On Keynes, Marx, Krugman, Cowen, and the Possibility of Utopia Via Inequality

At the end of a good post on the shift of income shares earned by capital (more) and labor (less) in the US over the past few decades, Krugman writes:

I think we’d better start paying attention to those implications.

What implications?

[I]t makes nonsense of just about all the conventional wisdom on reducing inequality. Better education won’t do much to reduce inequality if the big rewards simply go to those with the most assets. Creating an “opportunity society”, or whatever it is the likes of Paul Ryan etc. are selling this week, won’t do much if the most important asset you can have in life is, well, lots of assets inherited from your parents. And so on.  

I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.

As it happens, I've been writing about this for quite some time. It was the focal point of my criticism of Tyler Cowen's "Great Stagnation" hypothesis (e.g. 1, 2, 3, and others), which I said was a "Great Redistribution". Basically the question I'd like to answer is why mean and median incomes have diverged, as pictured in the graph above. A "Great Stagnation" hypothesis seeks only to explain the flattening of median income growth. But we haven't had a Great Stagnation, since mean income growth has continued, at least until the Great Recession.

A Great Redistribution view, on the other hand, says that the structure of the global economy has changed over the past 40 years in ways that benefit (US) capital and hurt most of (US) labor. Specifically, the rise of a low-skill labor force in the former global South has competed away wage gains from low-skill American workers, while the rise of a medium-skill industrialized labor force in places like the NICs has competed away wage gains from medium-skill American workers. Additionally, the rise of mechanized labor (via robotics, which prompted Krugman's post) shifts income from labor to capital. Take a look at this chart:

Wages are converging globally, and since the US had disproportionately high wages this is hurting American labor in relative terms. At the same time, the global market has expanded dramatically. This increases the return to high-skill American labor as well as the owners of capital, who can now sell their production to much larger markets. This is particularly the case for goods and services which are reproducible at essentially zero marginal cost: think intellectual property and entertainment. Since the "high skill labor" and "owners of capital" groups are not mutually exclusive, this shows up in the data as both a) increasing wage inequality, and b) increasing returns to capital.

This is the simplest story in the world... basically just stating comparative advantage, at a mix of sectoral and factoral levels. The fact that it's so novel -- even to someone with a Nobel Prize in international macroeconomics! -- is a point of evidence that our intellectual class is way too focused on explaining everything locally. The Great Redistribution view has plenty of implications for political economy at global and local levels, but it is essentially a rejection of many public choice arguments, which tend to emphasize capture of political institutions by bankers or other oligarchs as the fundamental driving force in recent trends in the American economy.

I'm not sure what Krugman means by "uncomfortable implications". It could mean that the fact that the economy is working the way the way it's supposed to is an inconvenient truth for those who think that our political economy is being wrecked by those who prefer public choice explanations. But I doubt Krugman means that. It could mean that the "Golden Age" of American labor that Krugman loves so much -- the 1950s-1960s -- was a historical anomaly, the result of specific contingent circumstances that are not likely to be replicated ever again (and would be tragic if they were, given that that arose because of two devastating world wars and a Great Depression). But I doubt Krugman means that either. It could mean that the technocratic neoliberal vision is a fraud, and that the politics of distribution is likely to dominate capitalist political economies for the foreseeable future.

In any case, as an example of this Krugman talks about "re-shoring", the process of bringing manufacturing production back to the United States. Krugman suggests that this will have no major effect on employment or the income accruing to labor, because much of this production is done using robots. I think he's right that the direct effects on labor and wages will not be much. The indirect effect could be much higher, however. Why? Because in order to have robots build things, you first have to have factories. Humans have to build those. And you have to have roads to transport the goods. Humans have to build those too. And you have to have shops where the goods can be sold. Humans have to work in those shops. The desire for human labor that is complementary to robot labor can support wage gains for the median worker. That may not be enough to overwhelm the relative redistribution from the median worker to the top 10%, but it can help the absolute numbers.

American labor can benefit in another way: by receiving more non-cash compensation. The trend in the US is to provide more years of subsidized non-work at the beginning and end of life -- longer periods of education, longer retirements as lifespans increase -- and more non-cash benefits -- subsidized health care and education -- in a somewhat egalitarian way. These programs are overwhelmingly funded by the top 10% of wage earners, who are the high-skilled workers and the owners of capital*. To the extent that goods are increasingly created by non-human labor they free up people to do other things, some of which will not be market work. We'll call that "unemployment" or "underemployment" but if we generate sufficient national income to guarantee minimum standards of living at a level that ensures human dignity it will function as quasi-early retirement.

At the same time, quality of life continues to increase rapidly as the marginal cost of entertainment, education, and other goods approaches zero as a result of advances in information technology. This gain is felt by the median member of society as much as the richest person in society, and is more valuable for those with more available time. In terms of maximizing valuable leisure and minimizing alienating labor the typical citizen might be doing better, maybe even much better, than she otherwise would even while the data continue to show that she is doing much worse.

If this is an equilibrium it will have some negative consequences, for sure. Among them will be a reduction in social mobility and an increasingly bitter political economy. But Keynes dreamed of a world in which the gains from capitalism were distributed in a way that allowed people to work less, and some people are still dreaming of it. Marx too: his criticism of capitalism was not just that it generated inequality, but that it created alienation as labor became routinized. Marx didn't care about social mobility... he cared about human dignity. So maybe the left should welcome our new robot overlords (and their capitalist owners) for bringing the vision of Keynes and Marx closer to reality. Instead of slaving away in factories we can all post kittens to Tumblr and write stimulating blog posts. Yeah, maybe it looks like inequality, but it could end up being Utopia.

*The US tax code is already pretty progressive, and is likely to get much more progressive over the coming years, beginning with whatever deal comes out of the fiscal cliff negotiations. At the same time, the US benefit system is one of the least progressive, but I expect this to change over the coming decades for political economy reasons. Ultimately it will be up to the democratic system to manage these structural shifts.

Austerity v. Drudgery

I recently posted on Twitter something to the effect of "what does 'austerity' mean when every country practicing it is running massive deficits?" It was meant to be provocative -- I know full well that deficits can come from a decrease in revenue as well as an increase in spending -- and led to an interesting but brief exchange with @dandrezner. My point is that different countries face different constraints, have different institutions, and have responded to the crisis in different ways. Describing them all as practicing austerity therefore doesn't seem appropriate. My takeaway from the exchange was that we don't have a good definition of what austerity is. We used to associate it with Washington Consensus policies enacted under duress in the midst of financial crises in exchange for emergency finance. That definition works alright for Europeriphery countries today, but not the U.S. and U.K. which were a) already following most of the Washington Consensus principles; b) not subject to external pressures from financiers; c) not really significantly altering fiscal policies in a contractionary way at all at least to this point.*

But people still use the term, often to denote something to the effect of "not enough Keynesian/monetarist stimulus". It seems to me that that is a different thing from austerity, and implies a different political interaction. As Steve Waldman notes, we're choosing our depression, and we're doing it in a way that prolongs the recovery but does not choke it off. This is being done for political reasons, but the reasons are very different than those that currently obtain in Greece, e.g. Greece is practicing true austerity -- or at least something closer to it... they keep agreeing to austerity but then missing their targets -- under duress; the U.S. is simply choosing to accept the risk of a slow recovery over the risk of higher inflation.

So why do we use the same work to refer to these two different things. I suspect there is an ideological component to it in many cases, but that's not satisfying enough. This sort of thing from Krugman** -- arguing that austerity is happening everywhere -- does not compute:

For the fact is that you can’t just look at spending levels to ask what is happening to spending programs. Here in the United States spending on unemployment insurance and food stamps has risen sharply, not because the welfare state has expanded, but because a lot more people are unemployed and poor. Similar effects are at work in European countries, which have stronger safety nets than we do. 

Right, but cutting social spending programs is pretty much the definition of austerity, at least as it used to be defined in relation to the implementation of the Washington Consensus during crisis periods. In fact, Krugman refers specifically to spending cuts elsewhere in the same post. So if we're doing the opposite of that how is it we're practicing austerity as well?

