What I learned in econ grad school

I always find it interesting that criticisms of economics education focus more on the graduate side than the undergrad. Consider this broadside by Brad DeLong and Larry Summers:

For Summers, the problem is that there is so much that is “distracting, confusing, and problem-denying in…the first year course in most PhD programs.” As a result, even though “economics knows a fair amount,” it “has forgotten a fair amount that is relevant, and it has been distracted by an enormous amount.”...

The fact is that we need fewer efficient-markets theorists and more people who work on microstructure, limits to arbitrage, and cognitive biases. We need fewer equilibrium business-cycle theorists and more old-fashioned Keynesians and monetarists. We need more monetary historians and historians of economic thought and fewer model-builders. We need more Eichengreens, Shillers, Akerlofs, Reinharts, and Rogoffs – not to mention a Kindleberger, Minsky, or Bagehot.

Yet that is not what economics departments are saying nowadays.

This is interesting because, as someone who never studied econ as an undergrad (I was a physics major), I learned everything I know about macro from my grad courses. If there is an aspiring economist out there whose understanding of macro has been hurt by an overly narrow graduate curriculum, it would be me.

So, what did I learn in my first-year graduate macro course at the University of Michigan?

My first semester was on business cycle theory. (the second semester was all growth theory). We spent a day covering the basic history of the field - the neoclassicals, Keynes, Friedman, Lucas and the RBC people, and finally the neo-Keynesian movement. I recall reading the Summers vs. Prescott debate but not really getting what it was about. From then on it was all DSGE. We did the Ramsey model and learned about Friedman's Permanent Income Hypothesis. We spent a lot of time on RBC. We took a big break to learn value function iteration and how to numerically solve DSGE models by fixed-point convergence. Then we did Barro's model of Ricardian Equivalence, learned a basic labor search model, briefly sketched a couple of ideas about heterogeneity, touched on menu costs, and spent a good bit of time on Q-theory and investment costs. Finally, at the very end of the semester, we squeezed in a one-week whirlwind overview of Calvo Models and the New Keynesian Phillips Curve...but we weren't tested on it.

This course would probably have given Brad DeLong the following reasons for complaint:

1. It contained very little economic history. Everything was math, mostly DSGE math.

2. It was heavily weighted toward theories driven by supply shocks; demand-based theories were given extremely short shrift.

3. The theories we learned had almost no frictions whatsoever (the two frictions we learned, labor search and menu costs, were not presented as part of a full model of the business cycle). Other than Q-theory, there was nothing whatsoever about finance* (Though we did have one midterm problem, based on the professor's own research, involving an asset price shock! That one really stuck with me.).

At the time I took the course, I didn't yet know enough to have any of these objections. But coming as I did from a physics background, I found several things that annoyed me about the course (besides the fact that I got a B). One was that, in spite of all the mathematical precision of these theories, very few of them offered any way to calculate any economic quantity. In physics, theories are tools for turning quantitative observations into quantitative predictions. In macroeconomics, there was plenty of math, but it seemed to be used primarily as a descriptive tool for explicating ideas about how the world might work. At the end of the course, I realized that if someone asked me to tell them what unemployment would be next month, I would have no idea how to answer them.

As Richard Feynman once said about a theory he didn't like: "I don’t like that they’re not calculating anything. I don’t like that they don’t check their ideas. I don’t like that for anything that disagrees with an experiment, they cook up an explanation - a fix-up to say, 'Well, it might be true.'"

That was the second problem I had with the course: it didn't discuss how we knew if these theories were right or wrong. We did learn Bob Hall's test of the PIH. That was good. But when it came to all the other theories, empirics were only briefly mentioned, if at all, and never explained in detail. When we learned RBC, we were told that the measure of its success in explaining the data was - get this - that if you tweaked the parameters just right, you could get the theory to produce economic fluctuations of about the same size as the ones we see in real life. When I heard this, I thought "You have got to be kidding me!" Actually, what I thought was a bit more...um...colorful. 

(This absurdly un-scientific approach, which goes by the euphemistic name of "moment matching," gave me my bitter and enduring hatred of Real Business Cycle theory, about which Niklas Blanchard and others have teased me. I keep waiting for the ghost of Francis Bacon or Isaac Newton to appear and smite Ed Prescott for putting theory ahead of measurement. It hasn't happened.)

Now keep in mind, this was back before the financial crisis, at the tail end of the unfortunately named "Great Moderation." When the big crisis happened, I quickly realized that nothing I had learned in my first-year course could help me explain what I was seeing on the news. Given my dim view of the standards of verification and usefulness to which the theories I knew had been subjected, I was not surprised.

Around that time, I started teaching undergrad macro (under Miles Kimball and others), and was instantly struck by the disconnect between what I was teaching and what I had learned. Intro macro had a lot of history. Explication was done with simple graphs rather than calculus of variations. And undergrad macro was all about demand - never once did I utter the words "technology shock" in class. We taught Keynes and Friedman. Minsky got a shout-out, and we spent a whole week on the fragility of the financial sector, in addition to the week we spent analyzing the 2008 crisis.

In other words, Brad DeLong would probably have approved of the macro course I taught. He would probably think that the bankers, consultants, managers, executives, accountants, and policy researchers who even now are going through life looking at the economy through the lens of that intro macro class have been reasonably well-served by their education.

But all the same, I absolutely don't blame the grad-level professor for teaching what he taught. Our curriculum was considered to be the state of the art by everyone who mattered. Without a thorough understanding of DSGE models and the like, a macroeconomist is severely disadvantaged in today's academic job market; if he had spent that semester teaching us Kindleberger and Bagehot and Minsky, our professor might have given us better ways to think about history, but he would have been effectively driving us out of the macroeconomics profession.

