conversableeconomist

Tax Expenditures: A Way to End Budget Gridlock?

Back in 1987, the very first issue of my own Journal of Economic Perspectives had a symposium on the just-passed Tax Reform Act of 1986, which famously (among economists, at least) reduced various exemptions, exclusions, deductions, and credits in the tax code, and then used the extra money to reduce marginal tax rates. In that issue, Nobel laureate James Buchanan offered a trenchant analysis of the political economy behind such legislation. He argued that politicians love to hand out tax breaks to specific groups, but as they do so, it becomes necessary to raise tax rate on remaining income that isn\’t getting a special break. Eventually, the tax rates get so high, and the tax breaks get so numerous, that Congress girds up its loins and passes a bill like the Tax Reform Act. However, Buchanan continued, it would be imprudent to view this bill as proof that Congress actually believe in a simpler tax code with lower rates. Instead, it is just politically necessary to pass such a bill from time to time, so that the political cycle of more tax breaks and higher rates can unwind again.(My journal is freely available on-line back to 1994, but the first issue is not yet freely available. However, it is available through JSTOR, and many academics will have access in that way.)

In our current impasse over crafting middle-run and long-run ways to reduce budget deficits, many conservatives would like to have a tax code with lower marginal tax rates and with fewer government efforts to micro-manage aspects of the economy, while many liberals would like to have a tax code that raises more revenue–in particular from those with high incomes. Reducing the reach of tax deductions, credits, exemptions, and exclusions–which collectively go under the name of \”tax expenditures\”–could offer a way to provide some satisfaction for all sides.

Daniel Baneman, Joseph Rosenberg, Eric Toder, Roberton Williams discuss \”Curbing Tax Expenditures\”  in a paper just published by the Tax Policy Center. They point out that a George W. Bush tax commission back in 2005 proposed limits on tax expenditures, as did more recently President Obama\’s President Obama’s National Commission on Fiscal Responsibility and Reform  and a commission from the Bipartisan Policy Center.

Tax expenditures comprise large sums. The authors of the TPC paper point out: \”Despite significant variation over the years, tax expenditures impose substantial costs on the federal budget and will continue to do so. In 2011, they were projected to cut revenues and raise outlays by $1.1 trillion, more than we collected from individual income taxes and nearly half of total federal revenue collections for the year.\”

Of course, the problem with altering tax expenditures is that people are used to them, and don\’t want to see them disrupted. By far the biggest tax expenditure is the fact that employer-provided health insurance isn\’t taxed as income: if it was, the U.S. Treasury would collect about $174 billion per year more. The second-biggest tax break is the deductibility of mortgage interest, which costs the Treasury about $89 billion per year. Other big-ticket tax expenditures include deductibility of state and local taxes, deductibility of charitable contributions, lower tax rates for capital gains and dividend income, and others. You can make all the tough-minded policy arguments you want about how in a U.S. economy where rising health care costs are a major policy concern, maybe having a $174 billion tax break subsidizing health insurance isn\’t the best idea, or in a U.S. economy that has just seen the destructive power of a housing price bubble, maybe a tax break to make it easier to spend more on houses isn\’t a great idea. But it\’s tilting at windmills to attack these sorts of provisions one at a time.

Instead, the TPC authors point out:  \”While an ideal tax reform process would comprehensively evaluate each tax expenditure on its merits, eliminating some and restructuring or retaining others, broad-based limitations on tax expenditures may be easier to enact and would still produce net benefits. This paper examines alternatives for implementing across-the-board limits applied to a selected group of the largest and most widely utilized tax preferences.\” Thus, they offer proposals like converting most tax expenditures into a single tax credit at a 15% rate, or putting a cap (as a share of income) on the total tax expenditures that could be claimed on any tax return, or even just reducing the cost of all tax expenditures across-the-board by a fixed percentage amount. In other words, don\’t tackle individual tax expenditures head-on, but instead try to rein back on many tax expenditures all at once.

Such proposal would mostly affect the tax bills of those with high incomes, because tax expenditures mainly flow to those with higher incomes. On their calculations, 41% of the total value of tax expenditures goes to the top 5% of taxpayers by income, and 24% of the total value goes to the top 1%. Remember, those in the upper part of the income distribution are far more likely to itemize deductions. And because those with high incomes face higher marginal tax rates, the amount of taxes they save from tax expenditures is also higher.

The next figure shows effective (that is, average) tax rates for different income levels, and then shows what the tax rates would be without tax expenditures. The federal income tax is progressive: on average those with higher incomes do pay a higher share of income in taxes than those with lower incomes. But at the upper income levels, the presence of tax expenditures reduced the extent of that progressivity.

Reducing tax expenditures would arguably reduce certain ways in which the government is influencing economic outcomes. It would free up revenue both to pay for reducing marginal tax rates, and also to pay for some reduction of long-germ budget deficits. I believe there is a deal waiting to be cut, although I\’m admittedly dubious as to whether the current crop of politicians can achieve it.

