Results for “markets in everything”
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China errors and omissions of the day

Adding the ‘errors and omissions’ deficit to recorded net hot money outflows gives an aggregate estimate of overall hot outflows or capital flight from the mainland. By construction, this slumped to a record $209.5bn ($838bn annualised) or an eye-watering 9¼% of GDP (Chart 2). Overall, in the year to Q1, China has seen capital flight of $584bn or 5.6% of GDP.

That is from Richard Iley, cited by David Keohane at the FT.

By the way, here is the response of the Chinese government:

China has again ruled out the possibility of massive capital outflow, saying an overwhelming majority of foreign companies that pulled out their investments in the country were shell firms, The Beijing News reported on Wednesday.

The average investment scale of those firms is relatively small, and 20 percent of them entered China less than five years ago, said the newspaper citing Tang Wenhong, head of the Department of Foreign Investment Administration of the Commerce Ministry.

Judge for yourself…a better response would have been “this outflow is a natural process of investment diversification, as China liberalizes its capital markets gradually over time.”  That doesn’t account for everything that is going on, but at least it makes potential sense.

By the way, if you ask some Chinese about India, they will mention Buddhism and people riding on the top of trains.

Two misunderstood movies, two Rorschach tests (not too many spoilers here)

American Sniper is one of the best anti-war movies I have seen, ever.  But it shows the sniper-assassin, and his killing, to be sexy, and to be regarded as sexy by women, while the rest of war is dull and stupid.  (Even the two enemy snipers are quite attractive and fantastic figures, and there is a deliberate parallel between the family life of the Syrian sniper and the American protagonist.  The klutziness of the non-assassin soldiers limited how many African-Americans and Hispanics they were willing to cast in those roles, as it is easiest to make white guys look crass in this way without causing offense.)  By making the attractions of war palpable, this film disturbs and confuses people and also occasions some of the worst critical reviews I have read.  It also, by understanding and then dissecting the attractions of blood lust, becomes a quite convincing anti-war movie, if you doubt this spend a few months studying The Iliad.  (By the way, Clint Eastwood, the director and producer, describes the movie as anti-war.)  The murder scenes create an almost unbearable tension, the sandstorm is a metaphor for our collective fog, and they had the stones to opt for the emotional overkill of four rather than just three tours of duty.  Iraq is presented as a hopeless wasteland with nothing of value or relevance to the United States, and at the end of the story America proves its own worst enemy.  It is not clear who ever gets over having killed and fought in a war (can anything else be so gripping?…neither family life nor sex…), even when appearances suggest a kind of normality has returned.  The generational cycle is in any case replenished.  I say A or A+, both as a movie and as a Rorschach test.

Two Days, One Night has some of the worst economics I have seen in a movie, ever.  It would be brilliant as a kind of Randian (or for that matter Keynesian) meta-critique of the screwed up nature of Belgian labor markets and social norms, and most of all a critique of the inability of the Belgian intelligentsia to understand this, except it is not.  It is meant as a straight-up plea for sympathy for the victim and as such it fails miserably, even though as a movie it embodies reasonably good production values.  Everything in the workplace of this solar power company is zero-sum across the workers and we never see why.  The protagonist campaigns to get her job back, but never asks or even considers how she might improve her productivity or attitude, asking only on the basis of need.  (And she is turned down only on the basis of need.)  At one point her employer states the zero marginal product hypothesis quite precisely, something like “when you took time off, we saw that sixteen people could do the work of seventeen.”  She never asks if there might be some other way she could contribute — but she does need the money — nor does the notion of a better job match somewhere else rear its head.  The depictions of financial hardship confuse wealth and income, basic survival and discretionary spending.  The rave reviews this movie has received represent yet another Rorschach test and one which virtually every commentator seems to have failed.

How do trends and cycles interact?

In a piece I already have linked to, Binyamin Appelbaum makes a point in passing that I think deserves further comment:

The new paper, like others of its genre, basically requires belief in a big coincidence: that a short-term catastrophe happened to coincide with the intensification of long-term trends — that the economy crashed at the moment that it was already beginning a gradual descent.

