Category: Economics

Understanding Imports and Exports Correctly

Theodore A. Gebhard

Trade association executives are paid to look after their member companies’ interests.  Part of that responsibility is to advocate public policy positions that advance or protect those interests.  Not surprisingly, such advocacy often cherry picks data and characterizes that data in ways that can generously be called suspect.  Nearly always, trade association public policy positions rest on the claim that the interests of the association’s member companies are the same as the interests of all Americans, and therefore what is good for the association membership is good for America.  Rarely, however, is this equivalence the actual case.

A good illustration of this kind of advocacy takes the form of a Letter to the Editor in today’s Wall Street Journal written by Mark Duffy, the president of the American Primary Aluminum Association.  (Canada’s Aluminum Subsidies Hurt the U.S., Letters, Digital July 27.)  Mr. Duffy laments the loss of U.S. aluminum smelting capacity, which he attributes, at least in part, to subsidized Canadian imports.  In so doing, Mr. Duffy makes the error of all those who see production and employment as the end of economic activity.  As Adam Smith taught us two and a half centuries ago, we engage in economic activity in order first to sustain life and then to improve life with ever higher standards of living.  That is to say, the ultimate purpose of economic activity is consumption and the wealth of a nation is the extent of its consumption pie.  Imports therefore are rightly considered benefits to a nation insofar as they add to the nation’s consumption pie, while exports are rightly considered costs as they deplete the consumption pie.  Another way to think about this to consider that when we export, we are utilizing our scarce resources for someone else’s (foreigners’) consumption benefit.  When we import, we are enjoying goods and services produced out of some other country’s scarce resources.  If a country is subsidizing its exports to the U.S., we benefit all the more.

Below is a reproduction of a response to Mr. Duffy’s letter that I submitted to the Journal.

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In his Letter to the Editor, Mark Duffy, President of the American Primary Aluminum Association, castigates Canada for subsidizing its aluminum industry to the tune of $850 million.  (Canada’s Aluminum Subsidies Hurt the U.S., Letters, Digital July 27.)  Mr. Duffy claims that these subsidies have contributed to a fall in the number of American smelters from 23 to four since 2000.  As to Mr. Duffy’s alarm over this development, I suppose it is obligatory that the president of a trade association equate his members’ interests with the interests of all Americans.  Doing so in this case, however, requires relabeling benefits as costs and costs as benefits.  In point of fact, America should be sending a thank you card to Canadian taxpayers who foot the bill for the subsidies, as the subsidies not only enable Americans to consume aluminum-containing products more cheaply but also enjoy a larger array of other products and services.  This larger array comes about because scarce resources, including labor, that are freed up by importing less costly Canadian aluminum become available to expand alternative productive activities and create new ones.  For American consumers and the American economy, it’s a double win — cheaper aluminum-containing goods and greater total national product.

Theodore A. Gebhard

(Mr. Gebhard was formerly a Senior Economist with the International Trade Administration.)

Micro vs. Macro Economics and Predictions

Theodore A. Gebhard

In a Wall Street Journal op-ed, regular Journal contributor, Joseph Epstein, compares modern day economists with ancient augurs. Mr. Epstein points out that there has been an infusion of politics in economics as exhibited by the fact that prominent economists who frequently appear in the media seemingly interpret economic data and make predictions in accordance with their respective political leanings. With a good deal of ridicule, Mr. Epstein notes that, in the end, these predictions, regardless of political preference, prove more often than not to be inaccurate. Is there really an “economic science,” therefore, or are economists simply mystics?

To me it is indeed lamentable that the public’s perception of economists is framed by those few media-savvy “economists” who know how to present themselves in a way that makes for “good” TV and newspaper quotes. What’s more, this perception arises almost exclusively from observation of macroeconomists whose forecasts are grounded in highly aggregated data. Rarely does one see microeconomists in the general media. I maintain that, if the public knew more about this older branch of economics and its scientific richness, the perception of economists would be quite more favorable.

To make this point, I submitted the following “Letter to the Editor” to the WSJ in response to Mr. Epstein’s narrow focus on macroeconomic forecasters.

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As someone who has spent a career teaching and practicing applied microeconomics, it dismays me that the public’s image of economists is largely formed by TV-savvy macroeconomic forecasters claiming to be able to look at highly aggregated data and predict where the economy or various economic measures will be in X amount time.  As Joseph Epstein points out (Is that an Augur, or a Mere Economist? op-ed April 23), not only are such forecasters often all over the board about the likely efficacy or lack thereof of a given policy, but considerably more often than not their predictions, regardless of initial side, turn out to be way off base.  All this, of course, provides grist for the kind of ridicule that Mr. Epstein exhibits. 

By contrast, microeconomics has a far better record.  Indeed, in comparison to macroeconomists, microeconomists are far more likely to agree in their analyses of microeconomic policies (i.e. market-specific regulations and interventions) as well as their predictions of the consequences of such policies.  This near unanimity derives from the fact that microeconomics rests on well-developed theory that has stood the test of time and consistently lives up to empirical verification. Regrettably, the absence of controversy does not make for good television, and the public rarely is exposed to this major branch of economics and its practitioners.

Theodore A. Gebhard

Fighting an AI “Monopoly” Where None Exists

Theodore A. Gebhard

In a Wall Street Journal op-ed, former U.S. Attorney General William P. Barr complains that regulators have been “asleep at the switch over the past 25 years” with regard to oversight of Big Tech companies. (“Big Tech’s Budding AI Monopoly,” 05/28/2024.) Now Mr. Barr is especially concerned about these companies’ efforts to develop artificial intelligence. According to Mr. Barr, Big Tech companies not only dominate primary markets but also stifle the ability of smaller competitors to emerge in adjacent markets by, among other anticompetitive practices, pre-empting entry into those markets. He fears that the Big Tech companies will eventually monopolize the entire AI space.

The former Attorney General is unduly alarmed. What’s worse, he espouses unsound competition theories that, if allowed to undergird regulatory and antitrust enforcement, could result in reduced innovation and ultimately harm U.S. economic interests. To add our views to the discussion, my friend and former colleague, Asheesh Agarwal, and I submitted a Letter to the Editor, which the Journal published on June 7 (print edition) and can be accessed here. The published version is slightly shortened. I reproduce our original letter directly below.

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On AI, General Barr Fights the Last War

In his recent op-ed, former Attorney General William Barr embraces outdated competition theories that could reduce innovation and undermine U.S. economic interests.  (“Big Tech’s Budding AI Monopoly,” 05/28/2024.)

First, Mr. Barr suggests that three companies, Microsoft, Google, and Amazon might establish an AI monopoly because they have market power in related sectors. Of course, it’s absurd to treat three fierce competitors as a “monopoly” of any sort, but setting that aside, Mr. Barr ignores many other AI competitors. Meta is spending tens of billions on AI and Elon Musk’s xAI is valued at $24 billion. And that’s just at home; the Senate estimates that China significantly outspends the U.S. on AI.

Second, Mr. Barr suggests that large companies shouldn’t invest in related markets because their resources and expertise might give them a competitive advantage. Queue Louis Brandeis and the Big is Bad crowd. Does Mr. Barr want large companies to reduce investment or commit to only internal innovations, without any acquisitions or hiring? Especially in dynamic tech markets, investment produces uncertain returns; to rely on antitrust enforcers to foresee the longer-term competitive effects assumes a crystal ball yet to be discovered. 

Finally, and surprisingly, Mr. Barr embraces the FTC and European Commission as champions of competition. As these pages have pointed out regularly, both agencies have promoted aggressive theories of antitrust liability grounded in speculative theories rather than evidence of harm to competition, usually targeting innovative American companies.

Instead, policymakers should encourage investment from all quarters — and avoid artificial constraints.

Asheesh Agarwal and Theodore A. Gebhard

Some Debate Questions For the Republican Presidential Candidates: Testing Their Commitment to Free Markets

Theodore A. Gebhard

The Republican Party platform preamble states the Party’s belief that political freedom and economic freedom are indivisible.  For decades, moreover, the Party has claimed to support free-market capitalism as the best means to promote economic prosperity and long-term rising standards of living.  Yet, the Donald Trump presidency’s adherence to these principles was questionable at best and to a substantial extent abandoned them altogether.  One glaring example of this abandonment was then-President Trump’s trade policies based largely on implementing new tariffs as part of his “America First” program. These were followed by massive payments to American farmers to compensate for lost revenue owing to the tariffs.  All told, the Trump tariffs not only resulted in an implicit tax on American consumers and American industry, but also according to estimates of the Tax Foundation, “will reduce long-run GDP by 0.21 percent, wages by 0.14 percent, and employment by 166,000 full-time equivalent jobs.”   In addition to this example of the Trump Administration’s abandonment of free market principles, U.S. sovereign debt increased by more than $8 trillion during the former President’s term, crowding out private capital accumulation in the short term and adding significant tax burdens on future generations.  This increase in debt came about notwithstanding Trump’s 2016 campaign promise to eliminate the debt during his first four-year term.

In view of this recent history, should Donald Trump become president again, it is reasonable to expect that his second Administration will adhere to free market principles no more than his first Administration.  For those, then, who are distressed by this prospect, the non-Trump 2024 Republican presidential candidates provide the best hope for a nominee who is committed to the stated beliefs of the Party’s platform and who, if elected, can be expected to not only limit further federal government intrusion into the economy but also who will advocate the deracination of existing entanglement of economy and state.

Unfortunately, the three televised non-Trump candidate debates that have taken place thus far have revealed little of any individual candidate’s firmness and depth of his or her commitment to free markets.  The number of candidates participating in the first two debates and the quality of the questions posed to them left little opportunity for any candidate to be clear and specific about his or her economic views, and the third debate, although more orderly, reasonably focused on foreign policy issues given the current turmoil in the Middle East and Ukraine and also China’s recent threats to stability in the South China Sea region.  A few questions were posed about the size and potential dangers of the U.S. debt and whether and how candidates might tweak entitlement programs, but these were at such a general level that little could be learned about any candidate’s analytical framework for how economic and regulatory policy would be formulated were he or she elected.

The next debate of the non-Trump candidates is scheduled for December 6.  This would be a good opportunity to shift the focus of the debate to questions about the candidates’ positions on specific economic issues.  In this regard, I offer here some suggested topic areas and questions that I would urge the debate moderators to consider posing to the candidates.  I believe these questions would go a long way toward discovering a candidate’s fidelity to the Republican Party’s long time claimed beliefs and his or her true commitment to free market capitalism.

Ethanol Mandates:

Among other things, the Energy Policy Act, enacted in 2005 under President G.W. Bush, required that a certain percentage of renewable fuel – namely corn-based ethanol – be added to the U.S. gasoline supply.  As most consumers know, it is today difficult to fill up the tank with anything but some ethanol blended gasoline, typically a 10% blend.  It is doubtful that this blended product would exist in a free market, and thus it distorts prices and resource allocation, diverting farm land to corn from other crops that otherwise would have been produced in a free market.  Moreover, except for corn producers, it is anything but clear what the benefits of the mandate are for the broader population.  Owing to extra costs to refiners, ethanol blended gasoline increases pump prices and, as experiments have shown, mileage per gallon is reduced, a double whammy for drivers.  Furthermore, a recent study published by the National Academy of Sciences concludes that the alleged reduction in greenhouse gas – namely carbon emissions – that ethanol blended gasoline generates is non-existent when one accounts for land-use conversions and ethanol processing.  In fact, the ethanol mandates may, on net, produce more greenhouse gases than refining and burning gasoline alone.  So, aside from corn growers and ethanol producers, it is difficult to identify any net social benefit resulting from this subversion of free markets.

With this background and with the Iowa caucuses just around the corner, an excellent test of the presidential candidates’ fidelity to free market principles would be for the December 6 debate moderators to probe each candidate’s position on ethanol mandates.  Would the candidate, if elected, seek to repeal the legislation authorizing the mandates?

The Export/Import Bank:

The Ex/Im Bank is primarily in the business of shifting credit risk from foreign buyers of American products to American taxpayers.  In so doing, it also promotes the use of U.S. scarce resources for the benefit of foreign consumers.  Also known sarcastically as the Bank of Boeing because Boeing’s foreign customers are some of the major beneficiaries of the Bank’s programs, the Ex/Im Bank is a clear example of corporate welfare, and its existence is a clear departure from free market principles.

Boeing has a large presence in South Carolina where it produces the 787 Dreamliner in North Charleston.  For this reason, I would urge the December 6 debate moderators to ask former South Carolina governor Nikki Haley, in particular, if she, on the basis of her support for free markets and the long-standing official Republican Party advocacy of limited government intervention into markets, would, if elected, work to shut down the Ex/Im Bank.  Of course, the question should be posed to the other candidates as well.

The USDA’s Sugar Program:

A Government Accounting Office report estimates that the U.S. sugar program administered by the Department of Agriculture costs American consumers somewhere between 2.5 and 3.5 billion dollars because of higher prices relative to the rest of the world.  The principal beneficiaries of the program are the U.S. sugar growers and refiners, but the dollar amounts of their benefits are significantly less than the costs to consumers.  Thus, the distortionary effects are a net loss to social welfare. 

The sugar program generates these distortionary effects by means of price supports, import quotas, and marketing allotments, all of which function to subvert a free market in sugar production.  Like the Ex/Im Bank, the sugar program is a costly form of corporate welfare, this one grounded in pure protectionism. 

Many of the major corporate welfare beneficiaries of the sugar program are domiciled in Florida.  For this reason, I would urge the December 6 debate moderators to ask Florida Governor Ron DeSantis, in particular, whether, as someone committed to free market capitalism, he would seek to eliminate the program were he elected president.  Naturally, the question should be posed to the other candidates as well.

The Federal Minimum Wage:

Economics teaches that minimum wage laws produce the opposite of proponents’ desired results.  Among other adverse consequences, these laws create short-term unemployment by making it illegal for employers to hire workers whose productivity does not generate sufficient revenue to pay the minimum wage and long-term unemployment by encouraging more substitution of capital for labor than otherwise would occur absent the distortionary effect of the minimum wage.  Typically, younger low skilled workers bear the burden – in the form of unemployment – of minimum wage laws.  Small businesses too, however, bear a significant share of the burden in the form of higher adjustment costs, and in worst cases, inability to survive.

The December 6 debate moderators should ask each candidate whether he or she will work to repeal federal minimum wage legislation if elected president. 

Federal Labor Laws and National Labor Relations Board Rules:

The recent labor strike action in the U.S. automobile industry highlighted the significant economic and political power of big unions.  The economic power was manifested by the ability to shut down much of the industry’s production, and the political power was evident in the United Auto Worker’s capture of key Democratic politicians, most particularly President Biden who made no secret of his support of the union in the dispute.  Such economic power generates not only short-term production losses and lower current GDP, but also distorts employment opportunities.  Like the minimum wage, union wage contracts that result in wages above the market wage foreclose employment to less productive workers and, over the longer term, encourage the substitution of capital for labor beyond what otherwise would have occurred.  In the worst case, given world markets and the competitive environment in those markets, labor unions holding substantial economic power can threaten the long-term survival of an industry, thus extinguishing all jobs.

As a test of their commitment to free market principles, the December 6 debate moderators should ask each candidate how he or she assess the impact of federal labor laws and NLRB rules that privilege unions on the efficiency of the overall economy and on the well-being of low income households.  If elected president, would he or she commit to appointing free market oriented persons to the NLRB?  How would he or she work to make labor laws better promote fluid labor markets?

The Federal Reserve and Monetary Policy:

We have experienced over the past year and a half the highest rate of price inflation in 40 years.  Notwithstanding some supply-side bottlenecks owing to the pandemic, covid spending programs and massive accommodation by the Fed to that spending facilitated this inflation tax on Americans.  Even before covid, however, for more than a decade the Fed pursued an easy money policy accompanied by artificially low interest rates and multiple episodes of quantitative easing designed to manipulate the term structure of interest rates.  Interest rates are the most important prices in the economy in that they serve to coordinate future expectations with the present and thus affect the allocation of capital. 