For a previous take on tax expenditures with some additional background and argument, see my post of last August 3, \”Tax Expenditures: One Way Out of the Budget Morass?\”

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The "Instant Economist": Early Reviews and Reactions

Last week my book The Instant Economist: Everything You Need to Know About How the Economy Works was published by Penguin/Plume. For a description of the book, see my January 31 post here.
To buy copies for yourself, as well as for those in your family, club, company, or community,  head for a local or click here for Amazon or here for Barnes and Noble–or just check a copy out of your local library. Here are some early reviews: 

In the February 2012 issue of Better Investing, Angele McQuade has written a view called \”Fun With Numbers–Making Economics Make Sense.\” It\’s not freely available on-line at this time, but here are a few excerpts: 

\”If your only exposure to economics was a class so boring you yawn at even the memory of it, you’re missing out on a lot of useful — and even fascinating — information, says author Timothy Taylor. With so much election year talk of budget deficits, health care costs, wealth disparity, foreign trade and unemployment, it’s not surprising that economic statistics and theories are flying fast and hard. No better time to brush up your knowledge of economics, especially with the help of Taylor’s latest book, The Instant Economist: Everything You Need to Know About How the Economy Works. …\”

\”What I liked: That Taylor branches beyond a purely domestic viewpoint into the heavily interconnected world of international economics. There’s a reason economists care so much about international trade, and Taylor does an excellent job explaining its importance. …\”

\”What I loved: How truly relevant Taylor’s lessons are.Yes, we all hear and read economic statistics all the time, but how often do we stop to think about their meaning in our daily lives? Taylor seems to delight in pointing out the many ways economics matters, as well as the ways we can put the knowledge he’s offering to use. …\”

\”I’m not going to sugarcoat the truth: The Instant Economist isn’t written in a finish-it-over-a-cup-of-coffee style. The content is rich, though, as will be your intellectual reward if you devote even a little effort to it.\”

In the December 1, 2011, issue of Booklist, Mary Whaley writes: 

 

\”[T]his handbook on economics is a readable, nontextbook approach on the level of an undergraduate introductory course. … We learn how markets work in the context of goods, labor, and financial capital and also about unregulated markets, including monopoly, the environment, and poverty; he notes that although these issues can attract democratic government involvement, such intervention can fail. He concludes with macroeconomics (an overall view of the economy), with topics including economic growth, unemployment, and inflation. Taylor wants us to respect the power of market forces but understand where those forces fall short; he encourages a belief that government policy can be useful but, in some cases, can be useless or even counterproductive. This guide to the key principles of economics is an important source of information for many library patrons. Excellent book.\”

From on-line sources, the first review up at Amazon, by Gene Chamson, gives the book five stars and is titled: \”Should be required reading for anyone who wants to participate in the economy. In other words, everyone.\” He adds: 

\”I am generally not a fan of books that dumb down important subjects, adding a veneer of folksy prose to make them appealing to \”dummies\” or \”complete idiots\”. This is not such a book.
\”The Instant Economist\”, despite its simplistic title, is a thoughtful, engaging survey of modern economic principles and issues. In 36 short, easy to digest chapters, the author provides a foundation in economic literacy, beginning with the basics of how markets work, then covering the main topics in microeconomics and macroeconomics. … Highly recommended.\”

From the blogosphere, here\’s Brian L. Belen, a graduate student in economics, writing from the Philippines.

\”Economics is such an important field of study, yet it is often perceived as too technical and complex for the everyman.  … For this reason, there is plenty of room for accessible books that demistify what economics is all about …  It is in this context that Timothy Taylor makes an important contribution with his new book The Instant Economist: Everything You Need to Know About How the Economy Works.

From the title alone, it\’s obvious that Taylor seeks to achieve two things: to explain the essentials and to do so in a practical way. He manages both quite ably, beginning with the requisite discussion on demand, supply and pricing, and thereafter branching off into weighty topics in macro- and international economics. When he does so, his presentation is often fairly Socratic: he identifies several specific issues (such as the minimum wage), poses an apparently polarizing question about them (\”Should it be higher or lower?\”), and then proceeds to present both sides, often with some statistics to back up the analysis. As a consequence, readers are left with a very balanced perspective on relevant economic concerns, and are hopefully empowered to make their own judgments accordingly. ….

In fact, there are several chapters that I particularly appreciated, having taught undergraduate macroeconomics myself. For example, the chapter on the monetary system (i.e. Federal Reserve, to use the U.S. case) is excellent, and I wish I had it as a reference back in my teaching days. Likewise, Taylor very capably devotes a chapter to exchange rates, and it is positively enviable that anyone can write so clearly about the subject.

The Instant Economist isn\’t your usual introductory economics book, even for casual reading. It\’s a little more than that — a little more advanced, a little more practical, and arguably a little more interesting. For that reason, it\’s material well worth having a look at in order to delve a little deeper into topics from Econ101, whether you took it last semester or years ago.\”

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Europe\’s Growing Imbalances Before Its Debt and Financial Crisis.

Europe\’s financial and debt problems were doubtless made worse and brought to a head by the global financial crisis that began in late 2007. But in the U.S., the financial crisis is fundamentally about the bursting of the bubble in housing prices and overborrowing, while in Europe, the current financial and debt problems have different economic roots, tracing to the arrival of the euro as a common currency in the late 1990s.

Nils Holinski, Clemens Kool, and Joan Muysken  offer many key ingredients of the story in \”Persistent Macroeconomic Imbalances in the Euro Area: Causes and Consequences.\” It appears in the January/February 2012 issue of the Federal Reserve Bank of St. Louis Review. As a useful expository tool, they discuss \”North\” and \”South\” Europe, where North includes Austria, Germany, Finland, and Netherlands, while South includes Greece, Ireland, Portugal and Spain. In the figures that follow, North and South refer to the averages of these groups not weighted by economy or population–because if they were weighted in that way, \”North\” would basically be Germany and \”South\” would basically be Spain. They focus only on the period of time from 1992-2007–that is, the financial crisis has not yet erupted. But their analysis strongly suggests that an eruption of some sort was coming.

As a starting point, look at trade balances. For the euro countries as a whole, the trade balance has been fairly close to zero in recent years. But as the euro got started, North countries began to run ever-larger trade surpluses, while South countries began to run ever-larger trade deficits. 

