Ten years after

I don’t know whether it is of note even to me, but today interfluidity is ten years old.

Here is the inauspicious first post. Thank you all for coming by, for reading, for putting up with me all these years.

So I’ll leave it up to you. If you live in one of those states, please vote today.

Policy as Mock UN

Ezra Klein offers a response to my previous post, and there’s a lot that’s good it in. I appreciate Klein’s characteristic effort to provide a nuanced and balanced take. Nevertheless, I can’t say that I am persuaded.

Before going into the substance of Klein’s piece, I want to clarify that my prior post was not a response to the controversy that has arisen following a letter from four former CEA chairs about Gerald Friedman’s projections of the effects of Sanders’ proposals. My piece was written last Monday, the CEA letter was published Wednesday, I promise you I have no moles on Mount Olympus. I do have an opinion about the “kerfuffle” provoked by that letter, and maybe I’ll express it in a future post. (Or maybe not.) But my post on theories of politics was not addressed to that controversy.

Anyway. Klein and I agree, I think, that “in a democratic polity, wonks are the help”. Elections are where voters set the interests and values in service of which wonks’ technical expertise will later be deployed. But Klein is quite correct to point out that we don’t elect disembodied interests and values, we elect people, and the competence of those people along myriad dimensions will determine whether they are capable of translating the interests and values they represent into meaningful social outcomes. I agree with Klein that voters are called upon to evaluate not candidates’ competence, but their competences, to trade off weaknesses against strengths, and sometimes to trade off evaluations of competence against their preferences with respect to interests and values.

As Klein very aptly puts it, “debating the details of campaign proposals is, on some level, fantasy football for wonks.” But, he argues

Watching a candidate run his campaign’s policy processes is one of our best ways of predicting how he would run his White House.

The key word there, by the way, is run. Some of the most important decisions the president makes are about how to run the processes that translate vision into policy. Those decisions include whom to hire, which advisers to listen to, which ideas make sense, which strategies are likely to work. The presidency is one damn decision like that after another. Obama, famously, is so exhausted by the decision fatigue of the job that he wears the same color suit every day so he has one less thing to decide in the morning.

This is one way in which campaigns give us insight into presidencies. Presidential candidates also have to decide whom to hire, which advisers to listen to, which ideas are truly good ones, which strategies are likely to work. To make those decisions well, they need a sound philosophy, yes, but they also need to want to hear good advice, they need to want advisers who will tell them when they’re wrong, they need to have good instincts for when something they want to believe is true simply isn’t, and they need to be realistic about the strategies that are likely to work and the ones that aren’t.

A White House has to be run, for sure, and Klein is eloquent and correct on the work and care that entails. But I don’t think a campaign’s policy processes tells us anything much about that. Presidential campaigns are not presidencies. The goals, incentives, and constraints are entirely different. The “policy process” of a campaign begins first and foremost with the work of a campaign, which is to signal the interests and values of the candidate. Policy details are, for the most part, elaborated reactively, as competing candidates try to work out inconsistencies between opponents’ broad policy visions and the interests and values of the electorate they are vying to win over. Policy details are also elaborated to signal competence and to concretize interests. Detailed white papers are more than most voters are willing to work through, but their existence, especially if certified by trusted experts, may persuade voters of a candidate’s competence. One way to appeal to voters’ interests is to be able to make claims like “the typical American family will save $5200 per year if my policy is enacted”, but making that sort of claim without some pretense at a projection opens candidates to attacks on character and competence. Candidates face tradeoffs between the benefits of making speculative or ambitious claims and potential costs in perceived credibility. They also face tradeoffs between perceived benefits of making promises and the constraints those promises may impose on their future choices or credibility should they be elected. These are the factors shape the policy details they come to offer.

Certainly presidents have to sell policies to legislators, so you might argue that the sales job that is an election may not be not entirely alien to the process of governing. Mostly that’s wrong. What gets legislated is a function of constraints imposed by the legislature, and the interests that shape those constraints are very different from those of the open electorate. President Obama signaled in a State of the Union address his strong support for Universal Pre-K, as Hillary Clinton or Bernie Sanders probably both would in the context of this election. Universal Pre-K is good policy on the merits, and is popular with the public, but President Obama has made no effort whatsoever to transform his call into legislation. The skill that a President requires to get policy enacted is the ability, somehow, to get the constraints of the legislature and her own policy agenda aligned. That can be done Lyndon-Johnson-style, by backroom armtwisting; it can be done per Coase’s Theorem, with various kinds of side payments; it can be done as the prior Clinton administration did with welfare reform, by letting the administration’s agenda shift to become more hospitable to the constraints of the legislature; it can be done by creating outside threats, in terms of adverse public opinion and potential electoral risk, as Bernie Sanders proposes to do with his “political revolution”.

One certainly can draw connections between skills on display during an election and skills that will eventually be required to get policy enacted. It is not unreasonable to suggest that Hillary Clinton’s locking up of endorsements by political insiders at all levels might indicate real skill in Johnsonian arm-twisting and Coasean bargaining that will help her “get things done”. It is also not unreasonable to argue that Bernie Sanders’ remarkable success at organizing a grassroots donor and volunteer base and his clear intent (unlike President Obama) to ask those grassroots to engage publicly in conflict with political opponents, suggests a competence at creating electoral risk. Voters can and should consider these competing competencies, along with their adjudications of values and interests. But these competencies have little to do with the quality of the campaigns’ policy white papers. For the most part, wonk-quality is not a useful differentiator of presidential candidates.

Let’s look at an example. As Klein notes

There are plenty of criticisms to be made of Obama’s presidency, but I think the baseline competence of his administration has begun to dim memories of how important presidential management really is.

My own view of the Obama administration is mixed, but I am happy to second Klein here. I think the administration takes its policy process seriously, and generally does fine work along dimensions of technical competence. That doesn’t mean I endorse all of its work, or that the administration’s technical work is apolitical. It is not. All policy is ideological. Technical work carries ideology with it in how things are framed, what is assumed, and what is considered. Still, within the boundaries the Obama administration has chosen to define, its technical work is high quality.

But as Klein reminds us, eight years ago, on the core wonk controversy of 2008, Barack Obama took a position of astonishing technical incompetence. You can accuse Bernie Sanders’ campaign of touting optimistically shaded estimates or underplaying some costs, but his proposals are fundamentally sound in wonkish terms. Single-payer healthcare does work, and would eventually reduce costs, but the politics of getting there may be impossible, or we might have to tolerate a long transition period during which costs remain high to appease incumbents. What Barack Obama proposed in 2008 — universally accessible health care through individually purchased insurance without an individual mandate — was sheer absurdity. As Paul Krugman has reminded us many times, the Obamacare approach to universal insurance is a three-legged stool: guaranteed-issue leads to a death spiral without an individual mandate, and an individual mandate is unaffordable without subsidies, community rating + mandate + subsidies. (See also Ezra Klein.) If you think policy details during a campaign are the best predictor of the policy process of an administration, you would have expected very little of Barack Obama’s tenure. And you would have been wrong. I suspect that even at the time, Klein was not terrified that Obama would become his caricature of Jimmy Carter as a man whose good values were eclipsed by bad management. Obama signaled competence in ways that Klein could recognize, despite the fact that he took a ridiculous position on the core technocratic issue of the campaign in order to be more appealing to voters.

What I really think is going on is that humans, proles and elites both, have a wide variety of largely unconscious ways of reading candidates. Wonkishly inclined people don’t see themselves reflected in Bernie Sanders, as they did in Barack Obama and do in Hillary Clinton. For them like everyone else, that leads to skepticism and mistrust. But wonkishly inclined people tend not to leave it there. They are verbal, they regard themselves as rational, and so they rationalize. But Klein’s rationalization is, I think, not ultimately supportable. Neither the wonkishness of the candidate nor the quality of campaign white papers is a predictor of the success of a presidential administration. As Klein points out, George H. W. Bush was no wonk, but he was a good manager and in retrospect a decent president. From the perspective his supporters, Ronald Reagan was a phenomenally successful president, but he was no wonk, and I suspect his campaign white papers weren’t anything special either. Johnson, JFK, FDR, admittedly, the farther back we go, the harder it is to “measure” analogues of the contemporary wonk. But I don’t think you’ll find sustainable a theory of campaign policy details as a reliable predictor of actual policy competence. I think wonks, like other humans, have a tendency to see what they want to see, and to reach for theories that flatter their own views and that elevate their own role in the democratic process.

Your theory of politics is wrong

I support Bernie Sanders in the Democratic primary. I don’t support Sanders because I think he is brilliant in some academic way. I don’t support Sanders because I am particularly impressed with the details of his policy proposals, although they are not nearly as hopeless as some self-proclaimed technocrats make them out to be. A democracy is not a graduate seminar.

