QOTD: The Climate-Industrial Complex May 21, 2009
Posted by federalist in Economic Policy, Energy, Markets.1 comment so far
The always incisive Bjorn Lomborg describes the emergence of a “climate-industrial complex” of politicians, special-interest groups, and for-profit corporations.
Spending a fortune on global carbon regulations will benefit a few, but dearly cost everybody else.
The Case for Government Investment March 28, 2009
Posted by federalist in Economic Policy, Government Spending, Markets, Taxation, Transportation.1 comment so far
As a libertarian I like to believe that anything worth doing will be done by for-profit entities. But we know that in practice there are many public goods and services worth providing that will not be provided in anarchy — typically because they suffer from at least one of three characteristics:
- They require more up-front or concentrated capital than private entities can reasonably provide.
- Potential returns are too risky or distant, rendering the risk/reward calculus untenable for a profit-seeker.
- Returns are too difficult to capture for a non-government entity (practically by definition of a public good).
If public infrastructure investment can reliably increase economic activity, then not only can government capture returns on the investment through constant-rate taxes on a growing economy, but it would even be reasonable to fund the investment with government debt. This is, in broadest terms, the premise for a large amount of the Obama administration’s proposed deficit spending. Robert Reich today presents a reasonable argument based on this premise: He suggests that the United States grows and competes internationally based on its productivity, and that public goods like a ready base of strong human capital and infrastructure are critical to growing productivity.
Only those Americans whose parents can afford to give them a high-quality private education and health care, and who can situate themselves in locations with excellent infrastructures of telecommunication, transportation, public health and safety, have been able to link up with global capital on more positive terms. But not even they are entirely secure economically, because they face growing shortages of talented people they can rely on within easy reach, and can’t entirely avoid the disadvantages of a deteriorating public infrastructure, such as ever more congested roads and airports.
Obamanomics recognizes that the only resource uniquely rooted in a national economy is its people — their skills, insights, capacities to collaborate, and the transportation and communication systems that link them together. Public investment is the key to attracting long-term private investment so that a nation’s people can prosper.
Tax Competition March 1, 2009
Posted by federalist in Diplomacy, Economic Policy, Taxation.3 comments
A few years ago I highlighted the importance of tax competition in restraining government and encouraging government efficiency. The US and EU are waging a new war against “tax havens.” Daniel Mitchell, who recently published Global Tax Revolution has also put a few videos advocating the preservation of tax competition on the Cato blog.
Citizenship is a Public Good January 24, 2009
Posted by federalist in Economic Policy, Human Markets, Taxation.add a comment
And as I previously suggested, we should consider selling such public goods in lieu of taxing citizens to fund government. That citizenship might qualify for such consideration was suggested today by James Kardon in a letter to the WSJ:
Immigration can be the key out of our current financial morass. The attack of 9/11 may have caused the current crisis by inciting the government to encourage real estate price inflation and, more importantly, slowing the immigration of talented people, caught in the red tape of the Department of Homeland Security. We could rescue the housing market and kick-start growth again by selling green cards to solvent immigrants for, say, $200,000.
If you build a valuable country why should you give it away via lottery, as the United States presently does with green cards? Especially when there are so many people willing to commit not only their allegiance but also real capital?
Let Profit Guide Government Spending (and Bailouts) January 23, 2009
Posted by federalist in Economic Policy, Energy, Finance, Government Spending.1 comment so far
How can we avoid turning a government bailout into a political boondoggle? As I suggested yesterday on Rick Bookstaber’s blog:
The expectation of profit is the only way to prevent politics from perverting market interventions. If government can interfere at times and in ways in which it does not expect to make a profit then you may as well tell special interests to grab their sacks and form a line to have them filled with taxpayer money.
But if there is a true financial crisis then, by definition, there is an objective opportunity for a liquidity provider to realize excess profits in the distressed markets.
If we insist that government can only intervene in times and ways in which it can expect a long-run profit (without abusing its power to “change the facts on the ground”), then we take most of the political hazard out of the equation. Instead of the current debate we see — are Paulson and Frank just funneling tax revenue to their friends and cronies in NYC? — the only debate would be on whether the long-run fair value of assets being bought by the government is clearly above the price at which the government can buy them.