What are the underlying causes of these trade deficits? A standard economic relationship, sometimes called the national savings and investment identity, lays out certain possibilities. If a trade deficit rises, it MUST be accompanied by some combination of the following: more government borrowing, less private saving, or more private investment. Conversely, if a trade deficit falls, it MUST be accompanied by some combination of the following: less government borrowing, more private saving, or less private investment. What was happening in Europe from 1992-2007?

When it comes to net public savings, both North and South countries were reducing their borrowing in the lead-up to the euro and in the early 2000s. In other words, the large trade deficits in the South weren\’t caused by higher government borrowing.

 

However, private saving did make a major contribution to the trade deficits in the South. Back in the mid-1990s, gross private saving was about the same in the North and South, at about 22-24% of GDP. It remained at about that level in the North, although there is an increase in the yeas from the arrival of the euro in 1999 up to 2007. But in the South, saving fell by more than one-third to about 14% of GDP by 2007. This drop in saving reflects higher consumption of imports, and thus is linked to the larger trade deficits of the South.

When it comes to private investment, the South has done shown a modest rise and the North a modest decline. 

When an economy runs trade surpluses, it accumulates financial capital to purchase foreign assets; for example, this is why the Chinese have come to own so much in U.S. Treasury bonds. When a country runs trade deficits, on the other side, it experiences an inflow of financial capital from other countries. At least in theory, such inflows and outflows of financial capital can in some cases be a healthy form of economic adjustment. For example, one can imagine the possibility of German investment capital flowing into Spain, being invested prudently, and helping Spain\’s economy grow rapidly while providing a good rate of return to German investors. One can also come up with less-pleasant scenarios, in which German investment capital flows into Spain, is not invested prudently, and leads to a situation where German investors do not receive a good rate of return. As the authors put it:\” In particular, in the presence of integrated real and financial markets, countries with a lower per capita income would be expected to attract domestic and foreign investment since higher productivity and economic growth rates promise above-average rates of return. The productivity of the invested capital ensures that the accumulated foreign debt can ultimately be repaid.\”

Of course, now that the debt and financial crisis has hit, all earlier expectations have been confounded. But the evidence up to 2007 doesn\’t suggest that the South countries–with the exception of Ireland–were using their inflows of financial capital to increase levels of productivity. Thus, it appears that the inflows of financial capital were either being invested unproductively or were financing a consumption boom.

Long story short: The situation in the euro zone between North and South was already headed toward severe instability before the financial and debt crisis. Large and unsustainable imbalances of trade and capital flows were already happening within the euro area. This story is a re-telling of what I called in a November 18 post The \”Chermany\” Problem of Unsustainable Exchange Rates. When trading partners are locked together by fixed exchange rates that are generating large surpluses in one country and large deficits in the other–whether in the case of China and the U.S economy, or in the case of Germany and northern Europe as compared to much of southern Europe–substantial economic stresses can be created.

Holinski, Kool, and Muysken conclude this way: \”In our view, in a common currency area—or an irrevocably fixed exchange rate system, for that matter—fiscal policy in the end will be forced to step in to address unsustainable current account imbalances. This is exactly what experience in the euro area over the past few years shows. To maintain and defend the euro area, northern euro area countries will need to bail out southern countries, willingly or not, and are doing so as witnessed by implicit and explicit guarantees and continuing emergency financial support. And they probably will need to keep doing so for a substantial period ahead.\”

This perspective emphasizes that Europe\’s debt and financial crisis isn\’t just another chapter of the U.S. financial crisis, but has distinctively European roots. It also emphasizes that Europe\’s imbalance aren\’t something that can be solved by cutting one mega-deal. Either the South needs to increase its saving so that its trade deficits diminish, or else raise productivity so that it can pay off the financial consequences of its trade deficits over time–or else the North will have to pay continued subsidies if it wishes to keep the fixed exchange rate of the euro area.

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What Are the Top Five Global Risks for the Next Decade?

The World Economic Forum has published Global Risks 2012, the seventh edition of an ongoing report. The report is based on survey data, so what it really reveals is what those at high-levels are worrying about–and how those worries are evolving over time.

Here\’s a description of the overall project from the report: \”Data and analysis are based on a newly designed survey covering a meaningfully expanded set of 50 global risks across five categories. The assessments of these risks more than doubled as a result of this year’s survey, with 469 experts and industry leaders responding worldwide. The survey captures the perceived impact and likelihood for each risk over a 10-year
time horizon using a clear and simple five-point scale …\”

As a starting point, consider the top five risks as rated by impact, and the top five risks as weighted by likelihood, and how they have changed during the last few years. The figures are below. The report sums up the change this way: \”The risk landscape in this 2012 report is based on a refined and expanded set of 50 risks, compared to 37 in previous years. This means that comparisons to the 2011 report are not like-to-like. However, it is clear that respondents’ concern has shifted from environmental risks in 2011 to socioeconomic risks in 2012, as shown in Box 1. Economic risks have displaced environmental risks as those considered most likely. In 2011, the risks perceived as having the highest potential impact were economic and environmental; in 2012, they are economic and societal.\”

The colors on these figures represent the category of risk: blue is economic, green is environmental, orange is geopolitical, red is societal, and purple is technological. The report itself offers a lot of interesting analysis of how these risks and others are interrelated, and how the risks may cluster into groups or scenarios.

My own main reaction is that when you are asked each year about risks over the next decade, your answers shouldn\’t change too dramatically. After all, if your answers change a lot in one year, it implies that you are reacting too much to current events, rather than trying to look ahead over the ten-year horizon. Of course, answers will evolve over time as new information arrives. Still, it\’s intriguing to me to look at the concerns that seem to fallen from the top of the lists, and wonder whether they are being underemphasized in the press of current events.

