Year: 2018

It is a truth universally acknowledged that arguing about the definitions of terms like \”capitalism\” and \”socialism\” is a waste of time. So rather than argue, I will simply assert that the world has many flavors of capitalism: among them, US/British, Japanese, Scandinavian/northern European, German, Spanish/French/Italian southern European, and doubtless others. Within the United States, one might further identify a spectrum of capitalist beliefs.

I\’ve known some true socialists. But the overwhelming majority of the people I run into who talk a \”socialist\” game aren\’t actually in favor of having the government own the means of production, which includes the government making decisions about what will be produced and how it is priced–and which might also be taken to include government decisions about who gets hired, what jobs they do, what workers get paid, what rate of return is paid on invested money.

Instead, most of the self-labelled socialists I meet are in favor of a policy agenda that includes a greater emphasis on social protection and a reduction in economic inequality. Referring to  \”socialism\” gives them that college-sophomore thrill of being daringly different and appalling the bourgeoisie.  But when asked for real-world examples, they do not typically point to other countries which display primarily government ownership of the means of production. Instead, they point to national health insurance and to various European countries–in particular, to northern European countries like Sweden, Denmark, Norway, and sometimes Finland.

The true socialists I know see this point of view as selling out to capitalism. And the Scandinavians themselves are quick to say that they are not an example of socialism. For example, the prime minister of Denmark gave a talk at Harvard back in 2015 and said:

\”I know that some people in the US associate the Nordic model with some sort of socialism. Therefore I would like to make one thing clear. Denmark is far from a socialist planned economy. Denmark is a market economy … The Nordic model is an expanded welfare state which provides a high level of security for its citizens, but it is also a successful market economy with much freedom to pursue your dreams and live your life as you wish,”

Or as Paul Krugman wrote last week in his New York Times column in a discussion of the standards of living in northern European countries: \”[T]hey aren’t `socialist,\’ if that means government control of the means of production. They are, however, quite strongly social-democratic.\”

Of course, at some level the \”socialist\” or \”capitalist\” labels is not really the issue here. If we avoid the s-word and instead just refer to a Scandinavian style of capitalism, what are some of the key elements of that economic model?

Before digging into those elements, it\’s worth noting that just because the Sweden and Denmark and Norway are countries, and the United States is also a country, public policy may not be easily transplantable between the two. For perspective, the combined population of Sweden (population 10 million) Denmark (population 5.8 million), Norway (5.3 million) is roughly equal to the 20.3 million people who live in the greater New York City metropolitan area (that is, the New York-Newark-Jersey City, NY-NJ-PA Metro Area). These countries have close economic ties to the much larger European Union, which clearly helps trade with close neighbors, but have kept their own currencies and don\’t use the euro. Norway has considerable oil wealth.

It\’s also worth noting that the Scandinavian style of capitalism has gone through several stages in the last 50 years ago. For a nice overview how these changes played out in Sweden, I recommend the article by the Swedish economist Assar Lindbeck, \”The Swedish Experiment, which appeared in the September 1997 issue of  the  Journal of Economic Literature (35:3, 1273-1319, available via JSTOR or here). Lindbeck tells the story of how Sweden had relatively rapid growth after about 1870. He writes:

Increasingly ambitious welfare state arrangements and full employment after World War II also provided exceptionally high economic security, generous provision of public-sector services, and a relatively even distribution of income. It therefore seems natural that, especially during the early postwar decades, Sweden was generally regarded as having been able to combine economic equality, generous welfare state benefits, and full employment with high economic efficiency and rather fast productivity growth. But slower economic growth from about 1970, a collapse of full employment in the early 1990s, a recent widening of income differentials, and retreats of various welfare-state benefits have made the picture of the \”Swedish model\” less idyllic.

Lindbeck describes a number of problems that arose, including \”disincentive effects, problems of moral hazard and cheating with taxes and benefits, deficiencies in competition in markets for products and services, as well as inflexible relative wages …. [and] the ever higher ambitions of politicians to expand various government programs, and the gradually rising ambitions of union officials to compress the distribution of wages as well as to expand the powers of unions.\”

\”The Nordic countries themselves recognized the economic harm of high tax rates in terms of creating and retaining businesses and motivating work effort, which is why their marginal tax rates on personal and corporate income have fallen 20 or 30 points, or more, from their peaks in the 1970s and 1980s. …

Regardless of whether they are rich, poor, or in between, Nordic households are required to pay an additional VAT of 24 or 25 percent on their purchases, on top of all the other taxes that they pay. By comparison, sales taxes vary by U.S. State, but none is that high, and the national average rate is about 6 percent.

Even without the VAT, the high Nordic rates apply to everyone, not just the rich. The OECD prepares a measure of progressivity that is the share of nationwide household taxes paid by the top 10 percent of citizens (ranked by their income), expressed as a ratio of the share of national aggregate income. The ratio would be 1 if the household taxes were a fixed proportion of income. A regressive (progressive) tax would have a ratio less (greater) than 1, respectively. … Four of the Nordic countries have essentially proportional household taxes. The average progressivity of all five countries is 1.01, which is 0.34 less progressive than in the U.S.\”

A second angle on the Scandinavian model of capitalism is to look at how these high taxes on average workers serve to finance lots of government programs and services that have a tendency to encourage employment. Henrik Jacobsen Kleven made this argument in \”How Can Scandinavians Tax So Much?\” in the Fall 2014 issue of the Journal of Economic Perspectives. Kleven calculates what he calls the \”participation tax rate,\” which is basically how much workers improve their income level by participating in the labor market, after taxes and the loss of benefits is considered. Kleven writes: 

The contrast is even more striking when considering the so-called “participation tax rate,” which is the effective average tax rate on labor force participation when accounting for the distortions due to income taxes, payroll taxes, consumption taxes, and means-tested transfers. This tax rate is around 80 percent in the Scandinavian countries, implying that an average worker entering employment will be able to increase consumption by only 20 percent of earned income due to the combined effect of higher taxes and lower transfers. By contrast, the average worker in the United States gets to keep 63 percent of earnings when accounting for the full effect of the tax and welfare system.