It is not that I am for Bernie Sanders, but that Bernie Sanders is for me. Bernie Sanders, more than any politician who has ever had a serious shot at the office of United States President, represents my interests and values. By that I don’t mean my interests in a narrow, self-interested sense, but in his vision for what kind of country my country can and should be.

A democratic polity does not elect a technocrat-in-chief, but politicians whose role is to define priorities that must later be translated into well-crafted policy details. Paul Ryan’s various budgets haven’t been wrong because they require giant magic asterices to make the numbers add up. They have been wrong because the interests and values Paul Ryan represents are wrong. The magic asterices don’t reflect dumb mistakes, but smart politics. The problems of our polity do not arise because one faction or another is too stupid to do high quality science. If your interests are the interests of the fossil fuel industry, and you are unwilling or unable to transcend the narrowness of those interests, then confusing the public about the science of climate change is a mark of intelligence, not stupidity. Being smart is great. You may be proud of your GRE scores, your PhD, your Nobel Prize even. And deservedly! But raw intellect is not scarce, and no faction holds anywhere near a monopoly.

In a democratic polity, wonks are the help. The role of the democratic process is to adjudicate interests and values. Wonks get a vote just like everyone else, but expertise on technocratic matters ought not translate to any deference on interests and values. If your theory of democracy is that informed citizens ought to cast votes based on the best social science, you have no theory of democracy at all. If you are honest, you will follow your own theory where it leads, as Bryan Caplan has, and work to limit democracy. But Caplan, whom I love, is mistaken, because he begins with a mistaken theory of politics. If you want to see how that theory of politics works in the real world, look no farther than the European Union, which is a real-time experiment in demoting democratic adjudication of values in favor of technocratic adjudication of facts. I know, you don’t agree with their science. Their economists haven’t died quickly enough to realize that a decades-old consensus has been discredited. Technocracy, like communism, like capitalism, has never been tried. Elevating technocracy above democracy is similar to, and as insidious as, letting military power escape civilian control. The problem with life under military rule is not that the army lacks patriotism, or that it doesn’t mean well. But the interests of the military are not the interests of the polity, and we invented democracy because human beings have a tendency to confuse their own interests with the public’s. The interests of the class of humans who might reasonably qualify as technocrats are also not the interests of the polity.

So, I am for Bernie. I am not against Hillary. But just as it’s foolish to say that Democrats and Republicans are “all the same” because they are both corporatist parties, it is foolish to claim that Bernie and Hillary do not represent meaningfully different interests and values. I’ll enthusiastically support either Bernie or Hillary over a Jeb Bush, Marco Rubio, Ted Cruz, or Donald Trump. But it is Bernie Sanders who is for me, and I’m supporting him without apology. If your interests and values are my interests and values, I hope that you do too.

Update History:

  • 16-Feb-2016, 1:00 a.m. PST: “which is a real-time experiment”

Quasiprogressivity

The word “progressive” is used in all kinds of ways. I’m not interested in the term as a label of people. I won’t even self-identify as “a progressive” (or almost any other thing), even though I often find myself making common cause with people who do. I’ll leave arguments about who is a progressive to others.

One frequent use of the term “progressive” is to refer to the distributional effects of an arrangement or policy. The income tax is “progressive” because it takes more (in absolute terms and in percentage terms) from high earners, thus reducing after-tax income inequality. A carbon tax, it is often claimed, would be regressive, because the poor spend a high fraction of their incomes on heating and transportation than the well-off, who therefore pay less (in percentage terms), accentuating after-tax income inequality.

It is easy to forget, in these kinds of conversations, that “progressivity” is not scalar. Policies cannot be ordered by their progressivity, because most nontrivial policies make different groups of people better off and worse off in ways that don’t monotonically map across the income distribution.

Let’s look at a few charts to make this clear. In all of our hypersimplified drawings, the x-axis will define three groups, which we’ll call “poor”, “middle”, and “rich”. For our purposes, it matters not at all whether we are talking about income, wealth, health, or ponies. There is some good thing and two alternative arrangements. We can think of one arrangement as the status quo and another one as a proposed new policy. Or we can think of both arrangements as hypotheticals we are considering and comparing.

Let’s first look at an example under which one alternative is plainly more progressive than the other:

ProgressiveChange

Arrangement B is plainly more progressive than Arrangement A. The distribution of, um, ponies is more equal across the distribution. Both the rich and the poor are brought towards the middle.

However, suppose we are evaluating the following two policies for their relative “progressivity”:

ScrewThePoorChange

Very few people would, I think, describe Arrangement B as “more progressive” than Arrangement A, because Arrangement B clearly screws the poor. The term “progressive” is garlanded with moral connotations about helping the poor, so this would not qualify. However, Arrangement B does include a transfer from the rich to the middle, and it reduces the inequality between the rich and the middle substantially. If your definition of progressive is “redistributes from richer to poorer”, you cannot definitively order one arrangement as more or less progressive than the other.

One might describe a proposal to go from Arrangement A to Arrangement B as “insider-outsider egalitarian”. It is not an irrelevant case. Although historical experience suggests they are mistaken, people who oppose unions frequently argue that they have precisely this effect. A better-off, unionized portion of the workforce, in this story, sees wages increases, at the expense of wealthy owners and managers (who have to pay unionized workers more), but also at the expense of the not-unionized (or not-employed) portion of the workforce, who see wages stagnate and prices rise.

While “insider-outsider egalitarian” is not an irrelevant case, it is not an ethically confusing one either. Holding constant the identity and the ordering of the humans, very few people explicitly argue that screwing the poor for the sake of egalitarianism among insiders is a good thing. Arguing that this will be the effect of a policy is a way of opposing it. (When identities are not held constant, the moral intuitions become less clear. Suppose under Arrangement B the poor are new immigrants whose poverty masks a great improvement relative to circumstances in their home country?)

Let’s consider a third case:

Quasiprogressive

This is the case I want to call quasiprogressive. Again, if our definition of “progressivity” is redistributing from richer to poorer, we can’t rank Arrangement A against Arrangement B. Going from Arrangement A to Arrangement B, ponies flow in both directions, to the poor, sure, but also to the rich from the middle. Nevertheless, people are tempted to call a shift to Arrangement B “progressive”, because it is good for the poor. Our ethical intuitions about this change may be positive. Or we may describe it negatively, call it a “hollowing of the middle class”. Is it a vase or a love affair? Suppose that a trade agreement will put middle-class workers in developed countries in competition with low wage workers elsewhere, leading to both a decline of middle-class wages and a proliferation of cheap consumer goods. The poor will benefit from cheap stuff, the rich will benefit from cheap stuff and cheap help, but the middle class will get screwed. Should we call this agreement “progressive” or “regressive”? Taking into account only domestic welfare, would it be a good thing or a bad thing?

If our only choices are Arrangement A and Arrangement B, we might be tempted to dispel once and for all with this fiction that Barack Obama doesn’t know what he’s doing. Short circuit. It doesn’t compute. Do we screw the poor or gut the middle class?

Fortunately, those are our choices only if the space of available policies is constrained artificially. In reality, our decision space usually looks more like this:

StatusQuoChoicesQuasi

The black bars in this chart represent the status quo. We are decided to enact a reform. Shall we jump to Arrangement A or Arrangement B? Absent political considerations, most of us would go for A. But suppose, not implausibly, that an ideological and institutional apparatus exists whose function is to defend the material interest of the wealthy? Then perhaps only Arrangement B will seem “politically possible”. Since Arrangement B does help the poor, it may seem unethical not to take it. If (as is usually the case) the harms to the middle are indirect — no one will “take” anything from anyone, market forces will do the dirty work — wealthier people of good will be tempted to support the reform. They stand to lose nothing, and maybe to gain something. The poor will be made better off! Harms to the middle will seem hypothetical, and in any case will amount to just desserts adjudicated by an impersonal market. Didn’t Rawls tell us that the welfare of the poorest should be our touchstone? Less wealthy people of goodwill may not be so sanguine about the reform. They may be torn. When a union member opposes a trade agreement that she understands will lower prices on many goods, but that also might put her out of a job, is she fighting the good fight for the middle class, or is she just a special interest screwing others to preserve her place at the trough? So long as Arrangement A is off the table, it will be very hard to mount an effective opposition to accepting Arrangement B, which after all benefits the poor so greatly.

Policy changes all the time, and the circumstances that favor reforms that look like Arrangement B over those that look like Arrangement A are permanent. Since wealth and influence correlate, each accommodation tilts the political economy towards the next capitulation. A weaker middle is less and less capable of opposing quasiprogressive alternatives that look both desirable and virtuous to the rich. In a world where the wealthy are genuinely interested in helping the poorest off but also vigilant caretakers of their own interests, quasiprogressive solutions are a political-economic sweet spot. The only way to prevent this dynamic without actively screwing the poor is to fight for solutions that work for the poor without sacrificing the middle. Those solutions will always be politically challenging. Even where a policy change is “positive sum”, as trade agreements are argued to be, policymakers almost unconsciously gravitate towards arrangements that segregate benefits towards the powerful rich and the sympathetic poor but shift burdens towards the less salient, less powerful middle.