For example, when looking at the table showing \”Global Risks in Terms of Impact,\” there is a lot of consistency in the answers. There\’s also a lot of blue in the figure, showing that economic concerns appear to loom largest: asset price collapse, fiscal crisis, financial crisis, energy price volatility, a slowdown in China\’s economy. Even some of the geopolitical concerns, like backing away from globalization, are important largely for their economic consequences. In the early years, pandemic and chronic disease hit the top five, but by 2012 food and water supply crises–again often economic in essense–in the top five. Environmental issues are not seen as ranking in the top group, the only green in the figure is \”Climatological concerns\” in 2011, in the aftermath of Japan\’s devastating earthquake, but it then drops off in 2012. There is no purple in the figure: that is, technological concerns are not thought to be in the top five in terms of impact. 

Remember, the questions in the surveys are about the size of risks over the next 10 years. But in assessing what risks have the largest size, it feels to me as if the lists are being driven pretty heavily by the Great Recession and its aftermath, as well as a few other current economic concerns.

This pattern is more evident in the lists of the top risks that are most likely to arise. Back in 2007, the most likely risk to occur over the next 10 years was \”Breakdown of critical information infrastructure.\” Then when the recession hits, that concern doesn\’t appear again in the top five from 2008-2012. \”Middle east instability\” is the #2 most likely risk to occur over the next 10 years in 2008–but then it doesn\’t appear again in the top five from 2009-2012. No environmental (green-colored) concerns appear in the most-likely list from 2007-2010–and then environmental concerns are four of the five most likely in 2011. \”Severe income disparity\” isn\’t in the top five most risky issues from 2007-2011–but then is the risk most likely to occur in 2012.

To me, these sorts of fluctuations are mildly disturbing. They suggest that the high-powered folks answering these kinds of surveys are often reacting to current headlines, and haven\’t actually given a lot of serious thought to what risks are most likely to arise in the next 10 years nor to how bad those risks might be. Of course, that\’s also why reports like this one are useful and potentially important. Taking actions to reduce future risks now can often be much cheaper than cleaning up after they occur. But that requires forcibly lifting our eyes up from the headlines of today and trying to develop a clear-minded vision of future risks over the middle-term and the long-term.

For the record, here are the 50 risks listed in the survey, by category:

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How Globalization Nearly Exterminated the Buffalo

M. Scott Taylor (no relation!) offers a new and persuasive explanation of why the American buffalo population declined from 10-15 million in the early 1870s to about 100 by the late 1880s in \”Buffalo Hunt: International Trade and the Virtual Extinction of the North American Bison.\” The article is in the December 2011 issue of the American Economic Review (which isn\’t freely available on-line, but many in academia will have on-line access to it through their library or a membership in the American Economic Association.)

Taylor summarizes his argument:  \”This paper examines the slaughter using theory, empirics, and first-person
accounts from diaries and other historical documents. It argues that the story of the buffalo slaughter is surprisingly not, solely, an American one. Instead, I argue that the slaughter was initiated by a tanning innovation created in Europe and maintained by a robust European demand for buffalo hides.\”

Of course, it\’s not a shock that the buffalo population declined as settlers spread across the western states in the mid-19th century. But the decline seemed to be happening gradually.

\”By 1830, buffalo were largely gone east of the Mississippi. During much of this early period natives hunted the buffalo not only for their own subsistence needs but also to trade buffalo robes at forts and towns. A buffalo robe is the thick and dark coat of a buffalo that is killed mid-winter. Robes could be used as throws for carriages, or cut to make buffalo coats and other fur items. They were a common item in the 19th century, and they made their way to eastern markets via transport along the Missouri river to St. Louis or overland via the Santa Fe trail. In the 1840s settlers pushed through the Great Plains into Oregon and California. The movement of the 49ers to California and the  Nevada gold rush years brought a steady stream of traffic through the Platte River  valley. Subsistence hunting along the trail plus the movement of cattle and supplies divided the existing buffalo herd into what became known as the Northern and Southern herds.

\”The division of herds became permanent with the building of the Union Pacific Railroad through the Platte River valley in the 1860s. While subsistence hunting for the railroad crews surely had some effect on buffalo numbers, as did the railroad’s popular day trips to kill buffalo, the harried buffalo herds withdrew from the tracks, creating a corridor centered on the Union Pacific line. The railroads also provided transportation for buffalo products to eastern and foreign markets, but in the 1860s railway cars were not refrigerated, and, hence, buffalo meat was marketed only as salted, cured, or smoked.\”

\”Despite the railroads, the market for buffalo robes, the increase in subsistence hunting, and the conversion of the high prairie to agriculture, most observers expected the population to decline gradually as it had east of the Mississippi. The force of habitat destruction was minimal on the Great Plains. In 1860, they held only 164,000 people. Farms occupied less than 1 percent of the land area.\”

This pattern of gradual decline for the buffalo changed abruptly not long after 1870, when tanners in England figured out a way to tan buffalo hides for leather:

\”The hardest evidence comes from a London Times article reporting from New York City in August of 1872. It reports that a few enterprising New Yorkers thought that buffalo hides might be tanned for leather, and when the hides arrived they were “sent to several of the more prominent tanners who experimented upon them in various ways, but they met with no success. Either from want of knowledge or a lack of proper materials, they were unable to render the hides soft or pliable, and therefore they were of no use to them.”