Thus, DeLong and Summers are right to point the finger at the economics field itself. Senior professors at economics departments around the country are the ones who give the nod to job candidates steeped in neoclassical models and DSGE math. The editors of Econometrica, the American Economic Review, the Quarterly Journal of Economics, and the other top journals are the ones who publish paper after paper on these subjects, who accept "moment matching" as a standard of empirical verification, who approve of pages upon pages of math that tells "stories" instead of making quantitative predictions, etc. And the Nobel Prize committee is responsible for giving a (pseudo-)Nobel Prize to Ed Prescott for the RBC model, another to Robert Lucas for the Rational Expectations Hypothesis, and another to Friedrich Hayek for being a cranky econ blogger before it was popular. 

If you want to change economics education, it is to these people that you must appeal. The ghost of Francis Bacon, unfortunately, is not available for comment.

*Update:  I now recall that we also learned the Consumption Capital Asset Pricing Model (CCAPM). So that was about finance too.

Update 2: In my second year I took a macro field sequence, which taught me all about demand-based models, frictions, heterogeneity, and other interesting stuff. I don't want to make it sound like graduate school taught me nothing about how to understand the recession...it taught me plenty. It just all came in the field course...

Update 3: I've decided to remove the professor's name from this post. Although I tried to make it clear (and it should be obvious anyway) that one teacher is in no way responsible for the problems in the field of macroeconomics, I am still worried that some readers might interpret the post to reflect negatively on him, which is the last thing I want.

Update 4: I added a sequel to this post, describing what I learned in my second year.

Short thoughts, mostly about the decline of America

1. The Economist is a "classical liberal" publication. The Economist understands that America needs more, not less, government spending on infrastructure if our economy is going to thrive. The Economist also understands that America needs more, not less, government spending on research if our economy is going to thrive. Which is to say The Economist understands well the existence and importance of public goods. (It occurs to me that this might be the difference between British "classical liberals" and American "libertarians"; the former will support government intervention in the economy if the intervention raises standards of living, while the latter will usually oppose it on principle.)

2. Why is American public good provision lagging? Brad DeLong blames Republicans, and I agree. Paul Ryan, the Republicans' thought leader on budget issues, wants to slash spending on both transportation infrastructure and research and development.

3. Why are Republicans so intent on starving the economy of public goods? Well, I think conservatives (and not a few liberals!) have really fallen into the rut of thinking that all government spending = redistribution. Part of this may be a simple failure to recognize that America's gravy days are over, and that arresting the rapid shrinkage of our national pie is more important than squabbling over who gets which slice. 

But if you read this blog, you know I think that there is something bigger and deeper at work, namely our national identity crisis. Remember Alesina and Easterly's finding that ethnic divisions reduce public good provisions. This is what I believe we're facing. Conservative whites have decided that America will soon cease to be the white ethnic nation that they think it used to be; therefore, they have little interest in bankrolling the nation's future.

4. This tribal divide explains why the birthers are birthers. James Fallows:

Tribal knowledge vs actual knowledge front: Yesterday, about half of all Republicans thought Obama was foreign born, and therefore an illegal occupant of the White House. How many Republicans will think the same thing one week from now? My guess is: about half. We've reached that stage on just about everything...[I]f "actual knowledge" mattered, the number of people who thought Obama was foreign-born would approach zero by next week...My guess is that the figures will barely change.

Birthers believe in birtherism because it is a rallying flag for their ethnic/tribal identity movement. Experessing doubts about Obama's American-ness is a way of expressing solidarity with other people who think that only whites can be "real Americans."

5. As I see it, most American liberals want to heal the ethnic rift. Liberals seem to believe that America is a nation based on shared ideology and shared institutions, not on blood and soil. This explains why liberals are more likely to favor spending on public goods, and IMHO it also explains why liberals tend to be more redistributionist (they view poor blacks and Hispanics as their fellow countrymen, which conservatives generally do not). This is why, although I'm not generally a redistributionist, I count myself a liberal on economic issues.

But we liberals are up against the terrific power of the conservative populist narrative, which holds that all government spending is redistribution, and that all redistribution is racial redistribution.This is the narrative of the lazy blacks and lazy Hispanics using government to confiscate white money and jobs. Nearly every day I hear this narrative repeated. Just today, Republican Sally Kern declared that "minorities earn less because they don't work as hard." If you want more of the same, just listen to...well, everything Rush Limbaugh has ever said.

Conclusion: If our nation-state is going to succeed, we need to start thinking of ourselves as a single nation again. But powerful forces are at work every day, trying to get us to think exactly the opposite. This has been a major theme and focus of this blog, but I think it bears repeating.

Market Value vs Replacement Costs

Market Value vs. Replacement Cost is something that we in the insurance business discuss a lot with property owners. Depending on the economic conditions there can be a variation between Market Value and Replacement cost. Since the current economic conditions have caused such a discrepancy we at Fey Insurance thought it might be a good time to explain the difference between the two terms.

Market Value is the amount that a house is worth on the real estate market. It is what you can buy or sell the house for. As we sit in the middle of a depressed real estate market, the value of homes is down from years past. When you hear a mortgage company or title company talk about getting an appraisal they are always talking about Market Value because the lending institution is mainly concerned with what they could sell the asset (building) for.

Replacement Cost is concerned with a different valuation of a building. Replacement cost deals with the amount of money it would take to rebuild a structure using the same materials at the same location with the same style of construction. Because this is based on building materials and cost of labor it doesn’t have the large swings that Market Value has. For example, in today’s poor economic conditions, material costs have stayed pretty level meaning the Replacement Cost of a building has stayed relatively flat.

So how do these two forms of valuations play out in numbers? Let’s take an example home that is a brick structure, has four bedrooms/ two baths and is about 2000 square feet. A house like this in our area may be listed on the real estate market for about $250,000 (depending on the school district, location to town, etc) and will probably sell for about $235,000 (which would then be the Market Value). This same structure would have a different value if we used Replacement Cost. In our area the same structure just mentioned would cost about $135.00 per square foot to rebuild if a fire or tornado totally destroyed it. Take the $135.00 per square foot and multiply that by the 2000 square feet and you come up with a value of $270,000 (which would then be the Replacement Cost).