Mark Blyth has been working on a book (due out next year) detailing the history of austerity as a policy idea, so perhaps he can give us a better definition. In the video above, he describes austerity as paying down public debt through the slashing of social services. But if we're not doing that in the US (and some other countries) -- if automatic stabilizers have kicked in -- then are we really practicing austerity? If so, only on the margins and not in aggregate.

I was thankful to see Tyler Cowen considering the same question and coming to a similar conclusion. He notes that for some, it seems like "doing less than the Keynesian optimum is always a form of austerity". But does the "Keynesian optimum" really apply to countries like Greece where the bond vigilantes have already shown up? Once we start talking about cross-national transfers we're well outside of the world of the General Theory.***

I think this is important because it implies different political logics. This is what Waldman was writing about. The political logic of "austerity as penalty for emergency finance", usually to prevent moral hazard and/or force through politically unpopular reforms, is quite different from "tolerate slower recovery because of concern about future inflation".

To give one example: both the Tea Party and the Occupy Wall Street movements arose out of protest over the policy responses to the financial crisis and recession. One of them is more or less explicitly anti-inflation and also espouses principles of laissez-faire. The Tea Party movement began in 2007 during Ron Paul's presidential campaign, but really took hold in early 2009, right after the bailouts and as the stimulus fight was being played out. This was a direct response to significant government intervention into the economy via bailouts and stimulus spending. This group wanted austerity, in large part because of fears of future taxation and inflation (which they often view as a form of taxation).

Occupy Wall Street, on the other hand, is not ideologically opposed to government intervention. That movement did not form until 2011, when it became clear that the economic recovery was going to be slow overall but that the banks had recovered relatively quickly. OWS opposed the types of intervention that we, pace Waldman, chose. This group wasn't professing opposition to austerity... they were protesting expansionary fiscal policies! They opposed the distributional nature of those expansionary fiscal policies. In some cases they too wanted austerity, but via tax increases on corporations and wealthy individuals rather than cuts in spending.

The Greeks, meanwhile, are protesting the slashing of pensions and raising of taxes. These are very different movements, animated by opposition to different sets of policies. Lumping all of those policies together as "austerity" doesn't capture that. Given that, and given the loaded nature of the term, I think we need another word to describe the U.S. experience as distinct from the Greece experience. For the latter "austerity" works fine. For the former I propose "drudgery".

*Is c) true? Maybe in the eye of the beholder. In my view, the U.S.'s bailouts of Wall St/GM + extension of tax cuts + new tax cuts + automatic stabilizers + increase in nominal government spending + stimulus > the miniscule cuts that have been imposed since 2008. In which case... is that really austerity?

**Picking on him again out of laziness... I had this link at hand already.

***At least I think we are. It's been awhile since I've read it.

Am I Reading This Wrong?

Krugman reproduces the above graph and writes:

[T]his recent survey paper (pdf) on teen births, which are much higher in America than in other advanced countries. The authors find evidence suggesting that inequality and lack of mobility are central, another sign that Wilkinson-type views about the corrosive effects of inequality are going seriously mainstream. ... [I]nteresting stuff — and more evidence that we are gradually poisoning our society with inequity. 

I've only skimmed the paper -- which was published in the Journal of Economic Perspectives -- but I don't read it the same way at all, nor do I see it from that graph. What I see is that the discrepancy is mostly driven by whether the mother is well-educated or not. As far as I know whether or not students graduate from high school is not a function of inequality, but of poverty and other socioeconomic and cultural factors. Indeed, that is what the authors of the report conclude:

We believe that the high rate of teen childbearing in the United States matters because it is a marker of a social problem, rather than the underlying social problem itself. If a teenager has a baby because her life chances seem so limited that her life will not be any better if she delays childbearing, then teen childbearing is unlikely to be causing much of a detrimental effect. Our review of the evidence is consistent with this position.

At times the authors seem to think that poverty, social mobility, and income inequality are the same thing. I would be more likely to attribute all of them to common underlying causes that has been transforming the global political economy over the past 20+ years. In any case, the authors argue that improving economic opportunities is the way to improve this statistic. In fact, they explicitly rule out increased income inequality as playing a causal role in recent trends, noting that teen childbearing has been going down over the past generation (implying a negative correlation with income inequality if there's any relationship at all):

One thing that we have not done is explain the dramatic decline in teen childbearing in the United States over the past 20 years. Although we believe that inequality and lack of opportunity explains a substantial share of the geographic variation in teen childbearing, it is not a candidate explanation for the downward trend in the United States over the past two decades, primarily because the 50/10 ratio that we rely on as a measure of inequality has not changed much during this period (although our results are insensitive to the specific measure used).

So what on earth did Krugman read? If teen childbearing has been going down at the same time that inequality has been going up that would seem like prima facie evidence that income inequality is not causing teen childbearing.

Bernanke, Not Borg

Krugman has a good NYT Magazine article on Bernanke. They have an interesting personal history -- as Chair of the Econ department at Princeton, Bernanke hired Krugman (over some opposition I believe) -- and also an interesting intellectual history -- they were both working on the Japan deflation in the late-1990s, with Krugman concluding that Old Keynesianism was still relevant because of its emphasis on the liquidity trap, while Bernanke concluded that the Bank of Japan was merely timid, not impotent.

In the article Krugman argues that Chairman Bernanke has not followed the advice of Professor Bernanke. He offers three possible explanations for this.

The Bernanke Conundrum — the divergence between what Professor Bernanke advocated and what Chairman Bernanke has actually done — can be reconciled in a few possible ways. Maybe Professor Bernanke was wrong, and there’s nothing more a policy maker in this situation can do. Maybe politics are the impediment, and Chairman Bernanke has been forced to hide his inner professor. Or maybe the onetime academic has been assimilated by the Fed Borg and turned into a conventional central banker.

The Ludlum-esque title is unnecessary, as the addition to the pile of "Krugman's Mystical Creatures" (confidence fairy, bond market vigilantes, etc.), but I believe Krugman's framing is correct and I think the second explanation makes the most sense: Bernanke is politically constrained (see here). So naturally Krugman concludes that Bernanke's been assimilated into the Borg, thus continuing our long-running streak of disagreeing on almost everything.

Today Krugman finds support for the Borg view in these words from Bernanke:

We have, uh, we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable, in that we’ve been able to take strong accommodative actions in the last four or five years to support the economy without leading to a, [indiscernible] expectations or destabilization of inflation. To risk that asset, for, what I think would be quite tentative and, uh, perhaps doubtful gains, on the real side would be an unwise thing to do.

In some ways Krugman's selection of Bernanke's comments are a bit disingenuous -- Bernanke starts by pointing out that the U.S. in 2010-12 is very different from Japan in the late-1990s, particularly since one was suffering from deflation and a recession while the other just has unemployment a few percentage points higher than it would like -- but more problematic is his interpretation of them. When Bernanke starts talking about the "credibility" of the Fed there is no a priori reason to think that he's only talking about credibility with markets. He's also talking about credibility with Congress, and in particular a Congress that is incredibly hawkish on inflation lately* and routinely threatens Bernanke in a number of ways.

The Fed likes its authority. It wants to keep it. It likes it's "independence". Ironically, it will only keep it if it does what Congress wants it to do (i.e. "There is no technocracy" + "There is no central bank independence"... common themes around here). That means not throwing away its credibility for inflation-control in pursuit of dropping the unemployment rate by a point or two. Note that this is also why Bernanke would like to see more fiscal stimulus: that would effectively prevent Bernanke from having to make a difficult choice. But if he's forced to make that choice, he'll the choose the path that doesn't jeopardize his authority.

Note: after I wrote the above, but before publishing it, I came across this excellent post by Greg Ip. Highlights:

This means, judging from the projections, that 13 of the FOMC’s 17 members want to tighten sooner than he does, and none want to tighten later. ...

The second problem is that even if Mr Bernanke’s views prevail while he remains chairman, the odds are that he no longer will be after January, 2014. He is unlikely to be reappointed even if Barack Obama is re-elected (even if wanted the job, a big if, he probably couldn’t be confirmed), and certain not to be if Mitt Romney wins.

