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August 2, 2010

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Paul Krugman: Defining Prosperity Down

Posted: 02 Aug 2010 12:42 AM PDT

Before the crisis hit, the dynamic nature of the US economy was cited as one of its strong points by free marketeers, especially in comparison with European economies. Economic shocks, we were told, would be bring about a quick adjustment in a relatively free economy like the US. There was no need for government intervention. The price system would send the necessary signals and in no time at all the economy would be back at full employment running just as well, if not better, than before. That is, so long as things like oversized government, social insurance, and unions don't get in the way (like they supposedly do in Europe).

So it will be interesting to see if the same people who promoted the economy's ability to quickly respond to shocks and reabsorb unemployed labor and other resources now blame structural factors for the slow recovery, particularly the slow reabsorbtion rate for labor. As noted below by Paul Krugman, blaming structural factors serves as an excuse for the Fed and Congress to say there's nothing more they can do to help, the economy will just have to heal on its own. Some people will also try to blame government for the slow recovery in order to resolve the inconsistency between their prior claim that the US economy could handle anything thrown at it (citing things like 911 and Hurricane Katrina as examples), and the slow recovery that we are actually experiencing. They'll say it's unemployment compensation stopping people from working, fear of deficits, uncertainty surrounding regulation, etc., etc.

Thus, we'll hear that it's structural factors, it's government, it's whatever it takes for policymakers to rationalize why they shouldn't do any more (and hence avoid any associated risks, real or perceived). And it's whatever it takes, real or imagined, evidence based or not, for those who oppose government intervention generally, and government spending most particularly, to stop any further action to help the economy and to discredit what has already been done:

Defining Prosperity Down, by Paul Krugman, Commentary, NY Times: I'm starting to have a sick feeling about prospects for American workers — but not, or not entirely, for the reasons you might think.
Yes, growth is slowing, and the odds are that unemployment will rise, not fall, in the months ahead. That's bad. But what's worse is the growing evidence that our governing elite just doesn't care — that a once-unthinkable level of economic distress is in the process of becoming the new normal. ...
First, we see Congress sitting on its hands, with Republicans and conservative Democrats refusing to spend anything to create jobs, and unwilling even to mitigate the suffering of the jobless.
We're told that we can't afford to help the unemployed — that we must get budget deficits down immediately or the "bond vigilantes" will send U.S. borrowing costs sky-high. Some of us have tried to point out that those bond vigilantes are ... figments of the deficit hawks' imagination... But the fearmongers are unmoved: fighting deficits, they insist, must take priority over everything else — everything else, that is, except tax cuts for the rich, which must be extended, no matter how much red ink they create.
The point is that a large part of Congress — large enough to block any action on jobs — cares a lot about taxes on the richest 1 percent of the population, but very little about the plight of Americans who can't find work.
Well, if Congress won't act, what about the Federal Reserve? The Fed, after all, is supposed to pursue two goals: full employment and price stability, usually defined in practice as an inflation rate of about 2 percent. Since unemployment is very high and inflation well below target, you might expect the Fed to be taking aggressive action to boost the economy. But it isn't.
It's true that the Fed has already pushed ... short-term interest rates, its usual policy tool,... near zero. Still, Ben Bernanke ... has assured us that he has other options... But the Fed hasn't done any of these things. Instead, some officials are defining success down.
For example, last week Richard Fisher, president of the Federal Reserve Bank of Dallas, argued that the Fed bears no responsibility for the economy's weakness, which he attributed to business uncertainty about future regulations — a view that's popular in conservative circles, but completely at odds with all the actual evidence. In effect, he responded to the Fed's failure to achieve one of its two main goals by taking down the goalpost.
He then moved the other goalpost, defining the Fed's aim not as roughly 2 percent inflation, but rather as that of "keeping inflation extremely low and stable."
In short, it's all good. And I predict — having seen this movie before, in Japan — that if and when ... below-target inflation becomes deflation, some Fed officials will explain that that's O.K., too. ...
Here's what I consider all too likely: Two years from now unemployment will still be extremely high, quite possibly higher than it is now. But instead of taking responsibility for fixing the situation, politicians and Fed officials alike will declare that high unemployment is structural, beyond their control. And ... over time these excuses may turn into a self-fulfilling prophecy, as the long-term unemployed lose their skills and their connections with the work force, and become unemployable.
I'd like to imagine that public outrage will prevent this outcome. But while Americans are indeed angry, their anger is unfocused. And so I worry that our governing elite, which just isn't all that into the unemployed, will allow the jobs slump to go on and on and on.

