Monday, January 14, 2019

Volalitily, now the whole thing

An essay at The Hill on what to make of market volatility, from Dec 31. Now that two weeks have passed, I can post the whole thing. I add some graphs too.  (Though at the rate things are going any forecast will have been proved wrong in two weeks!)

What’s causing the big drop in the stock market, and the bout of enormous volatility we’re seeing at the end of the year?

The biggest worry is that this is The Beginning of The End — a recession is on its way, with a consequent big stock market rout. Is this early 2008 all over again, a signal of the big drop to come? 
Maybe. But maybe not. Maybe it’s 2010, 2011, 2016, or the greatest of all, 1987. “The stock market forecast 9 of the last 5 recessions,” Paul Samuelson once said, and rightly. The stock market does fall in recessions, but it also corrects occasionally during expansions. Each of these drops was accompanied by similar bouts of volatility.  Each is likely a period in which people worried about a recession or crash to come, but in the end it did not come.



Still, is this at last the time? A few guideposts are handy. 

There is no momentum in index returns. None. A few bad months, or days, of stock returns are exactly as likely to be continued as to be reversed. The fact is well established, and the reason is simple: If one could tell reliably that stocks would fall next month, we would all try to sell, and the market would fall instantly to that level.

Twenty percent volatility is normal. Twenty percent volatility on top of a 5 percent average return, means that every other year is likely to see a 15 percent drop.

Big market declines come with a recession, as in 2008. But recessions are almost as hard to forecast as stock prices, and for much the same reason. If we knew with confidence that a recession would happen next year, businesses would not invest or hire, and people would not spend, and we’d have a recession now.

Recessions do have some momentum. But the cyclical indicators of the real economy are strong, much stronger than they were in 2007-2008. Unemployment is 3.7%. There is no slowdown in real GDP growth or industrial production, or business investment in the most recent data. Inflation is close to the Fed’s target, so there is little reason to fear the Fed will quickly raise rates and cause a recession. Now, the market aggregates more information and faster than the rest of us. Still, the lack of any slowdown adds weight to the suspicion that this correction may pass as well.

In thinking about the economy, remember that it has passed from “demand” to “supply.” At 3.9% unemployment, we cannot get greater growth from simply putting unemployed people and machines to work.

The stages of the business cycle
As we complete the transition from a demand-limited economy to a supply-limited economy, it is perfectly natural for interest rates to rise. One or two percent above the inflation rate is perfectly normal. As interest rates rise, it is perfectly natural for interest-sensitive sectors like housing and autos to decline a bit – but other sectors do better. Demand shifts between products, and auto or housing slowdowns do not mean an overall slowdown.

The economy no longer needs or can use monetary or fiscal “stimulus.” Now growth must come more productivity. Growth-oriented policy requires efficiency, “structural reform,” better incentives, not just money in pockets. In my view, the US has gotten an extra percent of growth, mostly from deregulation and a bit from the incentive effects of the tax cuts. But these are over, and further reform is unlikely. So a growth slowdown is certainly in the cards.



What about the yield curve? It is flattening – the difference between long-term rates and short term rates is narrowing. And an inverted yield curve has, historically, been a good forecast of a recession to come.

But we are not yet at inversion, as the graph shows. Moreover, there have been long periods of nearly flat yield curves in the past, when the “supply” economy kept growing before the next recession, most notably the mid 1990s. In fact, if inflation remains contained, it is possible that the world starts to resemble earlier eras with permanently inverted yield curves. In a non-inflationary environment, long-term bonds are safer for long-term investors. Last, the form of inversion matters as well as the fact. An inversion that comes from the Fed quickly pushing up short rates to cause a slowdown, fighting inflation, is likely to, well, cause a slowdown. An inversion that comes when long-term rates plummet, seeing trouble ahead, is likely to be followed by trouble ahead. We have neither of those circumstances.

So what is going on? I hazard a guess.

Volatility occurs when there is great uncertainty. Investors are worried big events are on the horizon, and can’t quite figure out what is going to happen. Prices aggregate information, so seeing a price decline can make you think other people know something you don’t in a time of great uncertainty. We see this clearly in studies of high frequency data, when bond markets are adapting and digesting Fed statements, and we know there is no other news to react to.

We are, no doubt, in a time of high uncertainty about policy and politics. Volatility broke out almost coincident with the November election, and I think the markets are trying to digest just what the political chaos of the next two years means for the economy.

Surely no major growth-oriented economic reforms will come out of Congress. Congressional democrats will bring the full weight of the legal system against the Administration. Cabinet secretaries trying to clean up regulation will have a hard time when being constantly subpoenaed.

The government shutdown over 1/10 of 1% of the Federal budget devoted to a border wall is emblematic. It is, of course, entirely symbolic as any border wall will be stuck in the courts for decades. But it is precisely when issues are symbolic that compromise is impossible.

So the best economic news that markets can hope for is two years of complete government paralysis, and therefore a return to 2 percent or so growth.

Things could be much worse, and markets know it. A large policy blunder in the next two years, such as a big trade shock could well happen.

More deeply, the US is now unable to respond to any genuine crisis — economic, financial, military. Imagine that another banking crisis hits, and President Trump asks Congress, again, for a trillion bucks to bail out banks, and another trillion for fiscal stimulus. Or imagine if he does not, and whether the Administration can implement better ideas to fight a new and different crisis. Imagine what happens if China invades Taiwan, or a big bomb goes off in the middle east.

Europe is not in much better shape. It has followed the Augustinian approach to structural reform – Dear Lord, give me reform, but not quite yet. Italian banks, and too many German banks, are still stuffed with Italian government debt. Brexit, Cinque Stelle, and Gilets Jaunes mean that pro-market, free trade, growth-oriented structural reform not likely, and there is a limit to what even the ECB can do. China is as usual obscure, and more fragile than they want us to believe.

Throughout the world, government debt remains the big danger. Where is there a lot of debt, no plan to repay it, shady accounting, extend-and-pretend, off-balance sheet guarantees, and the debt is mostly short term and prone to runs? Government debt. If a serious recession comes, in a time of dysfunctional government, it may well provoke a government debt crisis, which would be an economic conflagration beyond anything we have seen.



So, we live in a time of great uncertainty, brought about by great political uncertainty. Great uncertainty leads to volatility. Volatility means that stocks are more risky, and thus must pay a greater expected return to get people to hold them. The only way for the expected future return to rise, is for today’s price to go down. So we see a correction – mild so far, to compensate for the mild risk of holding stocks through a few months of ups and downs.

There is a silver lining to this story. If prices are low because required returns have risen, then if nothing bad happens, long-term investors will do fine. Bond prices go down when yields go up, and the larger yields eventually make up for the price loss.

But greater uncertainty means a greater chance that something truly terrible will happen. As well as a greater chance that it won’t. The big message of the moment is that risk is higher. Managing risk, not following some sage’s directional bet, is the best investment advice anyone should start with.

(I also wrote here "The Jitters" related thoughts about the spring 2018 bout of volatility.)

Friday, January 11, 2019

Property tax present value

How much is the property tax? In Calfornia, we pay 1%  per year.

That doesn't seem bad, except that property values are very high. You can't get a tear-down in Palo Alto for under $2 million. If you buy a house that costs 5 times your income -- say someone earning $200,000 per year buying a $1 million house -- then that is equivalent to 5 percentage points additional income tax.  On top of 42% federal, 13.2% state, 9% sales, and other taxes, it's part of my view that we're past 70% top marginal rate now.