The report continues to note “several bales of these hides were sent to England, where they were readily taken up and orders were immediately sent to this country for 10,000 additional hides. These orders were fulfilled, and since then the trade has continued.” Further still, the methods are spelled out: “The hides are collected in the West by the agents of Eastern houses; they are simply dried, and then forwarded to either New York or Baltimore for export… The low price that these goods have reached on the English market, and the prospect of a still further decline, may in time put an end to this trade, but at present the hides are hunted for vigorously, and, if it continues, it will take but a few years to wipe the herds out of existence” (my emphasis). …

The market for buffalo hides boomed; buffalo hunters already in the field—like George “Hodoo” Brown—started to skin buffalo for their flint (hairless) hides, and hundreds if not thousands of others soon joined in the hunt. Previous to the innovation, hides taken from the Southern herd or hides taken in all but three winter months were virtually worthless as fur items. The only saleable commodity from a buffalo killed in these regions or times was its meat, but this market was severely limited by transportation costs. With the advent of a flint-hide market, killing a buffalo anywhere and anytime became a profitable venture. By 1872, a full-scale hide boom was in progress.\”

Taylor acknowledges and discusses the standard explanations for the decline of the buffalo: hunting by the United States Army, the presence of the railroads, and changes in native American hunting practices. While each of these may have contributed a bit to the decline, his estimates suggest that demand from the global market played a central role: \”[T]he newly constructed export data support the export-driven slaughter hypothesis, while the evidence for the alternative hypotheses that hold the railroads, the Army, or native Americans responsible is far weaker. The magnitudes of the implied export flows are considerable. My findings suggest approximately six million buffalo hides are exported over the 1871–1883 period, and this represents a buffalo kill of almost nine million.\”

Taylor boils down three crucial economic factors behind the buffalo slaughter: \”[A] combination of a tanning innovation, open access to buffalo herds, and fixed world prices delivers a punctuated slaughter matching that witnessed on the Great Plains…. The slaughter is not a unique example of resource overuse created by burgeoning demand and poor regulation. It may, however, be unique in its scale, its speed, and the critical role played by international markets.  … Although the bison slaughter was a major event in US history, it was a minor event on the world stage. And being small on world markets meant that some of the typical insulating and signaling properties provided by a market price system were missing.\”

In short, when smaller countries and economies around the world express concern that combinations of new technology and global demand might devastate their natural habitat or resources, Americans should be willing to listen. In our own history, it\’s what nearly exterminated the buffalo.

As a coda, the slaughter of the buffalo was one of the events leading to the creation of an American environmentalist movement: \”The slaughter of the North American buffalo surely represents one of the saddest chapters in American environmental history. To many Americans at the time, the slaughter seemed wasteful and wrong, as many newspaper editorials and letters to congressmen attest, but still, little was done to stop it. The destruction of the buffalo and the wanton slaughter of other big game across the West did, however, pay some dividend. The slaughter of the buffalo in particular was pivotal in the rise of the
conservation movement in the late nineteenth and early twentieth century. Almost all of the important players in the conservation movement experienced the slaughter firsthand—Teddy Roosevelt, John Muir, and William Hornaday. The creation of the national park system in general, and the Yellowstone herd in particular, reflect
the revulsion many felt to the Slaughter on the Plains.\”

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Recovery Delayed, Says CBO

Twice a year, the Congressional Budget office puts out \”The Budget and Economic Outlook,\” which provides budget and economic forecasts. After the report last August, I called my blog post Unrequited Economic Optimism from the Congressional Budget Office, because it predicted that in 2012, the fall in housing prices would bottom out and the unemployment situation and growth would improve a bit, which would finally be followed by much better news in 2013 and thereafter. However, the just-released January 2012 report dials back the optimism. Here\’s CBO (footnotes omitted):

\”CBO’s current economic forecast differs in some respects from its previous one, which was issued in August, as well as from the January Blue Chip consensus forecast (which is based on about 50 forecasts by private-sector economists) and the consensus of January forecasts by Federal Reserve Board members and Federal Reserve Bank presidents. 1 Compared with what it forecast in August, CBO is currently projecting weaker growth of real GDP in 2012 and 2013 but slightly stronger economic growth over the remainder of the decade … The current forecast also includes a higher unemployment rate and lower interest rates through 2021. CBO’s current projections for the growth of real  GDP in 2012 and 2013 are also weaker than those by the Blue Chip consensus and the Federal Reserve— perhaps owing to different assumptions about federal
fiscal policy—and CBO’s projections for the unemployment rate are higher.\”

Growth
Overall, CBO writes: \”A large portion of the economic and human costs of the recession and slow recovery remains ahead. In late 2011, according to CBO’s estimates, the economy was about halfway through the cumulative shortfall in output that will result from the recession and its aftermath.\” Here\’s a figure comparing the projected growth rate of the U.S. economy with a group of leading trade partners of the U.S., where their growth rates are weighted by their shares of U.S. exports. The countries are Australia, Brazil, Canada, China, the euro zone, Hong Kong, Japan, Korea, Mexico, Singapore, Switzerland, Taiwan, and the United Kingdom. A forecast like this one, which suggests the bad news slower growth than the comparison group now and for for several years, but faster growth later on, is inherently discomforting.

Unemployment

With bounceback more-rapid growth not kicking in to 2014, the unemployment rate is predicted not to fall much in the near-term, either. \”In CBO’s forecast, the unemployment rate in 2012 and 2013 remains largely
unchanged from its value last year. However, in the forecast, as growth picks up after 2013, the unemployment rate falls to 6.9 percent by the end of 2015 and 5.6 percent by the end of 2017.\”

Housing

CBO continues to believe that housing prices will bottom out in the second half of 2012, which would help a lot of U.S. households feel more secure. However, a historically large share of U.S. housing stock is vacant, which means that the house construction industry won\’t rebound until a few years later.

