Monthly Archives: February 2017

Tariffs and Trade Balances

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In response to a comment, here is some textbook international economics.

1. A 10 percent tariff has the same effect on the relative cost of imports as a 10 percent depreciation of our currency.

2. The macroeconomic theory of the trade balance is that it is determined by the difference between domestic saving and domestic investment:

(private saving minus private investment) plus (government surplus) = (trade surplus)

3. If a tariff does not change anything on the left-hand side, it cannot change anything on the right-hand side. That requires an offsetting appreciation of the exchange rate.

4. Thus, textbook international economics predicts that a tariff (or a tariff combined with an export subsidy) will have no effect on the trade balance, but instead it will cause the domestic currency to strengthen.

5. The border-adjustment tax is analyzed as if it were an import tariff and an export subsidy. Ergo, its effect is on the exchange rate, not on the trade balance.

Why American Cities Cannot Compete on Cost

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Handle comments,

if a company can move some operations even 50 miles away from a high price place, then why not move them to the cheapest feasible place?

…If a job doesn’t have such distance-limitations regarding interactions with other humans, it will immediately be outsourced from high wage counties to the cheapest place.

If your company needs to plug into a specific talent pool, you want that talent pool close by. If your company can use just anyone, then the lowest-cost place to locate is not a cheap American city but an even-cheaper foreign city.

Timothy Taylor on Capital Allocation

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He writes,

I’m not opposed to spending more money on fixing up roads and bridges and other physical infrastructure–indeed, it’s often an investment fully justified by cost-benefit analysis–but I am dubious that 21st century economic growth is going to be based on fewer potholes. When talking about investment to drive economic growth, I’d like to see more focus on expansion of research and development spending.

I will go a step further and say that I am opposed to more infrastructure spending as carried out by the Federal government. Politicians are fond of allocating capital to themselves, and my guess is that as flawed as the private sector may be, it will spend an additional dollar more wisely than the politicians.

So when the infrastructure bandwagon rolls through town, leave me off.

Montgomery County (Md) Politics

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A commenter asks,

You’ve mentioned many times that Montgomery is owned part and parcel by the teacher’s unions. . .what aspects of county government do they control, and how?

Don’t take my word for it. Take theirs.

“It was the Unions that put Duchy in office n it was the Unions that took her out. Justice served!” read a text message forwarded at 1:24 a.m. Wednesday by John Sparks, head of Montgomery’s firefighters union.

Trachtenberg netted support from public employee unions four years ago but later challenged what she considers unsustainable compensation packages. The cost of government salaries and benefits have soared over the past decade in Montgomery and are a key driver of ongoing budget problems in the wealthy county.

That was 2010 and it was the firefighters’ union that threw her out. But four years earlier, it was the teachers’ union that put her in.

Political observers say the incumbents could be facing tough reelection battles. Four — Floreen, Subin, Phil Andrews (D-Gaithersburg-Rockville) and Marilyn Praisner (D-Eastern County) — failed to capture endorsement from the county’s influential teachers union.

The candidates backed by the teachers’ union won, leading someone an observer to comment.

MCEA was upset that Floreen and Subin had supported delaying a 2003 cost-of-living increase that was due to teachers under their contract because of budget problems. As a result, Leventhal and challengers Elrich and Trachtenberg made the Apple Ballot, while incumbents Floreen and Subin were excluded. The Apple candidates won the top three slots, while Floreen earned the fourth seat and Subin lost. Subin’s loss was particularly notable because he was a 20-year council veteran and the long-time head of the council’s education committee.

The author concludes,

So what does the Teachers’ emergence as Montgomery County’s dominant political force mean for the future? With property tax growth slowing down, the next county council will face tough budgetary decisions. Public schools account for half of the county’s budget and would be an obvious location for cuts. But don’t expect any action there: the county’s politicians have learned that those who cross the Teachers Union once are unlikely to be given a second opportunity.

An increasing share of that budget is going to pensions and non-teaching staff who are union members. Actual classroom teachers are badly over-worked.

Because spending per student is by far the highest in the state, the WaPo constantly refers to Montgomery County as a high quality school system. However, the average outcomes in the County schools are mediocre. Students from the wealthiest parts of the County (three high schools in particular) produce good test scores, and the rest do not. Other school districts in Maryland get similar outcomes with students of similar backgrounds while spending much less money per student.

I know relatively little about Education Secretary Betsy DeVos. But I see the teachers’ union as an enemy, and they see her as an enemy. Ergo, I am inclined to view her in friendly terms.