The other way to look at taxes is in present value. At 1% interest rate, the value of a 1% payment is $1.00. What that means: Suppose you bought a $1,000,000 house. It's going to cost you $10,000 in property taxes per year. Let's set up an account that will pay your property taxes. If you get 1% interest on that account, you need to put $1,000,000 in the account!

A 1% property tax at a 1% interest rate is equivalent to a 100% tax on houses. That $1,000,000 house is really going to cost you $2,000,000!

There is a general paradox here: The top two things our politicians say they want to encourage are jobs and homeownership. Jobs are perhaps the most highly taxed economic activity in the economy, and by this calculation houses come in a close second.

(California also assesses a 1% personal property tax, on top of a sales tax, for anything they can prove you own, which usually means boats and airplanes. That too is an additional 100% tax.)

The second lesson, the value of wealth taxes depends sensitively on the interest rate, as I'm sure some of you are chomping at the bit to point out. If the interest rate is 2%, then the tax rate is "only" 1/0.02 = 50%. If the interest rate is 5%, then the tax rate is 1/0.05 = 20%. I suspect these taxes were put in place in a time of higher interest ares and nobody is really thinking about the effect of lower rates.

Similarly, suppose the government puts in a 1% per year wealth tax. If wealth generates a 5% rate of return, then the 1% wealth tax is the same thing as a 20% one-time confiscation of value*.  If wealth generates a 1% rate of return, a 1% wealth tax is a 100% confiscation of value**. Mercifully, our income tax system taxes the rate of return, not the principal, and avoids this conundrum. Others do not.

What is the right rate? We can have a lot of fun with that one. The current 30 year TIPS (inflation indexed) rate is 1.19%. The 30 year nominal Treasury rate is 2.97%.  In California, under Proposition 13, you pay 1% of the actual purchase price per year, but that quantity never increases. (This fact results in the paradox of extremely high property taxes on new purchasers, older people staying in huge old houses, and low property tax revenues.) So you might say that the nominal rate applies.

In Illinois, you pay a percentage of assessed value, which is usually a good deal lower than the actual value. (It also leads to a fun game of fighting over what the assessed value is. No surprise some of Illinois' most powerful politicians are also lawyers whose firms argue property assessment cases. ) That means however that the real interest rate matters.

But in both cases, we need to use the after-tax rate. If you put your money in a 30 year treasury (or a long-term bond fund that keeps a long maturity), you pay taxes on the interest. If your marginal tax rate (federal + state + local) is 50%, that means you only get half the interest. So that 3% nominal yield is really a 1.5% nominal yield, and the Californian should use a 1.5% rate, resulting in a 1/0.015 = 66% tax rate.

The tax treatment of TIPS is more complicated. (Really, inflation protected bonds are a great idea, but did the Treasury have to screw up the tax treatment so thoroughly?) You pay taxes on the nominal interest payments, and also on increases in principal value. This causes an accounting mess that I don't want to get into here, but as a rough guide, if you are in a 50% marginal tax bracket, then you need to buy $200 worth of TIPS to generate a $1.00 after-tax stream. So, if you live in a state where property tax assessments rise over time, we're really talking about 2  x 1/0.01 = 200% tax rate on the initial assessed value.

Now, house prices rise more than inflation. That argues for an even higher present value of taxes.

On the other hand, you're not going to keep your house forever. But you will sell it, and the price reflects the property tax. On one extreme, if there is no house supply, then the price reflects the full property tax. Without property tax, you could sell it for double the current value. Then these calculations are right. That's a good approximation for Palo Alto. If house supply is flat, then the house price equals construction costs, and we need to cut off these present values at your horizon for owning the house.

The back of my envelope is full.

I'm not very good at taxes, so I welcome comments and corrections on this.  Also if it's all standard stuff, send a pointer to the source.

*sum_j=0^inf (0.05 - 0.01)/(1.05)^j = 0.04/0.05 = 0.80 = (1-0.20) x sum_j=0^inf 0.05 / (1.05)^j

**sum_j=0^inf (0.01 - 0.01)/(1.01)^j = 0 = (1-1) x sum_j=0^inf 0.01 / (1.01)^j 

Update: Thanks to several commenters who point out that California property tax rises at the lesser of inflation or 2%. This means that the lower real interest rate is the right discount rate, not the higher  nominal interest rate. 

Sunday, January 6, 2019

Krugman on optimal taxes

As you may have noticed, I try very hard not to get in to the business of rebutting Paul Krugman's various outrages. The article "The economics of soaking the rich" merits an exception. I will ignore the snark, the... distoritions, the ... untruths, the attack by inventing evil motive, the  demonization of anything starting with the letter R, and focus on the central economic points.

Paul correctly cites recent work by Diamond and Saez, estimating the optimal top marginal tax rate at 70%, and Christina Romer's concurring opinion.

The howlers are well epitomized by

"Why do Republicans adhere to a tax theory that has no support from nonpartisan economists and is refuted by all available data? Well, ask who benefits from low taxes on the rich, and it’s obvious.

And because the party’s coffers demand adherence to nonsense economics, the party prefers “economists” who are obvious frauds and can’t even fake their numbers effectively."

1) 70% is not carved in stone.

Diamond and Saez made a big splash precisely because their estimates were so novel and so much higher than the prevailing consensus. For example, Greg Mankiw, also a previous CEA chair, and not a fraud, writing the excellent "Optimal Taxation in Theory and Practice" in the Journal of Economic Perspectives, a nonpartisan (or left-leaning) academic journal, not a fraud, with with Matthew Weinzierl and Danny Yagan, writes
A well-known early result of the Mirrlees (1971) model is the optimality of a zero top marginal tax rate. ...
All this leaves the policy advisor in an uncomfortable position. Early work, following Mirrlees (1971), assumed a shape for the ability distribution, a social welfare function, an individual utility function, and a pattern of labor supply elasticities that yielded clear and surprising results— declining marginal tax rates at the top of the income distribution. Some recent work has yielded dramatically different results more consistent with existing policy, but many of the key assumptions are open to debate.
... 
Lesson 3: A Flat Tax, with a Universal Lump-Sum Transfer, Could Be Close to Optimal 
The claim that the optimal marginal tax schedule is generally flat has been challenged often in the nearly four decades since Mirrlees (1971). Most prominently, Saez (2001) finds optimal tax rates that increase steadily from incomes around $50,000 to $200,000. Of course, the optimal tax schedule is sensitive to assumptions about the inputs discussed in the previous lesson: the shape of the distribution of abilities, the social welfare function, and labor supply elasticities. None of these three components of the problem is easily pinned down. 
You get the picture, the optimal top tax rate is in fact a highly contentious number, depending on many assumptions, all very hard to measure or even to define really.

As Mankiw et al point out, the position "let's implement textbook optimal taxation theory" might be a bit uncomfortable for Krugman's position that all things that start with D are holy.
Lesson 6: Only Final Goods Ought to be Taxed, and Typically They Ought to be Taxed Uniformly
Lesson 7: Capital Income Ought To Be Untaxed, At Least in Expectation
There is a lot of controversy on these too -- the best way to get an AER publication is to disagree with orthodoxy, but they are still the rough orthodoxy, and there are sensible non-evil people who agree with them.

