Monthly Archives: May 2014

The first lesson in economics is a lesson in English

Professor Newton: Okay class. Today we are going to talk about my 3rd law. Imagine I am standing on a small, unmoored boat. I am about to step off on to a dock. What advice do you have for me?  

Susie: Be careful. Every action has an equal and opposite reaction. As you step off of the boat, you might push it out from under you and end up in the water.

Professor Newton: Bravo. Any other thoughts or questions? [Pointing to Bobby] Yes, Bobby? 

Bobby: It’s clear that Susie doesn’t like you because she wants you to be marooned on the boat.

Professor Newton: How did you get into this school anyway, Bobby?   

Bobby’s error is elementary. He has misunderstood Susie to be making a statement about what she wants to see happen–what economists call a “normative” statement. In fact, Susie intends her comment as a “positive” statement about what she thinks will happen. 

His mistake is uncharitable and illogical. 

Regarding charity: There is no need to impugn Susie’s intentions. Until there is evidence to the contrary, he owes her the respect of assuming her intentions are good.

Regarding logic: His statement is a non-sequitur. There would have been nothing illogical if he had questioned the validity of her analysis; perhaps the boat bottom is resting in the mud below, creating enough friction to make her concern unfounded. But in questioning Susie’s motives rather than the soundness of her analysis, Bobby robs himself of the chance to gain better understanding of the world. And he makes himself a fool. 

Though it might have been a common reaction in Galileo’s time, Bobby’s error is unusual today. When it comes to the physical world, people rarely mistake positive statements for normative statements.

Unfortunately, when it comes to the social world, Bobby’s mistake is incredibly common. I’m amazed at how many college educated people make it. I’m amazed at how many nationally syndicated columnists make it.

Though it is really more of an English lesson, I’ve come to believe that the first lesson every economics student needs to learn is the difference between a normative and a positive statement.

Consider this exchange, which seems to play out every day on some editorial page or on some talking-head show:

Ms. A: A minimum wage raises the price of labor. Since most demand curves slope downward, theory predicts that if the minimum wage is set above the market equilibrium wage, a smaller quantity of labor will be demanded than supplied. In other words, a minimum wage may exacerbate unemployment, harming the very people it was intended to help. Those especially likely to be harmed are those with few skills such as the young and uneducated.    

Ms. B: Ms. A doesn’t really care about poor people. She just cares about the wealthy and that’s why she opposes a minimum wage.

Note that it would be completely legitimate for B to challenge A’s positive analysis. Maybe there are good reasons to believe that her theory fails to capture the complexity of the issue. Or maybe B believes the evidence is just too mixed to make any definitive conclusions. These are legitimate responses.

But to impugn A’s intentions is both uncharitable and illogical. Nothing of what A said suggests she wants anything but the best for low-income earners. B is robbing herself of the opportunity to gain a better understanding of the world. And she makes herself a fool.

The mistake is not unique to any particular ideology or worldview. Consider this exchange, some version of which I’ve heard many times over the past 13 years:

Mr. Dove: U.S. foreign policy–including the support of regimes that are unpopular with their own people–angered antagonists and made the U.S. more susceptible to attack on 9/11. 

Ms. Hawk: Dove thinks that America got what it deserved on that horrible September day.

Note that it would be completely legitimate for Hawk to challenge Dove on either his theory or his facts. But to impart normative meaning to what is essentially a positive statement is uncharitable and illogical. Assume for the moment that Dove’s assessment is correct (though, of course, it would be difficult to ‘test’ it). This does not change the fact that attacking innocent civilians is normatively reprehensible and nothing in Dove’s statement suggests he believes otherwise.

But because Hawk jumps to impugn Dove’s normative beliefs, he deprives himself of the opportunity to gain a better understanding of the world. And in so doing he makes himself a fool.    

Science is all about positive claims. But it’s also about normative claims; the only reason to study unemployment or terrorism is because–as human beings–we have strong normative beliefs about the desirability of these things.

The next time you hear a positive claim–especially an unsettling one that challenges your belief system–think twice before you assume the claim says anything about what its speaker believes normatively. You don’t want want to be uncharitable or foolish.

Municipal pension news: Baltimore to offer DC plan

Earlier this month, Baltimore’s city council approved a measure to give the city’s workers a choice between a defined contribution or defined benefit plan plan. According to Pensions and Investments, new hires will contribute 5 percent of their salary to whichever plan they choose, a significant increase from the 1 percent that workers were required to begin contributing to the city’s pension system last year. (Previously, workers had not contributed to their pension). As the article notes, the choice between a DB and a DC plan is a compromise. Mayor Rawlings-Blake preferred to move all newly hired employees to a DC plan, but this was not agreed upon by unions. In total, Baltimore two pension systems have an unfunded liability of $1.4 billion on a GASB-basis.