When it comes to banks and lenders they care about Market Value ($235,000 in our example) where the insurance companies, since they will have to pay to have the home rebuilt after a fire or tornado, cares about the Replacement Costs ($270,000 in our example).

So next time you see your homeowner policy or commercial building policy and look at what they are insuring your structure for don’t say to yourself, “I couldn’t sell my building for that” because the amount you are thinking of is the Market Value. Insurance companies are only interested in the Replacement Cost because they want to make sure they are able to rebuild your property and make you just as you were prior to the fire or tornado.

The tax debate has never been about the evidence

Matt Yglesias sees the American right retreating from intellectual/empirical attacks on progressive taxation, and falling back on moral attacks:

You can tell something’s happening in the economic policy debate when you start reading more things like AEI’s Arthur Brooks explaining that it would simply be unfair to raise taxes on the rich. Harvard economics professor and former Council of Economics Advisor chairman Greg Mankiw has said the same thing...[W]e used to have a debate in which the left said redistributive taxation might be a good idea and then the right replied that it might sound good, but actually the consequences would be bad. Lower taxes on the rich would lead to more growth and faster increase in incomes.

Now that idea seems to be so unsupportable that the talking point is switched. It’s not that higher taxes on our Galtian Overlords would backfire and make us worse off. It’s just that it would be immoral of us to ask them to pay more taxes[.]

Paul Krugman attributes this to the closing of the conservative intellectual worldview:

[M]y take is that what we’re looking at is the closing of the conservative intellectual universe, the creation of an echo chamber in which rightists talk only to each other, and in which even the pretense of caring about ordinary people is disappearing. I mean, we’ve been living for some time in an environment in which...Chicago professors making several hundred thousand a year whine that they can’t afford any more taxes, and are surprised when that rubs some people the wrong way. Why wouldn’t such people find it completely natural to think that the hurt feelings of the rich are the main consideration in economic policy?

While I think neither Yglesias nor Krugman is incorrect, I do think there are a couple of important factors that they don't mention in their posts.

The first of these is a selection effect. Specifically, after decades of conservative economic policies, the only people left arguing for even more conservative policies tend to be either blinkered ideologues or vested interests. Back in the 70's taxes on the rich were high, but now they're quite low. There's no room to cut them any more without forcing the American government into default (and, in fact, the Bush tax cuts will probably do this if not repealed). Any economic benefit that we might ever have gleaned from trickle-down economics had to have been tapped out way back in the 80s. 

So who is still arguing that taxes on the rich are oppressively high? Well, rich people who don't mind if the country is forced into default, for one. And also people who, because of their personal morals, just really, really, really don't like progressive taxation. The winnowing of the conservative raison d'etre is going to produce the kind of "echo chamber" that Krugman sees, as well as the increasing moralization cited by Yglesias. Conservatives won the policy debate, back when Matt Yglesias and I were in diapers. What we call the "conservative intellectual movement" in 2011 is a handful of corrupt, silly, or monomaniacal people trying (somewhat lamely) to replicate the victory their forebears won in the 80s.

But actually, I think there is something even bigger that Yglesias and Krugman don't mention. Specifically, the debate about taxation may have been an intellectual one at the elite level, but on the level that really matters - mass opinion - it has always been about morals and emotions, and never about elasticities or deadweight losses. The idea that progressive taxation "punishes success" is something my dad was hearing back in the early 80s; my history teacher gave me that line back in '97, and I suspect it was a common refrain a century earlier than that. The "fairness" argument is not new. And on an even broader level, it was stereotypes of "welfare queens" and lazy minorities that turned working-class whites against social insurance (and against government programs in general) in the Reagan years.

It was these emotional and tribal appeals that shifted much of America to the Republican camp. The average working- or middle-class Republican voter doesn't have a clue who Greg Mankiw is, what determines economic growth rates, or how trickle-down economic policies are supposed to work. But, in whole or in part, he has bought into a narrative that tells him that he does a hard, honest day's work, and that taxes and government spending are nothing more than a way of punishing him for that hard day's work (and, probably, rewarding some black or Hispanic person for a life of indolence).

That is why we are still having a debate over progressive taxation at all. The rump movement that is still trying to make an intellectual case for tax cuts at the elite level maintains their outsized clout and elevated profile only because of the success of the populist narrative that keeps the Red States red. Until we change that populist narrative, we can smack down Arthur Brooks and laugh at Greg Mankiw all we like, but we're not going to save our nation-state from fiscal ruin. I'm sorry if that sounds overly pessimistic.

Update: More on that conservative populist narrative.

Local nonsatiation and the "man who can't be taxed"

Some people I've talked to are of the opinion that I've been too harsh on Steven Landsburg. They say that I've been too harsh because:

A) Landsburg wasn't talking about current consumption being constant, he was talking about consumption from now until the end of time being constant.

B) Landsburg was assuming full employment (i.e. no wasted resources), so consumption from now until the end of time is in fact fixed, since it must then equal income from now until the end of time.

Yes. If by "consumption" Landsburg means "the present value of (infinite) lifetime consumption", and if he is assuming full employment, then Reasons 1 and 4 from my previous blog post do not apply (and Reason 2 is nitpicky). So was too quick to label Landsburg's idea "nonsense" and hit him with the Bat Boy picture?

The thing is, even granting the aforementioned assumptions, Landsburg is still clearly wrong. And the reason is not hard to see.

The reason is something called Local Nonsatiation. It is a basic axiom (assumption) of economic theory. It means that you're never 100% satisfied. And if you're never 100% satisfied, then any additional dollar you get will increase your utility, because you will use it to buy some of what you want. Conversely, any dollar that I take away from you will shrink your utility, because that is a dollar that you would have otherwise used to buy something you wanted.

