VC for the people

Oddly (very oddly), I found myself last week at the INET Economics conference in Toronto. Larry Summers was the final speaker. His presentation was excellent. Whatever I might object to in Summers’ history or politics, he’s brought to the mainstream a set of views I’ve long held, and he is an engaging, cogent presenter.

I had a question for Summers that I didn’t get to ask. So I’ll ask it here.

Early in his talk, Summers pointed out, accurately, that economists really need to rethink the standard “labor / leisure tradeoff”. Almost no one prefers a life of pure “leisure”. Human beings like to regard themselves and to be regarded by others as “productive”. They like to “make a contribution” or “pay their own way” or “kick ass” or “dominate others”, to do something that they believe confers value and status. As Summers pointed out, retirement is often not so good for people. The luckiest people, young or old, are those whose work is fulfilling and enjoyable, not those who do not work at all. As people grow wealthy, they become more free to choose the ways by which, and the terms under which, they will do useful or important things. Wealth is better understood as conferring upon individuals a greater freedom of choice over what kinds of work they wish to do than as endowing lives of “leisure”. A person with wealth can explore roundabout and risky production processes (become an artist, write a novel, start a business), can opt for work with no hope of remuneration (volunteer, help raise a child or grandchild), or can hold out for only the most fulfilling or best-paid market labor. A person without wealth may be forced to accept degrading and poorly paid work, just to pay the bills.

Summers’ talk was the capstone of a conference whose theme was “innovation”. In an excellent session a day earlier (see John Cassidy for a full write-up, ht Mark Thoma), there was surprising agreement among several panelists that speculative bubbles help support innovation. William Janeway distinguished between bubbles in productive vs nonproductive sectors, financed by banks vs nonbanks, and argued that productive-sector, not-bank-financed bubbles promote socially useful innovation at modest social cost, despite high private costs to investors. He went so far as to suggest that agency problems in the delegated investment process, specifically the inability of career-minded fund managers to stay away from bubbles regardless of any personal reservations, make an important contribution to innovation. Steven Fazzari (whose work on inequality this blog has featured before) described research showing that R&D expenditures of young firms are constrained by external finance and increase in bubblicious periods. Ramana Nanda investigated whether investments made at the top of bubbles were poor, and found that they were not. They were just riskier. Firms funded by venture capitalists in heat were unusually likely to crash and burn, sure, but they were also unusually likely to succeed spectacularly. In an earlier panel, Mariana Mazzucato described the importance of “mission-oriented” investment by the public sector. States determined to gain military advantages or put humans in space accept experimentation and failure that would be intolerable to private venture capitalists (whose enthusiasm for risk, she argues, is in general overstated). The common thread in all these accounts is that too much market discipline can be socially counterproductive. If (nonbank-financed) speculative bubbles create social value that exceeds the costs borne by investors and entrepreneurs, then the fact that market participants fail to impose privately optimal discipline on their own portfolios is beneficial. If revolutionary developments in technology depend upon states accepting large, nonrecoverable expenses, a managerialist insistence on quantifiable performance metrics may be foolish. Even in the private sector, powerhouses of invention like Bell Labs and Xerox PARC thrive primarily within cushy monopolies, where they are sheltered from quotidian fretting over the bottom line, where market incentives are present but blunted.

So, Summers argued (as he has now argued for a while), Western economies may have entered a period of “secular stagnation” in which the “natural rate of interest” (the rate at which the resources of the economy, human or otherwise, would be fully employed) is so low that we cannot achieve it, or should not try (because rates so low become ineffective at spurring demand or carry with them other costs). He emphasized infrastructure investment as a solution, a near free-lunch which simultaneously increases the economy’s capacity as it spurs aggregate demand. I have no quarrel with that. Infrastructure investment would be a great thing to do, if we could solve the political and regulatory problems that have rendered competent public enterprise nearly impossible.

But we do have other options. If it is true, as Summers seems to think, that humans prefer to do important things even when they are not forced by a labor-market cudgel, and if it is also true that financial constraint causes people to accept safe and sure work rather than take chances on activities that might be speculative but more valuable, then there might be social return in having the state absorb some of the risk of failure faced by individual humans. In effect, the state could provide venture capital to the people. If ordinary citizens had a small but reliable annuity, too modest to live comfortably but enough to prevent destitution, then at the margin, we’d expect people who currently seek or accept unfulfilling, underpaid work to opt for entrepreneurship, or education, or art, or child-rearing, or just hold out for a better gig. “VC for the people” would combine a reduction in labor supply with a lot of new labor demand, forcing employers to increase wages and encouraging substitution of capital for the least desirable jobs. Both the wage effect and the annuity itself would increase the share of national income available to those without direct claims on capital, reducing inequality. In his talk, Summers mused (wonderfully) that he’d prefer we not evolve to an economy in which people are employed providing increasingly marginal services to the rich, working as specialized “knee masseurs” and the like. A straightforward way to preclude that is to ensure that everyone has the means to refuse those jobs and take chances on more meaningful and ultimately more valuable work.

“VC for the people” would reduce market discipline, but it would certainly not eliminate it. People do not require the threat of destitution to cultivate ambition. It is much better to supplement ones modest annuity with a vigorous market income than to crouch inertly in a hovel. Most people (like most of you, my not-nearly-destitute readers) will still try hard to achieve economic success. It’s just that people who have options are much more likely to actually find success than people who don’t.

“VC for the people” has a more common name. It is called a universal basic income. Properly implemented, it is not means-tested and carries no disincentive to earn. It is inflationary via increased purchasing power of ordinary people, the best kind of inflation, especially desirable in disinflationary times. Its level is a policy instrument and need not be indexed to prices. If it “works too well”, positive interest rates can tamp down spending, and, presto, no more secular stagnation.

So, what do you say, Larry Summers? Would you support a universal basic income?


Note: The title of this post is a bit of a play on Anatole Kaletsky’s QE for the people, which is similar to my own Monetary Policy for the 21st century, as well as proposals by David Beckworth, Ryan Cooper, Ashwin Parameswaran, Matt Yglesias, Haitao Zhang, and I’m sure many others.

However, it’s important to note a difference between those proposals (for fiscalist central banks that “cut checks” to regulate the macroeconomy in addition to using traditional monetary tools) and proposals like this one, for a universal basic income. A fiscalist central bank must be able to tighten as well as loosen when macroeconomic conditions change. In order to retain policy flexibility, recipients of “helicopter money” must not come to depend upon it as permanent income. A fiscalist central bank would have to take care to cut its checks irregularly, or (as I suggested) wash its transfers to the public through a lottery to avoid recipient dependence.

A universal basic income, however, is intended to be depended upon. Its purpose is to alter people’s behavior, to render them more risk-tolerant, to increase their bargaining power in wage negotiations. Macroeconomically, a universal basic income might provide a low-frequency “reset” to positive interest rates, but it should not be adjusted monthly or quarterly like a central bank policy instrument. A universal basic income should be determined like the minimum wage, via acts of Congress. “Helicopter money”, on the other hand, should not depend upon acts of Congress. Its purpose to offload a macro-stabilization component of fiscal policy from legislatures to central banks. (Larry Summers, in his talk, admitted confusion as to the point of helicopter money proposals. Don’t fiscal expenditures plus open market operations amount to the same thing? In terms of net flows to the private sector, they do amount to the same thing, but in institutional terms they are very different. Central banks are much more agile, more nimble, than legislative bodies. If fiscal policy is to be used as a macro stabilization tool, then some aspects of fiscal policy must be delegated to an agency capable of responding at the frequency required for macro stabilization. That is the attraction of “helicopter money”.)

Update History:

  • 16-Aprr-2014, 3:55 p.m. PDT: Added David Beckworth and Haitao Zhang to list of helicopter money (-ish) proposals. Added “start a business” to list of risky, roundabout production process things.

“Incentives to produce” are incentives to rig the game

That’s obvious, right? But let’s belabor the point.