2) Even in Diamond, Saez, et Al, 70% is the total tax, not the federal income tax, and it is the marginal rate not the average rate.  (Though not always as you'll see in a minute)

We have to add up every wedge between one dollar of extra revenue you create for your employer, and the value of what you receive in turn. That includes the  federal income tax, plus state and local income taxes,  property taxes, excise taxes, estate taxes, and so forth. We have to include sales taxes, personal property taxes, payroll taxes on employees you might hire. We have to include your share of corporate and business taxes (corporations raise prices to pay their taxes, so you're paying in the end). It's a marginal rate -- we have to include phaseouts of tax benefits, and loss of income-related subsidies.

Greg Mankiw calculated his marginal tax rate at over 90% (Sorry, I can't find the link anymore). He thought about, what if he takes a consulting job, pays all tax on it, saves it, paying taxes on dividends and intrerest, gives it to his kids, paying estate taxes, and they spend it. Even greg forgot about sales taxes and property taxes (if they buy a house) in this calculation. In California, where I live, the top rate is at least 42% federal + 13.2% state (not deductible anymore)  + about 10% sales tax + about 6% property tax (1% of house value per year, house = 5 times income) +  .. it goes on like this.

Watch what you wish for. A 70% all in marginal rate might well be a tax cut for many households. I once semi-humorously proposed an alternative maximum tax.

Krugman and company are proposing a 70% top federal rate on top of all the others, which is... a bit deceptive relative to the 70% total marginal tax rate even in his cherry-picked sources.

3) Disincentives. Krugman correctly points out the central tradeoff.
So why not tax them at 100 percent? The answer is that this would eliminate any incentive to do whatever it is they do to earn that much money, which would hurt the economy. 
But then Krugman, and those he cites, take an extremely narrow view of this disincentive effect.

By and large the "optimal redistribution" theory considers only the static question, how many hours will you work.
 If a rich man works an extra hour, adding $1000 to the economy, but gets paid $1000 for his efforts, ...
 And, correctly, I think, this literature by and large agrees with the labor supply literature that once people have found jobs and careers, they tend to work about 40 hours a week or so even at pretty high tax rates. We can argue about that, but I think it's more productive to look at all the margins that are ignored here.

The big margin for economic growth is peoples human capital decisions -- the decision to go to school, to take hard courses (computer programming) rather than softer more pleasant ones, the decisions to start businesses and invest enormous time when young developing them. The optimal redistribution literature just ignores all of this. And, like the decision to relocate, it depends on the total tax bite, not just the marginal tax bite. How much will I earn, after all taxes -- what lifestyle will I lead -- if I go to med school, or just stay where I am? High tax countries do not immediately see people staying home from work. But they do not see vibrant business formation and human capital investment. (Chad Jones has a great new paper on this.)

The other margin is avoidance. Throwing around high statutory tax rates in the 1950s as if anyone actually paid them is past disingenuous at this point, as often as the opposite has been pointed out. (Diamond and Saez engaged at least recognized that nobody paid 90%, but engage in a subtle .. sleight of hand. They assume that all corporate taxes were paid by wealthy people in the 1950s -- the one and only burden or indirect calculation in the paper, and contrary to the usual assumption that capital supply curves are flatter than labor or product demand.)

The one thing we should learn from the New York Times and others' probes in to Trump Tax Land is just how far very wealthy people will go to avoid paying taxes. Especially estate taxes -- there is nothing like the government coming for nearly half your wealth to concentrate the mind. I venture that we would have gotten a lot more out of the Trump family with a 20% VAT and no income tax or estate tax!

A 70% or 80% marginal federal income tax would be first and foremost a boon for tax lawyers and accountants. If one were in the mood to match Krugman's attacks of which party has which dark motives to serve which evil interest, the direction would be easy.

Moreover, Krugman gets the benefit of labor to society wrong in an astonishing econ 1 way
If a rich man [or woman, Paul, please!] works an extra hour, adding $1000 to the economy, but gets paid $1000 for his efforts, the combined income of everyone else doesn’t change, does it? Ah, but it does — because he pays taxes on that extra $1000. So the social benefit from getting high-income individuals to work a bit harder is the tax revenue generated by that extra effort — and conversely the cost of their working less is the reduction in the taxes they pay.
If you are paid your marginal product, as you are in a competitive market, then you are paid how much revenue your efforts add to your employer's bottom line. But society benefits by the consumer surplus, the area under the demand curve, and loses that consumer surplus when taxes put a wedge between your effort and your wage. When Steve Jobs worked hard and sold us all Iphones, he made a ton of money, and apple made a huge profit. But we all benefitted by far more than we paid Apple for the phones.

No, the world is not a static, zero-sum game.

I should add though, that economics really doesn't care how much taxes you, or "the rich" pay. Economics cares about the marginal rate, how much you pay on the extra dollar. There is not much of an economic case, really, for low taxes on the rich, or anyone else, so long as taxes do not distort economic decisions. That's the case for a very broad base -- and a low rate. Krugman et al are beyond misleading if they characterize the case for low taxes as handouts for the rich. No, the case is incentives for the rich -- and everyone else. (Incentives are particularly bad at the low end, where you lose a dollar of benefits for every dollar of earnings.)

4) Garbage in, garbage out.

Every result in economic theory starts from assumptions and derives conclusions. This one is the same. Before we get to the distribution of talent, the accumulation of human capital, and the rest, this whole business starts with the presumption that the US Federal Government is a benevolent dictator, whose job it is to take from Peter to give to Paul -- to maximize the sum of everyone's utility, and yes making intrapersonal comparisons to do it -- constrained only by Peter's willingness to work if faced with a steep tax rate.

If you don't buy that basic assumption, along with all the others along the way, you don't buy the result. If, in particular, you look at the world circa 1850, or even in Krugman's cherished 1950, and you look at how amazingly better off we all are today, and you conclude that the government's job is to foster economic growth as fast as possible, then all bets are off.

No, the world is not a static, zero-sum game, in which we fleece the rich one just enough to keep him playing.

I think it's time to reactivate my no-Krugman new year's pledge.




Friday, January 4, 2019

Selgin on IOER and TNB

George Selgin has a nice piece on TNB and IOER, which I missed when it came out in September, but it's still relevant.

(HT a correspondent. TNB is "The Narrow Bank" which I wrote about here; IOER is interest on excess reserves. The Fed pays banks interest on reserves, which are accounts that banks hold at the Fed.) 

As George points out, TNB's model is to take money from, large corporations or money market funds, invest that money at the Fed as interest-paying reserves, and give as large an interest rate back to the depositors as possible. (Well, that's what their model will be if their suit against the Fed  winds through the US legal system before the next crash, which is unlikely, These customers can't get large enough insured deposits at regular banks; that TNB invests entirely in reserves make it impossible for TNB to fail so its customers don't need insurance. TNB doesn't want to let you or me give them money because that opens them to an immense amount of costly regulation.

The puzzling question is, how can TNB make money at that.?TNB takes money, invests it with the Fed, and the Fed in turn buys US treasuries. How is that better than TNB simply operating a money market mutual fund that invests directly in Treasurys?

The answer is, that for most of the last decade, the Fed has paid more interest on reserves than comparable treasury rates. Yes, "money" pays higher interest than "bonds," an inversion of classic monetary theory. Since money is more liquid, how can this survive? The answer is, because only banks can access this kind of "money." TNB was going to upend that.

