In Canada, the state of the economy has everyone worried. The fall in oil prices is causing the oil sector in the western provinces and in some of the Atlantic provinces to contract. As a result, everyone has the impression that Canada is sliding towards a recession and governments should act.
I disagree. My disagreement is fueled by two factors. The first is that we should never reason from a price change. The fall in the price of oil is mostly the result of increasing supply of oil. Such a price change is actually a good thing for the Canadian economy. The slowdown in economic activity is merely the result of frictions in the reallocation of resources. The second reason is that the slowdown is caused by “real factors” – policy decision affecting key regions of the Canadian economy. Any government action would worsen a situation caused by too much interference in the first place.
A fall in oil prices can indeed affect the Canadian economy. The oil produced in Canada is generally profitable when prices are relatively high (they require very capital-intensive methods of extraction and refining). An increase in the world oil supply (which is the case right now) would indeed affect the Canadian oil industry. However, Canadians win through lower oil prices – one important input has gotten cheaper. The problem is that once such a slowdown happens, resources are not reallocated without frictions. Business plans are positively affected by the lower oil prices and numerous firms are laying out new plans to expand production. Employment and output will fall in the oil industry before they will pick up in other industries. Eventually, there might even be greater output and employment because of the greater worldwide supply of oil. Right now, Canada is in-between those two situations.
My second reason for dissenting from the majority opinion is that certain regions of the Canadian economy are plagued by poor policy. To make my argument, consider a two-region (West and East) and two-industry economy (oil and manufacturing/services). In the West, the dominant industry is oil. In the East, the dominant industry is manufacturing/services. The West economy has a more flexible market for inputs (limited regulation, freer labor market and low taxes on capital). The East economy suffers from greater rigidity in its market for inputs – high taxes, burdensome regulation and stringent labor laws.
In a way, this describes the Canadian economy. The provinces of Alberta, Saskatchewan, Manitoba and British-Columbia have been pulling the rest of the Canadian economy for the last twenty years. That’s the West. In the East, the historically poorer province of Quebec has been constantly pulling everyone behind, but less so in recent years as the province of Ontario (the most populous of Canadian provinces) began to slow down. Ontario dramatically expanded the size of its public sector, implemented important regulations and raised taxes – straight in the middle of the recession. In fact, if you exclude Ontario from the rest of Canada, you find (as Philip Cross did) that Canada’s performance is actually quite decent. So in the East, you have Quebec whose policies have not changed and you have Ontario who has adopted increasingly anti-growth policies. The East also has consistently higher taxes. The West has lower taxes. Etc.
Given the accuracy of this stylized description, imagine the effect of a shock on the western economy through a shock on its oil industry. Normally, firms in the East could adapt to lower oil prices by expanding their output in the manufacturing/services sector (thanks to cheaper inputs) while firms in the West contract their output and liberate inputs. However, in the presence of government-imposed frictions, this reallocation of resources is much harder and output has a harder time expanding in the East.
No demand-side policy can solve this problem! You could have easy money and a massive stimulus program, but if firms are discouraged from increasing output, little will happen. In Canada, the current slowdown is explained by “real factors”. Improving provincial policies would be the best channel for improving the state of the Canadian economy.
Sean McFate, a political scientist at National Defense University in Washington, DC, has a fascinating article in Aeon about the reemergence of mercenary and quasi-mercenary security firms throughout the world. The whole article is fulfilling throughout, especially if you’re a well-read anarchist or a history buff, but I wanted to highlight this tangent:
With the fall of the South African apartheid regime, unemployed soldiers from special forces units such as the 32nd Battalion and the Koevoet (‘crowbar’ in Afrikaans) special police formed the first modern private military company, appropriately named Executive Outcomes. Unlike WatchGuard, Executive Outcomes was not a military enterpriser but a true mercenary firm, waging war for the highest bidder. It operated in Angola, Mozambique, Uganda and Kenya. It offered to help stop the genocide in Rwanda in 1994, but Kofi Annan – then head of UN peacekeeping – refused, claiming ‘the world may not be ready to privatise peace’. Annan’s was an expensive ideology, given the fact that 800,000 people died. By 1998, the company closed its doors, but the mercenary market for force surged.
