Saturday, March 31, 2007

Can $15 Per Ton Be The Right Price?

The figure commonly thrown about for damages from global warming is roughly $15 per ton of carbon. This startlingly reasonable number has left me wondering whether our methods of damage estimation are correct.

I haven't scrutinized these exact estimates but typically we do damage estimation by calculating either the willingness-to-pay to avoid the externality or the willingness-to-accept to live with it.

That is, we figure out either how much people would pay, if they could, to get rid of the problem of global warming or how much we would have to pay them so that they would rather take global warming and the money than be without either.

This is all very normal and accepted.

The problem comes in when the people who are creating the externality and the people who are going to suffer from the externality are radically and systematically different. In this case the United States is the world's largest producer of carbon emissions and also happens to be the wealthiest nation in the world. On the other hand by many account Bangladesh will suffer some the worst consequences of global warming and is among the poorest nations in the world.

All else being equal the more money you have the higher your willingness-to-pay to avoid externalities will be, this is in part because rich people have more time to be concerned with these types of things, but more importantly its because rich people simply have more money to pay.

Before my economist readers pooh-pooh this line of reasoning as being dealt with by Kaldor-Hicks let me weave a story that I think is important.

Suppose we continue with the example of the US and Bangladesh. The US is emitting carbon which we will assume has little to no impact on the quality of life in the US but will potentially kill roughly 10 Million Bangladeshis because of the rise in sea levels.

Now we could say - Look America, the Bangladeshis have a right to life and property which you are infringing upon. Please cease and desist. By many accounts this would be fair. I don't have the right to fire bullets into a crowd or start uncontrollable fires in my backyard because I could be taking other people's lives. Why does the US have the right to pump carbon into the atmosphere? The fair thing to do would be to make America stop.

Economists rush in, however, and say - Look, it may or may not be fair but it is certainly not efficient. No particular Bangladeshi will die with certainty in the floods and many risk death every day from other things. I think some of them would rather have money which they could use to buy food and medicine for their families and then just chance the flood.

So, we figure up how much medicine we'd have to give the Bangladeshis to make them indifferent to global warming and we call that the damages. If we just charge that to the US then by the miracle of markets we've managed to make the Bangladeshis whole and reduce the cost to the US to a mere fraction of what it would be if we stopped carbon all together.

The problem with the story is this - The miracle was possible in large part because Americans had to give up very little happiness in the form of money to make the Bangladeshis very happy with medicine.

In other words here, the major gain is that in this example there are huge gains from trade between the United States and Bangladesh. That gain, however, is only realized if in fact we trade with Bangladesh. If we keep the tax money and use it to reduce our own income taxes we haven't taken advantage of that gain and so the calculations we used to come up with the marginal damages are invalid.

Another way to think about this, suppose that each human being has the right to produce a given amount of carbon, a personal carbon permit. Bangladesh would have about half as many permits as the US but a fraction of the carbon. They would gladly trade some of their permits in exchange for life saving resources.

America, in desperate need of permits would take the exchange. However, in the end this transaction involves two parts. A given reduction in US carbon emissionas and an increase in medicine in Bangladesh. The first part does not make sense without the second.

If we aren't going to give the money to Americans then we have to ask another question. What would an American pay to avoid the consquences the average Bangledeshi is going to experience. My guess is that that number is significantly higher.

hat tip to mankiw

Friday, March 30, 2007

I Share Goolsbee's Lack of Outrage

I was happy to find a kindred spirit in Austan Goolsbee The hand wringing over the subprime meltdown has left me a little confused.

Money was cheap and to steal a phrase from the A Bronx Tale the subprime borrowers "took a shot, what I am going to say." That is, they tried to stretch their way into a house. When you take a shot, sometimes you miss. There is nothing wrong with that. Would you prefer that they never had a shot in the first place? Maybe the lenders where too desperate and let people in the door they shouldn't have. Maybe. I am still not sure about that.

There is uncertainty in the world and sometimes even calculated risks don't pan out. Either way, however, its the lender that ends up holding the bag. The subprime borrower looses his house, but he didn't have a house to begin with. And his credit? His credit was already subprime, whats really the loss there.

I just don't see who is made better off by preventing these transactions from happening.

hat tip to Mankiw

Thursday, March 29, 2007

Skill Shock and Stagflation

Something occurred to me while I was looking through Bernanke's statement yesterday. Bernanke mentioned the oft repeated fact that while it was easy for employers to find low skilled workers the market for high skills is becoming tighter and tighter. These tight conditions keep alive concerns that inflation will remain high even as the economy weakens - a mild case of seventies style stagflation.

What I hadn't thought of before, however, was that the decline in skilled labor represents a supply side shock of the same type we experienced during the oil crisis. The economy increasingly depends on skilled workers for growth but the supply growth is slowing and may even decrease in the coming years.

This drives up the price of skill labor but it doesn't do much to drive up the average productivity. The result is a real supply side shock - the kind that can lead to slower growth and higher prices. If this is true then stagflation may prove unavoidable.

What are your thoughts?

Tuesday, March 27, 2007

Rudy's A-

Saw Rudy Guliani on Kudlow and Company. Overall I was impressed. I have never seen someone so openly support classical liberal ideals. It didn't come across a pure rhetoric either, he seemed to have some grasp of the underlying issues.