I view this somewhat differently.  Very often trends accumulate, often without much notice, and then a cyclical event causes that trend to explode into full view.  Such a coincidence of cycle and trend is very often no accident and in fact the two are closely related.

Let’s say, as seems to be the case, that wages stagnated, labor market mobility slowed down, and non-outsourcing productivity was slow during 2000-2007 (or maybe longer).  Those are all long-term economic trends and they are all bad news.

During 2000-2007 most Americans acted as if were are on a good trend line when in fact they were on a less favorable trend line.  This influenced spending decisions, borrowing decisions, real estate decisions, and so on.  People overextended themselves and they also created unsustainable bubbles.  Sooner or later the debt cannot be rolled over, the bubbles pop, the crash ensues, AD falls, and so on.  This often takes the form of a discrete cyclical event, as indeed it did in 2008.

One point — still neglected in much of today’s macroeconomic discourse — is that the mis-estimated trend was a major factor behind the cyclical event.  But there is yet more to say about this interrelationship between cycle and trend.

The arrival of the cyclical event, in due time, makes the negative underlying trend more visible.  At first people blame everything on the cycle/crash, but a look at the slow recovery, combined with a study of pre-crash economic problems, shows more has been going on.

The cyclical event itself places greater stress on labor markets, on firm liquidity and thus on R&D, on perceived stocks of wealth, and so on.  As individuals observe the reaction of the economy to this added stress, they start seeing just how wide-ranging and deep the previously existing structural problems have been.

Those observations, and the accompanying economic responses, make the problems worse.  Forecasts become more pessimistic, investment declines, firms will be less keen to commit to workers who are less than the “sure thing,” and so on.  Sometimes this is moving along curves, other times there are shifts in multiple equilibria (“is Greece a European country or a Balkans country?”), toss in some herd behavior too.  In any case these changes are ill-served by the terminology of cyclical vs. structural.  They are cyclical and structural in an intertwined fashion.  And of course this all leads aggregate demand to fall all the more.

I am reminded of the literature in finance that shows how apparently small shifts in information can lead to big movements in market prices.  The initial small shift illuminates the reaction functions of other market traders, which illuminates depth of sentiment, which in turn causes a revision of expectations and thus prices.  For instance the market as a whole may learn from a small shift in orders that core traders were never so optimistic in the first place.

It’s also worth visiting the literature on how sand piles can collapse rather suddenly (“self-organized criticality” is one term used in the economics literature).  That too is a cyclical event yet based on underlying structural problems.

If you hear someone say “if this were structural unemployment, wages would be rising a lot right now,” that is a sign they have not thought through this issue deeply enough.

If you hear someone argue or rebut “so what, did everyone get lazy or stupid in 2009?”, that too is a sign only one dimension of the problem is being considered.

In macroeconomic debate, most one-line zingers are not very good.

Have stuff delivered to your car

Via Mark Perry:

In a ground-breaking technology move for the automotive industry, Volvo Cars demonstrates the world’s first delivery of food to the car – a new form of ‘roam delivery’ services. The service will allow consumers to have their shopping delivered straight to their car, no matter where they are. Volvo’s new digital keys technology means that car owners will be able to choose their car as a delivery option when ordering goods online. Via a smartphone or a tablet, the owner will be informed when a delivery company wants to drop off or pick up something from the car.

Having accepted the delivery, he or she then hands out a digital key and can track when the car is opened and then locked again. Once the pick-up or drop-off is completed, the digital key ceases to exist.

For the pointer I thank Samir Varma.

Which kinds of music are encouraged by streaming vs. downloads?

Let’s compare iTunes downloads to a mythical perfect streaming service which lets you listen to everything for a fixed fee each month or sometimes even for free. In the interests of analytical clarity, I will oversimplify some of the actual pricing schemes associated with streaming and consider them in their purest form.

