Results for “private equity” 114 found
Bets, beliefs, and portfolios: some further observations on the theses of Bryan Caplan
Bryan Caplan thinks that portfolios don’t reveal much about actual beliefs,. Here is one of his arguments:
Even prominent Nobel prize-winning economists admit they follow simple rules of thumb when they invest. So unless people’s beliefs are carved in stone, how could portfolios possibly reveal much about their beliefs? Tyler is a case in point: He changes his mind a hundred times a day, but he follows a simple financial strategy that hasn’t varied in years.
I view it differently. I don’t trade in public markets but I vary my allocations by changing how much money I spend and how to allocate my time. Perhaps not coincidentally, this puts me square into the world of classical finance theory as represented by “the mutual fund theorem,” with a static equity portfolio of fixed proportions and some unique covariances on my human capital. I call that rationality not inertia.
Bryan, you will note, is a founder of the theory of rational irrationality, which suggests you become more rational as the private stakes from your decisions go up. These days he is wishing to argue that the truly small stakes reflect what you really think, through the lens of mental accounting and compartmentalization. Of course that would undercut or at least drastically relativize his earlier theory. I say he has made a large and successful career bet — much bigger than any of his piddly ante monetary bets — on the theory of rational irrationality, so he must really agree with me after all.
It also happens that Bryan’s emphasis on simple rules of thumb will work against his interest in person-to-person bets as a metric of authenticity. If you don’t change or examine your overall portfolio very often, that means some reasonably wide range of portfolios is a matter of indifference or near indifference to you, if only because fine-tuned improvements are hard to find. (Do you really give matters a re-ponder when a firm in your portfolio pays dividends?) In that case, however, the small bets won’t be authentic either. One could compartmentalize one’s personal bets quite easily and say to oneself — whether consciously or not — “I can make this small bet: it still keeps my overall portfolio within that broad range of indifference.” Which indeed it does. The bet is then undertaken for expressive reasons, which is fine, nothing against that, but for me it is more fun to cheer for Tony Parker (without betting on him). I think of these small personal bets as akin to sports loyalties most of all and not as a unique window into our real beliefs.
The small person-to-person bets pay off (or not) in terms of pride, including for some people the pride in betting itself. One relevant substitute is to attempt to produce pride using your own internal mental accounting of your own predictions and so we must make the broader portfolio comparison. What the $$ betters are signaling is a lack of vividness for their own internal mental worlds. In my mind, I’m already betting an optimal amount of pride through my own mental accounting. Maybe some of us are already betting too much internal pride on external events; after all, the variance of pride introduces some new exogenous risk into life and perhaps we should be trying to move in the opposite direction toward greater pride indifference to external events. That is what the Stoics thought.
Most of all, I fear that Bryan’s results are coming from an asymmetric approach where he applies positive observation to large portfolios and normative recommendations to small bets. Bryan could go for a “positive vs. positive” comparison, in which case he would point out that people trade and adjust their large portfolios all the time, but don’t make small bets on public policy nearly as much. Alternatively, he could try a “normative vs. normative” comparison, in which case would you sooner recommend that people drop their inertia for their large portfolios or for their small ones? To even raise such a question is to answer it.
Do you want to find out “what a person really thinks”? Look at whom they married, how much money they spend, and how they devote their time. That is the most important portfolio of them all.
Just don’t bet that Bryan and I are going to agree anytime soon.
Sentences to ponder
Starting January 1 of 2013 the top tax rate on dividends in the US will officially become the highest in the developed world. If you live in NY for example, the top rate on stock dividends will be close to 50% – which is significantly higher than France.
…According to JPMorgan, this dividend tax will reduce mature firms’ valuations by $1.5 trillion. That’s going to hit private and state pensions as well as IRA, 401K, and 529 accounts.
And JPMorgan adds:
Capitalizing this foregone capital income generates a $1.5 trillion reduction in equity market value, or about 6% of the $24 trillion value of corporate equities at the end of 2Q. Standard wealth effects suggest this will reduce consumer spending by a little over $50 billion, or about 0.5%.
Mexico’s investment in the United States
No, I am not referring to immigration. The net flow of immigrants is negative, but capital investment is rising:
Cemex, the Mexican cement and building materials manufacturer, is now the largest producer in its segment in the US – commanding 10.5 per cent of a highly fragmented market.