But all that's irrelevant. Instead, Bernanke's been captured by the Borg.

*Some of the reasons for that may be found in this excellent post by Steve Randy Waldman. I hope to have more to say about it soon, but for now it's worth reading that one in its entirety. The takeaway is that the coalition of political interests that would be harmed by higher inflation is much larger (and much more politically active) than the coalition that would benefit from it.

"Ohhh Buh-yam!" of the Day

Stephen Williamson, on the Krugman-Cochrane rivalry:

It's likely that, in the absence of his Krugman-critique, Cochrane would never have appeared on Krugman's radar screen, much like the rest of the the economics profession or, indeed, economics in general. However, Cochrane now has a place of honor on Krugman's list of bad guys, and serves as a convenient foil, particularly given his University of Chicago affiliation.

I still think this is basically theater.

Closing Thoughts on Elites

I spent a lot of time in this Crooked Timber comment thread discussing my previous two posts and the reactions to them. I think it's safe to say that I convinced exactly no one, and it's now devolved well past the original point of contention, so I want to clarify a few things and then I'm letting this go. I suspect that in terms of actual views of politics there’s less disagreement than first appears, but I could be wrong. The first point is related to the initial context of Krugman, and why I reacted the way I did to him. The other points are more general, and mostly refer to specific arguments brought up by commenters at CT. Drezner has additional thoughts. Phil Arena had a good post too. And Michael Flynn adds some important points. Dan Nexon jumps back in, and I agree completely with him that politics is almost entirely about rent-seeking and redistribution, but interest groups are part of the public and elite opinion is only one component of political competition. I expound on this below.

1. (NOTE: After I wrote this, but while Blogger was down so I couldn’t post it, Krugman himself took note, although he tries to rise above it by not offering comment. Too bad… he might’ve used the opportunity to express what it is, exactly, I’m “creatively misreading” by saying how much responsibility he believes the public bears. Since he says my accusation – that he’s trying to exculpate the public – is a misreading, I’ll take that to mean that he agrees that the public does deserve some blame. This makes his column, as written, very odd. It also makes many of the criticisms of me in the CT thread criticisms of Krugman as well. Anyway, I’m leaving this in the post because it gets at the reading I originally had, and the reasons I had it, which is the most interesting thing from the perspective of argument rather than piss-contest.) A lot of people think I misread Krugman, or was otherwise uncharitable. I was definitely uncharitable, because I have a pretty strong distaste for Krugman's predilection towards a "good vs evil" characterization of politics. CTers, who all seem to like Krugman quite a bit more than me, were much more charitable. That's fine with me. But I don't think I misread him. [Ed.: I accept that I did, now that he says I did. I stand by my general argument, which may be knocking down a straw man in Krugman's case, but as I learned at CT there are certainly others who hold a view close to this.] The point of his op-ed was to place responsibility for policy disasters on policy elites (at least the ones he disagrees with). To do that, he felt he needed to exculpate the public. So he argued that these were "top-down" policies, not "responses to public demand". Only once in his column (Greece) does he mention that the public had any role in this ("So who was to blame for these budget busters? It wasn't the man in the street")*. There wasn’t any sort of “and the public went along with it” or even “and the public was gullible enough to buy Dubya’s lies hook, line, and sinker” or anything like that. A lot of time in CT comments was spent dissecting exactly what was meant by "responses to public demand", and no agreement was reached, but my definition (and Drezner's) included "doing things that the public broadly supports so that you get elected". The modal CT commenter seemed to prefer a stricter definition of "demand", and perhaps a lot of our disagreement stems from that semantic question, but short of election results and polling data I'm not really sure what they could mean by that and none of them was able to say. Krugman’s “top-down policies” implies, to me, that the bottom-up public had nothing to do with it.

My argument against what Krugman is saying now is actually congruent with what Krugman has written previously. Not just on Medicare Part D, as Henry Farrell pointed out, but more generally. When it comes to enacting policies that Krugman prefers, he has no problem at all citing poll data or election results as evidence of public demand, so I remain unconvinced that I was misreading him [Ed.: Caveat above applies here too.]. To drive this point home, here's what Krugman wrote a few weeks ago:

Eventually, of course, America must choose between these differing visions [from competing elites]. And we have a way of doing that. It’s called democracy. ...

For what it’s worth, polls suggest that the public’s priorities are nothing like those embodied in the Republican budget. Large majorities support higher, not lower, taxes on the wealthy. Large majorities — including a majority of Republicans — also oppose major changes to Medicare. Of course, the poll that matters is the one on Election Day. But that’s all the more reason to make the 2012 election a clear choice between visions. ...

So let’s not be civil. Instead, let’s have a frank discussion of our differences. In particular, if Democrats believe that Republicans are talking cruel nonsense, they should say so — and take their case to the voters.

This is the same evidence -- polls and election results -- that Drezner and I cited when arguing that the macro polity supported Bush's policies while Krugman says they didn't (or didn't "demand" them). So Krugman is trying to have it both ways: public demand as measured by polls and elections matters when it agrees with him, but does not when it doesn't. If the Democrats take their case to the voters and win, Krugman will claim a public mandate; If the Republicans win, he will claim elite manipulation by Very Serious People. How is this not a double-standard?

And I agree; let's not be civil. When an elite "pundit in good standing" plays intellectual three-card monty, let's call it what it is: "Unwisdom", to borrow Krugman's expression. Krugman is a partisan, and that's fine, but that shouldn't give him license to be this selective in evidence.

2. I very much believe that elites (and interest groups) play a huge role in creating policy, particularly in the details (i.e. where the devil is). In fact, the conclusion of my post previous to the one that started all this was:

It's no secret that investors will try to move markets in ways that are advantageous to them, nor that political elites will try to turn public opinion through the media. But in this case basically everyone agrees that Greece is insolvent, and that some form of restructuring is all but inevitable. That doesn't mean that the terms of that restructuring, nor the political implications for the eurozone, are assured. These might be examples of certain investors, government officials, or policy entrepreneurs [trying] to influence the timing of the restructuring, as well as the political response to it.

Elites matter, but within the context of public opinion plus institutional and other constraints. The relative weight of each of those -- public, elites, institutional constraints -- will vary by issue, but for high salience issues like tax policy and wars the public will play a large role in shaping the policy space.

One example (of several) I gave in comments at CT to illustrate this fact is that in addition to tax cuts that largely benefitted the wealthy, Bush also wanted to privatize Social Security. Many of the same elites that Krugman is attacking supported both policies. One of those became policy. The other didn't. Reference to "elites" in the way we've been discussing them doesn't tell us anything about why there were divergent outcomes in these cases. What we do know is that the public supported one, and not the other. Therefore, is it really so unreasonable to conclude that public opinion might be a relevant variable? And if it is, then shouldn't the public share some (not all) of the blame when things go wrong?

3. What we mean by "elites" isn't clear. As I pointed out in CT, and as Drezner mentioned too, by the definition Krugman uses -- "self-appointed wise men, officials, and pundits in good standing" -- Krugman himself qualifies as an elite. As does practically everyone else with a recognizable name. Elites often have different preferences, so ex post it will always be easy to find some that supported any particular policy, and then blame them for any bad outcomes following from it. While this might be cathartic, it doesn't help us understand which elites got their way and why. For example, many elites (including Greenspan and the whole Republican party) wanted the Bush tax cuts. Many others (including Krugman and the whole Democratic party) did not. If that's all we knew, and we start from the assumption that only elites matter, how could we understand outcomes? And if elites aren't the only thing that matters, why should they be the only ones to take the blame when things go wrong?

Similarly, the “public” does not refer to 100% of everyone. Krugman’s definition of an elite – “self-appointed wise men, officials, and pundits in good standing" – actually excludes the sort of interest groups that we generally think are involved in rent-seeking political behavior: industry groups (e.g. Wall Street), trade unions, religious organizations, farm associations, AARP, etc. According to Krugman’s definition, those would all be included in the “public” that had little-to-nothing to do with this. Instead, it’s all David Brooks’ fault.