One result of this long era of monetary accommodation is the proliferation of so-called zombie companies which survive largely on the basis of low interest financing.  Now that the Fed has raised interest rates, a major shakeout of these zombie companies with accompanying unemployment can be expected if the higher interest rate environment persists.   Another result of the Fed’s actions over the past decade is that it is now technically insolvent with a negative cash flow.  Most telling of the Fed’s success since its 1913 founding is the fact that the price level increased by over 2300% and the dollar’s value fell by over 95%  over the first 100 years under its watch.  This is not a record of good stewardship of the dollar, and Americans have borne a substantial cost as a result.

Given the Fed’s historical record and its policy failures, the December 6 debate moderators should ask each candidate for his or her position on the efficacy of monetary central planning and the Fed’s power to control interest rates.  Does the candidate believe a central bank with these powers is consistent with a free market economy?  Would the candidate favor an alternative monetary system such as some form of gold standard or neutral currency board?  If so, would the candidate commit to working toward that end if elected president?  Similar to what candidate Trump did in 2016 with respect to prospective Supreme Court nominees, would the candidate publically submit a short list of people from whom the candidate would choose nominees to fill vacancies on the Fed’s Board of Governors?

Income Taxes:

A candidate’s position on taxes will reveal much about his or her commitment to limited government intrusion into the economy.  A number of questions might be posed by the December 6 debate moderators.  I would begin by asking whether it is proper to use federal income tax provisions as instruments to advance social goals and industrial policies.  These might include, for example, tax incentives to purchase and install solar panels in one’s home or tax credits and subsidies to certain industries that incentivize activities thought desirable by government.  By contrast, does the candidate believe that that income tax collection should be solely for the purpose of funding legitimate federal government functions and services?  If so, would the candidate commit to working toward reforming the tax system to this end by seeking legislation that would neutralize the tax code in all respects and make it solely a revenue source?  At a more basic level, does the candidate favor progressivity in the income tax code?   What is each candidate’s position on a flat tax?

Fiscal Policy:

The Full Employment Act of 1946 codified a federal responsibility to stabilize the economy and promote full employment.  It made fiscal policy – tax and spending to smooth out business cycles – an official federal government function.  Ever since, the efficacy of fiscal policy has been questionable.  Among other problems, tax and spending legislation aimed at altering macroeconomic conditions often takes substantial time to implement.  The legislation must be offered, debated, amended to reach a majority in both houses of Congress, passed, and signed by the president.  In an ever changing and mostly self-correcting dynamic economy, lags in the implementation of fiscal policy can result in more harm than good.  If the economy has already largely recovered from a recession, a sudden infusion of federal spending accompanied by lower taxes may overheat the economy and restart the cycle.

A fundamental question for the candidates is whether, in their view, fiscal fine-tuning is consistent with free market capitalism.  Is it a legitimate role of government to manage the macro-economy by means of taxing and spending, especially given the practical problems of doing so successfully?  Would any candidate favor repeal of the Full Employment Act? 

Entitlements:

As noted, in the previous debates, some of the candidates were asked about various forms of tweaking Social Security and Medicare.  According to some estimates, the present value of the cost of the unfunded promises of these two programs now stands at more than $160 trillion.  Plainly, the programs are unsustainable in their present form.  Mere tweaking of the programs will not likely save them.

I would urge the December 6 debate moderators to ask each candidate whether he or she has considered approaches to providing old age income floors and medical benefits that better rely on free market principles.  If so, would they be prepared, if elected, to offer legislation that would jettison the present programs – no doubt in the face of substantial political opposition – and replace these programs with a market oriented system?  What would be the essential features of the market oriented system?

Green Energy Industrial Policies:

The Biden Administration, by means of the so-called Inflation Reduction Act, has supercharged industrial policy with subsidies and tax breaks for favored industries and favored production activities, all in the cause of promoting a green economy that reduces human impact on the environment.  Industrial policy inherently diverts resources from uses that the free market otherwise would have directed them. 

Questions for the candidates should include whether they, if elected, would continue these industrial policies.  If not, are there free market oriented approaches better suited to achieve environmental objectives?  What would be the key elements of these approaches?  Would the candidates be prepared to jeopardize the survival of businesses that depend heavily on tax credits and subsidies such as makers and developers of EVs? 

Trade:

As Adam Smith taught us, trade expands the benefits of the division of labor across national borders.  In so doing, it increases the size of the consumption pie for all parties engaged in trade.  Moreover, a nation benefits from free trade even when trading partners impose trade restrictions.  That is, unilateral free trade is superior to retaliatory measures.

In light of this teaching and setting aside limited export controls respecting goods with national security implications, the December 6 debate moderators should ask each candidate whether he or she sees any positive national purpose for tariffs, quotas, or other programs that restrict voluntary trade between Americans and foreigners.  If elected president, would he or she seek legislation that would reduce or eliminated U.S. tariffs and quotas even if trading partners did not follow suit?

Regulatory Reform:

According to one study, complying with federal regulations cost businesses over $3 trillion in 2022.  No doubt some of these regulations are necessary and generate sufficient positive benefits to justify their cost.  Complying with many, however, just as certainly costs more than the benefits that they provide.  In these cases, the economy is burdened with less real output and slower growth.  Production possibilities shrink, and GDP is less than it otherwise would be.

Each candidate should be asked how he or she, if elected, will implement serious regulatory reform in order to lessen unnecessary burdens on private productive activities.  What specific federal regulations would be on each candidate’s priority list for elimination or reform?

The Federal Debt:

The national debt now amounts to over $33 trillion of which about $26 trillion is held by the public.  During the previous debates, some of the candidates identified the debt as a serious problem facing the country, but spoke to the problem only in generalities.  The December 6 debate will provide an opportunity to ask the candidates to give specifics as to how they would attack the problem.  The moderators should pin down the candidates on these specifics.  The moderators might ask each candidate to state the percentage of annual GDP at which the debt would no longer be a serious problem in his or her view and why that percentage.  What would each do to reach this percentage, and how long would it take?  Could private sector economic growth over time be sufficient to achieve this goal?  How fast would growth have to occur relative to any continued deficit spending to achieve the lower desired debt to GDP ratio in an acceptable time frame?  Would outright reductions in the debt by means of taxes and retirement of government bonds also be required?  As president, how would you make sure that any increase in taxes to reduce the debt does not hinder capital accumulation and economic growth?

Summing Up:

Of course, it is not realistic to expect any political candidate, nor a political party for that matter, invariably to adhere to professed principles.  In politics, expediency trumps principle, and this condition applies to the group of non-Trump candidates who will debate on December 6 as much as to any other group of politicians.  Nonetheless, for those voters who share a belief in the instrumental as well as moral value of free markets, I believe that posing the questions I set out above to the candidates will provide a meaningful test of each candidate’s basic, if not complete, commitment to limited governmental intrusion into private markets.  No one candidate will be a god-send in this regard, but the exercise should reveal differences among them that voters can find useful.  In any case, I offer these suggested questions to the December 6 debate moderators in the hope that they will consider them.

The ‘Worst U.S. President’ Who Wasn’t

Theodore A. Gebhard

In a Wall Street Journal piece published on June 24 (print edition), longtime journalist and essayist Lance Morrow compares today’s turbulent times with earlier episodes in American history. He notes that what we are experiencing today is hardly new or exceptional. He ends his piece, however, with lumping in Warren Harding with James Buchanan and Andrew Johnson, describing them as our worst presidents.

In my view, however, Harding has much to his credit and hardly ranks among our worst presidents. To add my perspective to the discussion, I submitted a Letter to Editor, which the Journal published on July 7 (print edition) and can be accessed here. To keep within word count limits, the Journal shortened the letter. I reproduce the original directly below.

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In an otherwise fine piece comparing and contrasting today’s turbulent times with earlier episodes in American history, Lance Morrow joins a long-standing tradition of naming Warren Harding along with James Buchanan and Andrew Johnson as our worst presidents.  (“Could This Be an Antebellum Age?”  06/24/2022 at A-19.)  Few would dispute that the two presidents bookending Abraham Lincoln were among our worst, but lumping in Harding with Buchanan and Johnson borders on slander.  As documented by James Grant in his marvelous book, The Forgotten Depression of 1921, Harding came into office in the midst of a post-WWI recession beginning in 1920 and quickly turning into a depression in early 1921, with the stock market eventually falling by nearly 50% and concomitant collapsing wages, profits, and employment.  Rejecting a mindset of interventionism (“we have to do something”), Harding held to the now long-jettisoned principle of separation of economy and state.  The facts speak for themselves.  Free-market prices and wages adjusted, and recovery was already underway by the middle of 1921, only 18 months after the downturn started.  A near decade of prosperity followed.  Would that we had more “worst” presidents like Warren Harding.

Theodore A. Gebhard

Memo to American Youth from the Treasury Secretary (Parody)

Theodore A. Gebhard

United States Treasury

July 4, 2021

Memo to: American Youth

From:      Janet Yellen, United States Secretary of the Treasury

Subject:  Facts of Life

Each of you is now old enough to appreciate certain facts of life. Therefore, in the interest of transparency, I am writing on this 4th of July to inform you of debt obligations you will face upon reaching maturity at the age of eighteen. In particular, at eighteen, each of you will receive an invoice from me or my successors for lifetime repayment in the approximate amount of $400,000. This amount represents the share of U.S. Government debt that is being assessed to everyone presently under the age of eighteen. The amount likely will be larger for the younger of you. Please note that this figure reflects the fact that your grandparents and parents have decided, through their elected representatives, not to receive invoices of their own. Consequently, the entirety of the debt obligation shall fall on your generation, which currently comprises 22% of the U.S. population.

Please also be informed that when you begin your productive years, all of the fruits of your productivity shall belong to the U.S. Treasury. Be assured, however, that I or my successors will always permit you to retain a varying percentage of your income for your personal use. Moreover, for the least productive of you, we will provide free of charge a number of benefits and services that we have determined are good for you.

We have also determined that, to control the Treasury’s debt service costs, it will be necessary that the purchasing power of the income you are permitted to retain, as well as any savings you might accumulate, decline year over year throughout your life. Therefore, you can expect to see your standard of living stagnate or possibly even fall as you grow older. 

Finally, as U.S. Treasury Secretary, I speak only to your federal obligations. You should be aware that you are also likely to receive similar notices from the state and local governments in whose jurisdictions you reside.

In closing, let me take this opportunity to wish you the brightest of futures as you approach adulthood in America.

J.Y. 

The GOP Must Articulate and Sell a Better Vision

Theodore A. Gebhard

In a Wall Street Journal op-ed, former Treasury Secretary and Secretary of State James Baker III says that Republican electoral success in 2022 and 2024 will be enhanced if candidates focus on the core conservative principles of fiscal responsibility and economic growth.  (Focus on Principle, Not Personality, for a Bright GOP Future, 6/7/2021) I concur. Nonetheless, I believe Mr. Baker left out at least one very important economic principle that should be a part of conservative and Republican advocacy. That principle is sound money.

To add my view to the discussion, I submitted a Letter to the Editor, which the Journal published today (June 12, print edition). (“GOP Must Articulate and Sell a Better Vision”) To fit within word count limits, the Journal shortened my submission. I reproduce the unshortened version directly below.

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Former Secretary of State James Baker is correct when he states that the key to Republican success in 2022 and 2024 is to focus on core conservative economic principles such as fiscal responsibility and policies promoting economic growth.  (Focus on Principle, Not Personality, for a Bright GOP Future, 6/7/2021)  I would add another conservative economic principle that regrettably has been neglected too long by Republicans but would also resonate with voters, sound money.  Especially as fear of inflation grows and likely materializes before the next election, advocacy of sound money will be a winning issue.  In 1978 Congress gave the Fed a duel mandate, price stability and full employment, but left it up to the Fed to define the contours of those goals.  Since that time, inflation has averaged 3.33% a year, and the purchasing power of today’s dollar is only 24% of the 1978 dollar (based on BLS statistics).  In addition, since 2012 the Fed has targeted an annual inflation rate of 2% — though because it has been unsuccessful in this effort, now desires to run inflation above 2% in order to make up for lost ground.  All of this Fed-defined “price stability” is grounded in the dubious theory that inflation spurs spending, which leads to a growing nominal GDP, which in turn encourages employment.  The Fed also asserts that inflation gives it more interest rate wiggle room to fight downturns.

I have little doubt that, were it possible to poll Americans, they would overwhelmingly reject having the purchasing power of their income and savings diminished by deliberate policy, a policy that furthermore undercuts the conservative value of personal fiscal prudence.  Republican candidates should aggressively make sound money a campaign issue.  This does not mean running on a platform to politicize the Fed, nor should it.  Candidates need only advocate that Congress update the 1978 legislation with a more precise definition of price stability, specifically one that conforms with the common sense meaning of the term.  Adding sound money to Secretary Baker’s list of economic principles will be a winning move.

Theodore A. Gebhard

Ignoring Microeconomic Conditions in Monetary Policy Risks Perpetual Failure

Theodore A. Gebhard

In a Wall Street Journal op-ed today, Hoover Institution Senior Fellow John H. Cochrane expresses his concern over the fact that some of President Trump’s potential nominees to the Fed’s Board of Governors have shown sympathy for a monetary system grounded in a gold standard. (John H. Cochrane, “Forget the Gold Standard and Make the Dollar Stable Again,” 1/18/2019) He argues that historical evidence shows that the gold standard the U.S. once had did not live up to the claims that current proponents of a return to such a monetary system make. He says that the evidence is that the gold standard prevented neither inflation nor deflation. Because of this history, Mr. Cochrane proposes a “CPI standard” as a rules-based means to determine monetary policy. Under this standard, the Fed would keep the CPI closely in line with a particular (and constant) value. He asserts that such a standard would be an improvement over the Fed’s current no-rules discretionary decision-making.

In my view, however, even if there were an improvement, it would be at best marginal and could result in undesirable outcomes under certain circumstances. The reason is because Mr. Cochrane’s proposal suffers from the same flaw that characterizes the rest of macroeconomics, namely a focus on aggregates and averages.  Such a focus neglects the significance of the underlying microeconomic variables that determine the path and composition of economic activity, including actual prices in individual markets.  So, for example, should significant productivity gains owing to technological advances or capital improvements take place across all economic sectors, the general price level should fall.  Such price deflation is neither a consequence of slowing economic activity nor indicative of the need for a policy response.  Yet, under the CPI standard unnecessary price inflation would have to occur to maintain the stability of the index.  An even worse scenario would occur if productivity gains are not spread evenly but instead are specific to certain of the index’s components.  In this situation, policies to keep the index stable risk inflating prices to bubble levels in those sectors for which there has been little or no productivity improvement in underlying microeconomic markets.  Moreover, relative prices would likely be distorted to the detriment of economy-wide allocative efficiency.  Perhaps, as Mr. Cochrane argues, returning to some form of gold standard is not workable under 21st Century conditions, but replacing discretionary policy with a CPI standard would also have its problems. 

Peter Navarro Is Wrong Still Again

Theodore A. Gebhard

Once again President Trump’s trade adviser displays his lack of understanding of how nations gain from trade. In an op-ed in today’s Wall Street Journal, Mr. Navarro contends that China’s trade practices victimize the U.S. (“China’s Faux Comparative Advantage,” 4/16/18) In doing so, he makes two errors. First, he is wrong to suggest that trade with China that diverts from the “textbook” model of comparative advantage always generates harm to the U.S.  To be sure, ever since David Ricardo described comparative advantage in terms of relative resource and knowhow endowments, that example has been a staple of textbook discussions of how trade can produce gains.  The gains arise because comparative advantage permits both sides to conserve resources.  Those saved resources can then be deployed in other productive activities, thus increasing national wealth.  This result holds even when one trading partner subsidizes its exports, gives tax preferences to its exporters, or “dumps” goods by selling overseas at a lower price than at home.  Such policies, though harming citizens and taxpayers in the exporting country, conserve resources in the importing country and benefit consumers with lower prices.  Letting Chinese citizens and taxpayers subsidize U.S. steel consumption, for example, means that resources that the U.S. would otherwise have to deploy to making steel can now be deployed elsewhere, i.e., we get cheaper steel and other stuff instead of just steel.  That the Chinese government chooses to harm its own citizens is no reason for the U.S. to retaliate by doing the same to its citizens.