Unfortunately Rudy suffers from Supply Side Syndrom (SSS) - an irrational belief that cutting taxes will always raise revenue. Moreover, he seemed to be too taxaphobic in general.

As Mankiw says to many Republicans fall into the following trap

A) Taxes are bad

B) Carbon Taxes are a Tax

C) Therefore, Carbon Taxes are bad.

In its place Rudy prefers regulations. Over estimating the cost of taxes and underestimating the cost of regulations is a significant problem among todays republicans. More later this week on how to over come that.

Higher Taxes Might Induce More Education - Seriously

Greg ponders whether or not Ed Lazear should follow his gut and assume that taxes discourage people from becoming more educated or follow Larry Katz’s analysis that there is no relationship.

This situation exemplifies a common conundrum for policy advisers like Eddie. In the absence of hard evidence, should he act as if there is no effect, as Larry seems to be suggesting here? Or should Eddie rely on the general principle that people respond to incentives and make an educated guess about the magnitude?

The problem, however, is we don't even know what the sign is. That is we don’t know if taxes increase or decrease the incentive to become more educated.

It could be that higher tax cause people to increase their educational attainment.

Also, the term higher/lower taxes is a bit misleading.

Raising the child credit would count as "lower taxes" for most policy makers. Show me the economic model where raising the child credit increases human capital accumulation.

I can build at least two strong arguments around a child credit decreasing human capital accumulation, especially of course among women.

Now if you said that we are going to specifically find ways to reduce the return to education then ok, at least you now have an ambivalent effect.

On the one hand lower returns to education would cause people to substitute towards other forms of wealth generation. On the other it would have a negative wealth effect for the talented which could cause them to seek more education.

One of the deepest problems for policy advisor is that the general equilibrium effects of a policy can be exactly the opposite of what you would first expect. When you tax something you get less of it, right?

Well, not necessarily. It depends on how you tax it, what you do with the tax revenues, and what options people have for avoiding the tax burden. The devil is in the details and the details are always a mess.

Monday, March 26, 2007

Spin Nation

There are no spending programs. Now there are only fully refundable transferable tax credits.

From Senator Coburn's Medi-Choice Proposal.

Under the Act, Americans would be eligible for a tax rebate to purchase health insurance. The “Medi-Choice” rebate would be made directly to a patient’s health insurer and would be worth $2,000. Families would receive a $5,000 tax rebate.

This my look like a "check" and may be payable to someone who is performing a government service, but in reality it is a tax cut. Trust Us.

By the way Senator Coburn's idea does look like a good spending proposal. But it does in fact increase spending.

Answer to Arnold

Arnold asks for comments on his theory of government.

His basic point is that government is the entity which can enforce arbitration between private parties. For this to work, we must turn over power to the arbiter. Once we have done this there is no stopping the arbiter.

I generally agree although my story goes a little bit like this:

You and I could come to various agreements about how we are going to live in peace.

However, in the absence of government we face a prisoners dilemma. No matter what you do it will always be better for me to sneak into your house in the middle of the night and kill you. Once I kill you there is nothing more you can possibly do to me. The permanence of death prevents us from getting out of this prisoners dilemma through repeated interaction. In any period even if I don't gain that much from killing you, I might do it just to prevent you from killing me later.

Now this is balanced against the fact that most of us don't like to kill and we want to have friends, etc. However, the incentive is always there underneath the surface and it will result in rent dissipating activity.

I might install some sort of early warning system, or I might expend energy appearing tough or macho so that you believe your efforts to kill me will be unsuccessful, or I might just live farther away and only trust my relatives or people I have grown up with.

This rent dissipation brings the opportunity for profit and profit seeking firms will take advantage.

This ives rise to the first evolution in government - Small For Profit Government.

In reality this takes the form of a group hero or leader, somone who mediates disputes and in return receives respect, admiration and likely a higher share of resources.

However, there are increasing returns in the production of violence. Small For Profit Government eventually gives way to Large For Profit Government often in the form of franchises. We call this feudalism.

The human story is that heroes from different tribes get together and either agree to work together or go to war. If they work together they themselves select a hero who will mitigate their disputes and so on up the chain until there is a king, a nobility below him, and knights below them. If they go to war then the winners simply institute the previous scheme among themselves.

Because this process reduces rent dissipation there are enormous social returns. Unfortunately, the government is in a position to capture all of the returns. After all, without them there would be no society.

Unsatisfied with this government people have looked to Not For Profit Government. This is where some subset of the populace revolts and creates a corporate governance structure where everyone who meets a basic criteria (male, land-owning, adult) is a shareholder.

This is where we are in the western world today. Yes, government has the golden scepter as Arnold puts it, but its not because we go along with it to make the system work. It is because the market abhors unclaimed rents, and if there is no Not For Profit Government in place the for profit ones will form.

Arnold's example of the heroin dealer is poignant because For Profit Governments (the Mafia and after their demise street gangs) dominate the illicit drug trade.

Government is inevitable because murder prevents us from escaping the prisoners dilemma through repeated action. Without government there is a huge profit to be made in deincentivizing murder.