Streaming seems to encourage the demand for variety, so the website vendor wants to make browsing seem really fun, perhaps more fun than the songs themselves.  (An alternative view is that the information produced by streaming services, and the recommendations, allow for in-depth exploration of genres and that outweighs the “greater ease of sampling of variety” effect.  Perhaps both effects can be true for varying groups of listeners with somehow the “middle level of variety-seeking left in the lurch, relatively speaking.)

The music creators are incentivized to create music which sounds very good on first approach.  Otherwise the listener just moves on to further browsing and doesn’t think about going to your concert or buying your album.

Streaming, with its extremely large menu, also means commonly consumed pieces will tend to be shorter or more easily broken into excerpts.  This will favor pop music and I think also opera, because of its arias.

Advertising is a more important revenue source for streaming than it is for downloads.  The music promoted by streaming services thus should contribute to the overall ambience and coolness of the site, and musicians who can meet that demand will find that their work is given more upfront attention.  It encourages music whose description evokes a response of “Oh, I’ve never had that before, I’d like to try it.”  Even if you don’t really care about it.

People who purchase advertised products are, on average, older than the people who purchase music.  Streaming services thus should slant product and product accessibility on the site toward the musical tastes of older people.

Since streaming divides up revenues among a greater number of artists, that should encourage solo performers with low capital costs, who can keep their (tiny) share all for themselves.  It also may require that the artists on streaming services can make a living or partial living giving concerts, even more so than under the previous world order.

This music industry source suggests that streaming boosts album sales in a way that downloads do not.  It also questions whether that boost will be long-lived, as streaming services take over more of the market.

When the marginal cost of more music is truly zero, does that make musical choices more or less socially influenced?

Hannah Karp shows that in the new world of streaming, mainstream radio stations are responding by playing the biggest hits over and over again.  Ad-supported media require the familiar song to grab and keep the attention of the listener.  Risk-aversion is increasing, which probably pushes some marginal listeners, who are interested in at least some degree of exploration, into further reliance on streaming.

The top 10 songs last year were played close to twice as much on the radio than they were 10 years ago, according to Mediabase, a division of Clear Channel Communications Inc. that tracks radio spins for all broadcasters. The most-played song last year, Robin Thicke’s “Blurred Lines,” aired 749,633 times in the 180 markets monitored by Mediabase. That is 2,053 times a day on average. The top song in 2003, “When I’m Gone” by 3 Doors Down, was played 442,160 times that year.

So the differing parts of the market are interdependent here.

What do you think?

The gambling demand for Bitcoin

Usually the house wins!  (With the exceptions of counting cards at blackjack or beating the table at poker.)  So why not try a game where the odds are — if not outright “better” — at least a lot less clear?  Enter Bitcoin.  No matter what your theory of its future value, there is no simple story which flat out amounts to “the house wins,” if only because of the opaqueness of the matter.  It is also a fun gamble and bundled with various symbolic commitments to future tech, libertarianism, and so on.  For many people that is better than affiliating with Vegas, the local football team, or perhaps Macau.  You can follow the price on as frequent a basis as you wish, rather than having to wait for a sporting event to take place.  And unlike in equities, futures, and options markets, you can feel — rightfully or not — that the pros also don’t know what they are doing.

I can’t find a reliable source on how much is spent on gambling each year, legal and illegal, but a variety of unreliable sources are suggesting a few hundred billion a year for the U.S. alone.  It’s likely to be well over a trillion dollars worth for the world as a whole.

Let’s say one percent of that gambling demand spills over into the cryptocurrency arena.  That’s a flow of $10 billion a year to fund new cryptocurrencies or bid up the value of old ones, maybe more.  Bitcoin also may interest people in gambling who otherwise do not gamble or think of themselves as gambling types.

I don’t gamble and I don’t enjoy gambling, but if I were going to gamble, I would prefer to gamble with Bitcoin than to bet on a dog race.  And it has to be better than buying a lottery ticket.

