Category: Economics

So reports The Washington Post.  It is worth reviewing (my interpretation of) Milton Friedman:

1. Attempts to stabilize nominal exchange rates, as the Chinese are doing, can in fact be destabilizing, since the eventual adjustment will often come suddenly rather than gradually.

2. Accelerating that adjustment by passing laws aimed at foreign countries is unlikely to be a good idea.  The laws encourage a sudden adjustment now, become a focus on rampant speculation, and the target of the laws is unlikely to react with good grace or feel gratitude. 

3. In the long run a country can peg its nominal exchange rate but not its real exchange rate.  In other words, if the Chinese lower the value of the yuan sooner or later Chinese prices will rise to restore the appropriate terms of trade.  Sterilization of flows (e.g., soaking up Chinese money supply by selling bonds) can succeed for only so long and eventually the problem will cure itself.

4. We might have to actually apply the punitive tariffs.

In other words, this development is really bad news.

Read all about it, via Brad DeLong.  I’ll add a dose of Michael Polanyi to the debate and note that recommender systems work best when combined with non-articulable knowledge.

Alan Blinder had a good column yesterday, summarized and discussed by Mark Thoma.  The current movement, supported by Greg Mankiw I might add, is trying to raise the rate of taxation on private equity income so that Warren Buffet is not paying a lower tax rate than someone poorer than me.  More generally, it seems to many people that the rate of taxation on capital gains should be the same as the rate of taxation on ordinary income.

It’s hard to go against the weight of that opinion, but I would like to refocus the debate on the difference between stated and real rates of capital taxation, most of all with regard to loss offsets.  I haven’t seen this discussed in the very recent debates, though it is an old theme in public finance.

My uninformed-by-ever-having-been-a-tax-lawyer sense is that loss offsets for the capital gains tax are worth a great deal to some investors.  Sell your winners to coincide with selling some losers and claim a net gains income of zero or very low.  Let the asset winners ride and they will end up in your bequest and have their taxable values reset upon your death.  If your option values line up the right way, you have enough diversification, and you are not liquidity constrained, it seems that for many people the de facto rate of capital gains taxation is not 15 percent but rather close to zero.  (Maybe not quite zero in expected value terms; it’s tricky because if the losses exceed the gains you can deduct only $3000 of the losses from regular income but on the upside you’re taxed all the way.  On the other hand, you can offset with charitable deductions.)

Let’s say we raised the book rate of tax on capital gains to forty percent.  For some people the net real rate of tax on capital gains could still be zero.  For other people it would be forty percent.

Let’s say we raised the book rate of tax on capital gains to eighty percent.  For some people the net real rate of tax on capital gains could still be zero.  For other people it would be eighty percent.

Under which of these scenarios have we equalized the tax rates on capital gains and labor income?

For any published capital gains rate, it seems there are two or more (and possibly wildly disparate) real rates de facto.  Again, I’m no tax lawyer, but it seems any capital gains tax hike falls disproportionately on the non-diversified (if you hold only one asset and it is a huge winner, where can you get a loss offset from?  The quality of your tax accountant probably matters too.  Any other factors?).

No matter what, capital gains rates for some investors are too high and for others the rates are too low.  And don’t be shocked if many of those "too low" rates are enjoyed by the wealthy.  There will be unfairnesses when compared with income taxation as well.  It is a question of choosing your unfairness, not being able to eliminate unfairness or differential treatment.  So the mere fact that one apparently unjustified unfairness has been pointed out…well…I’m not yet ready to cry uncle.

One reason why the Clinton tax hikes weren’t so bad for capital formation is because capital gains taxes can be avoided in various ways.  The Bush defenders should recognize that and admit that K gains tax hikes are not always a disaster.  On the other hand, the notion of equalizing income and capital gains rates is a myth, and always will be.  There simply isn’t a single capital rate that ends up applied to everyone, no matter what it says on paper.

You might go down another path and talk about eliminating the loss offset.  I wonder if that can be done feasibly.  For instance it would mean that assets A and B, held together in a mutual fund are worth more than assets A and B held separately.  You can think of other problems with this in your spare time.