The modal CT commenter surely thinks that the people who voted for George W. Bush made a big mistake, borne of ignorance, stupidity, or a view of politics that they completely disagree with. What’s wrong with saying that people who make mistakes deserve some portion of blame? (This is Krugman’s primary thesis, just applied to elites rather than voters.) If folks wish to exempt themselves from that slice of the public they are free to do so, without complaint from me. For my part, I never voted for Bush, actively campaigned against him in 2000 (I sat out 2004), and did not support any of the policies under discussion at the time they were put in place. So I’m more than happy to criticize those that did.

I didn’t highlight the role of interest groups within the public in my first post. That was a mistake. I think about politics is as interest group competition, and since (I believe) Krugman does too it didn’t occur to me that such a clarification was necessary. Sometimes interest groups coalesce around certain policies – tax cuts, wars – in sufficient numbers that referring to a macro polity as if it was unified makes sense (to me, at least), but that’s not to imply that interest groups are homogenous.

To reiterate and close: I'm fine with blaming elites for bad outcomes. I do it all the time. It's fun, they deserve a lot of scorn, and are rightly punished at the polls when they screw up. The thing I like most about Krugman, and basically the only constant thread in his popular writings from the 1990s until now, is that he's great at punching holes in bad numbers and illogic that pundits and politicians often use. But some blame is surely left over for an electorate that prefers low taxes and high spending, and rewards politicians that give them both, when those policies lead to a budget mess.

My next post will about something I really like about Krugman.

P.S. Farrell suggests I read Pepper Culpepper's book. It's been at the top of my Amazon wish list since I first heard of it (I believe via Farrell) six months or so ago. I hope to get to it later this summer. But as I understand it, the book is about "quiet politics", i.e. issues that the public knows and hears little or nothing about. I don't think that accurately characterizes the public debates over tax cuts, wars, or health care. (It probably does with regard to financial regulation, in the late-1990s and early-2000s at least.) Salience with the public is important, and these are the most salient issues in American politics. I'm not sure why we should expect case studies of some of the least salient issues (in other countries) to map on to this discussion very well. In fact, if David Soskice's blurb -- "Culpepper argues with detailed empirical plausibility that democracy can only impose change in technical policy debates if they are of high salience" -- is accurate, then if anything we should take the opposite view in these high salience cases. There's appears to be a huge generalizability problem. So while I'm willing to accept Farrell's chiding on how to do IPE better, we need to make sure that we're not going off too far in the other direction of extrapolating too much from limited cases.

*He doesn't mention Medicare Part D in his column, but does toss off "with few exceptions" which is possibly a reference to that, and as Farrell pointed out to me, Krugman mentions Part D in a separate blog post as being a response to public demand. The fact that he was this selective with his examples in his column indicates to me that a charitable reading isn't the right one. He's stacking the deck on purpose. And of course I think that the tax cuts, Iraq war, and euro-adoption are about as much "exceptions" as Part D. But I've already said that I'm not inclined to give Krugman a charitable reading, so YMMV, of course.

7 Year Old Politics

Henry Farrell goes after me over this post, and says he'd rather be an unsophisticated 6 year old than... whatever I am. Dan Nexon seconds the motion. Really Farrell's making a much bigger point about IPE and is using me as an illustrative case. He's written about this before.

This puts me in a weird position. I tossed off that post, mostly because I was short of time and because Krugman perpetually annoys me. The point of the post was intended to be that Krugman's constant moralizing doesn't get us anywhere, not even as far as the most basic view of democratic politics. The point was not that the most basic view is the right one. I tried to caveat a bit ("first approximation", "doesn't always work"), but that obviously didn't get across. So I guess Farrell's response is just desserts for being lazy. I'll try to flesh out what I meant better in this post. While I don't want to run away from what I wrote, much less what I intended to convey, I also don't want to get the shit kicked out of me for something I don't really think. So this will be at least as long as Farrell's post, and much longer than Nexon's.

As (I think) Farrell knows, I agree with many of his points about IPE in general. I agree that IPE does a very poor job of explaining preference aggregation, and a pretty poor job of preference formation (although, ideally, we could just import at least some of that from comparative politics). In fact, I'd extend it: I think IPE has a generally poor view of the political space, and like other subfields of political science is too reductionist. I agree that IPE does not have a very good sense of how interest groups and elites influence policy in democracies. I agree that we should pay more attention to subfields that examine these questions in detail. As he says, IPE generally infers preferences from economic theory, then applies some crude form of the median voter theorem (if that) to explain outcomes*. IPE generally assumes (implicitly) that voters are fully informed, and actually care about whatever issue we happen to be studying.

This is lazy even when it's not entirely wrong, and a big part of my dissertation is dedicated to more rigorously exploring how interest groups shape policy in a global context. So, as a jumping-off point, I don't mind him taking me to the rails. Except. He's writing this in defense of Krugman's purely elite-driven take. Here's what Krugman says:

The fact is that what we’re experiencing right now is a top-down disaster. The policies that got us into this mess weren’t responses to public demand. They were, with few exceptions, policies championed by small groups of influential people — in many cases, the same people now lecturing the rest of us on the need to get serious. And by trying to shift the blame to the general populace, elites are ducking some much-needed reflection on their own catastrophic mistakes.

Here's what Farrell says:

On many important policy issues, the public has no preferences whatsoever. On others, it has preferences that largely maps onto partisan identifications rather than actual interests, and that reflect claims made by political elites (e.g. global warming). On others yet, the public has a set of contradictory preferences that politicians can pick and choose from. In some broad sense, public opinion does provide a brake on elite policy making – but the boundaries are both relatively loose and weakly defined. Policy elites can get away with a hell of a lot if they want to.

These are two very different statements. On the issues we're talking about -- tax cuts, Iraq war, prescription drugs covered by Medicare, housing policy -- the public did have pretty clearly identifiable preferences about policy, and those happen to map onto policy debates (and resulting legislation) fairly well**. As I linked in the prior post (via Drezner), a majority of the public supported the Bush tax cuts and the Iraq war. The former represented the biggest policy proposal of Bush's 2000 campaign, the latter represented the biggest policy proposal of his 2004 campaign. He won both of them. (Okay, only kind of won in 2000.) Moreover, the public's representatives in the House and Senate voted for both policies.

Now we could believe that public preferences had nothing to do with the Bush tax cuts becoming law and the Iraq war being prosecuted. But then how to explain how a number of other policies supported by the same elites but not the public during the same period -- Social Security privatization, immigration reform, invading Iran -- did not become law or practice? If we're to discard polls and the votes of representatives, how else are we going to get at the public's preferences to know whether they're relevant?

That's not to say that elites don't have a huge role in shaping public opinion, crafting the specific nuances of policy, or even that they have quite a lot of flexibility to shape policy to their own ends. Of course they do. Legislation is written by elected elites, who are influenced by unelected elites and interest groups within their states/districts. One casual glance at trade law is enough to convince anyone of that. Medicare Part D gets closer to Farrell's last sentence. The public supported coverage of prescription drugs by Medicare. It seems likely to me that the public did not have strong preferences over precisely how that happened, other than that they would prefer not to have to pay higher taxes. So what we got was an unfunded bill that catered strongly to the interests of the drug industry. Similarly, the public supported tax cuts. The particulars of the Bush tax cuts met that demand, but in a way that also privileged powerful interest groups and likely Republican voters (see the cartoon in the Bartels paper Farrell links to). There is nothing in the Hacker/Pierson or Bartels studies that Farrell cites that disputes this interpretation***.

But here's the key point: the policy space that elites use to manipulate for their own ends does not exist without the broad support of mass publics****. Or, as Farrell says, "It is fair to say that the Medicare changes began in a shift in partisan patterns of competition over issues. However, it surely didn’t end there." No argument from me. That, however, is not what Krugman argues. He claims that the public had nothing to do with it at all. That this is purely a top-down disaster. This view is disputed by the Campbell and Morgan quote that Farrell reproduces:

More generally, gaining the support of powerful interest groups was essential in passing a reform that was likely to garner little Democratic support and was viewed skeptically by more conservative Republicans.