To the extent we are uncertain about the future gambling demand for Bitcoin, the price of Bitcoin will be correspondingly volatile.  And we have no solid sources for trying to estimate such future demands.  At the very least it seems likely that such demand has not yet peaked or close to it.  In any case, the trading of Bitcoin itself will reveal information about the shape of the demand curve and thus the trading of the asset can inject further volatility into the market, a standard result when not everything is a flat, horizontal demand curve.

Here are various tweets related to Bitcoin and gambling.

What would default look like?

As you may know, I do not wish to be a sensationalist on this topic.  As Felix Salmon has pointed out, the recent spike in short-term T-Bill prices still isn’t that big a deal.  So please consider this question as a (mostly) academic exercise.  And by the way, if/when they pass a short-term debt limit extension, you can simply update the specific dates given in this post accordingly, maybe you will need to add six weeks or so.

Anyway, here is one (unlikely) scenario.  As the evening of October 16th approaches, John Boehner is preparing to invoke the Hastert Rule when a car accident intervenes and he is temporarily out of commission.  Coordination collapses and some Republicans believe that on the 17th debt payments can continue while some other federal obligations are violated instead.  A combination of insufficient payment prioritization (for bizarre technical reasons) and angry Social Security voters, who irrationally fear missing their deposits, means that some payments are in fact missed on Treasury securities.  Some GOP representatives see this as a new chance to blame the Obama administration, and no one can agree quickly exactly how to reorder the payments, and so the mess isn’t cleared up immediately.

But before this accident gets well underway, word leaks out through various “insider trading in conjunction with investment banks Capitol Hill staff members” that not all is well.  Interest rates skyrocket and there are numerous collateral calls from clearinghouses and thus a squeeze on Treasuries.  Everyone is scrambling after Treasuries and suddenly T-Bill liquidity is quite scarce.  (Here is one FT post on collateral crunch.)  The next morning retail runs on money market funds commence and most redemptions cannot be made (another FT post here).  Those funds are shuttered and new commercial paper issues are put on hold.

By mid-morning of the 17th the payments system has shut down entirely.  The Fed tries everything possible, but even with a flood of monetary liquidity, T-Bills are “not what they used to be” and no flow of reserves can make up for this.  The monetary authority cannot become the fiscal authority in the span of an hour or a day, especially when it doesn’t have a fully credible fiscal authority behind it.  The payments system remains gridlocked.  Elsewhere, the Italian 10-year rate shoots over eleven percent, so the ECB has to invoke Outright Monetary Transactions, but the Germans get nervous and don’t go whole hog with this program.  A lot of European credit markets shut down too.  A major clearinghouse is nationalized.

Obama prepares the Super-Premium Treasury issue, and a few days later this happens.  By that time Boehner is again running the Republican Party and enough of the payments mess is sorted out for money markets to function again, albeit at slow speed, although some previously illiquid major financial institutions are now insolvent and they are nationalized.  No one knows which of the others are actually solvent, due to the interest rate spike, and so there is a general and longer-lasting credit collapse.

A full sorting out of the payments mess takes months.  In the meantime gdp has shed five or ten percent and borrowing costs are permanently higher.  Credit stays slow and the United States enters another major recession.  Scott Sumner issues a call for higher nominal gdp.

Fortunately, none of that is very likely to happen (except the part about Scott).

Addendum: By the way, we used to read that an attack of the bond market vigilantes would be good for the economy, but it seems this is no longer the case when the vigilantes are led by Republicans.  Hint: an attack of the bond market vigilantes is not good for the economy.

How much of education and earnings variation is signalling? (Bryan Caplan asks)

On Twitter Bryan asks me:

Would you state your human capital/ability bias/signaling point estimates using my typology?

He refers to this blog post of his, though he does not clearly define the denominator there: is it percentage of what you spend on education or explaining what percentage of the variation in lifetime earnings?  I’ll choose the latter and also I’ll focus on signaling rather than trying to separate out which parts of human capital are from birth and which are later learned.  My calculations are thus:

1. I don’t wish to count “credentialed” occupations, where you need a degree and/or license, but you are reaping rents due to monopoly privilege.  It’s neither human capital nor signaling (it’s not about intrinsic talent), though you could argue it is a kind of human capital in rent-seeking.  In any case, let’s focus on private labor markets without such barriers.

