Saving Jaguars and Elephants with Property Rights and Incentives

When it comes to saving endangered species, many people have the instinctive reaction that that the policy answer is to pass a law that forbids disturbing or hurting the species. Economists have long pointed out that while such a law may be a useful first step, the incentives of those who live locally to avoid hurting the animal and to protect its habitat matter a lot. If finding an endangered species on your land means that you are deprived of the use of that land, there is a counterproductive incentive, as the old saying goes, to \”shoot, shovel, and shut up.\” In low-income countries, in particular, protecting endangered species and their habitat will require active cooperation of nearby villages and farmers.

A classic example is whether to allow hunting of elephants in Africa. Terry Anderson  and Shawn Regan provide a lively and opinionated overview last June in \”Shoot an Elephant, Save a Community.\”  

\”Anti-hunting groups succeeded in getting Kenya to ban all hunting in 1977. Since then, its population of large wild animals has declined between 60 and 70 percent. The country’s elephant population declined from 167,000 in 1973 to just 16,000 in 1989. Poaching took its toll on elephants because of their damage to both cropland and people. Today Kenya wildlife officials boast a doubling of the country’s elephant population to 32,000, but nearly all are in protected national parks where poaching can be controlled. With only 8 percent of its land set aside as protected areas, it is no wonder that wildlife in general and elephants in particular have trouble finding hospitable habitat. …

\”In sharp contrast to Kenya, consider what has happened in Zimbabwe. In 1989, results-oriented groups such as the World Wildlife Fund helped implement a program known as the Communal Areas Management Programme for Indigenous Resources or CAMPFIRE. This approach devolves the rights to benefit from, dispose of, and manage natural resources to the local level, including the right to allow safari hunting. Community leaders with local knowledge about wildlife and its interface with humans help establish sustainable hunting quotas. Hunting then provides jobs for community members, compensation for crop and property damage, revenue to build schools, clinics, and water wells, and meat for villagers … By granting local people control over wildlife resources, their incentive to protect it has strengthened. As a result, poaching has been contained and human-wildlife conflicts have been reduced. While challenges remain, especially from the current political climate in Zimbabwe, CAMPFIRE has quietly produced results with strikingly little activist rhetoric. … Ten years after the program began, wildlife populations had increased by 50 percent. By 2003, elephant numbers had doubled from 4,000 to 8,000. The gains have not just been for wildlife, however. Between 1989 and 2001, CAMPFIRE generated more than $20 million in direct income, the vast majority of which came from hunting. During that period, the program benefitted an estimated 90,000 households and had a total economic impact of $100 million. 
Wildlife imposes real costs on African communities. Those communities need the right incentives to protect wildlife and its habitat. The results go beyond the CAMPFIRE areas. Between 1989 and 2005, Zimbabwe’s total elephant population more than doubled from 37,000 to 85,000, with half living outside of national parks. Today, some put the number as high as 100,000.\”

A more recent example focuses less on hunting, and more on a combination of tourism and property rights as the local incentive. The October 2011 issue of Smithsonian magazine has an article about \”The Jaguar Freeway: A bold plan for wildlife corridors that connect populations from Mexico to Argentina could mean the big cat\’s salvation.\”  The article discusses an effort to connect existing jaguar habitats from Mexico to Argentina with corridors in which the jaguars could travel, in an attempt to preserve their biodiversity and to prevent the animals from being confined in nature preserves. Here\’s a map of the plan, where the green areas are jaguar population centers, the yellow lines are corridors that are pretty likely, and the red lines are jaguar corridors at risk: 

This article isn\’t written by or for economists, but the negotiations with government, local landowners and farmers over whether to create these jaguar corridors often refer to incentives for tourism. Here is a scattering of comments from the article: 

\”[I]n 1984, Belize’s Cockscomb Basin became the world’s first jaguar preserve. Now en­compassing about 200 square miles, it is part of the largest contiguous forest in Central America. Jaguars are now thriving in Belize, where ecotourism has made them more valuable alive than dead.\”

Here\’s a description of two \”conservation ranches\” in Brazil: \”The ranches straddle two preserves, making them an important link in the corridor chain and together creating 1,500 square miles of protected habitat. …
These ranches are expected to be more successful than others by using modern husbandry and veterinary  techniques, such as vaccinating cattle herds. Because disease and malnutrition are among the leading killers of cattle in this region, preventing those problems more than makes up for the occasional animal felled by a jaguar. “My vision was to ranch by example,” Kaplan says, “to create ranches that are more productive and profitable and yet are truly jaguar-friendly.”\”

\”In Belize, where jaguars serve increasingly as an attraction for ecotourists, Maya who once killed the animals are now their protectors. “It’s not born-again enlightenment,” says Rabinowitz. “It’s economics.” Jaguar tourism is also bringing money into the Pantanal [in Brazil]. Carmindo Aleixo Da Costa, a 63-year-old rancher, says that hosting a few foreign tourists doubles his annual income. “Now is the time of the jaguar!” he says, beaming.\”

Government Redistribution : International Comparisons

Income inequality has been growing in most high-income countries around the world. How much do the redistribution policies of government hold down this growth in inequality? The OECD has published Divided We Stand: Why Inequality Keeps Rising. (The report can be read for free on-line with a slightly clunky browser, and a PDF of an \”Overview\” chapter can be downloaded.) Chapter 7 of the report discusses \”Changes in Redistribution in OECD Countries Over Two Decades,\” which basically means from the mid-1980s to the mid-2000s. The chapter draws on a longer background paper that is freely available on-line: Herwig Immervoll and Linda Richardson\’s paper, \”Redistribution Policy and Inequality Reduction in OECD Countries: What Has Changed in Two Decades?\”

The United States does relatively little redistribution in comparison with other OECD countries. This graph from the \”Overview\” of the OECD report compares the inequality of market incomes to the inequality of disposable income after taxes and benefit payments. Inequality is measured by a Gini coefficient. For a more detailed explanation of how this is measured, see my November 1 post on Lorenz curves and Gini coefficients. But as a quick overview, it suffices to know that a Gini coefficient measures inequality on a scale from zero to 1, where zero is perfect equality where everyone has exactly the same income and 1 is perfect inequality where one person has all the income. The United States has one of the most unequal distributions of market income and of disposable income, and in this comparison group, U.S. policy does relatively little to reduce the disparity. The OECD writes: \”Public cash transfers, as well as income taxes and social security contributions, played a major role in all OECD countries in reducing market-income inequality. Together, they
were estimated to reduce inequality among the working-age population (measured by the Gini coefficient) by an average of about one-quarter across OECD countries. This redistributive effect was larger in the Nordic countries, Belgium and Germany, but well below average in Chile, Iceland, Korea, Switzerland and the United States (Figure 9).