Kleven also focuses on government policies that can be thought of as encouraging people to work–in particular, \”provision of child care, preschool, and elderly care. He writes:

Even though these programs are typically universal (and therefore available to both working and nonworking families), they effectively subsidize labor supply by lowering the prices of goods that are complementary to working. That is, working families have greater need for support in taking care of their young children or elderly parents. … [H]igher public support for preschool, child care, and elder care is positively associated with the rate of employment. Moreover, the Scandinavian countries are strong outliers as they spend more on such participation subsidies (about 6 percent of aggregate labor income) than any other country. … Broadly speaking, countries tend to be divided into those with relatively small tax-transfer distortions and at the same time small subsidies to child care and elderly care (such as the United States and countries of southern Europe) and those with a lot of both (like the countries of Scandinavia).

A third angle on the Scandinavian model of capitalism is presented in the recent op-ed column by Paul Krugman mentioned above. He presents a useful figure put together by Janet Gornick, which seeks to estimate the income level for people at different points in the income distribution for the Nordic countries and the US. The essential message of the figure is that below about the 30th percentile of the income distribution, income levels are higher in Nordic countries, thus showing both the greater equality of wages and greater government support for economic equality in those countries. For perspective, the 30th percentile of the US income distribution is roughly $32,000 per year. 

The figure is worth contemplation. Just to to be clear, the underlying data seeks to measure income after taxes are paid and after transfer payments are received: in a US context, this means \”including all cash transfers and several near-cash and non-monetary components as well: SNAP, LIHEAP, housing vouchers, school lunches, also EITC.\” However, health care benefits provided through government programs would not be counted, in either the Scandinavian or US context. (The omission is interesting to consider. US health care spending per person is so much more than in other countries that including Medicaid in the US and government-funded health care spending in the Scandinavian countries would probably close the gap at lower levels of income to some extent.)

The figure uses a ratio on the vertical axis, and it\’s useful to focus on what that means. Consider a low-income person at the 10-20th income percentile: the people at that location in the income distribution in Denmark or Finland have income about 20% above the US person at that place in the income distribution. Now think about those a little above the middle of the income distribution in the the 55th-60th percentile, where those in Finland and Denmark are 20% below the similar person located at the same place in the US income distribution. The percentages are the same–20% higher, 20% lower–but the absolute amounts are not. After all, 20% higher applies to low incomes, and so it\’s going to be substantially less than the 20% higher applied to middle incomes. Thus, if measured in absolute terms, the amount that those at the top of the US income distribution are above the Nordic countries would be a lot more than the amount that those at the bottom of the US income distribution are below those in the Nordic countries.  The figure thus does not reveal that average income levels are about 20% higher in the United States.

Of course, income isn\’t everything. I mentioned above the availability of preschool, child care, and elder care services. US workers have much less vacation than those in European countries in general countries. Parental leave is much longer in European countries.

I won\’t try to make the case here either for or against the Scandinavian model of capitalism. Strong majorities of people living in those countries seem to like the tradeoffs,  which is all the justification that is needed.

If you want to cite the Scandinavian countries as an economic model for the US, that\’s of course fine–but then you should also feel some obligation to be aware of what that model actually includes. I\’ve already mentioned parts of that model: strong support for international trade and participation in global markets; much higher taxes on the middle class, and lower taxes on corporations; much higher levels of social services and benefits related to labor market participation. It\’s a model where the decisions about production, investment, pricing, job choice, and consumption happens in the context of private-sector decision-makers.

Here are a few more aspects of the Scandinavian model of capitalism. Again, my point isn\’t to advocate for or against the overall model, but just to suggest that it\’s not just a political slogan of elastic meaning; instead, it\’s a real-world system with real-world tradeoffs, many of which are not what Americans who advocate \”a Scandinavian  model\” have in mind.

For advocates for a higher US minimum wage, it\’s perhaps worth noting (as the CEA report notes) that the \”Nordic countries do not have minimum wage laws, although the vast majority of jobs have wages limited by collective bargaining agreements.\”  Rates of unionization are typically in the range of 70-90% of the workforce in Norway, Denmark, and Sweden, as opposed to about 11% of the US workforce. Of course, negotiating pressure from these unions is a powerful reason for the greater equality of wages and benefits for labor.

College tuition in the Nordic countries is free to the student. However, it also seems true that college education in these countries doesn\’t provide much economic payoff. As a result, Americans are more likely to attend college, even needing to pay for it. Quoting again from the CEA report:

\”The same OECD study estimates that, while many American students pay tuition, Americans are somewhat more likely to attain tertiary education on average. In comparison with the tertiary schooling returns in the Nordic countries, American college graduates get their tuition back with interest, and also a lot more. To put it another way, the rates of return to a college education in Nordic countries are low, and propensities to invest are not high, despite the fact that such an investment requires no tuition payments out of pocket.\”

Sweden\’s social security system is based on mandatory contributions to individual accounts, with people having a wide range of several hundred possible investment options for their account, or a default fund mostly invested in stocks. 

One of the early 1990s policy changes in Sweden is that its equivalent of the US K-12 school system gives every family vouchers, which can be used for education at public, private, and for-profit schools.