Just why does the Fed pay more interest on reserves than comparable treasuries?  This is, like it or not, a nice little subsidy to banks, who get about 0.2% more on their reserves than anyone else can get.

Where does that 0.2% come from? You and me. George explains vividly
Just how is it that the Fed's IOER payments could allow MMMFs to earn more than they might by investing money directly into securities themselves? Because the Fed has less overhead? Don't make me laugh. Because Fed bureaucrats are more astute investors? I told you not to make me laugh! No, sir: it's because the Fed can fob-off risk — like the duration risk it assumed by investing in so many longer-term securities — on third parties, meaning taxpayers, who bear it in the form of reduced Fed remittances to the Treasury. That means in turn that any gain the MMMFs would realize by having a bank that's basically nothing but a shell operation designed to let them bank with the Fed would really amount to an implicit taxpayer subsidy. There Ain't No Such Thing As A Free Lunch... As it stands, of course, ordinary banks are already taking advantage of that same subsidy.
This is good, and I conclude that the Fed should keep a large balance sheet, flood the economy with liquidity as Friedman said it should, and run a tight corridor system paying no more on excess reserves than comparable Treasury rates.  Here we part company.

George seems to agree with the Fed though, that this subsidy is an integral part of the interest on reserves scheme, and that TNB will undermine the whole project of a large balance sheet and targeting interest rates directly via interest on reserves and later, the discount rate. I disagree.

Deregulation

Many of us free-market types bemoan how poorly designed regulation hurts economic growth. But unlike "stimulus," regulation is a death by a thousand knives. Each one seems innocuous, but they add up. It's hard to tell the story without details. There is no handy government statistic on "impact of regulations." We tend to talk about what we can easily measure. Likewise, there is a general sense that the current deregulation effort may be helping, but again without details it's hard to know if this is truth or spin.

In this context, I just learned of an interesting new website at the Brookings Institution that tracks Trump Administration deregulation efforts (HT Daniel Henninger at WSJ).  I get the general sense that Brookings isn't too happy with it and wants to expose removal of useful regulations. But they've done a nice job, so you can read it both ways.

Yes, the big ones you've heard of are there. The Waters of The US Rule, The Coal Fired Powerplants Rule, Title IX, Asylum Seeker restrictions, Fuel Economy standards, lots of rules pecking away at capital standards for financial institutions (so much for procyclical capital!)  and so forth.

It's interesting quite how many are not really Administration deregulations, but compliance with the Supreme court throwing out Obama era regulations. This really is what the Supreme Court battle is about.

It's also interesting actually how short this list is. For all the talk of "deregulation," you would think thousands of individual rules would be on the chopping block.

But I enjoyed this mostly for details for all the little ones you don't read about every day, a little peek into the bowels of the regulatory state.
Affordable Housing Program Amendments 
The Federal Home Loan Bank Act requires each Federal Home Loan Bank to establish an affordable housing program to enable members to provide subsidies for long-term, low- and moderate-income, owner-occupied, and affordable rental housing. 
What? You might have thought Trump officials were going to stage a book burning of that one, but no, it's modest
This proposed rule invites comment on several amendments to the regulations governing Federal Home Loan Banks, among others, giving Federal Home Loan Banks additional authority to allocate their Affordable Housing Program funds and relaxing or streamlining certain regulatory requirements.
Baby steps, baby steps

Monday, December 31, 2018

Volatility

An essay at The Hill on what to make of market volatility:

What’s causing the big drop in the stock market, and the bout of enormous volatility we’re seeing at the end of the year?

The biggest worry is that this is The Beginning of The End — a recession is on its way, with a consequent big stock market rout. Is this early 2008 all over again, a signal of the big drop to come? 



Maybe. But maybe not. Maybe it’s 2010, 2011, 2016, or the greatest of all, 1987. “The stock market forecast 9 of the last 5 recessions,” Paul Samuelson once said, and rightly. The stock market does fall in recessions, but it also corrects occasionally during expansions. Each of these drops was accompanied by similar bouts of volatility.  Each is likely a period in which people worried about a recession or crash to come, but in the end it did not come. 
Still, is this at last the time? A few guideposts are handy. 
There is no momentum in index returns. None. A few bad months, or days, of stock returns are exactly as likely to be continued as to be reversed. The fact is well established, and the reason is simple: If one could tell reliably that stocks would fall next month, we would all try to sell, and the market would fall instantly to that level.
Twenty percent volatility is normal. Twenty percent volatility on top of a 5 percent average return, means that every other year is likely to see a 15 percent drop. 
Big market declines come with a recession, as in 2008. But recessions are almost as hard to forecast as stock prices, and for much the same reason.

...

They asked me to hold off a few weeks before posting the whole thing. So either wait two weeks or head over to The Hill. I also wrote here "The Jitters" related thoughts about the spring 2018 bout of volatility. 

Sunday, December 30, 2018

Sumner on teaching economics

Scott Sumner has a terrific post on teaching economics. (HT Marginal Revolution)
The core ideas of economics are extremely counterintuitive and are not accepted by most people....
Non-economists also tend to reject the central ideas of basic economics, and for reasons that are not well justified. [In particular these central ideas do not rest on hyper-rationality.] For the economics profession, our “value added” comes not from spoon feeding behavioral theories that the public is already inclined to accept, rather it is in teaching well-established basic principles of which the public is highly skeptical.  Thus we should try to discourage people from believing in the following popular myths: 
1.    People don’t respond very strongly to economic incentives.  (I.e., the demand for life-saving drugs is very inelastic.) 
2.    Imported goods, immigrant labor, and automation all tend to increase the unemployment rate. 
3.    Most companies have a lot of control over prices.  (I.e. oil companies set prices, not “the market”.) 
4.    Policy disputes over taxes and regulations are best thought of in terms of who gains and who loses. 
5.    Experts are smarter than the crowd. 
6.    Speculators make market prices more unstable. 
7.    Price gouging hurts consumers. 
8.   Rent controls help tenants. 
These myths are all widely believed by the general public.
Our primary goal should not be to add new information, it should be to have people unlearn false ideas about the world.
My emphasis.

One is tempted to add to the list. (An invitation to comments.)  Many of them stem from a basic principle -- "find the supply response" or ("demand response") that the fallacy ignores. "State the budget constraint" is another good habit.  Look for competition, entry, and choice among alternatives -- a market is not just bilateral negotiation. I might add reverse causality and selection bias -- empirical economics has stories to tell as well.

Scott frames the essay as a reaction to an Atlantic story advocating more teaching of behavioral economics. Scott is very clear: he is not opposed to behavioral economics. (He will likely be misquoted on this. Some behaviorists are very touchy. I know this from painful experience.) He is merely opining that our profession has more value added in teaching regular economics first. Regular economics is harder, less intuitive, less known, and therefore more valuable. To really understand behavioral economics, you have to understand what it is behaviorists object to -- and the vast amount of regular economics that good behaviorists agree with. Art schools might do better teaching people to draw, music schools to teach classical before atonal, physics programs newtonian before quantum mechanics, and so forth.
Most people find the key ideas of behavioral economics to be more accessible than classical economic theory. If you tell students that some people have addictive personalities and buy things that are bad for them, they’ll nod their heads.  And it’s certainly not difficult to explain procrastination to college students. [Dave Henderson's nomination for best sentence in the essay!] Ditto for the claim that investors might be driven by emotion, and that asset prices might soar on waves of “irrational exuberance.”  ... One should spend more time on subjects that need more time, not things that people already believe. 
I.e. let us not indulge in our own quest for teaching ratings via confirmation bias.