Any economy that has a progressive tax code and benefits for those with low incomes will find that as inequality increases, redistribution will also increase automatically as a result of these preexisting policies Some countries may also take additional steps, when faced with rising inequality of market incomes, to raise the amount of redistribution. A table in Ch. 7 of the OECD report calculates how much of the increase in increase in market incomes from the mid-1980s to the mid-2000s was offset by a rise in redistribution.

Denmark is the extreme case: increased redistribution from the mid-1980s to the mid-2000s offset more than 100% of the rise in inequality of market incomes. In a number of countries, the rise in redistribution offset from 35-55% of the rise in inequality of market incomes over this time period: Australia, Canada, West Germany, Netherlands, Norway, Sweden. By comparison, in the U.S. the rise in government redistribution from the mid-1980s to the mid-2000s offset just 9% of the rise in market inequality.

It\’s useful to look at redistribution policies both from the tax side and the benefits side. The striking theme that emerges is that in most countries, benefits for those with low incomes are much more important in reducing inequality than are progressive tax rates.

On the tax side, the U.S. tax code is already highly progressive compared with these other countries. The OECD published at 2008 report called \”Growing Unequal: Income Distribution and Poverty in OECD Countries, which states (pp. 104-106): \”Taxation is most progressively distributed in the United States, probably reflecting the greater role played there by refundable tax credits, such as the Earned Income Tax Credit and the Child Tax Credit. … Based on the concentration coefficient of household taxes, the United States has the most progressive tax system and collects the largest share of taxes from the richest 10% of the population. However, the richest decile in the United States has one of the highest shares of market income of any OECD country.After standardising for this underlying inequality … Australia and the United States collect the most tax from people in the top decile relative to the share of market income that they earn.\”

This finding is surprising to a lot of Americans, who have a sort of instinctive feeling that Europeans must be taxing the rich far more heavily. But remember that European countries rely much more on value-added taxes (a sort of national sales tax collected from producers) and on high energy taxes. They also often have very high payroll taxes to finance retirement programs. These kinds of taxes place a heavier burden on those with lower incomes.

In addition, top income tax rates all over the world have come down in recent decades, and the U.S. top rate is near a fairly common level. From the \”Overview: \”Top rates of personal income tax, which were in the order of 60-70% in major OECD countries, fell to around 40% on average by the late 2000s.\” From the
Immervoll and Richardson working paper: \”Reductions in top [personal income tax] rates were steepest in Japan (from 70 to 37 percent), Italy (65 to 43), United Kingdom (60 to 40), and France (65 to 48). The flattening of schedules mostly concerned higher income ranges (Australia, Austria, Finland, France, Germany, Japan, United Kingdom, United States).\”

The real difference in how much redistribution affects inequality arises from differences in benefits. The OECD writes: \”Benefits had a much stronger impact on inequality than the other main instruments of cash distribution — social contributions or taxes. … The most important benefit-related determining factor in overall distribution, however, was not benefit levels but the number of people entitled to transfers.\” This theme applies to a number of benefit programs, including disability payments. But here is an illustrations with regard to unemployment insurance, taken from the Immervoll and Richardson working paper. They write: \”Figure 11 indicates that the shares of unemployed reporting benefit receipt have dropped in a majority (two thirds) of the countries shown, while only a few recorded significant increases.\” Notice that the share of the unemployed in the U.S. who get unemployment benefits is on the low end of the spectrum.

This pattern also fits with my post on November 1 about a Congressional Budget Office report which found that Federal Redistribution is Dropping. It pointed out that the share of federal redistribution spending programs going to the elderly has been steadily rising, while the share going to the non-elderly poor and near-poor has not been rising. The working paper also notes: \”[O]ver time, almost all countries devoted declining shares of total spending to cash benefits that mostly benefit children and working-age individuals.\”

The OECD report been criticized for suggesting that higher taxes on those with the very highest incomes might be worth considering, but this is certainly not the main focus of the report. Indeed, given that the U.S. tax system is already one of the most progressive, this recommendation seems aimed more at other countries than at the United States. The \”Overview\” of the OECD report states: \”However, redistribution strategies based on government transfers and taxes alone would be neither effective nor financially sustainable. First, there may be counterproductive disincentive effects if benefit and tax reforms are not well designed. Second, most OECD countries currently operate under a reduced fiscal space which exerts strong pressure to curb public social spending and raise taxes. Growing employment may contribute to sustainable cuts in income inequality, provided the employment gains occur in jobs that offer career prospects. Policies for more and better jobs are more important than ever.\” In particular, the OECD report emphasizes as policy tools to fight unemployment job-related training and education, continuing education over the work life, and reforming rules prevalent in many countries that separate the workforce into temporary and permanent employment contracts.

As part of an overall plan to get the budget deficit under control, and given the rise in inequality over recent decades, I would be favor a somewhat higher marginal tax rate on those with very high income levels. But it seems to me that U.S. political discourse has focuses way too much on taxing the rich. Hard-core Democrats and Republicans both like the familiar arguments over taxes: it gets their blood pumping and their base motivated. But U.S. political discourse has far too little about reforming labor markets to open up more jobs, or about how to stimulate job-related education for life. And neither party stands up for raising government spending in ways that would affect those with lower income levels more, whether through income payments to families (especially to the working poor) or through spending on public goods like neighborhood safety (police, lighting and activities), parks and libraries, or education and public health that would have a greater effect on the quality of life for those with lower incomes.

Africa\’s Prospects: Half Full or Half Empty?