In Landsburg's example, the rich and idle Mr. Kendrick consumes essentially zero; hence, confiscating his bank account does not hurt him in any way. This statement clearly violates Local Nonsatiation. By confiscating Kendrick's bank account, the government has reduced Kendrick's choice set. The set of possibilities open to Kendrick is now smaller. Hence, by Local Nonsatiation, Kendrick's lifetime utility must go down. 

Why does Kendrick's utility go down? Perhaps he wanted to leave his wealth to his heirs. Perhaps he planned to consume more someday. Perhaps his wealth was a safety cushion that made him feel secure. Who knows! The point is: as long as Local Nonsatiation applies, you're always worse off with less wealth. It really is that simple.

Landsburg compares Kendrick to a dead man, since he consumes nothing. But there is a big difference between the ascetic and the dead. That difference is called the future. A live Kendrick may have very little current-period consumption, but he has the option to consume more, or give away his wealth, in the future. You cannot take options away from a dead man, but you can take them away from an ascetic.

Now, you may ask: OK, but why should we assume that Local Nonsatiation holds? What if someone really could be completely, utterly satisfied with what he has - not just today, but forever? 

Fine. Maybe Kendrick is a bodhisattva, and has reached his bliss point. He violates Local Nonsatiation. BUT, if you take away Local Nonsatiation, then Landsburg's case completely falls apart, for a different (and yet still obvious) reason.

Central to Landsburg's case is the statement that "taxes must impose a burden on someone." But that is only true if Local Nonsatiation holds. If people can be perfectly satisfied with X amount of stuff, then taking any extra stuff away from them imposes no burden on them whatsoever, because they still have X. Taxing a man who is still at his bliss point after being taxed is like finding apples on the ground; it's a free lunch. If you don't understand that, you need to think harder!

Ever heard "There's no such thing as a free lunch"? Well, take away Local Nonsatiation, and that's no longer true. That's why economists pretty much always assume Local Nonsatiation!

So we arrive at a concise statement of Landsburg's error: The statements that "Taxation must impose a burden on someone" is logically inconsistent with the statement that "There exists a person who cannot be burdened by any tax."

All the brouhaha about full employment, interest rates, price levels, accounting identities, etc. is just a fun sideshow. The central point here is that Landsburg is making a case that is logically contradictory. In my opinion, the logical contradiction is immediately and clearly obvious. And that is why I called his case "nonsense."

But yes, of course Steve Landsburg is not insane. He's just wrong! We all say slightly insane things from time to time...

Update: Steven Landsburg responds in the comments:

The assumption throughout this exercise, as I believe I've made clear multiple times, is that Mr Kendrick is at what you call his bliss point...The other assumption is that people other than Mr Kendrick are not at their bliss points. (Mr Kendrick, as the article makes clear, is a very unusual person.) 

Well, that clears things up! It appears we have isolated the nub of the problem: Landsburg believes that taxation of a person who is at a bliss point must still impose a burden on someone, somewhere.

This is not correct. Suppose I have everything that I could ever possibly want (I am at my bliss point). I also have a chocolate bar, which I do not want. A man (the "government") comes and takes my chocolate bar and gives it to a third person, Ry, who enjoys eating the chocolate bar. My utility is not decreased, since I am still at my bliss point. Ry's utility has been increased, since he enjoyed the chocolate bar. No third party has been affected by this event. Hence, confiscation of my chocolate bar (taxation) has not imposed a burden on anyone, anywhere, at any time. The taxation was a Pareto Improvement.

From this simple and indisputable example we see that taxation of a person who is at his bliss point can be a Pareto Improvement, and hence need not impose a burden on anyone. This is why Landsburg's argument is a fallacy.

Update 2: Greg Mankiw chimes in. He thinks Landsburg is making an interesting point about tax incidence. Seems to forget that you can't actually do tax incidence - the traditional way, anyway - unless you have Local Nonsatiation, which Landsburg says he is chucking. Oh well.

Update 3: Niklas Blanchard with more reasons Landsburg is wrong.

Deductible Basics

When a covered insurance claim happens the insured, in many cases, will be responsible for the first few dollars of most losses. The amount they are responsible for is called the deductible. More often than not, deductibles are only associated with property damage of the insured’s own possessions whether that is a vehicle that was damaged or damage to their contents, their buildings or even their loss of income. On some occasions you may see deductibles on liability claims but not in many.

Deductibles can come in many different forms on insurance policies. You can have a given dollar amount, say $500. Often times you see this type of deductible on home insurance or business property insurance. Some deductibles might be a percent of the loss like 1% or 10%. Sometimes you will see this type of deductible on a home or business but many times it will be associated specifically with earthquake coverage. Deductibles can be vanishing deductibles. As the insured racks up years of no losses, their deductible gradually drops each year until eventual it is $0.

In most cases the deductible is per claim. This means that each time you have a claim you pay a deductible. It isn’t like your typical health insurance policy where you have an out of pocket deductible for the year and once you meet that limit you are done with the deductible. In property and casualty, if you have a $500 flat per claim deductible you will pay $500 each time you have a claim no matter how many you have in a given year.

Deductibles can be a helpful cost savings tool. They can be raised to help drop premiums but the insured needs to understand that by raising deductibles they have taken on a bit more of the burden of possible claims.

It is important for insureds to understand what their deductible is so that they can be prepared to financially meet its requirement if a claim were to happen. I mention this more in connection with a percentage deductible. The insured should know if the percent is on the cost of the claim or on the coverage limit. For example, if a person had a $200,000 house and an insurance policy with a 5% deductible (on the coverage limit) it would be best to know that you have a $10,000 deductible before you have a claim. Someone that doesn’t know their policy might think that it is 5% per the cost of the claim.