Two aspects are important here, one said and one unsaid. First, the unsaid. If this mercenary outfit was “waging war for the highest bidder,” why did it offer to go in to Rwanda to stop the bloodshed? I think scholars assume the worst when it comes to stateless actors and warfare. Why has Anheuser-Busch begun shipping free cans of water into Flint, MI?Why does Wal-Mart donate billions of dollars to charity? When it comes to reputation, costs may sometimes not make sense to outside observers who don’t have a sufficient understanding of benefits. Why on earth would a corporation built solely to wage war for the highest bidder be interested in offering its services to a country that would not be able to afford its services? To ask the question is to answer it, of course, but understanding incentives using a costs-benefits framework requires more effort than you might suspect.
There is simply no logical coherence to the idea that, in a world where stateless mercenary firms are the prominent form of security, violence and lawlessness will reign supreme; nor is there any evidence whatsoever to suggest that “[m]ore mercenaries means more war, as they are incentivised to start and expand wars for profit, and turn to criminality between contracts.” Indeed, as McFate notes in his excellent article, the market for security is already becoming freer and while he ends his piece on a depressing note, lamenting this indisputable fact of the present-day world, I couldn’t help but remember the now-famous graph on battle death trends produced by political scientist Jay Ulfelder (using data from the Uppsala Conflict Data Program [UCDP]), which illustrates nicely the overall decline in deaths due to warfare violence around the world:
Notice that the most deadly conflicts are the ones involving states with armies that had been nationalized?
Now, two graphs showing that deaths from warfare have been in decline for half a century does not necessarily mean that a freer market in security services has led directly to this overwhelmingly good news. I am confident in claiming, though, that the freeing up of security services markets, combined with the steady presence of a few, still-powerful nationalized armies has led to a reduction in war-related deaths (and violent conflict in general). Both graphs illustrate well what happens when there are too many nationalized armies vying for power and prestige. (It is worth noting here that the main goal of diplomats and policymakers everywhere, no matter their ideological orientation or citizenship status, is still to avoid another world war.)
Second, the said. Annan’s refusal to decriminalize mercenary activities led directly to the 800,000 Rwandan deaths. How is this moral failing any better than when a mercenary firm breaks its contract and ends up killing a few dozen more people than it was supposed to? Again, the graphs are useful here: When conflict is nationalized, everybody suffers; when it is privatized, atrocities happen but not on the same scale we have seen with nationalized conflicts. It’s not even close. Annan’s short-sightedness reminds me of economist Scott Sumner’s 2012 summary of Hillary Clinton’s view of the War on Drugs:
[…] in response to a final question on drugs (from a Latin American reporter), she said drug legalization would do no good because drug dealers are really bad people, and they would simply do other crimes. No discussion of how America’s murder rate fell in half after alcohol was legalized in 1933.
Like drug use, the privatization of security services causes many people, well-educated or otherwise, to bristle at the notion without quite thinking through its logical implications. While ugly, mercenary firms are far more efficient and effective at quelling “bush wars” than are nationalized armies and, in turn, mercenary outfits are far less capable of sowing the type of destruction that nationalized armies routinely carry out.
I don’t think that a world with a few nationalized armies and an abundance of mercenary firms is necessarily the best option going forward, though. It is, however, a better option than most scholars and analysts give it credit for. In fact, it’s the best option at the moment, and while the status quo may sometimes be ugly, remember the graphs. Privatization of security services has contributed, at least in part, to a more peaceful and less violent world.
In order to move forward from this status quo it is best not lament the way things are going, but to acknowledge that things are the way they are for a reason, and then look for avenues to alter the status quo without falling back on a blanket policy like nationalizing security services again. The horrors of the World Wars should still be fresh in our minds, and the horrors of those wars were enabled and encouraged by nationalized security forces.
The best way to move forward is by looking at where these “bush wars” are taking place and begin thinking about ways to incorporate these regions into the global order (such as it is). This policy represents a departure from traditional post-war thinking about international relations, but it doesn’t make it radical or unfeasible. Indeed, there is a long tradition of republican thinking in Western thought pertaining to international relations. The West needs to start recognizing the legitimacy of secessionist sentiments in the post-colonial world, even if it means friction with Russia and China.
Washington and Brussels will have to endure charges of hypocrisy when it comes to ignoring the lobbying efforts of places like Tibet and Dagestan, but Biafra should have become a member state of the United Nations long ago. Baluchistan should have access independent of Pakistan and Iran to the IMF and World Bank. Two or three soccer teams from the region known as Kurdistan could easily be present in all major FIFA tournaments. Examples abound throughout the world. The West should also be open to recognizing arguments made by Russia and China for the independence of regions. There is no good reason why Western diplomats should ignore Moscow’s recognition of places like South Ossetia and Donetsk; doing so only hardens Russia’s stance on recognizing secession in parts of the world where its influence is limited or non-existent and forces the West into bed with unsavory post-socialist regimes.