There has been a flurry of articles recently with optimistic economic news about sub-Saharan Africa. For example, the December 3 issue of the Economist featured \”Africa’s hopeful economies–The sun shines bright–The continent’s impressive growth looks likely to continue.\”  The December 2011 issue of the IMF publication Finance & Development has a group of articles about Africa; for example, an article by Calestous Juma titled \”Africa\’s New Engine: Africa looks to its middle-class consumers to drive prosperity.\” These articles draw to some extent on a September 2011 report from the African Development Bank: \”Africa in 50 Years Time: The Road Towards Inclusive Growth.\”  

Good economic news about Africa has been hard to come by these last few decades, but in the last 5-10 years, there have been some encouraging signs. For example, I posted last June 13 on how Africa was making up a growing share of international trade in Africa\’s Economic Development, and on September 19 about Africa\’s Growing Middle Class (!?!). I\’ll re-cap here some of the optimistic news, but buried a little deeper in these reports is some gloomy reality, too. 

Here\’s the Economist: \”From Ghana in the west to Mozambique in the south, Africa’s economies are consistently growing faster than those of almost any other region of the world. At least a dozen have expanded by more than 6% a year for six or more years. Ethiopia will grow by 7.5% this year, without a drop of oil to export. Once a byword for famine, it is now the world’s tenth-largest producer of livestock. … Severe income disparities persist through much of the continent; but a genuine middle class is emerging. According to Standard Bank, which operates throughout Africa, 60m African households have annual incomes greater than $3,000 at market exchange rates. By 2015, that number is expected to reach 100m—almost the same as in India now. These households belong to what might be called the consumer class.\”

Here\’s Juma in F&D: \”Cell phone use has grown faster in Africa than in any other region of the world since 2003, according to the United Nations Conference on Trade and Development. Africa became the world’s second most connected region after Asia in late 2011, with 616 million mobile subscribers, according to U.K.-based Informa Telecoms & Media. Of course, South Africa—the most developed nation—still has the highest penetration, but across Africa, countries have leapfrogged technology, bringing innovation and connectivity even to remote parts of the continent, opening up mobile banking and changing the way business is done. Seeing the cell phone success, banking and retail firms are eyeing expansion in Africa to target a growing middle class of consumers.\”

Unlike many areas of the world with aging populations, Africa is on the brink of a \”demographic dividend\” of rising numbers of prime-age workers. The last few decades have seen real strides in health and education. The region is urbanizing. The business climate is improving. It has vast quantities of natural resources and 60% of the world\’s undeveloped arable land. Africa\’s economies have strong and developing connections to China and to India, with their rapid growth rates. Africa\’s diaspora outside the continent of 30 million or so sends back something like $60 billion per year to the region–along with connections to other markets and skills. Capital inflows to the region are rising and now substantially outstrip foreign aid to the region: here\’s a figure from the Economist:

The Economist cites a World Bank report from last March, \”Africa’s Future and the World Bank’s

Support to It,\” which says: \”Putting these factors together, the Bank concludes that Africa could be on the brink of an economic take-off, much like China was 30 years ago, and India 20 years ago.\”

Good economic news about Africa\’s economic development  is welcome, and it may be churlish–or a sign of short days and looming Minnesota winter–to look at the gloomier side. But Africa\’s current growth projections, although they are presented in an optimistic tone, still mean odiously high levels of severe poverty even a half-century from now. Juma writes: \”Poverty will be a fact of life for a long time: one-third of all Africans will still be extremely poor in 2060, living on less than $1.25 a day, according to the AfDB.\” The African Development Bank writes: \”A dramatic decline in Africa’s poverty would require the continent to grow at an average of 7%. These projections fall short of that level. And there are still serious risks ahead to Africa’s growth path.\”

Developing Africa\’s possibilities for trade will require infrastructure investment, perhaps $500 billion over the next decade.  Paul Collier writes about the possibilities for African railroads in F&D: \”The continent is a huge landmass, well suited to railroads. Yet during the past half-century Africa’s rail network, never very extensive, has shrunk. Even the United States, a huge landmass with relatively low population density, has one kilometer of track for every 43 square kilometers of land. By contrast, Nigeria, home to one-fifth of the population of sub-Saharan Africa and one of its most densely populated countries, has but one kilometer of rail for every 262 square kilometers. Nigeria is not atypical: by radically reducing transportation costs, railways could open up vast tracts of Africa to economic opportunities, especially in agriculture and mining, which many countries are relying on for future growth. The continent needs a decade of massive investment in rail networks. Railways are hardly technologically challenging. They represent the oldest continuous industrial technology. Africa’s lack of railways compared with other regions is primarily a consequence of politics.\” But as Collier points out, rail in Africa would need to cross many national borders, which raises questions of who will invest, how the railroad would be governed, and how it would be priced. 

Electricity is another infrastructure need. Here\’s the African Development Bank: \”Africa’s electrification rate
as at 2009 was estimated at 42%, with coverage of 69% and 25% for urban and rural areas, respectively.
Available projections for electrification rates indicate a steadily rising trend in the coming three decades to a
rate of 51% in 2030.\” Investment in this area also raises questions of electrical generation and distribution systems that would cross multiple national borders. The AfDB again: \”Africa’s road infrastructure development is quite low in quantity, quality and access. Under 20 percent of roads are currently paved, and a study by the World Bank found that a significant share of the road networks built in the 1970s and 80s were in poor condition due to lack of maintenance.\”
African agriculture has been in reverse. Here\’s Juma: \”There is also vast untapped potential for African agriculture, which has actually regressed. World food production has increased by 145 percent since 1960, but sub-Saharan African food production is 10 percent lower today than it was 50 years ago, largely as a result of underinvestment in agriculture. For example, fertilizer use is strikingly low—only 13 kilograms a hectare in sub-Saharan Africa compared with 71 kilograms in northern Africa. Only 24 percent of cereal production uses improved seeds compared with 85 percent in eastern Asia. The lack of nutrient input has led to a dramatic depletion of soil quality; 75 percent of farmland in sub-Saharan Africa has been degraded by overuse. Only about 4 percent of Africa’s crops are irrigated, compared with about 40 percent in south Asia, which leaves sub-Saharan Africa vulnerable to fluctuations in world food prices.\”

Of course, one can look at these issues of investment and infrastructure not as problems, but as potential opportunities to accelerate Africa\’s growth. The current 50-year projections, although they sound optimistic, don\’t offer enough progress for me. Here\’s a graph from the African Development Bank. The top line, with the tan diamonds, shows a decline in extreme poverty for those living on less than $1.25 per day, but it would still be one-third of Africa\’s population in 50 years. The bottom line with green squares shows a second poverty line: those living on between $1.25 and $2 per day. This would still be another 10% of Africa\’s population 50 years from now. Yes, the line with diamonds, showing the \”middle class\” living on $4-$20 per day is rising. But my eyes just keep returning to the two poverty lines and their distressingly high predictions even 50 years from now.