(Profit is the same criterion I previously proposed for managing the Strategic Petroleum Reserve.)
Trust Funds of the World: Unite! December 29, 2008
Posted by federalist in Economic Policy, Finance, Pensions.Tags: pension reform
6 comments
State and local government pension funds contain several trillion dollars in assets. I have previously highlighted the significant hazards of public defined-benefit pensions, but I neglected to note a particularly terrifying one: Many of these funds are overseen by novices.
Some time ago the WSJ reported on Stanford’s “Committee on Fund Governance” forum report:
Some recommendations are so elementary they seem hardly worth stating. One suggests trustees educate themselves about their duties. “A fund should identify and disclose its leadership structure,” reads another. Many funds profess to follow these and other principles. Yet Mr. Clapman says his group found “a very large percentage [of funds] are not doing one or more of” the report’s recommendations.
There is no reason for every trust to get involved in investment management when the only thing that varies between funds is how much they owe and when. They’re all trying to do the same thing — and all for public benefit — so there should be huge economies of scale to merging their funds. A number of UK endowments realized this and joined a cooperative called OXIP (Oxford Investment Partners). Vanguard is a cooperative investment company in the US that offers similar outsourcing of investment management.
But outsourcing investment management does not go far enough. Any ongoing exposure by taxpayers to pension obligations is dangerous and unjustifiable. Taxpayers, shareholders, creditors, and employees have no business carrying the risk that pensions will be underfunded or mismanaged, or that investments will not perform as projected.
Defined-benefit pensions should buy annuities to cover their liabilities. For a small fee this transfers the risks of longevity, investment performance, and investment management to third an insurance company which is formed and regulated precisely to handle those risks. (As an added bonus, buying annuities from an insurance company makes it nearly impossible to obscure the present value of pension benefits being promised.)
The status quo is outrageous: The same government officials who offer pension benefits to government employees get to pick the models that predict how long pensioners will live and how well investments will perform. These perennially optimistic projections make the pension obligations look cheap, but some taxpayer money is still taken and put in a trust fund to invest against those obligations. Of course, these funds are under government control, which means they are constantly threatened with political abuse. Meanwhile, the trustees are not investment experts, so they have to pay for a staff, which has to pay for consultants, which recommend funds of funds, which invest in individual funds. Every party in this investment management chain collects fees, but none of them guarantees anything. So when the trust fund comes up short the taxpayers have to cough up yet more money to cover pensions promised long ago, and nobody is held to account for the failure of the trust to meet its obligations.
If governments were not allowed to run their own pension fund scam, they could still offer defined-benefit pensions: They would just have to provide them by purchasing (up front) annuities from insurance companies.
Proper Market Bailouts September 23, 2008
Posted by federalist in Economic Policy, Finance, Markets.3 comments
Last week U.S. capital markets were in unprecedented distress and were on the verge of locking up, imperiling both the U.S. economy and world markets. Over the past year excessive leverage throughout the markets began to unwind as market participants realized that many assets were worth less than they had previously believed. This gradual unwind became critical last week when it began to happen too fast for market participants to react in an orderly fashion.
In the normal course events capital markets are like a nuclear reactor, pooling capital and risk to create heat that powers the economy. Without the concentration and free exchange of capital and risk no heat is generated and economic development is stagnant. However, the same leverage and risk exchange that fuel the economy can produce critical conditions that can spiral into a system meltdown. Meltdowns can be provoked by systemic frauds and bad government regulation, of which the massive government-sponsored mortgage debacle was a prime example.
Whatever the root causes, the U.S. markets were undergoing a protracted delevering that began to look like a meltdown. Until recently private sources of capital have always stepped up to halt such crises by buying distressed assets and institutions at deep discounts. But last week the unwind became so fast and widespread that no private entity could intervene: So many market entities and normally low-risk assets were caught in the unwind that there was simply not enough leverage and liquidity in private hands to put a stop to it.
This is a painful and difficult thing for us free-market adherents to acknowledge. We may very well be able to pin some of the blame on past government interference in the markets. But we can now see how large-scale fraud and mismanagement can cause markets to fail in a catastrophically contagious way: i.e., one that threatens the ability of regular people and companies that depend on modest debt financing or the lowest-risk assets to go about their daily business.
