The New Voodoo

John Cochrane writes,

Economics is a work in progress. But it is certainly brand-new, made-up-on-the spot economics, designed to buttress policies decided on for other reasons.

He is describing the economic analysis that claims that policies to distort labor markets to try to increase wages will increase aggregate demand, so that instead of reducing employment these policies will raise employment.

I am reminded of the made-up-on-the spot economics of the Laffer Curve, which claimed that cutting taxes would reduce budget deficits. That became known as “voodoo economics.”

So where once we had supply-side voodoo economics, we now have demand-side voodoo economics. Just what we needed.

17 thoughts on “The New Voodoo

  1. It is an economic certainty that there is a tax rate such that reducing the tax rate will reduce the budget deficit. And a lower one that will maximize the size of the economy. Nothing voodoo about either.

    • You forgot the curve part.

      What you just did was change the argument to make it reasonable, a mathematical identity in fact.

      There are others who change it to make it sound ridiculous and others wh change it to make it sound too good to be true.

      • The curve requires only that every tax rate should be associated with tax receipts, continuously. That seems reasonable – there is no tax rate where a tiny change in tax rate would cause a large change in tax receipts.

        Once you assume that, and the idea that tax receipts will be close to zero at both a 0% rate and a 100% rate, then you also know – as a mathematical fact – that the first-order effect of a change in the marginal tax rate will vary as the square of the tax rate. So, even without knowing where the peak revenue to the government is, you know that the social cost of raising the tax rate goes up quickly with the tax rate.

        First principles can be very powerful!

        • Correction – will vary at least as fast as the square of the tax rate. It could be faster.

  2. Any claim which concedes any trade off between competing values is always untenable in the long term and will inevitably be supplanted by a conflating rhetoric that insists all objectives are perfectly aligned.

    That’s basic marketing (not to mention ideological simplification). This thing isn’t less tasty but at least very healthy, it’s good and good for you. Justice, prosperity, and efficiency are not at odds, but instead will all emerge from the same policy.

    • I recently had some unpleasant political conversations with my leftwing brother. He simply refuses to concede that there is a downside to any of the policies he supports (e.g. high immigration always helps the existing population, even those competing against the immigrants for jobs, by increasing aggregate demand). And he refuses to admit that any of the current administration’s policies, even if mistaken (e.g. Libya), have had serious harmful consequences for the world (as opposed to the 4 Americans who got killed). At least libertarians have the intellectual honesty to admit that their favored policies will probably help some people at the cost of hurting others.

      • I’ve seen this inevitable progression many times from ‘costly but worthwhile’ (“in order to make an omelet you have to break some eggs”) to mindless ‘win-win’ (“we’ll get to eat our cake and then still have it too.”)

        Some Libertarians are recently becoming guilty of this rhetorical tactic too. Instead of saying immigration or free trade produces winners and losers, some are now fond of saying that, from the right perspective and in the long term, there are really only winners, or at very least we shouldn’t worry about the losers because we don’t worry about them in ordinary domestic competitive situations.

        For the progressives every reform is Pareto efficient and the reason it doesn’t happen spontaneously is market failure.

        In the alternative, the only costs accrue to bad, unjustly privileged oppressors, and either they don’t count, or bringing them down a notch is a positive contribution to social justice.

  3. It is interesting those who denigrate Laffer do so not because it is impossible but that rates aren’t high enough to do so, an empirical fact, while those that denigrate demand do so by claiming it is impossible rather than empirically possible but wages increases are too high to have this effect. I will always weigh empirics more than theory, even as difficult and messy as they are. Always.

    • That is because that is precisely the case. The critique of the Laffer curve is a critique of a distortion, a strawman, a caricature of the concept. There is some empirical support that there is in revenues versus tax rates (something like the insanely high rate of 70%) as well as the common sense insight that it must exist.

      Is it possible to create demand by destroying demand? Maybe, but it sure does need some explaining. I am rather suspicious of the suggestion of empirical experimentation that starts with “first, we shift the entire economy.”

      It’s basically the same complaint I/we have about the circular reasoning of the market monetarists. So don’t take it personally. Furthermore, nobody is criticizing (here) demand virtuous cycles, just the distortion of them for nefarious purposes and the inappropriate allusion to the actual theories to make people think actual economics is happening.

      Shifting towards a higher propensity to consume is a theory of short-term recovery, not long-term growth. The type of wage growth we want but haven’t seen for 44 years didn’t result from slicing the pie differently and it won’t come back from it.

      • It’s like a full-time job assuring some of you people that we don’t believe the things your respective sides say our pundits are telling us.

        As sensitive as you people are you wouldn’t last a weekend as a libertarian!

      • The right always assumes its conclusions. It is fairly easy to create demand by shifting income to those willing to spend it and investment isn’t very sensitive to interest rates or we wouldn’t be at 0.5% and 10 year at 1.6%. Even longer term, higher wage rates can increase investment to save labor which supports increased demand for as long as it takes to make the investment, by which time other opportunities for investment arise. Not that this would be necessary if the Fed didn’t always try to thwart inflation in advance. Participation is still low, though it did make more sense earlier.

        • “It is fairly easy to create demand by shifting income to those willing to spend it”

          Demand for what? Demand for capital goods tends to come from those with low near-term demand for additional consumption. But everyone demands something. The amount of money kept as cash under the mattress is minimal. ALL the rest of it is used to buy something. Sure, that thing may be T-bills, but those are not the same as cash under the mattress, because T-bills pay for… government consumption.

          The “propensity to consume” theory is wrong because everyone has a propensity to consume all their money. The only thing you can change is what they consume it on – government spending, capital spending, or end product consumption.

  4. Two things always came to my mind when people would reference the Laffer curve:

    1. How do you know which side of the curve we’re on?

    2. Everyone seemed to assume that the ideal point of the curve to target was the peak. While that may maximize government revenues, was anybody interested in the point on the curve that would maximize economic growth and living standards? My guess is that would be somewhere well to the left of the curve’s peak.

    • To know which side of the Laffer curve one is on, as a first approximation, one might watch what happens when there is a significant tax change. If federal receipts do not quickly implode, then you were likely to the left of the peak.

  5. So, the idea is that more mone going to those with high propensity to consume will enhance specialization and trade, in the most charitable version, right?

    But they are not coupling it with a reduction in stifling regulation.

    Therefore, just another example of “restricting supply and subsidizing demand?”

    Bonus points for the added claim that restricting supply itself stimulates demand.

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