Average is Over for regional job creation

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Janet Adamy writes,

in the mid-1980s, 29 metropolitan areas that contained 45% of the country’s jobs were home to half of the national increase in companies after an earlier recession.

Now look at what happened after the painful 2007-09 economic downturn. The aforementioned five metro areas [New York, Miami, Los Angeles, Houston, and Dallas] housed half of the nation’s net increase in new firms and accounted for 17% of employment between 2010 and 2014. Left behind are thousands of small towns and rural areas that stitch together much of America.

She cites a new report, Dynamism in Retreat. I recommend checking out the report, and in particular the section “How did we get here?”

I think it is important to keep in mind that this is a global phenomenon. Commenter Handle has convinced me to consider a scenario in which wealth becomes more highly concentrated in a few key cities.

In traditional economic terms, think of an economy consisting of three sectors. One sector is monopolistically competitive. A second sector is protected somewhat from competition by licensing rules. The third sector consists of new natural monopolies.

Monopolistic competition is what you see as you drive along a road with strip malls. The nail salons, restaurants, and small financial services firms operate on low profit margins, because entry is easy.

The license-protected sector is where you find medical professionals, teachers, and others where credentials are required. If you can obtain a license and you are willing to work long hours, you can make a lot of money in some of these occupations. But nothing spectacular.

The spectacular profits come from the natural monopolies. These are the software-driven firms that exploit network scale advantages.

For a would-be natural monopolist, the difference between success and failure is so dramatic that the savings that might come from setting up in a low-cost area seem trivial. Better to locate in one of the high-growth cities where the best talent can be found.

As the seekers of natural monopoly gravitate toward big cities, the licensed professionals and the monopolistic competitors follow, because that is where spending on services is high. Tax revenue is high there also, which helps to generate government jobs.

The difference between the few winning cities and the loser regions is widened by self-selection. Talented, achievement-oriented people move to the big cities, and they leave the loser regions.

The Economics of a Border-Adjustment Tax

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Timothy Taylor writes,

Most countries around the world and all high-income countries other than the United States have “border adjustments” in their tax code, but a key point to recognize is that border adjustments are typically part of a value-added tax–not the corporate income tax.

. . .the Trump administration proposal for revising the corporate income tax is actually a first-cousin-once-removed of a value-added tax.

Taylor cites scholars of various political persuasions in support of this analysis. Greg Mankiw makes a similar point. If you prefer taxing consumption to taxing saving and labor, then you should get to know the economics of the border-adjustment tax in the context of a shift from taxing corporate profits to taxing corporate net revenue.

But John Cochrane points out

a tax system in which you tax $100 of sales, but offer $99 of deductions (costs, wages, earnings retained for investment), then tax only the last $1, then tax that $1 again as personal income, would seem to offer lots of room for shenanigans on just what gets deducted. Along with interesting financial engineering to “invest” more earnings and pay less dividends and interest.

The more radically you reform taxes, the more you risk creating new distortions, both foreseen and unforeseen.

Tyler Cowen has a point about politics.

I say anything complicated they will just screw up, and the lack of transparency in the plan means eventually it will lead to a tax hike and furthermore a good deal of favoritism and rent-seeking along the way. Best hope is simply that they cut the corporate tax rate and don’t do much else on that front.

It is true that lowering the corporate tax rate would reduce the malincentive effects of loopholes in the tax. Lowering the stakes involved would lower the rent-seeking. Also, simply lowering the rate seems less risky (see John Cochrane’s whole post.

The economic theory of how a border-adjustment tax should work is worth knowing. However, theory tends to apply to concepts in the abstract. In practice, a lot of tax policy turns on what gets defined as taxable and what does not. And those regulatory and legislative decisions are where the rent-seeking and the distortions kick in.

Finance: Practitioners vs. Economists

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Pablo Fernandez writes,

If all investors had identical expectations,
A) Trading volume in financial markets would be very small. However, the trading volumes of many markets are
huge.
B) All valuations of the shares of a company should coincide. However, there are huge differences in stock
valuations (analysts, investment banks, consultants, financial companies …)
C) The return required for the shares of a company should be identical in all valuations.
D) The expected cash flows of the shares of a company should be identical every year in all valuations.

Since our world is not characterized by any of the four above characteristics, how can one even insinuate the
hypothesis of homogeneous expectations?

My thoughts:

1. I think that the models developed by financial economists have some value, unlike those of Keynesian macroeconomists.

2. However, the fiction of the “representative investor” is problematic for some of the reasons that the fiction of the “representative agent” is problematic in mainstream macro.