In 2010, Grupo Bimbo, the Mexican baker, announced the purchase of Sara Lee, the US baker, in a deal initially estimated at US$959m. The acquisition, which received approval from the US Department of Justice late last year on condition of some divestitures, consolidated Bimbo as America’s biggest breadmaker.
Televisa, the Mexican broadcaster, significantly deepened its exposure to the US market in 2010, investing $1.2bn in Univision, the US’s largest Spanish-language network. It took an initial 5 per cent stake and debentures convertible into an additional 30 per cent equity stake in the future.
Probably the most recognised Mexican brand in the US in the past 20 years is Corona Extra, the beer in the clear glass bottle served, in the US at least, with a wedge of lime in the neck. Corona is now the best-selling imported beer in the US – a title it has held every year since 1997.
Even Alfa, the Mexican conglomerate with interests stretching from petrochemicals to food processing, has started to drill for natural gas – not in Mexico, where the country’s constitution restricts private investment, but in Texas in a partnership with Pioneer Natural Resources and Reliance.
Between 2006 and 2011, the US received US$8.4bn in direct investment from Mexico, according to data from the US Department of Commerce’s Bureau of Economic Analysis. The figure is higher than that for any previous six-year period (though 2000 was the highest year on record with US$5bn).
The article gives further good economic news about Mexico, a country which is oddly understudied in the United States.
The Big Easy’s School Revolution
Interesting op-ed in the Washington Post on schools in New Orleans.
…the levees broke and the city was devastated, and out of that destruction came the need to build a new system, one that today is accompanied by buoyant optimism. Since 2006, New Orleans students have halved the achievement gap with their state counterparts. They are on track to, in the next five years, make this the first urban city in the country to exceed its state’s average test scores. The share of students proficient on state tests rose from 35 percent in 2005 to 56 percent in 2011; 40 percent of students attended schools identified by the state as “academically unacceptable” in 2011, down from 78 percent in 2005.
….Most of the buzz about the city’s reforms focuses on the banishment of organized labor and the proliferation of charter schools, which enroll nearly 80 percent of public school students, up from 1.5 percent pre-Katrina. But what really distinguishes New Orleans is how government has redefined its role in education: stepping back from directly running schools and empowering educators to make the decisions about hours, curriculum and school culture that best drive student learning. Now, state and school-district officials mostly regulate and monitor — setting standards, ensuring equity and closing failing schools. Instead of a traditional school system, there is a system of schools in what officials liken to a fenced-in free market. Families have more choice about where their children can best succeed, they say, and educators have more opportunity to choose a school that best aligns with their approach.
The population of New Orleans changed pre and post-Katrina so it’s difficult to compare pre and post-Katrina test scores; although given the state of the schools pre-Katrina it’s hard to believe that the schools have not greatly improved. What really drives innovation, however, is not a simple substitution of private for public but a system substitution of competition for monopoly. The key therefore is to expand charters and voucher programs.
The state of Louisiana just passed a voucher program that although limited to poor and middle class students in failing schools will offer as many as 380,000 vouchers to be used at private schools or apprenticeships. Indiana has passed a potentially even larger program that would make about 500,000 students voucher-eligible. Keep in mind that at present there are 50 million public school students and only 220,000 voucher students nationwide.
My ideal program would fund students not schools and would make vouchers available to all students on a non-discriminatory basis. We are far from that ideal but we are slowly moving in the right direction. Charters and the expansion of voucher programs around the country are starting to bring more competition, dynamism and evolutionary experimentation to the field of education.