This sounds very abstract, so let me name some examples where I think the American polity has chosen quasiprogressive solutions. We’ve talked about trade. The choice of quantitative easing rather than fiscal policy to stimulate the economy at the zero-lower-bound is another example. QE-assisted asset-price rises undoubtedly helped people at the margins get or keep their jobs while they also helped wealthy assetholders. Fiscal stimulus would have helped the marginally employed at least as well and might have put pressure on middle class wages too. But bonds might not have performed so well. The bank bailouts of 2008-2009 are frequently justified on quasiprogressive terms. Surely, had there been a catastrophic financial collapse, the poor would have suffered most of all! Of course they would have. They always do, that is the essence of poverty. But we might have averted a financial collapse with transfers to underwater homeowners, for example, or to be more fair, with helicopter money for everyone. Instead, we let middle-class homeowners collapse into negative equity and, too frequently, foreclosure, even as we provided generous support and regulatory forbearance to ensure that financial institutions and their creditors would be made whole. Most of the fiscal stimulus came not from Obama’s headline $800B program, but via automatic stabilizers that kick-in for the poor and unemployed. We rescue the rich. We congratulate ourselves for paying so much to help the stigmatized, traumatized poor. We tell the middle to suck it. That’s the quasiprogressive way, and it’s at the heart of American political economy.

Let’s do one more chart.

TokenProgressive

Which one, Arrangement A or Arrangement B is more progressive? If our definition of “progressivity” is redistributing from richer to poorer, we absolutely can rank a shift between these two arrangements. Going from Arrangement A to Arrangement B is clearly progressive. Ponies are shifted from both the rich and the middle to the poor.

So should our moral intuitions applaud this change? I don’t think so. I call this one “token progressivity”. While helpful to the poor, a transition from Arrangement A to Arrangement B extracts a small concession from the wealthy but burdens the middle disproportionately.

A lot of conversations bog down into arguments over whether the effects of some event were quasiprogressive or token-progressive. It just doesn’t matter very much. Uniformity of the direction of altered outcomes is too simplistic a criterion to rest moral intuitions on. A society is more than a summation of hypothetical utilities. The shape of the distribution of ponies matters as well. If we want to live in a middle class society, we have to fight for policies that protect the middle class. If we content ourselves with a progressivism of the politically achievable, we may find ourselves torn between doing nothing at all or celebrating accomplishments that may genuinely help the poor, but at the expense of an erstwhile middle class on a path of downward convergence. The work of good policy lies more in expanding the menu of choices than in optimizing over what is straightforwardly achievable.

At this particular moment, I want to emphasize “expanding the menu” needn’t mean preferring single-payer healthcare to reforming ObamaCare, or preferring universal free tuition over means-tested financial aid. But it is an implication of this analysis that the centrist acceptance of net budgetary impact as a criterion for valuing programs — where “net” means net of user fees like insurance premiums or tuition contributions — deserves special scrutiny. The first question should always be “value for the money”. Regardless of how a program will be financed, are the goods to be purchased worth the opportunity cost of the resources that will be expended? If we decide that a program is worthwhile, we then face a political trade-off. The smaller its net budgetary impact, the easier our program will be to pass. However, every shift in financing from general revenue towards means-tested user fees moves us precisely along a path from progressive, to token-progressive, to quasiprogressive, as defined in the discussion above. There are sometimes colorable reasons for user fees, besides political expedience. User fees can address fairness concerns about programs whose benefits aren’t universally available and yield few positive spillovers. Importantly, program value may not be independent of fee-structure. For example, copays may discourage frivolous doctor visits, and so enhance “bang-for-the-buck” of expenditures overall. These are sometimes valid concerns, but they often serve as fig leaves for imposing fees just to reduce net budget impact. That is, they serve as politically motivated excuses to reduce the progressivity of programs in order to increase their burden on the middle class relative to counterfactuals under which the programs would be financed from general revenue.

Update History:

  • 11-Feb-2016, 3:20 a.m. PST: “Holding constant the identity and orderingsthe ordering of the humans”; “new immigrants whose relative poverty masks a great improvement relative to circumstances”; “They stand to lose nothing, and maybe to gain something.”

There’s nothing smart in surrendering bargaining power for policy details

While we are taking lessons from the ugly compromises FDR accepted in order to get Social Security passed, we might also consider other events. FDR, you probably don’t recall because it has oddly been erased from conversational history, pursued almost as an idée fixe a cap on incomes of $25,000 (call it $360K in today’s money). The idea was as divisive then as it would be today, and despite dogged efforts, the proposal did not succeed. But, as Sam Pizzigati reminds us

[T]he setbacks the Roosevelt administration had suffered on the $25,000 salary cap executive order, on pay-as-you-go tax forgiveness, and the Revenue Act veto were obscuring a much more fundamental reality…

Roosevelt’s relentless drive to make sure the war created “not a single war millionaire” had made an incredible difference. His refusal to take “no” for an answer on his $25,000 income cap proposal had kept the entire war finance debate revolving around the rich and how much they ought to be paying in taxes. Conservatives didn’t want that debate. They wanted a national sales tax that would shunt the war’s heavy burden onto average Americans, but FDR’s aggressive advocacy for equity never allowed a sales tax to gain traction. Roosevelt would not get all he wanted on the tax equity front. But he did get plenty, enough to deliver against plutocracy a staggering knockdown.

The odds of enacting decent single-payer health care in the United States, given the broad range of powerful and not always unsympathetic stakeholders in the current system, are modest. But a modest chance is very different from no chance at all. The deep aversion among current stakeholders that makes single payer politically hard also makes any chance it might happen a potent motivator for those same stakeholders to accept or even propose meaningful alternatives. Taking single payer off the table, promising to build from the status quo, leaves the comfortable with nothing to fear from the many people for whom American health care remains a nightmare. It strikes me as more a license for inaction than a sensible plan of action.

(Dean Baker has made a similar point.)

Home is where the cartel is

Housing is a bitch.

A case can be made that divisive hot-button issues like inequality and immigration ultimately derive from housing dysfunction. Kevin Erdmann eloquently tells the tale. Matt Rognlie has famously argued that the increase in capital’s share of income, often blamed for inequality, is due largely to housing, once depreciation is taken into account. All of this reinforces the thesis of people like Ryan Avent, Edward Glaeser, and Matt Yglesias who have argued for years that housing supply constraints are to blame for high rents in powerhouse cities, and may constitute an important drag on productivity growth and a cause of macroeconomic stagnation. (See also Paul Krugman, quite recently.) Several of these writers argue that cities should eliminate restrictive zoning and other regulatory barriers to development, then let the free-market create housing supply. In a competitive marketplace, high prices are supposed to be their own cure. Zoning restrictions, urban permitting, and the de facto capacity of existing residents to veto new development are barriers to entry that prevent the magic of competition from taking hold and solving the problem.

My view is that the “market urbanist” diagnosis of the problem is more persuasive than its prescription for addressing it. As a positive matter, they just won’t win the political fights they propose. On normative grounds, I’m not sure that they should. The market urbanists present themselves as capitalist deregulators but I think they can be described with equal accuracy as radical redistributionists. The customary property rights surrounding homeownership in many cities and suburbs include much more than the use of a square of earth and whatever is built on it. Existing homeowners bought into particular neighborhoods in large part because of their “character”, which includes nice-sounding things like walkability or “charm”, as well as not-so-nice-sounding things like access to exclusionary education. Newer residents have bought and paid for those amenities, while older residents may feel they have earned them by helping to create them. Economists describe houses as a form of capital that provides a stream of services, rather than a cash flow, to owner-occupants. We should also describe the arrangement of neighborhoods as a form of capital that provides services people value. Property owners have disproportionate use of, and, informally, enjoy substantial control rights over this “neighborhood capital”, and these benefits have been capitalized into residential real-estate prices. (Location, location, location!) “Zoning reform” is an anodyne way to describe an expropriation of those customary rights. It amounts to diminishing residents’ ability to preserve or control the evolution of their neighborhoods, in order to challenge the exclusivity on which the value of existing neighborhood amenities may be based.

Market urbanists sometimes respond that eliminating restrictions should, in economic terms, be good for existing property owners. Suppose I own a plot of land, and today I’m only allowed to have a two story house on it. If tomorrow I suddenly have the right to build ten stories, but I can still keep the little house if that’s what I prefer, the new option can only improve my property’s value, right? Surely de-zoning would be a windfall for property owners, as land prices would include part of the capitalized stream of rents from the ten urban lofts that could now, potentially, be built there.

