.

I find it striking how many people are responding to this column by insisting that Merkel should do more fiscal stimulus.  She should (though I don’t find “stimulus” to be the most instructive word here), as I suggest in the piece, because the Germans have been letting their infrastructure run down for a good while now — internet speeds anybody?  But at the end of the day, I don’t think that spending will eliminate the basic macroeconomic problem facing the EU, nor is most of that spending likely to land on the doorstep of the countries which most need it (though Huawei may benefit a good deal).  There is also this:

So if a policy of negative interest rates is just a Band-Aid, it is one that should be ripped off. And if monetary policy is insufficiently expansionary, that is going to require an increase in the ECB’s inflation target, or a move to nominal GDP targeting, not a jerry-rigged tax on deposits.

There is also an argument that Germans are saving too much. But by some measures, they have a level of national wealth relatively low for their per capita income, in part because Germans are less likely to own their own homes. According to the OECD, Germany’s near neighbors Sweden, Denmark, the Netherlands, and Switzerland all save more in percentage terms than Germany does.

German savers: underrated.

The rise of niche consumption

Here is a new and neat paper which, to the extent it is true, would appear to address several significant puzzles at once.  From Brent Neiman and Joseph S. Vavra:

We show that over the last 15 years, the typical household has increasingly concentrated its spending on a few preferred products. However, this is not driven by “superstar” products capturing larger market shares. Instead, households increasingly focus spending on different products from each other. As a result, aggregate spending concentration has in fact decreased over this same period. We use a novel heterogeneous agent model to conclude that increasing product variety is a key driver of these divergent trends. When more products are available, households can select a subset better matched to their particular tastes, and this generates welfare gains not reflected in government statistics. Our model features heterogeneous markups because producers of popular products care more about maximizing profits from existing customers, while producers of less popular niche products care more about expanding their customer base. Surprisingly, however,our model can match the observed trends in household and aggregate concentration without any resulting change in aggregate market power.

This is related to what I called “matching” in The Complacent Class.

The Entire German Yield Curve is Trading Below Zero

The German government could today borrow billions of Euro and in a decade they could give back to investors less than they borrowed and the investors would be happy. Does the German government have no net positive investments to make?

The global savings glut which drives asset prices higher and makes them more volatile is very much still with us. Around the world there is now over 15 trillion in negative interest debt.

From the FT.

The labor share is not in general falling

We study the joint impact of three measurement issues in the empirical literature on the labor share: (i) start and end periods for the empirical analysis; (ii) accounting for self-employment; and (iii) accounting for residential real estate income. When we correct for these three potential biases, we do not find a general decline in the labor share in our sample of advanced economies. In that respect the behavior of the US labor share after 2000 presents a puzzle.

That is from a new NBER Working Paper by Gilbert Cette, Lorraine Koehl, and Thoimas Philippon.

Identity Politics Versus Independent Thinking

Anthony Kronman, former Dean of the Yale Law school, writes in the WSJ:

The politically motivated and group-based form of diversity that dominates campus life today discourages students from breaking away, in thought or action, from the groups to which they belong. It invites them to think of themselves as representatives first and free agents second. And it makes heroes of those who put their individual interests aside for the sake of a larger cause. That is admirable in politics. It is antithetical to one of the signal goods of higher education.

…Grievance is the stuff of political life…Academic disagreements are different. Important ones are often inflamed by passion too. But the goal of those involved is to persuade their adversaries with better facts and arguments—not to bludgeon them into submission with complaints of abuse, injustice and disrespect to increase their share of power. Today, the spirit of grievance has been imported into the academy, where it undermines the common search for truth by permeating it with a sense of hurt and wrong on the part of minority students, and guilt on the part of those who are blamed for their suffering.

…For college students, the search for truth is important not because reaching it is guaranteed—there are no such guarantees—but as a discipline of character. It instills habits of self-criticism, modesty and objectivity. It strengthens their ability to subject their own opinions and feelings to higher and more durable measures of worth. It increases their self-reliance and their respect for the values and ideas of those far removed in time and circumstance. In all these ways, the search for truth promotes the habit of independent-mindedness that is a vital antidote to what Tocqueville called the “tyranny of majority opinion.”