All too often in discussions about the vast dispersion of circumstance we call “inequality”, people concede a kind of trade-off. Yes, reducing rewards to those at the top of the wealth/income distribution might blunt their incentives to produce. But the cost of that might be offset by utilitarian benefits of transfers to the less well off, or by greater prosperity engendered by MPC effects on aggregate demand, or by whatever.

That’s all well and good as far as it goes. But at current margins, I suspect (with Paul Krugman) there is no tradeoff. There might be a tradeoff in measured GDP, but GDP happily tallies economic coercion and rent-capture along with genuinely productive activity. Suppose that a comic-book evil pharmaceutical company secretly unleashes a disfiguring virus for which — miracle of miracles! — it has an expensive, patented treatment. After the pandemic, consumers would have a choice: tolerate an odiferous oozing eczema (but remain otherwise healthy and productive!), or pay for the treatment. GDP would likely rise! In macroeconmic terms, this kind of thing is an example of the “broken window fallacy“. Causing a disease and then expensively treating it does not in fact make the world richer. But it may well inspire economic activity — the mass production of a new drug, visits to doctors, extra hours people choose to work in order to afford the treatment, etc. In aggregate, we work harder just to stay in place. But the distributional effects of the operation are very real. The extra personal income enjoyed by the conspirators spends nicely.

In real life, it’s not so common for comic-book villains to release icky pathogens and then charge for a cure. But it is very common for doctors to restrict entry into their profession and to act politically to inflate the cost of their services. Goaded by “incentives to produce”, participants in the financial industry do a lot of “innovating” that amounts to finding ways of skimming invisible or unexpected fees from people or persuading them to bear underappreciated and undercompensated risks or maximizing the value to them (and costs to others) of guarantees implicitly or explicitly provided by the state. Nearly every industry hires lobbyists to carve out favorable loopholes and subsidies and regulatory schemes at everyone else’s expense. Tech firms make a business model of invasive surveillance and selling information about people who are their users but not their customers. Patent trolls send extortion letters to users and creators of new technology. Politicians “revolve” out of government into perfectly legal, extravagantly compensated sinecures in the private sector, and then often back into government. Senior members of the military become “private sector entrepreneurs”, garnering contracts from friends and former colleagues in a burgeoning defense and intelligence industry, often for work that used to be performed more cheaply internally. Executives collude with friendly boards who rely upon transparently idiotic consulting practices to extract huge salaries. Some of these things contribute to measured GDP, to “growth”, but their effect on the actual well-being of those outside their industries is, um, questionable.

This stuff isn’t marginal, nor should we expect it to be. In fact, we should expect the prevalence of rent capture (or worse) as a source of economic profit to increase with technological progress. Why? Because, absent chicanery, technology increases the ease of production and the efficiency of distribution. As Schumpeter pointed out, the source of profit in real-life capitalism is the fact that monopoly power is ubiquitous because of natural barriers to competition. The corner store has a monopoly on the convenience of its neighbors, and so can capture some of the surplus that might otherwise be bid away to customers by competitors. On-demand delivery drones would eliminate that monopoly. Yet the corner store industry might lobby to prevent residential rooftop deliveries, in which case it is no longer exploiting a natural inefficiency but capturing a rent. In business school, students are taught that a successful business has a “moat” that makes it difficult for competitors to bid away ones margins. Technological progress renders moats that derive from nature harder to come by. Instead, successful businesses — and successful people (since under capitalism, a human is just a small business) — must rely increasingly on moats that result from social and political arrangements. We choose to grant monopoly rights to “creators” in the form of intellectual property and to expand their scope. We choose to limit the taxi business to medallion holders. We choose to prevent Indian doctors from competing in American hospitals, even though airplanes have eliminated locals’ natural monopoly. We choose to hire from the Ivy League. The distribution of profits is determined by social choices rather than by natural scarcities.

None of this is to say that any particular such choice is “wrong”. The static inefficiency inherent in patent monopolies at least under some circumstances may be overcome by the incentives to invent they yield. Minimum wage laws are restraints on competition that I enthusiastically support precisely because of to whom the “rents” are directed. Maybe sending a gigantic, very random fountain of money to producers of health-care inputs via an inscrutable hodge-podge of public and private payers really is the best way to ensure our cancers are cured before we are diagnosed with them. Who knows?

But the distribution of affluence is less and less a matter of direct attachment to production, and more and more a function of winning social games and political contests that determine to whom the fruits of production will be allocated. There’s no conspiracy in that. Nor is it an answer to say “capital” now determines who enjoys wealth. As technology improves, capital goods become mere commodities like everything else. Financial capital, whatever it is, is not an input into any material production process. It is a construct and artifact of a huge and ever-changing array of social and legal institutions. “Human capital”, “social capital”, and “organizational capital” are things we impute ex-post to winners of distributional contests as an explanation of observed returns. They do not straightforwardly exist in the world.

“Inequality” — high dispersion of outcome — creates a strong incentives to be on the side of winners. There are some circumstances where being on the side of winners means making an outsize contribution to economic production. There are other circumstances where winning means aligning oneself with coalitions capable of winning legal and political contests that may be orthogonal to, or much worse than orthogonal to, any contribution to production. The two strategies don’t preclude one another. Perhaps outsize rewards are shared between those who make unusual contributions to production and those who participate in politically potent guilds. But, at best, increased dispersion increases the incentive to engage in both sorts of behavior. Incentives to produce are also incentives to contest for rents. And at any given time, for any given person, one may be an easier or more reliable means of gaining outsize rewards than the other.

Suppose, reasonably I think, that ceteris paribus humans prefer to “be good”. That is, we prefer to do work that is productive and engage in behavior that is ethical. Suppose, also reasonably, that a well ordered society depends upon people sometimes making choices opposed to their material interests on ethical or other grounds. Then it is obvious how inequality might be costly. Instead of talking about “incentives to” (produce, extract rents, whatever), we might describe outcome dispersion as a tax on refraining from mercenary behavior. If the difference between economic winners and losers is modest, people of ordinary virtue might refrain from participating in activities they consider corrupt, might even be willing to “blow the whistle”, because the cost of doing so is outweighed by their preference for behaving well. But as outcome dispersion grows, absenting oneself from or even opposing activities that would be personally remunerative but socially undesirable becomes too costly. The required sacrifice eventually overcomes a ceteris paribus preference for virtue. Preventing the misbehavior of large coalitions is a collective action problem. An isolated malcontent or whistleblower is likely to be evicted from the coalition without meaningfully improving behavior, if others choose to “circle the wagon”. Outcome dispersion both increases the costs to individuals of engaging in pro-social behavior, and diminishes the likelihood that bearing those costs will be fruitful, since others will have strong incentives not to follow.

Wouldn’t it be odd to live in a country where, say, bankers individually acknowledge that their industry often behaves destructively, where insiders perceptively describe the conditions that create incentives for people to take bad risks or fleece “muppets“, but continue to work in those places and do nothing about it? Wouldn’t it be odd to live in a country where doctors privately apologize for the way their services are “priced“, but nevertheless take home their paychecks and pay AMA dues? Or in a country where economics instructors teach agency costs with case study of textbook pricing, during a course for which students were required to purchase a $180 textbook?

I don’t mean to criticize anyone in particular. (I used to be the economics instructor.) In all of these cases, there really isn’t anything any one individual can do to remedy the bad practices. Making a big issue of them would lead to useless excommunication. Instead we shrug ironically. In our society, an ironic attitude is a token of sophistication (a telling word, which once meant corruption but now implies competence). An ironic attitude towards collective ethics is adaptive. It helps basically decent individuals participate in coalitions that ruthlessly contend for rents. But perhaps we’d have a better society if, rather than turning our ethical discomfort into an object of aesthetic consideration, lots of us worked straightforwardly to remedy it. And perhaps more of us would do so if the risk of losing our place were not so terrible. Ethical behavior is endogenous. “Inequality” renders it costly.