This is unpersuasive “partial-equilibrium” reasoning, which explains why homeowners are usually unpersuaded. Any given property owner rationally wants restrictions lifted on the use their own property, but lifting restrictions on neighbors’ use of their properties creates risks and costs. The ultimate effect of a general upzoning is hard to predict and may not be positive for incumbents, especially when potential impairment existing amenities — “neighborhood capital” — is factored in. Far from being a sure gain to existing residents, upzoning is a form of risky investment, the proceeds of which will be shared with developers and new residents, the costs of which will be concentrated on people whose financial statements and human lives are deeply exposed, with little diversification, to the quality of their neighborhoods. Even if, in aggregate, land values increase, densification of an existing neighborhood creates risks for individual property owners they many not wish to bear. If an apartment block is built next door, my old neighbor may have gotten rich from selling, but my plot may not be suitable for putting up yet another tower, and my home may be worth less for its busy, unquaint new neighbor. People experience individual not aggregate outcomes, and individual outcomes are usually riskier than aggregate outcomes. Absent some insurance mechanism, it is rationally hard to persuade individuals to consent to policy changes that, in aggregate terms, would meet a return-to-risk hurdle but at an individual level might not. When market urbanists point to how much more productive and awesome the city as a whole might become, they are missing this point.

Finally, whatever economic gains might accrue to existing property owners from rezoning has to be traded off against a huge cost, the loss of existing monopoly rents. If you buy a home in San Francisco today, the last thing you want to happen is for the housing affordability problem to be solved next year. If apartment prices become reasonable, you’d find yourself with a huge financial loss and an underwater mortgage. Residential property is expensive in power cities because it includes the capitalized value of the large incomes streams one can earn from accepting tenants. (Now more than $5K/month for the median 2BR apartment in San Francisco I hate this city.) Making housing affordable means that value goes away. High rents are like poverty at the Brookings Institution, a problem we claim we desperately want to solve but don’t really want to solve because the things we would have to do to solve it would be costly and disruptive to the people whose interests get termed “we” in a sentence like this one. So we make other stuff up, hey, how about a little affordable housing requirement with a poor door you’ll have a 1/1600 chance of getting into? The home cartel is stable by virtue of regulatory coordination, which cannot be undone by adversarial political action because cartel members practically define the enfranchised municipal community.

Home is where the cartel is. I use the word “home” not “housing” advisedly. Homeowners understand their actions not as monopolizing the housing market but as protecting their homes and neighborhoods from the market. The libertarian “deregulatory” rhetoric by which market urbanists sometimes make their case is counterproductive. Telling people to think of their homes as a commodity upon which market forces should be brought to bear in order to ensure production of housing services at competitive prices is obtuse. People purchase property, rather than renting, largely to gain security and control, to escape the vicissitudes of the market. The worst place to emphasize “deregulation” is in dense urban environments, where almost every sort of action has spillovers. Construction in dense cities will always be heavily regulated, and should be. There can be good regulation and bad regulation, but talking about “deregulation” in an urban context is just self-branding. Dense cities in developed countries expand their housing stock as a policy choice, not because anonymous producers respond to price signals. Price signals — high market prices — give cities the option to expand their housing stock without financial subsidy by reregulating to attract developers. But nobody is dumb. You actually have to persuade an urban polity to choose to permit development, in a particular place, over the objections or with the consent of diverse stakeholders.

The deregulatory narrative not only fails to help, it very directly hurts. If you frame your solution as being about “freeing markets”, you are likely to oppose rent control on naive and misleading Econ 101 grounds. Price controls, you have been taught, create scarcity, by eliminating the incentive to produce up to the market-clearing quantity. But to claim “the rent is too damn high” implies directly that housing prices are already above the level that would inspire further production, if there weren’t other regulatory barriers. In the prosperous cities where we perceive housing crisis, market-rate housing is already priced at levels that would attract further development, if only the polity could be persuaded to allow it. New construction is market-rate housing: It is almost never subject to rent controls. The existence of rent controls on older buildings does suggest a danger that housing built today might someday be placed under rent controls too, sure. But that risk is already priced into market-rate development. If market-rate apartments sell for substantially more than their physical cost of replacement, then the market deems the risk of future value-impairing rent regulation to be sufficiently small, or sufficiently distant, or the present demand for housing to be sufficiently acute, as to cover that risk. The Econ 101 case against rent controls only holds if the threat of controls prevents the market value of newly produced rentable properties from substantially exceeding the cost of development after regulatory hurdles have been overcome. [1] This is not what we observe in real life. Impaired prices are simply not the binding constraint on new development. Market urbanists unnecessarily make enemies of a critical constituency, tenants in rent-stabilized apartments who have extraordinarily much to lose. Renters should be cities’ natural advocates for new supply. But when proposals to build come bundled with an ideology that would price people out of their current homes, renters’ enthusiasm is unsurprisingly muted. [2]

Market-centered narratives about homeownership are the source of housing supply problems at least as much as they might suggest solutions. As Daniel Hertz has observed (ht Ryan Cooper), there is a fundamental contradiction at the heart of housing capitalism. We encourage people to take on highly leveraged, undiversified exposure in homes with promises that they are good “investments”, meaning they will increase or at least retain their values over time. We also claim that housing is a consumption good that should be efficiently provided, a good for which competitive markets should expand supply to drive prices down to a technologically declining marginal cost of production. Housing cannot be both of those things at once. Much of the work we have to do if we wish to increase housing supply is to deemphasize the housing-as-investment narrative in favor of housing-as-consumption-good. Price ceilings would prevent windfall investment gains (and so investment-motivated purchases). Price ceilings would also new prevent buyers from becoming levered against much-higher-than-replacement-cost home values, and therefore lobbyists for housing scarcity. Surprisingly from an Econ 101 perspective, the best way to encourage housing supply might be to cap home prices, at a level sufficiently above physical construction cost to keep development profitable when consumption demand is strong, but no higher than that, to discourage the use of homes as speculative financial investments and to prevent scarcity rents from getting capitalized into prices.

I don’t advocate trying to impose price ceilings on existing market-rate housing. That would be an expropriation at least as unfair and politically challenging as eliminating zoning restrictions. Plus, maximizing the quantity of housing supplied cannot be our sole, overriding objective. There is much to be said for encouraging “neighborhood capital” production, incentivized in part by the prospect of rising home values, as a means of increasing quality of life and sheer aesthetic joy, despite the “NIMBY-ism” it rationally provokes. There are trade-offs. However, when we build new neighborhoods, we might want to be open to new regulatory ideas. As long as builders and buyers know the rules of the game up front, anything is fair. Experimentation should be encouraged. “Deregulation” cannot be our touchstone. The word is meaningless (it sneaks in some definition of neutrality which is wholly arbitrary), and discourages creative thinking or even looking around to see what works.

I don’t know what will work. But, looking around a bit, I’d suggest we take a look at two particularly promising examples. The housing policies of Singapore and Germany couldn’t be more different. But both countries have been remarkably successful.

Singapore never solved the problem we are banging our head against, how to take existing prosperous neighborhoods and make them more dense. It never tried. Instead, Singapore expanded its housing supply, at remarkable speed and scale, by building out extremely dense but nevertheless green, livable, and attractive “new towns“. Rather than restricting our attention to putting more housing in existing desirable neighborhoods, why not follow Singapore and build new neighborhoods, and when we run out of space for those, new ring cities? Singapore has done a ton of experimenting, in regulation, architecture and urban design, in putting greenspaces around (and on) increasingly creative high-rise developments. Obviously, Singapore is very different, socially and politically, than the United States and other Western countries. Some things won’t (and shouldn’t) translate. But we still have a lot to learn from their experience. Are we really incapable of building new, compact, microcities without their becoming Cabrini-Green or the banlieues of Paris?

Germany’s virtues are less sexy than Singapore’s sci-fi eco-towers. But they are great virtues nonetheless. Somehow, Germany has managed to avoid the price booms that in so many countries (including the Scandinavians) have segregated society between those who were homeowners at just the right times and those who were not. Germany’s path is ideologically mixed. On the one hand, German property owners have a right to build within broad planning parameters. On the other hand, what we in the United States call rent controls are universal in Germany. (German leases are implicitly “rent stabilized”. Berlin has recently begun an experiment with old fashioned administered prices.) Lending for home buying is regulated and conservative in Germany, preventing joint credit/housing booms. (You’ll recall that German banks had to dive headlong into American junk housing securities and Southern European bonds to get themselves into trouble, since their own economy wouldn’t produce enough product.) Homeownership and renting are roughly balanced, and home prices have had no tendency to increase dramatically. Homes in Germany are what a naive economist might predict they should be, a very durable consumption good that provides a stream of housing services, not a ticket to financial gain at all. Germany’s cities are very affordable relative to their counterparts elsewhere in Europe and in the United States. Germany’s housing success seems boring, in the way that your chest might seem boring to a guy who has just been stabbed and is spurting blood from a ventricle. Boring, but wonderful.