2. Most capital and resource income is due to factors better explained by human capital theories or due to inheritance.  That is more than a third of earnings right there.  Note that the higher is inequality, the less the signaling model will end up explaining.  That is one reason why the signaling model has become less relevant.

3. Depending on job and sector, what you’ve signaled, as opposed to what you know, explains a big chunk of wages in the first three to five years of employment.  Within five years (often less), most individuals are earning based on what they can do, setting aside credentialism as discussed under #1.  Here is my earlier post on speed of employer learning.

Keep in mind that everyone’s wages change quite a bit over their lifetime and that is mostly not due to retraining (i.e., changes in the educational signal) in the formal sense, as most people stop formal retraining after some point.  The changes are due to employer estimates of skill, modified by bargaining power.  In this sense all theories are predominantly human capital theories, whether they admit it or not.

To be generous, let’s give Bryan the full first five years of income based on signaling alone, out of a forty year career.  And let’s say that on average wages rise at the rate of time discount (not true as of late, but a simplifying assumption and I think Bryan believes in a claim like this anyway.)

How much of income is explained by signaling?  I’m coming up with “1/8 of 2/3,” the latter fraction referring generously to labor’s share in national income.  That will fall clearly under ten percent, but recall I’ve inserted some generous assumptions here.

Bryan wants to call me “a signaling denialist,” yet I see signaling as still very important for understanding some aspects of the labor market.  But it’s far from the main story for the labor market as a whole, especially as you move into the out years.

That all said, this “decomposition” approach may obscure more than it illuminates.  Let’s consider two parables.

First, imagine a setting where you need the signal to be in the game at all, but after that your ingenuity and your personal connections explain all of the subsequent variation in income.  Depending what margin you choose, the contribution of signaling to later income can be seen as either zero percent or one hundred percent.  Signaling won’t explain any of the variation of income across people with the same signal, yet people will compete intensely to get the signal in the first place.

Second, in a basic signaling model there are two groups and one dimension of signaling.  That’s too simple.  A signaling model implies that a worker is paid some kind of average product throughout many years, but of course the reference class for defining this average product is changing all the time and is not, over time, based on the original reference class of contemporaneous graduating peers.  For the purposes of calculating your wage based on a signal, is your relevant peer group a) all those people who got out of bed this morning, b) all those people in the Yale class of 2012, or c) all those who have been mid-level managers at IBM for twenty years?  This will change as your life passes.

So there’s usually a signaling model nested within a human capital model, with the human capital model determining the broader parameters of pay, especially changes in pay.  The employer’s (reasonably good but not perfect) estimate of your marginal product determines which peer group you get put into, if you choose to invest in additional signals (or not).  The epiphenomena are those of a signaling model, but the peer group reshufflings over time are ruled by something else.  Everything will look like signaling but again over time signaling won’t explain much about the variation or evolution in wages.

Seeing the relevance of those “indeterminacy” and “nested” perspectives is more important than whatever decomposition you might cite to answer Bryan’s query.

*How Asia Works*

The author is Joe Studwell and the subtitle is Success and Failure in the World’s Most Dynamic Region.  That’s an excessively bland title and subtitle, but so far this is perhaps my favorite economics book of the year.  Quite simply, it is the best single treatment on what in Asian industrial policy worked or did not work, full of both analysis and specific detail, and covering southeast Asia in addition to the Asian tiger “winners.”

Studwell explains that South Korean policy was based in a notion of “export discipline” and that policymakers were quite ready to see leading chaebol go bankrupt, which indeed they did often.  Everything was directed toward export capacity and they didn’t worry about what rate of price inflation, often in double digits, the cheap credit policies might create.  It was a gamble on a world-historical scale, noting that South Korea engaged in much more borrowing than did the other Asian tigers.  His p.111 account of how Park and his cronies started arresting most of the nation’s leading businessmen, to teach them a lesson and to skew corruption in nation-building directions, is sobering and thought-provoking reading.