From the pen of Interfluidity
Post-Keynesians did predict a crisis, on broadly the terms that we actually experienced. They argue that there are adverse side effects to using monetary policy to manage aggregate demand. Although in theory this might be avoidable, post-Keynesians point out that in practice monetary stabilization, even above the zero-bound, seems to engender increasing indebtedness and financial fragility, and to distort activity towards overspecialization in finance and real estate. They pay much more attention to the details of financing arrangements than the other schools, and emphasize that vertiginous collapses of aggregate demand are nearly always accompanied by malfunctions in these arrangements. Aggregate demand, post-Keynesians argue, cannot be managed without concrete attention to the operation of financial institutions and the conditions that lead to their fragility. Post-Keynesians make the deep and underappreciated point that fiscal policy, even if it is conventionally tax-financed, can deleverage the private sector and reduce financial fragility in a way that monetary operations cannot. Monetary operations, if you follow the cash flows, amount to debt finance of the private sector by the public sector. The central bank advances funds today, in exchange for diverting precommitted streams of future cash from the private sector entities to the central bank. Fiscal expansion is more like equity finance of the private sector by the public sector. Public funds are advanced, and captured by parties with weak balance sheets as well as strong. But taxes are not withdrawn on a fixed schedule. They are recouped “countercyclically”, in good times, when private sector agents are most capable of paying them without financial distress. Further, the private sector’s tax liability is distributed according to ex post cash flows realized by individuals and firms, while debt obligations are distributed according to ex ante hopes, expectations, and errors. So tax-financed fiscal policy acts as a kind of balance-sheet insurance. Both by virtue of timing and distribution, taxation is less likely than monetary-policy induced debt service to provoke disruptive insolvency in the private sector. Plus, during a depression, fiscal expansions may never need to be offset by increased taxation…Never-to-be-taxed-back fiscal expenditures, if they are not inflationary, shore up weak private-sector balance sheets without putting even a dent into the financial position of the strong. They represent a free lunch both in real and financial terms.
Here is more, and it is insightful throughout. I would add two points, both in the skeptical direction:
1. I so rarely hear the post Keynesians utter the word “Congress” in discussions such as this.
2. Fiscal policy does best when it is obvious what should be produced, and there is a political consensus to make that stick, as was the case in 1940-45 for instance.
Does going public affect innovation?
From Shai Bernstein, on the job market from Harvard:
Abstract: This paper investigates the effects of going public on innovation. Using a novel data set consisting of innovative firms that filed for an initial public offering (IPO), I compare the long-run innovation of firms that completed their filing and went public with that of firms that withdrew their filing and remained private. I use NASDAQ fluctuations during the book-building period as a source of exogenous variation that affects IPO completion but is unlikely to affect long-run innovation. Using this instrumental variables strategy, I find that going public leads to a 50 percent decline in innovation novelty relative to firms that remained private, measured by standard patent-based metrics. The decline in innovation is driven by both an exodus of skilled inventors and a decline in productivity among remaining inventors. However, access to public equity markets allows firms to partially offset the decline in internally generated innovation by attracting new human capital and purchasing externally generated innovations through mergers and acquisitions. I find suggestive evidence that changes in firm governance and managerial incentives play an important role in explaining the results.
False deleveraging
European banks, vowing to sell distressed assets as regulators tighten capital requirements, are lending money to buyers to get deals done.
Royal Bank of Scotland Group Plc (RBS) may provide as much as 600 million pounds ($939 million) in debt to help Blackstone Group LP acquire part of a 1.4 billion-pound portfolio of commercial mortgages from the bank after the private-equity firm struggled to get outside funding, three people with knowledge of the transaction said. The deal, scheduled to close within weeks, follows Credit Suisse Group AG (CSGN)’s agreement to finance the sale of $2.8 billion of property loans to Apollo Global Management LLC in December, two people with knowledge of the matter said.
“The use of vendor financing to de-lever defeats its own purpose,” said David Thesmar, a professor of finance at HEC Paris, a business school. “The assets may become safer because the buyer injects equity, but the actual gain in core Tier 1 capital ratio for the bank isn’t as great as if it was purely and simply sold. It shows banks’ deleveraging is going to be tougher than planned.”
Here is more, none of it reassuring. Hat tip to Interfluidity and Dvolatility.
What can Italy do with its wealth?
Italian private debt is quite low and yesterday I mentioned that Italian homeowners don’t have much in the way of mortgages. David Henderson then asked a good question:
“Were more Italians to take out mortgages on their houses to buy government bonds, for example, Italy could eliminate its interest-payment problem.” How is that good news? The government would still have to pay interest on this debt.
The Italian government has high debt and productivity is not going up any time soon. We can expect a mixture of lower government spending and higher taxes, otherwise the country defaults, maybe the country defaults anyway. Ideally “they” would like to send equity in Italian homes to bondholders in lieu of making the interest payments. Italy doesn’t do a good job collecting taxes and the economy already has lots of distortions, so pulling wealth out of homes would in principle be a way to go. A CDO tranche instead of an interest coupon, so to speak. One can imagine the Italians borrowing more against their homes and sending the money to their government as a tax, or accepting lower transfer payments from the government, and that would implicitly serve as a way of paying off the bonds with fractions of homes. Of course that probably won’t happen.
