The Case for Skepticism

About a book by sociologist Duncan Watts, I write,

Watts’ book can be regarded as an extended argument in favor of what I might term Epistemological Skepticism about Social Phenomena, or ESSP. Those of us with ESSP believe that we should be skeptical about how much we can know with certainty in the fields known as the social sciences. We may learn things that are true for a majority of cases under specific circumstances. But we are less likely to find perfectly reliable, broadly applicable laws comparable to those found by physicists.

Financial Stability, Regulation, and Country Size

Lorenzo writes,

Something that is very clear, is that “de-regulation” is a term empty of explanatory power. All successful six have liberalised financial markets–Australia and New Zealand, for example, were leaders in financial “de-regulation”. If someone starts trying to blame the Global Financial Crisis (GFC) on “de-regulation”, you can stop reading, they have nothing useful to say.

Pointer from Scott Sumner.

The deregulation story amounts to saying that we know that regulation can prevent a crisis, but a crisis occurred, therefore there must have been deregulation. In fact, the risk-based capital rules that I have suggested helped cause the crisis were at the time they were enacted viewed as regulatory tightening, to correct flaws in the regime that existed at the time of the S&L crisis. The deregulation that did take place was intended to reduce bank profits by making the industry more competitive, not to increase profits or risk-taking.

Lorenzo’s post mostly beats a drum that I have been beating, which is that government tends to get worse as scale increases. He writes,

It is generally just harder to stick it to folks (either by what you do or what you don’t do) in a way that doesn’t get noticed in smaller jurisdictions. (Unless jurisdictions are so small they fly under the media radar but are big enough to be semi-anonymous–urban local government in Oz has a bit of a problem there.)

On Housing Finance Reform

I write,

The dysfunctional and regressive nature of policy in housing reflects the political configuration in Washington. For several decades, policies combined the efforts of social engineers clumsily seeking to expand home ownership with well-heeled interest groups skillfully lobbying for profits. The social engineers put taxpayer subsidies up for grabs, and the interest groups do the grabbing.

No One Standard of Living

John Cochrane writes,

The deeper point is that things are getting cheaper and cheaper, and people — services provided with their expertise — are getting more and more expensive.

He points to an NYT chart showing plummeting prices for goods and soaring prices for education, health care, and child care.

My view is that a lot of spending on these services is discretionary (not all of it, of course). I think this makes any broad statement about “the” real wage incorrect. See my essay on that topic.

Me on Greg Clark’s Latest

I write,

his findings argue against the need to create strong incentives to succeed. If some people are genetically oriented toward success, then they do not need lower tax rates to spur them on. Such people would be expected to succeed regardless. The ideal society implicit in Clark’s view is one in which the role of government is to ameliorate, rather than attempt to fix, the unequal distribution of incomes.

The book I am reviewing is The Son also Rises, in which Clark argues that social status is highly heritable everywhere in spite of many differences in institutional rules. I spend a lot of the review talking about the statistical basis for Clark’s work.

SNEP Solution: Flexible Benefits and Extreme Catastrophic Health Insurance

The problem is high implicit marginal tax rates on many people who are eligible for benefits from means-tested government programs. I think that a generic solution might consist of flexible benefits.

One approach would be to replace all forms of means-tested assistance, including food stamps, housing subsidies, Medicaid, and the EITC, with a single cash benefit. For this purpose, we might also think of unemployment insurance as a means-tested benefit.

The classic approach is the negative income tax. What I would suggest is a modification of the negative income tax, in which recipients are instead given flexdollars. These would be like vouchers or food stamps, in that they can be used only for “merit goods:” food, health care/insurance, housing, and education/training. One way to think of this is that it takes the food stamp concept and broadens it to include the other merit goods.

Flexdollars would start at a high level for households with no income and then fade out at rate of 20 percent of the recipient’s adjusted gross income. This “fade-out” would act as a marginal tax rate on income, so we should be careful not to set the fade-out rate too high.

Suppose that a household receives $7500 in flexdollars per member. Thus, a family of four with zero income would receive $30,000 in flexdollars. A family of four with $20,000 in income would lose 20 percent of $20,000, or $4,000, to fade-out, and hence would receive only $26,000. A family of four with a $50,000 income would receive $20,000. A family of four with a $100,000 income would receive $10,000. A family of four with a $150,000 income would receive nothing.