Although the Scandinavian system has greater government regulation of labor markets than the US, it has less regulation of product markets and companies.  The CEA report again: \”[T]he OECD ranks all five Nordic countries as having less product-market regulation than the United States, largely due to Nordic deregulation actions over the past 20 years. In comparison with the Nordic countries, the study finds the United States to be especially high on price controls and command-and-control regulation of business operations.\”

The Scandinavian countries do have national programs of health insurance coverage, but in these systems, users of health care typically have substantial co-payments with an annual cap for health care spending.  For example, OECD data suggests that out-of-pocket health care spending is only a little lower in Norway than in the United States.

I\’m all for studying alternative approaches to capitalism, considering the tradeoffs, and seeing what lessons can be learned. I suspect that a number of the lessons to be learned from studying the actual real-world Scandinavian style of capitalism are different from what many Americans might expect. 

I was hired back in 1986 to be the Managing Editor for a new academic economics journal, at the time unnamed, but which soon launched as the Journal of Economic Perspectives. The JEP is published by the American Economic Association, which back in 2011 decided–to my delight–that it would be freely available on-line, from the current issue back to the first issue. Here, I\’ll start with Table of Contents for the just-released Fall 2018 issue, which in the Taylor household is known as issue #126. Below that are abstracts and direct links for all of the papers. I may blog more specifically about some of the papers in the next week or two, as well.

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Symposium on Climate Change

\”An Economist\’s Guide to Climate Change Science,\” by Solomon Hsiang and Robert E. Kopp
This article provides a brief introduction to the physical science of climate change, aimed towards economists. We begin by describing the physics that controls global climate, how scientists measure and model the climate system, and the magnitude of human-caused emissions of carbon dioxide. We then summarize many of the climatic changes of interest to economists that have been documented and that are projected in the future. We conclude by highlighting some key areas in which economists are in a unique position to help climate science advance. An important message from this final section, which we believe is deeply underappreciated among economists, is that all climate change forecasts rely heavily and directly on economic forecasts for the world. On timescales of a half-century or longer, the largest source of uncertainty in climate science is not physics, but economics.
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\”Quantifying Economic Damages from Climate Change,\” by Maximilian Auffhammer
Climate scientists have spent billions of dollars and eons of supercomputer time studying how increased concentrations of greenhouse gases and changes in the reflectivity of the earth\’s surface affect dimensions of the climate system relevant to human society: surface temperature, precipitation, humidity, and sea levels. Recent incarnations of physical climate models have become sophisticated enough to be able to simulate intensities and frequencies of some extreme events, like tropical storms, under different warming scenarios. In a stark juxtaposition, the efforts involved in and the public resources targeted at understanding how these physical changes translate into economic impacts are disproportionately smaller, with most of the major models being developed and maintained with little to no public funding support. The goal of this paper is first to shed light on how (mostly) economists have gone about calculating the \”social cost of carbon\” for regulatory purposes and to provide an overview of the past and currently used estimates. In the second part, I will focus on where empirical economists may have the highest value added in this enterprise: specifically, the calibration and estimation of economic damage functions, which map weather patterns transformed by climate change into economic benefits and damages. A broad variety of econometric methods have recently been used to parameterize the dose (climate) response (economic outcome) functions. The paper seeks to provide an accessible and comprehensive overview of how economists think about parameterizing damage functions and quantifying the economic damages of climate change.
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\”The Cost of Reducing Greenhouse Gas Emissions,\” by Kenneth Gillingham and James H. Stock
Most countries, including the United States, have an array of greenhouse gas mitigation policies, which provide subsidies or restrictions typically aimed at specific technologies or sectors. Such climate policies range from automobile fuel economy standards, to gasoline taxes, to mandating that a certain amount of electricity in a state comes from renewables, to subsidizing solar and wind electrical generation, to mandates requiring the blending of biofuels into the surface transportation fuel supply, to supply-side restrictions on fossil fuel extraction. This paper reviews the costs of various technologies and actions aimed at reducing greenhouse gas emissions. Our aim is twofold. First, we seek to provide an up-to-date summary of costs of actions that can be taken now using currently available technology. These costs focus on expenditures and emissions reductions over the life of a project compared to some business-as-usual benchmark—for example, replacing coal-fired electricity generation with wind, or weatherizing a home. We refer to these costs as static because they are costs over the life of a specific project undertaken now, and they ignore spillovers. Our second aim is to distinguish between dynamic and static costs and to argue that some actions taken today with seemingly high static costs can have low dynamic costs, and vice versa. We make this argument at a general level and through two case studies, of solar panels and of electric vehicles, technologies whose costs have fallen sharply. Under the right circumstances, dynamic effects will offer a justification for policies that have high costs according to a myopic calculation.
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Symposium on the Tax Cuts and Jobs Act

\”Is This Tax Reform, or Just Confusion?\” by Joel Slemrod
Based on the experience of recent decades, the United States apparently musters the political will to change its tax system comprehensively about every 30 years, so it seems especially important to get it right when the chance arises. Based on the strong public statements of economists opposing and supporting the Tax Cuts and Jobs Act of 2017, a causal observer might wonder whether this law was tax reform or mere confusion. In this paper, I address that question and, more importantly, offer an assessment of the Tax Cuts and Jobs Act. The law is clearly not \”tax reform\” as economists usually use that term: that is, it does not seek to broaden the tax base and reduce marginal rates in a roughly revenue-neutral manner. However, the law is not just a muddle. It seeks to address some widely acknowledged issues with corporate taxation, and takes some steps toward broadening the tax base, in part by reducing the incentive to itemize deductions.
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\”Measuring the Effects of Corporate Tax Cuts,\” by Alan J. Auerbach
On December 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act (TCJA), the most sweeping revision of US tax law since the Tax Reform Act of 1986. The law introduced many significant changes. However, perhaps none was as important as the changes in the treatment of traditional \”C\” corporations—those corporations subject to a separate corporate income tax. Beginning in 2018, the federal corporate tax rate fell from 35 percent to 21 percent, some investment qualified for immediate deduction as an expense, and multinational corporations faced a substantially modified treatment of their activities. This paper seeks to evaluate the impact of the Tax Cuts and Jobs Act to understand its effects on resource allocation and distribution. It compares US corporate tax rates to other countries before the 2017 tax law, and describes ways in which the US corporate sector has evolved that are especially relevant to tax policy. The discussion then turns the main changes of the Tax Cuts and Jobs Act of 2017 for the corporate income tax. A range of estimates suggests that the law is likely to contribute to increased US capital investment and, through that, an increase in US wages. The magnitude of these increases is extremely difficult to predict. Indeed, the public debate about the benefits of the new corporate tax provisions enacted (and the alternatives not adopted) has highlighted the limitations of standard approaches in distributional analysis to assigning corporate tax burdens.
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Symposium on Unconventional Monetary Policy