Effecient Markets and the Booyah

So can the Efficient Market Hypothesis (EMH) stand up in the face of market manipulations by hedge fund managers.

Shouldn't it

A) Be impossible to manipulate and Efficient Market and

B) Be unprofitable to try

My answer is no is on both counts. The EMH says that the market has priced in all publicly available information. Cramer's antics are based on altering the information available to market analysts. As long as the market in information provision is not perfectly competitive this will be possible.

That is, as long as their are trusted information sources who have the power to single handedly change people priors it will be profitable to make money by manipulating those sources.

Saturday, March 24, 2007

Kids Make You Miserable

Greg, posts a link to an article in Slate which reveals that happiness reaches a minimum at age 45. We are happy we are young, we are happy when we are old. We are miserable in middle age.

The economists behind the research suggest that perhaps during middle age your sense of invincibility is crushed leading to less happiness. By the time you are old you have come to terms with it.


You are crushed in middle age. You are crushed by the responsibility of taking care of whining rug rats. Sure you say, you are more often happy because of your kids than mad. Yet, the true cost of kids isn't simply whether or not they make you pull your hair out. It's what you give up to have them. Its romantic nights together with your significant other, trips to Europe and Asia, and the chic loft downtown. Its giving up the sports car in favor of a minivan and replacing salsa lessons with soccer practice.

Kids, in short, make you miserable.

Yet, there are few desires more strong, few life choices more satisfying than having children. All of which serves to underscore one of the most important points about happiness research - what we want to do and what will make us happy are not the same thing.

Sure people want to be happy. They just don't want to do the things that make will make them happy. They want to do the things they are emotionally driven to do. This may or may not end in happiness.

For economists this means that there is no reason to suppose maximizing utility and maximizing happiness will produce the same results.

Friday, March 23, 2007

The EMH vs. Jim Cramer

The business world is a buzz with reports on Jim Cramer's market manipulation admissions.

Cramer confesses that a hedge fund manager "must" use false rumors and strategically placed purchases to create the impression that a stock price is headed in the direction he wants. For example, Cramer argues that one could buy a bunch of puts on Apple stock and then call the reporters and say that someone in Apple has told you their relationship with the mobile phone carriers is breaking down.

Puts are contracts which allow you to sell your stock for a set price even if the market price plunges. The presence of a bunch of puts and negative rumors will lead many people to think that Apple stock is headed down. Cramer could then swoop in and buy it cheap.

So, a natural question for economists is - can the Efficient Market Hypothesis (EMH) hold up in the face of market manipulations like the ones Cramer describes?

Comments are welcome. My thoughts tomorrow.

Background Here

Thursday, March 22, 2007


Msnbc says that educators are upset by wikipedia.

I am actually thrilled by it. I use it myself to refresh my memory on economics topics or to uncover fomulas otherwise burried inside my heap of reference books.

Moreover, its a living demostration of the power of volutanry association. There are some inaccuracy where hot but topics are considered but in general I have found it reliable. On the few occassions where I noticed an error, I simply hit refresh on my browser and the error removed. In the time it took me to read it and recognize it, someone had already corrected it.

Up or Down

The brouhaha continues over the Federal Reserve's statement.

For non-Nerds the Federal Reserve, those are the guys with the printing presses, decided to keep interest rates where they are. In the accompanying statement, however, they changed the language they use about future decisions.

For what its worth I believe that the firming bias was remove - the Fed isn't leaning towards raising rates anymore.

Yet, I believe this was a mistake. Not only has inflation been running high but inflationary expectations have been creeping up. There are those who are beginning to question whether the 90s was a fluke. The Fed needs to send a strong signal that price stability will be maintained in the face of temptation.

Wednesday, March 21, 2007

Genetic Inequality

Like many academics I have become increasingly convinced of the power of genetics over the last decade. I was first awaken from my blank slatist slumber by E.O. Wilson but the evidence has since come in on all fronts.

Sociobiology or Evolutionary Psychology, as I think it has now morphed into, is becoming increasingly undeniable.

This has lead at least one pundit to declare that the new definition of a liberal is someone who believes in evolution but not in biology. That's clearly a jibe at old notions of class warfare and income inequality caused by injustice inherent in the "system"

Perhaps I am the only one to experience this but the triumph of sociobiology has actually made me less libertarian not more. If anyone was theoretically capable of anything then why tax people on the basis of their choices. In Jim the Janitor is sad because he earns less than Cecil the CEO then he should change his career path.

Tabula Rasa means the we, and our parents, are ultimately completely responsible for our lot in life. Even if society had a hand in it somewhere it certainly wouldn't help things for society to start rewarding behavior it didn't want in the first place.

If its not all a blank slate, however, then maybe Jim the Janitor could have never been a CEO, no matter how bad he wanted it, no matter how hard he studied, no matter what sacrifices his parents made to send him to the best schools. It just wasn't going to happen for him.

In crew (that's rowing for the uninitiated) we talk about stroke volume, or how much blood your heart can pump in a single beat. By the time you're on a college crew team either you have it or you don't. You can train you guts out. You can be in the gym everyday, but you will simply never beat a guy who has a physically much larger heart.

