Category Archives: links to my essays

An Immigration Tariff

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Reihan Salam discusses the idea.

The problem with Kenny’s proposal, in my view, is that if we are going to set a tariff, $50,000 is almost certainly not the “correct” price. Kenny’s concern is that the price might be too high, yet the findings of Miao Chi and Scott Drewianka suggest otherwise. Moreover, his thought experiment stipulates that a $50,000 tariff would lead to an influx of 1 million, but of course we don’t know what the market-clearing price would be. In the first year of the new system, in light of pent-up demand, the $50,000 tariff might lead to far more than 1 million immigrants, which in turn might lead to a backlash against immigration tariffs.

The way to fix the number slots, Salam argues, is with an auction of immigration slots, rather than a tariff. But I do not see why this is an instance where it is easier to know the number of slots than the correct price. (Not that i have any idea about what the correct price would be.)

When I thought about this issue nine years ago, I wrote

The tax rate for guest workers would provide a means with which to fine tune the competition between domestic and foreign workers. If we believe that foreign workers are driving domestic wages too low, we can raise the tax on foreign workers. On the other hand, if the economy is at full employment and we want continued expansion without inflationary pressure, we could lower the tax on foreign workers.

I was talking about a high payroll tax for guest workers, not about an immigration fee.

Note that the employers of illegal immigrants would much prefer a quota to something like my payroll tax proposal.

Why Large Corporations?

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In a comment on an earlier post, Ajay asks,

what is the point of a large corporation in the first place?

Some possibilities:

1. Governments want them. Surely, from a “seeing like a state” perspective it is better to have large corporations that are dependent on favors than small firms that are not.

2. There are genuine economies of scale and scope, including network effects.

3. Workers believe that they are more secure working for large corporations, and they are willing to take less compensation as a result. Note that this sort of belief could be self-fulfilling. Note also that it is not terribly consistent with the data: compensation appears to be higher at large firms, although that comparison assumes that the investigator’s idea of objective value of workers is more meaningful than their actual choices.

Think about Google. It needs to retrieve, store, and process huge amounts of data. There are scale economies. Once you have that data, you can benefit from other data, so you want to expand into email, location services, social networking, phones, and anything else that generates data. So there are economies of scope as well.

Maybe that is an exceptional case.

My tendency is to think that economies of scale are fairly common, but economies of scope are relatively rare. I understand big companies that specialize in a relatively narrow capability–something like Fedex, for example. I am less convinced about organizations that branch into many functions, like universities or large financial firms.

When I re-read what I wrote on this topic fifteen years ago, I see that my views have not moved very much.

Mortgage Rules and Mortgage Risk

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To much fanfare (it was the lead story in last Thursday’s Washington Post), the Consumer Financial Protection Bureau promulgated rules intended to reduce risky mortgage lending. My thoughts:

1. Horse. Barn Door.

2. Ed Pinto offers valid criticism.

3. Nothing has changed in Washington. Pinto notes that Freddie and Fannie are effectively granted exemptions from following the rules. To me, this leaves no doubt that the housing lobby is still setting mortgage policy. The CFPB may be a brand new agency, but it is caving into the same old rent-seekers.

4. The rules do not strike me as evidence-based. As I point out in a new essay, mortgage defaults are driven largely by the borrower’s loss of equity. Thus, the most important risk factor at the time the loan is made is the size of the down payment. The rules ignore that. Instead, the focus in the borrower’s debt/income ratio, which is far and away the least predictive of the major factors used in predicting default (the down payment is most useful, followed by credit score and then by loan purpose, although the effects of these variables interact with one another so that it is not so easy to rank-order their importance).

5. Later this month, I am going to be launching a course on the American housing finance system at Marginal Revolution University. Details to follow. But the course will be aimed at the sort of agency staff who work on housing policy issues. My goal is to share what I know about mortgage analytics and business processes within the mortgage industry. I am confident that my target audience is capable of absorbing this information. I am less confident that they will be able to have as much influence with policy makers as the industry lobbyists. But one can only hope.

James Buchanan and the Ideological Divide

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The death of Nobel Laureate James Buchanan has been much noted in the libertarian blogosphere, by Don Boudreaux for example. Alex Tabarrok lists more.

In contrast, those of us who were educated at left-leaning institutions learn almost nothing about Buchanan. There, he is (was) that right-wing guy who was a big proponent of public choice theory. He is treated as a shallow thinker whose claim to fame is treating government officials as self-interested.