Italy is house rich, somewhat cash poor, and has a miserable recent history of growth. If you look at the wealth side of the balance sheet, you can easily work up a heady optimism for Italy. If you study public choice theory, it is harder to do so. How many people in that country are either paid to do the wrong thing, or paid to do not so much at all? TGS reigns.
Italy’s privileges and distortions are so often so local, and so concentrated in inefficient professional services, that it is hard to imagine clearing them up quickly in the form of a big bang, in the way that say New Zealand or Chile or Thatcher’s England did. And even those successes took some time to pay off and underperformed for years.
Note that if Italy could credibly be expected to grow a mere 2 pct. a year — maybe less — the entire eurozone crisis probably would be messy but manageable. It’s not.
File under: non siamo cosi’ ricchi come pensavamo di esserlo!
Thomas Sargent, Nobel Laureate
Most of all, this is a prize about expectations, macroeconomics, and the theory and empirics of policy. Let’s start with Sargent, noting that I will be updating throughout.
Sargent has made major contributions to macroeconomics, the theory of expectations, fiscal policy, economic history, and dynamic learning, among other areas. He is a very worthy Laureate and an extraordinarily deep and productive scholar. Here is Wikipedia on Sargent. Here is his home page, rich with information. Here is Sargent on scholar.google.com. Here is the explanation for both laureates from Sweden. Here is a Thomas Sargent lecture on YouTube.
He now teaches at NYU, and is a fellow at Hoover, though much of his career he spent at the University of Minnesota. Sargent is one of the fathers of “fresh water” macro, though his actual views are far more sophisticated than the critics of his approach might let on. He has done significant work on learning and bounded rationality, for instance. This is very much a “non Keynesian” prize.
I think of Sargent as a “foundationalist” economist who always insists on a model and who takes the results of that model seriously. In general he would be placed in the “market-oriented” camp, though it is a mistake to view his work through the lens of politics.
Sargent was first known for his work on rational expectations in the 1970s. He wrote a seminal paper, with Neil Wallace, on when rational expectations will mean that monetary policy does not matter. You will find that article explained here, and the paper here. Expected monetary growth will not do much for output because it does not fool people and thus its nominal effects wash away.
One of his most important (and depressing) papers is Sargent, Thomas J. and Neil Wallace (1981). “Some Unpleasant Monetarist Arithmetic“. Federal Reserve Bank of Minneapolis Quarterly Review 5 (3): 1–17. The main idea of this paper is that good monetary policy requires good fiscal policy. Otherwise the fight against inflation will not be credible. This is probably his most important paper.
He followed up this paper with Sargent, Thomas J. (1983). “The Ends of Four Big Inflations” in: Inflation: Causes and Effects, ed. by Robert E. Hall, University of Chicago Press, for the NBER, 1983, p. 41–97. This is a masterful work of economic history, showing that monetary stabilizations, from hyperinflation, first required some fiscal policy successes. I view this as his second most important paper, following up on and illustrating “unpleasant monetarist arithmetic.”
These two papers inspired work from other researchers on a “fiscal theory of the price level,” integrating monetary and fiscal theories. In Sargent’s view the quantity theory is a special case of a more general theory of asset-backed monies, and for fiat monies the relevant backing cannot be determined without referring to the fiscal stance of the money-issuing government.
His Dynamic Macroeconomic Theory has been an important Ph.d. text for macro.
Sargent also has important work on computational learning, such as Sargent, Thomas J. and Albert Marcet (1989). “Convergence of Least Squares Learning in Environments with Hidden State Variables and Private Information”. Journal of Political Economy 97 (6): 251. doi:10.1086/261603. A short summary of his work on learning can be found here; I will admit I have never grasped the intuitive kernel behind this work. I have not read Sargent’s work on neutral networks, you will find some of it here. It may someday be seen as path breaking, but so far it has influenced only specialists in that particular area. It is considered to be of high quality technically. Here is his piece, with Marimon and McGrattan, on how “artificially intelligent” traders might converge upon a monetary medium of exchange; think of this as a modern and more technical extension of Carl Menger.