The Unpaved Road to Serfdom

Posted: 02 Aug 2010 12:24 AM PDT

Maxine Udall wonders "are our roads the canary in the coal mine?":

The Road to Serfdom Is Gravel, by Maxine Udall: Richard Green sends readers to this article about how China has been expanding its network of paved roads, despite a dearth of cars and car owners at present. They are devoid of traffic now, but ready for the day when growth in China's economy produces millions of car owners.

The US experienced a similar expansion in our national roads system during the post-war years of the Eisenhower administration. ... This was back in the days when both sides of the congressional aisle still did occasional collaborative work for a common purpose: advancing the good of the people of the United States of America. ...

As a military leader, Ike was keenly aware of the advantages of good highways for troop and supplies movement. ... But Ike wasn't just a military leader, he was a leader of a nation; a capitalist nation built on commercial enterprise. He recognized the commercial value of a road system in transporting goods long distances. What he may not quite have anticipated was the extent to which it would foster commercial exchange at the bottom and middle of the economic pyramid. With an expanded road system, small farmers are no longer hindered by distance to market. Manufacturers in remote locations ... can expand output and reach distant markets with greater ease. ...

Now the Wall Street Journal tells us that the economic downturn is causing some small towns in more rural sections of the US to tear up asphalt roads and return them to gravel.

In Michigan, at least 38 of the 83 counties have converted some asphalt roads to gravel in recent years. Last year, South Dakota turned at least 100 miles of asphalt road surfaces to gravel. Counties in Alabama and Pennsylvania have begun downgrading asphalt roads to cheaper chip-and-seal road, also known as "poor man's pavement." Some counties in Ohio are simply letting roads erode to gravel.

The moves have angered some residents because of the choking dust and windshield-cracking stones that gravel roads can kick up, not to mention the jarring "washboard" effect of driving on rutted gravel. But higher taxes for road maintenance are equally unpopular. In June, Stutsman County residents rejected a measure that would have generated more money for roads by increasing property and sales taxes.

"I'd rather my kids drive on a gravel road than stick them with a big tax bill," said Bob Baumann, as he sipped a bottle of Coors Light at the Sportsman's Bar Café and Gas in Spiritwood.

Well, there you have it. "I'd rather my kids drive on a gravel road than stick them with a big tax bill." What if the paved road will enable them to make more money? Would that alter Mr. Baumann's benefit-tax analysis? What if an ambulance got someone to hospital in time to save their life? Would that alter a world view in which all taxes are bad?

I read an article in Smithsonian magazine last year about an old Roman highway, the Via Aurelia.

In 12 B.C., Augustus, at the height of his power, commanded his legions to build a highway that would traverse the province of Gallia Narbonensis, or southern Gaul, the last of whose unruly tribes had only recently been subdued. Over the next ten years, surveyors, engineers and construction crews carried off one of antiquity's greatest feats: grading and paving a road from the mountains above the Mediterranean near modern Nice to the Rhone River, 180 miles distant. For nearly four centuries, the Via Aurelia served as the region's principal artery, over which armored legions, charioteers, couriers, traders, government officials and countless others passed. It was the Interstate 95 of its time, complete with rest stops and chariot service stations every 12 to 20 miles—a crucial part of a 62,000-mile road network that extended from the Iberian Peninsula to Asia Minor. Along this paved and finely graded route, Rome maintained its control over far-flung provinces, developed commerce, and disseminated its culture and architecture. But as the empire began its long decline—Rome would fall in the fifth century A.D.—the Via Aurelia began to disintegrate.

I remember thinking at the time: "are our roads the canary in the coal mine?" As they crumble, so do we? How does it happen?