Its a sad thing to see guys struggling, and know that they can never achieve their goals. Its sad and we don't want it to be true. But it is true. I have seen men pass out as their hearts pumped away in a furious yet ultimately futile attempt to keep their muscles oxygenated.

The experience is made bearable only by the notion that not everyone can make the "A" boat and it wouldn't be a sport if they could. Yet, how does one deal with the notion that not everyone can be economically productive - at least not at the level many of us take for granted.

No matter how hard they try, now matter how much they train they simply can't do it. They just weren't made that way. Its hard to have a cold heart in the face of that reality.

Is Wage Insurance What I've Been Looking For?

Greg brings up the new wage insurance proposal that I have been meaning to blog about.

He's skeptical. I'm interested.

In part my reasons are political economy. I am looking for a mechanism that will prompt all Americans to buy into to globalization and technological change. I understand that globalization per se is overly blamed for job losses but I think that's the term the populace uses for "things beyond our control."

I want to assuage their fears and let them know that the things beyond their control are evolving in a way that on average will benefit them more than it will hurt them.

Secondly, I am concerned about the welfare implications of policies which pass our basic cost-benefit test. If I am forced to choose between assuming that the marginal utility of income is constant across the population or that everyone has the same utility function with respect to aggregate consumption, I won't hesitate to choose the later.

For non-nerds I mean that if I either have to assume that $1000 means just as much to Bill Gates as it does to Bill the Plumber or to assume that Bill Gates would value $1000 the same as Bill the Plumber, if he had Bill the Plumbers income then I am going to go with the second one.

This means that I have to worry about who gets what benefit. I believe there was a time when Milton Friedman's comment that we are generalized in consumption and therefore will all benefit from lower prices was enough. However, I think that the new economy is systematically biased in favor of talented people in ways that cannot be ignored.

Practical Education

Bryan Caplan gratiously writes that he is lucky to have me as a reader. He calls me Prof. Smith which not only still sounds icky but makes me wonder whether my addressing him as Bryan was too familiar.

Nonetheless, his point about overestimating practicality is well taken. Though, I wonder how truly ivory tower one must be to suffer from this form of bias.

I am also still curious as to how university education, with its professors spending more time on research than in the classroom, could be the most effecient form of signaling the market can muster.

Some university education is highly subsidized for sure. Yet, there is competition between states and for charity dollars. If anything this compeition seems to be reinforcing the research university model not replacing it.

Moreover, why do young scholars in North Carolina dream of going to Duke not Davidson. Davidson was recently named the most difficult undergraduate institution. Surely, it must be a great signal when one graduates from it with a 3.5.

Yet, accross the country education seems to be moving away from the intensive liberal arts model towards a much more don't-bother-us-while-we're-in-the-lab reseach university model.

If there is not some sort of important human capital transfer going on then quite frankly why is the rest of the world so willing to put up with research professors' you know what.

But, perhaps I'll have to wait for Prof. Caplan's book?

Tuesday, March 20, 2007

Home Ownership Might Still Be Good For America

Greg and Tyler have both mentioned the result by Andrew Oswald that high levels of home ownership are associated with high levels of inflation.

Now, as you all may know, the mortgage interest deduction is a perennial whipping boy for economists. Liberal economists see it as a tax give away to upper middle class owners who are more likely to itemize. Conservative economists view it as turning potential investors away from the stock market towards the less productive real estate market.

While I am sensitive to both those arguments the question remains - is more home ownership in and of itself a good thing or a bad thing for America as a whole. At first blush Oswald's results seem to suggest that it is a bad thing.

I am, however, not so sure. Home ownership exposes families to more systemic risk. That is, if the your local economy turns bad not only are you out of a job but you are stuck in a home which is decreasing in value.

On the other hand it shields people from idiosyncratic risk. That is, suppose that your town is doing well but your business just happens to do poorly this year. Well, at least you still have the house. Even if you have to tap it for equity or sell and scale down, you still get to keep whatever premium your neighborhood commands.

My thought is that the second result might be more important than the first. People are attached to their communities and buying a home helps the hedge against the risk that their personal fortunes will not match those of their neighbors. It allows them to keep their kids in the same schools even if those schools are in greater and greater demand.

All together I think home ownership decreases the risk level homeowners face and perhaps that's precisely why they face higher unemployment. They are more willing and more able to hold out for a better position. If that's the case the home ownership may be good for America after all.

Monday, March 19, 2007

Markets Out in Front

In two posts Greg Mankiw discusses why Milton Friedman felt economists should ignore political realities and why Milton's son David believes that they must not.

Irrespective of political reality markets, I say, must be out in the front of the policy discussion. The truth of politics is if no good solutions to a perceieved problem are offered bad ones will be excepted. You can't be something with nothing. You have to be responsive to the concerns of the electorate and that means proposing market based solutions to the problems they face.

Whether its widening inequality, global climate change or the dismal performance of our K12 system failure to offer solutions grounded in economics only empowers the command and control set.

Arnold Makes a Good Point

Arnold's point about self education is well taken. There is a strong possibility that part of what students are buying is "personal training" for knowledge.

That is, they need some guidance about what to learn and more importantly they need an accountability partner. They need someone to test them and say look - you really didn't study this as in extensively as we originally planned.