Here is an old paper with Sims, co-laureate, on how to do macro econometrics with a minimum of theoretical assumptions; this reflected a broad move away from structural models and toward “theory-less” approaches such as Vector Auto Regression. Here is his introductory paper on how to understand the VAR method. Sargent’s worry had been that structural models estimate parameters, but then those parameters will vary with policy choices and in essence the economist will be using an “out of date” model. VAR models are an attempt to do without structural estimation as much as possible, though critics might suggest this enterprise was not entirely successful.
Here is Sargent’s take on the history of the Fed; basically the Fed first had an OK model, then forgot it for a while (the 1970s), then relearned it again. In July 2010 he penned a defense of the Greenspan-era FOMC, based on the view that they were tackling worst case scenarios. Here is Sargent’s paper, with Tim Cogley, on what the Fed should do when it does not know the true model.
Circa 2010, in an interview, Sargent defends the relevant of freshwater macro during the recent financial crisis. While my view is not exactly his, it is a good corrective to a lot of what you read in the economics blogosphere. This is the single most readable link in this entire post and the best introduction to Sargent on policy and method for non-economists. The last few pages of the interview have a good discussion of how the euro was an “artificial gold standard,” how it was based on an understanding of the “unpleasant monetarist arithmetic point, and how breaking the fiscal rules has led to the possible collapse of the euro. Recommended.
He has a very interesting 1973 paper on when the price level path will be determinate, again with Neil Wallace. Here is his old paper on whether Keynesian economics is a dead end. Here is his appreciation of Milton Friedman’s macroeconomics. Here is his recent paper on whether financial regulation is needed, in a context of efficiency vs. stability. Sargent has toyed with free banking ideas over the decades, casting them in the context of “the real bills doctrine.” Here is a recent paper on determinants of the debt-gdp ratio.
He is not primarily known for his work on unemployment, but he has a lot of good papers in the area, many of them are listed here. Here he uses layoff taxes and unemployment compensation to explain the behavior of unemployment in Europe over the decades.
His work on “catastrophe,” with Cogley and others, suggests that the equity premium changes with historical memory.
With Velde, Sargent wrote a detailed and excellent book on the history of small change; why was small change scarce for so many centuries? Hint: the answer involves Gresham’s Law. There is an MR discussion of this book here. This book illustrates just how deep Sargent’s learning and erudition runs.
Here are his new papers, Sargent remains very active.
Overall: Sargent really is one of the smartest, deepest, and most scholarly of all contemporary economists. The word “impressive” resonates. He has enough contributions for 1.6 Nobel Prizes, maybe more. He has influenced the thought of all good macroeconomists. The economic history is dedicated and path breaking. If I had to come up with a criticism, I find that some of his papers have an excess of rigor and don’t leave the reader with a clear intuitive result. I am not as enamored of foundations as he is. Still, that is being picky and this is a very very good choice for the prize. I would have considered a co-award with Neil Wallace, however, since two of Sargent’s most important papers (JPE 1975) and “unpleasant monetarist arithmetic” were written with Wallace.
Probably I won’t be updating this post any more!
Why they call it Green Energy: The Summers/Klain/Browner Memo
The LA Times reports that Larry Summers and Timothy Geithner “raised warning flags” about the loan guarantee program for renewables long before the Solyndra bankruptcy. The article doesn’t have a lot of new information (the key players are clearly protecting themselves) but it does link to a fascinating briefing memo written for the President in October of 2010 by Summers, Ron Klain (then chief of staff to the Vice President), and energy advisor Carol Browner.
The memo says that OMB and Treasury were concerned about three problems, “double dipping” (massive government subsidies from multiple sources), lack of “skin in the game” from private investors and “non-incremental investment,” the funding of projects which would occur even without the loan guarantee.
The memo then illustrates with one such program, the Shepherds Flat Loan guarantee. Here is the relevant portion of the memo:
The Shepherds Flat loan guarantee illustrates some of the economic and public policy issues raised by OMB and Treasury. Shepherds Flat is an 845-megawatt wind farm proposed for Oregon. This $1.9 billion project would consist of 338 GE wind turbines manufactured in South Carolina and Florida and, upon completion; it would represent the largest wind farm in the country.