Yes, people do nutty things. But if you approach rent control, and all you have in the back of your head is behavioral stories, you will miss the clear prediction, borne out time and time again, that within a decade there will be a massive shortage of rental housing.

Scott does not neglect how awful most economics courses are
That doesn’t mean that I agree with the way that economics majors are currently being taught.  Our intermediate level courses are far too theoretical; they waste students’ time on lots of minor theories that would only be useful for people planning to do graduate work in economics.  (Most students do not.)  Too many homework problems with Cobb-Douglas utility, Hicksian demand, marginal rates of substitution, Giffen goods, gross substitutes, indifference curves, etc.  Some of that is appropriate, but all economics courses should focus heavily on applied economics. 
Most students come out of such courses still unable to coherently judge Scott's nice list of fallacies. Most of our courses are histories of thought, "greatest hits" of past theoretical contributions, passed on rather mindlessly. We teach many harmful parables. For example, natural monopoly due to increasing returns to scale, and the need for resulting regulation is a staple, passed down from about 1910. It has little to do with modern industrial organization in a global economy.

In part, it's easy to get through an hour by moving the curves around. Teaching real applied cases is much harder.

Macroeconomics teaching is in worse shape. Keynesian macro, like behavioral economics, enshrines most people's intuitive fallacies. Consuming more will increase output - forgetting the budget constraint. Breaking windows is good as it gives employment to window repair people. Good Keynesian macro justifies these apparent fallacies with carefully described "frictions," by which classical economic results fail. But you have to understand those classical results first to arrive at a correct economics that recognizes frictions (like behavioral biases) but doesn't violate budget constraints and accounting identities. Most macro teaching consists of young professors pushing IS-LM curves around, though such curves appear nowhere in their own research, nor anyone else's since the time they were born. Well, it passes the time easily.

An important point is implicit. Economics is not hard because of math. The math in even graduate level economics is no greater than in sophomore physics. Classical economics is hard because it can attack social problems in a value-free, cause-and-effect way, and upends the little morality stories that most people use to think about those problems -- rents are high because landlords are greedy. "Learning to think like an economist" is indeed best learned by application. And "learning to think like a behavioral economist" requires learning to think like an economist first.

Saturday, December 29, 2018

Homeless

Christopher Rufo at the New York Post has an interesting article on homeless problems in Seattle. The analysis rings true of many other areas, especially San Francisco. It is also  a good microcosm of how policy and law in so many social and economic areas stays so profoundly screwed up for so long.
The real battle isn’t being waged in the tents, under the bridges or in the corridors of City Hall, but in the realm of ideas, where, for now, four ideological power centers frame Seattle’s homelessness debate. I’ll identify them as the socialists, the compassion brigades, the homeless-industrial complex and the addiction evangelists.
My emphasis. And the political influence of groups organized around absurdly counterfactual narratives is the larger picture of this story.

Who are these people? "Socialist" is not an insult, it is how the new left-wing groups describe themselves:
Socialist Alternative City Councilwoman Kshama Sawant claims that the city’s homelessness crisis is the inevitable result of the Amazon boom, greedy landlords and rapidly increasing rents. 
The capitalists of Amazon, Starbucks, Microsoft and Boeing, in her Marxian optic, generate enormous wealth for themselves, drive up housing prices, and push the working class toward poverty and despair — and, too often, onto the streets. 
...According to King County’s point-in-time study, only 6 percent of homeless people surveyed cited “could not afford rent increase” as the precipitating cause of their situation, pointing instead to a wide range of other problems — domestic violence, incarceration, mental illness, family conflict, medical conditions, breakups, eviction, addiction and job loss — as bigger factors.
...the evidence suggests that higher rents alone don’t push people onto the streets. Even in a pricey city like Seattle, most working- and middle-class residents respond to economic incentives in logical ways: relocating to less expensive neighborhoods, downsizing to smaller apartments, taking in roommates, moving in with family or leaving the city altogether. King County is home to more than 1 million residents earning below the median income, and 99 percent of them manage to find a place to live and pay the rent on time. 
To be clear, that response does not imply everything is hunky-dory in Seattle's (or San Francisco's) housing market. The point is narrow -- high rents do not cause people to live on the streets.

Next,
The compassion brigades are the moral crusaders of homelessness policy. Their Seattle political champion is City Councilman Mike O’Brien,... O’Brien has become a leader in the campaign to legalize homelessness throughout the city. He has proposed ordinances to legalize street camping on 167 miles of public sidewalks, permit RV camping on city streets, and prevent the city’s homeless-outreach Navigation Teams (made up of cops and other workers) from cleaning up tent cities. 
O’Brien and his supporters have constructed an elaborate political vocabulary about the homeless, elevating three key myths to the status of conventional wisdom. The first is that many of the homeless are holding down jobs but can’t get ahead... 
But according to King County’s own survey data, only 7.5 percent of the homeless report working full-time, despite record-low unemployment, record job growth and Seattle’s record-high $15 minimum wage. The reality, obvious to anyone who spends any time in tent cities or emergency shelters, is that 80 percent of the homeless suffer from drug and alcohol addiction and 30 percent suffer from serious mental illness, including bipolar disorder and schizophrenia.
Common sense suggests that the central conundrum of city policy to deal with homelessness is that people move. The "compassion brigades''  must deny this fact:
...Progressive publications like The Stranger insist that “most people experiencing homelessness in Seattle were already here when they became homeless.” This assertion, too, clashes with empirical evidence. More than half of Seattle’s homeless come from outside the city limits, according to the city’s own data. Even this number might be vastly inflated, as the survey asks only “where respondents were living at the time they most recently became homeless” — so, for example, a person could move to Seattle, check into a motel for a week, and then start living on the streets and be considered “from Seattle.”
More rigorous academic studies in San Francisco and Vancouver suggest that 40 percent to 50 percent of the homeless moved to those cities for their permissive culture and generous services. 
There's much more at the original. The next group are "addiction evangelists." I'm pretty libertarian about drugs, but there are certain externalities especially to policies that encourage drug use out doors and in concentrated areas. And again easy drugs in just one place forms  a magnet:
public consumption sites do tremendous damage to businesses, residents and cities at large. It also attracts more homeless to a city. 
In Seattle, the influx has already begun. According to survey data, approximately 9.5 percent of the city’s homeless say that they came “for legal marijuana,” 15.4 percent came “to access homeless services,” and 15.7 percent were “traveling or visiting” the region and decided that it was a good place to set up camp... Even King County’s former homelessness czar admits that the city’s policies have a “magnet effect.” 
Last time I was in San Francisco, as we were entering a restaurant a half-clothed man was shooting up heroin on the four foot wide sidewalk just in front of the restaurant. I feel for the problems this man must have been facing, and the terrible life he leads. But San Francisco's policies are not a functional response, either to his problems, or those of a city where this is a normal part of life.