Yet another (and better) path is to institute a consumption tax, but in the meantime these other kinds of unfairness are not going to disappear.  See also Martin Feldstein on other costs of capital income taxation.

It makes perfect sense to say: "we’ve already spent the money, taxes somewhere have to go up."  But the Buffet example, taken alone, doesn’t convince me much.  Let’s start by taxing negative externalities at a higher level, not by focusing on major creators of wealth.

Some states ban the use of credit scores to price auto insurance in part because African-Americans and Hispanics tend to have lower (worse) credit scores and thus pay higher auto insurance rates.  The brute facts, however, are that credit scores are good predictors of auto claims. Luke Froeb at Management R&D summarizes a recent FTC study on the issue.

1. Credit scores effectively predict … the total cost of [auto insurance] claims.
2. Credit scores permit insurers to evaluate risk with greater accuracy, which may make them more willing to offer insurance to higher-risk consumers … . [note: this is why you can call up GEICO, let them look at your credit report, and get an auto insurance quote over the phone].
3. ..as a group, African-Americans and Hispanics tend to have lower scores than non-Hispanic whites and Asians.
4. …scores effectively predict risk of claims within racial and ethnic groups.
5. The Commission could not develop an alternative scoring model that would continue to predict risk effectively, yet decrease the differences in scores among racial and ethnic groups.

Thus banning the use of credit scores would at best force good drivers (of all races) to subsidize bad drivers.  At worst, if insurance companies cannot price according to risk an adverse selection problem could be created in which good drivers purchase less insurance (to avoid having to pay the subsidy to bad drivers) thus pushing rates even higher and perhaps unraveling the market.

Today I will pick E. Glen Weyl, a mere Youngling, who is studying at Princeton University.  Here is his paper on neural networks, and the abstract:

I consider a potential neural basis of overconfidence, the well-documented tendency of individuals to overestimate the precision of their predictions. I present a simple, classic connectionist model for predicting a binary variable. I show that while the network initially makes weak predictions (in the middle of the probability range) regardless of input, after observing randomly generated data it learns to be overconfident in the sense that when presented with other, unrelated random data it makes strong predictions. The model matches behavioral data in that it shows overconfidence growing with experience and then, eventually, declining. The model shows how overconfidence, far from being a surprising fallacy, can be seen as a natural outgrowth of statistical over-fitting in the brain.

Glen probably won’t be underappreciated for long.  Here is his seminal paper on two-sided markets (e.g., Match.com).  There is already talk he will be a leading economist of the next generation.

Here is Glen’s home page, and his other papers.

Here is Dave Warsh on Weyl.  Here is an article full of praise.  (He’s already looking non-underappreciated; note the CV, A.B. 2007, Ph.d. expected 2008.)  Here is Glen’s commencement address.  Here is Glen’s fight against protectionism.  Here are Glen’s film reviews.  Here is Glen’s dining guide for Princeton cuisine (hmm…).

I very much liked Glen’s paper on Simon Kuznets: Economist of the Russian Jewish Diaspora.

Here is Glen’s muse, Alisha Holland.  Here is Glen’s path to Unitarianism.

Let us all be grateful for people like Glen Weyl.

You’ll find a lengthy list of criticisms here, read for instance the continuing invective from the usually reasonable Ezra Klein.  Brooks for instance wrote:

…after a lag, average wages are rising sharply. Real average wages rose by 2 percent in 2006, the second fastest rise in 30 years.

This met with many screams, not the least because he did not report the median wage.  Yet the following shows up as reported in Brooks’s own NYT:

The average hourly wage for workers below management level [emphasis added] – everyone from school bus drivers to stockbrokers – rose 2.8 percent from October 2005 to October of this year [2006], after being adjusted for inflation, according to the Bureau of Labor Statistics. Only a year ago, it was falling by 1.5 percent.