Here is one instructive bit of many:

Thailand holds the record for the most consistent import substitution industrialisation (ISI) policy in south-east Asia, running from the early 1950s into the 1980s.  Industrial policy also was led by probably the most competent, professional bureaucracy in the region.  But, as the Japanese scholar of development Suchiro Akira observed, there was almost no pressure for favoured manufacturers to export…Unlike in northeast Asian states, the Thai bureaucracy never  brought export discipline to bear because the Thai generals and politicians who ran the country did not prioritise it.

In other words, industrial policy has to work with the market and rely on market discipline, not try to circumvent such constraints.  That is hard to pull off, although clearly it happened in South Korea.

It is also an excellent book on the agrarian pre-histories of East Asian industrialization and why South Korea, Japan, and Taiwan pulled off successful land reforms and Indonesia and the Philippines did not.

I would wish for more coverage of education and labor markets, and the final section on China still awaits me.  Think of it as a kind of “tweener” book: too specific and analytic to be truly popular, too broad, historical, and anecdotal to count as formal economic research.  That is not a complaint.

Definitely recommended, you will learn lots from it, and it will upset people of virtually all ideologies.

Addendum: Here is a good FT review.

Are we living in a time of asset bubbles?

Here is one typical complaint about bubbles, from Jesse Eisinger, excerpt:

We are four years into the One Percent’s recovery. Now, we are in Round 3 of quantitative easing, the formal term for the Fed injecting hundreds of billions of dollars into the economy by purchasing longer-term assets like Treasury bonds and Fannie Mae and Freddie Mac paper. What’s that giving us? Overvalued stocks. Private equity firms racing to buy up Arizona real estate. Junk bond yields at record lows. Ratings shopping on structured financial products.

These are dangerous signs of prebubble activity.

Here is a Krugman rebuttal.  I will offer a few points on a series of debates which in general I have stayed away from.

1. I don’t find most predictive discussions of bubbles interesting, while admitting that such claims often will prove in a manner correct ex post.  “OK, the price fell, but was it a bubble?  I mean was there froth, like on your Frappucino?”  Or to quote Eisinger, it might also have been “dangerous signs of prebubble activity” (what happens between the “prebubble” and the “bubble”?  The “nascent bubble”?  The “midbubble”?  The “midnonbubble”?)

2. Good news and improving conditions may well bring more bubbles or greater likelihood of bubbles, but that is hardly reason to dislike good news and improving conditions.

3. Relative to measured real interest rates, stocks look cheap right now.  That doesn’t mean they are, but reread #1.

4. No one understands the term structure of interest rates, no matter what they tell you.  Reread #1.

5. I don’t see why anything particular about the current state of affairs, at least in the United States, needs to be “unwound.”  I sometimes draw a distinction between those of us who have been thinking about interest on reserves since S. Tsiang, Fischer Black, and the Reserve Bank of New Zealand, and those of us who have not.

6. One coherent definition of bubble is that of a hot potato, traded in a world of heterogeneous expectations, but which must ultimately pop, because eventually the price of that asset will consume all of gdp, a bit like those old Tokyo parking spots.  Fair enough, but I don’t see that in many asset markets today if any (Bitcoin for a while?).

7. Another coherent definition of a bubble has less to do with a dynamic price path and ongoing resale for gain, but rather there may be a (temporary) segmentation across classes of asset market buyers.  The obvious candidate here is that  many people and institutions have been frightened into Treasuries and away from almost everything else.  That could mean we have a real interest rate bubble, but it also could mean that lots of other assets are undervalued, at least if the liquidity effect defeats the higher real interest rate effect of moving out of Treasuries.  (It would be odd to think that a shift of funds out of Treasuries and into stocks would cause stock prices to fall, but perhaps some people fear this.)