Deductibles are just one of many facets to an insurance policy. Be sure to familiarize yourself with your policy and policy coverages and consult your independent insurance when ever you have any questions.

In which Steven Landsburg utterly flips out

Steven Landsburg thinks he has come up with a proof that taxation of the "idle rich" is impossible:

[The extremely rich] Mr. Kendrick appears to do pretty much nothing but park and re-park his four cars all day long...Assuming the facts are as she states them, it is quite literally impossible to raise revenue by taxing the likes of Mr. Kendrick...

Here’s why it’s impossible: For the government to consume more goods and services, somebody else must consume fewer. But Mr. Kendrick...consumes almost no goods or services whatsoever. He just pushes cars around all day. His consumption can’t go much lower.

Ah...but there’s still that $84 million in the bank. Surely we can tax that, no?...[but] what happens if the government takes Mr. Kendrick’s $84 million away? Answer: A bunch of zeros and ones get shifted around on bank computers. Mr. Kendrick goes right on pushing his cars around. And nothing else has changed.

Unless, of course, the government decides to spend some of that $84 million. Now the government consumes more goods, Mr. Kendrick consumes no fewer, so someone else must consume less. Who is that someone else?...[T]he most likely answer is that when Mr. Kendrick withdraws $84 million from the bank to make his tax payment, the bank makes fewer loans, interest rates rise, and someone cancels a vacations, or postpones a car purchase, or abandons a half-built factory. Who bears the burden of the tax? The people who cancel their vacations and car purchases and factories, that’s who. Not Mr. Kendrick.

You can try to tax him, but any attempt to tax him turns into a tax-in-disguise on somebody else. And the reason for this is not ultimately to be found in the laws of economics; it’s to be found in the laws of arithmetic. You can’t drive a man’s consumption below zero.

OK, clever readers, your assignment is to reread the above blog post very carefully, and think of four reasons why Landburg's post is utter nonsense. That's right, four. I don't want to make it too easy for you.

All right, now here's the reasons I've come up with:

Reason 1: GDP does not equal consumption. This is a very, very basic Econ 101 fact. Like, the first thing you learn. GDP = Consumption + Investment + Govt. Purchases + Net Exports. Landsburg says: "For the government to consume more goods and services, somebody else must consume fewer." This is obviously false, since Government Purchases can rise if Investment or Net Exports goes down (or GDP goes up), with Consumption unchanged. There is no "conservation of consumption".

So, even before we go on to other, more sophisticated reasons why Landsburg is talking nonsense, we know from the most basic accounting identity in all of economics that he is, indeed, talking nonsense.

Reason 2: Revenue does not equal consumption. Landsburg writes: "It is quite literally impossible to raise revenue by taxing the likes of Mr. Kendrick." Wrong. Even if Landsburg's nonsensical idea about the "conservation of consumption" were right, this statement about revenue would be patently false, since a rise in Government Purchases accompanied by a fall in private Consumption would, if the deficit is unchanged, constitute a rise in revenue.

And yes, I know this is a fairly trivial and obvious reason that Landsburg is talking nonsense, but it bears pointing out before we move on to deeper and more interesting reasons.

Reason 3: Consumption today does not equal lifetime consumption. Maybe today Kendrick just reparks his cars, but tomorrow he might get tired of that, and might want to use some of his fortune to buy, say, a yacht. Confiscating his fortune takes away his ability to do this. Landsburg has decided that if Kendrick's current consumption is not reduced, it does not constitute "taxation" of Kendrick. By this logic, if I confiscate the entire contents of Steven Landsburg's bank account, it will not qualify as "robbery" if he did not plan on making an ATM withdrawal until tomorrow. 

Corollary to Reason 3: Local nonsatiation is an axiom of modern economics. This axiom states that, over his lifetime, Kendrick will consume his entire lifetime income (as Brad DeLong notes, this may include bequests to his descendants). Eventually he will do something with that $84 million, even if he just leaves it all to his kids untouched. So taking Kendrick's $84 million reduces the present value of Kendrick's lifetime consumption by...$84 million.

But wait, there's more.

Reason 4:  If Landsburg were right, aggregate savings could never change. Landsburg states that if Kendrick's fortune were withdrawn from his bank and spent on consumption goods, the bank would raise interest rates, and someone else's consumption would fall by an exactly countervailing amount. That is just wrong. Consider this: what if Kendrick himself decides to withdraw his $84 million and spend it on consumption goods (say, a few dozen more cars). Must consumption elsewhere in the economy fall by $84M? No? But in real terms, that is exactly the same as if the government confiscated Kendrick's $84M and bought the new cars for him - which, Landsburg insists, would reduce consumption elsewhere in the economy. 

Landsburg's statement is therefore equivalent to the mathematical statement that economy-wide consumption cannot be raised by a decrease in a single individual's savings. And since Income = Savings + Consumption, Landsburg is therefore saying that any decrease in one person's savings must, mathematically, be accompanied by either a decrease in economy-wide income (GDP) or an increase in someone else's savings. If the former is the case - if reducing my savings by $X reduces GDP by $X - then increasing my savings by $X must increase GDP by $X. And that would mean GDP is maximized if people consume zero (i.e. everyone dies). This is clearly not the case. So, by process of elimination, Landsburg must be asserting that if my savings go down by $X, someone else's must go up by precisely $X, and hence aggregate saving is constant over all time.

Needless to say, that is total nonsense.

There, that's four (though you may notice that Reasons 1, 3, and 4 basically address the same fallacy). I'll leave it to you readers to come up with more (and I'm fairly sure there are some more).

But I'll end by pointing out that Alex Tabarrok of Marginal Revolution gives the following uncritical endorsement of Landsburg's nonsense:

Steve is quite right. The key is this sentence, “For the government to consume more goods and services, somebody else must consume fewer.”