The author on that piece is David Leonhardt (with Jeremy Peters), who is usually accorded significant (and deserved) respect by the left-wing side of the blogosphere.  Yes there are other ways to read the data, and of course that was December, but read that piece and you will see that Brooks is not way out of line.  For instance Leonhardt and Peters report (with caveats):

For now, however, paychecks are growing fatter in nearly every corner of the economy.

A 2007 update shows higher gas prices hurting this trend in real terms; that doesn’t change the fact that labor markets have been doing better than in the recent past.

Brooks makes nine claims (or try this link), and to my eyes eight of them check out directly, based on material I am familiar with and yes I mean the original sources, not journalistic summaries of them.  (I should note it is not easy to estimate the total gains from globalization, and I wouldn’t put much weight on any particular number here; still those gains are likely very large, as Brooks suggests.) 

I am busy recording your podcast requests, and haven’t had time to check out his claim number two:

The second complicating fact is that according to the Congressional Budget Office, earnings for the poorest fifth of Americans are also on the increase. As Ron Haskins of the Brookings Institution noted recently in The Washington Post, between 1991 and 2005, “the bottom fifth increased its earnings by 80 percent, compared with around 50 percent for the highest-income group and around 20 percent for each of the other three groups.”

Your opinions on this claim are, of course, welcome in the comments.  But in the meantime the economy — however imperfect — simply isn’t as bad as many bloggers are suggesting.

We again see life imitating art:

The picketers marching in a circle in front of a downtown Washington office building chanting about low wages do not seem fully focused on their message.

Many have arrived with large suitcases or bags holding their belongings, which they keep in sight. Several are smoking cigarettes. One works a crossword puzzle. Another bangs a tambourine, while several drum on large white buckets. Some of the men walking the line call out to passing women, "Hey, baby." A few picketers gyrate and dance while chanting: "What do we want? Fair wages. When do we want them? Now."

Although their placards identify the picketers as being with the Mid-Atlantic Regional Council of Carpenters, they are not union members.

They’re hired feet, or, as the union calls them, temporary workers, paid $8 an hour to picket. Many were recruited from homeless shelters or transitional houses. Several have recently been released from prison. Others are between jobs.

"It’s about the cash," said Tina Shaw, 44, who lives in a House of Ruth women’s shelter and has walked the line at various sites. "We’re against low wages, but I’m here for the cash."

Carpenters locals across the country are outsourcing their picket lines, hiring the homeless, students, retirees and day laborers to get their message across. Larry Hujo, a spokesman for the Indiana-Kentucky Regional Council of Carpenters, calls it a "shift in the paradigm" of picketing.

Political groups also are tapping into local homeless shelters for temps.

One resident of the Community for Creative Non-Violence shelter earns $30 a day holding a sign outside a Metro stop protesting nuclear war. In 2004, residents of at least 10 shelters were paid to collect signatures on petitions in favor of legalized gambling. Residents call this type of work "lobbying."

The carpenters union is one of the most active picketers in the District, routinely staging as many as eight picket lines a day at buildings where construction or renovation work is being done without union labor.

Supporters of the practice consider it a creative tactic in an era of declining union membership and clout. But critics say the reliance on nonunion members — who are paid $1 above minimum wage and receive no benefits — diminishes the impact and undercuts a principle established over decades of union struggles.

Here is the story, and thanks to Scott Rogers for the pointer.

The women of Tiger Time Lawn Care offer to mow customers’ lawns dressed in bikinis…

A click here will get you through to a story and video.  Thanks to Michael for the pointer.

The market seems (more or less) competitive on the supply side.  So the greater the opportunity for fraud (by lenders), the more lenders will enter the market.  This will bid down prices (interest rates on loans).  The loan contract will move toward lower price, lower quality.  Of course prices are lower on average but for those who end up ripped off the real price, ex post, is much higher.

On average who loses from such a shift?  Well, to some extent there is a pooling of heterogeneous tastes into a single market segment.  The ones who don’t like the lower price, lower quality equilibrium will be the higher valuation buyers for the contract, that is the wealthier people in the relevant loan class, not the poorer people.  The poorer buyers in the market segment might well be better off.