A Soft Drinks Tax?

The October 2011 issue of Choices, published by the Agricultural and Applied Economics Association, has a set of six short readable articles on the subject: \”Should Soft Drinks Be Taxed More Heavily?\”

The case for taxing soft drinks–or as some of this literature puts it, SSBs (sugar-sweetened beverages)– is based on a hope that taxes on sugary beverages would reduce obesity and improve public health. Jason Fletcher cites some striking evidence (citations omitted here and throughout):  \”[S]oft drink consumption has increased by almost 500% in the past 50 years, and recent data suggest it represents 7% of overall energy intake in adults and often larger proportions in children … a 16% share of calories in youth ages 12-19 and 11% in children ages 2-11.\” Carlisle Ford Runge, Justin Johnson, and Carlisle Piehl Runge write: \”U.S. sugar-sweetened sodas account for one-half of the increase in caloric consumption over the past 25 years, and are the largest source of added sugars in the average diet …\”

 Reducing calories by a small amount, if sustained continually, would bring down weight. Fletcher again: \”We know that soda consumption is an important share of total consumption, and ample evidence suggests that maintained reductions in consumption of approximately 100 calories per day—less than a can of soda—could halt weight gain for 90% of the population …\”

Jason P. Block and Walter C. Willett cite a number of studies which estimate a price elasticity of demand for soda, often finding estimates in the range of .7 or .8–that is, a 10% rise in the price of the soda would lead to a decline of 7 or 8% in the quantity consumed.

The main counterargument is that when people cut back on soda or soft drinks, they don\’t switch to drinking water. Instead, most of them will shift to other equally caloric beverages, including cheaper brands of soft drinks, sugary fruit waters, and juices or milk. As a result, calorie intake won\’t drop. Fletcher one more time: \”[T]here is now ample research that examines the association between the level of state soft drink taxes—or soft drink prices—and obesity rates and found no effect. … [W]hile individuals in states with higher soda taxes have lower soda consumption, these individuals completely offset the reductions in calories from soda by consuming other high-calorie beverages, such as milk and juice. This evidence is consistent with the view that individuals demand calories each day, and if the price increases on one mechanism of attaining calories (soda) then individuals shift their consumption relatively easily to satisfy their demand.\”

There is also some evidence that there may be mildly positive health effects from a soda tax, but at best, the empirical evidence that an SSB tax would improve health is questionable and uncertain. Indeed, it may be that those who most need to lose some weight are also the group who would be most likely to substitute toward other caloric drinks.

Even if a sugar-sweetened beverage tax didn\’t reduce obesity, it might have some side benefits. For example,
Runge, Johnson, and Runge have an essay titled: \”Better Milk than Cola.\” Their point is that drinking milk or orange juice provides some other nutrients, even if the calorie count is the same, rather than just empty sugar. There may be dental health benefits, too.

Is there a way to make sugar-sweetened beverage taxes into a more useful policy tool? There are a number of possibilities. First, an obvious possibility would be to have higher taxes on sugar-sweetened beverages, and to focus them on those beverages in particular, not on all soft drinks.  Block and Willett point out that \”the inflation-adjusted price of soda has declined by as much as 48% over 20 years.\”

At present, lots of states apply their sales taxes to soft drinks. But usually such taxes are not specific to sugar-sweetened beverages vs. diet or low-calorie drinks. In addition, such taxes are not usually very large, and so are unlikely to have much effect on behavior. Here is Frank J. Chaloupka, Lisa M. Powell, and Jamie F. Chriqui (citations omitted): \”[V]ery few governments, including seven U.S. states, levy small taxes that are unique to soft drinks and other non-alcoholic beverages, and almost none of these, including the few state taxes, apply only to sugar-sweetened beverages.  However, most governments do impose their value added or sales taxes on a variety of beverages, with about two-thirds of U.S. states levying sales taxes on carbonated soft drinks. Again, none of these differentiate sugar-sweetened from unsweetened or artificially sweetened beverages. Given the low sales tax rates in the United States, these taxes add very little to retail prices, on average accounting for less than 5% of the tax inclusive price.\” A true SSB tax would presumably focus on sugar-content or calorie count.

A number of the essays point out that there may be interactions with public information campaigns or advertising and a soda tax. For example, publicity about the soda tax might help to make the tax salient in the minds of the consumers, so that they react to it more strongly. Publicity about healthier alternatives might also help in making healthier substitutions. Joshua Berning points out that soft drink companies spend tens of milllions each year on television advertising for top brands, which certainly suggests that advertising can influence choices. It also suggests that a tax on sugar-sweetened beverages could be undercut or offset by changes in advertising strategy.

One concern sometimes raised about a tax on sugar-sweetened beverages is that if people switch to diet soda, that might also have some negative health effects. However, studies of health effects of drinking diet soda need to account for two-way causality: that is, it may be that drinking diet soda causes poor health, or it may be that those who are already in poor health are more likely to drink diet soda. Block and Willett write: \”When all of these studies are considered together, it appears that many, if not all, of the apparent adverse effects reported for artificially sweetened beverages may be due to reverse causation—individuals may switch to artificial sweeteners because of weight gain or blood glucose abnormalities. The studies that properly account for possible reverse causation, by using longitudinal data on subjects over time and controlling for dieting behaviors and weight, find no clear association between artificially-sweetened beverage consumption and metabolic risk.\”

The final essay, by Robbin Johnson, offers a counterargument to the idea of a soft drink tax. He points out that there are lots of contributors to obesity: \”spending too much time sitting down watching screens; a physical environment that promotes vehicle use rather than walking; competition for the dining-out dollar that leads to larger portion size; lack of access to healthy foods or individualized portions; advertising messages promoting processed, calorie-dense foods; genetic factors; hormonal or other metabolic causes; use of medicines that contribute to weight gain; emotional needs that encourage overeating; quitting smoking; sleeping too little or too much; and aging.\” Most advice about weight loss and good health is about taking responsibility for moving toward an overall healthy lifestyle, not about identifying certain foods as \”bad foods\” and taxing them.