Chris doesn't offer easy solutions, nor do I.
The best way to prevent homelessness isn’t to build new apartment complexes or pass new tax levies but to rebuild the family, community, and social bonds that once held communities together.
That's nice, but let's put it mildly a large project. And neighborhoods where the vast majority of children are born to and raised by single women, with few fathers or working men in sight, seems like a larger goal of such a policy. (Another great topic for fanciful narratives is political discussion of "inequality" in which this screaming impediment to economic advancement is as unmentionable as is nuclear power at a climate-change rally.)

More realistically,
Homelessness should be seen not as a problem to be solved but one to be contained.
Cities must stop ceding their parks, schools and sidewalks to homeless encampments. In San Diego, for instance, city officials and the private sector worked together to build three barracks-style shelters that house nearly 1,000 people for only $4.5 million. 
They’ve moved 700 individuals off the streets and into the emergency shelter, allowing the police and city crews to remove and clean up illegal encampments. 
In Houston, local leaders have reduced homelessness by 60 percent through a combination of providing services and enforcing a zero-tolerance policy for street camping, panhandling, trespassing and property crimes. There’s nothing compassionate about letting addicts, the mentally ill and the poor die in the streets. The first order of business must be to clean up public spaces, move people into shelters and maintain public order.
The latter is the heart of Chris's point. The former seems sensible, and I have heard good superficial reports of similar programs. Still, I'm skeptical. One trip to a public toilet is enough to convince you of the difficulties of renting any kind of apartment to people who are struggling with mental illness and drug addictions. Didn't we just close down housing projects all over the country? Plus, we are infatuated with building new housing. The easiest way to get cheap housing is to move wealthy people out of older houses by letting them build new. And this too is the sort of thing that really has to be done at the state level. If one city does too good a job, it will only attract people to move there and make its job harder.

Today's post though is not about exactly what policy is best to solve this tough problem. Most of all, I am struck by Chris' insight about how really dysfunctional policies persist through the repetition of these fairy-tale narratives.

The current policy dysfunction is pretty clear.
the Seattle metro area spends more than $1 billion fighting homelessness every year. That’s nearly $100,000 for every homeless man, woman and child in King County, yet the crisis seems only to have deepened,... By any measure, the city’s efforts are not working
Now let's talk about job training programs, disability, food stamps, agricultural subsidies, trade, tax laws...

Wednesday, December 26, 2018

Imagine what we could cure -- full oped

WSJ oped with J J Plecs, formerly of Roam Analytics, which does a lot of health related data work. This is the full oped now that 30 days have passed. The previous blog post has a lot of interesting updates and commentary.


The discovery that cigarettes cause cancer greatly improved human health. But that discovery didn’t happen in a lab or spring from clinical trials. It came from careful analysis of mounds of data.

Imagine what we could learn today from big-data analysis of everyone’s health records: our conditions, treatments and outcomes. Then throw in genetic data, information on local environmental conditions, exercise and lifestyle habits and even the treasure troves accumulated by Google and Facebook .

The gains would be tremendous. We could learn which treatments and dosages work best for which people; how treatments interact; which genetic markers are associated with treatment success and failure; and which life choices keep us healthy. Integrating payment and other data could transform medical pricing and care provision. And all this information is sitting around, waiting to be used.

So why isn’t it already happening? It’s not just technology: Tech companies are overcoming the obstacles to uniting dispersed, poorly organized and incompatible databases. Rather, the full potential of health-care data analysis is blocked by regulation—and for a good reason: protecting privacy. Obviously, personal medical records can’t be open for all to see. But medical-data regulations go far beyond what’s needed to prevent concrete harm to consumers, and underestimate the data’s enormous value.

Most of us have seen how regulations kept medicine in the fax-machine era for decades, and how electronic medical records are still mired in complexity. It’s tough enough for patients to access their own data, or transfer it to a new doctor. Researchers face more burdensome restrictions.

“Open Data” initiatives in medical research, which make medical data freely available to researchers, are hobbled by Health Insurance Portability and Accountability Act (HIPAA) regulations and data-management procedures that reduce the data’s value and add long lead times. For example, regulations mandate the deletion of much data to ensure individual privacy. But if the data are de-identified to the point that patients can’t possibly be distinguished, nobody will be able to tell why a given patient experienced a better or worse result.

HIPAA “safe harbor” guidelines require removing specific dates from patient data. Only the year when symptoms emerged or treatments were tried can be shown. So which treatment was tried first? And for how long? Was the patient hospitalized before the treatment or three months later? All of a sudden, the data aren’t so helpful.

Health-care data released for public use are also closely hemmed in. For instance, Medicare prescription data are censored if a doctor wrote 10 or fewer prescriptions for a particular drug. That means whole categories of usage and prescribers are systematically missing from the publicly available data.

Regulators need to place greater weight on the social value of data for research. Data use can be limited to research purposes. Specific dangers, rather than amorphous privacy concerns, can be enumerated and addressed. The Internal Revenue Service seems to have figured out how to keep individual-level tax data private while allowing economic researchers to study it. Similar exploration is needed for health data; the opportunity cost of medical discoveries not made is too high to ignore.

Research consortia or governmental agencies can release patient-level data sets, including high resolution on symptoms, treatments, lab test-results and medical outcomes, but with names and identifying details anonymized. It should be freely available to researchers first for conditions with the most serious need for new insights, such as Alzheimer’s, ALS or pancreatic cancer. These can be the leading edge for which regulators develop data-control systems they can trust.

Laws and regulations can stipulate that patients’ medical data can’t be used for nonmedical and nonresearch purposes such as advertising. Patients can be explicitly protected against any harms related to being identified by their data. Data couldn’t be used to deny access to insurance, set the cost of insurance, or for employment decisions. Patients should opt-in by default to share their medical records for research purposes, but always be able to decline to share if they’d like.

Free societies have long benefited from a wise balance between the open exchange of ideas and information, and individuals’ rights and sensitivities. We need to get that balance right for medical data. Otherwise, societies less concerned with individual rights and privacy may seize the opportunities we’re giving up.

Mr. Plecs is a consultant for the pharmaceutical and biotechnology industries. Mr. Cochrane is a senior fellow of the Hoover Institution and an adjunct scholar of the Cato Institute.

More updates. In addition to  to  RoamTafi, Datavant and the  FDA sentinel initiative mentioned in the previous blog post, a colleague points out Project Data Sphere which aims to "share, integrate, and analyze our collective historical cancer research data in a single location." It also mixes a wide variety of data sources, and makes data available to academics.

Thursday, December 13, 2018

Series on recession and financial crisis




Over the last few weeks we have had a series of discussions at Hoover on the 10th anniversary of the financial crisis and recession. This all happened mostly due to the energy of John Taylor.

The final event on Friday Dec 7 was a Panel Discussion Summary, including Taylor, Shultz, Ferguson, Hoxby, Duffie, and myself, with question and answer. Click the above video.

This was preceded by four smaller discussions. We did not video them, but there are transcripts and presentation materials.

October 19, The causes.  (Follow links to a transcript and to the presentation slides.)  John Taylor and Monika Piazzesi present and learn discussion on the causes of the financial crisis, emphasizing monetary policy, regulation, and housing.

November 9 The Panic What happened on in the panic of August through November (or so) 2018? Did the actions of government officials help or hurt? Or both? George Shultz and Niall Ferguson present their views and lead the discussion.