Business Investment

\”Net\” business investment is the amount of investment after depreciation has been subtracted out: that is, it is the amount added to the capital stock after replacing what has worn out. This is a modest bright spot for the U.S. economy, having already turned up, with CBO expecting that it will continue to rise back toward historical averages.

My standard line about the U.S. economy, as we all buckle our seat belts for the election next fall, is that whoever is elected president in November 2012 is like to be regarded as an economic saviour by the end of his first or second year of office. But a lot of the eventual turnaround won\’t have much to do with whatever policies are enacted between now and then; it will just be that the economy will have finally managed to work through most of the backlog of problems from the Great Recession.

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My New Book — "The Instant Economist: Everything You Need to Know About How the Economy Works."

Here\’s the start of my new book called The Instant Economist: Everything You Need to Know about How the Economy Works. It\’s available as of today on Amazon here, or at Barnes and Noble here.

\”Talking about the wisdom of economists in polite company is like talking about the honesty of politicians or the lips of chickens. Yet in the face of this prejudice, I maintain that economics has useful lessons for understanding the world. My wife says I hold this belief because I am an evangelist, with economics as my religion. Perhaps so, but I have also been asked many times, by many people—at venues as diverse as conferences and cocktail parties—to recommend “just one book” that explains economics. These people aren’t looking for a treatise on the beauty of the free market, or for a lecture on the need for government regulation. They have their own views on politics and policy, but they are self-aware enough to recognize that at least some of their views are built on a shaky or nonexistent understanding of economics. I can sympathize. There are dozens of books out there on economics—freaky and otherwise—but I’m hard-pressed to point to a readable non-textbook that would give a soup-to-nuts understanding of the key principles of economics. I hope that the book you’re reading will impart a working understanding of both micro- and macroeconomics, not enough to prepare you for setting up your own economic forecasting business, but enough that you can read and speak about economics topics with greater confidence and conviction.\”
\”I know what you’re thinking. You’re wondering if I’m out to push a certain set of economic policies, and if so, whose side of the political fence I’m on. Such skepticism is understandable, but here’s the honest truth: If you’re wondering whether this book’s contents are slanted toward liberal or conservative economic policy—or toward the Democratic or Republican Party—the short answer is no. Professional economists of all political leanings use the tools and concepts I will discuss here. Economics is not a set of answers, but a structured framework for pursuing those answers.\” 

For an idea of what the book tries to accomplish, maybe it\’s useful to tell the back story of how this material has percolated a long time, through five episodes of thinking about how to teach intro economics.

Episode #1 started in the late 1980s was when I worked with Joseph Stiglitz in putting together his introductory economics textbook. This led to episode #2, which was when I started teaching large-lecture introductory economics courses at Stanford University in the late 1980s. This in turn led to episode #3 a few years later, when Stanford got a Pew Foundation grant to bring over groups of young diplomats from countries of eastern Europe. Many of them had been educated and trained with the expectation that they would become part of the larger Soviet diplomatic apparatus, but with the break-up of the Soviet Union, those expectations has become obsolete. Groups would come over and spend a few months based at Stanford, with side trips to see other parts of the U.S. They sat in on various courses, but also had an international affairs course and an economic course just for their group. For a few years while the grant money lasted, I gave the economics lectures, which were were an intuitive and nontechnical 15-hour version of the intro economics course.

This led to episode #4, which was a call from the Teaching Company, a firm based near D.C. I\’d won a student-voted award as the outstanding teacher of a large lecture class at Stanford, and they wanted to know if I would record a version of that course for their adult education lectures. I\’d never heard of the company, but I had the lecture notes pretty much ready to go from my talks to the eastern European diplomats, so I said \”sure.\” That course was first recorded in 1994; the most recent edition (the third) was recorded in 2005. This led to episode #5, when Penguin/Plume started having talks with the Teaching Company about turning some of their more popular courses into books. They asked if I would take a stab at doing this with the economics book. This involved a huge cut in the word count from the 18 hours of lectures, because they didn\’t want a tome, and then updating the material as needed so that it would cover the economic events of the Great Recession and its aftermath.
 
I\’m pleased with the book. For those looking for an actual introduction to economic thinking, and a bunch of examples and applications, this book should help to organize  the concepts and clarify the tradeoffs. I suspect that the book may also be used as background reading for those who want to teach an intro economics course with almost no graphs or equations. Buy a bunch and give \’em out as party favors! Send a copy to political figures! Use them as paperweights!

Here\’s the review from Library Journal, which I thought captured the flavor of the book:

\”Taylor’s (managing editor, Journal of Economic Perspectives) volume can help conversationalists looking to raise the bar for their watercooler chats and casual readers who want to understand better the current economic condition of the United States. Taylor uses simple language with field-specific vocabulary to explain economic concepts, and each concept is successfully reinforced with a real-life—and usually entertaining—example. He hits all the subjects that might interest a layperson, such as division of labor, supply and demand, wages, competition and monopoly, inflation, banking, and trade, for a total of 36 petite chapters—just enough information to give the reader a basic but well-rounded understanding of the subject. VERDICT This highly readable, nonpoliticized look at some of the economic principles that shape our society, presented in an engaging, anecdotal fashion, is highly recommended for armchair economists and anyone with a general interest in the state of our economy. —Poppy Johnson-Renvall, Central New Mexico Community Coll. Lib., Albuquerque

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Economic Underpinnings of the U.S. Revolutionary War

The U.S. war for independence from Britain is often described in terms a desire for democratic self-government and protection of the rights of citizens. But among historians, there has been a long tradition arguing that economic factors were more important. Perhaps most famously, Charles Beard argued back in 1913 in his book, An Economic Interpretation of the Constitution of the United States that the Founding Fathers were just out to protect their own personal property. But as the decades passed, a consensus developed that Beard\’s arguments was so simplistic and contentious and stark that it was just wrong.