\”Outside the Box: Unconventional Monetary Policy in the Great Recession and Beyond,\” by Kenneth N. Kuttner
In November 2008, the Federal Reserve faced a deteriorating economy and a financial crisis. The federal funds rate had already been reduced to virtually zero. Thus, the Federal Reserve turned to unconventional monetary policies. Through \”quantitative easing,\” the Fed announced plans to buy mortgage-backed securities and debt issued by government-sponsored enterprises. Subsequent purchases would eventually lead to a five-fold expansion in the Fed\’s balance sheet, from $900 billion to $4.5 trillion, and leave the Fed holding over 20 percent of all mortgage-backed securities and marketable Treasury debt. In addition, Fed policy statements in December 2008 began to include explicit references to the likely path of the federal funds interest rate, a policy that came to be known as \”forward guidance.\” The Fed ceased its direct asset purchases in late 2014. Starting in October 2017, it has allowed the balance sheet to shrink gradually as existing assets mature. From December 2015 through June 2018, the Fed has raised the federal funds interest rate seven times. Thus, the time is ripe to step back and ask whether the Fed\’s unconventional policies had the intended expansionary effects—and by extension, whether the Fed should use them in the future.
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\”Unconventional Monetary Policies in the Euro Area, Japan, and the United Kingdom,\” Giovanni Dell\’Ariccia, Pau Rabanal and Damiano Sandri
The global financial crisis hit hard in the euro area, the United Kingdom, and Japan. Real GDP from peak to trough contracted by about 6 percent in the euro area and the United Kingdom and by 9 percent in Japan. In all three cases, central banks cut interest rates aggressively and then, as policy rates approached zero, deployed a variety of untested and unconventional monetary policies. In doing so, they hoped to restore the functioning of financial markets, and also to provide further monetary policy accommodation once the policy rate reached the zero lower bound. In all three jurisdictions, the strategy entailed generous liquidity support for banks and other financial intermediaries and large-scale purchases of public (and in some cases private) assets. As a result, central banks\’ balance sheets expanded to unprecedented levels. This paper examines the experience with unconventional monetary policies in the euro zone, the United Kingdom, and Japan. The paper starts with a discussion of how quantitative easing, forward guidance, and negative interest rate policies work in theory, and some of their potential side effects. It then reviews the implementation of unconventional monetary policy by the European Central Bank, the Bank of England, and the Bank of Japan, including a narrative of how central banks responded to the crisis and the evidence on the effects of unconventional monetary policy actions.
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Symposium on Development and State Capacity

\”Ending Global Poverty: Why Money Isn\’t Enough,\” Lucy Page and Rohini Pande
Between 1981 and 2013, the share of the global population living in extreme poverty fell by 34 percentage points. This paper argues that such rapid reductions will become increasingly hard to achieve for two reasons. First, the majority of the poor now live in middle-income countries where the benefits of growth have often been distributed selectively and unequally. Second, a reservoir of extreme poverty remains in low-income countries where growth is erratic and aid often fails to reach the poor. If the international community is to most effectively leverage available resources to end extreme poverty, it must ensure that its investments in institutions and physical infrastructure actually provide the poor the capabilities they need to craft an effective pathway out of poverty. We term the human and social systems that are required to form this pathway \”invisible infrastructure\” and argue that an effective domestic state is central to building this. By corollary, ending extreme poverty will require both expanding state capacity and giving the poor power to demand reforms they need by solving agency problems between citizens, politicians, and bureaucrats.
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\”Universal Basic Incomes versus Targeted Transfers: Anti-Poverty Programs in Developing Countries,\” by Rema Hanna and Benjamin A. Olken
Of the 17 Sustainable Development Goals articulated by the United Nations, number one is the elimination of extreme poverty by 2030. While future economic growth should continue to reduce poverty, it will not solve the problem by itself; thus, there is a potentially important role for national-level transfer programs that assist poor families in developing countries. Such programs are often run by developing country governments. Many countries have implemented transfer programs that seek to target beneficiaries: that is, to identify who is poor and then to restrict transfers to those individuals. Some people have begun to advocate for \”universal basic income\” programs, which dispense with trying to identify the poor and instead provide transfers to everyone. We begin by considering the universal basic income as part of the solution to an optimal income-taxation problem, focusing on the case of developing countries, where there is limited income data and inclusion in the formal tax system is low. We examine how the targeting of transfer programs is conducted in these settings, and provide empirical evidence on the tradeoffs involved between universal basic income and targeted transfer schemes using data from Indonesia and Peru—two countries that run nationwide transfer programs that are targeted to the poor. We conclude by linking our findings back to the broader policy debate on what tools should be preferred for redistribution, as well as the practical challenges of administering them in developing countries.
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Features