The second error that Mr. Navarro makes is conflating such activities as cyberespionage and intellectual property theft with export subsidies and tax preferences.  Stealing property, whether tangible or intangible, is categorically wrong, and Mr. Navarro is right to call out such illicit activities.  The error lies in failing to distinguish between these harmful Chinese practices and practices that are beneficial to the U.S.  The former of course should be targeted for reprobation and fully proscribed.  The latter should be left alone.  Regrettably, the Trump Administration’s recent trade initiatives toward China, which Mr. Navarro helped to formulate, aim indiscriminately at both the good and the bad.   

Why Not a Stable Dollar?

Theodore A. Gebhard

In a “Letter to the Editor” in today’s Wall Street Journal, Michael Bird comments on the Fed’s 2% inflation target and on the long term effects on the purchasing power of American’s income. Mr. Bird is correct in his observations. Adding two more points to those observations, however, I submitted the following to the Journal as a follow up letter. I would also recommend that the reader see my longer piece on the Fed’s “Inflation Tax” here.

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To letter-writer Michael Bird’s observations about the Fed’s Orwellian definition of stable prices as 2% inflation and its long term effects on the purchasing power of the dollar, I would add two points. (“Fed’s Sole Policy Should Be a Stable Dollar,” 3/18/2017)  First, there is nothing in economic theory that generates the 2% inflation number as opposed to, say, 0% or 1% or 3%.  It is purely an arbitrary choice based on the idea that it is good to have an inflation rate above zero to incentivize spending and discourage saving, a policy goal of  questionable merit.  Second, designed inflation operates as a tax on wealth as well as a revenue generator for the government insofar as pushes people into higher tax brackets and permits the repayment of bonds with debased dollars.  Yet, Article 1, Section 7 of the Constitution assigns the taxing power solely to Congress and further requires that all revenue bills originate in the House of Representatives, the chamber most accountable to the people.  Even if not legally cognizable as a revenue bill, an inflation tax imposed by unelected central bankers plainly violates the spirit of the Framers’ constitutional framework.

Still More Trade Illiteracy from Peter Navarro

Theodore A. Gebhard

Sadly, President Trump’s instincts regarding trade wherein he believes negative trade balances to be a consequence of other countries’ ripping off the United States is reinforced by his chief trade advisor, Peter Navarro. Economists have long known this view to be specious, and acting on it in policy will only end up making Americans economically worse off. In an op-ed in today’s Wall Street Journal, Mr. Navarro rejects over 200 years of economic learning. In response, I have submitted the following to the Journal as a Letter to the Editor. (See also my earlier Posts on trade economics here and here.)

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As a former economics professor, I am disheartened to see one of Mr. Trump’s chief advisors, Peter Navarro, reject over 200 years of economic learning by speciously using GDP accounting to contend that current account imbalances should be a significant policy concern.  (“Why the White House Worries about Trade Deficits,” 3/6/2017)  Mr. Navarro contends that boosting net exports over imports boosts growth and, implicitly, the country’s economic well-being.  As many economists acknowledge, however, GDP is a poor proxy of economic well-being and, in turn, GDP growth is a poor measure of changes in a country’s wealth.  Indeed, by Mr. Navarro’s reasoning, we can increase wealth simply by enlarging government expenditures financed by fiscal deficits or money printing.

Starting with the indisputable premise that the ultimate end of economic activity is consumption, Adam Smith taught in The Wealth of Nations (1776) that a nation’s well-being is determined by the amount of final goods available to its people.  Exports thus are a cost to a nation (using up its scarce resources for foreigners’ consumption benefit) while imports a benefit (consuming out of others’ scarce resources).  Exports are the cost of paying for imports. 

A nation benefits from trade whenever it can obtain goods from abroad cheaper than it can produce those goods at home.  Obtaining goods cheaper from foreign sellers not only increases the available consumption pie (and thus a nation’s wealth), but it also frees up resources that can be deployed to expand wealth even further.  What’s more, it matters not whether the goods are cheaper because of comparative resource advantage or because other countries inflict harm on themselves by subsidizing their exports. 

Economic history has confirmed Smiths’ wisdom many times over.  One would hope that this wisdom is not entirely lost on our policy makers. 

Theodore A. Gebhard

More Economic Illiteracy on Trade

Theodore A. Gebhard

In the “Letters to the Editor” section of today’s Wall Street Journal, Felix Dupuy of Whitefish, Montana laments that the 41 million U.S. jobs supported by trade come with a $500 million trade deficit, which he claims is largely paid for by the Treasury “in the form of increased debt.” (Letters, July 27, 2016)  The assertion is a non-sequitur.  The connection between the U.S. current account deficit and the U.S. fiscal deficit is tenuous at best.  The former moreover represents neither harm to the American economy nor any debt to the Treasury.  To the contrary, the current account deficit is an indication of the greater prosperity of  the U.S. relative to the rest of the world.  Because Americans are rich, they buy more from others than others buy from them.  Also, the current account deficit does not increase the public debt.  The Treasury has nothing to do with private sector trades that happen to cross borders.  Finally, foreign sellers accept dollars for goods only because those dollars represent claims on American goods.  That the dollars are not repatriated in some arbitrary time frame (one year) is unimportant.  Ultimately, our imports must be paid for with exports when foreign dollar holders redeem their claims.  —  By contrast, the fiscal deficit is real debt arising from unpaid-for federal spending.  It is also cumulative, now standing now at a $19 trillion burden on future generations of Americans.  (See also my earlier Posts on trade economics here and here.)

Too Few Jobs: Trade Is Not the Problem, Slow Growth Is

Theodore A. Gebhard

[Note:  This post originally appeared in American Thinker magazine on May, 27, 2016.]

The irrefutable evidence of economic history over several centuries is that the wealth of societies (later nation states) significantly increases as trade expands.  Scarce resources are conserved by being able to obtain goods from others who can produce those goods more cheaply.   The conserved resources then become available to be redeployed to other productive activities, thus adding to the total stock and diversity of a society’s wealth.

Notwithstanding this overwhelming evidence, however, expansion of trade is often singled out as detrimental to a society’s well-being.  Presumptive Republican presidential nominee, Donald Trump, for example, has made the alleged “costs” of trade a centerpiece of his campaign.  Mr. Trump cites current account deficits with China and Mexico as evidence that those nations are taking advantage of the U.S. and stealing U.S. jobs.  He says that, if elected, he will use his business skills to renegotiate existing international trade agreements so as to eliminate the deficits and bring jobs back home.

Regrettably, Mr. Trump sees the conservation of resources, especially labor, as a cost instead of a benefit to be exploited to the nation’s advantage.  This view is short-sighted, and it ignores the principal reason for the lack of new employment opportunities for resources that have been freed up because of trade, a near stagnant economy.

Economic systems are highly complex. In a market-based economy, all economic variables, including policy variables, are interconnected.  If you push on one variable, every other variable shifts — some imperceptibly, others measurably.  A consequence is that focusing on a specific perceived problem in isolation nearly always leads to a failure to grasp the actual causes of the problem.  Regrettably, politicians rarely learn this lesson.  As a result, they try to “fix” a specific problem that they can see with cocooned policy that does not account for other variables either unseen or incorrectly perceived to be unrelated.  In the end, the “corrective” policy more often than not does more harm than good.

Mr. Trump’s view about the “costs” of trade suffers from this short-sightedness. It focuses solely on what is visible, the displacement of resources (e.g., jobs) in those industries most affected by trade.  Such a restricted view has great emotional appeal because structural changes owing to trade can cause severe hardship to those whose lives are disrupted, and a compassionate nation should rightly address this result (I will come back to this).  Limiting one’s focus only to what is visible, however, excludes accounting for the benefit, on a macro level, of the nation’s enhanced capacity to grow by reallocating those conserved resources to other productive activities.

In this regard, a nation is no different from an individual. Most individuals find that it is cheaper to buy groceries at a supermarket than to produce their own food.  Because it is cheaper, money is conserved that then can be spent on other items that enrich one’s life.  Similarly, a nation that buys goods from abroad at a cost less than it would incur producing those goods at home can use those savings to expand output in other areas.  Moreover, when low-priced imports are intermediate goods, the gains extend to domestic industries using those goods, thus permitting, at the macro level, positive job creation.  Implementing restrictive policies (e.g., tariffs, quotas, duties, etc.) designed to “protect” jobs from being lost to trade (the visible problem) thus suppresses a nation’s wealth potential.

What’s more, this focus on the visible misdirects attention away from doing what is necessary to ensure that the wealth-enhancing gains from trade are fully realized and that trade-related structural change does not produce lasting localized hardships.  In other words, instead of forgoing resource savings and the gains to consumers (including industrial consumers) from low-priced imports in order to “protect” jobs, would it not be better to have a rapidly expanding domestic economy characterized by continuous new job creation?  It is no coincidence, I believe, that Mr. Trump’s pronouncements about the “costs” of trade come at a time when the U.S. has experienced an historically tepid recovery following a severe recession.  Had economic growth been anywhere close to historical norms since the 2008 crisis, it is doubtful that complaints about other nations “stealing” U.S. jobs would have nearly as much currency.

So, the real question to be asked is how do we restore economic growth. This is the problem to which Mr. Trump and others should direct their attention.  Undesired resource idleness does not occur in a vibrant economy with expanding job opportunities.  The goal should be to accrue all of the gains from low-cost imports while maintaining full employment at home.

Putting the economy back on a job-creating growth path will, in turn, require addressing the several significant self-imposed interconnected impediments to that path.  These include, among others, the massive and growing overlay of federal regulations on business; leviathan government spending that saps the economy of productive resources; and a tax system that hinders capital accumulation and is laden with special interest provisions that distort allocative efficiency.

Space here does not permit a full discussion of these yokes on growth and job creation, but a few facts illustrate the magnitude of the yokes.

Regulatory Costs:

According to estimates made by the Competitive Enterprise Institute (CEI), federal regulations imposed a $1.88 trillion cost on the U.S. economy in 2014.  Those costs include direct and indirect costs on businesses and higher prices on goods and services to consumers.  CEI estimates that, all told, the costs amount to nearly $15,000 per U.S. household.  This number would of course be even higher if state and municipal regulations are added in.

Of course, not all regulations are bad. Nonetheless, a $1.88 trillion burden on the economy certainly contains substantial overreach.   In turn, each dollar of unnecessary cost on businesses reduces the output rate at which a business maximizes its profit and thus reduces its demand for labor.  Moreover, the enormous compliance burden diverts resources away from more productive uses that would otherwise expand the size of the economy, and the higher prices on final goods mean that consumers’ real income is reduced.  The end result is stunted growth and fewer jobs.

Spending and Taxes:

Federal government spending for fiscal year 2015 was $3.7 trillion.  Total government spending (including state and local government) was $6.4 trillion. At the same time, the federal government took in $3.25 trillion in tax revenue.  State and local governments took in another estimated $3.1 trillion.  Such a huge diversion of resources away from private, productive uses robs the nation of both wealth and jobs.

In addition, the inefficiencies that spending and taxing policies impose on the economy hinder growth and job creation still more.  For example, special interest tax provisions and spending programs vitiate market-determined resource allocation.   The result is distortions throughout the economy.  Further, taxes on business income, capital gains, and income from savings reduce the returns on capital and make capital less desirable to accumulate.  Less capital accumulation means slower economic expansion and less demand for labor.

Summing Up:

Low-priced imports that American buyers find cost-effective and that provide the opportunity for expanding the total national wealth are a net benefit to the U.S., not a cost.  Restrictive trade policies that focus only on the visible hardships suffered by those most affected by trade misperceive the real problem, a near stagnant economy characterized by slow growth.  In the end, such polices will not only fail to stop inexorable structural change, but make the country poorer.  Far better would be to restore a vibrant, robustly growing economy in which there is continuous job creation that ensures an abundance of new opportunities for those otherwise displaced by expanded trade.  Of course, where short-term transition assistance is needed, that assistance should be provided, but long term unemployment need not be the norm. The next president will have a fresh opportunity to refocus on growth.  A good start toward this end is serious reduction in regulatory overreach, overhauling the tax system to remove anti-growth biases, and major cuts in the amount of national income that big government consumes. — The Chinese and the Mexicans are not the problem.  The problem is us.

Paying One’s “Fair Share” of Taxes Redux

Theodore A. Gebhard

[Note:  This post is an update of an earlier one to take account of more recent developments, including President Obama’s news conference on May 6, 2016.]

In his news conference on Friday (May 6), President Obama reiterated his claim that, owing to tax loopholes, the wealthy do not pay their “fair share” of taxes, a claim he has made several times during his presidency.  Vermont Senator Bernie Sanders has made this same claim in most, if not all, of his presidential campaign speeches.  Former Secretary of State Hillary Clinton has also stated that, if elected president, she intends to institute a four percent “Fair Share Surcharge” on Americans who make more than $5 million a year.

I have always been puzzled when I hear politicians, particularly Democrats and others of the left, talking about people needing to pay their “fair share” of taxes.  What President Obama, Senator Sanders, and Mrs. Clinton mean by this idea is that those earning higher incomes owe society more in taxes than they already pay, notwithstanding that income tax rates are already progressive, i.e., marginal rates increase with income.  Rarely, however, do proponents of raising rates on high income earners say exactly what a “fair share” of taxes is or, more precisely, what the upper limit, if any, of a “fair share” of taxes is.  Even more vague is their philosophical basis, either in ethics or some other grounding, for what constitutes “fairness” in this context.

It seems to me that Obama, Sanders, Clinton, and others of similar views have the tables turned upside down.  In fact, rather good philosophical arguments can be made from both an ethics and an economics perspective that, if anything, high income earners are already paying well more than their fair share of taxes and that their absolute tax payments or marginal rates should therefore be reduced.

Taxes are the cost of financing government.  In our democracy, every qualified voter is afforded one vote, no more and no less.  Just as this political shareholding is allocated equally among citizens, it would seem intuitively fair that the burden of the cost of government should similarly be allocated equally.  That is, everyone should pay the same amount in taxes in the form of a simple per capita tax.  This way, each person contributes the same amount toward the cost of government, much like dues assessments in a club.  At the least, it would be interesting to ask President Obama, Senator Sanders, and Mrs. Clinton to explain, from an ethics standpoint, why their proposals to make taxes even more progressive, i.e., even more unequal, are fairer than an equal per capita tax.

Of course, as a practical matter, given the current size of government, an equal per capita tax would necessarily mean that many, if not most, taxpayers would owe more than they earn or have in savings and, in some cases, likely much more.  Such a tax thus would be unworkable unless government were shrunk substantially.  The cost of government would have to shrink at least to the point where the per capita tax would be affordable by each taxpayer, a goal unlikely to be shared by the political class, left or right.  Even so, the size of government and the practical ability to have fairness in the tax code would seem to be inextricably linked.

Admittedly, I am uneasy to render judgments on purely ethical grounds about whether the amount of taxes a particular taxpayer pays is fair for that taxpayer.  I do, however, claim some expertise in economic reasoning.  On that basis, I think an argument can be made that, in the alternative to a per capita tax, a regressive income tax is actually fairer than a progressive one.