December 7 The Recession. Why was the recession so deep? Why wasn't it deeper, repeating the Great Recession? Why did it last so long? Did fiscal stimulus help or hurt? Caroline Hoxby and John Taylor led, focusing on labor markets and stimulus. I added some comments on QE and the lessons of the long zero bound for monetary economics; Bob Hall comments on labor markets and unemployment, Mike Boskin comments on stimulus, and much more

December 7 also, Lessons for Financial Regulation. Darrell Duffie and me. Darrell summarizes his excellent "Prone to Fail." I expound on the need for more capital.

What's distinctive about this series, given all the other conferences and retrospectives?

First, we decided not to have retrospectives from people in power at the time. Many other such meetings are descending into memoirs of how we saved the world. Maybe they did, maybe they didn't. And maybe that's not so interesting, except of course to the parties involved who would like to go down nicely in history.

Second, you will find an effort to trace the intellectual lessons of the last 10 years of thought, not just whether certain actions were right or wrong in context of some eternal truth. We all have learned a great deal in the last 10 years, and opinions are shifting. For example, I discuss how capital, once thought immensely costly and regulation much prefereable, has slowly emerged as not at all costly and the best salve for financial crises. Similar lessons have emerged throughout.

Third, and perhaps most importantly, you will find here many disagreements with the standard narrative and what is becoming the first draft of history, as Ferguson nicely described. No, maybe it wasn't just "greed" and "deregulation." No, maybe our officials contributed to panic as much as they helped to stop it. No, maybe fiscal stimulus and QE did not save the world. No, maybe our super-confident regulators armed with an immensely larger rule book are not ready to save the world again next time. And in each case you will hear contrary views buttressed with facts and thoughtful analysis. Perhaps when the second draft of history is ready to be written this will be a starting place.

Friday, December 7, 2018

Canadian Debt

Corey Garriott, Sophie Lefebvre, Guillaume Nolin, Francisco Rivadeneyra and Adrian Walton at the Bank of Canada have issued a thoughtful and crisply written proposal for restructuring Canadian government debt, titled Alternative Futures for Government of Canada Debt Management.

Their third and fourth ideas are the most radical and attractive to me: Replace all government debt with 1) a set of zero-coupon bonds issued on a fixed schedule and/or  2) a long perpetutity, a long indexed perpetuity, and fixed-value, floating-rate short term debt, essentially the same as interest-paying central bank reserves or a money market fund. (Naturally I like it, since it draws on my "new structure for Federal Debt")

Why? Well, a simpler and smaller set of securities would be more liquid.
...investors will pay more in the primary market for assets they believe will be more liquid. Thus, issuing assets that are more liquid would decrease the issuer’s costs. ... a decrease in the total cost of funding of just one basis point would save the government $68 million annually
There is a social benefit as well. We hear a lot about "safe asset shortage," and the need for liquidity. Well, the easiest way to create safe liquid assets is to make the safe assets more liquid!

Thursday, December 6, 2018

Brexit and democracy

Tyler Cowen has a very interesting Bloomberg column on Brexit. Essentially, he views the UK getting this right -- which I agree it does not seem to be doing -- as a crucial test of democracy. Tyler notes that the current agreement serves neither leave nor remain sides well.
Brexit nonetheless presents a decision problem in its purest form. It is a test of human ingenuity and reasonableness, of our ability to compromise and solve problems...
The huge barrier, of course, is the democratic nature of the government.... 
So many of humanity’s core problems — addressing climate change, improving education, boosting innovation — ultimately have the same structure as “fixing Brexit.” It’s just that these other problems come in less transparent form and without such a firm deadline. We face tournament-like choices and perhaps we will not end up doing the right thing.
...Brexit would likely cost the U.K. about 2 percent of GDP, a fair estimate in my view. But that is not the only thing at stake here. Humanity is on trial — more specifically, its collective decision-making capacity — and it is the U.K. standing in the dock. 
I guess I have a different view of the merits and defects of democracy. My view is somewhat like the famous Churchill quote, "democracy is the worst form of Government. Except for all those other forms."

Democracy does not give us speedy technocratically optimal solutions to complex questions revolving around 2 percentage points of GDP. Democracy, and US democracy in particular, serves one great purpose -- to guard against tyranny. That's what the US colonists were upset about, not the fine points of tariff treaties. US and UK Democracy, when paired with the complex web of checks and balances and rule of law protections and constitutions and so forth, has been pretty good at throwing the bums out before they get too big for their britches. At least it has done so better than any other system.

2 percentage points of GDP? Inability to tackle long run issues? Let's just think of some of Democracy's immense failures that put the Brexit muddle to shame. The US was unable to resolve slavery, for nearly 100 years, without civil war. Democracies dithered in the 1930s and appeased Hitler.  The scar of Vietnam  is still festering in US polarization today. On the continent, when France stood for democracy and Germany for autocracy, France's defense decisions failed dramatically in 1914 and 1939.

And if we want to raise UK GDP by 2 percentage points, with free-market reforms, there is a lot worse than Brexit simmering on the front burner. A team from Cato and Hoover could probably raise GDP by 20 percent inside a year. If anyone would pay the slightest attention to us.

Yes, Brexit is a muddle which nobody will be happy with, until the UK decides if it really would rather remain or become a free-market beacon on the edge of the continent. But do not judge democracy on it. Democracy's errors as the mechanism for collective decision-making capacity have been far worse. And then there are the failures of all the other options.

Canadian non-QE

Friday at Hoover we will have a series of events reexamining the lessons of the financial crisis and recession. (There is a public event here, in case you're interested. Presenters include George Schultz, John Taylor, Niall Ferguson, Caroline Hoxby and Darrell Duffie.)

In preparing a presentation on QE, I stumbled across the following fact.



1) Canada did not do QE, quantitative easing. (Kjell Nyborg showed us this fact in a very interesting finance seminar on a different topic -- European banks are borrowing from the ECB using rotten collateral)


2) Use vs. Canadian 10 year government bond rates were nearly identical in the QE period.

Conventional wisdom states that US QE lowered interest rates by 1%. I am a skeptic, and this graph reinforces my skepticism.

One might say that the US exports its monetary policy effects to Canada. But the Canadian Dollar is its own currency, so exchange rates, not interest rates should soak up that difference.

One can complain in many ways, but this seems to me to add to the view that QE didn't even change interest rates.

Wednesday, December 5, 2018

Taylor on China and Trade and Ideas

Tim Taylor, also reviewing Summers on China, makes a few excellent points.

Growth comes from within. Trade is not conquest.
The formula for economic growth is to invest in human capital, physical capital, and technology, in an economic environment that provides incentives for hard work, efficiency, and innovation. China has made dramatic changes in all of these areas, and they are the main drivers behind China's extraordinary economic growth in the last four decades, and its expectation of above-global-average growth heading into the future.
No matter your views of China's trade surplus, there's no sensible economic theory which suggests that China's trade surplus, which as a share of GDP is relatively small, is a major driver of China's growth....
Conversely, the US economy has not done a great job of investing in the fundamentals of economic growth.