\”Retrospectives: On the Genius Behind David Ricardo\’s 1817 Formulation of Comparative Advantage,\” by Daniel M. Bernhofen and John C. Brown
Last year marked the 200th anniversary of Ricardo\’s famous \”four numbers\” paragraph on comparative advantage, which is one of the oldest analytical results in economics. Following the lead of James Mill (1821), these four numbers have been interpreted as unit labor coefficients. This interpretation has provided the basis for the development of the \’Ricardian model\’ from John Stuart Mill (1852) to Eaton and Kortum (2002). However, if we accept the labor unit interpretation of these numbers, Ricardo\’s exposition in his 1817 Principles of Political Economy and Taxation makes little logical sense. Building on Sraffa\’s (1930) interpretation of Ricardo\’s numbers as labor embodied in trade, our discussion reveals the amazing simplicity and generality of Ricardo\’s comparative advantage formulation and gains-from-trade logic.
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\”Recommendations for Further Reading,\” by Timothy Taylor
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Those who have faced issues of \”statistical significance\” and the use of a p-value of 5%  might appreciate this cartoon from xkcd.com. It\’s an oldie from back around 2011, but a goodie.

For a punchline, you can imagine the follow-up headline: \”So, uh, we did the green study again and got no link. It was probably a– \”RESEARCH CONFLICTED ON GREEN JELLY BEAN/ACNE LINK; MORE STUDY RECOMMENDED!\”\”

Wealth is not income. Income is the inflow measured over a period of time, like a pay period or a calendar year. Wealth is the accumulation of financial and real assets, minus debts. The total in retirement account and the equity in your house are wealth, but they are not income. The Credit Suisse Research Institute provides some perspectives in its recently published Global Wealth Report 2018, 

\”Measured in current US dollars, total global wealth rose from USD 117 trillion in 2000 to 317 trillion in mid-2018, a rise of USD 200 trillion, equivalent to roughly 2.5 times global GDP.\” Global wealth works out to $63,100 per adult.

Along with its overview of global wealth, the report has discussions of the distribution of global wealth, both overall and across regions, and short reports for the growth of wealth in countries. Here\’s the \”global wealth pyramid.\” At the bottom, about 3.2 billion adults, roughly two-thirds of the adult population of the world, have 1.9% of the total wealth. At the top, there are 42 million adults or 0.8% of the world population who have more than $1 million in wealth, and as a group they hold 44.8% of total world wealth.

The US economy, with its combination of high incomes and a large number of people, has many more milliionaires and ultra-high-worth individuals than other countries. Here\’s a figure showing the number of people with over $50 million in wealth across countries.

In different countries, what share of wealth is held by the top 1% of wealthholders? US wealth is more concentrated than Germany or China, but less so than Brazil, India, or Russia.

It\’s important to keep wealth numbers in some perspective. Being an ultra-high-net-worth person with more than $50 million in wealth is very rich indeed, wherever you live. But for Americans, for those in their 50s or older who have a lot of equity in their homes in parts of the US where real estate is pricey, and who also have accumulated a chunk of money in their retirement account during several decades of working wealth, exceeding $1 million in accumulated wealth is not an extraordinary event. I\’ll finish here with a couple of images of wealth patterns in the US.

Why do societies worry about high or rising inequality more at some times than at others. Albert O. Hirschman offered a classic answer in \”The Changing Tolerance for Income Inequality in the Course of Economic Development,\” which appeared in the November 1973 Quarterly Journal of Economics (87: 4, pp. 544-566). His argument is in large part structured around a tunnel metaphor, which goes like this (footnotes omitted):

\”Suppose that I drive through a two-lane tunnel, both lanes going in the same direction, and run into a serious traffic jam. No car moves in either lane as far as I can see (which is not very far). I am in the left lane and feel dejected. After a while the cars in the right lane begin to move. Naturally, my spirits lift considerably, for I know that the jam has been broken and that my lane\’s turn to move will surely come any moment now. Even though I still sit still, I feel much better off than before because of the expectation that I shall soon be on the move. But suppose that the expectation is disappointed and only the right lane keeps moving: in that case I, along with my left lane cosufferers, shall suspect foul play, and many of us will at some point become quite furious and ready to correct manifest injustice by taking direct action (such as illegally crossing the double line separating the two lanes). …

\”As long as the tunnel effect lasts, everybody feels better off, both those who have become richer and those who have not. It is therefore conceivable that some uneven distribution of the new incomes generated by growth will be preferred to an egalitarian distribution by all members of the society. In this eventuality, the increase in income inequality would not only be politically tolerable; it would also be outright desirable from the point of view of social welfare.\”

Hirschman was focused on issues of economic development. He offers examples of a number of countries where many poor people welcome signs of economic development before it touches them personally in any way–presumably because they are in the position of that driver stuck in the left lane who is taking hope from the movement of the right-hand lane.  He also points out that this tunnel effect can lead to a sense of complacency among leaders, when most people seem to be supportive of the processes that are leading to inequality, so that the leaders are unprepared when people start to denounce those same practices.

\”Providential and tremendously helpful as the tunnel effect is in one respect (because it accommodates the inequalities almost inevitably arising in the course of development), it is also treacherous: the rulers are not necessarily given any advance notice about its decay and exhaustion, that is, about the time at which they ought to be on the lookout for a drastically different climate of public and popular opinion; on the contrary, they are lulled into complacency by the easy early stage when everybody seems to be enjoying the very process that will later be vehemently denounced and damned as one consisting essentially in `the rich becoming richer.\’\”

Writing back in 1973, Hirschman offers examples of \”development disasters,\” in which those stuck in the left lane have come to strongly suspect that economic development will not benefit them, and thus a high degree of social unrest emerges. and he cites Nigeria, Pakistan, Brazil and Mexico as facing these issues in various ways.