A \”bad foods\” tax, after all, would probably also focus on potato chips, french fries, snacks, candies, desserts, and processed meat, along with sugar-sweetened drinks, A \”bad lifestyles\” tax would tax or subsidize all sorts of actions. Leave aside the practical difficulties of designing and administering a bevy of such taxes. The conceptual insight is that these taxes would affect many foods and actions that are not bad for your health if done in moderation. There is something of a mismatch between a bevy of taxes to micromanage food and lifestyle choices for the average person, and the goal of discouraging the minority who are obese from overconsuming.

Will U.S. Government Debt Lead to Higher Interest Rates?

As the PIIGS economies of Europe–Portugal, Ireland, Italy, Greece, and Spain–have staggered into a sovereign debt and monetary crises, the interest rates on their government debt have risen substantially. Pedro Amaral and Margaret Jacobson of the Cleveland Fed point out that on certain basic measures of government indebtedness, the U.S. seems to be in the same neighborhood as the PIIGS countries. However, drawing on analysis from the IMF\’s September 11 Fiscal Monitor Report, they also point out some ways that the holders of U.S. debt are significantly different from holders of government debt in these other countries, which at least so far has helped to shelter the U.S. government from an interest rate spike.

Here\’s a table that puts U.S. borrowing in the context of the PIIGS. The first three columns apply to 2011. The first column shows \”Maturing debt\” as as share of GDP: that is, how much of what was borrowed in the past comes due in 2011. The second column shows the budget deficit: that is, how much additional borrowing in 2011. The third column, \”Total Financing Needs,\” adds up the first two, for the total amount that needs to be borrowed in 2011 both to roll over past borrowing and to cover new borrowing. The next three columns show the same calculations as projected for 2012. The last two columns show the \”Average years to maturity\” of government debt, because obviously it matters how soon the debt needs to be paid off. The final column shows the debt-to-GDP ratio for these countries.

What jumps out from the table is that the \”Total financing need\” for the U.S. is larger than in any of the PIIGS economies in 2011 and 2012. The U.S. budget deficits as a share of GDP are larger in 2011 and 2012 than for any of the comparison countries, except Ireland. The U.S. debt has a shorter average maturity than the other countries. And while the U.S. debt-to-GDP ratio is mercifully nowhere near that of Greece or Italy, and well behind that of Portugal, it is similar to Ireland and substantially larger than Spain.

These other countries have faced higher and rising interest rates in 2011, as shown in the figure for Spain and Italy, while U.S. borrowing has faced lower and declining interest rates. Why? 

Amaral and Jacobson provide some discussion of why U.S. interest rates haven\’t been rising. They draw on  the IMF Fiscal Monitor for September 2011, which has a Chapter 3 called \”The Dog that Didn\’t Bark (So far): Low Interest Rates in the United States and Japan.\”  The IMF writes (references to figures and tables omitted):

\”The relatively benign treatment by market participants of sovereign bonds issued by Japan and the United States, however, may not fully reflect fiscal fundamentals: current general government debt and deficits, and projected increases in debt over the next five years, are at least as high for the United States and Japan as they are for several euro area economies under market pressure or the euro area in general. In addition, projected long-term increases in pension and health care spending in the United States are larger than in many euro area economies. Japan and the United States face the largest gross financing requirements among all advanced economies this year and are projected to do so in 2012 and 2013 as well, reflecting their large deficits and debt stocks as well as their still relatively short debt maturity profiles, notwithstanding some success in lengthening maturities in recent years. Fiscal adjustment in the United States and Japan is lagging that in other advanced economies.\”

The IMF lists a number of  \”structural factors\” that have kept the the U.S. and Japan to keep interest rates on government borrowing low, at least so far. Most of the reasons relate to the basic idea that if government debt is held by large domestic investors, then those investors are less likely to flee to other financial investments. Here\’s the IMF on such factors (again, footnotes and references to tables and figures omitted):

Low interest rates in the United States and Japan partly reflect structural factors, including some that do not seem likely to change abruptly in the near term:

  • A substantial share of domestic debt holdings. In Japan, close to 95 percent of public debt is held domestically. The share is lower for the U.S. federal government, but rises to 70 percent for the general government. Moreover, the share of debt held domestically increases further for the United States if holdings by foreign central banks are excluded. This is significant, because private nonresidents may be more willing to shift their investments out of a country than are domestic investors, and foreign central banks may follow different investment practices than do other market participants …
  • Significant local central bank debt purchases. The U.S. Federal Reserve has purchased 7½ percent of GDP in Treasury securities (cumulative, under its quantitative easing programs), an amount equivalent to 12 percent of publicly held Treasury securities. …

  • Strong demand by a relatively stable investor base. Institutional investors—including insurance companies, mutual funds, and pension funds—hold 24 percent of government securities in Japan and 12 percent of Treasury securities in the United States. A further 22 percent of U.S. Treasuries and an estimated 2 percent of Japanese government bonds are held by foreign official entities. In addition, more than one third of U.S. Treasuries issued by the federal government are held by other government agencies, including the Social Security Fund …
  • Lower banking sector risks. Banking risks, which as the recent crisis has shown can dramatically affect fiscal developments, are perceived to be lower in the Unites States and Japan than in Europe …\”

So, can the U.S. government keep borrowing with impunity? After all, the dog of higher interest rates hasn\’t barked yet. The IMF offers a few cautionary remarks:

\”The widening crisis in the euro area shouldnevertheless serve as a cautionary tale for the United States and Japan, as well as other countries with high debts and deficits. Recent developments in Spain and Italy demonstrate how swiftly and severely market confi dence can weaken and how even large advanced economies are exposed to changes in market sentiment. … Low borrowing costs in Japan and the United Stateshave arguably created a false sense of security, but should be viewed instead as providing a window
of opportunity for policies to address fiscal vulnerabilities. In the absence of a new round of quantitative easing, higher interest rates could be required to attract new buyers of sovereign debt. …  Perhaps most importantly, Japan and the United States have also benefited from large stores of credibility—in other words, the implicit belief among investors that both countries will implement policies to ensure the sustainability of their debt. Such credibility might weaken suddenly if market participants became less convinced that such policies were forthcoming.\”

Horse Slaughter and Unintended Consequences

Buried in a U.S. Department of Agriculture bill that President Obama signed into law on November 18 is a provision that will probably lead to reopening horse slaughterhouses in the United States. The founder of the often-controversial People for the Ethical Treatment of Animals, Ingrid Newkirk, supported re-opening the slaughterhouses. She said in one interview:  “It\’s quite an unpopular position we\’ve taken. There was a rush to pass a bill that said you can\’t slaughter them anymore in the United States. But the reason we didn\’t support it, which sets us almost alone, is the amount of suffering that it created exceeded the amount of suffering it was designed to stop.”