Update History:

  • 29-Mar-2014, 6:00 p.m. PDT: Struck near duplicate: “…treatment, etc. GDP rises! In aggregate…”; “hodge-podge of public and private institutions payers

Followup: Pro-family, pro-children, anti-”marriage promotion”

Responding to the previous post, James Pethokoukis misreads the views of people like me. He writes:

Folks who agree with [Waldman's] view often advocate a hugely expanded government safety net — universal pre-K, one-year paid parental leave, a universal basic income among other programs — to do the work of transmitting social and intellectual capital that intact families no longer can.

Folks who are me do advocate for vastly expanded government benefits for families. I’d support universal pre-K, and I especially support a universal basic income. (Paid parental leave not so much, if the payer would be a prior employer.) But the purpose of these programs is not to “do the work…that intact families no longer can”. On the contrary, I support these programs because they would enable and assist the work that couples must do to stay together and in love and raise children well.

As I tried to emphasize in the previous piece (maybe the goat sex joke obscured it): There is no nonmarginal constituency in the United States advocating for alternatives to the two parent family as the core unit of childrearing. (Advocates of alternative forms of parenting by gay people might once have been an exception here, but the ascendancy of same-sex marriage has largely assimilated the gay community into the broad cultural norm.) While as a free society we should be open to alternative arrangements, my expectation is that in flourishing communities, traditional families will remain the norm. The quantitatively relevant challengers to the intact, two-parent household are divorced parents and single moms. Those households do not result from any decline in positive norms surrounding married life, though they may in part enabled by a relaxation of negative norms surrounding single parenthood and divorce. Americans do not, in large numbers, choose to become single or divorced parents when they have the option of raising children in loving, economically secure marriages. They become single parents because they want to be parents and the loving, economically secure marriage is not available. People who imagine that nefarious alternatives to married childrearing are being promoted and must be countered in the cultural sphere are simply misguided.

The effective way to support traditional families would be to increase the likelihood that a marriage chosen remains loving and economically secure. Matt Yglesias (who is much nicer than me) helpfully suggests this as a means of finding common ground:

[R]ather than being skeptical about this rhetoric [of marriage promotion], a more productive posture might be for liberals to see the family stability angle as a way of getting social conservatives more invested in helping poor people. The suite of things most likely to make for more stable working class families are basically better demand management, better schools, more wage subsidies, better transportation connections to jobs, and overall the kind of stuff that makes things better.

That’s a good idea! But promoting the social and material conditions in which people would likely form durable marriages is very different from nagging people for making poor choices that may not be poor choices, given circumstances on the ground. And it is very different from trying to narrow people’s options by bullying them into marriage with a return of shotgun weddings or restrictions on divorce. That would be the worst kind of cargo cult: One cannot conclude from correlations between voluntary unions and good outcomes that more-or-less coerced marriages would be awesome. But the coercion would carry obvious costs and risks, to people who aren’t pundits or think-tank fellows. Too often, marriage promotion is presented as a substitute rather than a complement to altering the material conditions that render people’s choices so difficult and outcomes so poor.

In a better world, social conservatives would have more confidence in the power of their own ideals. One doesn’t have to be cajoled or trapped into the good life. In the United States, people who have options — even irreligious urbanites with dissolute norms — freely choose marriage at high rates. Yes, Hollywood puts out a lot of prurient and violent movies. But the same industry produces scores of romantic comedies and sappy chick-flicks in which marriage epitomizes the happily-ever-after. Those films remain popular across all socioeconomic classes (if not across genders).

Even in social-conservative-nightmare-land, marriage-indifferent Scandinavia:

“Nowadays, it has become fashionable for the father to hand over the bride. This isn’t a Scandinavian custom, but is something that people have picked up from watching American TV programs,” according to Yvonne Hirdman, professor of history at Stockholms University. Another new imported trend is the practice of placing gifts on the table for guests at the wedding banquet. “That is another new custom that comes from America,” says Anna Lundgren, editor-in-chief of bridal magazine and internet site Bröllopsguiden.

Weddings are parties. They aren’t marriages. Nevertheless, the centrality of wedding fantasy in American cultural life reflects a powerful, durable aspiration. America really is exceptional in its attitude towards marriage.

There is every reason to believe that, if their options were better, many women who today become single moms would instead form traditional families. I know there is more to life and love than material wealth. But there is little more harmful to life and love than poverty and economic instability. Social conservatives are fond of pointing out that AFDC used to explicitly subsidize single motherhood, and that was obviously bad. (It was!) But present arrangements subsidize romantic cohabitation in preference to marriage in poorer, more precarious, communities. Household economies of scale turn into painful diseconomies when a partner neither brings in an income nor does much housework or childrearing. The option of kicking out an indigent partner is extremely valuable, especially for moms in communities where men are frequently out of work. Mothers are wise, not foolish, to retain that option. (The behavioral effects of being a male adult who brings nothing but a mouth to the dinner table ensure that exercise of this option will become emotionally justifiable, pretty fast.) Vigorous full employment, or a universal basic income, would eliminate the strong economic incentive for mothers to prefer cohabitation without commitment and make marriage rational where now it is not.

Conservatives often claim to have faith in America, in American exceptionalism. I wish they’d have a bit more faith in the institutions that they claim are valuable and in Americans who aren’t rich. Marriage “passes the market test” in America among people who could afford, in social and economic terms, to adopt more informal Scandinavian lifestyles. Rich liberals aren’t shamed, exhorted, counseled, bribed, or propagandized into marriage. They choose it. There are rational, remediable reasons why poorer Americans don’t make the same choice. I wish we would address those reasons rather than pretend the choices are mistakes or moral failures.

“Marriage promotion” is a destructive cargo cult

I think I’ll basically be repeating what Matt Yglesias said yesterday, but maybe I can put things more plainly.

“Marriage promotion” as a means of address social problems at the lower end of the socioeconomic ladder is a bad idea. It’s not a neutral idea, or a nice idea that probably won’t work. It’s inexcusably obtuse and may be outright destructive. It is quite literally a cargo cult.

A cargo cult is a particularly colorful way of mistaking cause for effect. Airplanes do not actually come to remote Pacific Islands because of rituals performed by soldiers at airports. But absent other information, to someone with no knowledge of the larger world, it might well look that way. So when the soldiers leave and the airplanes full of valuable stuff no longer come, it’s forgivable in its way that some islanders populated the abandoned tarmacs with wooden facsimile airplanes and tried to reenact the odd dances that used to precede the arrival of wonderful machines. It is forgivable, but it didn’t work. The actual causes of cargo service to remote Pacific Islands lay in hustle of industries vast oceans away and in the logistics of a bloody war, all of which were invisible to local spectators. Soldiers’ dances on the tarmac were an effect of the same causes, not an independent source of action. That is not to say those dances were irrelevant to the great bounty from the skies. An organized airport is part of the mechanism through which the deeper causes of cargo service have their effect, so something like those dances would always be correlated with cargo service. But even a perfectly equipped and organized airport will not cause airplanes sua sponte to deliver valuable goods to islanders. A mock facsimile even less so.

The case for marriage promotion begins with some perfectly real correlations. Across a variety of measures — household income, self-reported life satisfaction, childrearing outcomes — married couples seem to do better than pairs of singles (and much better than single parents), particularly in populations towards the lower end of the socioeconomic ladder. So it is natural to imagine that, if somehow poor people could be persuaded to marry more, they too would enjoy those improvements in household income, life satisfaction, and childrearing. Let them eat wedding cake!