Formal education then is explained by some form of hyperbolic discounting, or in common parlance lack of self control.

There is no wonder then education is less valued by entrepreneurs. Among the traits necessary for being a successful entrepreneurs is a high degree of self motivation.

Sunday, March 18, 2007

My Answer to Bryan's

Query on his on selection bias.

I think those who spend their lives in academia will tend to underestimate the return to education.

As Card points out the return to education is higher for those who have limited access. Moreover, academics tend to enjoy the education process and will seek education beyond the point where the marginal pecuniary return is exceeds the marginal cost.

This will lead academics to conclude that education doesn't pay.

Indeed, I felt this way myself until leaving academia to make my fortune on the Internet and subsequently losing it all. My stint in working class America lead me to believe that if anything the return to education is smaller for those with talent than those without. Indeed I suspect that the standard OLS measures may underestimate the return average return.

That is marginal benefit falls with increasing talent but 'disutility' falls faster causing the talented to seek more education and downwardly biasing the estimates.

Why Are We Teaching These Kids?

The first page from Byran Caplan's new book summarizes a position he is stated many times about education - that it is mostly a waste of time. There are several points I'd like to make relating to the economics of Bryan's assertion and how he arrived at it. To maintain the reader's interest I'll address the juicer ad hominem points first.

First, Bryan says that education, for him, was mostly a waste of time. I would say much the same about my classroom education. Yet, in my case, and I suspect Byran's, this wasn't because there was too much learning going on but too little.

I could absorb material much faster than the teacher taught it. So much faster that I was better off simply to read the book and struggle with it myself rather than waiting for the class to come along.

This problem, however, exists for a small minority of children. Most children actually tend to lag behind the school systems highest expectations. Just because the best could do better on their own doesn't mean that most could.

Secondly, Bryan confesses that he has never really worked outside of academia or even spent much time outside of the education sector. This, I suspect, is the real culprit. Byran doesn't realize just what it means to be uneducated because he has not worked closely with uneducated people.

Its one thing to think that obscure memorization of multiplication tables or facts about rivers basins is useless. Its another to try to build a creek side patio with someone who doesn't know these things.

You don't often use much of the trivia you learn in grade school but when you do it can be vitally important.

Perhaps, if we were all perfectly specialized in our occupations and could predict what we wanted to do from an early age it wouldn't matter. You could just learn what you needed on the job. There would be no need for a generalized education.

Yet, when the demand for new houses rises, reminding a group of new apprentice carpenters what right triangles are and teaching a bunch 30 year-old guys who have never heard of an angle are radically different.

Ironically, when you work in the knowledge economy it can be easy to forget just how important knowledge can be. In jobs where knowledge aquistion is the goal, intellectual horsepower has a greater return than possesion of the very knowledge you are working to make obsolete. In most other feilds intelligence matters but well established empirically verified knowledge matters more.

Third, from a economics prospective its hard to reconcile the notion that there is too much schooling with the literature showing that the returns from schooling are high. I am not talking about simple minded studies that show educated people make more money. More careful examinations conclude that the causal effect of education on earnings dominates most of the return.

Indeed, at the margin education seems to be most important for groups that are disadvantaged in their ability to obtain it.

Lastly, there is the market test. If education is so useless why is the market so incapable of finding an alternative. Fast track programs are common in finance, consulting and now even retail. Shouldn't it pay to snag brilliant 16 year-olds and put them to work in I-Banking before they waste time in high school and college.

Despite the severe shortage of talented labor no one has thought of a way to do this?

Saturday, March 17, 2007

What are we teaching these kids

Some time ago Garth asks if anyone out there is smarter than a fifth grader. Appearnatly a new TV show asks adults fifth grade science, math and history questions. Most adults seem not to know, leaving Garth with the impression that fifth grade is full of useless trivia that it soon forgotten.

While I do think that education hasn't yet caught up with technology - why teach how meany tablespoons in a teaspoon when Google can answer instantly - I must note that most education uses the overteaching method. We cram way more facts than you need to know into your head in the hopes that you will remember at least a few of them.

I do think, however, that in this day an age to much time is spent on basic facts at a young age. Real math and science need to come earlier so that we can make way for important facts at the end. For example, the percentage of American's who understand what a Corporation actually is appaulling low, depsite the fact that vitually all Americans have strong opinions about them.

With our shrinking personal savings rate number of Americans who understand how compound interest works is shamefully low as well. Of all the "factual" subjects that one needs to know personal finance seems well near the top.

Of course a dose of general economics would be a bad thing to toss in as well.

The Causes of Leisure Inequality

My problem with Lansburg's latest piece in Slate is that it leaves the impression that lower income workers have lower incomes because they work fewer hours. I don't think Lansburg means to give this impression but in my opinion he doesn't work hard enough to avoid it.

The cause for the inequality in leisure is, by my guess, a result of both rising wage inequality and the progressiveness of the tax structure. Allow me to explain.

As most economic students know rising wages have two effects on the amount people choose to work. On the one hand people want to work more because they are getting paid more for each extra hour. On the other hand people want to work less because they've already earned so much from their previous hours work and so they don't need the extra money as much. In the end we are not sure which way it will go.