What\’s the back-story here? Starting in 2006, Congress started placing provisions in the funding for the U.S. Department of Agriculture that prohibited government funding for inspecting horses destined for food. By 2007, this led to the shutdown of horse slaughterhouses in the United States. In June 2011, the GAO did a report on the aftereffects of the policy, and named the report: \”Horse Welfare: Action Needed to Address Unintended Consequences from Cessation of Domestic Slaughter.\”

Slaughtered in Mexico and Canada instead of the U.S.
The most obvious consequence is that instead of being slaughtered in the U.S., horses were shipped to Canada and especially to Mexico to be slaughtered instead. In 2006, about 100,000 horses were slaughtered in the U.S. By 2010, the number of horsed exported for slaughter had risen by about 100,000. Here\’s a graph of horses exported from the GAO report:

In other words, the policy didn\’t save horses.  A New York Times story reported in October: \”The closing of the country’s last meat processing plant that slaughtered horses for human consumption was hailed as a victory for equine welfare. But five years later just as many American horses are destined for dinner plates to satisfy the still robust appetites for their meat in Europe and Asia. Now they are carved into tartare de cheval or basashi sashimi in Mexico and Canada.\”

Indeed, the policy probably worsened the treatment of horses at the end of their lives. The horses needed to travel farther before being slaughtered. Their transit was no longer monitored by the USDA. And slaughterhouses in Mexico are not under USDA rules for humane slaughter. 

Indeed, in a few cases U.S. firms were re-importing horsemeat from Mexican and Canadian slaughterhouses for use in zoos. GAO writes that as of the end of 2010,  \”USDA identified at least three establishments—in Colorado, Nebraska, and New Jersey—that import horsemeat for repackaging and distribution to purchasers in the United States who feed the meat to animals at zoos and circuses.\”

Horse Abuse Expanded
As it has become logistically harder and less remunerative to send a horse to slaughter, the amount horse abuse has been rising. The GAO reported: \”Comprehensive, national data are lacking, but state, local government, and animal welfare organizations report a rise in investigations for horse neglect and more abandoned horses since 2007. For example, Colorado data showed that investigations for horse neglect and abuse increased more than 60 percent from 975 in 2005 to 1,588 in 2009. Also, California, Texas, and Florida reported more horses abandoned on private or state land since 2007. … [T]he Montana Association of Counties reported that the number of horses being abandoned by their owners has rapidly increased since horse slaughter for human consumption was halted in the United States, but the association did not have specific data. In addition, the National Association of Counties reported that the increasing abandonment problem is notexclusive to Montana or the West but is happening nationwide.\”

Although it was not possible to slaughter horses for human consumption in the U.S., it continued to be legal to bring the corpse of a horse to a rendering plant to be turned into pet food or glue. As GAO explained: \”Before 2007, horses were slaughtered in domestic slaughtering facilities only when the horsemeat was destined for consumption by humans or zoo animals. Currently, pet food and other products, including glue, may still be obtained from the corpses of horses that are hauled to rendering plants for disposal. The production of these products is not covered by the requirements of the Federal Meat Inspection Act …\” There doesn\’t seem to be evidence on this point, but one suspects that some horses that would have ended up in the slaughterhouse before were now ending up at rendering plants.

There are also concerns that wild horses might be being shipped to Mexican and Canadian slaughterhouses. USDA used to work with the Bureau of Land Management to prevent wild horses from being slaughtered in the U.S., but with USDA inspectors out of the picture, it\’s not clear

Return of the Horse Slaughterhouse
In the aftermath of the new law, the Christian Science Monitor reported: \”[M]eat processors are now considering opening facilities in at least a half-dozen states, including Georgia, North Dakota, Nebraska, Oregon, Wyoming, Montana, and possibly Idaho.\” A number of animal rights groups like the Society for Prevention of Cruelty to Animals are outraged. The president of the U.S. Humane Society, Wayne Pacelle, takes the view that all U.S. horse owners should be required to provide lifetime care for their animals. (Exercise for the reader: Consider some likely unintended consequences that would arise from such a rule.) But as Newkirk, the head of PETA, said about the end of the U.S.  horse slaughter ban: \”It\’s hard to call [the end of the horse slaughter ban] a victory, because it\’s all so unsavory. The [funding] bill didn\’t mean any horses were spared, but it does mean the amount of suffering is now reduced again.\”

Should the Top Income Tax Rate be 48% or 73%?

How high should the top marginal tax rate be: that is, how much should those with the highest incomes pay in tax not on average, but out of any additional marginal dollars they earn? In the Fall 2011 issue of my own Journal of Economic Perspectives, \”The Case for a Progressive Income Tax: From Basic Research to Policy Recommendations,\” Peter Diamond and Emmanuel Saez argue that a top marginal tax rate of 73% is justifiable. For comparison, they estimate that the current top marginal tax rate–combining federal income tax rates, Medicare payroll taxes, and average state and local income taxes–is about 42.5%.

The Diamond-Saez 73% top tax rate has occasioned some controversy in the blogosphere. For example, Scott Sumner expresses his disagreement in \”Saez and Diamond explain taxes in the Journal of Economic Propaganda.\” Brad De Long expresses his approval in \”The 70% Solution: Taxing the Rich Department.\” Paul Krugman also expresses approval in \”Taxing Job Creators.\”

To me, the most thought-provoking counterpoint to the Diamond-Saez paper is an article published two years ago in the Fall 2009 issue of JEP. In \”Optimal Taxation in Theory and Practice,\” N. Gregory Mankiw, Matthew Weinzierl, and Danny Yagan make a case that the top marginal tax rate should be around 48%–roughly the current level.