3. Economists tend to assume that the conflict between financial practitioners and financial economists should be resolved in favor of economists. To some extent, this has happened, as index funds and Black-Scholes option pricing became important in practice. But as Fernandez points out, financial practice still differs sharply from what models say that it ought to be, and the economists seem to be unwilling to explore why this is the case.

I have influence with Steve Bannon

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Apparently.

he was indeed reading “The Best and the Brightest.”

Read the whole article, by Marc Tracy in the NYT. No, there is no indication that I had anything to do with Bannon’s choice of reading. Tracy makes this point:

If “The Best and the Brightest” is a brief against the East Coast meritocracy, though, its proposed alternative is not pure ideology. It is expertise.

Time and again, in Mr. Halberstam’s telling, lower-level government officials who understood Vietnamese politics, sentiments and even geography assessed reality accurately and offered correct policy recommendations to the major characters — who shunted them aside.

Well, in hindsight, the lower-level officials who raised doubts about the Vietnam commitment were experts. But there were other lower-level officials who argued the other way, and in hindsight they look like fools, or like toadies saying what they thought the senior policy makers wanted to hear.

I did not come away from the book thinking that the main conflict is between ideology and expertise, although I think that is a plausible reading. Instead, I came away from it thinking that the major conflict was between “can-do” overconfidence and sensible skepticism. The political process prefers the overconfident individual promising to solve problems, and so power accrues to people with “solutions,” even if those turn out to have dreadful consequences.

It did not take an expert to sense that there was something wrong with getting involved in Vietnam. On p. 181, Halberstam writes,

Thruston Morton was assigned to inform Senator [Richard] Russell of the Armed Services Committee that the President would be sending an estimated 200 men to South Vietnam as well as funding the country. Russell answered that it was a mistake, it would not stay at 200, it would eventually go to 20,000 and perhaps one day even as high as 200,000. . .

“I think this is the greatest mistake this country’s ever made,” Russell said.

That was during the Eisenhower Administration. A few years later, Russell and others advised President Kennedy against expanding the commitment, but at the same time other powerful figures argued for an even stronger U.S. buildup. This was to be the case throughout the war, and neither Kennedy nor Johnson were decisive enough to either limit the commitment on the one hand or to undertake the most aggressive military actions on the other.

As I pointed out in a previous post, Eisenhower deserves credit for staying out of a war in Vietnam. Halberstam writes (p. 178-179),

Eisenhower was in no mood for unilateral action, and in 1954 his manner of decision making contrasted sharply with that of Lyndon Johnson some eleven years later. Whereas Eisenhower genuinely consulted the Congress, Johnson paid lip service to real consultation and manipulated the Congress. Eisenhower’s chief of staff had made a tough-minded, detailed estimate of what the cost of the war would be; eleven years later an all-out effort was made by almost everyone concerned to avoid determining and forecasting what the reality of intervention meant. In 1954 the advice of allies was genuinely sought; in 1965 the United States felt itself so powerful that it did not need allies, except as a means of showing more flags and gaining moral legitimacy for the U.S. cause. Eisenhower took the projected costs of a land war to his budget people with startling results; Johnson and McNamara would carefully shield accurate troop projections not only from the press and the Congress but from their own budgetary experts. The illusion. . .that bombing could be separated from combat troops, which was allowed to exist in 1965, was demolished in 1954 by both Ridgway and Eisenhower.

The lessons that Mr. Bannon might take away from this are to consult widely on decisions, pay attention to pessimistic estimates of potential costs and adverse consequences, and above all encourage honesty from subordinates. Beware of those who tell you what they think you want to hear, and instead encourage those who give you their honest analysis.

One of My Pet Peeves

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Jenna Robinson writes,

Emphasizing amenities over education also does a disservice to the faculty and students more interested in academic pursuits. A recent National Bureau of Economic Research (NBER) paper found, perhaps not surprisingly, that demand for high-quality academics is limited to only the best and brightest students, while wealthy students with low academic aptitude have the strongest demand for recreational amenities. In such an environment, university leaders likely feel financial pressure to cater more to the lowest common denominator.

She goes on to give examples. Pointer from George Leef.

I really hate the fads in college facilities. The state-of-the-art fitness centers, the Kennedy-Center-rivaling performing arts centers, etc. Brandeis University, which is hurting for money because of the Madoff scandal, nonetheless wasted money on building a new admissions office. Swarthmore College probably has the equivalent of several buildings worth of unused facilities on its campus, and it still campaigns for more donations.