Boring Germany, sci-fi Singapore, or something else entirely. Urban housing is a really hard problem. We’ll need lots of inspiration. That economics textbook might help a little, but don’t try to use it as a cookbook.

FD: I’m very grateful to live in a rent-stabilized apartment in San Francisco.


[1] One might be tempted to argue that regulatory hurdles are themselves a “cost”, so very high prices are necessary to incentivize developers to do the necessary lobbying and lawyering. If that were a good model, the housing problem in places like San Francisco and New York would already have been solved. There is no fixed cost of permission that high property values can overcome. The political process doesn’t set a price in lobbying and paperwork and bribery and then let the supply of permits and variances expand elastically once that price is met. A better approximation is that the political process fixes a quantity and uses price to ration permission, so that any additional willingness of developers to bear regulatory costs feeds into a bidding war that feeds lawyers and architects and bureaucrats (and generates free amenities to buy off the neighbors!) but does not greatly expand the number of permits granted, or, therefore, the quantity of dwellings supplied.

[2] There is one channel through which existing rent control really might discourage new supply in high market-price neighborhoods, and it has nothing to do with supply and demand diagrams. In order to increase the housing stock of an existing, well-utilized neighborhood, one often has to knock down buildings that exist in order to put up something denser and/or taller. The prospect of this sort of “redevelopment” is always going to anger humans, who sometimes grow attached to their homes. For people in rent controlled housing in very hot markets, the threat of redevelopment is existential. Rent control in America is mostly “second generation rent control” or “rent stabilization”. You rent at market rates, or even some premium to market rates, but thereafter rent increases are tied to some administrative measure of inflation. If the building that you’ve lived in for years gets torn down to build something new, the clock starts over and you have to rent at current market rates, even if you find a new rent stabilized apartment. Many (probably most) current residents of rent-stabilized apartments would not be able to afford to live in their neighborhoods at market rates, or even in their cities. “Affordable housing” programs (of which I have a low opinion) may offer sanctuary to some of the displaced, but they offer at best an uncertain prospect. Because the stakes are so high, residents of rent-stabilized apartments become a political constituency implacably opposed to redevelopment. The long-tenure rent-stabilized are a precise mirror image of property owners who prefer constrained supply to support prices. Both have rents (in the economist’s sense of the word) to protect, benefits that markets would compete away under a different set of regulations. Both perceive securing those rents not as cashing in, but as protecting their homes and their families. Both will work (in coalition with one another) to prevent redevelopment, densification, upzoning, etc. “Reduces the future flexibility of neighborhoods” may be a colorable reason to have opposed rent stabilization back in the day. You may be cruel enough to simply wish to end it abruptly now, on the theory if those people are kicked out anyway they’ll have nothing left to oppose. You may wish that, but if you are smart you will shut up about it.

Advice for Twitter

In my accustomed role of moralist scold, I probably shouldn’t want to help Twitter. I should want it to be replaced with an open-source, distributed, decentralized ÐAPP or something. And at some level I do want that. But for now, Twitter is the only social whatnot I actively use, and when I don’t hate the service I sometimes really like it.

I keep reading articles about how Twitter is dying or failing or crashing or whatever. I have ideas! I don’t know whether anything I propose might justify Twitter’s current or recent-past stock price. I could care less. But here are some things I would do to make Twitter a better business, in multiple senses of the word better.

  • Ditch the whole ads and analytics model Twitter currently aspires to. It’s an evil business model, no matter how well it works for companies that once promised not to do evil. Putting aside the moralism, Facebook and Google pretty much have a lock on that gold mine. Apple, not a don’t-be-evil company by any measure, has seen the writing on the wall and chosen to differentiate itself by not spying on people. Twitter should do the same. Just stop it, and make a big show of stopping it. Twitter, to its credit, has a decent record overall of standing up for people’s rights to use its platform for controversial political speech. It should keep doing that, stop doing this, stop spying, and make respect of user privacy an integral component of its brand.

  • Charge the people who get the most from Twitter. Don’t give “producers” micropayments, take their money. People who interact on Twitter, especially those who gain a large-ish following, get a lot more out of Twitter than people for whom it is just one more passive information source. This is tricky: if people have to pay to tweet from the start, they would never get enmeshed in the service deeply enough for it to become worth paying for. What Twitter needs is a payments model that lets casual users Tweet for free indefinitely but cajoles power users into paying to support the business.

  • That business model exists. It falls right out of the experience of power users. Over the years, I have wasted tens of hours trying to shave a few characters off some vain idiocy I imagined to be clever and witty in order to conform to the 140 character limit.

    It would be a terrible idea for Twitter to let users pay to escape the character limit arbitrarily. Twitter’s raison d’etre is the micro in microblogging. No one should be embedding essays into people’s timelines. However, it would not kill Twitter if I could pay a little to slip in an extra few characters rather than waste five or ten minutes reworking, abbreviating, or mangling the perfect quip that happens to clock in at 143.

    My suggestion is exponential pricing. One extra character, a tweet length 141, costs 1¢. Two extra characters costs 2¢. Three extra characters costs 4¢. n extra characters costs 2n-1 cents. By 28 extra characters, the cost spirals to more than $1M dollars. I think it’s fair to say that this pricing model would enable people to go a few characters over without worrying about it while keeping intact the “around 140 character” user experience. I think I’d end up paying $20-ish a month under this model, but I’d be grateful for the time saved and the preserved quality of expression relative to my current use of the service. And of course, users would continue to have the option to treat 140 as a hard limit and pay nothing. The tradeoff between perfectionism and money would be entirely at each users’ discretion.

  • Twitter’s default algorithm should remain real-time, reverse chronological feeds whose contents are fully determined by users’ choice of followers. But critics are right to point out that the standard feed may not provide the best curation for everyone. Since Twitter would be out of the corrupt and corrupting business of selling eyeballs for ads, it could leave the choice of alternative curations entirely at each user’s discretion. Twitter could offer a menu of algorithms that it thinks will be useful to different categories of users, even impose a default (in a tab distinct from the standard feed) that users would be able to replace or augment. Twitter could define an API through which outsiders could publish their own algorithms for curating timelines that would then become available to users in a kind of (free) “app store”.

  • It should be possible to Tweet stuff to people. Real stuff, goods and services. Twitter should try to earn users’ trust and collect meatspace identities and addresses while promising to hold them in strict confidence. Without necessarily knowing the true identity of the recipient, Twitter users should be able to send gifts to Twitter handles. Twitter would partner with various merchants to define the range of available goods, and work with them to fulfill.

    Since Twitter itself would know the transacting parties, it would be able to deter abuse. Individual users could define whether they accept gifts and from whom. Only from people I follow? A special Twitter list? Anyone and everyone? Users decide. Users could also decide whether to let gifts surprise them at their doorstep, or could require on-line approval before an order is processed. Obviously, this would be a very easy service for Twitter to monetize. They would just take a percentage of the cost of the gift as a service fee. Gifts might be represented by a special kind of glyph in tweets (that one can click to inspect), and might be included in both public tweets and direct messages. Attempts to publish Tweets with gifts to users not configured to accept them should be blocked, and Tweets with gifts that recipients will screen before accepting might be withheld from publication until the gift has been approved. There should be modest limits to the dollar value of tweetable gifts individually, and to the total value transferred from one person to another over a period. The intent would not be for Twitter to become a payments system or a means of sending large bribes. Over the years, I’ve wanted to send people books, a delivery of chicken soup, a stuffed animal or a card. Obviously digital goods would be easy, gift certificates or music or an ebook.

    As with exponential pricing of characters, no one should be forced from their existing practices by this new option. Users who don’t wish to send or receive gifts could continue to use the service as they currently do, without providing any identifying information to Twitter. They would remain as pseudonomous as they currently are (perhaps even moreso, if Twitter flamboyently forewent the kind of spying on users that is now the standard practice of ad-supported sites).

  • Twitter should go back to making itself open to outside developers and third-party clients. I am delighted to read that it plans to do so. Obviously, Twitter has a credibility problem, having crushed outside developers when it decided it wanted to gather eyeballs to ads and control what they see. The service behaved abysmally. Twitter should do everything it can to commit to never doing anything like that again. Having a business model that makes money independently of how people encounter or publish tweets would render their devotion to a new glasnost less suspect. If there are things they will need to restrict (like, say, a free tweet-longer service embedded in clients), they should think about that carefully and publish those restrictions in advance.