I find myself thinking about the tunnel effect and expectations about future social mobility in the current context of the United States. Rising economic inequality in the United States goes back to the 1970s, and the single biggest jump in inequality at the very top of the income distribution happened in the 1990s when stock options and executive compensation took off. But my unscientific sense is that at that time, during the dot-com boom of the 1990s, many people who were either pleased, or not that unhappy, with the rise in inequality of that time. There seemed to be new economic opportunities opening up, new businesses were starting, unemployment rates were low, cool new products and services were becoming available. Even if you were for the time stuck in the left lane, all that movement in the right lane seemed to offer opportunities.

But that optimistic view of high and rising inequality came apart in the 2000s, under pressure from a from a number of factors: the sharp rise in imports from China in the early 2000s that hit a number of local areas so hard; the rise of the opioid epidemic, with its dramatically rising death toll exceeding 40,000 in 2016; and the carnage in employment and housing markets in the aftermath of the Great Recession.  In Hirschman\’s words, it seems to me that many politicians were \”lulled into complacency by the easy early stage when everybody seems to be enjoying the very process that will later be vehemently denounced and damned as one consisting essentially in `the rich becoming richer.\’\”

Of course, no country is really one big tunnel. When people look at high or rising inequality, their views will often depend on the extent to which they feel some commonality–Hirschman calls it \”shared historical experience\”–with those who are moving ahead more briskly. In turn, this feeling may depend on the extent to which those who are moving ahead more briskly segment themselves off as a special and separate guild, with an implicit claim that they are just more worthy, or the extent to which they act in ways that embody broader and more inclusive outcomes.

Rent control is back on the public policy agenda, at least in California, where Proposition 10 on the November ballot \”Expands Local Governments’ Authority to Enact Rent Control on Residential Property.\” Hence some thoughts about rent control in general, and a couple of the more recent studies on the topic.

Some thoughts:

1) Rent control is typically justified by pointing to low-income people who have difficulty paying the market rents. I\’m sympathetic to this groups, and favor various policies like income support and rent vouchers to help them. But as I have argued in other contexts, invoking poverty and necessity as the basis for rent control is a ruse. The poor are not helped in any direct way by controlling rental prices for all income groups, including the rich and the the middle-class.

One response I have heard to this argument is that if rent control only applied to those with low-incomes, there would be an incentive to avoid renting to those with low incomes and not to build any more low-income housing. Of course, this argument is of course an admission that rent control discourages the growth and maintenance of rental properties. Expanding rent control to cover all income groups will expand those negative incentives to the entire rental housing stock, rather than just part of it.

2) Many of those who favor rent control also favor higher minimum wages. Thus, it is useful to remember that rent control is fundamentally different from minimum wage rules, because prices for physical objects like buildings are fundamentally different from wages paid to workers. When the price of an hour of work changes, workers can have higher or lower incentives, or higher or lower morale, or can search more or less for jobs, or consider different kinds of jobs, or look for jobs in other jurisdictions or in the underground economy, or even withdraw from the labor market. Buildings are not flexible in these ways, and so the implications of rent control are easier to predict with confidence than the implications of minimum wage laws. 

3) Before you own a house, there can be a tendency (which I certainly had) to think of the housing stock as immutable, rather like the pyramids. When you own a house, you instead come to think of it as a large machine that requires continual maintenance on all its separate parts. Many arguments in favor of rent control implicitly view the housing stock like the pyramids, and underestimate both the short-run costs of maintenance and repair and the longer-run costs of property upgrades and new construction.

4) Rent control offers a tradeoff between present benefits for one group and future costs for another. The present benefits go to those already living in apartments that are rent-controlled–whether they are low-income or not. Rent control benefits the well-settled. The future costs are imposed on those who are unable to find a place. In addition, rent control discourages building additional rental housing, which means that the possibility of mutual gains for future builders and future renters are foreclosed.

5) In any local housing market, the price of owned housing and rental housing is going to be closely linked, because one can be converted with relative ease into the other. If the price of housing is high, the price of rentals is also going to be high. The notion that a local housing market can make all the existing homeowners happy, with high and rising resale prices, but also make all the renters happy, with low and stable rents, is a delusion.

With rent control, as with so many other subjects, it can be tricky to sort out cause and effect. For example, say that we observe that cities which have rent control are more likely to have high housing prices. This of course would not prove whether rent control leads to high housing prices, or high housing prices make rent control more likely to be enacted, or whether some additional factors are influencing both housing prices and the political prospects for rent control.  Thus, researchers often try to seek out a \”natural experiment,\” meaning a situation in which some change in law or circumstance affects part of a market at a certain time and place, but not another part. Then one can compare the more-affected and less-affected parts of the market.

For example, I wrote a few years about about a study on the unexpected end of rent control in Cambridge, Massachusetts, see \”When Rent Control Ended in Cambridge, Mass.\” (October 4, 2012). That study found that rent-controlled properties had lower rents and were also lower quality with less maintenance. When a substantial number of properties in a neighborhood are poorly maintained, property values also fall for the building that are not rent-controlled.

Rebecca Diamond , Tim McQuade, and Franklin Qian offer a more recent study in \”The Effects of Rent Control Expansion on Tenants, Landlords, and Inequality: Evidence from San Francisco.\”  An updated draft of the research paper is available at Diamond\’s website. It\’s also available as an NBER research paper, for those with access to that series. For a summary of the intuition behind the paper, you can turn to either a Cato Institute version or a Brookings Institution version.

From the Brookings summary, here\’s an description of the natural experiment they analyzed:

\”In 1979, San Francisco imposed rent control on all standing buildings with five or more apartments. Rent control in San Francisco consists of regulated rent increases, linked to the CPI [Consumer Price Index], within a tenancy, but no price regulation between tenants. New construction was exempt from rent control, since legislators did not want to discourage new development. Smaller multi-family buildings were exempt from this 1979 law change since they were viewed as more “mom and pop” ventures, and did not have market power over rents.