Baltimore’s proposed reforms are a bit stronger than the plan currently considered by Chicago mayor Rahm Emanuel, which is largely focused on filling in very daunting funding gaps in the city’s multiple plans. The Wall Street Journal reports that the mayor’s plan to raise property taxes by $250 million represents an increase of about $50 a year for the owner of a $250,000 home. And, it’s not enough to cover the gap. The state will demand an additional $600 million in annual payments for the city’s police and fire funds by 2016. In addition, Mayor Emanuel proposes benefit cuts, such as  increased employee contributions and reduced COLAs. But structural reforms aren’t being pushed too strongly, instead, the focus in Chicago appears to be a search for more revenues. Consider a proposal floated by The Chicago Teachers Union. They would like to see a per-transaction tax levied on futures, options, and stock trades processed on the Chicago Mercantile Exchange (CME) and Chicago Board Options Exchange.  Both the CME and Mayor Emanuel oppose the idea recognizing that it will simply drive the financial industry out of town.

 

Is American Federalism conducive to liberty?

In new Mercatus research, Dr. Richard E. Wagner, Harris professor of Economics at George Mason University tackles a fascinating question: Is the American form of federalism supportive of liberty?

His answer is a qualified ‘yes.’ Under certain conditions, American federalism does support liberty, but that very same system can also be modified resulting in the expansion of political power relative to the liberty of citizens. The question of what results from the gradual constitutional transformation of the American federalist system is a salient one for not only students of government but also policymakers.

The important conditions that determine which form of federalism prevails (liberty-supporting or liberty-eroding) are rooted in competition among governments. Today we are experiencing a very different kind of federalism than the one instituted by the Founders. For the better part of a century, the US constitution has often been amended in a way to encourage collusion among the states thus undermining a key feature of a liberty-supporting federalism.

Restoring a liberty-supporting federalism first requires a deeper diagnosis of the American federalist system. Dr. Wagner develops that possibility through a very engaging synthesis of public choice theory, Austrian and new institutional economics.  Student of Dr. Wagner may be familiar with many of these concepts, developed in his public finance books including Deficits, Debt and Democracy (2012, Elgar). Rather than summarize the paper in today’s blog post, for now I encourage you to read the piece in full.

What would a business-cycle balanced budget rule look like in Illinois?

A few years ago, I testified before the U.S. House Judiciary Committee. I’d been invited to talk about the design of a federal balanced budget amendment and much of my testimony drew on the lessons offered from state experience. Since 49 of the 50 states have such requirements, and since these requirements vary from state to state, I noted that federal lawmakers could learn from the state laboratory.

The best requirement, I argued, would have the following characteristics:

  1. Require balance over some period longer than a year. This effectively disarms the strongest argument against a balanced budget amendment: namely, that it would force belt-tightening in the middle of a recession. In contrast, if budgets need to balance over a longer time period, then Congress is free to run deficits in particular years as long as they are countered by surpluses in others.
  2. Allow Congress some time to come into compliance. You don’t have to be a Keynesian to worry that a 45 percent reduction in the deficit overnight might be a shock to the system.
  3. Minimize the gamesmanship associated with revenue estimation: Across the country, states with balanced budget requirements have to estimate revenue throughout the year (I’m a member of Virginia’s Joint Advisory Board of Economists and our responsibility is to pass judgment on the validity of these estimates). But this invites all sorts of questions: what model to use for the economy, should revenue be scored dynamically or statically, etc. One way to sidestep all of these questions is to make the requirement retrospective: require that spending this year not exceed revenue from years past.

Michigan Republican Justin Amash has proposed an amendment along these lines. It would be phased-in over 9 years and from there on out would stipulate that outlays “not exceed the average annual revenue collected in the three prior years, adjusting in proportion to changes in population and inflation.” Because it requires balance over three years rather than one, Amash calls it the “business cycle balanced budget amendment.”

Writing in Time, GMU’s Alex Tabarrok points to Sweden’s positive experience with a similar rule. And economists Glenn Hubbard and Tim Kane also endorse such a rule in their book, Balance.

Now, some Illinois state lawmakers have put together a proposal for a state rule that appears to be largely based on this model. It requires:

Appropriations for a fiscal year shall not exceed the average annual revenue collected for the 3 prior years, adjusting in proportion to changes in population and inflation.