But neither wedding cake nor the marriages they celebrate cause observed “marriage premia” any more than dances on tarmacs caused airplanes to land on Melanesian islands. In fact, for the most part, the evidence we have suggests that marriage is an effect of other things that facilitate good social outcomes rather than a cause on its own. In particular, for poor women, the availability of suitable mates is a binding constraint on marriage behavior. People in actually observed marriages do well because they are the lucky ones to find scarce good mates, not because marriage would be a good thing for everyone else too. Marrying badly, that is marriage followed by subsequent divorce, increases the poverty rate among poor women compared to never marrying at all. Married biological parents who stay together may be good for child rearing, but kids of mothers who marry anyone other than their biological father do no better than children of mothers who never marry at all. As McLanahan and Sigle-Rushton put it (from the abstract):

[U]nmarried mothers and their partners are vastly different from married parents when it comes to age, education, health status and behaviour, employment, and wage rates. These differences translate into important differences in earnings capacities, which, in turn, translate into differences in poverty. Even assuming the same family structure and labour supply, our estimates suggest that much of the difference in poverty outcomes by family structure can be attributed to factors other than marital status. Our results also suggest that full employment is essential to lifting poor families — married or otherwise — out of poverty.

Let’s stop with the litany of citations for a minute and just think like humans. Marriage is a big deal. The stylized fact that the great preponderance of grown-ups with kids who seem economically and socially successful are married is known to everybody, rich and poor, black and white. Yes, the traditional family is not uncontested. There are, in our culture, valorizations of single-parenthood as statements of feminist independence, valorizations of male liberty and libertinism, aspirational valorizations of nontraditional families by until-recently-excluded gay people, etc. But, despite the outsized role played by Kurt on Glee, these alternative visions are numerically marginal, and probably especially marginal among the poor. Single motherhood is the alternative family structure that matters from a social welfare (rather than culture-war) perspective. The problem marriage promotion could solve, if it could solve any problem at all, would be to increase the well-being of the people who currently become single mothers and of their children.

But why do single women choose to become single mothers? It does not, in any numerically significant way, seem to have much to do with purposeful rebellion against traditional family norms. No, marriage of poor women seems constrained by the availability of promising mates. And why might that be?

Charles Murray recently wrote a wonderful, terrible, book called “Coming Apart“. The book is wonderful, because it identifies and very sharply observes the core social problem of our time, the Great Segregation (sorry Tyler), or more accurately, the Great Secession of the rich from the rest, and especially from the poor. The book is terrible, because it then analyzes the problems of the poor as though they come from nowhere, as though phenomena Murray characterizes as declines in industriousness, religiosity, and devotion to marriage among the poor have nothing to do with the evacuation of the rich into dream enclaves. There are obvious connections that Murray doesn’t make because, I think, he simply doesn’t wish to make them. Let’s make some. We were talking about marriage.

Murray does a wonderful job of describing the homogamy of our socioeconomic elites. The people who, at marriageable age, seem poised to succeed economically and socially, tend to marry one another. Johnnie doesn’t marry the girl next door, who might have been a plumber’s daughter while Daddy was a bank manager. Johnnie doesn’t marry anyone at all he met in high school, but holds out for someone who got into the same sort of selective college he got into. The children of the rich marry children of the rich, with notable allowances made for children of the nonrich who have accumulated credentials that signal a high likelihood of present or future affluence. Of course, love knows no boundaries.

As a matter of simple arithmetic, increasing homogamy among the elite and successful implies a reduced probability that a person who cannot lay claim to that benighted group will be able to “marry up”, as it were. Once upon a time, in the halcyon days that Murray contrasts to the present, the courting would not have been so crass. There were many fewer markers of social class and future affluence. The best and brightest were not so institutionally, geographically, and culturally segregated from the rest. (That is, within the community of white Americans. For black Americans, all of this is old hat.) The risk of “mismarrying”, for a male, was not so great, as he would be the primary breadwinner anyway, and her family, while perhaps poorer than his own, was unlikely to be in desperate straits. Men could choose whom they liked, in a personal, sexual, and romantic sense without great cost. Women from poor-ish backgrounds had a decent chance at landing a solid breadwinner, if not the next President. Very much like an insurance pool, a large and mixed pool of potential spouses renders marriage on average a pretty good deal for everyone. Really bad future husbands existed then as now, and then as now women were wise to do all they could to avoid marrying them. But the quality of a marriage is never revealed until well after you are in it. In a middle-class society, it was reasonable for a woman to guess that a nice guy she could fall in love with would be able to be a good husband and father too.

Flash-forward to the present. We now live in a socially and economically stratified society. By the time we marry, we can ascertain with reasonable confidence what kind of job, income, neighborhood, and friends a potential mate is likely to come with. The stakes are much higher than they used to be. Our lifestyle norms are based on two-earner households, so men as well as women need to think hard about the earning prospects of potential mates. Increasing economic dispersion — inequality — means that it is quite possible that a potential mate’s family faces circumstances vastly more difficult than ones own, if one is near the top of the distribution. It is unfashionable to say this in individualistic America, but it is as true now as it was for Romeo and Juliette that a marriage binds not only two people, but two families. If you have a good marriage, you will love your spouse. If you love your spouse and then her uninsured mother is diagnosed with cancer, those medical bills will to some perhaps large degree become your liability. More prosaically, if the inlaws can’t keep the heat on, do you wash your hands of it and let them shiver through the winter? In a very unequal society, the costs and risks of “marrying down” are large.

As with an insurance pool, too much knowledge can poison the marriage pool, and reduce aggregate welfare by preventing distributive arrangements that everyone would rationally prefer in the absence of information, but which become the subject of conflict when information is known in advance. Because the stakes are now very high and the information very solid, good marriage prospects (in a crass socioeconomic sense) hold out for other good marriage prospects. The pool that’s left over, once all the people capable of signaling their membership in the socioeconomic elite have been “creamed” away, may often be, objectively, a bad one. Marriage has a fat lower tail. When you marry, you risk physical abuse, you risk appropriation of your wealth and income, you risk mistreatment of the children you hope someday to have, you risk the Sartre-ish hell of being bound eternally to someone whose company is intolerable. More commonly, you risk forming a household that is unable to get along reasonably in an economic sense, causing conflicts and crises and miseries even among well-intentioned and decent people. It is quite rational to demand a lot of evidence that a potential mate sits well above the fat left tail, but the ex ante uncertainty is always high. When the right-hand side of the desirability distribution is truncated away, marriage may simply be a bad risk.

If you are at all libertarian, what the behavior of the poor tells you is that it is a bad risk. After all, marriage is not subject to a Bryan-Caplan-esque critique of politics, where people make bad choices in the voting booth that they would not make in the supermarket because they don’t own the costs of a bad vote. The consequences of a decision to marry or not to marry or who to marry are internalized very deeply by the people who make them. Humans, rich and poor, have strong incentives to try to make those choices well. Both common sense, social science, and revealed preference suggest that marriage rates among the poor have declined because the value of the contingent claim upon the future represented by the words “I do” has also declined within the affected population.

Promoting marriage among this population is not merely ineffective. It is at best ineffective. If the marriage-promoters persuade people to marry despite circumstances that render it likely they will marry poorly, the do-gooders will have done outright harm. Pacific Islanders no doubt bore some cost to build their wooden planes, lashed to a mistaken theory of causality. But lives were not destroyed. Overcoming peoples’ well-founded misgivings about the quality of potential mates with moral exhortations and clipboards of superficial social science might well destroy lives. It would create plenty of success stories for marriage promoters, sure, because even bad bets turn out well now and again. But it would create more tragedies than successes, tragedies that very likely would be blamed on personal deficiencies of the unhappy couple while the successes would be victories for marriage itself in some insane ideological version of the fundamental attribution error.

Fortunately, people aren’t stupid, so marriage promotion is more likely to be ineffective than devastating. But why go there at all? There is some evidence, for example, that where prevailing social norms prohibit premarital fun stuff and push towards early marriage, people do marry earlier and they marry poorly. Social norms matter, and even smart people are sometimes guided by them to do stupid things. Let’s not reinforce foolish norms.

None of this is to say marriage is bad! On the contrary, despite my lefty hippie enthusiasm for transgressive goat sex and stuff, I think in the context of the actually existing society, the prevalence of durable marriages is a reflection of social health. Marriage is part of how we organize a good life when a good life is on offer, just like airports with people guiding planes on the tarmac are part of how Pacific Islanders might organize trade for valuable cargo. But before the odd dances on the tarmac must come the production of goods and services for trade, or at least some kind of arrangement with the people in faraway places who control the airplanes. Before you get to smiling families, you have to create the material circumstances that render marriage on average a good deal. For poor women in particular, it very often is no longer a good deal.

