Timothy Taylor on Capital Allocation

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.

The Economics of a Border-Adjustment Tax

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.

Price Discrimination Explains Everything

Two years ago, the Executive Office of the President wrote,

Ultimately, whether differential pricing helps or harms the average consumer depends on how and where it is used. In a competitive market with transparent pricing, the benefits are likely to outweigh the costs. For example, while there is lots of differential pricing in airline ticket sales, the Internet has made it relatively easy for many travelers to compare prices and itineraries across airlines and to select the best deal for any given trip. Some studies even suggest that differential pricing can intensify competition relative to uniform pricing, by allowing high-margin sellers to compete more aggressively for price-sensitive customers who might otherwise buy from a lower-priced rival.

differential pricing seems most likely to be harmful when implemented through complex or opaque pricing schemes designed to screen out unsophisticated buyers. For example, companies may obfuscate by bundling a low product price with costly warranties or shipping fees, using “bait and switch” techniques to attract unwary customers with low advertised prices and then upselling them on different merchandise, or burying important details in the small print of complex contracts.

Pointer from Timothy Taylor.

The report’s reference to “a competitive market with transparent pricing” is disingenuous. There is little scope for price discrimination in a truly competitive market. If there are only one or two airlines flying a particular route, you can price discriminate. Not so if there were a hundred.

So get the highly competitive model out of your mind. The real world in which most businesses live is one with high fixed costs and low marginal costs. Then marginal-cost pricing is too low, while average-cost pricing is too high.

A numerical example will help. Suppose that the fixed cost is $1 million and each unit costs you $1 at the margin to produce. Think of selling a hundred thousand units, which means a total cost of $1.1 million, or an average cost of $11. If you price at marginal cost, of only $1, you fail to recover fixed cost, and you go out of business. If you price at average cost, $11, you drive away a lot of customers who are willing to pay more than your marginal cost of $1 but less than a price of $11.

If you can price discriminate, then you might charge $2 to the price-sensitive customers and $20 to the price-insensitive customers. That way, both sets of customers contribute to covering your fixed costs.

Gita Gopinath on Trade and Exchange Rates

She says,

most of trade invoicing is done in dollars. More recent research shows that these dollar prices tend to be sticky—that is, these dollar prices are far more stable than exchange rates. For non-U.S. economies, therefore, a depreciation of their currency relative to the dollar leads to almost a one-to-one increase in the price of imported goods in their own currency and, therefore, the pressures on inflation are high. On the other hand, because dollar prices of traded goods are relatively stable, the inflationary pressures on the U.S. economy are weak.

Pointer from Timothy Taylor.

It is as if there has been a bottom-up decision to stabilize the purchasing power of the dollar. That consensual hallucination makes U.S. monetary policy less effective at wiggling the inflation rate.

Later, she says,

we instead explored the role of value-added taxes and payroll subsidies or, more specifically, raising value-added taxes and cutting payroll taxes. What we found, surprisingly, is that this form of intervention did extremely well in mimicking the outcomes of a currency devaluation, not approximately but exactly.

The point is that a country like Italy or Greece is not trapped by being in the euro. It could increase its competitiveness by raising value-added taxes on consumption and cutting payroll taxes.

I recommend the entire interview. I do not buy everything she says, but it is all interesting.

Timothy Taylor on Christmas Trees

He wrote,

One artificial tree used for one year has greater environmental impact than one natural tree. However, an artificial tree can also be re-used over a number of years. Thus, there is some crossover point, if the artificial tree is used for long enough, that its environmental effect is less than an annual series of trees. For example, the ellipsos study finds that an artificial tree would need to be used for 20 years before its greenhouse gas effects would be less than those of an annual series of natural trees. The PE Americas study offers a wide range of scenarios, and summarizes, but here is the situation “for the base case when individual car transport distance for tree purchase is 2.5 miles each way. Because the natural tree provides an environmental benefit in terms of Global Warming Potential when landfilled, and Eutrophication Potential when composted or incinerated, there is no number of years one can keep an artificial tree in order to match the natural tree impacts in these cases. … For all other scenarios, the artificial tree has less impact provided it is kept and reused for a minimum between 2 and 9 years, depending upon the environmental indicator chosen.”

I think that it is hopeless to try to do these sorts of estimates. For one thing, note that if everyone bought artificial trees, then there would be fewer Christmas tree farms.

