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July 24, 2010

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Latest Posts from Economist's View


"Trickle Down Meanness"

Posted: 24 Jul 2010 02:07 AM PDT

Maxine Udall:

Trickle Down Meanness, by Maxine Udall: Linda Beale ... had a really excellent post a few days ago about a study by Sreedhari Desai, Arthur Brief, and Jennifer George that examines

...a heretofore ignored consequence of rising executive compensation. Specifically, we claim that higher income inequality between executives and ordinary workers results in executives perceiving themselves as being all-powerful and this perception of power leads them to maltreat rank and file workers. We present findings from two studies - an archival study and a laboratory experiment – that show that increasing executive compensation results in executives behaving meanly toward those lower down the hierarchy.

The study conclusions are consistent with my own conjectures that there are ethical as well as economic consequences that result from dysfunctional financial markets and the dysfunctional labor markets they induce. The economic consequences include gross misallocations of financial, physical and human capital, away from activities that would promote long run economic growth and well being and to activities that will promote rising income inequality. The ethical consequences are erosion of trust and compassion, both prerequisites to fairness in rewarding contributions to long run growth and prosperity. If the above study is right, we can add frank meanness to the list of ethical consequences. ...

Causal relationships are always difficult to establish in non-experimental settings. Desai, Brief and George provide results from a small experiment that lend support to their conclusion that increased wage disparity engenders meanness or as Smith might call it "lack of sympathy" among those at the top for those at the middle and bottom of the wage pyramid. Nevertheless, it remains difficult at the societal level to determine to what extent economics shapes ethics and to what extent ethics shapes economics and economic systems.

I would be willing to bet that just as disparity between worker and CEO pay has produced "meanness," so has growing US income inequality produced similar disruption of fellow feeling in the population generally. As the "distance" between the wage rates at the top of the US income distribution and the middle and bottom of the distribution has increased, so has grown the "distance" in sympathy one for the other.

This is not an argument for income equality. There is every reason to believe that most people in the US approve of income differences based on rewards for greater productivity or other merit. I happen to share those views. However, the current disproportionate increase in the percent of national output going to the top 1% of the population, despite increasing productivity among those of us still employed and those who were employed up until 2 years ago, suggests that merit is no longer the trait that is being rewarded.

The conclusion seems self-evident. There is more at stake here than our economy. We must, as a nation, decide whether we want to continue on the path we have been on since roughly 1980. Do we want to continue to reward disproportionately a small fraction of the population that (based on recent performance) seems better at misallocating financial, physical, and human capital through speculative endeavors? Do we want to continue the trickle down of meanness? Shall we live in a society in which trust and fellow feeling are lost, replaced by mindless (not rational, not productive) winner-take-all competition that favors one group disproportionately? If the answers to these questions are all "yes," then the social fabric may already be torn beyond repair and I fear we are about to learn firsthand how empires crumble.

"A Toxic Toolkit"

Posted: 24 Jul 2010 01:17 AM PDT

Why is the Fed unwilling to do more to help the economy?:

A toxic toolkit, by Greg Ip, Free Exchange: Asked Wednesday what he'd do if the economy needed more stimulus, Ben Bernanke was noncommittal: "We are going to continue to monitor the economy closely and continue to evaluate the alternatives that we have."
Mark Thoma (here and here) is dismayed that Mr Bernanke, given the time the Fed has had to study this, doesn't seem to know what he'll do. Robin Harding says Mark is unfair: what Mr Bernanke does will depend on what happens, and then on developing a consensus with his colleagues.
Mr Harding is right that what the Fed would do differs depending on whether it faces a liquidity crisis or a shortfall in aggregate demand and rising threat of deflation. Yet Mr Thoma is also right that this does not exonerate Mr Bernanke. That he knows what to do in a liquidity crisis ... is of small comfort since such a crisis is not in anyone's forecast. To echo Mr Thoma, the question is, how will you deal with the plausible forecast of inadequate demand, disturbingly high unemployment and low inflation bordering on deflation? That the Fed has a plan for when another fire breaks out on its drilling rig is fine, but where's the plan for capping the well that's already spewing oil into the ocean?
I think the reasons for Mr Bernanke's reticence are twofold. First, he's genuinely optimistic the economy will be okay, in part because he's sanguine about the expiration of fiscal stimulus.
If it becomes clear ... that that optimism is misplaced, I think the Fed will swing into action quite quickly. ... Only a minority of FOMC members are opposed to more quantitative easing (QE), but because they're so vocal, it gives the impression of more opposition than really exists. ...
The Fed is not helpless; it has two powerful tools left—but both are politically toxic. One is unsterilized foreign exchange intervention: buying foreign currencies with newly printed dollars... This would both stimulate net exports by pushing down the nominal value of the dollar, and alleviate deflation pressure by pushing up the price of tradable goods. ... But the Fed won't do this without the Treasury's approval, which for its part doesn't want the rest of the world accusing it of exporting its deflation.
The other tool is a money-financed fiscal expansion..., buying newly issued bonds specifically to enable the federal government to spend more money would be a powerful boost to demand. But this needs the federal government to agree to a lot more fiscal stimulus and the Fed to set aside concerns about being the Treasury's hand maiden. Neither looks likely.
Mr Bernanke described both those options as hypothetical in his famous 2002 speech on deflation. Eight years later, it's apparent they are just that: hypothetical.

links for 2010-07-23

Posted: 23 Jul 2010 11:02 PM PDT

"Anomalous Capacity Shrinkage"

Posted: 23 Jul 2010 03:06 PM PDT

Tim Duy promised himself he'd stay away from this topic:

Anomalous Capacity Shrinkage, by Tim Duy: I am drawn to this topic like a moth to a flame.

In this week's Congressional testimony, Federal Reserve Chairman Ben Bernanke notes:

Both U.S. exports and U.S. imports have been expanding, reflecting growth in the global economy and the recovery of world trade. Stronger exports have in turn helped foster growth in the U.S. manufacturing sector.

Typical of policymakers, Bernanke ignores the negative impact of rising imports on US growth. In reality, as global trade has recovered, the external accounts have weighed on US GDP growth. Putting that aside for a second, officials are also quick to point out that the export recovery is aiding manufacturers. It is worth considering how far they can continue to push that argument given the path of manufacturing capacity this decade.

To illustrate the anomalous pattern of manufacturing capacity growth, I focus on the path of capacity for thirty months after the peak of each business cycle, scaling capacity to 100 at each peak:

Note that although the pace of capacity growth slowed since the 1940's, capacity continued to grow even during the typical post WWII recession. This pattern changes dramatically this decade, with very little capacity growth in the wake of the 2001 recession and actual capacity declines after the most recent recession. Arguably, the traditional increases were at risk in the 1990's as well, but the technology revolution intervened. 

One interpretation of this data is that the failure to add capacity is actually a good thing, as a more rapid absorption of excess capacity will speed economic healing and provide the incentive to add additional capacity, providing a desperately needed boost to investment spending. Of course, this interpretation is completely at odds with history. Typical post WWII recessions experienced V-shaped recoveries even as capacity grew.  Now we get jobless recoveries and no capacity expansion.

Another interpretation is that US firms have no intention of adding net new capacity, planning instead to source any excess demand from overseas. This implies that the manufacturing recovery will not be a net positive to US growth. It also implies that the trade deficit will widen further and that the challenge of global imbalances will remain unresolved. The rise of Dollar assets abroad will with either force a fall in the US dollar which would then create more incentive for export and import-competing industries or, more likely, encourage the accumulation of reserve assets among foreign central banks.