But what about the children? One variant of marriage-centric social theory refrains from pushing marriage so hard, and simply asks that people delay childrearing until the marriage comes. (See e.g. Reihan Salam for some discussion.) If a woman is likely to find a good spouse at a reasonable age, then it might make sense to suggest she delay childbearing until the happy couple is stable and married, since kids reared by married biological parents seem to do better than other kids. Even that is subject to a causality concern: Perhaps childrearing is best performed by the kind of mother capable of finding a good mate, and at a time some unobservable factor renders her both ready to raise a child well and likely to take a husband. This would create a spurious correlation between the presence of biological fathers and good kid outcomes. We can’t rule that out, sure. But we have no reason to think it’s so, and lots of common sense reasons to think a biological father in a stable marriage improves outcomes by contributing to better parenting. So, I’d agree that women likely to find great marriage partners should by all means delay children until they have actually found one.

But women likely to find great marriage partners already do exactly that. Single motherhood is not a frequent occurrence among women who expect to marry happily and soon. The relevant question is whether we should discourage from having children women who reasonably expect they may not find a good spouse at all, at least not while they are in their youth. That is to say, should we tell women who have been segregated into the bad marriage market, who on average have lowish incomes and unruly neighbors and live near bad schools, that motherhood is just not for them, probably ever? We could bring back norms of shame surrounding single motherhood, or create other kinds of incentives to reduce the nonadoption birth rate of people statistically likely to raise difficult kids. It is possible.

I think it would be monstrous. I believe that, as a society, we should commit ourselves to creating circumstances in which the fundamentally human experience of parenthood is available to all, not barred from those we’ve left behind on our way to good schools and walkable neighborhoods. Women unlikely to marry who wish to have children by all means should. The shame is ours, not theirs. It belongs to those of us who call ourselves “elite”, who are so proud of our “achievements” that we walk away without a care from the majority of our fellow citizens and fellow humans, from people who in other circumstances, even in the not so distant past, would have been our friends and coworkers, lovers and spouses. It’s on us to join together what we have put asunder.

Update History:

  • 23-Jan-2014, 12:55 p.m. EEST: “invisible to local spectators” Thanks Noumenon!
  • 24-Jan-2014, 2:25 a.m. EEST: “caused airplanes landing to land on Melanesian islands”, fixed misspelling of Reihan Salam’s name.
  • 24-Jan-2014, 11:35 a.m. EEST: “as though phenomena he Murray characterizes”

Tax price, not value

Property rights are primarily rights to exclude. If I “own” something, what that means is that it is legitimate for me to exclude others who may wish to use or consume it.

Exclusion, very obviously, carries externalities. My choice to exclude alternate uses of a resource affects those who might have benefited from those uses. By convention, we don’t usually refer to the effects of the exclusion at the core of a property right as an “externality”. One could argue, as is often argued of so-called “pecuniary externalities“, that the effect of property rights on alternative users is the sort of externality that should not be discouraged — because undoing the externality would amount to a mere redistribution rather than a welfare gain, or because the operation of the externality is part and parcel of the process by which the market system functions. But, as with pecuniary externalities, there are devils in details.

The social cost of the excluding alternative uses varies dramatically between resources. A Ferrari, for example, may be a costly and valuable resource, but it is plausible to claim that its owner’s exclusive control does not subject potential alternative users to real deprivation. On the other hand, the exclusive right to commercialize a potentially lifesaving medicine may impose huge costs on potential users deprived of access because a patent owner has chosen not to make a drug available where they live, or has chosen to set an inaccessible price. The new urbanists (Yglesias / Avent / Glaeser ) frequently argue that homeowners’ ability to exclude alternative uses of their neighborhoods (a kind of tacit property right) imposes very large social and economic costs by preventing higher-density alternative use of uniquely situated real estate.

I presume that most ordinary property rights don’t burden alternative users so much as to merit policy intervention. It is wise to simply tolerate very small externalities and address their consequences collectively, rather than create annoyances and transaction costs by trying to impose fine-grained discipline. We don’t tax humans for eating beans, despite the fact that methane is a powerful greenhouse gas.

But for some classes of property, most notably patents and real estate, a tax on the externalities of exclusion might be very sensible. You can frame it as a Pigouvian tax, or alternatively as a kind of user fee that compensates the state for its enforcement of a right to exclude despite external harms. But on what basis should such a tax be collected?

Usually property or wealth taxes are levied against the “market value” of an asset, with the scare quotes particularly appropriate. When property taxes are assessed against real property, some appraisal or estimation has to be made of what is often an entirely hypothetical value. Assessment procedures are vigorously contested and frequently reflect social and political concerns unrelated to the question of what a property “would” sell for. Patents are extraordinarily specialized and illiquid assets. Any bureaucratic value assessment would be a farce.

There is, of course, a much easier way to gauge what a property would sell for: Solicit from its owner a price.

The price at which an owner would be willing to sell a thing has a particularly valuable characteristic. It limits the burden to alternative users of the exclusion in a property right. If the price is set low, a user harmed by exclusion can simply purchase the thing and have at. If the price is set high, alternative users may be seriously burdened yet be unable to buy access.

So, for the sorts of exclusion that do impose substantial burdens to alternative users, a natural policy intervention would be to require property owners to declare a price at which they commit to sell the property (for some period of time), and levy a tax of some legislatively determined percentage against that actual, actionable price, rather than a hypothetical market value. Property owners could pay as much or as little tax as they choose. When they set their price, they face a trade-off, between the risk of being undercompensated for losing the asset if the price is too low, and an exaggerated tax burden if they set a price so high that the risk of sale is negligible or the required overcompensation extreme. The owner is free to choose how much she values certainty of continued ownership, but she must pay for that.

The price set by the property owner might constitute an option to buy for all comers, or just for the state. (I’m not sure which would be best. What do you think?)

This sounds very dry and complicated, but ultimately it’s a simple and natural scheme. Suppose that a drug company invents a cure for a rare tropical disease that could cure thousands in the developing world but only hundreds domestically. It might well be the case that the profit-maximizing commercialization strategy would be to make the drug available at a very high price domestically, but not sell it cheaply in poor countries, to prevent reimportation from cannibalizing sales. As long as the tax rate is material, the drug company would try to set its price no higher than the discounted value of domestic profits, less the discounted cost of the new tax. However, since the social value of the drug if the patent were not used to exclude is much higher than that market value of the profits, governments and nonprofits could pool funds to buyout the patent. In theory, this can happen already — governments and nonprofits could band together and negotiate with drug companies to buy out patents. But the coordination costs of that are very high, and once interest has been signalled the patent owner has every incentive to hold out for a price very near the drug’s social value, which is much higher than the market value it would otherwise have realized. A tax on enforcement of exclusion would force all patent holders to decide a value and precommit to a price without the negotiating advantage of knowing they have a captive buyer. Of course, if a company thinks a public-interest buyout is very likely, it might set its price high in hopes of earning a windfall gain from a sale. But there are limits to that strategy unless a swift buyout is certain. The cost in overpayment of taxes and the risk that a buyout won’t actually happen increases with the level at which the price is set.

Firms will set a dear price on patents with such high and unique social value that a prompt buyout is inevitable. But as long those patents are genuinely for new, nonobvious inventions — admittedly a weak point! — that’s arguably a feature, as the scheme creates incentives that don’t now exist for firms to develop goods with high social value but low market value. At present, there is no functioning market in public-interest sales of patents. Instead, firms understandably avoid high-social-value, low-market-value projects. Given the negotiating realities and political perceptions surrounding licensing or sale of patent rights to the public sector, the prospect of a high payout is offset by risks of outright expropriation and public relations catastrophes.