He even repeats one of Landsburg's patently nonsensical assertions (see Reason 1 above)! And although he does acknowledges Brad DeLong's critique (i.e. my Reason 3) in an addendum, he never takes back the nonsensical assertion that present consumption is conserved.

WHY? "Economics by accounting identity" is dubious at the best of times, but "economics by patently false accounting identity" is just inexcusable. You can get economic theory to say damn near anything you want. But by Adam Smith and all that is holy, you just cannot get it to say that consumption is constant by definition! You just...can't!!!


Update: Paul Krugman explains why Landsburg is misunderstanding the nature of taxation, a point that Brad DeLong also noted. That's five... 

Update 2: Niklas Blanchard points out that the government doesn't just consume, it invests! The existence of public goods and government investment mean that Landsburg's statement about "government consumption", in addition to being nonsense, is also a bit irrelevant to real public policy issues.

Update 3: Landsburg, responding to Krugman, doubles down: 

1) A tax imposes a burden.

2) If a tax has no effect on a man’s lifestyle, then it imposes no burden on him.

3) Therefore, if a tax has no effect on a man’s lifestyle, then it must impose a burden on someone else.

This demonstrates a failure to understand Local Nonsatiation. If Kendrick's $84M is confiscated, either A) his present consumption is reduced, B) his future consumption is reduced, or C) his ability to bequeath money to his heirs is reduced. Either way, his choice set is reduced, so by Local Nonsatiation his utility is reduced, i.e. a burden has been imposed upon him, QED.

Auto Liability Basics

Auto insurance liability limits come in a few different forms as well as in many different levels. The two main forms of auto insurance liability are “Split Limits” and “Combined Single Limit”. One main thing to first understand about auto insurance liability limits is that these limits are what’s used by the insurance company to pay out on your behalf the damages that you cause to someone’s body and or property. Auto insurance liability limits are not used to pay money toward your injuries or property damage. Those coverages are auto insurance medical payments coverage, comprehensive coverage, collision coverage and uninsured/underinsured motorist coverage. We will not be addressing those items in this blog post.

Split Limits have three different ceilings or maxes that the insurance policy will pay out. Those three different maxes are “bodily injury per person”, “bodily injury per accident” and “property damage”. Often you will see insurance policies with split limits of $250,000 bodily injury per person and $500,000 bodily injury per accident and $100,000 in property damage. What this means is that if you cause an auto accident the most that one individual will get for their bodily injuries is $250,000 from your insurance policy. If there are multiple people in the other party’s vehicle then the most the policy will pay out is $500,000 in bodily injury to all involved. Accidents that you cause will usually result in property damage to others and $100,000 is the max that the above example limits will pay for someone else vehicle or property.

Combined Single Limit still covers bodily injury and property damage but there is only one lumped together limit for the policy. For example if you have a $500,000 combined single limit policy than the most the other party will receive for their bodily injuries (no matter how many people are in the vehicle) and property damage that you cause is $500,000. There is not a per person limit sublimit nor a property damage sublimit.

There are many different levels of auto insurance liability limits you can have. Each state has a minimum which means you at least have to have the amount they require in order to legally operate a vehicle. This limit is usually very low and in order to best protect your assets and help restore people that you cause injury and damage to we recommend much higher limits of insurance. Obviously the higher the limits of insurance you purchase the more money the insurance policy will cost but extra money you spend could be the difference in protecting your assets after a large claim or have the possibility of losing some of your assets.

Idea of the day: National universities

I'm a little late in getting to it, but Matt Yglesias has a great post about America's human capital stagnation:

[T]hroughout our history, America has traditionally been the best educated country in the world. That goes all the way back to New England’s settlement by Bible-obsessed Puritans who through up schools everywhere so kids could learn to read the word of God. It continues through Justin Smith Morrill’s Land Grant Colleges Act, through an emphasis on being an attractive destination for high-skill workers, through to the GI Bill, and public school desegregation in the twenty years after 1955. But we’ve really slowed down. Our fancy colleges are getting more expensive rather than getting bigger or better. The downscale for-profit college sector is dynamic and innovative, but it’s basically a scam where barely anyone graduates. We’re not investing in high-quality preschool, we’re shutting the door on skilled migrants, and we’re not investing in effective job training programs. (Emphasis mine)

Yglesias is, of course, completely right. In fact, human capital stagnation seems to me a much likelier culprit for a "Great Stagnation" than the dubious hypothesis of a slowdown in technological innovation. People can't spend their whole life in school, so education really is "low-hanging fruit".

But that doesn't mean there isn't fruit left to be picked! Check out this graph of U.S. college enrollment rates:

There is some improvement here, but as you can see, just over a third of Americans of college age is actually enrolled in college. Furthermore, as Matt points out, a lot of that increase is in crappy for-profit colleges from which few people actually graduate, and which teach skills of dubious value. There is plenty of room to increase enrollment. In fact, since high school dropout rates have fallen to 10%, and since postgraduate education really isn't for everyone, increasing college enrollment (and completion!) might be our best bet for increasing our human capital.

Now note the phrase I highlighted in Matt's post above. State and private four-year universities - the real generators of top human capital - have been getting more expensive at an astronomical rate:

While college enrollment rates are up a little over 50% since 1980, the price of college is up by over 1000%.

What this points to is a supply shortage. As any Econ 101 student could (hopefully) tell you, when you have rapidly increasing price and slowly increasing quantity exchanged, it's indicative of a situation of a positive demand shock under inelastic supply:

More people want to go to college (probably because of the higher college wage premium), but the supply of high-quality colleges simply isn't that big. People are flocking to for-profit colleges because there just isn't room at public ones. And since there are good theoretical as well as empirical reasons to believe that for-profit universities just can't deliver the goods, the key fact of U.S. higher education would seem to be the stagnant number of spots at good universities. As Yglesias says, colleges are getting more expensive, but not bigger.