The sponsor’s equity is about 11% of the project costs, and would generate an estimated return on equity of 30%.
Double dipping: The total government subsidies are about $1.2 billion.
Subsidy Type Approximate
Amount
(millions)Federal 1603 grant (equal to 30% investment tax credit) $500
State tax credits $18
Accelerated depreciation on Federal and State taxes $200
Value of loan guarantee $300
Premium paid for power from state renewable electricity standard $220
Total $1,238
Skin in the game: The government would provide a significant subsidy (65+%), while the sponsor would provide little skin in the game (equity about 10%).
Non-incremental investment: This project would likely move without the loan guarantee. The economics are favorable for wind investment given tax credits and state renewable energy standards. GE signaled through Hill staff that it considered going to the private market for financing out of frustration with the review process. The return on equity is high (30%) because of tax credits, grants, and selling power at above-market rates, which suggests that the alternative of private financing would not make the project financially non-viable.
Carbon reduction benefits: If this wind power displaced power generated from sources with the average California carbon intensity, it would result in about 18 million fewer tons of CO2 emissions through 2033. Carbon reductions would have to be valued at nearly $130 per ton CO2 for the climate benefits to equal the subsidies (more than 6 times the primary estimate used by the government in evaluating rules).
In my view, the Summers/Klain/Browner analysis was a damning indictment of the Shepherds Flat project. The taxpayers were expected to fund by far the largest share of the bills and also of the risk and in return they weren’t getting many benefits in terms of reduced pollution. In contrast, Caithness Energy and GE Energy Financial Services, the corporations behind the project, weren’t taking much risk but they stood to profit handsomely. I guess that is why they call it “green” energy.
In short, the Shepherds Flat project was corporate welfare masquerading under an environmental rainbow.
So are you surprised to learn that shortly after the memo was written the Shepherd Flats loan guarantee of $1.3 billion was approved? Of course not; no doubt you also saw that the memo authors were careful to inform the President that the “338 GE wind turbines” were to be “manufactured in South Carolina and Florida.” Corporate welfare meet politicized investment.
In the Solyndra case just about everything went wrong, including bankruptcy and possible malfeasance. Caithness Energy and GE Energy Financial Services are unlikely to go bankrupt and malfeasance is not at issue. As a result, this loan guarantee and the hundreds of millions of dollars in other subsidies that made this project possible are unlikely to create an uproar. Nevertheless, the real scandal is not what happens when everything goes wrong but how these programs work when everything goes right.
Crowd Investing versus the SEC
Crowdfunding has become well known thanks to popular websites like Kiva and Kickstarter so it may come as a surprise that crowd investing, investing in order to earn a return as opposed to “investing” for philanthropic reasons, remains essentially illegal. If a website like Kiva or Kickstarter tried to connect small investors with small firms it would run afoul of state and Federal laws regulating securities. As Amy Cortese writes in the NYTimes:
Under those laws, crafted largely in the 1930s, the sites would have to either limit the fund-raising to wealthy investors, who the S.E.C. deems sophisticated, or go through a registration process that would prove too costly given the small sums being sought…
In the United States, these outdated laws are cutting off a huge pool of potential capital for small, private businesses that have been all but abandoned by banks and Wall Street.
…President Obama, as part of his jobs act, advocates an exemption for sums totaling up to $1 million. Representative Patrick McHenry, a Republican from North Carolina, has drafted legislation that would allow companies to obtain up to $5 million from individuals through crowdfunded ventures, with a cap of $10,000 per investor, or 10 percent of their annual incomes, whichever is smaller.
In Britain the regulations are less onerous:
For a glimpse of what is possible, look at Britain, where securities laws are helpful to crowdfunding and several start-ups are vying to be the Facebook of finance. The year-old Funding Circle, a business-lending site based in London, raises more than $2.3 million each month for small businesses from individuals who can invest as little as $30 and earn an average yield of roughly 7.3 percent after fees. Those are loans; two other start-ups are applying the model to equity shares in small companies.
Hat tip: Daniel Lippman.
The new British university model?
Well, it’s certainly star-studded. A new private university in London, devoted to the humanities, will have the philosopher and public intellectual A.C. Grayling as its “master.” Richard Dawkins will teach evolutionary biology, Niall Ferguson economic history, Steven Pinker psychology, and Ronald Dworkin the philosophy of law.