In short, I continue to worry that policymakers are ignoring the possibility that increasing reliance on external production to satisfy US demand has contributed significantly to the jobless recoveries we have seen this decade. Something is very different this decade. I think it is a mistake to write off this decade's shift in manufacturing as simply a repeat of the agricultural experience. At least agricultural output continued to rise as its relative  employment importance fell. The capacity numbers are telling us the same cannot be said of manufacturing any longer. And in the past, the relative decline in manufacturing jobs was matched by a more than corresponding increase in service sector jobs. No longer the case; job growth is flat for a decade. If we intend to ignore this issue, the supposed reality of tradable services had better get a lot more traction very quickly. Otherwise, we are further solidifying a permanent underclass of citizens who require the constant support of fiscal authorities.

"Who Ultimately Pays the Corporate Income Tax?"

Posted: 23 Jul 2010 11:43 AM PDT

I wish we had a better answer to this question, it would make tax policy recommendations much easier:

Who Ultimately Pays the Corporate Income Tax?, by Uwe E. Reinhardt: I ended last week's post by asking whether anyone knows which human beings ultimately pay the corporate income tax. An intuitively appealing answer is that the tax is levied on profits... Therefore, those who made that investment — the shareholders — absorb the tax fully in the form of a lower after-tax return on their investments.
That impression would be reinforced by the short-run, partial-equilibrium model ... that we sometimes trot out in freshman economics courses. In the partial-equilibrium model, the company's capital stock is assumed to be fixed in the short run. Imposing or raising a tax on the profits will not change the company's decisions...

But ... all bets are off in the longer run, when the company's capital stock relative to the input of labor can change and when the owners of investable funds can decide whether to invest their money ... abroad or in enterprises not subject to corporate taxation. General-equilibrium models accommodating this wider view of the economy and the longer run ... show that who actually pays the corporate income tax — the owners of capital or labor — is driven by a number of factors in complicated ways that elude simple intuition. ...

The earliest formal general equilibrium model, published in 1962 by a University of Chicago economist, Arnold C. Harberger ... assumed a closed economy. In that model, the burden of the corporate income tax ultimately fell entirely on the owners of capital.
When the model was modified as an open economy in which capital in the taxed country can escape by flowing abroad to untaxed or lower-taxed countries, some or all of the burden of the corporate income tax shifted to labor. Under the assumption of perfect international capital mobility and perfect substitutability..., labor would ... bear the entire corporate income tax, because labor is the only immobile factor than cannot escape the tax.
Other modeling efforts since that time, or econometric estimates inspired by these models, have ranged between these extreme incidence models. Economists are divided on the issue. Some (including Gregory Mankiw) are persuaded that the corporate income tax ultimately falls mainly on labor... One can actually make a case for cutting the tax in the name of a more progressive income-tax structure... Other economists, including the authors of the surveys cited above..., are persuaded by the available empirical evidence ... that the burden of the corporate tax ultimately rests mainly on the owners of capital. ...
So ... why not abolish the tax altogether and instead tax human beings directly? The arguments against such a move are twofold.
First, even bringing in only 12 percent or so of total federal taxes, the corporate income tax represents the third-largest source of federal revenue and could not easily be replaced..., especially in these times of fiscal pressures.
Second, if the profits of corporations were not taxed, the corporate form of enterprise would become one more major tax shelter through which wealthy people could shield their income from taxation. That probably is the main reason why abolishing the corporate tax has never had any political traction, in the United States or abroad.

(There is quite a bit of additional detail in the original post, including links to papers summarizing what is known on this issue and a list of factors that affect the distribution of the tax between capital and labor.) Though there is uncertainty, when thinking about tax policy I would go with the view of those who are most familiar with the theory and evidence, i.e authors of the surveys, as opposed to more casual observers and assume that the burden is mainly on capital.

"Is Nothing I Ever Wrote on Ezra Klein's Journolist Worth Pulling Out of Context and Misrepresenting?"

Posted: 23 Jul 2010 09:36 AM PDT

I doubt that anyone much cares what I said, so it may be that even with the standard misrepresentations, distortions, and out of context quoting there's nothing I've written that will draw the traffic they are looking for, but I feel the same way:

Is Nothing I Ever Wrote on Ezra Klein's Journolist Worth Pulling Out of Context and Misrepresenting?: I am somewhat offended...

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