Is a government-sponsored bailout justified in such circumstances? I am inclined to believe so, just as the government should have the ability to issue gobs of debt to jump-start a defensive war for our survival (as in WWII, for example). When assets cannot find buyers even at distressed levels, and when this market failure will trigger a meltdown, the government should be able to buy distressed assets at a discount. When contracts and their counterparties that are essential to the operation of the capital markets are in danger, and when their failure will exacerbate a meltdown, the government should be able to backstop those contracts.
Many conservative writers are appalled at the bailout proposed by the U.S. Treasury, and for many good reasons. It is fraught with moral hazard, and it risks increasing the ongoing involvement of government in markets. Therefore, a proper government-sponsored market bailout should adhere to the following principles:
- Anyone who stood to gain from a risky position should ultimately bear the maximum possible loss if that position is bailed out. For example, equity holders in bailed out GSEs and banks should lose all their equity. Debt holders should also be charged for losses that are not recouped. Even money market investors know that their investments are at risk and should take losses where they occurred. Bailouts can provide liquidity to halt the vicious cycle of selling, but ultimately losses need to be born by the market, not the taxpayers.
- Anyone who participated in fraud should be prosecuted. This would include mortgage brokers and debtors who lied, and brokers and underwriters who misrepresented the liquidity of auction-rate securities.
- The government intervention should be strictly temporary.
- Government liquidity should ultimately make a profit for the taxpayers. Liquidity should always be able to earn excess returns in free markets. When the government steps in to buy assets and contracts in a crisis, it should do so at a steep discount. It can afford to hold those assets for as long as necessary, but its ultimate goal should be to cash out those assets or return them to the market — at a profit.
Brace for Dollar Inflation August 25, 2008
Posted by federalist in Economic Policy, Finance, Taxation.7 comments
The Wall Street Journal editorial board has been cautioning the Fed on its loose money policies for some time now. Two recent op-ed’s step up the warning.
The Federal Reserve has only one lever to push: the short-term lending rate for dollars, which affect the “supply of money.” Ideally it would only use that lever to control one thing: inflation. However, as Ben Steil explains, economics are complicated and the effects of interest rate changes on inflation can be delayed and indirect. So the Fed has allowed itself to consider questions like employment, GDP, and market conditions when setting its rate.
For example, with credit and liquidity crises racking the markets the Fed has dropped its rate perilously low even as inflation has hit dangerous highs. The Fed argues that it can solve the market crisis and that the current recession will deal with inflation before long. So far the Fed has gotten away with this — markets are still pricing in an expectation of nominal long-term dollar inflation — presumably thanks to the credibility the Fed has banked since the early 1980s. I.e., people still believe that the Fed will finally make the hard call to raise rates if the recession doesn’t pull us back from the brink of inflation.
Gerald O’Driscoll (”Washington Is Quietly Repudiating Its Debts“) doubts this can continue. The presence of political pressure in the Fed’s calculus should give us pause. The U.S. government is piling on obligations: Debt spending, unsustainable entitlements, and now government bailouts of market makers. It will be increasingly difficult for government to resist the temptation to inflate its way out of its debt — certainly not while the Fed is willing to subjugate a stable dollar to concerns of market strength or shorter-term financial stability.
A stable currency is a tremendous boon to market efficiency and general welfare. Large or unexpected inflation takes money from creditors and transfers it to debtors, with bad results for the overall economy. Fortunately, it is possible to limit one’s exposure to the risk of excess inflation, as I suggested earlier. This is a good time to increase your hedges against dollar inflation.
Stimulus: The Differences Between Spending, Saving, Storing, and Investing August 2, 2008
Posted by federalist in Economic Policy, Taxation.1 comment so far
It’s easy to criticize the Federal government’s plan to “stimulate” the economy by sending money to taxpayers who didn’t earn too much last year. The government believes that those people have the highest marginal propensity to spend. I.e., the government is trying to boost current retail spending by taking money from both future taxpayers who can’t spend now, and from current wealthier taxpayers who presumably are more likely to save than to spend. The government’s canard is that this is the best way to lift us out of the current credit crisis and recession.