Right, but this was only important because the public wanted Medicare to cover prescription drugs in the first place. If they hadn't, a bill that both Republicans and Democrats were ambivalent about is unlikely to have become law. To gain passage, and thus satisfy the public demand, it became necessary to craft a bill in such a way as to get the necessary support from powerful interest groups. But that doesn't negate the public's interest in reform along the broad lines that reform occurred. A very similar process occurred during the PPACA ("Obamacare") deliberations.

Near the end Farrell writes:

One can certainly make a reasonable case that electoral politics plays a more important role than Krugman acknowledges. But one cannot make a good case that policies of the kind that Winecoff describes are a simple reflection of public preferences.

This where Farrell is misreading me. (And, I think, Drezner.) We're not saying that the public was perfectly represented, much less "reflected". Indeed, I think such a statement is all but meaningless. Drezner has written a book about how interest groups dominate regulation of the economy, particularly in highly-technical areas in which the public is unlikely to have much information or strong preferences. We're both very interested in how power and influence is filtered through political institutions/interactions. I'm just saying, contra Krugman, that mass publics are part of that equation. After linking to a bunch of surveys showing that the public broadly supported the policies Krugman says they had nothing to do with, I wrote in my post, "This [reference to public opinion] might not work all the time, but as a first approximation this sort of thinking holds up fairly well". Or, at least, to entirely excuse the public from the outcomes of policy you should first have to show that they didn't create the political space for those policies to be enacted. Krugman can't do that. That's the point.

(As for housing policy, I'd refer Farrell (and anyone else interested) to the CPE/IPE research done by Seabrooke and Schwartz (also here and this special issue of Comparative European Politics). Ragu Rajan has argued that the rise of credit was encouraged by policymakers to offset stagnating median wages. Oatley has an argument that "what we're experiencing right now" is a result of a number of macro policies, operating within an international context, that both elites and the public broadly supported, culminating in disaster. I think, though I've done no research to back it up, that home ownership was encouraged by major public policies -- including the mortgage interest deduction and Fannie/Freddie -- supported through a host public policies by administrations and majority Congresses from both major parties across several decades, and that the most recent housing crisis is only the most recent, not the only. In many cases, bipartisan elite opinion is/was that these policies distort the economy and should be abandoned. Which mass publics wanted less access to credit and higher interest rates? Sure, finance liked it also, but they weren't the only ones. I.e., We got the housing finance we got because the public wanted credit, the politicians wanted votes, and the financiers wanted profits. NOTE: I slightly modified this parenthetical after initial posting to improve clarity and fix typos.)

*Usually IPE just pumps POLITY into a regression and mumbles something about transparency or checks and balances and then moves on.

**As for "On other [issues], [the public] has preferences that largely maps onto partisan identifications rather than actual interests"... Who's lazily inferring interests now? Why can't partisan identification be an interest?

***The dearly departed George Rabinowitz used to befuddle his Intro to American Politics students every year by assigning Showdown at Gucci Gulch, a journalistic account of the passage of the 1986 tax reform act. It does a great job of explaining how the pressure for tax reform was generated by the mass public, but how the vagaries of getting it passed heavily involved elites and interest groups.

****For one thing, saying "elites did it" doesn't actually tell us anything at all. There are elites on both sides of every issue. Krugman himself is an elite now, as he was during all of the 2000s, and yet he disagreed with most major policies enacted during that period. Which elites get to control policy is decided, among other things, by the publics.

There Will Be Politics

UPDATE: Henry Farrell and Dan Nexon have taken their shots at me, at least partly deserved, but I didn't say the things I said. A more fleshed out version of my thought is here.

Paul Krugman thinks that democratic politics does not exist:

Well, what I’ve been hearing with growing frequency from members of the policy elite — self-appointed wise men, officials, and pundits in good standing — is the claim that it’s mostly the public’s fault. The idea is that we got into this mess because voters wanted something for nothing, and weak-minded politicians catered to the electorate’s foolishness.

So this seems like a good time to point out that this blame-the-public view isn’t just self-serving, it’s dead wrong.

The fact is that what we’re experiencing right now is a top-down disaster. The policies that got us into this mess weren’t responses to public demand. They were, with few exceptions, policies championed by small groups of influential people — in many cases, the same people now lecturing the rest of us on the need to get serious. And by trying to shift the blame to the general populace, elites are ducking some much-needed reflection on their own catastrophic mistakes.

If Greenspan's "with notably rare exceptions" deserves internet infamy, and it does, then surely Krugman's less notable exceptions should too. As Drezner notes, Krugman's examples -- the Bush tax cuts and the Iraq war, mainly -- were supported by majorities of the population. Bush campaigned on a platform of tax cuts too, so it's not as if he tricked the public once elected.

What interests me about this isn't that Krugman is playing fast and loose with his factual claims, or even stacking the deck in a blatantly partisan way. That's par for his course. It's that he thinks that a simple political explanation is just not feasible. Instead, some moral lesson is needed. If something bad happens, it must be because bad people are doing it. This is the political sophistication of a six year old. The specific bad people in this case -- "self-appointed wise men, officials, and pundits in good standing" -- are less interesting than his usual coterie of sado-masochists, mythical creatures, and conspirators, but at least this time Krugman manages to indict a category of people that includes himself.

Occam's Razor can help us here. If there are tax cuts, maybe it's because people wanted tax cuts. If there is Medicare Part D, maybe it's because people wanted Medicare Part D. If there is a housing bubble, maybe it's because public policy was skewed in ways that home ownership attractive, because that's what people want*. This might not work all the time, but as a first approximation this sort of thinking holds up fairly well. In the examples Krugman gives, it's batting 1.000**. Saying that democratic polities have problems with time inconsistency and preference aggregation isn't exactly a new insight.

Krugman closes with this:

But the larger answer, I’d argue, is that by making up stories about our current predicament that absolve the people who put us here there, we cut off any chance to learn from the crisis. We need to place the blame where it belongs, to chasten our policy elites. Otherwise, they’ll do even more damage in the years ahead.

Amen, I suppose, but there's plenty of blame to go around. We all played a role in this crisis. Not an equal role of course, but a part nonetheless. Might as well own up to it.

*Mortgage interest tax deductions, subsidized subprime (and prime) loans, lower capital requirements for MBS, etc.

**Drezner wonders about public support for financial deregulation. I challenge Krugman to name the deregulatory act that led to the financial crisis. If he can't, and he hasn't, then his example fails and Drezner doesn't have to worry about it.

Politics, Not Economics, Will Decide Europe's Path

I'm jealous. Waldman's response to me got links from Financial Times, The Economist, Naked Capitalism, and Krugman, and I'm sure many others. I got none of that*. Even worse, Krugman jumped in and completely missed the point, as he has since this crisis began:

Steve Randy Waldman has a good post critiquing the now widespread notion that debt-troubled economies will have to engage in the same amount of austerity regardless of what they do with their currencies.

But I would go further than Waldman here; it’s not just that the fiscal deficit and the external deficit are different things; even the fiscal deficit becomes much easier to reduce if you can have a devaluation-led boom.

The "now widespread notion" is just me. I haven't seen anybody else make the argument. (I'm sure someone has, but it doesn't seem like many. I don't have unlimited time to scour the interwebs for every stray blogger or columnist, but I read Krugman every day and if it really was widespread I'm sure I'd've seen him rant about it several times by now.) But set that aside.

Iceland, Krugman's favorite crisis country, begs to differ. Debt-to-GDP has trebled, and with a devalued currency servicing any external debt is now much more expensive. Yes, they're getting to fiscal balance, but only because of... austerity. Krugman cites Argentina as a positive example, and their experience has been better than most. But Argentina's debt-to-GDP doubled after default. Their real GNI/capita halved (Atlas method), and took nearly a decade to get back to its prior level. They can't borrow on international markets, so they've had to boost domestic saving (and reduce domestic consumption). That's austerity. And that's the most positive example.