The argument rests on the idea that whenever there is voluntary exchange, every transaction creates wealth.  A voluntary transaction will not take place unless each party becomes better off as a result of the transaction.  It follows therefore that, so long as high income earners obtain their income through voluntary exchange of their labor, services, or other resources, each dollar of that income is the product of a wealth-creating transaction.

Significantly, however, the high income earner does not keep all of the created wealth, but only a fraction.  The rest of the new wealth necessarily accrues to everyone else with whom the high income earner engaged in voluntary exchange, either directly or indirectly.  Thus, the higher the income of the high income earner, the greater the earner contributes to other people’s wealth.  It follows then that high income earners benefit society more than lower income earners before any taxes are taken out of those earnings.

Based on this reasoning, one possible way to measure tax fairness would be on the basis of relative additions to aggregate social wealth.  Under such a definition, people who contribute less to social wealth would be required to make up for the deficit by paying more in taxes, while those who contribute most to social wealth would be rewarded by lower taxes.  Put another way, fairness would require that high income earners be taxed less than low income earners.  The former have already made a disproportionate positive contribution to social welfare.

Of course, as with the per capita tax, a regressive income tax would require considerable downsizing of government.  Such a tax simply could not finance the current government.  Once again, the size of government and the practical ability to have tax fairness are inextricably linked.  But that practical consideration aside, a fairness argument for a regressive income tax that rests on economic reasoning, unlike the Obama, Sanders, and Clinton fairness arguments, at least has an analytical grounding.  It would be interesting to learn how they would respond to the argument.

In that regard, I will myself volunteer one necessary exception to the general conclusion.  The exception owes to the fact that many high income earners today derive their high incomes not from contributing to aggregate wealth but rather by using the machinery of government to expropriate the wealth created by others.  Rent seeking can be very lucrative.  Thus, if “paying one’s fair share” in taxes is inversely related to one’s contribution to social wealth, these high income rent seekers should be taxed at a 100% marginal rate.  Given that the Democratic left has its own set of favored rent seekers, however, I am not sure that Obama, Sanders, and Clinton could even agree to this exception.

To be sure, I write all of the above with a considerable amount of tongue in cheek.  I stand by the larger point, however, that tax “fairness” is hardly a known parameter, and that one can construct ethical and/or syllogistic arguments leading to completely opposite conclusions as to what is fair.  In view of this conundrum, it seems to me that we all would be better served if politicians and policy makers purged “fairness” from their thinking (and speeches) and simply focused on a tax system that finances essential government functions in the most efficient manner possible and impedes economic vitality and long-term growth as little as possible.  I suspect that, in a prosperous and growing economy, questions of “fairness” will lose much of their political cachet and recede to the academic lounges where they belong.

Demagoguery and the Minimum Wage

Theodore A. Gebhard

[This post was originally published by American Thinker magazine on April 2, 2016.]

On Monday (Mar. 28) California Governor Jerry Brown announced that he would sign a bill to raise the state’s minimum wage to $15/hr.  The increase from the current minimum of $10/hr. would be fully completed by 2022.  Last year, New York passed legislation raising the minimum wage for fast food workers to $15/hr.  At the local level, the city of Seattle has mandated a minimum wage of $15/hr. to be fully phased in by 2021.  In the presidential campaign, Hillary Clinton and Bernie Sanders have proposed raising the federal minimum wage from $7.25 to $12/hr. and to $15/hr. respectively.

Particularly among politicians of the left, raising the minimum wage has long been a staple as a campaign talking point.  Mrs. Clinton and Senator Sanders claim, for example, that raising the wage floor is necessary to help people to move into the middle class.  The argument rests on the idea that if incomes are too low for some people to reach the middle class, a law mandating higher incomes is justified.  Certainly, the argument has strong emotional appeal.  Regrettably, it is also subject to significant demagoguery.

As economists have taught for generations, price controls (wages are prices) never achieve their intended ends.  Simply put, there are irrefutable laws of economics that cannot be repealed by political action.  Demagoguery and emotional appeal may produce short-term political advantage, but ultimately claims based on unsound economics must disappoint those who put faith into those claims.  Minimum wage laws are an exemplar of political action that cannot live up to its claims.

A fundamental law of economics is the law of demand, which states that as the price of something rises, the quantity purchased decreases in a given time period, and vice versa.   The law rests on the fact that, in the real world, resources are scarce, and thus the process of satisfying human wants requires making choices among alternative uses of those scarce resources.  Relative prices determined in free markets facilitate this process by permitting persons to make spending decisions according to the incremental value they obtain per extra dollar spent on a good or service.  The lower the price, the higher is that ratio.  The higher the price, the less is the ratio.  Hence, if the price of something goes up – thus reducing the value per dollar spent – less will be purchased as substitutes become a better bargain.

Artificially controlling specific prices distorts this process and creates inefficiency in resource allocation, as relative prices no longer fully reflect market forces.  Wages are prices.  Hence, if wages for unskilled labor are artificially set above the market wage by means of legislation, less unskilled labor will necessarily be purchased per period of time.  Moreover, the structure of wages throughout labor markets – skilled as well as unskilled – will be distorted, and economic efficiency will be compromised.  These outcomes are givens, and economists have known about them for a long time.

Why then do minimum wage laws persist?  Are not the harmful effects sufficient for voters to reject politicians who push these laws?  The answer, I believe, is that, although the harmful effects are real, they are generally not immediately visible, while the superficial, demagogic appeal of minimum wages is easy to articulate.  For example, both Mrs. Clinton and Senator Sanders claim that raising the minimum wage will help to elevate people – particularly unskilled workers — into the middle class. Senator Sanders further claims that raising the minimum wage will have a desirable redistributive effect that will lessen income inequality.

Neither of these contentions, however, lives up to its full billing.  As for elevating lower income people permanently into the middle class, minimum wage laws are highly inefficient because they focus on symptoms and ignore causes.  In this regard, vast amounts of evidence indicate that rising incomes are best achieved by education, stable families, and cultural factors such as personal discipline and a strong work ethic.  Entry level jobs – even at low wages – help to foster the personal characteristics, especially among young people new to the workforce, necessary to succeed in a work environment and eventually advance into higher paying positions with greater responsibility.  Minimum wage laws that price these persons out of the labor market remove the opportunity to develop these traits.  In addition, in few households is the primary income earner a minimum wage worker. Hence, even for households where jobs are retained, raising the minimum wage will have little impact on household income.  A far better emphasis for public policy directed toward building the middle class would be on augmenting incentives for skills acquisition and maintaining stable families.

Raising the minimum wage is a similarly inefficient means to address income inequality. This is not controversial among economists.  Any income redistribution that raising the minimum wage achieves is likely temporary, as employers adjust to the higher wage rate over time by substituting to other inputs such as labor-saving technology.  In addition, the higher wage rate only raises the income of those who continue to keep their jobs.  For workers who, at the margin, lose their jobs, income falls to zero.  And, finally, the redistribution comes at the expense of distorting relative prices, which can be considerable depending on the size of the wage hike.  There are far better ways to achieve income redistribution (assuming that’s the goal) such as simple cash payouts or a negative income tax.  Either of these measures ensures that the incomes of the entire targeted group increase, and both mitigate against compromising efficiency because of price distortion.

Regrettably, demagoguery on the minimum wage is not limited to political candidates seeking electoral advantage. Minimum wage laws also receive strong support from organized labor under the guise of helping out all workers.  The California legislation, for example, was backed strongly by unions.  At first glance, such support would seem odd as union jobs, after all, are typically at hourly wages much higher than the minimum wage.  Even so, there are at least two reasons why unions can be counted on to advocate for higher minimum wages.  First, many union contracts contain clauses that structure union wages relative to the minimum wage.  That is, the union pay scale is set, in relative terms, to be some percentage above the lowest pay scale.  Hence, when minimum wages are hiked, the union pay scale is similarly adjusted upwards.  Second, even aside from contract terms, it is in the interest of skilled union workers to have the wage rates of unskilled workers continually increase.  The higher the wage of the unskilled worker, the less that worker competes for the same job as the more productive skilled worker.  In the end, despite contrary rhetoric, both of these factors work against greater employment of unskilled workers.  Once again, legislated wage floors produce perverse consequences for those intended to be helped.

To sum up, higher minimum wages cannot be justified in sound economics. Fundamental economic laws simply cannot be overridden by political action.  Unskilled labor in California, New York, and Seattle will, in the end, suffer the most from the economic demagoguery of their elected officials.  Moreover, if Mrs. Clinton or Senator Sanders succeeds in raising the federal minimum wage, the perverse consequences will be spread across the nation.  This result would be unfortunate because it need not be so.

Indeed, higher real wages for all workers (unskilled as well as skilled) and permanent rises in standards of living have been the historical norm in the U.S. The drivers of this experience have been ever-increasing labor productivity and an expanding economy in which competition for labor services remains intense.  The proven recipe to those ends is a vibrant and growing free-market private sector incentivized by low taxes and minimal regulation, and a culture that encourages skills enhancement and personal responsibility.  Demagoguery over the minimum wage is no substitute.

The Basic Point of Trade

Theodore A. Gebhard

Today in his weekly Wall Street Journal column, William Galston says that trade has not lived up to its promise because it has cost the U.S. too many jobs. (“Why Trade Critics Are Getting Traction, Mar. 30, 2016″)  Someone should give Mr. Galston a copy of Adam Smith’s Wealth of Nations as quickly as possible.  In equating U.S. jobs with the nation’s economic well-being, Mr. Galston ignores Smith’s key insight.  Smith taught that a nation’s wealth is measured not by its store of gold, its exports, or the number of jobs it has, but rather by the quantity of goods and services available for consumption by its populace.  Smith makes the point that the ultimate purpose of all economic activity is to satisfy human wants and needs.  Work and production are means to that end, but not ends in themselves.  In a world in which resources are scarce, employment of labor and other factors of production is the cost that a nation incurs in order to consume.  Hence, if a nation can reduce the employment of any resource, including labor, required to yield a given output, those freed up resources can then be used to produce even more goods, thus making the nation wealthier.  Simply put, a wealthy man is someone who can live well while working less; a nation is no different. Mr. Galston, like too many others in this political year, fails to grasp this basic economic point. (See also my earlier Posts on trade economics here and here.)

Donald Trump v. Adam Smith

Theodore A. Gebhard

[This post originally appeared in American Thinker magazine on March 1, 2016]

In the 1980s Reagan Republicans were fond of wearing Adam Smith neckties.  (I personally still have two hanging in my closet that hail from that era.)   Adam Smith, of course, was the 18th Century Scotsman who wrote An Inquiry into the Nature and Causes of the Wealth of Nations, a book considered by many to be the founding work of modern economics.  Wearing the Adam Smith neckties was intended to display fidelity to Smith’s ideas and, in particular, fidelity to free markets and free trade.

One does not see many Republicans wearing these neckties anymore.  Perhaps this loss of ubiquity is to the good, considering how far removed the Party’s front runner in the presidential race, Donald Trump, is from the free market ideas of Smith.  For example, in response to the announcement earlier this month by the air conditioning products manufacturer, Carrier Corporation, that it would be closing a U.S. production facility and relocating to Monterrey, Mexico, Mr. Trump stated on Sean Hannity’s Fox News Channel program that, if elected, he would impose a 35% tariff on Carrier products re-entering the United States.  In the same vein, Mr. Trump made a similar threat last year with regard to Ford Motor’s announcement that it will double its Mexican-based production capacity.  Mr. Trump asserts that the threat of high re-entry tariffs is necessary to discourage these and other American companies from seeking lower-cost production outside of the United States.

Mr. Trump also claims that the Chinese government engages in unfair trade practices by intentionally devaluing the yuan in order to impose a de facto tariff on all imported goods from the U.S., which he says is “costing millions of American jobs.”   He says that, unlike the “stupid politicians” in Washington, he will use his superior deal-making skills to stop this job loss by negotiating a U.S.-friendly trade agreement with China.  While those negotiations are taking place and to encourage the Chinese to come to the table, he will designate China a “currency manipulator” on day one of his presidency and impose countervailing duties on “cheap Chinese imports.”

Adam Smith would be alarmed by Mr. Trump’s retaliatory threats. The central thesis of The Wealth of Nations is that a nation’s economic well-being is measured not by its store of gold or currency, the amount of goods it exports, or the number of jobs that exist within its borders, but rather by the quantity of goods and services available for consumption by its populace.  Smith makes the point that the ultimate purpose of all economic activity is to satisfy human wants and needs.  The reason that economic activity takes place is so that people can consume.  Work and production are means to that end, but not ends in themselves.  In a world in which resources are scarce, employment of labor and other factors of production is the cost that a nation incurs in order to consume.

Thought of in this way, it becomes clear that if a nation can reduce the employment of any resource, including labor, required to yield a given rate of output of consumer goods, those freed up resources can then be used to produce even more goods, thus making the nation wealthier.  Such a result can come about because of several reasons, including the discovery and adoption of new technology that raises resource productivity, trade that derives from comparative advantage, and the free flow of capital to those uses and locations where it is employed most efficiently.

Thus, for example, American wealth stands to gain when Carrier can produce air conditioners at lower cost in Mexico and Ford can do the same with cars.  The gain comes about in two ways.  First, absent re-entry tariffs, as Mr. Trump proposes, more air conditioners and cars can be made available to American consumers at a lower price.  Second, the resources freed up in the U.S. become available for other output-expanding uses.

Trade also increases the wealth of nations by permitting them to take advantage of each other’s relative productive efficiencies.  So, for example, a nation’s wealth grows whenever it purchases goods from those nations that supply them most cheaply.  Hence, notwithstanding Mr. Trump’s outrage at “cheap Chinese imports,” American consumers are better off because of those imports.  By their own actions, consumers have revealed that they prefer spending their dollars on the Chinese goods to spending the dollars on anything else.  In addition, because the U.S. does not have to use up scarce resources to produce these goods, those resources are available to produce other goods that otherwise could not be produced.  Instead of harming the U.S., the “cheap Chinese imports” generate an increase in American wealth.

But what about the trade deficit that is created by importing all of these goods from China?  Isn’t Mr. Trump’s alarm justified on this ground?  The answer is “no.”

Of critical importance here is the fact that the dollars obtained by the Chinese sellers have value only because they represent a claim on American-produced goods and services. Because in the modern global economy, exchange does not take place by barter of goods for goods but by goods for currency, final settlements need not, and rarely do, occur instantly.  Rather, they take place over time, often many years.  Ultimately, however, the dollars in Chinese hands will find their way back to the U.S., either directly or through multinational trade, to be redeemed for real goods and services.

What Mr. Trump fails to grasp is that voluntary trade is always beneficial to both sides regardless of current account deficits or surpluses.  Moreover, he misses Adam Smith’s key insight, namely that exports are a cost to a nation; imports a benefit. When a nation imports, it is enjoying the consumption of goods produced from the scarce resources of some other nation. Although settlement may not occur immediately, ultimately a nation must pay for that enjoyment with exports of real goods and services produced out of its scarce resources.  In the end, trade allows each nation to obtain goods that yield greater consumer surplus than could be obtained if the goods were produced domestically.

The principal lesson here is that a nation that can become more efficient in supplying consumer goods to its people becomes wealthier.  The free flow of capital and international trade are two ways that increased efficiency can come about.  (There are others, of course.)  Tariffs and other policies that impede the potential gains in efficiency ultimately make a nation poorer.

Regrettably, Mr. Trump evinces no awareness of these principles from The Wealth of Nations.  His repeated promises to “be the greatest jobs president ever” and seek “fair trade, not free trade” are founded on long-discredited mercantilist ideas that confuse costs with benefits and focus solely on observable metrics while ignoring the less observable perverse consequences.