I don’t agree with this view, but I do feel I understand it.  The most likely “bubble” is then in real interest rates, due to a (temporary?) skewing of the risk premium.  That all said, I do not think this should be called a bubble.  Changes in the risk premium and “bubbles” have traditionally been considered alternative explanations for asset prices.  Reread #1, and reread #4 while you’re at it.

8. Ruchir Sharma made some interesting points yesterday:

Far from fighting off a deluge of foreign capital, leaders from India to South Africa are struggling to attract a greater share of global capital flows in order to fund widening current account deficits. Over the past decade, the foreign exchange reserves of the developing world grew at an average annual rate of 25 per cent, swelling from $570bn in 2000 to $7tn in 2011. But over the past year, the average rate slowed to a crawl of barely 5 per cent.

The idea that money is still flooding emerging markets misses the big picture, which is that global cross-border capital flows are down 60 per cent from their 2008 peak. The largest shares of cross-border capital flows are in bank loans, trade and foreign direct investment, which are slowing worldwide.

9. I expect the real economy over the next twenty years to be more volatile than it was say in the 1990s.  In that sense, many current asset market prices may be revised and quite dramatically.  Still, I don’t find the bubble category to be so useful in this regard.  We really don’t know what is going to happen and that is why the current prices are wrong, not because of a “bubble.”

10. I am probably done blogging about bubbles for a while.  Satisfying you was not the goal of this post, but that is in the nature of the subject area, not out of any desire for spite.

Realism on Infrastructure Investment

Keith Hennessey has an excellent post on government infrastructure investment. Here are his key points:

  1. Capital investment by government often pursues multiple policy goals, some of which conflict with maximizing productivity growth. If you’re investing for long-run growth you’ll invest differently than if you also have goals to maximize short-term job creation and to change the future balance of energy sources to reduce greenhouse gas emissions (for instance). The pursuit of multiple policy goals lowers the expected economic growth benefit of public capital spending.
  2. Geographic politics distorts and often dominates government investment in physical infrastructure. Highway funds and airport funds especially are allocated in part based on which Members of Congress have maximum procedural leverage over the spending bill. Even if you could somehow get Congress to stop earmarking infrastructure spending (good luck), and even if you could rely on the Executive Branch not to allow their own political goals to influence how they allocate funds, local geographic politics would come into play at the state level, since much federal infrastructure spending flows through State governments. This is where reality most falls short of a valid theoretical starting point for increasing productivity and long-term growth.
  3. Non-geographic politics can distort government capital spending. This is principally an Executive Branch concern, as we saw with the Obama Administration’s decision to throw good money after bad to postpone Solyndra’s failure. And rent-seekers come out of the woodwork, looking to leverage their connections to government officials to win infrastructure investment contracts.
  4. Once “investment” is favored, everything gets relabeled as investment. The Obama Administration has been particularly guilty of this; almost every spending increase they propose is an “investment” of some sort. We should allow them some rhetorical leeway, and we should recognize that government has other reasons to spend money than just to maximize future economic growth. At the same time, it’s misleading when they claim that increased government spending that serves other policy goals (some quite legitimate) also increases future economic growth.
  5. There’s a difference between government investments in the commons and government spending that primarily benefits individuals.  A new airport benefits all who use it. A scientific research grant benefits the researcher and society as a whole if his research advances our understanding. A subsidized student loan is an investment in human capital, but the return on that investment accrues mostly to the student and his or her family. That’s not wrong, it’s just having a more limited effect on increasing long-term growth for society as a whole.
  6. Government investment in physical infrastructure is slow. The Administration learned this as they tried to force money out the door in 2009 for “shovel-ready jobs” that turned out not to be there. This doesn’t mean you don’t build roads and improve ports and airports, it just means the short-term fiscal stimulus argument for this type of spending is weak.
  7. Government investment in physical infrastructure is intentionally expensive because of “prevailing wage” requirements, championed by construction labor unions, that mandate the government must pay more for workers than an aggressive private firm might be able to find in the labor market.
  8. We should evaluate the marginal productivity benefits of additional investment. The President sometimes argues that building the national highway system was good for growth, therefore his specific proposal to increase highway spending is good for growth, too. But those are different investments, and we need to examine the marginal benefits (and rate of return) on the specific incremental investments he is now proposing. The transcontinental railroad definitely increased national economic growth, but that doesn’t mean the feds should subsidize a costly California bullet train with questionable growth benefits.
  9. International comparisons of government infrastructure are silly. U.S. government capital spending should be determined based on what will most increase U.S. productivity without comparison to what other countries are doing. If American ports are clogged and that is harming our trade and slowing American economic growth, then we should upgrade our ports. We shouldn’t instead improve our airports because other countries have shinier ones. We have a different geography, a different economy, and different infrastructure needs than does China, or Japan, or Dubai or France. It is crazy to suggest that the U.S. should build bullet trains because China is doing so.
  10. Government investment faces no market discipline. Capital investment in a private firm can face some of the above challenges—a CEO, for instance, might want a new facility built in his hometown rather than where it will produce the highest rate of return. Or a firm might reject an investment that would maximize its’ workers’ productivity because that investment is inconsistent with the firm’s broader strategic goals. But these firms ultimately face the discipline of the market to curb their excesses. Government does not, and in some cases policymakers are rewarded by their election markets to distort infrastructure investment even farther from its growth-maximizing ideal.
  11. Government capital investment financed by raising taxes on private capital investment will slow long-term economic growth. While in theory there probably are government infrastructure investments with very high rates of return, all of the above reasons suggest that in practice the actual rate of return on government-directed investment is going to be lower than in the private sector. If you advocate raising capital taxes (on capital gains and dividends, for instance, as Senate Democrats appear poised to do) at the same time you argue for increased government capital spending, you’re shifting capital investment from the private sector to the public sector. That will slow long-run economic growth rather than increase it.