At the end of the year, unused flexdollars could go into flexible savings accounts. Tghese could be used for medical emergencies, down payments when buying a home, or to save for retirement.

There are two ways in which this represents an improvement over the current approach. First, it ensures that implicit marginal tax rates are low for benefit recipients. As it is now, people with low incomes easily can find that if they work they lose more in benefits than they obtain in pay. I think that is very corrosive, and I would put a high priority on restoring the incentive for people to work, while still giving them the means to meet basic needs.

The second benefit is that it gives recipients more flexibility and choice. Just as food-stamp recipients can decide for themselves what groceries to buy, flexdollar users can decide for themselves how much to allocate to housing vs. food vs. training.

One problem with a negative income tax or with flexdollars is that some families are needier than others, particularly with respect to medical issues. Someone with a lot of ailments and little in the way of resources will not have enough flexdollars to pay medical bills (remember that there is no longer Medicaid in this approach).

The solution I would propose would be to have taxpayers provide extreme catastrophic health insurance that kicks in if a household’s medical expenses exceed $30,000 in a year. For every additional dollar of medical expenses over $20,000, the government would pay 90 percent. For example, a household requiring $100,000 would receive $72,000. Of course, households would be permitted to obtain private insurance to cover lower levels of spending and/or to cover the remaining 10 percent of higher levels of spending. Overall, this idea bears some resemblance to the idea of “catastrophic reinsurance” that was floated about ten years ago.

I am thinking that we would eliminate Federal support for unemployment compensation. Instead, perhaps a private-sector form of unemployment insurance might emerge, and households would be able to buy this using flexdollars. If it turns out that nobody wants to spend their flexdollars on unemployment insurance, then that might be a sign that unemployment insurance is not such a great thing.

It might be best to phase in implementation. The first phase might be to fold in the EITC, food stamps, housing vouchers, and health insurance subsidies. Those are all programs that already take the form of cash or vouchers given to households. A later phase would be to replace Medicaid and unemployment insurance with flexdollars given to households. (Of course, if states want to continue to continue Medicaid or to provide unemployment compensation, without any Federal dollars to support the, they are welcome to do so. I doubt that would happen.) Another phase would be to wind down all forms of housing assistance, mortgage subsidies, Federal aid to education, training programs, Pell grants, and student loan programs, and replace these with flexdollars.

One challenge with implementation is in deciding which goods and services are eligible for flexdollars. Just as the food stamp program has to decide which groceries are eligible, the flexdollar program has to decide what counts as eligible medical services, housing services, and education services. Yes, that opens up the floodgates for lots of rent-seeking. If that gets really out of control, then it would be better to give people a straight cash benefit.

This is just a concept I am toying with. Criticism welcome.

Note that I once wrote an essay that I called The FlexDollar Welfare State that was not about an idea of this character. Instead, the essay criticized the George W. Bush Administration’s domestic policy initiatives. Actually, the best thing about the essay is the discussion of the oxymoron of “company benefits.”

What is interesting is that workers are not naturally suspicious of companies that pay “good benefits.” Apparently, most people believe that “good benefits” reflect generosity and sharing by the company, rather than a shrewd, calculated effort to save on compensation costs. My guess is that the people who see through the scam of “good benefits” tend to gravitate toward self-employment, which allows them to take their payments in cash and buy benefits themselves.

Thoughts on Charter Schools

My latest essay, which is a bit unusual for me in that it promotes a national government policy.

It would provide grants to states to support the administrative apparatus needed to ensure that charter school operators are given both a fair opportunity to offer educational alternatives and timely audits to ensure that they meet their responsibilities to students and parents. The grants should be sufficient to cover much more than the cost of this administrative apparatus. That way, recalcitrant states will have a strong incentive to adopt best practices for approving and evaluating charter schools.

I am not entirely sure that this is a good idea. But living in charter-hostile Maryland, I think it would take something like this to get charters going here.