However, progressive taxation adds a wrinkle. Lots of money is taken from those at the high end and redistributed roughly evenly in the form of government services. This means that rising wages ensure that everyone has more whether they work more hours or not.

The effect is biggest for the poor because government services are a larger part of their consumption. As the rich get richer the poor receive larger and larger transfers and this induces less work. One of the most obvious examples is the child tax credit.

When the Bush administration lowered taxes it cuts rates for the wealthy but it also greatly increased the direct transfer to the poor and middle class through the child credit. This has in economic terms a wealth effect but no substitution effect. The result is that the poor and middle class are incentivized to work less.

Hat tip to Mankiw

Friday, March 16, 2007

Til Death

The personal savings rate in the United States has been comfortably in the red for over a year now. This means that on average Americans are spending more than they make on a regular basis.

Does this mean our country is going to the dogs? Have we lost all sense? Are we mortgaging our children’s future in exchange for Plasma TVs?

Perhaps. Though I am skeptical that the entire nation has suddenly gone mad. I am not expressing an opinion about the fraction of countrymen who are mad. I simply don’t think that fraction has changed significantly over the last decade.

Then what other possible explanations could there be? The one that is the most interesting to me is that the nature of work has changed.

Increasingly Americans work in occupations that are less physically demanding. Increasing Americans also work in occupations that they enjoy, especially those who have more experience and are further along in their careers.

It is reasonable to suspect that many of these people don’t plan to retire in the traditional sense. Many of them likely plan to work well past their sixties and perhaps as long as they are physically able.

This radically changes a family’s financial life cycle. In the past we assumed that a family’s peak earning years during their 40s and 50s. This meant borrowing a little to get started in their twenties. Breaking even during their 30s and saving for retirement during their 40s and 50s.

If they plan to work into their 70s then the path changes drastically. In particular this means that there is an enormous potential gap between income and expenditures after 60. By then the kids will be gone and the mortgage will be nearly paid off. If they are healthy both spouses have the time to work.

Providing for two adults in a home that’s paid for costs a fraction of what most families spend. Yet, its entirely possible that two experienced 60+ adults could make significantly more than younger households.

In this case it makes little since to struggle to put away money, when money is tight simply to be rolling in dough at 70. Far from being mad the drop in savings might be a sign that Americans have escaped the madding oppression of slaving away at a job they hate only for the promise of a few years of peace.

Thursday, March 15, 2007

Is the AMT Worth Fixing

Greg points us to an AEI piece demonstating why democrats have been so keen on "fixing" the Alternative Minimum Tax (AMT).

As it turns out states that tax their residents, particularly their high income residents, heavily tend to be hit hardest by the AMT. Thats, of course because the AMT doesn't allow you to dedcuct state and local taxes. If you pay a lot of state and local taxes then you are more likely to have a high burden under AMT rules.

Which leads us to ask - is allowing state and local deductions a good thing?

THe quick retort of most economists is no. Why should someone get a tax break just because they choose to buy more things using the government rather than the private market place? An often repreated example is public vs. private pools. One community decides to build a public pool and tax its residents for it. They get a tax break.

The other community decides to build a private pool and charge member fees. They don't get a tax break.

However, I ask - do state and local taxes really pay for pools? What exactly is high local spending subsituting for?

The more accurate answer may be charitable contributions. Here in NC for example the state does three things, pays for public school instruction, Medicaid, and prisons. Everything else is pretty much rounding error. Local governments pay for school and road construction.

Now public roads may in some sense subsititute for toll roads. Medicaid and public schools, however, are largely transfer programs. Yes, most parents will send their kid through the public school system. So, perhaps on some level they substitute for private schools. Funding, however, for schools is not equally borne by all tax payers.

High income tax payers, end up putting in far more for schools than they take out. Those are precisely the people who are getting hit most by the AMT. So, in many ways state and local taxes on the wealthy subsitute for charity. It makes sense given that high AMT states also tend to be highly urban states.

Charity doesn't work as well when there are a lot of other rich people to free ride off of. Instead the state opts for higher taxes on high income residents. So, as long as we think the charitable deduction is a good idea, then it stands to reason that the state and local tax deduction may be worth keeping too.

Cruel Calculus - CT Scan Edition

Cruel Calculus - A series is in which I propose efficient but politically and perhaps morally unpalatable solutions to what ails society.

Kling refers to the gray area of medicine - procedures, like CT scans to uncover lung cancer, that are not justified by statistics. CT scans don't do a cost effective job a catching cancer but they do make the patient feel better. So should insurance pay?

Kling says no.

I say yes, but with a catch. If we find cancer then not only is the CT scan covered but you get to pocket the money the insurance company saves because it has the option of tackling the problem earlier.

If there is no cancer then you owe the cost of the procedure, payable in 60 monthly installments, financed at the current 5 year T-Note rate.

Not only does this allow who "just have to know" to get the procedures they want without imposing high costs (and hence premiuums) on the rest of us, it also gives a nice bonus to those truly in touch with their medical needs.

Imagine,insurance that pays you when bad things happen and charges you when they don't.