My goal in this post is not to take sides between these papers, and get shot in the crossfire. I have proud parental feelings toward all of the articles that appear in my own \”Journal of Economic Propaganda\”–er, \”Perspectives.\” But even a proud parent can note the ways in which his offspring differ from each other.

Both sets of authors start with the standard optimal tax theory, which is built on two pillars. First, taxing those with high incomes at a higher rate makes sense if the marginal utility from income declines as income rises. But second, raising the marginal tax rate will reduce the incentive to work. So any gains from greater equality must be balanced against reductions in incentives to work. But even when two papers use a fundamentally similar framework, they can reach different conclusions. I\’m still trying to work through the fine print of the two papers, but at this point, here are some of the underlying differences.

1) How does one value the marginal dollar to someone with a high-income as opposed to the marginal dollar of someone with a low income? Diamond and Saez, for example, apply a formula such that the marginal value of a dollar of consumption for the average household in the top 1% of the income distribution, with about $1.3 million in income on average, is worth 3.9% of the marginal dollar of consumption for a family with median income of about $52,000. The lower the value put on marginal dollars for those with high incomes, the higher the implied marginal tax rate. But any such comparisons involve some dose of value judgment.

2) How much do high marginal tax rates discourage work effort? This effect is quite difficult to estimate accurately, because what we usually observe in the real world is a change in tax rates and a change in level of income reported–which is not the same thing as work effort. For example, if higher top tax rates cause a number of taxpayers to find ways to take more of their compensation in the form of employer perks or deferred benefits or lower-taxed capital gains, the data may show that higher tax rates lead to less current income–but how much of this is due to shifts in the form of compensation and how much is due to less work effort is hard to dig out of the data. Especially at the top of the very tip-top of the income distribution, most workers don\’t fill out time cards, and they often have considerable flexibility in the form in which they are paid. Of course, if higher marginal tax rates are highly discouraging to work effort, then there is a case for holding down those top rates.

3) As one simulates tradeoffs between equality and output, it\’s necessary to model the distribution of wages at the top of the income distribution. It turns out that how you describe that distribution matters. For the statisticians out there, Diamond and Saez argue that a Pareto distribution is a good fit, while Mankiw, Weinzeirl and Yagan argue that something between a lognormal and a Pareto distribution is a better fit. For the non-statisticians, imagine a graph of how many households have any given level of income. The right-hand tail of this graph, describing incomes of the very rich, will be getting \”thinner\” as income levels rise. The Pareto and lognormal distributions are two different formulas for how quickly the right-hand tail of income thins down. A \”fatter\” tail of high-income people tends to favor a higher marginal tax rate. The two sets of papers have a variety of other differences, too, like the extent to which capital income should be taxed and how this equity-incentive tradeoff should apply to the marginal tax rates of those with low incomes.

It is also fair to note that political beliefs probably play a role in these differences. Greg Mankiw is a Republican-leaning economist: he was chair of the Council of Economic Advisers in the George W. Bush administration and has been an adviser to Mitt Romney. On the other side, Peter Diamond is a Democratic-leaning economist: Barack Obama attempted to appoint him to the Federal Reserve Board of Governors, and when he was blocked by Republican senators, his name was rumored as a possibility for Obama\’s Council of Economic Advisers. To be clear, I\’m not suggesting that either author would consciously shade his analysis to fit pre-existing political beliefs. But I do believe that when working through a complex model with a number of discretionary choices, we all have a tendency to come out with what seems a \”reasonable\” answer–which often happens to be not too far from our preexisting beliefs.

For noneconomists, this difference in answers about top tax rates is frustrating. There\’s often a belief that economics is like an arithmetic problem–even if it\’s a complicated arithmetic problem–and it should have a right answer. But the study of economics isn\’t a cookbook with a set of ready-made answers. Instead, economics is a way of thinking that can be used by all political persuasions.

John Maynard Keynes once wrote (in the introduction to the Cambridge Econonomic Handbooks): \”[Economics] is a method rather than a doctrine, an apparatus of the mind, a technique of thinking which helps its possessor to draw correct conclusions.\” Indeed, debates among economists often seem odd to outsiders, because the shared framework is to use economic analysis to break down the arguments into their components, and then to use additional analysis and data to argue over the components. Frankly, I don\’t expect the Diamond-Saez and Mankiw-Weinzierl-Yagan authorial teams ever to reach agreement. But the ways in which they specify the components of their disagreement will be the basis of research in this area for years to come.

Rising Income Economic Inequality: Video Discussions

Each fall, Haverford College holds an \”Economics Alumni Forum.\” In October, Jane Dokko (class of \’98) and I (class of \’82) discussed \”Rising Income Inequality: Causes and Consequences.\” Jane and I loosely divided up the subject by having her focus more on U.S. experience with income inequality in recent decades, while I focused more on long-term historical patterns like the old Kuznets curve arguments, along with international and global patterns of inequality.

A press release summarizing the presentations is here. A video of the presentations, roughly an hour in length, is available here.  My presentation starts about 32 minutes into the forum. 

Added: Greg Mankiw has posted at his website a video presentation of a symposium of Harvard professors discussing inequality, including economists Larry Katz and Ed Glaeser.  It\’s about 80 minutes long, available here.