Karl Zinsmeister writes,

Twenty-five years ago, charter schools hadn’t even been dreamed up. Today they are mushrooming across the country. There are 6,500 charter schools operating in 42 states, with more than 600 new ones opening every year. Within a blink there will be 3 million American children attending these freshly invented institutions (and 5 million students in them by the end of this decade).

1. As I see it, the main advantage that charter schools have over public schools is fact that bad teachers will tend to be fired and bad charters schools will tend to be closed.

2. Charter schools may follow a Clayton Christensen “disruptive innovation” path. That is, at first they will cater to low-income consumers. However, as they prove themselves in that niche, they may rapidly move up-market. Right now, many affluent parents are very attached to their public schools. However, that is an equilibrium that could tip. If parents come to view charter-school children as having an advantage in, say, college preparation, they will exit the regular public school system with great haste.

3. Another reason that charters may take off quickly in states and school districts that allow them to compete is that good young teachers are likely to prefer working at charter schools. If this happens over the next five to ten years, parents will notice that it is getting difficult to find good public school teachers and easier to find good teachers at charters.

4. If there is a rapid move toward charter schools, I think that this exacerbates the problem of unfunded pensions for retired teachers. If public school enrollment levels off or declines, I believe that the share of the budget devoted to paying for pensions is bound to increase.

5. I suspect that, relative to public schools, on average charters undertake less left-wing indoctrination of students. This is possibly the main reason for conservatives and libertarians to get excited about charter schools.

6. The political opponents of charters have to prevent them from getting started. Where I live, the opponents have succeeded. But once charters become entrenched, getting rid of them is quite difficult. See NYC.

Ignorance, Exit, and Voice

In this essay, I suggest that even if voters were knowledgeable about issues, our democratic process would still not be as desirable as having the exit option. This is in the context of talking about a recent book by Ilya Somin. In my view, an even more frustrating problem than voter ignorance is the enchantment that many people have with democratically elected leaders.

As I see it, reasonable government, including the protection of liberty, requires those in office to follow norms of behavior that are bound by Constitutional constraints and principles of limited government. The problem with democratic enchantment is that it sanctions whatever majority-elected political leaders can get away with.

My Review of Brynjolfsson and McAfee

Is here. An excerpt:

Back at the turn of the millennium, these applications seemed to Kurzweil to be on the near-term horizon. These strike me as the same applications that Brynjolfsson and McAfee suggest are on the near-term horizon today. While a few of Kurzweil’s other predictions did materialize, and while some of these applications are certainly closer to reality today than they were in 1999 or 2009, we should be wary that some of what The Second Machine Age tells us to expect may not in fact appear for several decades, if ever.

The Danger of Bond Bubbles

Gillian Tett writes,

In recent years an astonishing amount of money has quietly flooded into fixed income funds, which buy corporate bonds, emerging markets bonds and mortgage debt. And as the US looks more likely to raise interest rates, creating potential losses for bondholders, the flows could reverse – creating destabilising shocks for regulators and investors alike.

Read the whole thing. Pointer from Phil Izzo. My thoughts:

1. The last time I talked about a “bond bubble” was in 2003. Subsequently, I wrote that only a bursting of the bond bubble could undermine high house prices. I was wrong about that one.

2. Larry Summers would explain the “bond bubble” as secular stagnation. In his view, there is low demand for capital. As you know, I have little regard for this thesis.

3. Perhaps I feel burned by the way that the housing bubble burst on its own, but I would not focus on a bursting of the bond bubble as the key risk today. I find myself sympathetic to Seth Klarman on the stock market (Klarman is cited by Tett, and if you search diligently you can find copies of his investor letter posted on the web). I am skeptical of contemporary market arithmetic.

4. Klarman blames the Fed for low interest rates, and so do many people of my ideological stripe. My view is that if the markets wanted high interest rates, they could have them, notwithstanding the Fed’s efforts. Perhaps we now live in a world in which the primary threat to saving comes from political risk. In that world, savers are not looking for the assets with the best financial characteristics. Instead, they are hoping to invest where they will not lose their capital to taxation and confiscation. This might explain why a lot of foreigners still prefer to invest in low-yielding U.S. assets.

But the bottom line is that today’s financial markets have me puzzled.