It’s worth reading Steve Waldman’s exposition on the Paradox of Thrift. “Saving” can take the form of storage or of investment. The latter stimulates, the former does not. I.e., if we save in the form of stocks, bonds, or other stakes in capital markets we are really making an investment in future production, which in a virtuous cycle both enables future consumption and increases current employment and incomes. However, if we save by accumulating stores of value — say land or old art — we do little more than create scarcity rents for those who possess that fixed supply.
It does appear that saving is now skewing more towards storage than investment. Waldman explains why this may be happening, and why “stimulus” spending is not a good response:
Storage eats wealth, while productive enterprise creates it. People know this. No one “invests” in gold or oil when a financial system is working. They do so when it is broken. Like now.
Encouraging people to go shopping in order to help the economy is not “second best” policy. It’s a desperate last resort. We’re not at a point where there’s so little economic activity that we can’t foresee future wants. We’re at a point where people are beginning to shift from investment to storage because of a well-deserved loss of confidence in the financial system. Encouraging consumption now is nihilistic. It feeds into a vibe (I feel it personally, do you?) that saving is so uncertain and money so volatile that one might as well spend, ‘cuz who knows what tomorrow might bring. The right way to sustain aggregate demand and maintain current income is to figure out what we should be investing in … and then to put current resources to work. Our financial system is failing spectacularly because it erred grievously. It built homes and roads and sewers that oughtn’t have been built, it “invested” in vacations and plasma televisions, and it paid itself handsomely for doing so. That’s not a problem we can spend our way out of.
Hauser’s Law of Taxation May 20, 2008
Posted by federalist in Economic Policy, Government, Taxation.add a comment
David Ranson dusts off some econometric results that should be the basis of all discussions of tax policy. In 1993, Kurt Hauser found, “No matter what the tax rates have been, in postwar America tax revenues have remained at about 19.5% of GDP.” This invariance still holds true, and Ranson dubs it “Hauser’s Law.”
The data show that the tax yield has been independent of marginal tax rates over this period, but tax revenue is directly proportional to GDP. So if we want to increase tax revenue, we need to increase GDP.
What happens if we instead raise tax rates? Economists of all persuasions accept that a tax rate hike will reduce GDP, in which case Hauser’s Law says it will also lower tax revenue. That’s a highly inconvenient truth for redistributive tax policy, and it flies in the face of deeply felt beliefs about social justice.
Presidential candidates, instead of disputing how much more tax to impose on whom, would be better advised to come up with plans for increasing GDP while ridding the tax system of its wearying complexity.
But perhaps we are too charitable with the tax-the-rich crowd’s intentions? It may be that they are not concerned with maximizing tax revenue but rather with using tax policy to minimize income inequality. And it may be that politicians are more concerned with acquiring the patronage of special interests through a byzantine tax code than simply maximizing the tax revenue at their disposal.
Tyranny of Special Interests: 110th Congress Edition May 15, 2008
Posted by federalist in Economic Policy, Government.1 comment so far
How can a minority extract rents from a majority in a democracy? Congress has illustrated this for years with abusive “earmarks.” Past posts (here, and here) have addressed the structural defects of our democracy. But this week Congress gave us an exceptional lesson in political logrolling: A small coterie of wealthy farmers secured record subsidies by … well, the Wall Street Journal summarizes it nicely:
If you wonder why urban Democrats would vote for this rural giveaway, the answer is they have been bought off with roughly $10 billion in extra funding for food stamps and nutrition welfare programs. Someone should tell them that their constituents might not need this cash if the farm bill didn’t help keep food prices high.
Conspiracy Theories and the Federal Reserve May 13, 2008
Posted by federalist in Economic Policy, Finance, Taxation.6 comments
If you spend much time in anti-income-tax libertarian circles you will discover that fear and loathing of the IRS is followed closely by deep suspicion of the Federal Reserve (”Fed”) and abiding nostalgia for the days of the gold standard. Libertarians spin vast conspiracy theories about who controls the Fed and who profits from it. They appear to be confused. The only legitimate argument against the Fed seems to circle back to the tax code, which presently levies taxes on inflation. But this is an argument against the tax system, not the monetary system.