To be sure, international movement of capital and goods often has severe localized effects on individuals and communities. These are the observable costs that Mr. Trump sees and seeks to prevent.  For example, the lives of those individuals who will lose their jobs at Carrier and Ford will be disrupted, perhaps severely so.  Far better than Mr. Trump’s steep tariff penalties, however, would be policies that make it possible for these individuals to find other jobs quickly.  In the short term, taxpayer funded retraining and other transitional assistance are in order; in the longer term, free market policies that promote a more efficient and expanding economy will assure continuing employment opportunities for everyone.

By contrast, policies that focus directly on protecting and creating jobs, such as Mr. Trump’s tariff penalties and duties, will in the end fail to do either.  Although visibly protecting some jobs in the short term, these policies will diminish the efficiency of the economy, make American consumers poorer, and reduce the nation’s wealth.  Ultimately, they will cost jobs and harm American living standards.  Bearing out Adam Smith’s insights, economic history and experience show that job opportunities expand most when a society focuses first on increasing efficiency over time.  This is the recipe for a growing and ever wealthier economy.  More jobs are, in turn, the byproduct of this process.

I won’t be sending one of my Adam Smith ties to Mr. Trump.

The Federal Reserve and the Inflation Tax

Theodore A. Gebhard

[This post was originally published in American Thinker magazine on Feb. 6, 2016.]

Article I, Section 7 of the Constitution states, “All Bills for raising Revenue shall originate in the House of Representatives.” In other words, the Framers wanted to make sure that, when taxes are imposed on the people, the legislation giving rise to those taxes springs from the people’s House, the body closest to the nation’s citizens.  No doubt the Framers thought that the taxing power of the federal government should not be taken lightly or at a distance from the people.

Just last Monday, speaking in New York to the Council on Foreign Relations, Federal Reserve Board Vice Chairman Stanley Fischer reiterated the Fed’s long-standing position that monetary policy should achieve an annual rate of price inflation of two percent.  This targeted inflation is specifically in consumer prices.  As anyone with common sense understands, such deliberate price inflation amounts to a tax on income earners, savers, and holders of cash assets — essentially all Americans.  Moreover, this two percent tax falls on top of all other properly enacted taxes.  The consequences are severe.  An annual two percent inflation rate means that the purchasing power of a dollar will decline by almost a third over 20 years.  As far as I know, no citizen voted for this tax, nor endorsed a member of the House of Representatives campaigning on such a tax.

Under what authority does the Fed have this power to tax? Ostensibly it derives from the so-called “dual mandate” that Congress assigned to the Fed in 1977 when it passed the Humphrey-Hawkins Act.  At that time, Congress told the Fed that its job is to promote maximum employment and stable prices.  To most people, stable prices means, well, stable prices, i.e., no price inflation.  Torturing the English language, however, the Fed defines stable prices to mean its targeted two percent inflation rate.  The Fed holds that maintaining this rate satisfies the price stability prong of its dual mandate.

The economic theory justifying this inflation tax is grounded in modern monetary thinking, which is a synthesis of traditional Keynesianism and Monetarism (hereinafter, “modern Keynesianism”). This theory holds that economic well-being and prosperity come about through spending.  Therefore, spending, and especially consumer spending, must be encouraged.  Indeed, saving is anathema to the theory.

One sure way to encourage spending is to punish financial prudence and frugality on the part of individual households. A positive inflation rate continuously maintained by design achieves this objective.  People are incentivized to forego saving and spend now before the value of their income and cash assets decline even further.

A second way to encourage spending is to incentivize debt-taking. Continuous inflation, especially accompanied by artificially low interest rates, achieves this objective too.  Debt-takers obtain relatively high value money to spend in the current period, and pay it back with relatively devalued money in a later period.

Another factor in this modern thinking is the idea that prices adjust faster than wages. Although a few prices may be fixed for a period by contract, most prices, especially consumer prices, can change quickly, if not immediately.  By contrast, wages, more often fixed by contract, are usually slower to adjust to inflationary pressure.  Even when not fixed by contract, burdens on both employees and employers can be severe with frequent turnover.  Thus, even when higher wages might be had elsewhere, small gains in income may not be worth the burden of changing jobs.

Given this price/wage adjustment disparity, household incomes do not keep pace with price inflation, which creates still another incentive to accelerate spending.  In addition, business earnings increase because revenues are rising faster than costs (i.e., prices are going up, while wages remain sticky). Hence, stock values inflate.  This asset inflation, according to the modern thinking, produces a wealth effect that also encourages spending.  That is, stockholders see their investments rise in nominal value, feel richer, and spend more.  In addition, the sticky nominal wages mean that real wages decline over time, thus creating more demand for labor by businesses.  Taken together, all of these behaviors – households spending now rather than later, asset holders feeling wealthier and spending more, and businesses increasing demand for labor — bring about prosperity in the form of higher nominal GDP and full employment.

So goes the modern Keynesian story. The core premises of the story survive despite the historically slow recovery of the economy in the aftermath of the 2008 financial crisis.  In fact, even allowing for fiscal policy failures, the evidence since 2008 is that monetary policy has done little to benefit middle and lower-income Americans by comparison to wealthier Americans with significant holdings of financial assets.  Still, the Fed persists in its desire to tax Americans by boosting inflation through artificially low interest rates and perhaps even another round of quantitative easing.

Nonetheless, there are several grounds on which to question the soundness of the Fed’s inflation tax. First, even taking the Fed’s monetary theory as valid notwithstanding its failures, no prominent economist of which I am aware has explained why two percent is the appropriate inflation rate to target.  Why not three percent?  Or, one percent?  In fact, there is nothing in the analytics of the theory itself that determines this precise rate.  At a minimum, if the people are to be taxed an extra two percent a year, there should be a firmer foundation for that tax than simply the guesswork of unelected central bankers.

Second, the theory’s focus on consumer spending neglects capital accumulation. Capital accumulation is essential to economic growth.  It is the basis for productivity gains in the economy.  Capital accumulation, however, requires saving to finance the new capital.  By making saving unattractive by means of the inflation tax, the rate of capital accumulation will be lower than what it otherwise would be.  Although the inflation policy may give the illusion of stimulating economic activity in the short term, the longer term consequences of diminished growth prospects are a lasting social cost.

Third, according to the Bureau of Labor Statistics, in the 100 years since the Fed’s founding, the price level in the U.S. has increased by over 2300%.  This means that the value of the dollar has dropped by over 95%.  This record is hardly one to be proud of.  More significantly, it shows just how severe an inflation tax is over time.

Fourth, aside from economic and theoretical defects, an inflation tax that punishes prudence and thrift creates a culture that discourages personal responsibility. This result comes about in two ways.  First, prudent saving for a rainy day or for retirement requires a willingness to see those savings depleted in real terms every year.  Certainly at the margin, fewer people will choose to save, or save as much, with this looming prospect.  Second, the inflation tax encourages debt-taking.  Debtors are rewarded by inflation by being able to pay back loans with cheaper money.  As a cultural phenomenon, widespread debt-taking leads to irresponsible spending, especially as it relates to short term spending by “maxing” out one’s credit cards, which often have among the highest interest rates.  With thrift and saving being irrational, instant gratification becomes the norm.

Where does this leave us?  Regrettably, a court is unlikely to find the Fed’s desired tax on the American people to be unconstitutional, as it does not derive directly from a “Revenue Bill” within the meaning of Article I, Section 7. Therefore, removing this taxing power will require legislation, a doubtful prospect.  Even so, in this political season, it might not be too much to ask that the presidential candidates weigh in on the topic.  Monetary policy being arcane to most in the media, however, I am not optimistic that the people will get answers.  

 

Capital Accumulation: The Missing Variable in Economic Policy Debates

Theodore A. Gebhard

[This post appeared originally in a slightly shorter form in American Thinker magazine on Feb. 3, 2016.]

Americans are rightly concerned about their current and future economic well-being. For several years, middle class household incomes have seen little overall growth, and tepid growth in hourly wages has meant that the purchasing power of incomes for some families has actually declined.   A consequence is that too many Americans live largely paycheck to paycheck.  Although on the macro level, there has been some deleveraging of debt on the part of households since the 2008 financial crisis, debt remains a significant problem for many.  It is not therefore surprising that polls show that Americans are deeply worried about their ability to sustain their standard of living, let alone pass on a better standard of living to their children.

In this political season, exposure to debates on economic policy for most Americans centers around what the presidential candidates in both parties have said about the economy and about what their economic plans will be, if elected.  In this regard, all of the Republican candidates have proposed tax plans of one form or another that either reduce marginal tax rates on businesses and individuals or, in the case of former Arkansas Governor Mike Huckabee, would replace the income tax all together with a national consumption tax.  Differences among those advocating reform to the income tax are largely in matters of degree, focusing on how much rates can be reduced, what deductions and tax credits should be retained, and how flat tax rates should be.  The common thread is that these reforms are necessary to incentivize work by allowing people to keep and spend more of what they earn, which will generate economic activity and job creation.

As for the Democrats, both Vermont Senator Bernie Sanders and former Secretary of State Hillary Clinton also want to adjust taxes.  Both say that income inequality is a serious national problem that the federal government needs to address through the tax system.  Specifically, taxes should be raised on higher income earners in order to pay for additional government services that will principally benefit the middle class.  Details, of course, differ between the two candidates respecting the extent of the additional services and the degree to which tax rates should rise, but the overall aim of their respective programs rests on a common belief that tax rates are too low on many higher income Americans.

The presidential candidates’ proposed tax reforms, having now entered the public discourse, regrettably focus almost exclusively on short term considerations.  Not surprisingly, presidential candidates seek to appeal to what they perceive as the current desires of voters.  What this has meant is that consideration of a crucial variable is missing from the public discussion, namely the impact of tax policies on capital accumulation.

Capital accumulation is essential to long-run growth and rising standards of living.  As most every student learns in the first week of an introductory economics course, a nation’s production possibilities – that is, its total potential output — at any given point in time is determined by its endowment of natural resources (including labor), current technology, and its capital stock.  At full employment of all of these factors, there is a near infinite range of alternative mixes of final goods and services that can be produced.[1]  Each of these mixes of goods and services, however, resides at a frontier.  With all resources fully employed, no more goods and services can be produced in the aggregate.  A boundary has been reached.  Thus, at full employment, the only way by which the output of any single good or service can be increased is to take resources away from the production of other goods and services.  That is to say, the cost of consuming more of one good or service is less consumption of other goods or services.[2]

At first glance, the concept of production possibilities seems to suggest that standards of living are fixed in place or, possibly worse, must decline over time because of depreciation of the capital stock.  In fact, experience tells us that this result need not be the case.  New natural resources can be discovered, the labor force can increase through immigration and natural population growth, technology can advance, and the capital stock can expand.[3]  It is the last of these on which tax policy can have the most significant impact.

To see why, consider that plant and equipment wear out over time.  Some plant and equipment may also simply become obsolete with the introduction of new technology.  If the capital stock is not replaced as it depreciates, production possibilities must necessarily decline to the extent not compensated by increases in the stock of other productive factors.  In the modern economic world, however, sufficient amounts of such compensation are highly unlikely.  Therefore, just to maintain current production possibilities, it is essential that some of a nation’s productive factors be devoted on an ongoing basis to replacing the capital stock that is wearing out.  What this means is that some amount of the production of final goods and services for current consumption must be sacrificed in order that resources can be diverted to producing capital goods.  In other words, a nation must consume less in the present and save more in order to sustain its capacity to produce.

Carrying this fundamental principle one step further, it becomes clear that, to grow (i.e, to expand its production possibilities over time), a nation not only must replace its depreciating capital stock, but it must accumulate capital at an even greater rate.  Of course, to do so means that still more sacrifice of current consumption is required.  Hence, society must save even more in the present.

Taxes on savings and investment discourage both and thus slow long run growth.  So, for example, taxes on business income, capital gains, and income from dividends and savings accounts reduces the returns on capital, makes capital less desirable to accumulate, and thus slows expansion of a nation’s production possibilities boundary.  Hence, such taxes rob future generations of goods and services that otherwise would have been forthcoming.  When taxes on saving and investment are claimed by the political class to be necessary to pay for additional government services, it is simply a claim that current needs are of higher priority than future needs.  More bluntly, it is a claim that future generations be damned.

In this regard, of the proposed tax reforms offered by the candidates, Senator Sanders’ and Mrs. Clinton’s rob the future the most.  Their proposals specifically aim to feed current gluttony for government services at the expense of capital accumulation.  Although considerably better in that they reduce marginal rates across the board, the Republicans’ tax proposals nonetheless would continue to tax income from saving and investment.  With the possible exception of former Governor Huckabee’s national consumption tax (flawed in other respects), none can be genuinely called pro-growth.  None fully replaces the anti-growth tax system that has hindered the U.S. economy for way too long.

At bottom, little or no economic growth can occur without capital accumulation.  Taxes that discourage saving and investment slow capital accumulation and thus adversely affect long run growth potential.  Surely during this political season, at least one member of the political class can muster the courage to explain the importance of capital accumulation and make clear that every new government service promised today robs the future.  I am not holding my breath, however.

__________________________

[1] In a free market economy, the mix of final goods and services actually produced is determined by consumers expressing their wants and desires with their spending votes in the marketplace.  Relative prices adjust to reflect such consumer preferences, signaling producers as to which goods and services will be most profitable to produce.  Although this is an important economic principle, it is not essential to the point at hand.

[2] This is a stark illustration of the principle of opportunity costs and tradeoffs in a world of scarcity.

[3] International trade can also increase production possibilities by permitting nations and economies to specialize in producing those goods and services for which their respective endowments are best suited.  This principle is tangential to my main point, however; so I will not explore it further in this post, but readers may want to see my earlier post discussing the benefits of trade linked here.

The Democratic Presidential Debate, Economic Literacy, and the Minimum Wage

Theodore A. Gebhard

During last Saturday’s Democratic presidential debate Vermont Senator Bernie Sanders, Former Maryland Governor Martin O’Malley, and Former Secretary of State Hillary Clinton vigorously competed to display which one is most earnest in his or her support of raising the federal minimum wage.  In so many words, each claimed that it is necessary, as well as compassionate, to raise the minimum wage so that people can more easily rise to the middle class.  The argument is that if incomes are too low for some people, a law mandating higher incomes is justified.  Mrs. Clinton was a bit more nuanced, noting that the cost of living differs locally and thus, according to her reckoning, states and cities should implement minimum wages even above her proposed higher federal minimum wage of $12 an hour, if appropriate for a given locality.

Notwithstanding the substantial intrusion into economic affairs that governments at all levels undertake in contemporary times, I have long ago foregone any hope that political figures will take it upon themselves to obtain even a modicum of economic literacy before formulating their economic policy proposals.  Many, if not nearly all politicians, claim that reason and science should inform government policy, but few, if any, manifest any understanding that there are irrefutable laws of economics that cannot be repealed or altered by political action.  As a consequence, few areas of public policy are subject to more demagoguery than economic policy.  Minimum wage laws are a poster-boy-like example of such demagoguery.  Such was on great display in the presidential debate.

One of the most fundamental laws of economics is the law of demand, which states that as the price of something rises, the quantity purchased will decrease in a given time period, and vice versa.  The law rests on the fact that, in the real world, resources are scarce, and thus the process of satisfying human wants and desires requires making choices among alternative uses of those scarce resources.  Relative prices determined in free markets facilitate this process by permitting persons to make spending decisions out of a limited income according to the value they obtain per dollar spent on a good or service.  The lower the price, the higher is the value per dollar spent.  The higher the price, the less is the value per dollar spent.  Hence, if the price of something goes up – thus reducing the value per dollar spent – less will be purchased as other goods and services become a better bargain.

Artificially controlling specific prices in the economy distorts this process and creates inefficiency in resource allocation, as relative prices no longer fully reflect market forces driven by consumer preferences.  Wages are prices.  Hence, if wages for unskilled labor are artificially set above the market determined wage by means of minimum wage legislation, less unskilled labor will necessarily be purchased per period of time.  Moreover, the structure of wages throughout labor markets – skilled as well as unskilled – will be distorted, and economic efficiency will be compromised.  These outcomes are givens, and economists have known about them for a long time.