Wednesday, March 14, 2007

What Bush Hath Wrought

David Brooks says that the days of neoliberal are over. Today's democrats are increasingly suspicious of capitalism and US military intervention. The tone on the blogosphere is more reminiscent of 1968 than 1998.

On the other side, the republican party is fractured and increasingly dominated by populist and theocratic sentiments. The unity of social and economic conservatism that Reagan embodied was interred with his bones.

Even Tyler Cowen seems to be putting the liberal back into libertarian.

When Rent Seeking Strikes

Newsweek reports that there is a coming shortage in oncologists. The results will be declining service, increasing costs and perhaps an otherwise aviodable increase in cancer deaths.

The leading cause of the shortage - a reduction in the number of residency slots in oncology by policy planners.

Rent Money

“Its like throwing money down the drain”

There is a misconception in America, one that may be partially responsible for the large and still slightly increasing housing bubble in a few of the nations costal cities. Rent, they say, is like throwing money down the drain. You get nothing in return! All of your money goes to the landlord and at the end of the day you have nothing.

Buying on the other hand, is an investment. Well, sort of. It turns out that most banks today demand that you invest money when you take out a loan. Before the Great Depression is was common for people to take out interest-only loans. In this case they weren’t investing at all.

They were buying the house all right, but they were renting the money.
Interest on your mortgage is the rent you pay on money. Without the funds to buy a house outright most people are left with only two options – rent the house or rent the money. However, after the defaults of the Great Depression banks became wary of renting money to people with little security. They demanded they you rented-to-own, not the house but the money.

That is, along with your monthly rent payment (the interest), the bank asked that you repay the original debt little by little (the principal). They figured it up so that you would repay the loan in about thirty years. Thirty years is a slightly mystical timeframe in finance. It turns out that from a payment standpoint, thirty years is really close to never. The payment on an interest only loan, for which the principal will never be repaid, is very close to the payment on a loan that will be paid off thirty years from now, so long as the interest rate is not too, too low.

The bank does this because with an interest-only loan, if you end up not being able to sell your house for as much as you paid for it, too bad – so sad, it’s the bank that takes the loss. However, if the bank makes you pay in a little in equity then it’s your equity that goes down the drain first. This is a much safer deal as far as the bank is concerned.

So, buying a house means renting money. Is that better than renting the house itself? To figure that out start by looking at what the interest-only payment would be. That’s a fair comparison between renting and buying. Then, correct for taxes.

The federal government subsidizes home buying by allowing you to deduct the rent on money (interest) from your taxable income. Sadly, the government is not so generous to those who rent the home instead. Whatever your tax bracket is, that’s what you knock off you interest payment to account for taxes.

However, there is bad news for money renters too, you have to add back in insurance and property taxes because landlords take care of those things for home renters. When you compare the figure you’ve got to the cost of renting a home you have a reasonable comparison of the two.
For those who live in the middle of the country the numbers should be pretty close. Those who live in a costal boom zone will probably see that renting the money is a lot more costly. However, there are a few additional things to consider and this is what really makes it a choice.

First, renting the money forces financial discipline on you. The bank (if its doing its job) is not going to let you be very irresponsible. It’s going to make sure that your house could be appraised for what you are paying. It’s going to make sure that you can afford the monthly payment given your other debts. Most importantly, it’s going to force you to save. If you are not a good saver then this one is key for you.

As we said before the bank is not keen on you leaving it with a principal sum of money outstanding that is worth more than the house. They are going to force you to repay the loan little by little. This is exactly the same as saving. This is the only saving many Americans do.

Second, there is the more complex financial issue of going short vs. going long. There are risks and rewards to both. Renting the house gives you lots of options. You can move easily. You can always have the right house for you. If you change jobs even within the city you can change to a closer house. You are totally mobile and totally free. If you have a mid-life crisis you can pack up and leave for Patagonia and you don’t have a debt hanging over your head.

This is the freedom of going short. Its something you give up if you go long. On the other hand going short has its risks. You could be evicted. The house you love could be bulldozed to put a sparkling new condominium. Most importantly, your rent could go up. This is the real risk you face. Going short means you owe nothing-to-no-one, but it also means that no one owes anything to you either.

This can be particularly scary when you’ve picked a great place to live. Once everyone else find out about it you could find yourself on the downside of an increase in demand.

Going long secures you from that. You never have to move if you don’t want to. This is your home and you can do what you want with it. However, you may never get to move if you need to. Selling during a downturn could destroy your equity. If you work for a big company then you are likely to get laid off when everyone else does too. That doesn’t bode well for your ability to sell your house.

All in all, it looks as if most people on the coast have looked at their options and thought that going long is a good idea. The big cities for the most part are getting bigger. The most dynamic job markets are there. Middle America retirees might enjoy life on the coast. There are reasons to think that going long, in general, might be a good idea.

However, with prices as high as they are in some places one has to wonder how much higher they can go. Is the premium to rent the money really worth it when you could be adding more to your 401K? At this point it’s hard to think the answer is yes. Rent is money down the drain and the rent on the money needed to buy a house in some places these days is stratospheric.

Tuesday, March 13, 2007

Education vs. Democracy

In the Journal's latestest debate I tend to side with Glaeser who argues that the connection between democracy and growth is supported by education. Acemoglu alternately suggests that democracy itself promotes growth. Though I know it’s a depressing thought I believe that democracy would tend to slow growth in societies that already have strong property rights.