Translating “net financial assets”

Steve Roth at Asymptosis offers a remarkable, detailed discussion of Modern Monetary Theory’s notion of “private sector surplus” with an emphasis on aggregate accounting. Roth’s core point is well taken: “Private sector surplus” (equivalently the increase in “private sector net financial assets”) should not be conflated with the economic saving of households. As Roth points out, household sector saving is the difference between household sector income and household sector (noninvestment) expenditure. “Private sector surplus” is likely to increase household sector income, and so in that sense it forms a component of household sector saving, but it is quantitatively small relative to total household income — especially, as Roth emphasizes, if you use comprehensive measures of income that include capital gains and losses. [1]

Roth is right about all this. But I think he is talking past MMT economists a bit. Roth invites us to think about comprehensive saving by households. But that’s very far from what MMT’s baseline sectoral balances decomposition claims to capture. Instead “net financial assets” capture only the financial position of the aggregated (domestic) private sector, including both households and businesses. MMT enthusiasts sometimes mix these things up, and when that happens it should be called out. But this confusion has been called out a lot over the years, and I think for the most part MMT economists have become pretty precise in expressing themselves. There is a great deal of value in the MMT decomposition, not as a measure of household saving, but of something else entirely. Let’s try to understand it.

I’m going to steal from my own, old post, a derivation of the MMT-standard decomposition (usually attributed originally to Wynne Godley). We start with a tautology:

Every financial asset is also some entity’s liability. The sum of all financial positions is by definition zero. So we can write:

NET_WORLD_FINANCIAL_POSITION = 0 [0]

Suppose that, quite arbitrarily, we divide the world into a “foreign” and a “domestic” sector. Then we have:

NET_FOREIGN_FINANCIAL_POSITION + NET_DOMESTIC_FINANCIAL_POSITION = NET_WORLD_FINANCIAL_POSITION = 0 [1]
NET_FOREIGN_FINANCIAL_POSITION + NET_DOMESTIC_FINANCIAL_POSITION = 0 [2]

Suppose that, again arbitrarily, we decompose the domestic economy into a public and private sector:

NET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + NET_PUBLIC_DOMESTIC_FINANCIAL_POSITION = NET_DOMESTIC_FINANCIAL_POSITION [3]

Substituting into our previous expression, we get

NET_FOREIGN_FINANCIAL_POSITION + NET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + NET_PUBLIC_DOMESTIC_FINANCIAL_POSITION = 0 [4]

We can also write this in terms of changes or flows. Since the sum above must always be zero, it must be true that any changes in one sector are balanced by changes in another:

ΔNET_FOREIGN_FINANCIAL_POSITION + ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + ΔNET_PUBLIC_DOMESTIC_FINANCIAL_POSITION = 0 [5]

Two of the flows in the equation above have conventional names, so we can rewrite:

CURRENT_ACCOUNT_DEFICIT + ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION + CONSOLIDATED_GOVERNMENT_SURPLUS = 0 [6]

Rearranging…

ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION = -CURRENT_ACCOUNT_DEFICIT + -CONSOLIDATED_GOVERNMENT_SURPLUS [7]
ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION = CURRENT_ACCOUNT_SURPLUS + CONSOLIDATED_GOVERNMENT_DEFICIT [8]

The highlighted Equation 8 is where the action is. NET_PRIVATE_DOMESTIC_FINANCIAL_POSITION is often described as net financial assets of the domestic private sector. MMTers (domestic) “private sector surplus” is precisely ΔNET_PRIVATE_DOMESTIC_FINANCIAL_POSITION.

The crucial thing to understand is what the net means in net financial assets. It is precisely financial savings net of domestic real investment by the private sector. It is the farthest possible thing from a comprehensive measure of household savings. It is private sector savings excluding the vast preponderance of household savings, which is backed by private sector assets (whether owned by households directly or owned by businesses who then issue financial claims to households). “Ordinary” private sector savings either doesn’t show up as financial assets at all (a home without a mortgage is just a real asset owned by a family, like a television or a baseball card), or else they “net out” when we aggregate, because one private sector entity’s asset is precisely extinguished by another private sector entity’s liability. If a household is “long” a share of stock, a firm is “short” that same position, and owes the household whatever that claim represents. The aggregate financial position of the private sector combines the financial positions of businesses and households, so the financial claims of households against firms are matched by mirror image liabilities of firms to households. They annihilate one another like matter and antimatter.

So why do we care about this odd sliver of savings? Why do MMT economists make it so central to their analysis? Private sector net financial assets are “special” precisely because they are not backed by domestic real assets, but instead by promises that are credibly independent of domestic real asset values, especially promises of states. Saving that takes the form of real stuff, whether that stuff is directly held or hidden behind financial claims, is inherently risky. House prices fall. If you own a factory, or shares in a firm that owns a factory, the factory can burn down. Even if you hold a diversified stock portfolio, you will find it subject to wild swings in value. If you own private sector debt, you expose yourself to credit risk. If you own a diversified portfolio of domestic stocks and bonds, your own circumstances and that of your investment portfolio will be correlated in an unpleasant way. The times when you lose your job and need to draw on savings are likely to be the same times when stocks have crashed and people are defaulting on their debts. People desperately covet assets that are divorced from the risks of the domestic real economy. And that is precisely what “net financial assets” are.

Net financial assets are special, because they serve insurance functions that assets produced by the domestic private sector simply cannot provide. When households are risk-averse, they covet these assets especially. For firms, these assets offer protection against insolvency risk that real assets, whose values both fluctuate idiosyncratically and covary with the real economy, cannot provide. MMT economists often suggest that if the public sector fails to accommodate the private sector’s appetite for net financial assets, recession and financial instability will result. That makes sense. It’s conventional, if a bit vapid, to describe recessions as times when “animal spirits” are low, when people are risk averse. But what matters is not the courage in people’s hearts (or lack thereof). What matters is how people behave. If people’s behavior is counterproductively risk averse, you can encourage greater risk-taking by offering insurance. That’s precisely what injections of “net financial assets” into an economy provide. If firms are teetering on the brink of bankruptcy, you can flood the economy with safe assets they can use to shore up their balance sheets to reduce their risk of default. That’s precisely how the United States saved its banks in 2008 (for better or for worse). The headline bailouts and TARPs and accounting forbearance were all expedients to keep those firms alive until a flood of assets immune to correlated private sector collapse could find their way onto bank balance sheets (with the help of opaque subsidies). Those special assets are “net financial assets”.

“Net financial assets” are a heterogeneous category. They include both claims against the domestic state and claims on foreign public and private sectors. A claim on a foreign firm in foreign currency does not provide the same insurance as claim against the domestic government in domestic currency. Nevertheless, claims on the foreign sector do provide insurance against domestic shocks that do not impair the foreign counterparty. And note that contrary to naive financial theory, which predicts developed economies will net-accumulate claims on emerging economies to invest in their growth, in practice emerging economies tend to net-accumulate claims on developed economies. The insurance function of safer foreign assets outweighs the investment function of accepting foreign capital (or at least it has since the Asian Financial Crisis). For firms and households in an emerging economy, foreign claims and claims on government are both useful insurance. In developed as well as emerging economies, negative positions with respect to foreign creditors increase the domestic private sector’s exposure to risk as surely as indebtedness to the state would, assuming debt contracts are uniformly enforced.

All this terminology — private sector surplus, net financial assets, etc. — is associated with heterodox, lefty MMT, but it maps very nicely to discussion of “safe asset shortages” in the mainstream financial press or Gary Gorton’s schtick on the importance of “informationally insensitive” assets. The main difference has to do with whether we can or ought to rely upon the domestic private sector to produce these kinds of assets. The MMT analysis, by construction, excludes private sector “triple-A” assets, where people like Gorton emphasize a role of private sector in producing assets that might provide this sort of insurance. The MMTers have it right. The domestic private sector simply cannot produce assets that provide insurance against systematic risks of the domestic economy without the help of the state. (Gorton tacitly recognizes this when he suggests the state should supervise and guarantee assets produced by shadow banks like it insures bank deposits. No thank you.)

The insurance function of “net financial assets” is not unambiguously a good thing. Net financial assets are special precisely because they provide insurance against systematic risk. When net financial assets are claims on foreign debtors, they are not so problematic, they just represent a form of diversification that can insure against domestically (but not globally) systematic shocks. Claims against the domestic state, however, offer safety to their holders in a manner that can be quite dangerous to the rest of us. “Insurance” against a truly systematic shock is necessarily a zero-sum game. If we are all collectively poorer, the only way the state can make some claimants whole is by shifting their share of the aggregate loss to people who don’t hold the government’s promises. We’ve experienced this very painfully over the past decade, as both the European and American policymakers refused to accept any risk of inflation (thereby prioritizing the value of past promises). Policymakers chose to make absolutely sure that holders of state assets would be made whole in real-terms, and imposed severe costs on debtors and the marginally employed to do so. (I think policymakers overshot the inherent zero-sum-ness of providing insurance during a systematic shock and have played a sharply negative-sum game.) It would be better, I think, if states downgraded the insurance they provide by weakening the promise they make to asset holders from price stability to an NGDP path target. And I worry much more than I think most MMT economists do about the unjust distribution of risk-bearing that might accompany a large stock of net financial assets very unequally distributed. (Unusually, I’m with Greg Mankiw on this one.) I think the economy includes people who are already overinsured by their stock of net financial assets, and those people tend disproportionately to accumulate new issues. So we should think more about how we can accommodate private sector entities’ need for some degree of insurance by redistributing existing net financial assets rather than creating new ones.