Staughton Lynd and David Waldstreicher offer a refreshing take on the role of economic forces in the U.S. Revolution in \”Free Trade, Sovereignty, and Slavery: Toward and Economic Interpretation of American Independence.\” It appears in the October 2011 issue of the William and Mary Quarterly, which is not freely available on-line, but will be available to many with academic ties if their institution has a certain kind of JSTOR subscription. Here\’s their opening (footnotes omitted):

\”What kind of revolution was the American Revolution? Four basic answers, all first suggested before 1800, continue to shape the scholarship. They can be denoted Answers A, B, C, and D.

Answer A was advanced by the Revolution\’s leaders and echoed by their friends in Great Britain, such as Edmund Burke: The American Revolution was a struggle for constitutional rights.

Answer B was that of the Revolution\’s opponents, again both in the American colonies and in Great Britain: The American Revolution was a struggle for economic independence from the British Navigation Acts and other economic restrictions. 

Answers C an D were put forward in a second round of controversy during the 1790s, as Americans tried to determine their proper relationship to the French Revolution. Answer C was that of the Jeffersonians: The American Revolution was a democratic movement essentially similar to the French Revolution. Their Federalist opponents responded with Answer D: The American Revolution was a colonialist independence movement essentially different from the French Revolution. …

We offer for further exploration what might be described as a B-D interpretation. That is, the American Revolution was basically a colonial independence movement and the reasons for it were fundamentally economic.\”

I can\’t hope to summarize their argument point-by-point, but in large part, it comes down to pointing out how economic conflicts were often prior in time other events of the Revolution,  and loomed large in importance. Britain often sought to tax or even to embargo various kinds of trade from the American colonies to the West Indies: for example, the import tax with the Molasses Act of 1733, or the way in which the British Navy tried to cut off trade between the colonies and the French West Indies during the Seven Years\’ War. The \”single most contentious issue\” in the First Continental Congress in 1774 was about the extent to which the British Parliament could regulate the U.S. economy, including these and other limits on navigation as well as acts that sought to prohibit manufacturing in the colonies (so that the colonies would need to import from Britain, instead). After reviewing the history in some detail, they write:

\”The commercial dispute preceded the constitutional, not just once but again and again in these years. It is important that colonists melded economic and constitutional arguments under the category of sovereignty–but not so important that we should ignore the originating nature of economic forces.\”

To anyone who has passed through the U.S. public school system, or who has listened to the rhetoric of politicians, thinking of U.S. independence as driven by economic motives has nearly sacrilegious overtones. Lynd and Waldstreicher respond like this:
 

\”If the American Revolution had fundamentally economic causes, it is not thereby demeaned. Post-World War II colonial independence movements should have taught us something about the many-sided meanings of economic sovereignty for developing nations. If not only merchants but also artisans, tenant farmers, cash-strapped yeoman, fishermen, and debt-ridden slave-owning planters can be shown to have had compelling economic reasons to favor independence, it should not seem too narrow or conspiratorial to suggest that they acted on these reasons and sought to combine them with a language that spoke to principles as well as to the bottom line.\”

To me, it seems quite plausible and believable that the urge of the colonists to move beyond protest and into actual war and rebellion needed the push of economic factors. In addition, if we have learned nothing else from last two centuries, it should be that when anyone starts talking about a revolution is needed for freedom and justice and for people to get their \”rights,\” warning sirens should go off in your brain. Such promises from revolutionaries have certainly been betrayed far more than they have been honored.

But it also seems to me that the cause of an event is often quite different than the lasting legacy of that same event. The causes of the U.S. Revolution probably were largely economic, albeit expressed in a language of constitutionalism. But the lasting legacy of American Independence was the creation of a constitutional structure that is flexible enough to adapt and strong enough to endure.

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Robert Kennedy on Shortcomings of GDP in 1968

Every year or two, I run across this lovely quotation from Robert F. Kennedy about the fundamental shortcomings of gross national product as a measure of well-being. It\’s from a speech he gave at the University of Kansas on March 18, 1968, and a transcript is available here.  Here\’s RFK:

\”Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things.  Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product – if we judge the United States of America by that – that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage.  It counts special locks for our doors and the jails for the people who break them.  It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl.  It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities.  It counts Whitman\’s rifle and Speck\’s knife, and the television programs which glorify violence in order to sell toys to our children.  Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play.  It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials.  It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile.  And it can tell us everything about America except why we are proud that we are Americans.\”

Although economists sometimes stand accused of worshiping GDP, this charge is untrue. Every introductroy economics textbook, including my own (available here through Textbook Media), acknowledges these shortcomings, although I confess we lack the poetic cadences of RFK. But the quotation can be a nice supplement when introducing students to the concept of GDP, or when looking for a topic for a short writing assignment or essay question.