Yes, in principle the Federal Reserve could choose to inflate the money supply. In an inflation scenario non-debtor citizens holding dollars are harmed as dollars lose value. Meanwhile our debtor government benefits since inflation not only reduces the national debt but also increases tax receipts from capital gains, thanks to the Tax on Inflation. (If you earn 5% interest during a period in which inflation runs at 5%, you have made no real gain on your savings. However, the IRS currently looks at your gains in nominal, non-deflated terms, and so they will tax you as if you had gained 5%.)
Gold-standard advocates see a commodity-backed currency as a solution to the moral hazard of government-instigated currency inflation. But gold-backed currency is not immune to inflation or manipulation either: It simply replaces the intentional control of the money supply by the Fed with the circumstances of world-wide gold production and storage. Inflation and deflation still occur when the production of new gold does not match the growth of the economy. Nations and corporations could still manipulate the money supply by hoarding gold or flooding the market with their stores. How is this any better than what we have right now?
Though in theory the Fed could take actions to inflate our currency its mission is the exact opposite: to limit inflation to a nominal level. The Fed is also accountable to the banking system, and since banks are predominantly creditors they are not happy with inflation since it reduces the value of their credits.
In any case, there are numerous ways an individual can protect himself from dollar inflation: Instead of storing dollars he can hold hard assets, other currencies, inflation-protected securities. He can even buy “inflation insurance” using swaps on the open derivatives market.
One thing an American can’t do at present is protect himself from the Tax on Inflation: As long as the IRS demands that gains be calculated against an inflating currency, it can assess capital gains even when real gains are zero (or negative!). So let’s return our focus to the IRS, not the monetary system.
Dead-Weight Government February 24, 2008
Posted by federalist in Economic Policy, Government, Pensions, Retirement, Taxation, Unions.add a comment
When you drive from Delaware into New Jersey, you don’t really see any differences. If you move from New Jersey to Delaware you don’t experience a significant decline in government services. But New Jersey has among the highest tax burdens in the nation, while next-door Delware has among the lowest.
If higher taxes aren’t buying better government services, then what do high-tax governments like New Jersey do with all of their extra tax revenue? Apparently the answer is that they buy votes. More specifically, public union votes:
Public workers and teachers can retire at age 55 after 25 years with a pension of 60% of salary — indexed to inflation. Police and firefighters can retire at 65% of salary at any age after 25 years of service and 70% after 30 years.
Not that we should be surprised at American democracies degenerating into this sort of patronage government. But isn’t it depressing to think of all those public resources going to bankroll lives of leisure for union members instead of something virtuous?
When $70 Billion isn’t enough January 26, 2008
Posted by federalist in Economic Policy.add a comment
Is Bill Gates discovering that even a charitable fund of $70 billion can’t put a dent in a world of government interference? We don’t need a “revision” of capitalism to improve the lot of poor countries. We could start with a more faithful implementation of capitalism: One in which developed countries do not erect tariffs against the export goods of poor countries, and one in which the foreign policy of developed countries does not prop up political regimes that obstruct market forces. The last thing we need is more government meddling with incentives and policies that inevitably derail the beneficent forces of capitalism.
Government Mismanages the Strategic Petroleum Reserve November 13, 2007
Posted by federalist in Economic Policy, Finance, Government Spending, Taxation.1 comment so far
Here’s another way government can replace taxes with the astute stewardship of public assets: David Henderson notes that the U.S. government is in a unique position to arbitrage commodities market. Since it stockpiles massive quantities of commodities it could take risk-free profits in a backwardated market — while helping to mitigate a transient supply crunch (which is what a backwardated market indicates). For example, right now it can sell oil from the Strategic Petroleum Reserve at $96/barrel, while buying contracts to refill the SPR in one year at only $87/barrel.
My cynical side suspects that this is such an obvious win for both commodities consumers and taxpayers that we can almost guarantee it won’t happen. [Sure enough, Nov 14, WSJ notes, "Last week, the Department of Energy announced plans to continuing buying crude oil to fill the 694-million-barrel Strategic Petroleum Reserve, noting that the reserve's purpose is to cope with oil supply disruptions -- not to manipulate prices." So if a backwardated market doesn't indicate a supply disruption, what does?]