Tuesday, December 4, 2018

Summers on China

(Continues from my last post on China trade)

Larry Summers has a good Financial Times oped on the same subject, titled "Washington may bluster but cannot stifle the Chinese economy."  He puts well the point of my previous post:
At the heart of the US’s problem in defining an economic strategy towards China is the following awkward fact. Suppose China had been fully compliant with every trade and investment rule and had been as open to the world as the most open countries at its income level. China might have grown faster because it reformed more rapidly or it might have grown more slowly because of reduced subsidies or more foreign competition. But it is highly unlikely that its growth rate would have been altered by as much as 1 percentage point.
Equally, while some US companies might earn more profits operating in China [IP sharing requirements] and some job displacement in American manufacturing due to Chinese state subsidies may have occurred, it cannot be argued seriously that unfair Chinese trade practices have affected US growth by even 0.1 per cent a year.
Larry gives more voice to China critiques than I do, which is excellent. One should listen to what people are saying, understand their objectives, and if one disagrees on outcomes -- tariffs -- usually it is because one believes a common objective has a preferable means of achievement. 

Yes, China misbehaves, to the annoyance mostly of producers in other countries and their mercantilist governments:

Flowers not tariffs

I wrote a little commentary on trade for The Hill, which they titled "The US should give China Flowers not Tariffs." Chocolates too.

Source: The Hill
(The facial expressions in the picture are priceless) 

The US should Give China Flowers not Tariffs

Trump and Xi met, and declared a 90 day cease fire. Where will this end? It’s hard to forecast. Our commander in chief is less predictable than the stock market. But we can opine on what should happen. And we can look for interest — what is in everybody’s interest to have happen? 

That answer is clear: Come to a quick deal, declare victory, and get back to work fixing real economic problems. China makes some commitments about intellectual property (reasonably good for both sides, though not as important as all the fuss makes it seem); China makes some promises to buy American goods (crony capitalist mercantilism, but it makes politicians feel good); the US announces the 25% tariffs are off the table. Both politicians announce a great triumph. In sum, roughly what happened with NAFTA. Better still, we could do some reciprocal opening: repeal the 25% tariff on pickup trucks, and our own restrictions on foreign investments.

Large additional tariffs would be terrible for the US economy. Tariffs are taxes. Traditionally anti-tax Republicans, fresh off a hard-won victory to lower corporate taxes, should get that. And these taxes are starting to bite. For just one example, GM’s decision to close car plants was not completely unaffected by the price of steel and aluminum needed to make cars. And the constant threat of tariffs is in some ways worse than tariffs themselves. Companies managing global supply chains need to know where and how to invest. Big uncertainty postpones those investments. The point of the corporate tax cut was to encourage companies to invest. The threat of tariffs undoes that incentive.

Big tariffs, with exemptions granted on a discretionary basis, are corrosive to our political system. The rest of the admirable deregulatory effort is trying to get government agencies out of this racket.  

If it ever was true that China stole our jobs, that’s not today’s problem. With a 3.9% unemployment rate, employers can’t find enough qualified workers. Our economy needs efficiency and productivity to grow, not protection for some and high prices for others.

The US economy is doing well, but it’s an iffy time. When does the long expansion end and the next recession come? Storm clouds are gathering. The stock market is dribbling down. Auto sales, home prices and sales are softening. America remains waist-deep in debt. With split government, there will be no significant economic legislation legislation for the next two years, and the House will do everything they can to stymie the deregulation effort. A big disruption of trade and immigration is a self-inflicted wound at a bad time.

It’s an even iffier time for China. Be careful what you wish for. A major downturn in China, which could well lead to financial crisis, could be just the spark for a global recession. 

What’s the long run goal? The right approach to trade is simple: zero tariffs or restrictions. Americans are free to buy from the cheapest and best supplier. Whether foreigners put in tariffs or not is irrelevant to that conclusion.

Trade is no different than new companies that can produce things cheaper or better. And just as hurtful to old companies and their workers, but we generally see that it’s unwise to stop innovation. Trade between countries is no different than trade between states, and we all recognize that tariffs between states are a terrible idea. 

Any money that goes to China to buy goods must — must, this is arithmetic, not economics — come back. It just comes back to a less politically favored industry. To the extent that trade is “imbalanced,” that means China works hard, puts goods on boats, and takes our government bonds in return. Would we really be better off if we worked hard, put the fruits of our labor on boats, in exchange for Chinese government bonds?  Paper and promises are cheap. 

If China wants to tax her citizens to subsidize goods for US consumers, the right answer is flowers, chocolates and a nice thank-you card, as you would for any gift. Even intellectual property protection is an iffy cause. Theft is bad. But if selling the technology isn’t worth the market access, US companies don’t have to do it. Moreover, much intellectual property protection is the right to just the kind of continuing profits that we bemoan at home, in the new worry about increasing monopoly. Just how enthusiastic are we about defending pharmaceutical companies’ right to charge whatever they want in the US for their intellectual property? 

If one wants to help the US economy, effort is far best spent at home — fix health care, financial regulation, the obscene tax code, zoning, occupational licensing, labor laws and on and on. The rewards are infinitely larger than any imaginable benefit from trade threats. 

US GDP per capita is $60,000. China’s is $9,000. The average American is more than six times better off than the average Chinese.  The air in Beijing is unbreathable. For the US to complain about China hurting us is like the captain of the football team complaining that a six grader cheated him out of lunch money. 

Even in the best case, tariffs and trade restrictions are zero sum — they make the US better off by making China worse off. There is no case that they increase the size of the pie. In fact they make us all worse off. Is this America’s place in the world? Would we send in the marines to take wealth from Chinese people to benefit Americans? That’s the case for tariffs.

The idea that we can use tariffs to threaten China into freer trade is dangerous. It’s hard to credibly threaten to do something that hurts us, without denying that it does hurt us, and then getting trapped doing it. It took decades to get rid of the trade restrictions of the 1930s. 

We should get a grip, set a standard for good self-interested free-trade behavior, and work with our allies to get China to obey the same rules. Such a China is far more likely to cooperate on security issues than one already at war with us over trade.

Update: 

I left out lots of obvious pot shots. An obvious one: Sanctions on North Korea, Iran, Cuba, Russia,  and so forth are designed to.. reduce imports. So we are doing to ourselves exactly what we are doing to them.

Monday, December 3, 2018

Financing innovation

I went to the Financing of Innovation summit at Stanford GSB last Thursday. (Sorry, I can't seem to find a full program online.) Here is a sample of two interesting papers, presented by Amit Seru and Steve Kaplan:


Friday, November 30, 2018

Opinions change

Source:David Brady and Mo Fiorina
My Hoover colleagues David Brady and Mo Fiorina gave a recent talk updating some of their work on polling American political opinions. I found this one particularly interesting. Notice how after President Obama's first win in 2008, the fraction of Democrats reporting that the economy is getting better jumped from 10% to 50%. The Republican fraction declined, though not as much. When Trump was elected in 2016, the Republican opinion jumped from 15% to 80%, and Democrats fell from 60% to 25%.


Tuesday, November 27, 2018

Financial reform video


Capital, more capital. I did a video interview for the Chicago Booth Review, summarizing a few talks I'm giving this fall. At some point I'll put the talks together in useful form for the blog. In the meantime, the Booth team did a nice job of cutting and splicing to make me sound coherent. 

Monday, November 26, 2018

ASU forecast luncheon

On Wed Nov 28 I will be giving a talk at the ASU Forecast Luncheon in Phoenix. Blog readers will likely be bored, as I'm going to unapologetically recycle blog material, emphasizing strategies for long run growth. But you may find it amusing, and do say hi if you're one of my dozens of readers.