This sentence is a pithy conclusion.


[1] Should you? Or should you use a NIPA-style accounting that “looks through” capital gains? That’s a complicated question. Looking through capital gains entirely is clearly unsuitable, because household capital gains include revaluations of shares due to e.g. retained earnings, which represent increases in the quantity of real assets that households’ shares lay claim upon. This kind of capital gain is economic saving. But what about price appreciation of the existing housing stock? On the one hand, this is certainly perceived by individual households as real wealth and a form of savings. On the other hand, housing price increases also represent a kind of liability on the part of households and households-to-be who are not yet homeowners. If our object is to study distributional questions, differences between households, capital gains of this sort should obviously take center stage. They are real wealth to the households who enjoy them, and often represent costs in some form to households who don’t. But if we are aggregating, it’s not as clear that mere repricings of existing assets should be included in household saving. Unfortunately, it’s almost impossible in practice to disentangle gains due to real growth in the assets backing claims from repricings of existing assets. Consider our prototypical example of “mere repricing”, price appreciation of an existing home. If a home remains entirely unchanged in an unchanged neighborhood in an unchanged city, then that is mere repricing. But perfect stasis is impossible outside of a thought experiment. If an “existing home” is renovated, and its price appreciates, how much of the price appreciation is “mere repricing” and how much of it reflects the change in real assets? If the neighborhood surrounding a largely unchanged home improves dramatically, then the house is a more efficiently deployed real asset, and a change in price may reflect new real value, which does constitute a form of economic saving — a claim on real growth — rather than mere repricing. Similarly, while stock appreciation can reflect an increase in the quantity or real-economic usefulness of the assets backing shares, it can also result from a mere revaluation of largely unchanged firms. When the Fed eases, stock prices rise, but the real assets that back them are not meaningfully improved. I think on the whole Roth’s choice to include capital gains in his analysis of aggregate household saving is right, much better than the alternative choice of ignoring it. But neither choice can be “correct”.

Update History:

  • 24-Jul-2015, 1:15 p.m. PDT: “Note that the The insurance function of “net financial assets”…”

1099 as antitrust

I have no idea what legal, regulatory, or policy process might achieve this outcome. But maybe it would be a good thing if it happened.

Suppose the criteria for 1099 status really emphasized having multiple customers. For example, if you make money by offering people rides, the fact that you get to set your own schedule doesn’t cut it, if substantially all of your business comes from Uber. To qualify as an independent contractor, if you do substantial business with a regular, repeat customer, you must have multiple customers in that line of business for whom you do substantial work. Otherwise, there is a strong presumption that you should be considered an employee of your customer.

Right now, the greatest danger to to the rest of us from “sharing economy” platforms like Uber is that these platforms benefit from network effects that render them “winner-take-all”. Today’s apparent innovators are really contesting a tournament to become tomorrow’s monopolists. The outcome we should be hoping to achieve is neither to strangle these products in their cribs (they are often great products that create real efficiencies), nor to permit wannabe monopolists to win their prize. We should want competitive marketplaces in the products these platforms provide.

Much of the network effect that might render Uber-like platforms anticompetitive derives from density of suppliers. Customers flock to the platform that has the densest, richest set of offerings. When suppliers pick just one, they prefer to work for the platform that has the most customers. So once one platform pulls ahead, a cycle may kick in, virtual or vicious depending on your perspective, leading to a single dominant platform. But if suppliers “multihome”, if pretty much all of them sell through pretty much all of the networks, this “market cramp” can be interrupted and multiple platforms might survive. I’ve recommended before, in a vague way, that policy should be geared to encouraging multihoming. But that was going to be hard work, because platforms’ incentives are to make it hard as possible for suppliers to be promiscuous.

But if 1099 status required that suppliers multihome — and in a substantive, not mere token way — platforms’ incentives would reverse. They would face a choice of bearing much higher per-supplier costs (as “suppliers” become employees), or of insisting that suppliers also do business elsewhere. All of a sudden Uber would need Lyft and Lyft would need Uber (and maybe my former favorite, Sidecar, would de-pivot back into this market). Reclassification of suppliers as employees would serve as an antitrust doomsday device for sharing economy platforms. That might be a pretty good outcome.

There is of course a huge, serious problem with this idea. The people who hope to benefit from employee rather than contractor status are not customers, but workers. This suggestion basically sells out benefits and protections for workers in order to secure competition on behalf of customers. Silicon Valley titans may not realize it, but everything they hope to do depends upon finding less intrusive ways than traditional employment regulation and collective bargaining to give workers the negotiating power they need to secure a decent living. An economy that defines “efficiency” as throwing the majority of workers into a competitive race to the bottom so that a relative few at the top can enjoy cheap services is neither desirable nor stable. We can prevent that the old fashioned way, by having labor form cartels (via unionization or regulation), or we can try something new. Silicon Valley types hate the old way. Any sort of cartel is a thing they want to disrupt, except when they are operating it. Great. But then it’s time to go beyond libertarian bromides and the rhetoric of plutocratic self-regard and actively support better ways to ensure that humans in the technoutopia to come have the leverage they need to negotiate good lives for themselves. I have suggestions.

Encouraging competition via the threat of reclassifying contractors as employees is, at best, a kludge. It would be better if we had laws explicitly designed to push back against winner-take-all dynamics and ensure a competitive marketplace. But even traditional antitrust doctrines are now rarely and weakly enforced. Addressing more directly the threats to competition posed by technological network effects would require creative, controversial, new legal doctrines. Until we work those out, and work up the courage to pass laws to give them force, maybe a kludge wouldn’t be a bad thing.

How to fix the Euro

I broadly agree with the Angloamerican consensus about the, um, challenges associated with the Euro from an economic perspective. (David Beckworth has a very nice explainer.) We do understand that the Euro was adopted for political more than economic reasons. Unfortunately, with the benefit of hindsight, the hoped-for political benefits of the common currency seem to have materialized less than the long-warned economic problems, and the economic problems have now poisoned the politics. But we are where we are. I think it unlikely that the Euro will be dismantled except in the context of a crisis that would put the whole European project at risk, even more than recent crises already have. So the challenge, I think, is to come up with institutions that would help mitigate the economic flaws of the common currency, and that might be acceptable in a political union whose electorates, for the moment, feel no great solidarity with one another. Ideally, Europe might pursue a US-style union, where transfers made upon universal criteria to households and business blunt regional wealth and income asymmetries, without provoking the indignation that direct intergovernmental transfers provoke (and would provoke in the US as well). But, after the trauma of recent events, I doubt that a Pan-European safety net will be politically achievable anytime soon.

If “ever closer union” is on pause for now, perhaps Ashoka Mody has it right when he advises, “To stay close, Europe’s nations may need to loosen the ties that bind them so tightly.” Mody’s specific suggestion is that Germany and other Northern European countries depart the Euro, replacing one very suboptimal currency area with two more reasonable blocs. He makes a good economic case, but the political symbolism of a Dollar/Peso Europe would be pretty terrible. I think there is a better way.

In the heat of the recent Greek crisis, many commentators (Coppola, Koning, Mason) noted that “membership” in a currency zone is not a discrete, all-or-nothing thing, but rather a continuum. Many people advised Greece to loosen its bonds to the currency zone just a bit by issuing its own scrip, not denominated in a new Drachma, but in the Euro itself. This is not a new or radical idea. Even in the United States’ famously functional currency union, the State of California has periodically resorted to issuing dollar-denominated “registered warrants” in order to sustain necessary spending through cash crunches. For related proposals, see Bossone & Cattaneo (1, 2), James Hamilton, Rob Parenteau, and of course Yanis Varoufakis.

Issuing Euro-denominated scrip would not mean leaving the currency zone, any more than California’s registered warrants took California out of the dollar zone. However, in the context of the current crisis, if Greece had issued such notes, it would have been interpreted as a first step away from full-fledged membership in the common currency. Looking forward, what would be better would be to normalize the practice, throughout the currency zone, of having governments make domestic expenditures (and only domestic expenditures) in scrip. Greece would issue scrip, and so would Germany. The characteristics of the scrip (but not the value) would be standardized across the Eurozone. In particular, each country’s scrip would be a zero-coupon security, to be redeemed in Euros at face value over an uncertain term. (I think fixed-payout, time-varying claims represent an underused design for securities; I’ve suggested them elsewhere.) Each week, each government would issue a new batch of scrip, to cover that week’s domestic payments. The rules for redemption would be simple: first-issued, first-redeemed, at a pace determined at the discretion of the Treasury without precommitment. Governments whose tax receipts easily cover their expenditures could choose to redeem the scrip nearly instantaneously (after some minimal period, perhaps one week). Governments that wish to run a deficit would redeem scrip more slowly.