Why then do minimum wage laws persist?  Are not the harmful effects sufficient for voters to reject politicians who push these laws?  The answer, I believe, is that, although the harmful effects are real, they are generally not immediately visible, while the superficial, demagogic appeal of minimum wages is easy to articulate.  This appeal has several components, each of which was stated during the Democratic debate.  First, it is argued that raising the minimum wage will have a (politically) desired redistributive effect (Bernie Sanders).  Second, it is argued that raising the minimum wage will help to elevate people – particularly unskilled workers — into the middle class (Martin O’Malley and Hillary Clinton).  Third, it is contended that the empirical data show no significant adverse impact on employment because of raising the minimum wage, and therefore there is no downside to doing so (Hillary Clinton).

None of these claims, however, lives up to its full billing.  For example, even accepting a goal of income redistribution, minimum wage laws are a highly inefficient means to accomplish this end.  This is not controversial among economists.  Whatever income redistribution raising the minimum wage achieves, that redistribution is likely temporary at best, as employers adjust to the higher wage rate over time by substituting to other inputs such as new technology.  In addition, it only raises the income of those who continue to keep their jobs.  To the extent that the higher wage rate causes, at the margin, others to lose their jobs, their income falls to zero.  And, finally, the distribution comes at the expense of distorting relative prices, which can be considerable depending on the size of the wage hike.  In point of fact, there are far superior mechanisms to achieve income redistribution such as simple cash payouts or a negative income tax.  Either of these measures ensures that the incomes of the entire targeted group increase, and both avoid compromising efficiency because of price distortion.

As for elevating lower income people into the middle class, raising the minimum wage again is highly inefficient.  Vast amounts of evidence indicate that rising incomes are best achieved by education, stable families, and cultural factors such as personal discipline and a strong work ethic.  Entry level jobs – even at low wages – help to foster the personal characteristics, especially among young people brand new to the workforce, necessary to succeed in a work environment and eventually advance into higher paying positions with greater responsibility.   In addition, in few households is the primary income earner a minimum wage worker.  In fact, most minimum wage workers are younger than 24 years old.  (See here.)  Hence, although raising the minimum wage may have some impact on household income, the impact will be small.  A far better emphasis for public policy directed toward building the middle class would be on augmenting incentives for skills acquisition and maintaining stable families.

Mrs. Clinton’s assertion that the empirical evidence “shows” that there is little or no impact on employment following a hike in the minimum wage is similarly flawed.  It is indeed possible to construct studies that yield this result.  In so doing, the studies seemingly refute the basic law of demand.  In fact, however, they do not.  Rather, such studies rest on highly selective data (undisclosed by Mrs. Clinton) that severely cabins the contours of the analysis to exclude either one of two critical factors, or both, that otherwise explain the anomaly.  The first is that when the market wage for unskilled labor has risen above the existing minimum wage because of inflation the latter has no effect on employment rates.  The minimum wage is no longer a floor.  It serves no purpose.  Under these conditions, if the minimum wage is raised anywhere up to but not exceeding the market wage, it is perfectly consistent with the law of demand that there will be no significant employment effects.  Only when the minimum wage is hiked above the market wage, will employment effects take place.  Hence, data that selectively exclude wage hikes that actually exceed the market wage necessarily mislead on the question of employment impact.*

A second explanation for selective data showing little or no employment effects concerns the time frame considered.  In the immediate aftermath of an increase in the minimum wage, many, if not most, employers have capital equipment fixed in place.   In the short run, it will not be possible in many instances to substitute away from labor to a more capital-intensive production environment.  Thus, there may be little immediate job loss.  Over time, however, this will change as equipment wears out and is replaced, and as entry of new capital takes place.  For example, when I was growing up, most elevators required full-time human operators, engaging personally with bank tellers was the only way to withdraw funds from an account, and there were no self-checkout lines at grocery stores.  Today, none of these conditions is true.  Of course, one cannot claim that each of these changed conditions was solely caused by successive hikes in the minimum wage over the years, but undoubtedly those hikes contributed to the long run substitution away from low and unskilled labor in these occupations.  Moreover, this transition certainly took place in innumerable other sectors of the larger economy.

Finally, I want to close with a comment about union support for the minimum wage.  Although historically unions have been a strong Democratic Party constituent, it would seem odd, at least on the surface, that unions would much care about minimum wages.  Union jobs, after all, are typically at hourly wages much higher than the minimum wage.  There are at least two reasons, however, why unions can be counted on to advocate for higher minimum wages.  First, many union contracts contain clauses that structure union wages relative to the minimum wage.  That is, the union pay scale should always, in relative terms, be some percentage above the lowest pay scale.  Hence, when minimum wages are hiked, the union pay scale is similarly adjusted upwards.  Second, it is in the interest of skilled union workers to have the wage rates of unskilled workers continually increase.  Suppose for example that a particular task could be performed by two unskilled workers in an hour or one skilled union worker in an hour.  If the wage rate for unskilled work were $5 /hour and the wage rate for skilled work were $11/hour, the employer can be expected to employ two unskilled workers to do the task at a total of $10/hour.  Now suppose the minimum wage is hiked to $6/hour.  Under this circumstance, the employer will hire the skilled union worker at $11/hour, as the two unskilled workers would now cost $12/hour.  The higher minimum wage not only priced the unskilled workers out of the market, it also created a demand for union work.

In sum, the Democratic presidential debate on Saturday night revealed a great deal of departure from economic science among the three candidates.  This departure was especially apparent in the Q&As concerning the minimum wage.  Even more troubling is the possibility – and perhaps even probability as it concerns Mrs. Clinton – that the economic hokey pokey did not entirely owe to economic illiteracy, but rather owed simply to deliberate political demagoguery to gain votes at the expense of serious thought.

Addendum:   In watching the debate, I could not help but be reminded of the incessant cant from the political left about the alleged consensus among scientists concerning climate change and global warming.  On the basis of this alleged consensus, the science is supposedly settled, and outlying views are to be shunned and ridiculed.  Yet, as the basis for her assertions about the minimum wage, Mrs. Clinton solely cited former Obama White House adviser Alan Krueger, who co-authored a study of the impact on fast food employment in New Jersey and Pennsylvania following an increase in the minimum wage in those states.  The study, published in 1994 and using early 1990s data, claimed to find insignificant employment effects.  This study, however, is the poster boy of outlying studies concerning minimum wages, has often been criticized on methodological grounds, and runs contrary to the “consensus” among economists about the actual employment effects of minimum wage laws.  Mrs. Clinton’s hypocrisy on this score is stunning.

Notes:

* A simple example demonstrates the law of demand in this context.  Suppose the tasks performed by a worker earning $5/hour contribute $5.25/hour in incremental revenue to the employer.  Each hour thus generates $0.25 in accounting profit for the employer.  In fact, under this circumstance, it would pay the employer to pay the worker any wage up to $5.25/hour.  Now suppose the minimum wage is hiked to $5.50/hour.  Absent any concurrent increase in productivity on the part of the worker, it no longer pays the employer to keep the worker and the job is lost.  At the margin, all such workers will be let go.

Mrs. Clinton seems to understand this concept.  At Saturday night’s debate, she stated that she favored an increase in the federal minimum wage to $12/hour, but not to $15/hour.  But why?  From a worker’s standpoint, $15/hour is better than $12/hour, and will produce a higher annual income.  Indeed, why not increase the minimum wage to $100/hour and elevate everyone to the higher end of the middle class?  Implicit in Mrs. Clinton’s reluctance to go higher than $12/hour, at least at the present time, is surely a recognition of the adverse employment effects that the minimum wage produces.

Business Acumen and Economic Understanding

Theodore A. Gebhard

In a recent Wall Street Journal op-ed, Republican presidential candidate Donald Trump asserted that the Chinese government imposes a de facto tariff on all imported goods by intentionally devaluing the yuan.  (“Ending China’s Currency Manipulation,” Nov. 10, 2015)  According to Mr. Trump, the undervalued yuan makes international trade unfair and hurts China’s trading partners.  By Mr. Trump’s reckoning, it particularly hurts the United States by weakening American industry and costing millions of jobs.  He goes on to say that he will designate China a “currency manipulator” on day one of his presidency, if elected.  In addition, he will impose countervailing duties on “cheap Chinese imports” as retaliation for the unfair currency manipulation.

On the day after Mr. Trump’s op-ed, Mr. Doug Parker and Mr. Keith Wilson lament, also in a Wall Street Journal op-ed, that the United Arab Emirates and Qatar unfairly subsidize their respective airlines with massive cash infusions.  (“Rigging the Game on Open Skies,” Nov. 11, 2015)  Mr. Parker is the chairman of American Airlines Group and Mr. Wilson is president of the Allied Pilots Association.  Like Mr. Trump, Messrs. Parker and Wilson claim that these subsidies hurt the United States by costing hundreds of thousands of jobs in the American airline industry.

The views of Messrs. Trump, Parker, and Wilson are hardly unusual among business leaders and corporate executives.  A quick look at the International Trade Commission’s website reveals that the ITC currently has some 30 active “import injury” investigations open and another 12 active “anti-dumping and countervailing duty” investigations.  These investigations seek to determine if imports are priced “unfairly” and thereby cause injury to specific U.S. industries or companies.  The current investigations run across a wide range of products, including among others chemicals, various steel and iron products, bricks, sundry welded products, woven ribbons, plastic tape, copper products, sugar, uncoated paper, plastic bags, wooden bedroom furniture, and even tissue paper and ironing boards.  All of these investigations are responses to U.S. companies’ claims of injury owing to unfair import competition.

Each of the above-described contentions illustrates an important – yet, unfortunate — fact, namely that mercantilist views run strongly among business leaders and corporate executives.  This is particularly regrettable whenever such leaders and executives take to a public forum and mistakenly equate their knowledge of business with knowledge of sound economics.  In point of fact, business and economics focus on quite different matters.  The danger of equating business acumen with authority on economics is that the former’s narrow focus on business success leads to the promotion of policy prescriptions that, although beneficial to parochial interests, are often harmful to the general interest.  Protectionism is perhaps the most blatant and harmful example of this phenomenon.

Case in point are Messrs. Trump, Parker, and Wilson.  Although all three claim to be supporters of free trade so long as it is “fair trade” and promotes American prosperity, each defines success only in terms of mercantilist metrics.  Specifically, each looks to export growth and job creation as the measure of a successful trade policy.  This perspective, however, stands in direct contradiction to Adam Smith’s central point that the wealth of a nation is measured, not by the quantity of goods that it sends to other nations or by resource employment, but by the amount of goods and services available for consumption by its citizens.

In his seminal book, An Inquiry into the Nature and Causes of the Wealth of Nations, Smith explained (as I discussed in greater detail in an earlier post here) that the sole objective of economic activity in a world of scarcity is consumption.  If human beings did not need to consume or if there were no scarcity, there would be no need for economic activity, let alone trade or trade policy.  Under real world conditions, however, people not only need to consume to stay alive but also possess wants and desires for goods and services that go far beyond the basic necessities.  Scarce resources must therefore be constantly employed to produce those goods and services.

In terms of trade, Smith went on to explain that, rightly understood, exports are a cost to a nation and imports are a benefit.  Exports mean that a nation’s scarce resources, including human employment, are being used up for another nation’s consumption benefit.  By contrast, importing goods and services allows a nation to consume while conserving scarce resources for deployment in other productive activities, thus expanding domestic production of consumable goods and services and permitting even greater rates of consumption.  The result is an increase in the nation’s total wealth.  Exports, and the resources that go into those exports, are the price a nation must pay for its imports.  As with all exchanges, the lower the price the greater the surplus value to the buyer.

Given this central tenet of economics about the genuine wealth of a nation, whenever the United States can obtain goods and services more cheaply by means of importing them than by producing them domestically, it benefits.  U.S. consumers are made better off.  This benefit will accrue regardless of why the imported goods are cheap, i.e., even if they are cheap because of subsidies or so-called currency manipulation.  Indeed, if subsidies or artificially undervalued currency is the reason, the true harm falls on the citizens of the nations providing the subsidies or “manipulating” their currencies.  Not only are those nations using up their scarce resources for the benefit of American consumers, but their citizens are being taxed to fund the subsidies and are being exposed to higher domestic prices because of the undervalued currency.  It is a double whammy.

What is more, instead of a cost to the United States, the “jobs lost” that Mr. Trump and Messrs. Parker and Wilson claim occurs because of “unfair” trading practices are actually necessary to expanding domestic wealth. The freed up human and other resources are now available for new productive uses or for increasing the output rate of existing productive activities.  The available consumption pie is necessarily enlarged.  By contrast, the logical end of the Trump, Parker, and Wilson mercantilist argument is either autarky or at least significantly diminished trade, either of which must result in lower living standards for the American people.

To be sure, whether owing to market fundamentals or external foreign government policies, the vicissitudes of the international movement of goods and services, as well as capital, will result in certain industry-specific disruptions and transactional costs to individuals.  This inevitable consequence is by all means a basis for a compassionate nation to lend support to those who require retraining and other transitional assistance, but it is not a basis for protectionism and lower living standards.  To the contrary, every time that China devalues the yuan or another country subsidizes its export industries, we Americans should give a hearty thanks for the gift.

Mrs. Clinton’s Repudiation of Scarcity

Theodore A. Gebhard

Imagine that you have all the ingredients to bake a twelve inch apple pie, including crust and filling.  Imagine further that the baked pie is initially cut into ten slices.  Under a new government program intended to ensure that everyone has access to quality pie, all citizens are required to buy pie insurance which, among other things, entitles each person to obtain one slice of pie each year at no out-of-pocket cost.  The pie provider bills the insurance company for each slice of pie it supplies to an insured. Assuming a population of eight citizens, after each person obtains one slice of pie, two slices remain.  These two slices might be provided, for example, at full cost or at least with a co-payment to two persons with special needs for additional pie.  Of course, once these last two pie slices are consumed, no pie remains until (1) additional ingredients are found or diverted from other uses, and (2) another pie production cycle ensues.

But wait.  There is a better solution to providing additional pie to everyone.  Specifically, the government could simply pass a law mandating that all citizens are entitled not to just one, but two slices of pie each year at no out-of-pocket cost.  Now each of the eight citizens can have two slices of pie each year.  Everyone is better off!

Of course, this solution is absurd, as there is no actual additional real pie to distribute.  There is still only one twelve inch pie cut into ten slices.  If each of eight citizens is entitled to two slices, all but two citizens would have to be denied a second slice.  In other words, there would be no pie left over to provide a second slice to six of the eight citizens.  Even this outcome assumes that a citizen is not entitled to a second slice until everyone has obtained at least one slice.  Without this rule, five citizens might consume all ten slices before three citizens consume any pie.

Alternatively, the pie might be cut into smaller slices so that there are sixteen.  In this case, there are now enough slices for each citizen to consume two slices.  No more total pie is being consumed, however, and the smaller slices may not adequately meet the needs of the insureds.

The point of this example is to illustrate that consumption must necessarily come out of real resources.  The using up of real resources is the true cost of consumption, and it is impossible to increase consumption in the absence of obtaining additional resources, which are scarce or otherwise deployed in other production activities.  It seems to me that this is not a complicated point, but it nonetheless appears to escape Hillary Clinton.

According to an article in today’s Wall Street Journal at A-4 (“Clinton Lays Out Plan to Cut Health Cost”), Mrs. Clinton, in her quest for the Democratic presidential nomination, has announced that, if elected, she will “improve” Obamacare by placing further limits on what insureds pay for healthcare.  Her goal, she says, is to reduce costs.  Her solution is to require insurance plans to permit three doctors’ visits a year before any deductible charges are made.  As quoted in the Wall Street Journal, Mrs. Clinton declared, “With deductibles rising so much faster than income, we must act to reduce the out-of-pocket costs families face.”