Urban property is another domain where the externalities associated with enforcing exclusive property rights are arguably very large. Suppose a developer or a city government believes that a neighborhood is horrifically underutilized, and wants to redevelop it at high density. Under this proposal, every parcel in the neighborhood would have a prearranged price. The developer (with or without a requirement of political buy-in) could plan to buy the lots she needs and those of near-neighbors with effective veto power, and then do with them what she will. As with patentholders, for most homeowners the best strategy would be to set the price at the actual value that would compensate them for the loss of the house and the trouble and heartache of eviction from their home (which might be a lot!), less the discounted cost of expected taxes. As with patents, some homeowners might strategically try to set very high prices in hopes of a windfall buyout, but again, that’s a costly and self-limiting strategy, unlikely succeed except in very rare cases where some parcel is so unique that alternative development plans that exclude it cannot compete. A real problem here is that this scheme would disadvantage property owners so cash poor they cannot afford any substantial taxation, who might set prices below what would actually compensate for the loss of property. But then these property owners have a hard time paying existing property taxes too. That devil would live in the detail of arranging the actual tax burden.

Just what should the tax rate on stated price be? Should it be a flat or progressive? I don’t know. Maybe some clever modeling can be done to try to elucidate the issues. Qualitatively things are pretty clear: the higher the tax rate, the more costly it will be to enjoy the rights of exclusion that come with property ownership. That’s already true with any sort of property tax. This new sort of property tax simply gives the owner the right to pay the tax in cash or in risk of being forced into a sale. A low tax rate, especially the status quo zero tax rate for patents, is very comfortable for property holders. It encourages people to set an infinite “sticker price” and so force potential buyers to reveal themselves as needful in bespoke negotiations. A high tax rate would be less comfortable. Owners would be forced to either pay up for the right to exclude or bear real risk that their property will be bought-out for a higher value use. In each domain — patents, real estate, whatever — legislators (or city councilpersons) would have to balance the social benefits associated with certain and inexpensively maintained property ownership, the social costs of excluding high-value alternative uses, and of course revenue requirements.

There are more radical, arguably better, solutions to problems created by socially costly exclusive use of real or intellectual property. But within the confines of incremental, neolibbish ideas, I think this one merits some consideration.


This proposal owes something to a recent conversation with Leigh Caldwell (@leighblue), the king of prices. The good ideas are his. The crappy ones are mine.

Update History:

  • 9-Jan-2014, 5:10 a.m. EST: Cleaned up a bunch of awkward sentences in this particularly awkwardly written piece. No substantive changes, but I didn’t track the small edits.

Not terrible.

Last week, I objected unquietly to what I thought and still think was a very poor column by Ezra Klein. However, Klein has followed that piece up with several more on the same subject. Although I doubt Klein worries all that much what I think, I feel honor bound to point out that his most recent columns, one at Bloomberg and another at his Wonkblog home, are decidedly not terrible. They are excellent.

Terrible.

On the bright side, I guess I couldn’t ask for a better example of the phenomenon I described in “Standards of Evidence” than this piece by Ezra Klein.

It’s terrible.

I have no idea whether inequality is the “defining challenge of our time”. That’s a meaningless trope. But Klein takes the phrase from a speech by President Obama and turns it into a question in order to knock inequality down a few pegs from the economic priority list. He does a very dishonest job of it.

Here’s the worst:

Economist Jared Bernstein has been worrying about inequality since way before worrying about inequality was cool. But in a careful paper released on the same day as Obama’s speech, Bernstein found that there wasn’t strong evidence for the idea that inequality is weakening demand — or for any of the other theories tying inequality to a weaker economy. There “is not enough concrete proof to lead objective observers to unequivocally conclude that inequality has held back growth,” Bernstein wrote.

That doesn’t mean inequality isn’t hurting growth. It just means it’s difficult to find firm proof of it. But if inequality really was the central challenge to growth, would proof really be so hard to come by?

Read Bernstein’s paper. Klein is misrepresenting Bernstein’s views. An intelligent reader would interpret Klein as saying that Bernstein looked for evidence, failed to find it, and concluded it just wasn’t there. In fact, Bernstein reviews the research and finds lots of suggestive connections between inequality and growth. The unfortunate bit that Klein quotes reflects a kind of handwringing on Bernstein’s part — no, the research is not incontrovertible, there are a lot of “moving parts”, the research is young. Bernstein offers a cautious invitation to take seriously evidence of connections between inequality and growth. Klein pulls the caution out of context and misuses it as an excuse to dismiss those connections.

[And "worrying about inequality since way before worrying about inequality was cool"? Excuse me? Way to conflate concern over an ongoing social catastrophe, and a genuine vocation on Bernstein's part, with the latest thing to go viral on Buzzworthy. Not all of us are paid by the click.]

There is no such thing as “the central challenge to growth”. Proof is impossible to come by with respect to all macroeconomic controversies. Klein vapidly handwrings that, “Growth simply isn’t producing enough jobs” without meaningfully addressing the question of how to achieve growth, or addressing the arguments that Bernstein carefully catalogs for why a broader distribution might be growth-supportive. When Klein writes “fixing [unemployment] is necessary, though not sufficient, to making real headway against inequality”, he is making an empirical assertion without evidence, and probably getting causality backwards. We might well move towards economic arrangements in which wages become less central to the income of the middle class, just as labor income is only one of multiple income sources for the wealthy. Broadening the distribution of income may well be prerequisite to full employment going forward, as jobs that cannot be automated or outsourced are largely in personal services, and mass employment in personal services requires a mass of customers with disposable income.

There is little tension between addressing inequality and pursuing the other goals Klein says we should focus on. Klein sets up a straw man when he argues

A world in which inequality is the top concern is a world in which raising taxes on the rich is perhaps the most important policy choice the government can make. A world in which growth and unemployment are top concerns are worlds in which very different policies — from stimulus spending to permitting more inflation — might be the top priorities.

One could make the world more equal just by burning everything down too! But no one advocates this. So obviously inequality doesn’t matter, right?

People concerned with inequality in fact argue not to tear down the rich but to raise up the rest — at the expense of the rich to the degree that is necessary, but not just because. We argue for policies like basic income, wage subsidies, and, yes, more inflation-tolerant macro policy and more fiscal stimulus where those policies help support the poor and middle. A focus on inequality sometimes does create wedges between us and other “progressives”. We might not be so excited, for example, by a fiscal policy that is “expansionary” by virtue of a deficit accounted for in large part by tax expenditures to the rich. We might celebrate less than a Democratic party that treats inflation in the price of real estate and financial assets as unambiguously good news.

A policy apparatus for which inequality is not a “top concern” might content itself with spurring demand by protecting and increasing the wealth of the politically-connected rich, on the theory that anyone’s misfortune hurts at the margin and providing support to the non-rich is politically impossible. But that’s, like, totally science fiction, right?

Update History:

  • 13-Dec-2013, 8:45 p.m. PST: Added context that the phrase “defining challenge of our time” comes from President Obama’s speech, and reworked that sentence. (Rereading, the beginning of the piece was incomprehensible to people who didn’t click through to Klein’s piece.)

Standards of evidence

In a broadly excellent discussion of theories relating inequality and growth, Jared Bernstein writes:

all of this research is relatively new, and while it makes suggestive connections, there is not enough concrete proof to lead objective observers to unequivocally conclude that inequality has held back growth.

Bernstein absolutely right, of course. But really? “concrete proof to lead objective observers to unequivocally conclude” Is that a remotely meaningful standard of evidence for, well, anything?

People on the political right, including many respected economists, make strong claims that ceteris paribus taxation is bad for growth. They certainly have plausible models in which it would be. But as an empirical matter, the fair thing to write would be there is not enough concrete proof to lead objective observers to unequivocally conclude that taxation has held back growth. The evidence is very conflictatory! To steal Bernstein’s apt metaphor, there are a lot of moving parts! It is in fact almost certainly false to claim that taxation is always and everywhere bad for growth, and almost certainly true that there are circumstances under which it has been and would be good. If you are behaving as a scientist, it’s kind of a shitty, stupid question, “how does XXX affect growth?” How does molybdenum affect life? They are related! But if you start running regressions of liveliness against concentrations of molybdenum, you won’t get very far. If you want to study the relationship between molybdenum and life, or XXX and growth, for any XXX, you’ll have to characterize mechanisms and offer detailed, contingent accounts. You won’t find simple, black box relationships.