In fact, Buchanan is one of the few economists who I credit with thinking more deeply than I do. (Yes, this reveals a lot about my self-regard. My egotistical view of the world is that other economists forego philosophical rigor in exchange for mathematical precision.)

To see what I mean about Buchanan, go to the library of economics and liberty and read Cost and Choice. (Note that you get to the contents of the book by clicking on the links over on the left. Or you can purchase the book relatively inexpensively.) Here is an excerpt (from the beginning of chapter three), to see what you are getting into.

A century has elapsed since the subjective-value revolution in economic theory, but the subjective theory of value has not been fully reconciled with the classically derived objective theory. As the notes on the development of the concept of opportunity cost indicate, economists have not drawn carefully the distinction between a predictive or scientific theory and a logical theory of economic interaction. As subsequent chapters will demonstrate, this methodological confusion is the source of pervasive error in applied economics. The treatment and discussion of cost, especially in its relation to choice, provides a usefully specific context within which the more general methodological issues can be examined.

…The following specific implications emerge from this choice-bound conception of cost:

1. Most importantly, cost must be borne exclusively by the decision-maker; it is not possible for cost to be shifted to or imposed on others.
2. Cost is subjective; it exists in the mind of the decision-maker and nowhere else.
3. Cost is based on anticipations; it is necessarily a forward-looking or ex ante concept.
4. Cost can never be realized because of the fact of choice itself: that which is given up cannot be enjoyed.
5. Cost cannot be measured by someone other than the decision-maker because there is no way that subjective experience can be directly observed.
6. Finally, cost can be dated at the moment of decision or choice.

I like to wrestle with these sorts of topics, but, for better or worse, my goal in writing is to bring them down to a layman’s level, as in my essay on subjective value.

Anyway, the point should not be to talk about me. What strikes me about James Buchanan is that, apart from the libertarian fringe, no economists attempt to appreciate the depth of his thought. I find that sad and disturbing.

Organizational Mediocrity is No Accident

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Tim Kane’s book, Bleeding Talent, earns a review from the New York Times.

That act binds the military into a system that honors seniority over individual merit. It judges officers, hundreds at a time, in an up-or-out promotion process that relies on evaluations that have been almost laughably eroded by grade inflation. A zero-defect mentality punishes errors severely. The system discourages specialization — you can’t expect to stay a fighter jock or a cybersecurity expert — and pushes the career-minded up a tried-and-true ladder that, not surprisingly, produces lookalikes.

Pointer from Tyler Cowen. Reihan Salam has more praise for the book.

This reminds me of the Federal Reserve Board, or of the public school system. To some extent it reminds me of the way large corporations treat middle managers. As I explained almost fifteen years ago,

For corporations, encouraging middle managers to take good risks is not as easy as it sounds. Middle managers understandably do not want the same degree of personal downside risk as entrepeneurs. However, in the absence of personal downside risk, the middle manager’s incentives would be skewed toward taking unjustifiable risks. Bureaucratic controls and limits on upside incentives may be an appropriate adaptation for correcting this potential bias.

I think that mediocrity is the natural state of organizations. Only the discipline of competition serves to bring about improvement.

Sovereign Default Threshold Analysis

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In a study of the prospects for Canadian provinces, Marc Joffe writes,

This method employs a multi-year fiscal simulation with a default threshold stated in terms of an interest expense to total revenue ratio (or interest bite). Using evidence from our historical survey, the conclusion is that default is likely at a 25% interest bite, so the simulations simply estimate the probability of each province reaching that level.

One way to think of this is that the political system will not tolerate debt payments that absorb more than 25 percent of revenue, and investors know that. So once the interest rate rises to the point where the interest bite hits .25, expect a debt crisis. That is, at that point, the government (in this case, a Canadian province) will consider default. The interest bite, B, is the average interest rate on debt, r, times the amount of debt, D, divided by tax revenue, T.

B = rD/T

Suppose that the ratio of debt to GDP is 50 percent and the ratio of revenue to GDP is 20 percent. Then we have

B = 2.5r

which means that once the average interest rate on debt hits 10 percent we are in crisis territory.

For the U.S. federal government, the ratio of debt to GDP is at least 70 percent (perhaps it is at least 100 percent), and the ratio of tax revenue to GDP tends to max out at 20 percent. At 70 percent, B = 35r. If we stick to the rule of thumb that a 25 percent interest bite is the point at which default becomes thinkable, then it would take an average interest rate of about 7 percent to reach that point. Note that because we have locked in low rates on some of the debt by issuing long-term bonds, it would take an increase in rates well above 7 percent in order to make the average interest rate on our debt reach 7 percent.