Christopher Shea has more. Daniel Davies notes correctly that few if any of these illustrious names will be resigning their normal academic posts. That is the real innovation of this business model. Why not rent illustrious names rather than paying the whole set of fixed costs? Then hire excellent teachers — mostly not top researchers — to provide most of the actual instruction. If say Dawkins teaches an intensive two-week course, that is perhaps more than a student would see of him anywhere else, while benefits of certification and affiliation remain in play. I predict this has a good chance of succeeding, and since the illustrious lecturers hold equity shares in the venture, their incentive is to talk it up. It doesn’t have to outcompete Harvard, it simply has to draw international interest from students/families who cannot get into Harvard or who do not wish to donate the required $$.
The people are upset at Greg Mankiw
You could try Kevin Drum, Mark Thoma, or Brad DeLong, or some of the comments on MR, among other commentators. Various remarks are made to lower the status of George Bush, or Greg Mankiw, or to raise the relative status of Barack Obama and his fiscal policy. Furthermore not everyone likes Greg's benchmarks, or accepts the typicality of his example.
When I read Greg's piece, I see it as fair to compare current marginal rates to a zero taxation benchmark, without advocating the latter. To understand a tax system you compare it to no taxes, as an exercise, and to avoid potential problems with the near-intransitivity of indifference.
I also see that if a person runs a successful small business, has a long time horizon, has a strong bequest motive, and can earn eight percent nominal a year (make it reinvestment in a private business if you don't buy the equity premium story), that person faces a very high marginal tax rate. In one of Greg's examples it's about ninety percent.
That some producers are motivated by ego does not change that fact. Furthermore, many small businessmen don't receive Greg's global recognition and they really do work hard for the money above all else.
Greg's column focuses on efficiency but I am more struck by the possibility that such marginal rates are morally wrong and I wonder if that is not his view too.
Greg's scenario doesn't have to be a "typical" case and indeed the taxation – if nothing else — will ensure that it is not a typical case or not nearly as common a case as it ought to be. Another way to put the point is to note that deviations from a progressive consumption tax may be less morally defensible than we had thought.
I also view Greg's column as a chance to learn. What comes to mind are two possible defenses of our tax system-to-be:
1. In reality, eveyrone has a short time horizon, driven by short-term ego rewards and thus such high long-term tax rates can work.
2. The tax system will be an efficient means of price discrimination. The people with truly long time horizons can work around some of the high rates, especially for estates. The people with short time horizons will pay up and those are the same people whose labor won't be much deterred. (There is an interesting discordance in that Greg claims to belong to one camp but some of his critics wish to put him in the other.)
The second claim seems more plausible to me, but they're both worth thinking about. Neither, in my view, removes the moral issue.
There are plenty of encoded status claims in Greg's initial piece, and perhaps that is one reason why it induced so much hostility. I say keep your eye on the ball, filter out the analytically irrelevant social information, and consider that, even if you wish to raise taxes on the wealthy, that a ninety percent marginal rate — even at a non-universal margin — is a sign that something really is amiss.
Addendum: Andrew Gelman comments, and again. And here is Reihan Salam. And here is Ryan Avent. And here is Greg's response.
Declines in demand and how to disaggregate them
Let’s say that housing and equity values fall and suddenly people realize they are less wealthy for the foreseeable future. The downward shift of demand will bundle together a few factors:
1. A general decline in spending.
2. A disproportionate and permanent demand decline for the more income- and wealth-elastic goods, a category which includes many consumer durables and also luxury goods. (Kling on Leamer discusses relevant issues.)
3. A disproportionate and temporary demand decline for consumer durables, which will largely be reversed once inventories wear out or maybe when credit constraints are eased.
Those are sometimes more useful distinctions than “AD” vs. “sectoral shocks,” because AD shifts consist of a few distinct elements.
If you see #1 as especially important, you will be relatively optimistic about monetary and fiscal stimulus. If you see #2 as especially important, you will be relatively pessimistic. You can call #2 an “AD shift” if you wish, but reflation won’t for the most part bring those jobs back. People need to be actually wealthier again, in real terms, for those spending patterns to reemerge in a sustainable way. Stimulus proponents regularly conflate #1 and #2 and cite “declines in demand” as automatic evidence for #1 when they might instead reflect #2.