(Unlike the Amash plan, however, the Illinois plan is not phased in over a number of years. Rather, it takes effect immediately upon passage of the bill.)

To see how it might work in a state, I decided to take the Amash Amendment for a test drive, using Illinois data. The solid blue line in the figure below charts Illinois’s actual general revenue from 1990 to 2012 in billions of current dollars. The dashed blue line phases in an Amash-type “business cycle” balanced budget rule. Once fully phased-in, it would limit spending to the average revenue of the three previous years, with an adjustment for inflation and population growth.

BCBBA

Notice three things:

  1. From 1990 to 2002, and from 2004 to 2007, the rule would have kept Illinois spending in line with Illinois revenue, and would have even allowed the state to run surpluses.
  2. In lean years (like 2008) when revenue levels off, the limit actually continues to rise. That’s because it is based on a longer time trend. This means that it wouldn’t require the sort of draconian budget cuts that balanced budget critics often fear. The accumulated surpluses from previous years could also be used to soften the blow.
  3. Lastly, note the (9 percent) revenue uptick from 2011 to 2012. The amendment would prudently make legislators wait a few years before they can go out and spend that money.

Conservatives, Liberals, and Privilege

Utah Senator Mike Lee (R) delivered an important, and timely address at the Heritage Foundation this week. It was focused squarely on what he called “America’s crisis of crony capitalism, corporate welfare, and political privilege.”

It is a problem, he said, that “simultaneously corrupts our economy and our government.” He pointed to a number of ways in which it manifests itself, including “direct subsidies,” “indirect subsidies, like loan guarantees,” “tax carve-outs and loopholes,” “bailouts,” the implicit bailout of “too big to fail,” and “complicated regulations.”

The Senator is careful to point out that the problem has a long history:

Just like the crises of lower-income immobility and middle class insecurity, the crisis of special-interest privilege is not Barack Obama’s fault. It predates his presidency. And though his policies have made it worse, past Republican presidents and Congresses share some of the blame.

He also stresses that the problem is bipartisan:

Too many in Washington have convinced themselves that special-interest privilege is wrong only when the other side does it.

And he’s willing to call Republicans to task for the part they have played:

We [Republicans] have tried being a party of corporate connections and special-interest deal-making. And we’ve lost five of the six presidential popular votes since [Reagan left office].

But though he believes Republicans bear some blame, the Senator contends that government-granted privilege is fundamentally incompatible with conservatism:

Properly considered, there is no such thing as a conservative special interest.

While I agree, I have a more ecumenical view of the issue.

Yes, privilege is incompatible with properly-considered conservatism, but I also think it incompatible with properly-considered progressivism (and properly-considered libertarianism, for that matter). The Senator, on the other hand, believes that “Liberals have no problem privileging special interests, so long as they’re liberal special interests.” As evidence, he quotes progressive thinker Herbert Croly, who wrote:

In economic warfare, the fighting can never be fair for long, and it is the business of the state to see that its own friends are victorious.

I won’t dispute that many progressives continue to view things this way. But I think there is value in framing the elimination of government-granted privilege in terms that attract progressives to the cause rather than in terms that seem destined to repel them.

And there is plenty of evidence that many progressives are at least open to the anti-privilege agenda. As I note in the beginning of the Pathology of Privilege, both the Tea Party and the Occupy movements oppose corporate bailouts. Consider the way progressive economist and Nobel Laureate Joseph Stiglitz framed the issue in Zuccotti Park:

Our financial markets have an important role to play. They are supposed to allocate capital and manage risk. But they’ve misallocated capital and they’ve created risk. We are bearing the cost of their misdeeds. There’s a system where we socialized losses and privatized gains. That’s not capitalism, that’s not a market economy, that’s a distorted economy and if we continue with that we won’t succeed in growing, and we won’t succeed in creating a just society.

Those words could have come out of Milton Friedman’s mouth.

Or consider the way progressives Mark Green and Ralph Nader framed regulatory capture in 1973:

The verdict is nearly unanimous that economic regulation over rates, entry, mergers, and technology has been anticompetitive and wasteful.

The result, they wrote, is a system which “undermines competition and entrenches monopoly at the public’s expense.”

Green and Nader’s concern about regulatory capture wasn’t just an academic exercise. It helped propel one of the most successful eliminations of government-granted privilege in U.S. history: the deregulation of trucking, air travel, and freight rail in the late 1970s. To the considerable benefit of consumers, these industries were substantially deregulated and de-cartelized. And it happened because liberals like Ted Kennedy and Jimmy Carter eventually joined the cause.

Our task today is to get modern libertarians, conservatives, and progressives to once again rally against government-granted privilege.