Some other thoughts:

1. It is hard to know what the rule of thumb might be for a U.S. default. It’s not like we have historical examples to serve as benchmarks.

2. For U.S. states, or for Canadian provinces for that matter, I wonder if pension payments to government workers should be added in order to estimate an “interest plus pension cost” bite. My thinking is that the political process may be stressed by taxpayers not receiving current services in return for their tax payments, and neither interest payments nor pension payments can be used to purchase current services.

3. Canadian provinces do not have balanced budget amendments, and consequently at least some of them are in more trouble than U.S. states. I am becoming more and more convinced that it is really hard to keep a democratic polity out of a debt trap in the absence of a Constitutional restraint.

4. Also, the Canadian single-payer health care system is run at the provincial level, so rising health care spending is a big driver of provincial fiscal problems.

5. I like the simplicity of Joffe’s rule of thumb. However, my own analysis of crisis triggers warns that the problem is complex and there are limits to what objective analysis can accomplish.

The Un-Malling of America

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Jeff Jordan writes,

Hundreds of malls will soon need to be repurposed or demolished. Strong malls will stay strong for a while, as retailers are willing to pay for traffic and customers from failed malls seek offline alternatives, but even they stand in the path of the shift of retail spending from offline to online.

Pointer from Tyler Cowen.

It used to be that a mall was lots of stores with a few places to eat tacked on as an afterthought. Now it’s the other way around.

It’s not just that people are buying more stuff online. They are buying less stuff (as a share of income), period. This is partly a long-term trend, as documented by economic historian Robert Fogel and picked up on by Nick Schulz and myself. It may be accentuated by information technology–think of all the stuff you don’t have to buy now because of digital technology: books, bookshelves, radios, music discs or tapes, stereo systems, calculators…

Fake Wealth

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Michael Munger writes,

If you measure from the peak of the bubble, we lost a lot of wealth. But that wealth was entirely fake, created by a revved up demand for houses as assets expected to appreciate rapidly.

Pointer from Mark Thoma. As Tyler Cowen would say, “We’re not as wealthy as we thought we were.”

If you are a Keynesian, fake wealth is a good thing. It is well known that deficit spending is pretty much useless if there is “Ricardian equivalence,” meaning that people realize that in the future their benefits have to go down and/or their taxes have to go up. However, I am a firm non-believer in Ricardian equivalence, as you might have noticed when you read Lenders and Spenders.

So if I thought that economic activity consisted of spending, then I would expect deficits to increase spending and economic activity. Instead, I think of economic activity as patterns of sustainable specialization and trade, and I do not think that deficit spending is helping, because it is so unsustainable.

To put this another way, I think that long-term government bonds are fake wealth these days. There has to be some kind of default on future government commitments. There is an off chance that the future commitments that get cut will be entitlements. There is an even more remote chance that the government will find tax revenue to cover all of its commitments. We can inflate away some of our past debt, but since our projected future deficits are even higher, inflation does not make the problem go away. So I think that it is likely that we will get some sort of default. The fake wealth will be marked down at some point in the future, either through inflation or default.

Once upon a time, we had an Internet bubble that gave us dishonest stock prices. Let us stipulate that it was caused by private sector shenanigans. When that collapsed, it was followed by a housing bubble. There were private sector shenanigans involved in that one, too, but I think that some of the fingerprints on the housing bubble belong to government officials. The fake wealth that is being created now? Pretty much entirely government-generated.

Happy New Year.

Year-end Stories

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In 2005, I listed five stories that I thought would have long-term significance: productivity; cognitive neuroscience, solar power, cancer therapy, and mainstream media meltdown. All five were areas where the trends were not clear. My inclination at the time was to take the optimistic view in all areas (in the case of the mainstream media, being optimistic to me means believing that the meltdown will be rapid).

Today, I would be less optimistic. Moreover, I think that the unsustainable fiscal outlook and its consequences have become one of the most important stories.

In 2003, I wrote one of my favorite essays, on what I called The Great Race between Moore’s Law and Medicare. There is an optimistic scenario for economic growth (think Ray Kurzweil) which would make all concerns about the long-term budget outlook seem foolish. However, other scenarios are less favorable. Recently, the budget situation has been deteriorating faster than the technological outlook has been improving. In terms of the great race, the wrong horse is gaining.