\”This exemption was lifted by a 1994 San Francisco ballot initiative. Proponents of the initiative argued that small multi-family housing was now primarily owned by large businesses and should face the same rent control of large multi-family housing. Since the initial 1979 rent control law only impacted properties built from 1979 and earlier, the removal of the small multi-family exemption also only affected properties built 1979 and earlier. This led to a differential expansion in rent control in 1994 based on whether the small multi-family housing was built prior to or post 1980—a policy experiment where otherwise similar housing was treated differently by the law.\”

The authors had data on those who lived in small multi-family units built before 1980, which were not covered by the 1979 rent control law, and those living in small multi-family units build from 1980 to 1990, who had not been covered by rent control in 1979, but were now covered by the 1994 change in the law. They also collected data on how properties were converted from rentals to condominiums or other types of properties.

The results are in some ways unsurprising. Those living in rent-controlled housing who remained in that housing benefited. But over time, landlords found ways to sidestep the rent controls. As they explain in the paper:

\”In practice, landlords have a few possible ways of removing tenants. First, landlords could move into the property themselves, known as move-in eviction. Second, the Ellis Act allows landlords to evict tenants if they intend to remove the property from the rental market – for instance, in order to convert the units to condos. Finally, landlords are legally allowed to offer their tenants monetary compensation for leaving. In practice, these transfer payments from landlords are quite common and can be quite large. Moreover, consistent with the empirical evidence, it seems likely that landlords would be most successful at removing tenants with the least built-up neighborhood capital, i.e. those tenants who have not lived in the neighborhood for long.\”

As a result of such changes, the expansion of rent control reduced the quantity of rental properties and led to greater gentrification of San Francisco, with the incentives for builders to construct only new high-cost rentals and to build of high-end condominiums. They write:

\”We find that rent-controlled buildings were 8 percentage points more likely to convert to a condo or a Tenancy in Common (TIC) than buildings in the control group. Consistent with these findings, we find that rent control led to a 15 percentage point decline in the number of renters living in treated buildings and a 25 percentage point reduction in the number of renters living in rent-controlled units, relative to 1994 levels. This large reduction in rental housing supply was driven by both converting existing structures to owner-occupied condominium housing and by replacing existing structures with new construction. This 15 percentage point reduction in the rental supply of small multi-family housing likely led to rent increases in the long-run, consistent with standard economic theory. In this sense, rent control operated as a transfer between the future renters of San Francisco (who would pay these higher rents due to lower supply) to the renters living in San Francisco in 1994 (who benefited directly from lower rents). Furthermore, since many of the existing rental properties were converted to higher-end, owner-occupied condominium housing and new construction rentals, the passage of rent control ultimately led to a housing stock which caters to higher income individuals.\”

You can make an argument that those who support higher minimum wages are seeking to help low-wage workers, and then quarrel over the evidence. But it is much harder to argue that comprehensive rent control is actually about helping low-income people find affordable housing. 

In December 2008, the Federal Reserve took the specific policy interest rate that it targets–the so-called \”federal funds interest rate\”–down to the range of 0% to .25%. The Fed then held the federal funds interest rate at this near-zero level for seven years, until December 2015. Since then, the Fed has raised the federal funds interest rate eight times in small steps, with the most recent step at its September 27 meeting, so that it now is in the range of 2% to 2.25%. How much higher is the Fed going to go?

Short answer: Four more interest rate increases by the end of 2019, taking the federal funds interest rate up to the level of 3% to 3.25%.

Longer answer:  Robert S. Kaplan of the Dallas Federal Reserve explains in \”The Neutral Rate of Interest\” (October 24, 2018). Or for another nice explainer on the neutral rate, see
\”The Hutchins Center Explains: The neutral rate of interest,\” by Michael Ng and David Wessel (October 22, 2018).

As Kaplan discussed, the Federal Reserve cut interest rates during the Great Recession and afterward, to stimulate the economy. But with the unemployment rate at 4% or less for the last six months, the Fed has been moving toward a \”neutral\” interest rate. Kaplan writes:

\”The neutral rate is the theoretical federal funds rate at which the stance of Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability. You won’t find the neutral rate quoted on your computer screen or in the financial section of the newspaper. The neutral rate is an “inferred” rate—that is, it is estimated based on various analyses and observations.\”

So what are the Federal Reserve policymakers current inferring? At each meeting, the participants provide their own estimates of the neutral rate. Kaplan writes:

\”Each of us around the FOMC table submits quarterly, as part of the Summary of Economic Projections (sometimes referred to as the SEP or the “dot plot”), our best judgments regarding the appropriate path for the federal funds rate and the “longer-run” federal funds rate. My longer-run rate submission is my best estimate of the longer-run neutral rate for the U.S. economy. In the September SEP, the range of submissions by FOMC participants for the longer-run rate was 2.5 to 3.5 percent, and the median estimate was 3.0 percent. My own estimate of the longer-run neutral rate is modestly below the median of the estimates made by my colleagues. My suggested rate path for 2019 is also modestly below the 3 to 3.25 percent median of the ranges suggested by my fellow FOMC participants.\”

So based on what Fed policy-makers are saying, that seems like what is likely to  happen (of course, barring substantial shifts in the economy that would lead to a reevaluation of plans). But is it what should happen? Kaplan makes the case for his own view, which in part involves looking at some prominent economic models that try to estimate the \”neutral\” interest rate. Thus, he writes:

\”These models differ in terms of their structural assumptions and the data they use to produce estimates of the neutral rate. For example, Laubach–Williams uses data on real GDP, core PCE inflation, oil prices, import prices and the federal funds rate as inputs for their model. This model attempts to estimate an output gap to assess the neutral rate of interest. The Koenig model uses data on long-term bond yields, survey measures of long-term GDP growth and long-term inflation as inputs for its estimates of long-run r*. Giannoni’s model uses a broad set of key macroeconomic and financial data series to generate estimates of the neutral rate at different time horizons.\”

All of these models suggest that the neutral interest rate is lower now than, say, 15-20 years ago, when it was more in the range of 5%. The estimates are surrounded by a reasonable degree of uncertainty. But they generally support Kaplan\’s argument that the Fed should continue along its current path of interest rate increases.

