Technology and Taxes

Gregory Clark writes that in the future the economic problem will be

the ineluctable increase in the number of people with no marketable skills, and technology's role not as the antidote to social conflict, but as its instigator.

Unlike the period between the start of the Industrial Revolution and the mid 1950's, the gains from technological progress no longer accrue to the unskilled. So the future will be one with sharper and sharper income differences. Perhaps we can accept this regarding restaurants and homes, Clark writes, but regarding health care it is politically unacceptable. The critical question is then:

So, how do we operate a society in which a large share of the population is socially needy but economically redundant? There is only one answer. You tax the winners -- those with the still uniquely human skills, and those owning the capital and land -- to provide for the losers.

The future will see higher taxes. The question is how to set them in a politically acceptable way.

The last great hope may be to design a more efficient tax system. .. A more efficient system would tax only where there is a need for some specific public good or a transfer to the poor.

Unfortunately, such measures are only stopgaps. In the end, we may be forced to learn to live in a United States where, by stealth, "from each according to his ability, to each according to his need" becomes the guiding principle of government -- or else confront growing, unattended poverty.

Efficient Markets Again

Paul Krugman reviews several books in the New York Times, especially Justin Fox's book, The Myth of the Rational Market. But I wonder if Krugman actually read his own article. He reviews the development of modern finance theory, and especially emphasizes efficient markets (EMH) and the capital asset pricing model, CAPM. He then argues that this is what created the financial crisis.

Wall Street bought the ideas of the efficient-market theorists, in many cases literally: professors were lavishly paid to design complex financial strategies. And these strategies played a crucial role in the catastrophe that has now overtaken the world economy.

Doesn't this seem strange? If Wall Street bought the ideas of the efficient markets hypothesis why would invest so much in complex trading strategies? If they believed CAPM, they would know that they could only earn more return by taking on more risk. Isn't it more correct to argue that they did not believe in the EMH and the CAPM?

P.S. Today, Falkenstein likes Krugmans review no more than I, and is much harsher.

French Health Care

An interesting article on French health care and the fiscal problems they are facing. The irony:

As Congress fights over whether America should be more like France, the French government is trying to borrow U.S. tactics.

And more irony:

Ironically, France is actually in the midst of shifting to a fee-for-service system for its state-run hospitals. The hope is that it will be easier for the government to track if the money is being spent efficiently, compared with the old system of simply giving hospitals an annual lump-sum payment.

Economics Attacked and Defended

Lord Robert Skidelsky attacks the dismal science in the Financial Times and Nobel Laureate Robert Lucas defends it in the Economist.

Skidelsky attacks economists for not predicting the financial crisis, an accusation that Lucas deals with pretty well. Skidelsky wants to rebuild economics, but his attack is based on faulty premises and misunderstandings of what economists do.

For example, according to Skidelsky economics assumes an environment in which

uncertainty disappears to be replaced by calculable risk. Shocks and mistakes may occur but these will cancel each other out, so that, on average, people get what they expect. An important implication of this view is that shares are always correctly priced. This is the basis of the so-called efficient market hypothesis that has dominated financial economics. It led bankers into blind faith in their mathematical forecasting models. It led governments and regulators to discount the possibility that financial markets could implode.

The Efficient Markets Hypothesis does not, however, predict that asset prices are always correct. Only, that all available public information is incorporated in them. This is very different from assuming the price is correct. It is possible to have rational bubbles in asset prices, and if Skidelsky looked at mainstream economics journals he would see plenty of articles analyzing them.

Skidelksy continues

The efficient market hypothesis is simply an application of the recently triumphant New Classical school, which preaches that a decentralised market system is always at full employment. In their obsession with getting government out of economic life, Chicago economists claimed that any consistent set of policies will be learnt and anticipated by a population, and will therefore be ineffective.

Is this just the creation of a straw man or complete ignorance of the last twenty years of macroeconomics? Very hard to tell. But even the most hard-line new classical economists never argued that the economy was at full employment at all times. Their argument was that systematic monetary policy could not permanently reduce unemployment below some natural rate consistent with frictions and structural change. And they certainly did not argue that tax policies could not change the level of unemployment. And the new classical types were only half of the profession anyway.

Skidelsky is making a straw man parody of the most hard-line new classical types and he even gets that wrong. In the last 20 years or so the differences between salt-water and fresh-water macro has decreased. Everybody deals with models with frictions and where policies can have effects.