The speech isn\’t long, and if you are a connoisseur of political rhetoric, it\’s worth reading. Of the current politicians on the national stage, I don\’t think any of them has the lovely touch with self-deprecating humor at the start of this kind of talk. Here\’s RFK warming up the audience–and remember that there are many Kansas students in the audience who don\’t especially support him:

\”I\’m very pleased and very touched, as my wife is, at your warm reception here.  I think of my colleagues in the United States Senate, I think of my friends there, and I think of the warmth that exists in the Senate of the United States – I don\’t know why you\’re laughing – I was sick last year and I received a message from the Senate of the United States which said: \”We hope you recover,\” and the vote was forty-two to forty. And then they took a poll in one of the financial magazines of five hundred of the largest businessmen in the United States, to ask them, what political leader they most admired, who they wanted to see as President of the United States, and I received one vote, and I understand they\’re looking for him.  I could take all my supporters to lunch, but I\’m – I don\’t know whether you\’re going to like what I\’m going to say today but I just want you to remember, as you look back upon this day, and when it comes to a question of who you\’re going to support – that it was a Kennedy who got you out of class.\”

It\’s also hard to imagine that the speechwriters for any contemporary politician would let them finish a speech with this kind of classical reference and slightly obscure flourish: \” I want the next generation of Americans to look back upon this period and say as they said of Plato: \”Joy was in those days, but to live.\”\”

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Economic Underpinnings of Arab Spring

Adeel Malik and Bassem Awadallah discuss \”The economics of the Arab Spring\” in a working paper (WPS/2011-23) for the Center for the Study of African Economies at the University of Oxford. They point out that despite rapid growth in education levels, access to water, and urbanization–all patterns that are often associated with sustained economic development–the region has failed dismally to develop a robust private sector. As a result, well-educated and youth-heavy populations see little chance for economic advancement. Here are some excerpts: 

On large numbers of young and unemployed workers: 

\”Over the last few decades, the Middle East has witnessed an unprecedented youth bulge that has dramatically changed its demographic profile. An overwhelming proportion of its population–in many countries about three-quarters–now consists of young people under the age of 30. Together with a greater female participation in the labour force, these demographic trends have greatly enhanced the number of people looking for jobs. During the period 1996=2006, labour force in Middle East and North Africa has grown three times as much annually as in the rest of the developing world, resulting in one of the larges rates of youth unemployment in the world.\”

On the collision between rising education and thwarted aspirations:

\”Of the tip 10 countries that made the most impressive strides in human development during the last 40 years, five were from the Arab world. Starting from one of the lowest levels of educational achievement in the 1960s, adult education rose faster in the Middle East during the 19890-2000 period than any other region in the World. Despite reservations about the quality of education imparted, even this quantitative expansion of education has led to a silent revolution of sorts. It is a revolution of aspirations. Even as aspirations have become more mobile with the new gadgets of globalization, the local systems of governance are ossified and offer limited economic mobility to the region\’s youth.\” 

On the centrality of government in the economic sphere:

\”The state in most Arab economies is the most important economic actor, eclipsing all independent productive sectors. When it comes to essentials of life, such as food, energy, jobs, shelter, and other public services, the state is often the provider of both first and last resort. The functioning of this system rests on a heavy dose of subsidies, economic controls, and a variety of other uncompetitive practices. … The state-centred development paradigm rests on an uninterrupted flow of external windfalls. In fact, many of the region\’s pathologies–whether it is a weak private sector, segmented labor markets, or limited regional trade–are ultimately rooted in an economic structure that relies overwhelmingly on rents derived from fuel exports, foreign aid, or remittances. Reliance on such unearned income streams is the \”original sin\” for Arab economies.\”

On the paucity of intra-Arab trade:

\”With a population of 350 million people that share a common language, culture, and a rich trading civilization, the Arab world doesn\’t function as one common market. … Few Arab countries consider their neighbors as their natural trading partners. Pan-Arab trade is noticeably insignificant. Despite having tripled between 2000 and 2005, the share in intra-Arab trade in total merchandise trade still hovers around 10 percent. … The share of intra-Arab imports, despite having fluctuated widely, is only marginally higher than that in 1960. … Even this limited trade is geographically clustered, with countries in the Gulf and North Africa trading predominantly within their own sub-regions.\”

Location and water access don\’t seem to be helping: 

\”The Arab world is well-positioned to be a global trade and production hub. Geographically, it lies at the cross-roads of major sea and trading routes with easy access to Europe, Africa, and the near East. … Strictly speaking, there is not even a single landlocked country in the Arab world, even if Iraq and Jordan have narrow coastal strips. … It is ironical that a region that connects Asian merchants with European markets is itself stuck in primary production. Everywhere in the world proximity to coasts tends to be associated with lower transport costs and better access to global markets. The Arab world defies these forces of gravity, however.\”

Urbanization doesn\’t seem to be helping:

\”[C]ities offer a range of mutually supportive activities. Bringing together machinery, skills, suppliers and resources together in a single location can be tremendously advantageous for firms. Such agglomeration economies are missing in the Middle East, even if it is more urbanized today than several developing regions: 58 percent of the region\’s population lives in urban areas, compared to 30-37 percetn in sub-Sarharan Africa and south Asia. … Yet, Arab firms are failing to reap the cost advantages that growing urbanization confers on them.\”

The jobs challenge and the private sector:

\”The private sector is at once the most despised as well as the most desirable aspect of reform. Business in the Arab world is often comfortably embedded within the state, wtiht eh result that it invokes images of crony capitalism. At the same time, an estimated 100 million jobs need to be created in the MENA [Middle East and North Africa] region in the next decade or so. This employment challenge cannot be addressed without a strong private sector. .. An independent business sector will also serve a vital political function: it can generate a middle class that can serve as a powerful constituency for political reform. … Viewed in this light, the struggle for a new Middle East will be won or lost in the private sector.\”

Malik and Awadallah lay particular emphasis, among all the policy steps that might be taken, on policies that would help to create a regional market across the Middle East: that is, policies and investments to make travel, shipping, business, and communication cheaper and easier. Such policies might be more politically acceptable (that is, less upsetting to local elites) than attempts to open more directly to the global economy. Riding the wave of discontented and well-educated young adults, such policies might also help to harness the power of Arab spring in a productive manner.