This result does not require buyers to be wary about fraud.  It is even possible to get a superior outcome if buyers are totally unaware of prospects for fraud.  To the extent buyers are suspicious, they will invest resources in monitoring the behavior of suppliers.  Often such monitoring is simply keeping/capturing pecuniary externalities, and thus it is oversupplied relative to a first best.  If buyers are fully unaware there will be no socially wasteful monitoring and the lower prices still will arrive.

You might say "Ah, but we cannot dismiss pecuniary externalities when insurance markets are incomplete."  I might say "Ah, but aren’t buyers generally risk-loving in terms of prices"?

The bottom line is this: whenever you see fraud, apply tax incidence analysis to understand the final results.

Steve Kaplan and Joshua Rauh write:

We consider how much of the top end of the income distribution can be
attributed to four sectors — top executives of non-financial firms
(Main Street); financial service sector employees from investment
banks, hedge funds, private equity funds, and mutual funds (Wall
Street); corporate lawyers; and professional athletes and celebrities. 
Non-financial public company CEOs and top executives do not represent
more than 6.5% of any of the top AGI brackets (the top 0.1%, 0.01%,
0.001%, and 0.0001%).  Individuals in the Wall Street category comprise
at least as high a percentage of the top AGI brackets as non-financial
executives of public companies.  While the representation of top
executives in the top AGI brackets has increased from 1994 to 2004, the
representation of Wall Street has likely increased even more.  While the
groups we study represent a substantial portion of the top income
groups, they miss a large number of high-earning individuals.  We
conclude by considering how our results inform different explanations
for the increased skewness at the top end of the distribution.  We argue
the evidence is most consistent with theories of superstars, skill
biased technological change, greater scale and their interaction.

Here is the link, here is the non-gated version.  How about this bit from the text?:

…the top 25 hedge fund managers combined appear to have earned more than all 500 S&P 500 CEOs combined (both realized and estimated).

This is important too:

…we do not find that the top brackets are dominated by CEOs and top executives who arguably have the greatest influence over their own pay.  In fact, on an ex ante basis, we find that the representation of CEOs and top executives in the top brackets has remained constant since 1994.  Our evidence, therefore, suggests that poor corporate governance or managerial power over shareholders cannot be more than a small part of the picture of increasing income inequality, even at the very upper end of the distribution.  We also discuss the claim that CEOs and top executives are not paid for performance relative to other groups.  Contrary to this claim, we find that realized CEO pay is highly related to firm industry-adjusted stock performance.  Our evidence also is hard to reconcile with the arguments in Piketty and Saez (2006a) and Levy and Temin (2007) that the increase in pay at the top is driven by the recent removal of social norms regarding pay inequality.  Levy and Temin (2007) emphasize the importance of Federal government policies towards unions, income taxation and the minimum wage.  While top executive pay has increased, so has the pay of other groups, particularly Wall Street groups, who are and have been less subject to disclosure and social norms over a long period of time.  In addition, the compensation arrangements at hedge funds, VC funds, and PE funds have not changed much, if at all, in the last twenty-five or thirty years (see Sahlman (1990) and Metrick and Yasuda (2007)).  Furthermore, it is not clear how greater unionization would have suppressed the pay of those on Wall Street.  In other words, there is no evidence of a change in social norms on Wall Street.  What has changed is the amount of money managed and the concomitant amount of pay.

There is a great deal of analysis and information (though to me, not many surprises) in this important paper.  The authors also find no link between higher pay and the relation of a sector to international trade.

…tax increases are highly contractionary.  The effects are strongly
significant, highly robust, and much larger than those obtained using
broader measures of tax changes.  The large effect stems in considerable
part from a powerful negative effect of tax increases on investment.  We
also find that legislated tax increases designed to reduce a persistent
budget deficit appear to have much smaller output costs than other tax
increases.

Their work is of the very highest quality, and not to be confused with many of the more dubious claims made about taxation and investment.  In particular they make a point of isolating exogenous changes in the tax code.  Here is the paper.  Here is a non-gated version.

Ah, this is good to see.  China’s "communist" rulers oppose price controls.