If you see #3 as especially important, and see capital markets as imperfect in times of crisis, you will consider policies such as the GM bailout to be more effective than fiscal stimulus in its ramp-up forms.
Sectoral shift advocates like to think in terms of #2, but if #3 lurks the shifts view can imply a case for some real economy interventions. I read Arnold Kling as wanting to dance with #2 but keep his distance from #3. But if permanent sectoral shifts are important, might not the temporary shifts (we saw the same whipsaw patterns in international trade) be very important too? Can we embrace #2 without also leaning into #3?
I wish to ask this comparative question without having to also rehearse all of the ideological reasons for and against real economy bailouts. It gets at why the GM bailout has gone better than the fiscal stimulus, a view which you can hold whether you favor both or oppose both.
Note there also (at least) two versions of the sectoral shift view and probably both are operating. The first cites #2. The second claims some other big change is happening, such as the move to an internet-based economy. If both are happening at the same time, along with some #1 and some #3, that probably makes the recalculation problem especially difficult.
I see another real shock as having been tossed into the mix, namely that liquidity constraints have forced many firms to identify and fire the zero and near-zero marginal productivity workers.
There’s also the epistemic problem of whether we have #2 or #3 and whether we trust politics to tell the difference.
The Germans had lots of #3 (temporary whacks to their export industries) and treated them as such, whether consciously or not, and with good success. Arguably Singapore falls into that camp as well. The U.S. faces more serious identification problems, whether at the level of policy or private sector adjustment. We have not been able to formulate policy simply by assuming that we face a lot of #3.
I would have more trust in current applied policy macroeconomics if we could think through more clearly the relative importances of #1, 2, and 3. And when I hear the phrase “aggregate demand,” immediately I wonder whether it all will be treated in aggregate fashion; too often it is.
Larry Kotlikoff responds on limited purpose banking
You can read his reply here. Note however that my criticisms explicitly are directed at narrow banking more generally, most of all my own (previous) version of the idea, not at the specific version of Kotlikoff's proposal. There is one particular topic I did not deal with, and on it I will quote Kotlikoff reproducing my critique and responding to it:
TC: A lot of what current banks do would be replicated by non-bank commercial lenders and the risk of the banking sector would be transferred somewhere else.
LK: You missed the key point that all incorporated financial intermediaries have to operate as mutual fund companies. There are no “non-bank commercial lenders” unless they operate as proprietorships and partnerships and their owners have their houses and yachts on the line. The risk of the banking sector is reduced because we set it up to eliminate any chance of bank runs and gambling by the banks with the taxpayers’ chips. Recall, the mutual funds are 100 percent equity financed at all times and in all situations.
TC: Ideally, these non-bank lenders would engage in greater “maturity-matching,” but if banks will exploit the moral hazard problem won’t these lenders exploit it too?
LK: The only financial intermediaries who can operate under Limited Purpose Banking according to the current rules of the road are private banks with no limited liability. The lack of limited liability will eliminate the moral hazard problem.
I am not inclined to see unlimited liability as a practical alternative. How many businesses supply commercial credit? Trade credit? Credit by any other name? — namely contracts involving derivatives, annuities, insurance, repurchase agreements, etc., with intertemporal payments and embedded interest rates in the prices. Would they all have to give up limited liability? Or would we end up channeling more financial intermediation through indirect credit transactions, while maintaining limited liability? A version of this dilemma is experienced regularly by systems of equity-based Islamic banking..
Second, unlimited liability creates a pecuniary externality across shareholders. Who wants to be the remaining "fat cat" shareholder? Why should Bill Gates ever invest? Non-mutual fund banks will end up owned by thinly capitalized individuals or entities, thereby defeating the purpose of unlimited liability while at the same time raising transactions costs. Walter Bagehot made this point, see also Joseph Grundfest, here is Hansmann and Kraakman with a reply. Alex very ably surveys the main arguments in an MR post.
Unlimited liability is fine for small-scale, private banking, especially in the international sector where tax evasion is a motive and the banks aren't fully part of any standard regulatory network. It doesn't work to force it on such a large sector of the economy as most commercial credit and non-bank lending.
In sum, I do not believe that narrow banking proposals benefit from being bundled with unlimited liability for other lenders.