Anyway. Before SRW says the thing Krugman likes he agrees with me that austerity in some form is unavoidable for the Europeriphery, so all of Krugman's talk over the past few years needs to be heavily qualified. As to whether it's the "same amount" (I never said it was, so not even I am part of the "now widespread notion"), that's unknowable ex ante. But here's what we do know:

1. Domestic polities in Ireland and Greece are pissed off at austerity. They have already voted out their governments. Nevertheless, no EMU economies have defaulted/devalued. Not only that, but the crisis Baltics that peg to the euro have held firm too, and Iceland is hoping to join. That to me strongly indicates that there is a common belief among politicians and publics in those countries that default/devalue is among the worst options, and that other forms of austerity should be pursued first. Hell, they'd rather run into the arms of the IMF than default/devalue. Given the history of many of these countries, that should tell you something. In other words, these countries think default/devalue is worse for them than any other realistic alternative. But whatever; I'm sure Krugman knows what's best for them.

2. Krugman (and to a lesser extent Waldman) is imagining a static world in which there's a default/devalue... and then nothing else happens. But other things happen. The people you defaulted on get pissed off. They freeze your assets. They sue you in EU courts. They might restrict IMF funding. They might place trade restrictions or other sanctions. They never lend to you again. These are the richest, most powerful countries in the world. Poking them in the eye is a bad idea.

And this brings me to the only thing that matters. It's not the size of austerity under different scenarios. It's who pays. This isn't a utility maximization problem. It's politics. Krugman might have all the economics right, but it would be completely irrelevant if the politics doesn't match. So what do we know about the politics of fixed exchange rate regimes during crises?

Stephanie Walter wrote an article in 2008 on how states responded to the Asian crisis: with internal devaluation (measured by high interest rate increases to defend the exchange rate) or external devaluation (abandonment of the exchange rate peg). Her conclusion is that policy choices depended the size of political constituencies in those economies. In Hong Kong, which was highly financialized, the state defended the exchange rate at all costs. In less-financialized economies, particularly those with export-biased economies -- e.g. Taiwan, South Korea, and Thailand -- states either devalued immediately or gave up defending their pegs fairly quickly. This should not be a great surprise, but it's worth pointing out.

Then of course there's Beth Simmons' classic study of the interwar period, Who Adjusts? (In our case, we might ask Who Pays?) Simmons argues that small open economies with stable governments that are dependent on trade were more likely to internally adjust in order to maintain the gold standard. Larger countries with less stable governments were more likely to devalue. Why? Small, trade-dependent countries with stable governments were more able to credibly commit to reforms, thus preventing capital flight. Others weren't. A sharp depreciation in the capital account not only makes keeping a fixed exchange rate more difficult, it also impoverishes an economy through a decline in investment**. This also needs to be built into the cost of austerity-via-devaluation.

So what lessons can we learn. Ireland is a small open economy, that is highly financialized and trade dependent. It has a stable government that has made a commitment to maintain its exchange rate, which, in this case, means staying in the euro. Because of its high financialization, it would be hurt terribly by a devaluation and capital flight. Considering how battered its financial sector already is, that would likely cause the economy to totally collapse. And of course it's already happening, but its low corporate tax rates have kept a lot of foreign finance in the country that would otherwise be gone. So expect no devaluation, unless there is literally no other choice.

Iceland, on the other hand, never had a fixed exchange rate to defend. The krona bounced around a lot to the euro even before the crisis, although that pales in comparison to what's happened since. Iceland tried fix the krona to the Euro it in late 2008, but that only lasted one day. Devaluation wasn't chosen as a rational option or a lesser evil; it happened because Iceland couldn't stop it. Now, as mentioned previously, Iceland is seeking membership in the EMU and adoption of the euro to prevent the sort of turbulence that they've recently gone through.

Greece? Not as highly financialized, a less stable government that is unable to make credible commitments to much of anything. Not as small or dependent on trade as Iceland and Ireland, although the difference might not be meaningful. Capital flight has already happened. A long history of profligacy, and a citizenry that didn't pay taxes in the best times. Internal devaluation is likely impossible even if it were desirable. Looks like a devaluation to me.

There are important political dynamics in the Eurocore as well, but this is (again) already too long. In a nutshell, it matter who owns the debt the periphery has accrued. That is mostly the core. They, obviously, don't want default. So they'll try to commit to my #2 above as credibly as they can. Maybe that makes austerity worse in aggregate than if they were nicer. Maybe not. The point is that question is irrelevant. It's like asking what nice things Obama would do if he didn't have to bother with elections.

*I am jealous, of course, but I don't begrudge Waldman anything. He's got a great track record, writes carefully and well, and is very smart. Plus fun to converse with on Twitter. I have no track record, write nothing until after at least four glasses of wine, and am cantankerous on social media.

**For those playing at home, this relates to Waldman's "as long as" statement that I honed in on in my last post.

The Lesson of Iceland

I've been thinking a lot lately about exchange rates, capital flows, and related issues. While looking for something else, I came across many news articles since the crisis Iceland's bid to join the EU, including the EMU. Many of the articles focused on how Iceland's refusal to pay Icesave's creditors might jeopardize their accession, but the screening process appears to be at a fairly advanced stage already, so negotiations leading to accession in 2013 or so are realistic. Emmanuel's discussed some of this.

All that reminds me of Krugman's constant arguing that Iceland was doing so much better than Ireland and the Baltics, because having their own currency allowed them to depreciate quickly. As I noted here, that's all fair and good, but a large depreciation massively increases the burden of external debt, and also leads to a large increase in costs of living for a small open economy. Particular one as small and open as Iceland. Iceland's 50% currency depreciation made them much poorer, and their debt-to-GDP not only quadrupled after the crisis but became much more expensive to service. Note that before the crisis, Iceland had no desire to join the EMU, and no intention of doing so, although it did "Euroize" the krona somewhat.

In other words, I was right. Iceland is applying for EMU membership so as not to be as exposed to currency risk and balance of payments problems as they are now, and they're willing to give up plenty of policymaking flexibility to achieve that. Including the right to depreciate.

We'll see whether the EU lets them in. I imagine that will have a lot to do with what happens to Greece, Ireland, and Portugal in the meantime.

Gaming Immigration

Gary Becker thinks we should charge immigrants $50k (on loan, if necessary) to come to this country. Via Adam Ozimek, who loves it. This baffles me. Becker is obviously a brilliant guy -- winner of both the John Bates Clark medal and the Nobel Prize -- and Ozimek's no slouch. So why don't they understand that the political opposition to increased immigration is centered on "illegal" immigrants? These immigrants are highly price-sensitive, do not earn high wages, are not deterred by formal requirements and have little problem avoiding them. Becker argues that many illegal immigrants will become normalized if given this path, but why should they? Under the status quo they can usually stay for free, and getting here costs much less than $50k. So who do they think is going to pay this $50k?

Perhaps highly-skilled workers, but they are more likely to have access to normal (read: free) immigration mechanisms anyway. Yes, we issue far too few H1B visas, but skilled labor will generally be more abundant in the US than where many of the immigrants come from; making the scarce factor (in their home country) pay to face more competition is generally going to be a self-defeating policy. Arguably we should be subsidizing these immigrants rather than the other way around.

This strikes me as a first-best-world policy recommendation that simply cannot work. Moreover, the prerequisites for it to work would be suboptimal relative to the status quo. It would require a tighter control on immigration than we have at present, and the tighter control is suboptimal on egalitarian and probably efficiency grounds, and so negates any possible benefits from the immigration-license system Becker proposes. On the fiscal side these benefits would be negligible at best. As a deterrent they would be detrimental.

The best (realistic) course of action from the perspective of the immigration advocate -- which Ozimek is, as I am and I believe Becker is -- seems to be a policy of benign neglect. We don't explicitly encourage illegal immigration, but we don't do much to stop it. We let demagogues make political noise about keeping the illegals out, but don't let them follow through. That doesn't work when Arizona goes nuts, but it does when we need to knock down the immigrant-bashing bill du jour.

Krugman vs. Krugman

I don't get Krugman's logic here:

Things are different for a country that shares a currency with other countries. Ireland can raise employment by cutting wages of Irish workers relative to German workers. But America, with its floating dollar, gains nothing — nothing at all — from overall wage cuts. All we get is a magnified real debt burden.