This leads Skidelsky to the conclusion that economics must be rebuilt. His prescription sure goes opposite to where our profession is going:

Beyond this, the postgraduate study of macroeconomics might with advantage be separated from that of microeconomics. Courses in microeconomics should concern themselves, as at present, with the building and testing of models based on a narrow set of assumptions. Their field of applicability lies in those areas where we have reliable views of the future. Macroeconomics, though, is an essential part of the art of government, and should always be taught in conjunction with subjects bearing on this.

The obvious aim of such a reconstruction is to protect macroeconomics from the encroachment of the methods and habits of the mathematician. Only through some such broadening can we hope to provide a proper education for those whose usefulness to society will lie as much in their philosophical and political literacy as in their mathematical efficiency.

In the past I have sometimes thought that the obsession to provide microfoundations for macroeconomics may have gone too far. Perhaps there are some areas where it is better to build models with aggregates and worry about microfoundations later. But after reading Skidelsky's plea I think I will try to drive that thought from my mind. What would Skidelsky macroeconomists do?

Instead I am going to work out how to restructure postgraduate education in history.

Clunker Policy

Cars for Clunkers removes old cars from the road and replaces them with more efficient cars. This saves gasoline and thus means less CO2 emissions. But new cars are produced using CO2. So how much is saved? Obviously it depends on the net improvement in mileage and the amount driven. This article in Slate goes over the figures.

Assume that 250,000 cars have been replaced with an average fuel efficiency gain of 69% (about what happens if we replace a car with 16 mpg with one that gets 27 mpg). Further assume no net increase in miles driven (a big if) so that stays at 12,000 per year. Then these cars cut overall fuel consumption by about 76 million gallons a year and CO2 emissions by about 737,200 tons annually.

What about producing the new cars?

According to William Chameides, dean of Duke University's Nicholas School for the Environment, making a new car produces 3.5 to 12.4 tons of carbon dioxide, with an average of 6.7 tons per vehicle. The average new car would therefore need to save about 700 gallons of gas to offset the carbon costs of its manufacturing.

If we use the 6.7 ton figure for 250,000 cars we estimate about 1.7 million tons for the new cars. Thus it would take more than two years of driving to achieve any net savings.

How to assess the total cost of the program? Compare it to the cost of a ton of CO2 in the marketplace:

Was spending $1 billion a particularly cost-effective way to achieve those CO₂ reductions? Probably not. Assuming the above calculations are correct and that each consumer keeps his or her car for 10 years, then the total savings should be a little less than 5.7 million tons of carbon dioxide. That means each ton of carbon dioxide would be worth about $175.53 to the U.S. government. As the Washington Policy Center pointed out on its blog in June, a ton of CO₂ currently goes for about $17.50 on the European Climate Exchange.

I guess we can conclude that, however, successful an auto stimulus program this is, it is not much of an environmental winner.

Born Again Keynesians

Posner has an interesting post on his blog criticizing born-again Keynesians, like Paul Krugman for ignoring their Keynes. The point is that uncertainty causes businessmen to hoard, which reduces investment and prevents recovery. His point is that the Obama health care plan, which Krugman, endorses, will create more uncertainty.

Posner quotes Keynes:

Keynes warned President Roosevelt in an open letter of December 31, 1933, about trying to combine far-reaching reform with recovery from an economic depression. He wote that

even wise and necessary Reform may, in some respects, impede and complicate Recovery. For it will upset the confidence of the business world and weaken their existing motives to action, before you have had time to put other motives in their place...And it will confuse the thought and aim of yourself and your administration by giving you too much to think about all at once.

The passage that I have italicized deserves particular emphasis (though Keynes's warning that "it will confuse the thought and aim of yourself and your administration by giving you too much to think about all at once" is equally timely) because of the strange turn that the debate over health reform has taken in recent days.

Posner, if you read his book on Failure of Capitalism, is more of Keynesian than most liberal Keynesians.

Killer App for Clunkers

The Wall Street Journal reports on the boom in the market for sodium silicate, the chemical used to kill clunkers under the government's cash program. The chemical turns into liquid glass and solidifies all the moving parts of the car.

There seems to be a chorus line of support for this program (but for a good post, see here). But if you take 250,000 cars off the road who gets hurt? Must be the people who buy these cars, and they must be the poor. So if we take another 500,000 off (if the additional $2 billion is appropriated) then the price of used cars for the poorest households must rise. Hardly seems progressive to me.

Wouldn't it be better to give a subsidy for new car purchases financed by a gasoline tax? The latter deals with the environmental cost, the former is the subsidy to the auto industry which is the real intent of the program.

What happens when all the clunkers run out?