But beginning around A.D. 235, the Via Aurelia fell on hard times. After centuries of political stability, a series of military coups roiled the empire. Roman divisions began turning on one another, the value of currency plummeted, urban renewal ceased and towns and entire districts were abandoned.

Are the number and condition of our roads leading indicators of a lost sense of common cause, lost shared purpose, crumbling political stability? Do we stop investing in and maintaining public goods because we feel no common cause with the other people likely to benefit from them? How do empire's crumble? Surely from within, at least at first. The internal weakening of shared purpose and sympathy, bolstered by mindlessly shrinking tax revenues that  otherwise would have maintained the infrastructure of a complex, advanced capitalist and commercial society, must make it easier for the barbarians to storm the maintenance-deferred, crumbling gate. ...

The astute among you will point out that even if untraveled rural roads are melting back into the prairie, we still have a substantial network of interstate highways. True. Unfortunately, a GAO report in 2002 anticipated that even in the absence of the recent and then unforeseen economic contraction, highway maintenance would fall behind over the next 10 years, while congestion would continue to impose costs on commuters, long-haulers, and the nation generally. ...

We have to make a collective choice. In effect, we must answer the question: how shall our grandchildren live? It is not helpful either to us or to our grandchildren to view this as Mr. Baumann apparently does as a pure tax minimization problem. It would be analogous to deciding we wanted to minimize health care costs without a quality or outcome constraint. As I have told students repeatedly in the context of health reform: if your only objective is minimizing cost, let everyone die untreated. Costs, like taxes, are only one piece of the decision-making equation.

I have written about this before. There are many things for which I would gladly accept indebtedness passed forward from my ancestors: better health, better education, better roads, better infrastructure, community lighting and safety, sanitation, disease control, higher productivity, better access to information and knowledge, and all the technology that makes cleaning my house easier. ...

What passes for discussion about social choice and taxation in this country has become the sound of one hand clapping. The divisions in discourse have been strategically engineered by interests whose objectives I do not understand, but that I am sure are not the commonweal. The divisions are fueled by oblique appeals to base sentiments about race, class, and sexual preference that all of us harbor to a greater or lesser extent. They drive wedges on issues on which most would otherwise agree and from which most would benefit near equally from the same solution. While sentiments are used to divide us, a nation founded on the idea of a government of, by and for the people lists dangerously toward income inequality and its bedfellow, concentrated economic and political power, while we bequeath to our grandchildren a world in which they travel a network of gravel roads with barely a high school education, they live in cities and towns with failing sewers and water systems, and risk their and our great grandchildren's lives crossing crumbling bridges and overpasses.

But their taxes will be low. I wonder if they'll thank us?

"The Economics of Tax Incidence"

Posted: 02 Aug 2010 12:15 AM PDT

Here is the beginning and end of a post by Stephen Gordon giving a graphical and intuitive explanation of tax incidence:

The economics of tax incidence: paying the tax is not the same as bearing the burden, by Stephen Gordon: ...The statutory incidence of a tax (who sends the cheque to the Receiver-General?) is usually very different from its economic incidence (who is out of pocket?).

The basic intuition is simple enough. We all understand that if the government chooses to impose a tax on gasoline retailers of $0.50 per litre, customers can expect to see a similar increase in gas prices. Even if the statutory incidence falls on the sellers, the economic incidence is borne by the consumers.

The question of who ultimately bears the burden of the tax is almost entirely separate from the question of statutory incidence. ... The key determinant turns out to be the relative elasticities of demand and supply for the the good that is being taxed. ...

Here are two important cases where this distinction has important policy implications:

  1. Corporate taxes. I've gone through this point several times (most recently here) and I've compiled a reading list on the topic over here. If you assume that we are in a small open economy where capital flows freely, the supply of capital is relatively elastic. This corresponds to the first set of graphs, and so the result is that very little of the burden of corporate taxes falls on capitalists. Those who claim that owners of capital bear the entire burden are implicitly assuming - as did Harberger (1962) - that the supply of capital is perfectly inelastic. For large countries such as the US, the supply of capital is less than perfectly elastic, so the applicability of small open economy results can be problematic. But the empirical evidence for small open economies is pretty clear: the burden of corporate taxes falls mainly on workers.
  2. Payroll taxes. These include employer contributions to EI and C/QPP as well as Worker's Compensation premiums. But as a HRCD survey notes, long-run labour demand is more elastic than labour supply, so the ultimate effect of payroll taxes is to reduce wages: "labour's share of the payroll tax burden in the long run is in the range of 87 to 100 percent."
If you're concerned about distributional issues, then this is an important concept. It's a mistake to go from noting that the statutory incidence is on a certain group of people to concluding that these are also the same people who actually pay the tax. Unfortunately, it's also a common mistake.