Are there artificial trees that can pass a Turing test? Do they smell like a tree? Do they have interesting asymmetries? If not, then it would seem as though artificial trees would be less fun to decorate.

The Gentrification Phenomenon

Derek Hyra writes,

Gentrification, in some places, is associated with political and cultural displacement. Some gentrifying areas once dominated by low-income minorities demonstrate an association between the movement of upper-income people and a loss of minority political representation. Remember, it was presumed upper-income people moving to low-income neighborhoods would bolster civic society, and it appears, in some circumstances, it has. Often, however, newcomers take over political institutions and advocate for amenities and services that fit their definition of community improvement. This process of political displacement can be linked with cultural displacement, a change in the neighborhood norms, preferences, and service amenities.

You don’t think that those poor urban residents appreciate the new bike lanes?

Thanks to Timothy Taylor–I took a small excerpt from his interesting post. Read the whole thing.

As you know, I think of gentrification as driven by the shift toward the New Commanding Heights of health care and higher education. These sectors create jobs for the affluent in urban areas.

The State of Arab Youth

From a UN development report press release.

Today, youth in the region are more educated, more connected and more mobile than ever before.

Pointer from Timothy Taylor.

We know from Martin Gurri’s The Revolt of the Public that this is a mixed blessing. Indeed, also from the press release:

increasing levels of armed conflict are destroying the social fabric of the Arab region, causing massive loss of life not only among combatants, but also among civilians. Conflicts also are also reversing hard-won economic development gains by destroying productive resources, capital and labour, within a larger territory neighbouring countries where they are fought. Between 2000–2003 and 2010–2015, the number of armed conflicts and violent crises in the region have risen from 4 to 11, and many of them are becoming protracted in nature.

Null Hypothesis Watch

1. Pro:
Timothy Taylor writes,

Why do the academic effects of early childhood education so often fade out? Is it lack of lack of follow-up in schools? The importance of peer effects as student who received pre-K assistance are blended in later grades with those who do not? Maybe the pre-K programs themselves vary in some way?

Read the whole post. Not all of the evidence is consistent with the null hypothesis, but it is very difficult to reject.

2. Con: David Leonhardt writes,

“The gains to children in Massachusetts charters are enormous. They are larger than any I have seen in my career,” [education researcher Susan] Dynarski wrote. “To me, it is immoral to deny children a better education because charters don’t meet some voters’ ideal of what a public school should be. Children don’t live in the long term. They need us to deliver now.”

Pointer from Tyler Cowen. For this research to be convincing to me, it would have to show that there is not much fadeout and also that the interventions are scalable.

The Null Hypothesis Strikes Again

Stephen L. Morgan and Sol Bee Jung write,

The results demonstrate that expenditures and related school inputs have very weak associations not only with test scores in the sophomore and senior years of high school but also with high school graduation and subsequent college entry. Only for postsecondary educational attainment do we find any meaningful predictive power for expenditures, and here half of the association can be adjusted away by school-level differences in average family background. Altogether, expenditures and facilities have much smaller associations with secondary and postsecondary outcomes than many scholars and policy advocates assume. The overall conclusion of the Coleman Report—that family background is far and away the most important determinant of educational achievement and attainment—is as convincing today as it was fifty years ago.

Pointer from Timothy Taylor, who links to other papers, not all of them as supportive of the null hypothesis.

Timothy Taylor on Shadow Banking

He writes,

if you still think banks are the core representative institutions in the financial system of high-income economies, you are a few decades out of date. If you are concerned about the dangers of financial sector risks cartwheeling into the real economy, you need to think about the shadow banking sector. Muscatov and Perez point out that while banking regulators do try to think about risks from the shadow banking sector, “Still, many areas of NBI remain obscured from regulators’ view, and not all NBI is subject to supervision.”

NBI is “non-bank intermediation.” Read the whole post.

Freddie and Fannie are non=bank intermediaries. Back in the late 1980s and the 1990s, they drove traditional lending institutions out of a large segment of the mortgage market. They did not do this through inherent advantages of scale or business model. They did it because they enjoyed small advantages from a regulatory standpoint, including lower capital requirements.

The moral of the story is that the “better” job you do of regulating banks, the more room you leave for other financial intermediaries to take over niches. I do not think that you can get financial regulation to achieve the goal of stabilizing the financial system. I think that it just winds up being a tool for allocating credit to politically preferred uses.