If that's the case, then why worry about China's currency peg, as he has done for years now? Either their peg helps boost American employment (at the zero lower bound), or it's of no concern for employment. Or Krugman is wrong.

Misc.

Things have been busy around here lately, so in lieu of a substantive post here's some links:

-- Dani Rodrik vs. Turkey. This has been going on for awhile, but in light of the "democratic" revolutions spreading through the Middle East it's worth noting that democracy is a long, uneven process. Rodrik accuses some in Turkey of operating a "state within the state", that is anything but democratic. I'm in no position to evaluate his claims, but if true they are damning.

-- The paradoxical politics of credible commitment. The conclusion is "Neat economic theory trips over messy political reality once again", and it illustrates the importance, but difficulty, of accurately matching interests to actions. Among other things.

-- Paul Krugman's posting template, revealed. Brilliant.

-- Iraq's economy is not doing well.

-- I'm not sure why Stephen Walt is still so concerned with debates that everyone else abandoned two decades ago, but he is. Here he tries to stack the deck in favor of realism in the context of the EU's ongoing debt crisis. I hope to properly smack this down sometime soon.

Aggregating Preferences

Every time a new poll of voter attitudes towards spending and taxes comes out, liberal commentators gleefully point out just how irrational the American public is. They seem to always want lower taxes and higher spending, but also a lower deficit/debt. Here, for example, is Krugman saying "The conclusion is inescapable: Republicans have a mandate to repeal the laws of arithmetic." And here is the Washington Post making their readers dumber:

Budget cutting is a top priority for the GOP, with 70 percent of Republicans in a new survey by the Pew Research Center saying the federal government should focus on reducing the deficit, not new economic stimulus. And in many cases, more Republicans now support cuts than did so two years ago.

But across 18 areas of federal spending, a majority of Republicans support decreasing spending in just one: aid to the world's needy.

This is stupid. For one thing, most (public) foreign aid does not go to the "needy poor", but rather to the military budgets of Israel and Mubarak's Egypt. There are perfectly good reasons for a pretty big consensus on cutting some of that spending. But more fundamentally, it is perfectly rational for a majority of individuals to support deficit reduction, while simultaneously opposing all means of doing so. Karl Smith points out one reason that is the case:

Suppose that you have three people. Adam, who believes in cutting spending to balance the budget. Bill who believes in raising taxes to balance the budget and Chris who believes that state balanced budgets are a pro-cyclical economic destabilizer that should be alleviated by federal transfers, or as he likes to say, “lame.”

Now we are going to ask a few questions.

First we ask: Should the state stick to its balance budget requirement? Adam and Bill say yes. Chris says no. We confidently conclude that the public wants balanced budgets.

Second we ask: Should we cut spending? Adam says yes. Bill and Chris say no. We confidently conclude that the public doesn’t want to cut spending.

Third, we ask: Should we raise taxes? Adam and Chris say no. Bill says yes. We confidently conclude that the public doesn’t want to raise taxes.

But wait a minute! Is the public insane! How can we balance the budget if we don’t cut spending or raise taxes.

No the public as individuals are completely sane, but when aggregated into a whole they become irrational. And, importantly there is no clear way to make them rational, since each person is answering truthfully and with complete knowledge of the facts.

That, as Krugman should know, is arithmetic. We should probably even expect this. When we ask a Yes/No question, we are almost guaranteed to get a majority in favor of one or the other. (Depends on whether or how strong of an option "Don't Know" is). In this case, that's a strong "Yes" in favor of deficit reduction. But if we then follow that up with a string of options of how to do that (18 in the WaPo survey of Republicans linked above, 13 in the Pew survey Krugman linked to), the broad-category majority will often -- even usually -- dissipate into a minority in each narrow category.

Here's a simple analogy to drive home the point: If you ask Americans if they like baseball, a majority will say yes. If you then ask them what their favorite team is, no team will get a majority. However, it would be daft to conclude from this that peoples' preferences over baseball are irrational.

Sometimes those options are nested, and when combined end up a majority (or even a supermajority, as in this example from Tyler Cowen). Sometimes they are not, or will not. But differences in the preferred means used to achieve an agreed-upon end is not a sign of individual irrationality, or even innumeracy.

You can sometimes get around this by changing the questions asked. Instead of asking "Yes/No" on a broad category then "Yes/No" on a series of smaller categories, for each category ask some variant of "If cutting Program X was the only way to balance the budget, would you want to do it?" I'll bet you find majorities pretty quick on many of those questions.

Final note: The Pew table that Krugman reproduces shows that in every single program, more people preferred cuts in 2011 than 2009.

Paul Krugman on China

I agree with all of this:

These days, China seems to play the same role in much of our discourse that Japan did two decades ago. We look at our own follies — which are immense — and then look at the Chinese, and ascribe to them all the virtues of foresight and determination we lack. ...

Basic economics says that by deciding to keep the renminbi undervalued, the Chinese put themselves under inflationary pressure; and sure enough, inflation is rapidly becoming a serious problem.

But political considerations seem to be ruling out all the reasonable responses. They won’t revalue, because that would hurt politically influential exporters. They’re reluctant to raise interest rates, because that would hurt politically influential real estate developers. They’re trying to impose quantitative limits on credit, but are finding that borrowers have enough influence to circumvent the limits. And now they’re trying price controls — which will inevitably come apart at the seams unless they do something about the underlying pressures.

I disagree about the implications of this, which Krugman calls "edifying" and (approvingly) schadenfreude. Why he would be happy to see the unraveling of the economic growth that has done more to advance human dignity and well-being than any other development in the past 100 years is beyond me. Because it makes his policy prescriptions look good? What a jerk.

But the substantive points are indeed true: there is no reason to just assume that China's recent economic performance is projectionable into the indefinite future. It's also true that China's domestic political system -- hailed by Friedman and his ilk for its efficiency and ability to adroitly maneuver through the global economy -- has its own share of tradeoffs that cause the Chinese leadership to privilege some groups over others.

One interesting thing about this is that China's real exchange rate is appreciating even if the nominal yuan is not. In other words, we don't need to start a trade war with China to get macroeconomic rebalancing. We don't need to risk global economic instability by trying to beggar our neighbors. I'd be interested to see what Krugman thinks about that, given what he's written in the past.

The "I'd Gladly Pay You Tuesday For a Hamburger Today" Theory of Economics

Munger took some time before getting his eyes lasered today to say this:

To have an effect on economic activity, tax cuts have to be credibly permanent.

The assumption here is that people will recognize that present tax cuts will be offset by future tax increases, so unfunded tax cuts will have no effect on behavior: people will just sit on the money until they have to pay it back. And that's true if people are atomistic Friedmanite permanent-income-smoothing fully-forward-looking individuals with complete and perfect information about their future incomes. We know this from theory that is deduced from those assumptions, and if those assumptions hold, then the conclusions also hold.

But the assumptions of theory do not necessarily hold. All of those descriptors above are wrong or at least (I'm being very generous) probabilistic rather than certain, so the question becomes empirical, not theoretical. And the empirical record, as far as I can tell, is completely bollocks-upped.

I can easily imagine a situation in which someone offers to give me money today, on the condition that I have to pay it back tomorrow, and I nevertheless alter my behavior and spend it rather than save it. That's how credit -- the foundation of the capitalist economy -- works. Mastercard does not have to credibly promise me a free $500 that I will never have to pay back in order for me to spend. They only have to promise me $500 today. If I think spending $500 today is worth paying back $525 tomorrow -- say, because I'm unemployed, or my house is at risk of foreclosure, or I just got furloughed at work, or... -- then I just might do it.

Example: the cash-for-clunkers program is routinely criticized for doing nothing more than pulling future spending into the present. But that was the whole point. And it worked! There were a lot of car purchases during that window that would have been spread out otherwise. (IIRC, Munger took advantage of this himself, but I can't find the post now so it could have been someone else in my RSS.) Of course people with clunkers would eventually buy a new car, but the government decided that they wanted them to buy a car today, not tomorrow. As it happens I think that was a poor choice of priorities, as I think most (not all) of this grand Obama/GOP bargain to be a poor choice of priorities, but the problem wasn't that cash for clunkers didn't work; the problem was that it was a silly and expensive tradeoff.