Which brings me to my idea of the day: A federally funded National University System.

When you have a supply shortage, one solution is to shift the supply curve to the right. Sometimes this is impossible. But in the case of U.S. public universities, it is very doable! Plenty of other countries have national university systems, and these national universities are often very high-quality. Why not us? Why don't we build a system of high-quality, federally funded national universities to co-exist alongside our already excellent state universities?

It's not as if we don't have the resources to do this. Land is not an issue. And academic jobs are in notoriously short supply, meaning that there is a huge pool of qualified PhD's ready to teach and do research. We bring the best and the brightest to get PhD's here, and then a bunch of them end up returning to India, China, or Korea...why not keep more of them here as professors?

As for Constitutional objections, note that we already have a number of federally funded universities.Ever hear of West Point?

Now, people who are opposed to this will say: Isn't this a risky undertaking? Suppose you build the national universities and you can't find enough high-quality students to fill them? In other words, what if demand for college enrollment has gone up in the U.S., but demand for high-quality college degrees hasn't, because we just don't have any more smart kids?

I highly doubt that this will prove be the case, since graduation rates have stayed constant or increased as enrollment has gone up. But even if we run out of smart kids, we have an easy backup plan to fill the national universities: overseas students. The world is a vast and infinite pool of smart kids waiting to be tapped. Now it's true that if we have to go shopping for smart kids overseas, the National University System won't do as much to reduce nationwide tuition costs (because that'll push up demand to match the increase in supply). But at least we'd wind up with a ton of imported human capital (assuming we let the overseas undergrads immigrate after graduating)!

And the spillover benefits from more top-quality research universities are potentially enormous. The U.S. depends on innovation and research for its prosperity, and yet federal spending on research and development has fallen by two-thirds since 1960, leaving private companies to pick up the slack. There are plenty of research activities that universities do that private firms can't, especially basic research. If the U.S. is to remain the world's technological leader, a National University System would seem to be a good move.

To sum up: a National University System would boost human capital, would boost research and development, and would probably reduce tuition costs. The U.S. has the world's best universities, and we should capitalize on this advantage. Until a rigorous cost-benefit analysis is performed, of course, I can't say with certainty that the benefits would justify the expense of building the universities. But it is an idea worth thinking about, and I don't really see anyone suggesting it. So here, I've suggested it.


Update: Niklas Blanchard at Modeled Behavior basically agrees. But there is one point of mine that I think he doesn't quite get. He asks: "But why would there be a supply shortage at such high tuition rates?" His answer is that universities require such huge initial investments, and take so long to pay off, that building them is not feasible for the private sector. I think that although this is true, the main reason for the supply shortage is that schools don't "pay off" in the traditional sense, ever. Colleges just seem to only work well as nonprofits. And the only people who are willing to invest huge amounts of money in nonprofits are the government and rich private individuals (e.g. Leland Stanford). We have a supply shortage because governments make the decision whether or not to build new public-school campuses (and recently they have not done so), while colleges themselves can only respond to skyrocketing demand by raising price.

Update 2: Matt Yglesias weighs in:

[T]he shortage isn’t so much of “universities” as it is of prestige. You could hire some people with PhDs and throw a few classrooms together pretty easily, but it would be extremely difficult to replicate the decades of history associated with America’s selective colleges and universities.

This is the old "signalling" model of education, which holds that college doesn't really give you useful skills, it only serves to prove to potential employers that you are smart and/or hardworking. In this model, a school's prestige is valuable because it sends a better signal.  I won't rehash the signalling debate here. But I would like to ask Matt: If you think that college is all about prestige and not about human capital, why did you equate human capital with years of schooling in the first place? Given that 95% of the populace graduates from high school, you pretty much have to think either that A) college gives you human capital, or that B) human capital shouldn't be measured in years of schooling. Pick one!

Update 3: Niklas Blanchard responds, and adds some interesting thoughts about why rich private individuals don't start universities anymore. My thoughts are: 

1) Even in Leland Stanford's day this was extremely rare. Stanford University is actually one of the youngest of America's elite schools, and probably only came into being because there were no elite schools in California in the late 1800s; in fact, Leland Sr. initially contemplated making Stanford an arm of Harvard! 

2) Although I think Niklas is right about the globalization of charity, it seems to me that private universities have never been that huge a factor in terms of numbers in the U.S. Schools like Harvard and Stanford grab headlines, but have small fractions of the enrollment levels of Berkeley or the University of Michigan. 

3) Niklas doesn't mention Baumol's Cost Disease by name (though he uses Baumol's favorite example of classical music!), but I think that's what he's getting at. Starting a top university is just a more expensive undertaking than it used to be...and it was always insanely expensive. But also keep in mind that large amounts of the funding for top public universities comes from charity (private alum donations).


4) Remember that universities don't just create human capital, they do research too! And research is as pure of a public good as exists anywhere. So government subsidies for research institutions are likely to get a lot of bang for their buck.

Calm down, Will Wilkinson! Joe Stiglitz is not the problem.

 

Will Wilkinson is normally one of the calm voices of reason in the political-econ blogosphere. But when liberals complain about inequality, it just drives him up the wall. In response to Joseph Stiglitz' Vanity Fair article decrying inequality, Wilkinson wrote the following:

[The] explosion in public-private "partnerships", and the inevitable political corruption and economic distortion they produce, is not at bottom due to a plot of the top 1%. It is due in no small part to the success of progressive ideologues like Mr Stiglitz in arguing for ever greater government control over everything.

A political system that enshrines governments' power to grant monopolies and other barriers to economic competition, whether they be direct subsidies to government's chosen champion firms, or less direct subsidies by way of taxes, tariffs, and regulations that disproportionately harm less-favoured firms, inevitably attracts money to politics. Under close inspection, the progressive master narrative...is an argument against money in politics that argues for precisely the sort of government power that draws money to politics.