…Tocqueville was an enthusiastic admirer of America’s democracy. He thought it the most just system of government the world had ever known. But he was also sensitive to its pathologies. Among these he identified the instinct to believe what others do in order to avoid the labor and risk of thinking for oneself. He worried that such conformism would itself become a breeding ground for despots.

As a partial antidote, Tocqueville stressed the importance of preserving, within the larger democratic order, islands of culture devoted to the undemocratic values of excellence and truth. These could be, he thought, enclaves for protecting the independence of mind that a democracy like ours especially needs.

Today our colleges and universities are doing a poor job of meeting this need, and the idea of diversity is at least partly to blame. It has become the basis of an illiberal and antirational academic cult—one that undermines the spirit of self-reliance and the commitment to truth on which not only higher education, but the whole of our democracy, depends.

Genetic Endowments and Wealth Inequality

That new paper by Daniel Barth, Nicholas W. Papageorge and Kevin Thom is attracting a great deal of attention and also some controversy.  Here is the first sentence of the abstract:

We show that genetic endowments linked to educational attainment strongly and robustly predict wealth at retirement.

But it’s not mainly about IQ.  I found this to be the most interesting part of the paper, noting that EA is a polygenic score:

Our use of the EA score as a measure of biological traits linked to human capital is related to previous attempts in the literature to measure ability through the use of tests scores such as IQ or the AFQT…We note two important differences between the EA score and a measure like IQ that make it valuable to study polygenic scores. First, a polygenic score like the EA score can overcome some interpretational challenges related to IQ and other cognitive test scores. Environmental factors have been found to influence intelligence test results and to moderate genetic influences on IQ (Tucker-Drob and Bates, 2015). It is true that differences in the EA score may reflect differences in environments or investments because parents with high EA scores may also be more likely to invest in their children. However, the EA score is fixed at conception, which means that post-birth investments cannot causally change the value of the score. A measure like IQ suffers from both of these interpretational challenges. High IQ parents might have high IQ children because of the genes that they pass on, but also because of the positive investments that they make…Compared to a cognitive test score like IQ, the EA score may also measure a wider variety of relevant endowments. This is especially important given research, including relatively recent papers in economics, emphasizing the importance of both cognitive and non-cognitive skills in shaping life-cycle outcomes (Heckman and Rubinstein, 2001). Existing evidence suggests a correlation of approximately 0.20 between a cognitive test score available for HRS respondents and the EA score (Papageorge and Thom, 2016). This relatively modest correlation could arise if both variables measure the same underlying cognitive traits with error, or if they measure different traits. However, Papageorge and Thom (2016) find that the relationship between the EA score and income differs substantially from the relationship between later-life cognition scores and income, suggesting that the EA score contains unique information…

…we interpret the EA score as measuring a basket of genetic factors that influence traits relevant for human capital accumulation.

If I understand the paper correctly, the polygenic score is what predicts well from the genetic data set, it is not a “thing with a known nature.”  And I believe the results are drawn from the same 1.1 million person data set as is used in this Nature paper.

A Toolkit of Policies to Promote Innovation

That is the new Journal of Economic Perspectives article by Nicholas Bloom, John Van Reenen, and Heidi Williams.  Most of all, such articles should be more frequent and receive greater attention and higher status, as Progress Studies would suggest.  Here is one excerpt:

…moonshots may be justified on the basis of political economy considerations. To generate significant extra resources for research, a politically sustainable vision needs to be created. For example, Gruber and Johnson (2019) argue that increasing federal funding of research as a share of GDP by half a percent—from 0.7 percent today to 1.2 percent, still lower than the almost 2 percent share observed in 1964 in Figure 1—would create a $100 billion fund that could jump-start new technology hubs in some of the more educated but less prosperous American cities (such as Rochester, New York, and Pittsburgh, Pennsylvania). They argue that such a fund could generate local spillovers and, by alleviating spatial inequality, be more politically sustainable than having research funds primarily flow to areas with highly concentrated research, such as Palo Alto, California, and Cambridge, Massachusetts.