But we are not always, or even usually, behaving as scientists. The Tax Foundation will tell you right off that taxes are bad for growth, much worse than spending cuts. Studies prove it, and if you disagree you are simply wrong. Steve Roth aptly wonders why so few voices among “respectable progressives” are willing to even give fair consideration to the case that inequality might be an impediment to growth. I think he has a point. This isn’t a general phenomenon. It’s not like “liberals are cautious scientists, while conservatives run roughshod over the truth”. Progressive economists are willing to assert, in the same stentorian, authority-of-science voice as the Tax Foundation people, that fiscal multipliers are real or that evidence against expansionary austerity is incontrovertible. But on connections between inequality and the macroeconomy, it feels like respectable progressives are always looking for an excuse to say there’s no there there. People who are usually very smart make very thin arguments that are frankly beneath them to cast doubt on the relationship.

Now let’s be perfectly clear: there is no reliable quantitative relationship between inequality and growth, just as there is no reliable quantitative relationship between taxation and growth, between government spending and growth, monetary policy and growth, or pretty much anything else and growth. There are studies, which pare and tease their panels in ways they justify on some grounds or other, and those studies yield conclusions. You can buy the assumptions, methodologies, and mechanisms implicit in those parsings or not, it’s your choice. But you won’t find a clear, incontrovertible relationship between any simple thing and developed world, per-capita growth. It’s too complicated a phenomenon. You have to buy someone’s stories, and interpret the numbers through those stories, to claim the evidence is strong.

But that doesn’t mean there is nothing at all that we can say about inequality and the macroeconomy. We can, for example, say that marginal propensity to consume effects are real. The intellectual history of MPC goes something like this:

  1. There is and has always been an obvious, intuitive, and robust stylized fact that people with higher incomes save greater fractions of their incomes than people with lower incomes. In the post-Great-Depression intellectual climate, which was acutely sensitive to the dangers of demand shortfalls, this suggested, uncomfortably to some, that inequality could be a macroeconomic hazard.

  2. Milton Friedman pointed out that differing marginal propensities to consume observed in the data might have nothing at all to do with inequality. If people try to smooth consumption over time, then in a stochastically equal society (one in which everyone’s expected incomes are the same, but each individual is subject to random fluctuations in any period), we would observe that individuals who happen to have unusually high incomes in one period save a lot, to cover the periods where they will have unusually low incomes. Friedman’s elegant Permanent Income Hypothesis suggested people just spend a constant fraction of their lifetime incomes in every period, so (under perfect information about that “permanent” income) each individual’s spending would be constant and apparently different marginal propensities to consume would be due solely to fluctuations in income, with no actual changes in spending.

  3. For reasons that would be baffling, if I weren’t so cynical about the economics profession, the Permanent Income Hypothesis was generally accepted as sufficient explanation of observed MPC effects in cross-sectional data, and the issue was considered closed. You were naive and ill-informed if you thought MPC effects in the data had anything to do with inequality. They had been explained.

Of course, you had to be an idiot to believe that the Permanent Income Hypothesis fully accounted for MPC effects. Undoubtedly consumption smoothing explains a part of cross-sectional variation in marginal propensities to consume, but you don’t need careful empirics to prove that it can’t explain all of them. Why not? Because not consuming leaves a residue, something called savings, which becomes wealth. If across the income spectrum everyone spent and saved in equivalent proportions, we’d expect no cross-sectional variation in terminal wealth as a proportion of lifetime income. But in real life, much of the bottom of the income distribution dies with zero or negative wealth (i.e. they stiff their creditors), while those near the top of the distribution leave large bequests. An intergenerational Permanent Income Hypothesis could only explain this if poorer people expect their kids to be much wealthier then the children of moguls. Which is not so plausible.

If things that are obvious don’t persuade you, if something has to have tables in the back and be peer-reviewed to qualify as “rigorous”, you are a very severely deluded human. Nevertheless, a few courageous researchers have done the work of examining in numerical detail whether the Permanent Income Hypothesis is sufficient to account for variations in spending, and the answer is always no. I’ve cited ‘em before, I’ll cite ‘em again: “Why do the rich save so much?” by Christopher Carroll; “Do the Rich Save More?”, by Karen Dynan, Jonathan Skinner, and Stephen Zeldes. I’m sure if MPC makes a comeback in macroeconomic conversations, someone prestigious will find some way to parse the data differently and explain it all away again. That researcher will surely die rich.

OK. So inequality-related MPC effects are real. But what to they have to do with growth? Nothing at all, in an unconditional sense. I’ll go further than Bernstein. It’s worse than “there is not enough concrete proof to lead objective observers to unequivocally conclude that inequality has held back growth.” There’s little reason at all to think that inequality has held back growth, in the past tense, through an MPC channel. Why not? Because we didn’t observe in the past anything that looked like an intractable insufficiency of aggregate demand! Past-tense, we reconciled inequality with growth. MPC effects suggest that one way to generate more demand would be to broaden the distribution of income. They do not imply that broadening the distribution of income is the only way. The macroeconomic footprint of increasing inequality lies not in growth, but in the interest rates and financial chicanery that were necessary to support that growth. Call it the monetary offset.

Prior to 2008, we found means of supporting aggregate demand despite an almost certain drag imposed by increasing inequality. Those means included a broad mix that included fiscal policy (we ran deficits), unsustainable equity booms, the “democratization of credit” and unsustainable credit booms, and of course straightforward monetary policy. Real interest rates have collapsed since the early 1980s. The reason we might talk about inequality is not because it is mechanically, unconditionally, here-is-the-regression-now-STFU connected with growth. It’s because many of us have decided that other, more “conventional”, demand stimulants have run their course, that repeating them or increasing the dose won’t work, or would have adverse side effects we’d prefer to avoid.

We have a large menu of ways we can try to support demand. We can go the Scott Sumner route, double down on monetary policy. We could do big, old-style fiscal stimulus, have the government give money to those who lobby best without worrying about fairness or income distribution. We could embrace inefficient health care provision and build more university rec centers. We could have the financial sector figure something out again, some means of enabling those who otherwise wouldn’t be able spend to do so. We can find ways of persuading rich people to spend more. We can import demand from elsewhere, like China and Germany. We can try electronic money and negative interest rates. We are, as they say, free to choose.

But the reality of MPC effects means that, along with all those other possibilities, broadening the distribution of income would be expansionary and narrowing that distribution would be contractionary, ceteris paribus. If, like Larry Summers, it pains you that maybe the “natural interest rate” is negative now, the reality of MPC effects means that policy which broadens the distribution of income would help push it positive, and put us back into more comfortable territory. If, like me and Pope Francis, you think that present levels of inequality are horrific for human and communitarian reasons, then among the many macro policies that might support demand, it is rational to tilt towards those more likely to engender a broad distribution. It is quite irrational, as I think some well-meaning economists do, to hold MPC effects to much higher standards of evidence than the mechanisms that justify other interventions, because “economics is not a morality play” and reducing inequality would be the moral thing. Better to err on the side of human welfare rather than reputational purity.

I happen to think that the macroeconomic case for reducing inequality is much stronger than the case I’ve made here. I think the character of growth is badly misshapen when demand is narrowly sourced, that technological stagnation is mostly a distributional problem, that institutional correlates of growth are harmed by increasing inequality. But those are all more speculative claims. You can tell me the “jury is still out” on those. But the jury is not out, it never reasonably has been out, on the reality of distribution-related MPC effects. I’ll disagree, respectfully, if you claim that for supply-side or libertarian reasons we should ignore that reality and prefer other means of supporting demand (or that we should not worry about supporting demand at all). But don’t say “it’s unclear” whether income distribution affects aggregate demand, holding other factors constant. Of course it does.