It is a shame that no one is asking Mrs. Clinton how this plan reduces the true costs of healthcare, namely the required resources to produce it.  She might also be asked where the additional resources are to be found or from what other productive activity they are to be diverted. If she favors more but shorter and less substantive doctors’ visits, she should explain how she has determined that such smaller but numerically more “slices” of the pie provide for superior quality healthcare.  Unless Mrs. Clinton magically discovers a means to eliminate scarcity – in which case there would be no need for any healthcare insurance – one should be highly skeptical of her pronouncements.

ZIRP Has Failed; So More ZIRP

Theodore A. Gebhard

If the definition of insanity is repeating the same thing and expecting a different result, the Fed is becoming close to being properly labeled as insane. After some six years of the Fed’s zero interest rate policy (ZIRP), economic growth rates remain in the tank. Plainly ZIRP’s failure to bring about anything close to a robust recovery from the 2008 financial collapse argues for a re-evaluation of the policy. Yet, in a Wall Street Journal op-ed today, Narayana Kocherlakota, president and CEO of the Federal Reserve Bank of Minneapolis and a participant in the Federal Open Market Committee, argues for more of the same. (“Raising Rates Now Would Be a Mistake”)

When I first began reading Mr. Kocherlakota’s op-ed, I thought that it had to be a deliberate parody on the Keynesian groupthink that characterizes the world’s central bankers. Then I realized that Mr. Kocherlakota is dead serious about wanting the Fed to continue with its ZIRP notwithstanding the policy’s proven impotence. He says it is imperative to do so because raising rates now would impede the Fed’s ability to achieve two goals: (1) raise inflation to its 2% target rate, and (2) stimulate spending via credit expansion and bank lending.  He fails to explain, however, how either of these goals arises from sound economic thinking or if met would change the trajectory of the economy and bring about the illusive recovery.  Indeed, both of these goals are highly questionable attributes of a growing and productive economy.

Regarding the first goal, Mr. Kocherlakota merely asserts that 2% inflation is how the Fed defines price stability.  No reason is given as to why 2% is superior to any other number, let alone superior to what most people outside of the FOMC would define as stable prices — zero inflation.  In fact, a 2% inflation rate means that the purchasing power of a dollar declines by almost a third over 20 years.  Not only is financial prudence on the part of households punished, saving is discouraged and debt-taking encouraged.  Diminished saving and increased debt, however, have never been shown to lead to growth and sustained prosperity.

Mr. Kocherlakota’s second goal, increased spending, is similarly misguided.  A focus on spending neglects capital accumulation, which is essential to productivity gains and economic growth. Capital accumulation, moreover, requires saving to finance the new capital.  Hence, incentivized spending and debt-taking, buttressed by lower saving owing to an inflation tax, must result in a lower rate of capital accumulation and ultimately diminished growth prospects.

In the end, price controls never work, and interest rate manipulation will be no exception.  Eventually, the distortions in asset pricing created by ZIRP must be corrected.  When that time comes, the tools that the Fed has in its bag will have been seriously depleted, and the correction could be long and deep. After years of tepid recovery, it is past time to jettison the monetary policy groupthink that Mr. Kocherlakota represents, bury the ZIRP, and return to free market principles in which interest rates are freely determined in the marketplace by peoples’ time preferences and an honest monetary policy.

(See also my earlier related Post here.)

Janet Yellen and the Power to Tax

Theodore A. Gebhard

Article I, Section 7 of the Constitution states, “All Bills for raising Revenue shall originate in the House of Representatives.” In other words, the Framers wanted to make sure that, when taxes are imposed on the people, the legislation giving rise to those taxes springs from the people’s House, the body closest to the nation’s citizens. No doubt the Framers thought that the taxing power of the federal government should not be taken lightly or at a distance from the people.

Janet Yellen, Chairwoman of the Federal Reserve Board, evidently has determined that she is a virtual member of the House of Representatives, and, in fact, holds a controlling position. She and the other members of the Federal Open Market Committee have publicly and repeatedly stated their desired intention to use monetary policy to achieve a continuous inflation rate of two percent a year. The targeted inflation is specifically in consumer prices. This means that Ms. Yellen has decided that income earners, savers, and holders of cash assets should be taxed annually an additional two percent. At this rate, the purchasing power of a dollar will decline by almost a third over 20 years.  As far as I know, no citizen voted for this tax, nor endorsed a member of the House of Representatives campaigning on such a tax.

The theory behind this inflation tax is grounded in modern monetary thinking, which is a synthesis of traditional Keynesianism and Monetarism (hereinafter, “modern Keynesianim”).* The theory holds that economic well-being and prosperity come about through spending. Therefore, spending, and especially consumer spending, must be encouraged. Indeed, saving is anathema to the theory.

One sure way to encourage spending is to punish financial prudence and frugality on the part of individual households. A positive inflation rate continuously maintained by design achieves this objective. People are incentivized to forego saving and spend now before the value of their income and cash assets decline even further.

A second way to encourage spending is to incentivize debt-taking. Continuous inflation, especially accompanied by artificially low interest rates, achieves this objective too. Debt-takers obtain relatively high value money to spend in the current period, and pay it back with relatively devalued money in a later period.

A key factor in this modern thinking is the idea that prices adjust faster than wages. Although a few prices may be fixed for a period by contract, most prices, especially consumer prices, can change quickly, if not immediately. By contrast, wages, more often fixed by contract, are usually slower to adjust to inflationary pressure. Even when not fixed by contract, burdens on both employees and employers can be severe with frequent turnover. Thus, even when higher wages might be had elsewhere, small gains in income may not be worth the burden of changing jobs.

Given this price/wage adjustment disparity, household incomes do not keep pace with price inflation, which creates still another incentive to accelerate spending.  In addition, business earnings increase because revenues are rising faster than costs (i.e., prices are going up, while wages remain sticky). Hence, stock values inflate. This asset inflation, according to the modern Keynesians, produces a wealth effect that also encourages spending. That is, stockholders see their investments rise in nominal value, feel richer, and spend more. In addition, the sticky nominal wages mean that real wages decline over time, thus creating more demand for labor by businesses. Taken together, all of these behaviors – households spending now rather than later, asset holders feeling wealthier and spending more, and businesses increasing demand for labor — bring about prosperity in the form of higher GDP and full employment. So goes the modern Keynesian story.

It is the story that continues to be taught in mainstream economics Ph.D. programs, and it is the story to which most prominent macroeconomists adhere. It is also the story most prevalent in the financial media. The core premises of the story survive despite the continuation of boom and bust cycles. Indeed, even the severity of the 2008 financial crisis and the historically slow recovery in its aftermath have done little to crack the edifice of modern Keynesianism.

Even so, there is a growing heterodox literature attacking this edifice and, in particular, the performance of the “Fed.” Much of this literature focuses on the period since the end of the Bretton Woods gold-exchange standard, which President Nixon jettisoned in 1971. Mr. Nixon’s decision made the dollar a full-fledged fiat currency and opened the door for the Fed to engage in wide ranging monetary discretion. This critical literature is too voluminous to discuss here. I will, however, set out a few reasons as to why I believe the prevailing paradigm should be abandoned.

First, even taking modern monetary theory as valid notwithstanding its failures, I am not aware of any explanation from Ms. Yellen, any of her fellow FOMC members, or any prominent macroeconomist as to why two percent is the appropriate inflation rate to target. Why not three percent? Or, one percent? Or, one and a half percent? As far as I know there is nothing in the analytics of the theory itself that determines this two percent. It seems to be nothing more than a preferred fancy of the monetary policy elites.** At a minimum, if the people are to be taxed an extra two percent a year, there should be a firmer foundation for that tax than simply the whims of unelected central bankers.

Second, the theory’s focus on consumer spending neglects capital accumulation. Capital accumulation is essential to economic growth. It is the basis for productivity gains in the economy. Capital accumulation, however, requires saving to finance the new capital. By making saving unattractive by means of the inflation tax, the rate of capital accumulation will be lower than what it otherwise would be. Although the inflation policy may give the illusion of stimulating economic activity in the short term, the longer term consequences of diminished growth prospects are a severe and lasting social cost.

Third, by most any measure, the Fed has historically performed poorly in taming the business cycle or making booms and busts less frequent. In fact, internal instability is built into modern monetary policy. Two factors, in this regard, are noteworthy. First, because the interest rate is one of the most important prices in any economy, its manipulation by the Fed creates massive price distortions and makes asset price discovery far more difficult. As a result, much malinvestment occurs. Such malinvestment ultimately has to be liquidated during a subsequent bust. Second, even if wages adjust more slowly than prices in the short term, they must eventually catch up to prices as pressures toward economy-wide equilibrium take hold. The boom therefore rests on an unstable platform. It can only persist if prices continue to outpace wages, an unlikely event.   The bust must inevitably follow.

Fourth, it is noteworthy that, in the 100 years since the Fed’s founding, the price level in the U.S. has increased by over 2300%, meaning that the value of the dollar has dropped by over 95%. (This information comes from the Bureau of Labor Statistics and can be viewed here.) That is hardly a record to be proud of. What is more, it shows just how severe an inflation tax can be over time.

Fifth, aside from economic and theoretical defects, an inflation tax that punishes prudence and thrift creates a culture that discourages personal responsibility. This comes about in two ways. First, prudent saving for a rainy day or for retirement requires a willingness to see those savings depleted in real terms every year. Certainly at the margin, fewer people will choose to save, or save as much, with this looming prospect. Second, the inflation tax encourages debt-taking. Debtors are rewarded by inflation by being able to pay back loans with cheaper money. As a cultural phenomenon, widespread debt-taking leads to irresponsible spending, especially as it relates to short term spending by “maxing” out one’s credit cards, which often have among the highest interest rates. With thrift and saving being irrational, instant gratification becomes the norm.

Where does this leave us?  Regrettably, Janet Yellen’s tax on the American people is unlikely to be unconstitutional, as it does not derive directly from a “Revenue Bill” within the meaning of Article I, Section 7. Moreover, the Federal Reserve System, although a creation of the government, does not itself operate as a government agency. Therefore, short of amending the Fed’s enabling legislation and taking away its independence to manage monetary policy, there is likely little the people can do to avoid the Yellen tax. Even so, I think it is important that people at least know that the tax exists.

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* For simplicity, I will use the term, “modern Keynesianism” herein to mean this synthesis. In so doing, I neglect the fiscal policy side of Keynesianism, which is not relevant to my discussion.

** Incidentally, this whim is worldwide. Mario Draghi, the head of the European Central Bank, similarly has stated his determination to maintain a two percent inflation rate. Not uncoincidentally, Mr. Draghi was American-trained at MIT and is well ensconced in the modern monetary paradigm.

Adam Smith and the Republican Presidential Candidates

Theodore A. Gebhard

In the 1980s Reagan Republicans were fond of wearing Adam Smith neckties. (I personally still have two hanging in my closet that hail from that era.)   Adam Smith, of course, was the 18th Century Scotsman who wrote An Inquiry into the Nature and Causes of the Wealth of Nations, a book considered by many to be the founding work of modern economics. Wearing the Adam Smith neckties was intended to display fidelity to Smith’s ideas and, in particular, fidelity to free markets.

One does not see many Republicans wearing these neckties anymore. Perhaps this loss of ubiquity is to the good, however. After observing the large crop of Republican presidential candidates over the past several months, I can only conclude that none of them is particularly well informed by Smith’s ideas. Indeed, I suspect that few, if any, have ever read The Wealth of Nations. Some of the candidates indeed display an extraordinary degree of economic illiteracy.

The central thesis of The Wealth of Nations is that a nation’s economic well-being is measured not by its store of gold (or other financial assets), the amount of goods it exports, or the number of jobs that exist within its borders, but rather a nation’s economic well-being is determined by the quantity of goods and services available for consumption by its populace. In the book, Smith makes the point that the ultimate purpose of all economic activity is to satisfy human wants and needs. That is, the reason that economic activity takes place is so that people can consume. Work and production are means to that end, but not ends in themselves. They are properly considered costs, not benefits. Put another way, in a world in which resources are scarce, employment of human labor and other necessary factors of production are what a nation must give up in order to consume.

Thought of in this way it becomes clear that if a nation can reduce the number of labor hours (or the employment of any other resource) required to maintain a particular rate of output of consumer goods and services, those freed up resources can then be used to increase the output rate even further, thus allowing the nation to become wealthier. One way by which such an expansion of wealth might occur is through the adoption of new technology that increases productive efficiency. The efficiency is manifested in higher labor productivity and potentially an increase in the productivity of other resources as well. Technological innovation may also yield higher quality products, or the introduction of entirely new goods and services.

Another way by which a nation’s wealth can increase is by trade with another nation that has a comparative advantage in the production of certain goods. In this case, both nations gain by taking advantage of each other’s relative productive efficiencies. The trade consists of one nation giving up some of its wealth by exporting goods produced out of its scarce resources in exchange for imports of higher-valued goods from the other nation produced out of that nation’s scarce resources. Each nation sacrifices some of its wealth in order to obtain something in return that it values higher. The result is that each nation becomes wealthier.*

As Smith taught, exports then are a cost to a nation; imports a benefit. When a nation exports, it is using up its scarce resources for the benefit of another nation’s consumers. When a nation imports, it is enjoying the consumption of goods produced from the scarce resources of some other nation. Properly considered, exports are the goods that a nation must sacrifice to pay for its imports.

The principal lesson here is that a nation that can become more efficient in supplying consumer goods to its people becomes wealthier. Whether that efficiency comes about because of new technology or because of international trade, the savings in resource use, including labor, permits an expansion in the nation’s wealth through redeployment of those resources to the production of still other goods and services. **

Regrettably, none of the Republican candidates for president evinces much awareness of this basic lesson from The Wealth of Nations. What they say instead are repeated promises to “create” jobs and artificially promote exports, presumably beyond that rate required to pay for imports. In other words, they promise that, if elected, they would make America poorer.

To be sure, individuals want jobs because they know that they have to work in order to have income to obtain the consumer goods and services that they need and want. They must exchange their labor for those goods and services.  This necessity is a fact of life in a world of scarcity.

But political leaders who respond with promises to focus directly on creating jobs, including jobs derived from exports, will largely fail to keep those promises. Bearing out Smith’s ideas, economic history and experience show that job opportunities expand most when a society focuses first on increasing efficiency over time. The proven mixture is technological advancement, free trade, and minimal government-imposed burdens on entrepreneurship and other economic activity. These factors along with other necessary conditions such as the rule of law are the recipe for a growing and ever wealthier economy. More jobs are, in turn, the byproduct of this process of economic growth.***

It would be refreshing if at least one of the Republican candidates for president evinced an understanding of these tested principles and could articulate them in a compelling manner. Instead, we get empty promises to create jobs and pursue programs that hinder trade with other nations. It is indeed appropriate that none of them wears an Adam Smith tie.

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* In the modern global economy, trade of course takes place multinationally and is not goods for goods but rather is financed by means of international currencies and other monetary instruments. This permits nations to trade indirectly with each other. It also means that settlements need not occur instantly but can take place over time. So, for example, one nation may export in one period, but rather than import in the same period simply hold claims on another nation’s goods to be redeemed in a later period.   Nonetheless, the basic wealth-creating principles of trade as discussed above continue to hold.

** For a notable illustration of this principle, simply consider how technology has improved agriculture and thus permitted the expansion of non-agricultural production.   Were we still to employ the agriculture technology of 1900, many more people would still have to be working on farms instead of producing the variety of consumer goods that we enjoy today. In other words, advances in agricultural technology throughout the 20th Century freed up the resources, including labor, that permitted the development and supply of that century’s wide-ranging new industries, products, and services. Indeed, a politician who his dead set on “creating” jobs could ensure full employment simply by outlawing the use of tractors. It would not be a situation that most of us would want to endure, but it certainly would create full employment.