The scrip would not become a de facto domestic currency. It would be too fragmented; each week’s vintage would have a different market value. Scrip would not be redeemable at face value to pay taxes.

What this all amounts to is a means by which states can finance themselves with forced borrowing from their own citizens who receive government payments. That sounds a bit mean, but it solves two important problems that currently plague the Eurozone:

  • International fragility — As the Greek crisis highlights, sovereigns ought not rely upon foreign borrowings in a currency the state cannot issue. The future is always uncertain, and when things go wrong debt securities must default or be renegotiated. That is awful even in small-scale private contexts. In an intersovereign context, it can lead to immiseration on a large scale through depression or war. Successful states mobilize the risk-bearing capacity of their own populations in order to finance government activity. Domestic politics can adjucate conflicts between local creditors and the public’s interest in government services in ways that outside institutions cannot. The interests of domestic creditors overlap much more with other domestic constituencies than the interests of foreign creditors do. International creditors have very little reason to support the work of a foreign government (other than taxation and debt service), while domestic creditors balance their interest in getting paid against other interests related to government performance.

  • No constituency for taxation — The Euro was conceived as currency of “prudence”, with its Stability and Growth Pact intended as a straitjacket on government borrowing. So it is ironic that the architecture of the Eurosystem destroyed the incentives of domestic constituencies to support efficient tax collection. By design, the Eurosystem preserved the practical ability of Eurosovereigns to borrow from the banking system inexpensively and at will (a privilege which remains intact, supported by the ECB, for all countries except Greece). Beneficiaries of government expenditures had little reason to support taxation, since the funds they wanted spent could be borrowed. More importantly, the Eurosystem absolved domestic constituencies of the usual consequence of undertaxation, that their incomes and saving would lose value from inflation. Ordinarily, creditors in any country are powerful constituencies for balanced budgets and “sound money”, which sometimes means cutting expenditures but also means raising taxes when expenditures cannot be cut. [1] While Eurozone states that borrowed (whether as sovereigns or through banking systems) did experience higher inflation than creditor countries, the difference was modest. Citizens knew that the value of their money was externally anchored, a Euro would always be a Euro. This imported stability hindered the emergence of any domestic constituency in favor of developing (and exercising) the state’s capacity to collect taxes.

    If government domestic expenditures, including transfer payments like pensions, are made in the scrip proposed, the market value of those securities would be directly related to the perceived willingness and ability of the state to tax in order to retire the IOUs at a reasonable pace. The villains’ in lazy creditor morality tales — beneficiaries of the welfare state, govenment employees, vendors of goods and services to the state — would become powerful constituencies for building and maintaining an efficient tax system. This would restore the natural tension in domestic politics, a balance that Eurozone institutions uninintentionally destroyed, between domestic constituencies with an interest in taxation, and other domestic interests who would be net payers of tax and so lobby to streamline expenditures.

This proposal would not fragment the Eurozone. The Euro would remain the universal unit of account and medium of settlement. [2] The proposal would loosen the strictures on government expenditure compared to existing arrangements, but importantly, the risk associated with that extra fiscal freedom would be borne entirely by domestic constituencies, not by external creditors. It would restore to Eurozone states some of the tools they lost for managing domestic shocks, without requiring unpopular transfers or destructive borrowing from other states. It would strengthen Eurozone states, as polities.

The lesson of the Asian Financial Crisis and the extraordinary reversal of financial flows that many Asian countries were able to engineer is that the strength of a state is largely a matter of its capacity to mobilize domestic risk-bearing, rather than rely upon external finance. Eurozone institutions unintentionally short-circuited that capacity. It’s time to restore it.


Some institutional details:

  • Universality — This proposal should be implemented universally within the Eurozone, as an institutional innovation for the common currency. Within states that have no immediate need for new borrowing, the market value of “state expenditure notes” would be par, and no one would have reason to complain. However, if adoption of the notes were made optional and became associated with perceived-as-weak states, states that could really benefit from financial flexibility and incentives to develop an effective tax system would be reluctant to adopt them for fear of stigma. A fig leaf — “Even the Germans do it!” — is the one concession to solidarity that this proposal requires. Otherwise, this proposal segregates risk, rather than blurring borders, which might be a relief to Northern European publics.

  • Liquid Markets — All states would be required to arrange low-transaction-cost, liquid markets in state expenditure notes. Recipients of government expenditures who need to make immediate payments may choose to convert them to cash Euros at a discount. Others may hold their notes and await redemption at face value. The discount to face at which the securities trade would provide ongoing information about the perceived fiscal strength of the state, and a very visceral incentive for recipients to see to that strength.

  • Banking considerations — Domestic, and only domestic banks, would maintain custody of the notes on behalf of customers. However, the notes would be held in segregated accounts, not on bank balance sheets. The Eurozone desperately needs to eliminate bank exposure to the sovereign debt of member states. These proposed notes would be an unusually speculative form of sovereign debt, and absolutely inappropriate as bank assets. Banks would merely provide the service of holding notes for customers and liquidating them into customer accounts on demand, as an important convenience and at regulated spreads.

  • Definition of “domestic expenditures” — A “domestic expenditure” by a member state would be defined as a payment to a domestic bank account. All domestic bank accounts would be paired with custodial accounts for expenditure notes. States could insist that transfer payments be made to domestic accounts, and might prefer to purchase goods and services from firms with domestic accounts as well. Foreign firms wishing to do business with cash-strapped governments and willing to accept the financing terms might open local bank accounts, but in general this restriction would ensure that most of the notes are spent to domestic constituencies. Speculation in the notes by nonresidents would be discouraged, in order to keep incentives (maximize the rate at which notes can be redeemed) and control (vote and participate in domestic politics) well-matched.

  • Interaction with traditional debt — The rate of redemption of expenditure notes would be entirely at the discretion of the issuing government, while coupon and principal payments on traditional debt must be made on a preagreed schedule. In that sense, one might imagine expenditure notes to be “junior” to Treasury bills and bonds. However, in the event of default, debt restructuring, or sovereign refinancing by ESM / EFSF / ECB / IMF / etc., expenditure notes would be treated as senior to other Treasury securities. (Expenditure notes would be treated analogously to uninsured deposits in bank capital structures, available for “bail-in” only after other unsecured creditors have been wiped out.) This is very important, as it would encourage buyers of traditional securities to price the credit risk of the sovereign’s full capital structure, including the debt embedded in outstanding expenditure notes. Formal seniority also reduces the risk that foreign creditors will be able to use the notes to shift the consequences of their own poor credit allocation decisions onto involuntary domestic creditors.

    Of course, short of an outright restructuring or refinancing, governments might choose to slow redemption of expenditure notes in order to retire traditional debt, which is fine. Strong domestic constituencies would limit the pace of such a reprofiling. If, eventually, finance via expenditure notes largely replaces traditional sovereign debt, that would be great. Domestic finance is much better for a polity than foreign finance, and variable maturity notes decay in value gracefully, while overextension of traditional debt causes disruptive oscillations between complacency and crisis.


Update: Perhaps the first proposal to address Eurozone problems via issuance of scrip came from Warren Mosler. When putting together cites for this post, I did not find that proposal where I had linked it previously, and simply omitted it. Fortunately, my commenters are not as lazy as I am, and point me to this 2012 version by Mosler and Philip Pilkington. I am very glad to acknowledge the prescience of Mosler’s work and the very strong influence of his “Modern Monetary Theory” on the thinking that underlies this post. My apologies for the original omission, and thanks to commenters JKH and Roberto for helping to remedy it.


[1] This may seem a little far-fetched in a US context, where creditors prioritize low taxes over any other thing, but that is unusual. The United States’ “reserve currency” status blunts the effect of debt and money issue on currency value, so creditors have less reason to prefer taxation to borrowing. In a small country with a floating currency, the potential hazard of overissuing government paper is more immediate to holders of local currency debt.

[2] Currencies are no longer “media of exchange” except for very small transactions. They are means of settlement. When I make a purchase with my credit card, I do not trade dollars for goods, but issue a bond (guaranteed by my bank) that may be eventually settled in government money if the recipient demands it. Currencies are media of settlement, not exchange.

Update History:

  • 24-Jul-2015, 5:20 p.m. EEDT: Bold update highlighting and acknowledging MMT and Mosler’s earlier work.
  • 24-Jul-2015, 10:30 p.m. EEDT: Added links to Bossone & Cattaneo proposals.