This is something that has always confused me about rational expectations econ, but then my econ education ended in undergrad. I can't even pretend to have a great grasp on the advanced literature, so possibly all these objections are easily overcome. If so, I'm sure someone will set me straight.

UPDATE: I've been grading finals all day (All Done!) so I didn't see Angus' relevant reply until just now. Angus believes in rational expectations, PLUS seems to have a zero percent discount rate, and still finds (to his apparent surprise) that he himself doesn't act as if these were his true beliefs. People, doesn't this tell you all you need to know? If a true believer rat expectations doesn't act like he should, who will? Yikes!

UPDATE 2: I'm still catching up on my RSS, and now I see Munger wrote a follow-up post in which he describes a scenario in which a car dealer offers a customer a loan, to be repaid with interest, if the customer is willing to purchase a car today rather than after he has saved up enough to pay the full sticker price in cash. Munger views this scenario as absurd. I view this scenario as basically the single most typical durable goods transaction in the world. One of us has to be wrong.

The Darkest Age of Macroeconomics

Modern Keynesians like Brad DeLong and Paul Krugman routinely excoriate those who forget the the wisdom of old economists, and rightly so. But Krugman seems to have forgotten the original lesson: the Smith-Ricardo insight that mercantilism does not increase the wealth of nations. It doesn't get more fundamental than that, as Krugman used to teach. I covered this once already here, and now Ryan Avent drives home the point:

What does economist Paul Krugman think of the [US/Korea FTA]? ... If you want to create jobs, go as mercantilist as possible. Maximise your exports; minimise your imports. ...

Hence, as Mr Krugman says, tariffs are good and free trade is bad.

But of course, tariffs aren't good and free trade isn't bad. Why? Well, if every country goes about using tariffs to maximise X and minimise M then no one gains (indeed, everyone loses).

Meanwhile, Mr Krugman does allow that:

There is a case for freer trade — it may make the world economy more efficient. But it does nothing to increase demand.

But a more efficient economy is one that can do more with less. Which is to say, it's one that produces more Y at full employment. Now, America isn't at full employment, and Mr Krugman argues that in a world of limited demand higher efficiency is a bad thing; it means that fewer people do the available work leaving more people jobless. But the actual economy is more dynamic than that. If expectations for long run growth improve, then businesses may increase I, which feeds into Y. And if tariffs shrink potential output, expectations may decline, curtailing investment and shrinking Y.

This is a fundamental theoretical mistake. That is not to say that the US/Korea FTA will have a huge impact on employment or output. As I noted in comments to my previous post, and as Avent claims in his, this is unlikely. If Krugman had said about the FTA that it was a good thing that was likely to have a minor effect on the US economy, I'd have no complaint. But to say that the effect on output and employment will be nil or negative (as Krugman alleges) or that mercantilism is preferable (as he also alleges) is just wrong. I really can't understand why he'd be arguing the point.

I suspect that he is mostly concerned about the distributional effects of increased trade, and is willing to make specious anti-trade arguments for that purpose. If that's the case I would only refer him to these excellent articles here and here, written by... Paul Krugman, in a more enlightened age. Now he favors placing countervailing duties on China. Now he says that a FTA with Korea will have a negative effect if it has any effect at all. He concluded the first article by noting this about "fuzzy-minded" individuals making similar anti-trade arguments:

I doubt that they are purely cynical. It is more likely that some kind of double-think, some convenient ability to stop thinking clearly when the situation demands it, is at work. But the truth is that I don't know--and I don't think it matters.

And the coup de grace in the latter:

In short, my correspondents are not entitled to their self-righteousness. They have not thought the matter through. And when the hopes of hundreds of millions are at stake, thinking things through is not just good intellectual practice. It is a moral duty.

I couldn't've said it better myself.

ADDENDUM: There's also a practical mistake. The U.S. is not at full employment, but global growth is still expected to be nearly 5% this year. There is demand in the world, even if there isn't in the U.S. So opening up to trade right now might have a stronger effect on employment than it otherwise would.

Oh My

I literally cannot believe this:

One thing I’m hearing, now that all hope of useful fiscal policy is gone, is the idea that trade can be a driver of recovery — that stuff like the South Korea trade agreement can serve as a form of macro policy.

Um, no.

Our macro problem is insufficient spending on U.S.-produced goods and services; this spending is defined by

Y = C + I + G + X – M

where C is consumer spending, I investment spending, G government purchases of goods and services, X is exports, and M is imports. Trade agreements raise X — but they also lead to higher M. On average, they’re a wash. ...

There is a case for freer trade — it may make the world economy more efficient. But it does nothing to increase demand.

That is international economist and Nobel Laureate Paul Krugman, arguing that trade does not matter for GDP or employment, but only for "efficiency". The post is entitled "Trade Does Not Mean Jobs". But trade markets don't operate in a fundamentally different way than other types of markets... does Krugman also believe that those markets have no effect on GDP or employment? Maybe he does, but it's wrong. Efficiency gains from markets leads to an increase in overall production. This is the logic of comparative advantage that Krugman used to defend so powerfully.

Let me break this down. GDP ('Y') can go up through trade in two ways: 1. If 'X' is greater than 'M', so that the economy is producing more than it is consuming; 2. If efficiency gains from trade leave people with more disposable income overall, which they then spend part of on domestically-produced goods ('C').

To see why number 2 is important let's think through a stylized example. Suppose we used to have to buy kim chi from Korea at $10/pound, because we had to pay a 100% tariff on the import. Suppose that tariff goes away through a free trade agreement. We can now buy our kim chi for $5, and have $5 left over to buy haircuts from Americans. The quantity demanded of Korean kim chi and American haircuts will both go up, as will GDP and employment in both countries. That is how gains from trade happen.

That is also why this makes no sense:

And there’s even an argument to the effect that increased trade reduces US employment in the current context; if the jobs we gain are higher value-added per worker, while those we lose are lower value-added, and spending stays the same, that means the same GDP but fewer jobs.

But why should we expect spending to stay the same? If we gain higher-value added jobs, we are also gaining income. If we are gaining income, we will spend more. That means higher GDP and more jobs.

I have Paul Krugman's textbook on international economics. It is very good. It covers standard trade models nicely. Maybe he should read it. Or any of his columns from the 1990s.

In Which I Don't Understand What Smart People Are Saying

I guess I'm an idiot, as I can't understand simple things. Paul Krugman says:

One clear result of the midterms is that we won’t have anything like a further round of stimulus. And this, in turn, means that the narrative all the Very Serious People will tell is that fiscal policy was tried, it failed, and that’s that.

To support this he presents two points of data, and only two. They are:

1. Germany's economic decline has been worse than the U.S.'s.

2. Germany's government spending has been higher than the U.S.'s.

From this, he concludes:

3. U.S. government should spend more in order to boost growth. (Or, alternatively, the U.S. didn't really try fiscal stimulus at all.)

As far as I can see, that conclusion is a non sequitur given the data he's presented. He updates the original post to say "Just to be clear, I’m not saying that the Germans were big Keynesians; the point is that neither of us were". Fine. But if there is a correlation between government spending and economic growth during this downturn, that correlation is very clearly negative given the data he's given us. How can we conclude from this that the election narrative that "fiscal policy was tried, it failed" is wrong? The data that he's given supports that very conclusion.

This is not a sophisticated analysis, and there are all kinds of relevant variables that aren't included. But Krugman doesn't say which of those might be mitigating factors. He doesn't qualify the data he presents. It's a really strange conclusion for him to reach. As I've noted before, Germany really messes with the standard Keynesian analysis. Tyler Cowen built off of that post here.

Brad DeLong writes about this post, but doesn't square the circle either. Like Krugman, DeLong is much smarter than me, so I guess I'm missing something obvious. I wish they'd point out what it is.

Also note that this crude analysis supports this recent study on the fiscal multiplier, since Germany has a fixed exchange rate with many of its trading partners, while the U.S. does not.

What am I missing?