The (Intangible) Wealth of Nations September 30, 2007
Posted by federalist in Economic Policy, Markets.2 comments
Ronald Bailey has a fascinating essay on “Intangible Wealth” in this weekend’s WSJ. This should be required reading for any discussion of foreign aid or economic development.
If one simply adds up the current value of a country’s natural resources and … capital, there’s no way that can account for that country’s level of income.
The rest is the result of “intangible” factors — such as the trust among people in a society, an efficient judicial system, clear property rights and effective government. All this intangible capital also boosts the productivity of labor and results in higher total wealth.
Citing a World Bank study, “Where is the Wealth of Nations?: Measuring Capital for the 21st Century,” Bailey gives us:
The bottom line: “Rich countries are largely rich because of the skills of their populations and the quality of the institutions supporting economic activity.”
What the World Bank economists have brilliantly done is quantify the intangible value of education and social institutions. According to their regression analyses, for example, the rule of law explains 57% of countries’ intangible capital. Education accounts for 36%.
Overall, the average per capita wealth in the rich Organization for Economic Cooperation Development (OECD) countries is $440,000, consisting of $10,000 in natural capital, $76,000 in produced capital, and a whopping $354,000 in intangible capital. (Switzerland has the highest per capita wealth, at $648,000. The U.S. is fourth at $513,000.)
By comparison, the World Bank study finds that total wealth for the low income countries averages $7,216 per person. That consists of $2,075 in natural capital, $1,150 in produced capital and $3,991 in intangible capital. … In fact, some countries are so badly run, that they actually have negative intangible capital.
Is Microcredit Efficient? September 9, 2007
Posted by federalist in Economic Policy, Markets.1 comment so far
Microcredit has a certain libertarian allure: It imagines that everyone is a potential entrepreneur and that the only thing that stands in the way of a typical impoverished human being is access to capital. A developing country may lack the legal and physical infrastructure to support large-scale industry, but any individual with a will and a way can produce something of value and prosper by that.
The reality may be quite contrary: Not every person is capable of producing excess value on their own, or of realizing that value through trade. It may be that we really do require healthy markets, exceptional industrial leaders, and economies of scale to turn raw human capital into valuable production.
This argument is made in compelling fashion by Aneel Karnani in this month’s Worth (adapted from a longer essay available in SSI Review):
Most clients of microcredit are not entrepreneurs by choice; they would gladly accept a factory job at reasonable wages if one were offered.
… Job creation is not enough. We also have to increase productivity so that wages are high enough to enable employees to rise above poverty. One way to increase productivity is to encourage enterprises that are large enough to achieve economies of scale. Rather than lending $200 to 500 women so that each can buy a sewing machine and make garments, we would be better served by lending $100,000 to an entrepreneur with managerial capabilities and business acumen to help her set up a garment manufacturing business employing 500 people. This type of business can exploit economies of scale, deploy specialized assets and use modern business processes to generate value for both owners and employees.
Department of Unintended Consequences — Part V August 23, 2007
Posted by federalist in Diplomacy, Economic Policy.add a comment
Arvind Subramanian summarizes research confirming what free-market thinkers have always suspected:
[Foreign] Aid, especially in large amounts, can damage governance and make an economy uncompetitive.
The problem is that development and long-run growth are less about resources than about the environment for generating and sustaining private sector investment. Two key aspects of this environment are decent public institutions or governance — the essential “software” for running a market economy, for creating rule of law and protecting property rights — and incentives that encourage the private sector to export, especially manufactured products.
Giving aid is like looking for the lost key under the lamppost because that is the easiest thing to do. But it is not obviously the most effective way that outsiders can help.
Social Security — Try to Calculate Your Benefits! June 27, 2007
Posted by federalist in Economic Policy, Government, Retirement, Taxation.add a comment
I would invite anyone who believes in Social Security to try to calculate their expected benefits based on what they have paid in. This is actually an amusing exercise which I recently undertook to answer the following question: If you haven’t paid any social security taxes in your life, what is the least you can pay in to get the maximal return from the Social Security system?