The West needs to start being more inclusive when it comes to its own federal and republican institutions, too. Morocco, for example, should have had its 1987 application to join the European Union taken seriously (same goes for Turkey). The US federation needs to be actively courting polities like Puerto Rico, Coahuila, Alberta, and Micronesia to join the union. Both the EU and US are contracts designed to dampen violent conflict by fostering diplomatic, economic, and cultural intercourse between provincial polities. The reasoning behind exclusionary policies simply doesn’t answer why these republican, supranational organizations should not be actively recruiting neighboring or geopolitically useful administrative units into their representative systems.
Without this change in mindset the status quo will continue, which again if we remember the graphs is not all that bad, but something worse may happen: There could be a reversion to the blanket nationalization of security services that we saw during World Wars I and II.
More than a year ago I promised Jacques a post on sovereignty and while I am not always able to follow up very quickly, I tend to do what I promise. So here it is! Jacques’ main cri de coeur was why (classical) liberals should care about sovereignty at all.
When it comes to the theoretical discussion about sovereignty (the literature is huge), I think there is no better start than the work of international relations theorist Robert Jackson. Or better and broader: any thinking about international relations benefits from this Canadian, former Boston University professor, especially his magnum opus The Global Covenant: Human Conduct in a World of States(Oxford University Press, 2000). But this is a side step.
sovereignty is an idea of authority embodied in those bordered territorial organizations we refer to as states, and is expressed in their various relations and activities, both domestic and foreign. It originates from the controversies and wars, religious and political of sixteenth and seventeenth century Europe. It has become the fundamental idea of authority of the modern era, arguably the most fundamental.
Also in regions where other kinds of arrangements existed before Western imperialism.
It is at the same time both an idea of supreme authority in the state, and an idea of political and legal independence of geographically separate states. Hence, sovereignty is a constitutional idea of the rights and duties of the governments and citizens or subjects of particular states. It is also an international idea of multiple states in relation to each other, each one occupying its own territories and having foreign relations and dealing with others, including peaceful and cooperative relations as well as discordant relations and periodical wars.
Of course a lot of popular and academic discussion follows from this, for example about the particular form of sovereignty (popular, or not), the relation between power and sovereignty, sovereignty and globalization, or if and when sovereignty may be breached to protect others through intervention. Yet here I solely focus on the relation between sovereignty and liberal political theory.
Concerning the domestic supremacy side of sovereignty a lot has been written by liberals. Most liberals (classical, social, and even libertarian minarchists, such as Ayn Rand or Robert Nozick; see my Degrees of Freedom for the precise definitions) realize some form of state is needed to protect individual rights. A state embodied with sovereignty. At the same time most liberals (social liberals less so, because they favor a relatively large state) recognize the state is also the largest danger to individual freedom. How to balance the two is the perpetual question of liberal political thought, one also without a definitive answer or solution, so far.
Less attention has been given to the international side of sovereignty. There are a number of libertarians, such as the anarcho-capitalist Murray Rothbard, or his intellectual successor Hans-Hermann Hoppe, who think there should not be states, hence no issues of sovereignty exist once their stateless world has materialized (they remain largely silent about how to reach that situation). Yet it seems to me the thinking should not stop there. These same thinkers romanticize the idea of secession, yet seem to overlook that those seceded groups or communities also need to deal with other seceded groups and communities. They are a bit lazy when stating everybody should look after themselves, and only defend themselves in case of attack by others. If everything would be nice and neat among people this might be ok. Yet of course history shows (also in those areas where sovereignty never played a big role before Western imperialism) that people interfere all the time in each others affairs, some rulers may have malign intentions, others belief some parts of the seceded lands belong to their community, let alone issues about religion, et cetera. In short, chances on a peaceful world with the occasional conflict that can be solved by self defense are zero.
Funnily enough, social liberals share the idea of the possibility of a world peace and cosmopolitan harmony. They also favor the abolition of sovereign states, not through secession but through the pooling of sovereignty at the transnational level, with the European Union as an example and a world federation as the ultimate end goal. This seems just as unrealistic, as even the EU is still mainly governed from the member states, as the current refugee crisis and the possible dissolution of the Schengen agreement illustrates. More generally, the pooling of sovereignty proves rather difficult, also in other parts of the world. ASEAN in South East Asia is an example.