The progressive master narrative runs on the fuel of class interest, but it makes an arbitrary exception for members of the progressive technocratic elite, like Mr Stiglitz...These men and women, the technocratic elite...may be trusted with almost unlimited power to manage the nation's economy...Sure, these godlike king-making powers make professional courtiers of the money men, but not to worry. The public-minded technocrat pledges in his heart of hearts to express only the will of the people...

Inequality is a red herring that draws our attention away from the real, hard task that faces truly public-spirited reformers: how to fix the corrupt and corrupting interface between America's economic and political institutions. We may hope for, but should not expect, useful, impartial advice in this regard from powerful academics holding golden key-cards to the revolving door. And we may hope for, but should not expect, useful advice in this regard from progressives dizzy from chasing their tails. So, instead, we get righteous rants about the injustice and danger of inequality.

You know, I share many of Will's concerns. Collusion between government and the private sector has always been the biggest source of corruption and of undeserved gains. It is arguably the main problem with our financial system today.

But it just seems a bit nuts to blame progressives for this problem!

Consider this assertion: "corruption...is due in no small part to the success of progressive ideologues...in arguing for ever greater government control over everything." Seriously?? First of all, has government control over the U.S. economy increased in recent decades? Any reasonable person would say "No." Regulation was slashed under Reagan, slashed under Clinton, and slashed under Bush. "Privatization" has continued apace, to the point where even our prisons and our military are now partially farmed out to contractors. Total government employment, as a percentage of total employment, has been flat since 1976 at a little less than 10%, and the federal slice has fallen substantially.

And during this time, conservatives, not progressives, have been in the driver's seat. Even Democratic presidents have had to kowtow - remember Clinton's declaration that "the era of big government is over"?

Equally mistaken is the notion that public-private partnerships - the collusion that Wilkinson and I both decry - are a result of socialist meddling. It is Republicans who pushed through the bulk of the aforementioned "privatizations" - outsourcing of government functions to well-connected firms, often via no-bid contracts. Does Will think that Blackwater or Halliburton got where they are today by cozying up to progressive politicians or technocrats? And on the lobbying side, it was Grover Norquist and Tom DeLay who led the K Street Project, an attempt to institutionalize the revolving door between private-sector lobbyists and the Republican party.

Conservative support for collusion is especially the case in finance. Read Simon Johnson's book 13 Bankers, and you will hear him point out again and again that it was Republican politicians who were most receptive to lobbying efforts by big banks. Sure, Democratic administrations were (and are) complicit in the "revolving door" between the government and Wall Street, but this has occurred over the loud objections of progressives, while conservatives have typically turned a blind eye.

All this leads me to ask: Are Will and I living in the same country? This idea that progressive success has led to public-private collusion is very clearly a false narrative.

It seems to me that Will is just really, really, really pissed off by the attitude and priorities of people like Joe Stiglitz, to the point where he blames these intellectual technocrats for everything that is wrong with our political economy. The "progressive master narrative" - that the masses need technocrats to protect them from plutocrats - strikes people like Will as horrifically arrogant, elitist, and even autocratic. I get that. But if Will and like-minded libertarians would just calm the heck down for a minute, they'd see that this progressive master narrative has been getting its butt handed to it all over the world for the past thirty years. Repellent as the progressive narrative might or might not be, it is the conservative master narrative - that government ought to be drowned in a bathtub, that businessmen always make the right decisions because they are businessmen, that there are no such things as public goods - whose excesses have actually been put into practice.

See, I have my own master narrative. It goes something like this: In a well-functioning economy, the government and the private sector complement rather than cannibalize each other. No country's private sector will ever get rich without the infrastructure, schools, research, legal system, police, army, etc. that only the government can and will provide in sufficient quantity. Private businesses should usually not try to take over these functions, just as the government should usually not attempt to build factories, dictate bank lending, or refine petroleum. To maintain this balance, one thing we need is a strong free-market ideology that prevents the government from overstepping its bounds. 

But we also need high-quality technocrats in the government - technocrats who are dedicated enough or well-paid enough to resist the efforts of rational, self-interested, profit-seeking businessmen to use the government as a cash cow. If you demonize technocrats, all you'll succeed in doing is in making the technocrat profession a disreputable one. And all that will get you is...low-quality, easily corruptible technocrats! And if you try to respond to the existence of low-quality, easily corruptible technocrats by saying "Aw heck, Nozick was right, let's just drown the whole government in the bathtub," you'll just end up impoverishing your country, and then eventually you'll end up with kleptocrats rather than technocrats, and just watch what happens to your liberty under the kleptocrats.

So to people like Will Wilkinson with strong libertarian instincts, I say: Calm down. Put aside your gut reactions and take a cold serious look at the dangers threatening America's political economy. The danger of Marxism is long past. The danger of becoming a failed state is real and big and increasingly immediate. Yes, Joe Stiglitz is a big-forehead limousine liberal who thinks he knows what's best for the common people. No, Joe Stiglitz is not what ails this country.

(Side note: At the beginning of his post, Will links to a post by Scott Winship attempting to refute all of Stiglitz' claims about inequality. I am pretty unimpressed with this post. It consists of A) a headline claim that is swiftly retracted, B) a claim that increasing health care costs represent real wage increases, C) some opinion statements saying that Stiglitz' numbers just aren't that big of a deal, and D) a whole lot of taunting and calling Stiglitz a commie. If this is the best his detractors can do, I score this round for Stiglitz, despite the fact that I am not nearly so worried about inequality.)

Update: See comments for an explanation of why I'm not hugely worried about inequality. Short answer: It doesn't seem to be impacting people's quality-of-life as much as things like unemployment, financial insecurity, and stagnating income.

Update 2: The Economist's Matt Steinglass takes his co-blogger Wilkinson to task, making basically all of my points and a whole lot more, in this epic rebuttal.