The Rise of Global Banks in Emerging Market: Future of Banking #3

Thorstein Beck has edited an e-book for Vox on \”The Future of Banking.\” It consists of 12 short and highly readable essays by expert economists, based on their academic research. The book is packed full of interesting and relevant analysis. This is the first of three posts on a few of the ideas that jumped out at me. The topics of the three posts are:

1) The dangers of persistently low interest rates
2) The misguidedness of a financial transactions tax
3) The rise of global banks in emerging markets 

My twentieth-century mind is used to thinking of global banking as an industry dominated by banks from high-income countries. That believe is already outdated, and becoming more so. Neeltje van Horen provides some background in \”The changing role of emerging-market banks.\”

Although many in the West are not familiar with emerging-market banks, they are by no means small. In fact, the world’s biggest bank in market value is China’s ICBC. The global top 25 includes eight emerging-market banks. Among these, three other Chinese banks (China Construction Bank, Agricultural Bank of China, and Bank of China), three Brazilian banks (Itaú Unibanco, Banco do Brasil, and Banco Bradesco) and one Russian bank (Sberbank). While excess optimism might have inflated these market values, these banks are large with respect to other measures as well. In terms of assets all these banks are in the top 75 worldwide, with all four Chinese banks in the top 20. Furthermore, in 2010 emerging-market banks as a group accounted for roughly 30% of global profits, a third of global revenues, and half of tier 1 capital.\”

Van Horen gives a number of reasons why growth of emerging market banks will outpace that of banks from advanced economies:

  • \”[L]oan-to-deposit ratios in general are very low due to the net saving position of these countries. This sheltered emerging-market banking systems to a large extent from the collapse of the interbank market and reduced the need for substantial deleveraging. This allows them now to continue lending using a stable and often growing source of deposit funding.\”
  • \”[M]ost emerging-market banks already have high capital ratios, limiting pressures for balance sheet adjustments. In addition, the new capital rules under Basel III are likely to be much less painful for these banks as they typically have less risky assets and their investment-banking business tends to be small.\”
  • \”[A] large part of the population in the emerging world is still unbanked. This provides for ample growth opportunities in these markets. In contrast, due to overall economic weakness and ongoing deleveraging among firms and households expected credit growth in advanced economies is low.\”
  • \”[T]he macroeconomic outlook in these countries is much better than that of advanced countries. Not faced with major sovereign debt problems nor large current-account deficits, most emerging markets are on pretty solid footing. Even though they will not be isolated from the problems in Europe and the United States, the dependency of these markets on the West has diminished in recent years.\”

I believe that if the U.S. economy is to grow at a robust pace over the next decade or two, it needs to figure out how to hook itself to the rapid growth that is occurring in emerging markets around the world. One of my standard examples is that this can happen as emerging markets where the legal and financial institutions can be rather shaky make use of the more developed financial, legal, and managerial structures of the U.S. economy. For example, while emerging market economies invest in safe U.S. assets, like  Treasury bonds, funds flow from the U.S. back these emerging markets looking for private sector investment opportunities. (For example, see my July 13, 2011, post on \”Producing Safe Assets, Searching for Risky Opportunities.\”) But van Horen\’s essay makes me wonder whether emerging markets will actually need the institutional infrastructure of U.S. and European banking and finance for very long, or whether they are moving into position to provide these lucrative industries within their own countries.

The Misguided Financial Transactions Tax: Future of Banking #2

Thorstein Beck has edited an e-book for Vox on \”The Future of Banking.\” It consists of 12 short and highly readable essays by expert economists, based on their academic research. The book is packed full of interesting and relevant analysis. This is the first of three posts on a few of the ideas that jumped out at me. The topics of the three posts are:

1) The dangers of persistently low interest rates
2) The misguidedness of a financial transactions tax
3) The rise of global banks in emerging markets

Proposals for a financial transactions tax are a hardy perennial topic. The European Commission proposed one in late September. Even the Vatican has gotten into the act by publicly supporting such a tax, a proposal I reviewed and critiqued in an October 28 post, \”Financial Transactions Tax: The Vatican vs. the IMF.\” In this book, Thorsten Beck and Harry Huizinga offer an overview of why such proposals are misguided policy in \”Taxing banks – here we go again!\”

There are two main arguments for a financial transactions tax: 1) by discouraging high-frequency financial transactions, it will encourage financial stability; 2) it could raise a lot of money at a time when government budgets are stressed.

The first argument is probably incorrect. As Beck and Huizinga explain:

\”As pointed out by many economists, transaction taxes are too crude an instrument to prevent market-distorting speculation. On the contrary, by reducing trading volume they can distort pricing since individual transactions will cause greater price swings and fluctuations. But above all, not every transaction is a market-distorting speculation. Speculation is not easy to identify. For example, which is the market-distorting bet – one against or for a Greek government bankruptcy? Did the losses of the banks in the US subprime sector occur due to speculation or just bad investment decisions? What is the threshold of trading volume or frequency beyond which it is speculators and not participants with legitimate needs that drive the market price for corn, euros, or Greek government bonds? Most importantly, however, FTTs are not the right instrument to reduce risk taking and fragility in the financial sector, as all transactions are taxed at the same rate, independent of their risk profile.\”

There is good reason to be concerned that excessive leverage can help lead to asset price bubbles and economic instability. But it is not at all clear that the raw number of financial transactions creates financial instability; indeed, it is possible that discouraging financial transactions could lead to greater instability. In this sense, a financial transactions tax is misguided.

If the goal is to raise more revenue from the financial sector, there are other ways to do it. In the European context, Beck and Huizinga point out that one simple approach would be to apply value-added taxes to financial services. They write: 

\”An obvious step towards bringing about appropriate taxation of the financial sector is eliminating the current VAT [value-added tax] exemption of most financial services. The current undertaxation of the financial sector resulting from the VAT exemption is mentioned by the European Commission as a main reason to introduce additional taxation of the financial sector. However, if the problem is the current VAT exemption, isn’t the right solution to eliminate it?\”

Another option for taxing the banking sector is to impose a tax on banks that have high levels of leverage. In a way, this is similar to policies where banks with low levels of capital need to pay higher premiums for their government deposit insurance–that is, it\’s an attempt to make banks face the possible social costs of their risky behavior. Beck and Huizinga refer to this policy as one of \”bank levies\”:

\”Bank levies are taxes on a bank’s liabilities that generally exclude deposits that are covered by deposit insurance schemes. Bank levies appropriately follow the ‘polluter-pays’ principle, as they target the banks – and their high leverage – that are heavily implicated in the recent financial crisis. Bank levies have significant potential to raise revenue and they directly discourage bank leverage, thereby reducing the chance of future bank instability. In sophisticated versions of bank levies, they are targeted at risky bank finance such as short-term wholesale finance, and they may be higher for banks with high leverage, or for banks that are systemically important.\”

In short, proposals for a financial transactions tax are an old nostrum. Whether the goal is enhancing financial stability or raising revenue, or both, better options are available.