*** For example, over time new labor saving technology most often actually expands total labor employment. It does this in two ways. First, in that area where the new technology is applied, the increase in labor productivity reduces per unit costs, and thus consumer prices. With lower prices, quantity demanded increases and more output is sold. Although labor hours per unit of output are fewer as a consequence of the new technology, the higher output rate often means that total labor hour employment grows. Second, the increase in labor productivity in one area frees up resources for expanding output rates, and hence labor employment, in other areas, including new and developing industries where job opportunities may increase dramatically.

Paying One’s “Fair Share” of Taxes

Theodore A. Gebhard

I have always been puzzled when I hear politicians, particularly Democrats and others of the left, talking about people needing to pay their “fair share” of taxes.  Most recently, Vermont Senator Bernie Sanders, Independent Socialist and candidate for the Democratic presidential nomination, has made this claim in most, if not all, of his campaign speeches.  What he and others mean by this idea is that those earning higher incomes should pay more in taxes than they already are, notwithstanding that income tax rates are already progressive, i.e., marginal rates increase with income.  Rarely, however, do proponents of raising marginal rates on high income earners say exactly what a “fair share” of taxes is or, more precisely, what exactly those marginal rates should be.  Even more vague is their philosophical basis, either in ethics or economics, for what constitutes “fairness” in this context.

It seems to me that Senator Sanders and others of similar views have the tables turned upside down.  In fact, rather good philosophical arguments can be made from both an ethics and an economics perspective that, if anything, high income earners are already paying well more than their fair share of taxes and that their absolute tax payments or marginal rates should therefore be reduced.

Taxes are the cost of financing government.  In our democracy, every qualified voter is afforded one vote, no more and no less.  Just as this political shareholding is allocated equally among citizens, it would seem intuitively fair that the burden of the cost of government should similarly be allocated equally.  That is, everyone should pay the same amount in taxes in the form of a simple per capita tax.  This way, each person contributes the same amount toward the cost of government, much like dues assessments in a club.  At the least, it would be interesting to ask Senator Sanders to explain, from an ethics standpoint, why his income tax proposals are more fair than a per capita tax.

Of course, as a practical matter, given the current size of government, an equal per capita tax would necessarily mean that many, if not most, taxpayers would owe more than they earn or have in savings and, in some cases, likely much more.  Such a tax thus would be unworkable unless government were shrunk substantially.  The cost of government would have to shrink at least to the point where the per capita tax would be affordable by each taxpayer, a goal unlikely to be shared by Senator Sanders.  Even so, the size of government and the practical ability to have fairness in the tax code would seem to be inextricably linked.

Admittedly, I am uneasy to render judgments on purely ethical grounds about whether the amount of taxes a particular taxpayer pays is fair for that taxpayer.  I do, however, claim some expertise in economics.  Drawing on that expertise, I think that there is a reasonable argument on economic grounds that, in the alternative to a per capita tax, a regressive income tax is fairer than a progressive one.

The argument rests on the idea that whenever there is voluntary exchange, every transaction creates wealth.  A voluntary transaction will not take place unless each party becomes better off as a result of the transaction.  It follows therefore that, so long as high income earners obtain their income through voluntary exchange of their labor, services, or other resources, each dollar of that income is the product of a wealth-creating transaction.

Significantly, however, the high income earner does not keep all of the created wealth, but only a fraction.  The rest of the new wealth necessarily accrues to everyone else with whom the high income earner engaged in voluntary exchange, either directly or indirectly.  Thus, the higher the income of the high income earner, the greater the earner contributes to other people’s wealth.  It follows then that high income earners benefit society more than lower income earners before any taxes are taken out of those earnings.

Based on this reasoning, one possible way to measure tax fairness would be on the basis of relative additions to aggregate social wealth.  Under such a definition, people who contribute less to social wealth would be required to make up for the deficit by paying more in taxes, while those who contribute most to social wealth would be rewarded by lower taxes.  Put another way, fairness would require that high income earners be taxed less than low income earners.  The former have already made a disproportionate positive contribution to social welfare.

Of course, as with the per capita tax, a regressive income tax would require considerable downsizing of government.  Such a tax simply could not finance the current government.  Once again, the size of government and the practical ability to have tax fairness are inextricably linked.  But that practical consideration aside, a fairness argument for a regressive income tax that rests on economic reasoning, unlike Senator Sanders’ fairness arguments, at least has an analytical grounding.  It would be interesting to learn how Senator Sanders would respond to the argument.

In that regard, I will volunteer one glitch in the reasoning. Regrettably, many high income earners today derive their high incomes not from contributing to aggregate wealth but rather by using the machinery of government to expropriate the wealth created by others.  Rent seeking can be very lucrative.  Thus, if “paying one’s fair share” in taxes is inversely related to one’s contribution to social wealth, these high income rent seekers should be taxed at a 100% marginal rate.

Hillary Clinton and Trickle Down Economics

Theodore A. Gebhard

Few utterances in public life over the last 30 years annoy me more than the term, “trickle down economics.”  I know of no economics textbook, treatise, or journal article that even mentions TDE, let alone discusses it as a recognized economic theory or school of thought.  Yet, in her recent speech outlining her economic plan for the future (see here), Democratic presidential candidate and former Secretary of State, Hillary Rodham Clinton, invoked the term several times, asserting that she is not only opposed to TDE but, moreover, would most assuredly not return to that policy as president.  Mrs. Clinton’s opposition to TDE is not new.  It has been a theme in her public utterances for some time.  See here.

I wonder, however, just whom Mrs. Clinton has in mind when she implies that TDE is a policy that her political opponents, specifically the current crop of Republicans running for president, would implement if elected.  I know of none of these Republicans who has said “elect me and I will pursue a policy of trickle down economics.”  Nor, for that matter am I aware of a period in which TDE was the reigning policy of a Republican administration, a period of time to which Mrs. Clinton does not want to return.  Indeed, to my knowledge, only Democrats use the term.

Certainly some of the current Republican candidates have advocated for reductions in marginal tax rates and the elimination of unnecessary regulations on businesses in order to incentivize work, productivity, and saving.  Perhaps policies of this sort are what Mrs. Clinton has in mind.  Yet, the economic theory underlying such supply-side policies is quite different from the description that Mrs. Clinton and other Democrats give to TDE.  According to that description, TDE is about giving more money to the rich in the hope that the rich will immediately spend that additional money on yachts and the like, which eventually will stimulate economic activity that trickles down to the lower income classes.

Supply-side economics, however, is not based on spending.  Quite to the contrary, it is based on the idea – long observed in economic life — that encouraging more work, productivity, and savings results in both immediate increases in aggregate wealth and increases in future wealth.  Future wealth comes about because additional saving provides the means to expand the capital stock.  Economic growth is the end result.  All income classes share in that growth.  Whether or not there is more spending by the rich on yachts is wholly irrelevant.

Milton Friedman was fond of saying, “there are only two kinds of economics — good economics and bad economics.”  Good economics teaches that, if you want growth and rising incomes, the capital stock must increase over time in order to make resources, including labor, more productive.  Increasing the capital stock, in turn, requires saving by those in the best position to save and also that the government exact as little of that saving as possible.  It is not a particularly difficult concept to grasp.  Perhaps even Mrs. Clinton will grasp it someday.

Central Banks Are the Problem, Not the Solution

Theodore A. Gebhard

In an op-ed in today’s Wall Street Journal entitled “Beware the Currency Wars of 2015”, Mike Newton, a former macro trader for Caxton Associates LLC and global head of emerging market FX strategy for HSBC, argues that global policy coordination among nations and central banks is called for to manage what otherwise will be all out currency wars later this year.  Absent such coordination, there will be a race to the bottom as nations devalue their currencies in order to stimulate exports and growth that years of artificially low interest rates have failed to bring about.  Indeed, to avoid a no-win situation, Mr. Newton goes so far as to suggest that “[t]he world may ultimately be heading toward a global managed exchange rate regime.”

Mr. Newton’s prescription, however, misses the root cause of the problem he describes and therefore his solution is misdirected. The solution is not to implement more coordination among the world’s central banks, but to curtail central bank interventions into domestic economies in their attempt to remedy market distortions, including global trade imbalances, that the central banks helped to create in the first place. The “ratchet effect,” an idea often attributed to economist Robert Higgs, states that the scope of government interventions continually ratchet up by dint of more interventions to address the unintended consequences of earlier interventions.  Regrettably, the idea is not limited to domestic fiscal and regulatory matters. The historical evidence continues to grow that the world’s central bankers, armed with their computer models and their money supply and interest rate manipulation tools, rarely succeed to achieve desired results (to their never-ending surprise) and even make matters worse by delaying recoveries and other needed domestic and global adjustments.  Rather than ratcheting up these failures with still more “coordinated” intervention that will have its own unintended consequences, it is long past time to concede that worldwide monetary central planning is fraught with human error and that what the world actually needs is a return to specie-backed sound money that resists manipulation and permits necessary global adjustments to take place undirected by monetary bureaucrats.   

Why Econometric Forecasting Is a Fool’s Errand

Theodore A. Gebhard

In a Wall Street Journal op-ed entitled “Government Forecasters Might as Well Use a Ouija Board” (appearing today, Oct. 16, 2014), Professor Edward Lazear of Harvard University cites several historical examples of gross inaccuracies in government macroeconomic forecasting that nonetheless were critical to policy formation. In light of this history, he properly urges government officials and political leaders to exercise far more humility in making claims based on such forecasts. 

Nonetheless, Professor Lazear leaves out of his discussion the principal reason why econometric forecasts are so notoriously bad.  Unlike models of the physical world where the data are insentient and relationships among variables are fixed in nature, computer models of the economy depend on data grounded in motivated human action and relationships among variables that are anything but fixed over time.  Human beings have preferences, consumption patterns, and levels of risk acceptance that regularly change, making mathematical relationships derived from historical data prone to being grossly inaccurate representations of the future.  Moreover, there is little hope for improved accuracy over time so long as human beings remain sentient actors.  It is no wonder that macroeconomic forecasting is largely an exercise in futility.

Modeling Climate v. Modeling the Economy

Theodore A. Gebhard

Recently the Wall Street Journal published an op-ed by theoretical physicist, Steven Koonin wherein Dr. Koonin discussed the difficulty in modeling the climate and climate change. As a consequence, climate science is hardly settled. The op-ed, as well as subsequent Letters to the Editor, brought to mind what I believe to be a similar difficulty in modeling the economy. In fact, I would go so far as to say that modeling the economy is even more problematic. To make these points, I sought to join the discussion by submitting a Letter to the Editor. I reproduce the letter below for anyone interested in my argument.

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Dr. Steven Koonin’s Review article (Sept. 20, print edition) and the subsequent Letters (Climate Science and Interpreting Very Complex Systems, Sept. 27) describing the problems with modeling climate change bring to mind the like problem of modeling the American economy.  A key difference, however, is that climate science models rely on unmotivated data and relationships among variables that are fixed in nature.  At least in principle, as data quality improves over time, the accuracy of climate change models should likewise improve.  By contrast, the computer models on which our monetary masters at the Federal Reserve rely to manipulate interest rates, contrary to what the free market would generate, depend on data grounded in motivated human action and relationships among variables that are anything but fixed.  Unlike carbon dioxide, human beings have preferences, consumption patterns, and levels of risk acceptance that regularly change, making mathematical relationships derived from historical data prone to being grossly inaccurate representations of the future.  Moreover, there is little hope for improved accuracy over time.  It is no wonder that macroeconomic forecasting is largely an exercise in futility.  Yet, it is the driver that makes us all slaves of the boom/bust cycles brought to us courtesy of the central planners on Constitution Avenue.

Theodore A. Gebhard

Is Economics a Science?

Theodore A. Gebhard

The Wall Street Journal recently published an op-ed by George Mason University economist Russ Roberts wherein Roberts questions whether economics can legitimately be called a science.  (Is the Dismal Science Really a Science? Feb. 27, 2010.)  Although Roberts makes excellent points on this question, I thought some additional ones were pertinent and submitted a Letter to the Editor. An edited version of my submission (to satisfy word count limitations) was published today (March 4, 2010), which can be found here on the WSJ’s website under the heading of “Economics Is Useful, but Not Nearly as Much as Physics.”

Below, I reproduce my original unedited version. A slightly modified essay-version is reproduced at Vienna Woods Law & Economics.

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Russ Roberts is spot on in questioning whether economics can legitimately be called a science.  (Is the Dismal Science Really a Science? Feb. 27, 2010)  The great 20th Century philosopher of science, Karl Popper, famously defined a scientific question as one that can be framed as a falsifiable hypothesis.  Economics cannot satisfy that criterion.  No matter the mathematical rigor and internal logic of any theoretical proposition in economics, empirically testing it by means of econometrics necessarily requires that the regression equations contain stochastic elements to account for the complexity that characterizes the real world economy.  Specifically, the stochastic component accounts for all of the innumerable unknown and unmeasurable factors that cannot be precisely identified but nonetheless influence the economic variable being studied or forecasted.

What this means is that economists need never concede that a theory is wrong when their predictions fail to materialize.  There is always the ready excuse that the erroneous predictions were the fault of “noise” in the data, i.e., the stochastic component, not the theory itself.  It is hardly surprising then that economic theories almost never die and, even if they lie dormant for a while, find new life whenever proponents see opportunities to resurrect their pet views.  Since the 2008 financial crisis, even Nobel Prize winners can be seen dueling over macroeconomic policy while drawing on theories long thought to be buried.

A further consequence of the inability to falsify an economic theory is that economics orthodoxy is likely to survive indefinitely irrespective of its inability to generate reliable predictions on a consistent basis.  As Thomas Kuhn, another notable 20th Century philosopher of science, observed, scientific orthodoxy periodically undergoes revolutionary change whenever a critical mass of real world phenomena can no longer be explained by that orthodoxy.  The old orthodoxy must give way, and a new orthodoxy emerges.  Physics, for example, has undergone several such periodic revolutions.

It is clear, however, that, because economists never have to admit error in their pet theories, economics is not subject to a Kuhnian revolution.  Although there is much reason to believe that such a revolution is well overdue in economics, graduate student training in core neoclassical theory persists and is likely to persist for the foreseeable future, notwithstanding its failure to predict the events of 2008.  There are simply too few internal pressures to change the established paradigm.

All of this is of little consequence if mainstream economists simply talk to one another or publish their econometric estimates in academic journals merely as a means to obtain promotion and tenure.  The problem, however, is that the cachet of a Nobel Prize in Economic Science and the illusion of scientific method permit practitioners to market their pet ideological values as the product of science and to insert themselves into policy-making as expert advisors.  Significantly in this regard, econometric modeling is no longer chiefly confined to generating macroeconomic forecasts.  Increasingly, econometric forecasts are used as inputs into microeconomic policy-making affecting specific markets or groups and even are introduced as evidence in courtrooms where specific individual litigants have much at stake.  However, most policy-makers — let alone judges, lawyers, and other lay consumers of those forecasts — are not well-equipped to evaluate their reliability or to assign appropriate weight to them.  This situation creates the risk that value-laden theories and unreliable econometric predictions play a larger role in microeconomic policy-making, just as in macroeconomic policy-making, than can be justified by purported “scientific” foundation.

To be sure, economic theories can be immensely valuable in focusing one’s thinking about the economic world.  As Friedrich Hayek taught us, however, although good economics can say a lot about tendencies among economic variables (an important achievement), economics cannot do much more.  As such, the naive pursuit of precision by means of econometric modeling —  especially as applied to public policy — is fraught with danger and can only deepen well-deserved public skepticism about economists and economics. 

Theodore A. Gebhard

Hello World!

Theodore A. Gebhard

Welcome to Liberty & Markets, my personal blog site.  I hope that you enjoy my commentary on legal, economic, and political issues of the day.  If you would like to know more about me and my background, please click on the About page on the opening screen.  TAG