Unlike pro-growth autocracies, think China, democracies have to temper growth with compassion for the poor. Rawlsian justice commands that the economy grows at the rate which benefits the least well-off the most – a rate almost always lower than that which benefits the average citizen the most.

For those who love median voter theory note that the median voter typically falls significantly below the average.

From the Journal via Mankiw

Sunday, March 11, 2007

Prizes vs. Monopolies

Joe Stiglitz says that prizes are preferable to patent protected monopolies when it comes to spurring research and development.

Mankiw warns that prize money has to be paid for by tax increases which could be as bad or worse than the monopolies.

I am reminded of the result that monopolies are only can be efficient if they are allowed to charge their customers different prices based on the willingness to pay.

See, monopolies are bad because in an effort to soak the rich or desperate, they raise prices and force the poor out of the marketplace. The result is too few goods at too high of a price. There is a way out, however. Let the drug companies charge the rich exorbitant prices and then give the poor a break.

If the point of a monopoly is to spur innovation then you might as well let them take all of the surplus. Why leave money on the table, if you believe that it will be used for innovation?

Not only is this more economically efficient, but it also increases equality and since it results in price reductions for the poor, politically palatable - a very rare policy hat trick!

Thursday, March 8, 2007

Bring Them All Here

Bill Gates says that we should have an infinite number of visas for skilled workers.

I agree wholeheartedly and while I think that some effort has to be made to make sure that an orderly flow is maintained and suspected terrorists don’t slip through in the mix, we should take as many as we can get.

In fact, I would be glad to take them all here. Not just here in the United States but here in Wake County, NC – The Research Triangle.

I believe that skilled workers can offer increasing returns to scale. That is, unlike most cases in economics where the second unit is never quite as satisfying as the first (this is especially true with pizzas and nights in Vegas) knowledge workers build on one another. They share ideas and make each other more productive.

If ten researchers is great then twenty researchers is more than twice as good. Of course this pattern can’t continue forever. There does reach a point when researchers get in each others way and can’t effectively communicate with one another.

However, increases in information technology keep pushing that point further and further out. Moreover, there are more basic reasons that skilled workers would make the US in general and Wake County in particular an even more spectacular place.

Lots of skilled workers create thick markets. It’s not uncommon for skilled workers to join projects for 6 – 36 months and then leave that project and even that company for something else. Because it’s very easy to measure a knowledge workers productivity and pay her accordingly firms don’t mind swapping around workers.

This only works, however, if there are lots of workers and lots of firms all in the same place. To some extent the consulting world solves this problem by flying knowledge workers around the country to where they are needed. However, most workers would prefer to be able to stay close to friends and family on regular basis.

Concentrating workers also brings side benefits to the rest of the economy. As noted by Mankiw, more skilled workers reduces the overall tax burden per person. More importantly, however, they increase the demand for semi-skilled services.

Knowledge workers have a greater demand for hand crafted goods and personal services like butchers and bakers. The west side of Wake County faces Research Triangle Park, where most of technology jobs are clustered. There the dominate grocery store is Harris Teeter where wine specialists and artisan bread bakers are there to interact with customers and help them find exactly what they need.

The west side also features famously employee friendly Whole Foods. The east side on the other hand is dominated by Food Lions. While Food Line is a strong company that provides jobs to thousands the worker satisfaction and pay are considerably less than in the West Side chains. This is quite simply because Food Lion’s clientele cannot afford the attention to details and elegant environment that Harris Teeter provides.

More skilled workers means more Harris Teeters, more Costcos, more stores that pay higher wages. For slightly more complex reasons, increases in the affluence of a customer base almost automatically increase the productivity of retail workers, but that is for another day.

Lastly, more skilled workers place more pressure on the school system to perform. They raise the expectations for teachers, administrators and students. My personal research indicates that there is a critical mass of involved parents necessary to dramatically transform a school. More skilled workers thus implies more high performing schools.

For all that I say bring them here.

Thursday, March 1, 2007

The Love of Money

Austan Goolsbee says the rich are motivated by a mysterious desire to accumulate wealth. After all they don't seem to be giving it away fast enough and its too much for their heirs to spend.

I find this strange for two reasons:

1) Don't most charitable donations come as bequests. You can typically give more to charity by waiting till you're dead than giving it when you are alive.

2) Isn't the reason most billionares have so much money is that money is the side effect of something else they want to do.

I doubt Bill Gates is in it for the money or really cares about money per se. He seems to care about dominating the market for enterprise software.
You need money to do this, and when you do it well you make money. However, if his fortune was forever tied up in the capital of Microsoft I am not sure that he would have cared one way or another.

Now of course, he is on a new mission to destroy malaria and ignorance and you need money to do that to. So, he has to take money out of Microsoft to accomplish those goals.

Seriously though, I doubt that many successful men really care about money per se. They might care about the fact that women are attracted to money.

However, mainly they care about being successful at whatever they do. Very few people get rich playing golf and I don't know of any who got rich playing raquetball but you are crazy to think that guys don't burn hours trying to master these worlds as well.

Hat tip to Mankiw