The Fed\’s decisions about raising interest rates since December 2015 have  not been without controversy and dissent. Those who opposed raising the rates feared that the higher rates might slow the economy. But at least so far during the last few years, those skeptics have turned out to be mistaken in their concerns.

It\’s useful to remember that the specific interest rate on which the Fed focuses, the federal funds interest rate, is not a full summary of how easy or hard it is to borrow money. The Chicago Fed publishes a National Financial Conditions Index which looks at factors like total amount of loans, along with measures of leverage and risk. The pattern in the last few years is that although the Fed has raised its policy interest rate, credit conditions as a whole have actually been getting a little easier, not tighter. I tried to explain this pattern in \”Rising Interest Rates, but Easier Financial Conditions\” (February 15, 2018). The basic story is that the economy has been gaining strength, and the financial sector appears to have been reassured by the Fed\’s ongoing willingness to move to a neutral interest rate.

In other words, it is too simple to argue that higher interest rates always and automatically slow down an economy. When the higher interest rates reflect a bounce-back from historically low rates that were in place for seven years, returning those interest rates to more usual levels both reflects and supports economic strength.

Back in 1990, the World Bank defined an \”absolute poverty\” line. It was based on the actual poverty lines as chosen by the governments of low-income countries around the world, and thus can be taken to represent those people who are beneath the most basic minimums for basic necessities like food, shelter, and clothing. This poverty line has been updated over time to adjust for changes in prices and exchange rates, and currently stands at $1.90 in consumption per person per day. The World Bank provides an overview of global poverty in its annual \”Poverty and Shared Prosperity\” report for 2018, titled \”Piecing Together the Poverty Puzzle.\”  Here are some points that caught my eye.

The world has seen a dramatic fall in absolute poverty in the last 30 years or so. In 1990, more than one-third of the world\’s population was below the absolute poverty line; by 2015, it was 10% and falling. The raw number of people below the absolute poverty line declined by more than 1 billion. This extraordinarily rapid rise in the economic well-being of the world\’s poorest is without historical precedent.

A breakdown of the data by region shows an unsurprising pattern. Poverty in the east Asian region has dropped dramatically, thanks in substantial part to economic growth in China. Poverty in the south Asian region has dropped dramatically, thanks in substantial part to growth in India, as well as Bangladesh and others. Poverty rates in sub-Saharan Africa remain high.

But poverty rates don\’t quite capture the entire story. Population levels are very high in China and India, so that even low rates of poverty in those countries implies large absolute numbers of poor. Indeed, one pattern that has emerged is that in absolute numbers, more of the world\’s absolute poor now live in middle-income countries (which includes China, India, Pakistan, Bangladesh, Indonesia and others) than in low-income countries.

The report includes chapters looking at other measures of need, like improving the economic status of the bottom 40% of the population, or a multidimensional measure of poverty that includes not just income but access to health care and a secure community, or measures of poverty focused especially on women and children.

The World Bank also defines a poverty line for low-middle-income countries of $3.20 in consumption per person per day, and a poverty line for upper-middle-income countries of $5.50 per person per day. The share of people below these poverty lines has also fallen dramatically, although they remain fearsomely high in the regions of South Asian and sub-Saharan Africa.

Markets for beer, wine and spirits offer can patterns of broad cultural interest–and for the college teacher, may serve to attract the attention of students as well. Kym Anderson, Giulia Meloni, and Johan Swinnen discuss \”Global Alcohol Markets: Evolving Consumption Patterns, Regulations, and Industrial Organizations\” in the most recent Annual Review of Resource Economics (vol. 10, pp. 105-132, not freely available online, but many readers will have access through a library subscription).  The authors take a global perspective on the evolution of alcohol markets. Here are a few points of the many that caught my eye.

1) \”The global mix of recorded alcohol consumption has changed dramatically over the past half
century: Wine’s share of the volume of global alcohol consumption has fallen from 34% to 13% since the early 1960s, while beer’s share has risen from 28% to 36%, and spirits’ share has gone from 38% to 51%. In liters of alcohol per capita, global consumption of wine has halved, while that of beer and spirits has increased by 50%.\”

2) \”As of 2010–2014, alcohol composed nearly two-thirds of the world’s recorded expenditure on beverages, with the rest being bottled water (8%), carbonated soft drinks (15%), and other soft
drinks such as fruit juices (13%).\” 

3) There is something of inverse-U relationship between quantity consumed of alcohol and per capita GDP of countries.

4) However, when it comes to spending on alcohol as a share of income, it does not seem to drop off as income rises. The implication is that those in countries with higher per capita GDP drink smaller quantities of alcohol, but pay more for it.

5) \”In early history, wine and beer consumption was mostly positively perceived from health and food security perspectives. Both wine and beer were safe to drink in moderation because fermentation kills harmful bacteria. Where available at affordable prices, they were attractive substitutes for water in those settings in which people’s access to potable water had deteriorated. Beer was also a source of calories. For both reasons, beer was used to pay workers for their labor from Egyptian times to the Middle Ages. Wine too was part of some workers’ remuneration and was included in army rations of some countries right up to World War II. Moreover, spirits such as rum and brandy were a standard part of the diet for those in European navies from the fifteenth century.\”