links for 2010-08-01

Posted: 01 Aug 2010 11:04 PM PDT

"Vulgar Keynesianism Robed in the Ideological Vestments of the Prosperous Classes"

Posted: 01 Aug 2010 01:17 PM PDT

I don't agree with a lot of this, but it's entertaining and hopefully informative at some level to watch Republicans fighting with other Republicans about the Party's economic policy. David Stockman -- Ronald Reagan's Budget Director -- is not happy:

Four Deformations of the Apocalypse, by David Stockman, Commentary, NY Times: ...The nation's public debt ... will soon reach ... a Greece-scale 120 percent of gross domestic product, and fairly screams out for austerity and sacrifice. It is therefore unseemly for the Senate minority leader, Mitch McConnell, to insist that the nation's wealthiest taxpayers be spared even a three-percentage-point rate increase. ...
Republicans used to believe that prosperity depended upon the regular balancing of accounts — in government, in international trade, on the ledgers of central banks and in the financial affairs of private households and businesses, too. But the new catechism, as practiced by Republican policymakers for decades now, has amounted to little more than money printing and deficit finance — vulgar Keynesianism robed in the ideological vestments of the prosperous classes.
This approach has not simply made a mockery of traditional party ideals. It has also led to the serial financial bubbles and Wall Street depredations that have crippled our economy. More specifically, the new policy doctrines have caused four great deformations of the national economy, and modern Republicans have turned a blind eye to each one.
The first of these started when the Nixon administration defaulted on American obligations under the 1944 Bretton Woods agreement to balance our accounts with the world. Now, since we have lived beyond our means as a nation for nearly 40 years, our cumulative current-account deficit ... has reached nearly $8 trillion. That's borrowed prosperity on an epic scale. It is also an outcome that Milton Friedman said could never happen...
When the dollar was tied to fixed exchange rates, politicians were willing to administer the needed castor oil, because the alternative ... would cause immediate economic pain... But now there is no discipline...
The second unhappy change in the American economy has been the extraordinary growth of our public debt. ... This debt explosion has resulted not from big spending by the Democrats, but instead the Republican Party's embrace, about three decades ago, of the insidious doctrine that deficits don't matter if they result from tax cuts. ... [T]he new tax-cutters ... hooked Republicans for good on the delusion that the economy will outgrow the deficit if plied with enough tax cuts. ...
The third ominous change in the American economy has been the vast, unproductive expansion of our financial sector. ...Republicans have been oblivious to the grave danger of flooding financial markets with freely printed money and, at the same time, removing traditional restrictions on leverage and speculation. ...
The fourth destructive change has been the hollowing out of the larger American economy. Having lived beyond our means for decades by borrowing heavily from abroad, we have steadily sent jobs and production offshore. In the past decade, the number of high-value jobs ... has shrunk by 12 percent... The only reason we have not experienced a severe reduction in nonfarm payrolls since 2000 is that there has been a gain in low-paying, often part-time positions in places like bars, hotels and nursing homes.
It is not surprising, then, that during the last bubble (from 2002 to 2006) the top 1 percent of Americans — paid mainly from the Wall Street casino — received two-thirds of the gain in national income, while the bottom 90 percent — mainly dependent on Main Street's shrinking economy — got only 12 percent. This growing wealth gap is not the market's fault. It's the decaying fruit of bad economic policy.
The day of national reckoning has arrived. We will not have a conventional business recovery now, but rather a long hangover of debt liquidation and downsizing... Under these circumstances, it's a pity that the modern Republican Party offers the American people an irrelevant platform of recycled Keynesianism when the old approach — balanced budgets, sound money and financial discipline — is needed more than ever.

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