Why (and when) interest-on-reserves matters…

Paul Krugman writes:

Incidentally, small nerdy note. Some people argue that the concept of the monetary base has lost its relevance now that the Fed pays (trivial) interest on reserves. I disagree. Reserves and currency are fungible: banks can turn one into the other at will. But the total of reserves and currency is fixed by the Fed — nobody else can create either. That, as I see it, makes them a relevant aggregate — and anyone who believes that all those reserves are sitting idle because of that 25 basis point reward is (a) silly (b) ignorant of Japan’s experience, where the BOJ sharply increased the monetary base without paying interest on reserves, and what happened looked exactly like our own later experience.

Nerdy indeed! Some might even describe it as dork-ish.

But I think that Krugman is mischaracterizing the view he is arguing with. I’m not sure he would even argue with the view properly characterized. Of course he might!

Perhaps there are people in the world who think that paying 25 basis points of interest on reserves means that base money doesn’t matter, but I have not met any of them. I certainly agree with Krugman that those 25 basis points have a pretty negligible macroeconomic effect now.

The view of people who think that interest-on-reserves permanently diminishes the macroeconomic meaning of base money is contingent on a conjecture that, henceforth, the Fed will always pay interest-on-reserves at a rate comparable to the rate paid by short-term US Treasury securities. If that conjecture is false, then the quantity base money will someday matter again.

In either case, the quantity of base money that exists right now is largely meaningless , and would be meaningless if the Fed were not paying any interest on reserves, because Treasury rates are near zero. This is Krugman’s liquidity trap, an effect of the negative unnatural rate of interest.

The quantity of base money is meaningless right now even if I am wrong about the Fed henceforth always paying interest on reserves at the short-term Treasury rate. Because if I am wrong, the only way that the Fed can create a spread between the interest rate paid on base money (whether zero or something higher) and the Treasury rate is to dramatically reduce the quantity of base money, so that some convenience yield on holding scarce base money offsets the opportunity cost implied by a T-bill / base money spread. Current quantities of base money simply can’t coexist with with a spread between the interest paid on reserves and the interest paid on Treasury bills. (Unless some unexpected thing dramatically increases the convenience yield of holding base money!).

So, there is almost no direct informational value to the current quantity of base money. Perhaps there is indirect information that matters. It could well be that the rate of change of the quantity of base money contains information about the likelihood of future interest rate changes, so it is not irrational of market participants to respond to rumors of tapering or moar QE. Perhaps there are institutional quirks related to the fact market participants can only hold interest-paying base money indirectly via banks, while the stock of risk-free securities depleted by monetary expansion can be held (and hypothecated) by non-bank actors. (If so, “monetary expansion” might be contractionary!)

But the first-order effect of monetary policy is gone. Changes in the base used to engender straightforward imbalances between a direct opportunity cost and the convenience yield of holding money. A reduction of interest rates / expansion of the monetary base would lead to an increase in the direct cost of holding money rather than Treasuries, and put the economy in disequilibrium until NGDP or (too frequently) asset prices adjusted to increase the convenience yield attached to the monetary base. A contraction did the reverse. While we are stuck at zero we can argue over expectations or collateral chains, but the old, blunt, simple channel no longer functions.

And it will never function, as long as the Fed always pays interest comparable to Treasuries on base money. There is nothing special about zero, or 25 bps. What makes a liquidity trap is that the rate of interest paid on money is greater than or comparable to the rate of interest paid on Treasury bonds. So long as that is true, whatever the level of interest rates of interest, macroeconomic outcomes will be much less sensitive to changes in the quantity of money than in once-ordinary times. That is not to say, full-stop, that monetary policy is impotent. Those squishy expectations and institutional quirks may matter. But post-2008, we live in a world where insufficiently expansionary monetary policy has meant tripling the monetary base. Pre-2008, tiny changes in the quantity of base were sufficient to halt an expansion or risk an inflation. The relative impotence of changes in the monetary base is not a function of the zero-lower-bound. It is a function of the spread between base money and risk-free debt, a spread which may well be gone forever.

A conspiracy theory of the debt ceiling

So, my working hypothesis is that, should the debt ceiling actually bind, the US Treasury will prioritize payment on formal debt securities and then institute some form of delayed payments on the rest of its obligations. Like the vaunted small business struggling to make payroll, it will borrow funds from suppliers and other creditors by stretching accounts payable. If I’m wrong about that, everything that follows will be wrong.

This is my second post trying to think through the consequences of such a regime. In the first, I pointed out that claims to future delayed payments would be securitized, and that prices of those securities would be informative, they would constitute a kind of back-door approximation of an NGDP futures market, which, as Scott Sumner has persuasively argued, would be a useful thing to have around.

That was an optimistic take on delayed payments. But there is a flip-side of the missing platinum coin that is a bit darker. If Treasury delays payments, what will not happen is a simple withdrawal of missing government expenditures from the economy. (It really is important to think about banks!) One of the oldest and most basic functions of a bank is to discount accounts receivable, to advance funds today against credible obligations of third parties to pay in the near future. Originally this was a service offered to business clients. Today, the same principle underlies credit lines offered to individuals, including direct-deposit, payday, “structured settlement”, and tax-refund loans.

If the government starts delaying payments, banks will be able to fill in the gap, quickly and profitably. Advances against government obligations would require no meaningful credit analysis. As they would be secured by obligations of the Treasury, they would have little or no cost in terms of regulatory capital. The banking system faces no meaningful reserve constraint. Nothing whatsoever would prevent the banks from simply lending “from thin air” payments that the US government is withholding.

The first hit might even be free! (ht Brad Plumer) But this service won’t be free over an indefinite long-term. Large business customers might pay the few basic points implied by a loan against government security for a few months time. But individual marks customers will undoubtedly be charged “convenience fees” for the service of drawing advances on government payments that render the overall cost of the loans, when annualized, very high. We will, of course, be treated to the usually litany of justifications for exorbitant short-term loan costs: You don’t annualize hotel rates and compare them with apartment rents! Dealing with stinky, not-rich people is expensive! But in the end, this would be a nice line of business, which would multiply over time if delayed payments become the new normal for debt-ceiling-constrained government borrowing.

A delayed payments regime would amount to a regressive tax issued at two levels: first by the Federal government, and then by the financial industry. By delaying payments, the Federal government would tax recipients of government disbursements by forcing them to finance loans to the Treasury for free. Like all taxes, the actual incidence would be more complicated than the direct hit. Payees with bargaining power — say vendors of bespoke military systems or well-connected contractors — would find ways to add the finance cost to their bills, and largely escape the tax. Payees without bargaining power — your average social security recipient, for example — would have to simply accept the delayed payment and eat the interest cost that the government should be paying. A second regressive “tax” would be imposed by financial service providers. They would, as usual, compete to offer cost-efficient products to wealthier and more astute customers, while charging smaller, weaker, more desperate customers large fees. In the end, the Federal deficit would be reduced and bank profits would swell, primarily on the backs of the least-savvy, lowest-bargaining-power government payees.

A common narrative about the debt ceiling is basically a Frankenstein story: businesspeople funded these Tea Party crazies, and now despite pulling all their levers, they just can’t control the monster they have created. And maybe that’s right.

But suppose, plausibly, that the Jamie Dimons of the world know what Treasury has assiduously ensured the rest of us do not, which is exactly what Treasury is capable of and planning to do when George Washington bumps his head. And suppose it is debt prioritization plus delayed payments. Is it too much to wonder whether some quarters of the business community — you know, the ones who own the place — may not be pushing quite as hard as they pretend to raise or eliminate the debt ceiling?

I hope that it is too much to wonder. I hope it is evidence only of my own paranoia that I do wonder.

Update History:

  • 15-Sept-2013, 10:15 p.m. PDT: Added link to mathbabe post at “exorbitant short-term loan costs”.