In general I agree with their points, but would have liked to have seen more on freedom to build, and of course on culture, culture, culture.  At the very least, policy is endogenous to culture, and culture shapes many economic outcomes more directly as well.  I’m fine with tax credits for R&D, but I just don’t see them as in the driver’s seat.

Paul Krugman’s Most Evil Idea

Erik Torenberg, co-founder of the VC firm Village Global, interviews me in a wide-ranging podcast. Here is one bit from a series of questions on what do you disagree about with ____. In this case, Paul Krugman.

AT: …Krugman and I are almost in perfect agreement. Only marginally different. Paul says ‘Republicans are corrupt, incompetent, unprincipled and dangerous to a civil society’. I agree with that entirely. I would only change one word. I would change the word Republicans to the word politicians. If Paul could only be convinced of doing that, coming over to the libertarian side, we would be in complete agreement. But he is much more partisan than I am and even though I worry about Republicans more than Democrats at this particular point in time I think the larger incentive is that we all need to be worried about politicians rather than any one particular party.

Although I agree with Paul a lot of the time, sometimes he does just drive me absolutely batty. He just says things which I think are so wrong. In his latest column which to be fair was written as a column fifty years in the future so maybe it was a bit tongue in cheek. The column was pretending that Elon Musk and Peter Thiel were a hundred years of age and fit and fiddle and still major players in society. And Krugman wrote:

Life extension for a privileged few is by its nature a socially destructive technology and the time has come to ban it.

Now to me this is just evil. This is like something out of Ayn Rand’s Anthem, that it is evil to live longer than your brothers and all must be sentenced to death so that none live more than their allotted time. I think it is evil if we accept even the premise of his argument that these technologies are very expensive. Even on that ground it’s evil to kill people just so that they don’t live longer than average. But perhaps even a bigger point is that I think these technologies of life extension are some of the most important things that people are working on today. And the billionaires are doing an incredible service to humanity by investing in these radical ideas and pushing the frontier and that is going to have spillover effects on everyone. If we are to reach the singularity it will because the billionaires are getting us there earlier and faster and they are the ones pushing us to the singularity and everyone will benefit from these life extension technologies.

So I agree with Paul quite a bit, more than you might expect, but sometimes he just says things which are absolutely evil.

We cover open borders, whether capitalism and democracy are compatible, the Baumol effect and more. Listen to the whole thing.

Average is Over: Newspaper Edition

Joshua Benton at the LA Times illustrates average is over for newspapers. On the left the print circulation of major newspapers in 2002. The NYTimes is the leader but other newspapers follow closely behind in a slowly decaying curve likely related to city size. On the right, 2019 digital subscriptions. The NYTimes dominates. Only the Washington Post is even in the same league (The Wall Street Journal, however, should also have made Benton’s list at 1.5 million digital subscribers.) Without classified ads and other local information, for which there are now multiple online substitutes, there isn’t a big demand for local newspapers. News is now national and only a handful of newspapers can survive at national scale. Moreover, the few who can survive at national scale are now so much better than their competitors precisely because they can afford to be better.

Image

 

Collective reputation matters for firms

This paper uses the 2015 Volkswagen emissions scandal as a natural experiment to provide evidence that collective reputation externalities matter for firms. We find that the Volkswagen scandal reduced the U.S. sales of the other German auto manufacturers—BMW, Mercedes-Benz, and Smart—by about 105,000 vehicles worth $5.2 billion. The decline was principally driven by an adverse reputation spillover, which was reinforced by consumer substitution away from diesel vehicles and was partially offset by substitution away from Volkswagen. These estimates come from a model of vehicle demand, the conclusions of which are also consistent with difference-in-differences estimates. We provide direct evidence on internet search behavior and consumer sentiment displayed on social media to support our interpretation that the estimates reflect a reputation spillover.

That is from a new NBER Working Paper by Ruediger Bachmann, Gabriel Ehrlich, Ying Fan, and Dimitrije Ruzic.