As Hennessey notes and as I second this is not a denial that “smart government capital investment can increase productivity and contribute to faster long-run economic growth.” Instead, it’s an argument for caution but also for more thought about how to make government investment smarter. See also Tyler’s related comments.

The two questions I am asked most often (low-skilled jobs and future inflation)

The first is what kinds of jobs will be available for low-skilled Americans in the decades to come.  I’ll be writing more on that.

The second is whether inflation is due to kick up in some kind of big storm, either in the next few years or when the major bills start coming due ten or so years from now.

Probably not.  Let’s consider a few factors:

1. The future budget situation will consist, most of all, of largely of unfunded Medicare liabilities, which to whatever extent they are met must be met in real terms.  Inflation will not make that problem go away.

2. The flow of debt is large, relative to the current stock (yes, I fully agree that is a scary thought in its own right).  That means the federal government won’t gain much, and would probably lose, by trying to inflate away the value of the stock of debt.  Furthermore a lot of the current debt is quite short-term.

3. Seigniorage revenue simply isn’t a big deal these days.

4. Everything we were taught about the monetary base is wrong in a world with interest on reserves (IOR).  A large base can sit there forever.  The price level is not proportional to the base, changes in the base, etc.  It just isn’t.  The broader aggregates, such as M2, haven’t grown so rapidly.

5. If needed, the Fed could soak up lots of the monetary base by selling assets from its portfolio.  I don’t have some utopian vision of the Fed doing this remarkably well (hard to say, this is not Fed-bashing either), but of course the Fed can make mistakes in many ways and I would not focus exclusively on that way, which is in any case part of a broader program of expectations management.

6. Every market price we can possibly look at it is forecasting low to moderate inflation.  The price of gold, by the way, seems these days to be a hedge against catastrophic risk not a hedge against inflation per se.

Please do not get me wrong, it is entirely possible that inflation will go up.  Things could change.  And even if the current deck of cards is played out, I do in fact think inflation will go up somewhat, perhaps more than markets are expecting (for one thing, I am more of a pessimist on supply bottlenecks than are many observers).  That said, I do not see any ticking inflationary time bomb.  Neither market evidence nor economic theory support such a conclusion.