More realistic are classical liberals, such as Hume, Smith, and Hayek, who acknowledged an emotional tie between the individual and his country, as well as the constant need to defend individual property rights against invasion by others, through standing armies, diplomacy, some international treaties, the balance of power, et cetera. Human nature does not allow for starry eyed fantasies about international harmony, let alone international peace. Hence, it is rather normal to care about external sovereignty, as it is foremost a means of protection. Not the sole means, but an important and fundamental institution of international relations.
Mordanicus of Fascinating Future, a sci-fi blog, is musing over the purpose of galactic government. As Mordanicus points out, galactic empires are a staple of science fiction. They can be found in the Star Wars, Star Trek, Dune, Firefly and Foundation universes.
…the feasibility of a galactic empire is questionable.
In Asimov’s description of the galactic empire, it consists of 25 million inhabited planets and 500 quadrillion people, 20 billion per planet on average. It is hard to even imagine a planetary empire, and no such thing has ever existed in human history, let alone such enormous empire.
The fundamental issue with an empire of this size is effective control by the central government. Its sheer size makes it inevitable to delegate many administrative powers to “local” planetary official. But the more power is transferred to individual planets, the less power remains with the central government. The question is then what is the proper function of the imperial government?
What is the purpose of these empires though? In those sci-fi universes with aliens these empires serve some defensive role for our Milky Way galaxy, but in many sci-fi universes there is no clear visible external threat. What is the purpose of the empire then? Or is it simply a way for wealth distribution by those living in the Saturn beltway?
I personally view merit in a galactic empire if it were able to maintain internal peace. I have no doubt that in a space faring civilization there will be pirates and I believe that there are economies of scale in galactic trade route policing.
There is also merit in an empire that can keep rogue planetary governments in check. A galactic empire would be restrained in its ability to govern on its own given the largess of space and would need to delegate many functions to different layers of government. An empire would however still serve as a last layer of resort for those petitioning against their planetary government.
What about NOL readers? Are you convinced that space piracy warrants an empire? Or would a space faring civilization be better government by planetary or sub-planetary governments?
The idea of splitting up California has been previously discussed on NOL (see here, here, and most recently). In this post I wish to consider how California could be split up.
California has a large population of 38.8 million. For comparison Canada has 35.1 million residents distributed among its 10 provinces and the New England states house 14.7 million yankees in six states. With such a large population it is not surprising that the state has several regions with distinct cultures. This in itself is not sufficient merit to split up the state. One of the wonders of a liberal republican form of government is that diverse populations can coexist so long as they are treated equally before the law and have the freedom to exercise their various cultures. The problem is when these cultural differences lead to different public policy demands.
Consider for example the issue of abortion. In most matters of religion it is sufficient to allow different faiths to practice their beliefs so long as they keep to themselves. Why should non-Jews care if Jews must follow kosher dietary restrictions? The same cannot be done with abortion though. Those who believe, often due to their religious inclinations, that abortion is murder cannot tolerate its practice among those of other faiths or atheists. What is to be done?
One option would be to break up California. Although those on both sides of the abortion debate exist across California, there is also quite a bit of spatial correlation. See here. The Central Valley and Inland Empire counties both have significant portions of their populations favoring abortion limitations. Both regions also have low support for same sex marriage, see here, so it is safe to assume that their cultural differences with the rest of California is not on just one issue but several important public policies.
I would caution those who propose splitting up California between its inland and coastal regions. Both the Central Valley and Inland Empire may be culturally conservative, but the inland northern counties do not seem to fall in line. Nor would I recommend the Coastal/Inland split for those concerned about partisanship, see here. The San Francisco Bay Area, Northern Coast and Los Angeles are liberal strongholds but the Central Coast and Orange-San Diego region aren’t.
Similarly a North/South split would do little to help address regional cultural differences. The North/South split would usually split the state apart at San Luis Obispo-Kern-San Bernardino county lines. This would lead to the conservative Central Valley being lumped into the same state as ultra-liberal San Francisco. Meanwhile the Inland Empire and Orange-San Diego counties would find themselves sharing a state with blue Los Angeles.
What would be a good split then?
I personally favor the creation of four new states. Jefferson (the northern coastal and inland counties), San Francisco (the bay area states), Los Angeles (LA County), Central Valley (everything between Fresno and Bakersfield roughly) and the rest of southern California.
Given that any division would have to be approved by Congress the new states of Jefferson, San Francisco, and Los Angeles would have to be gerrymandered in such a way as to ensure they are blue states and maintain as many electoral votes from old California as possible. The Central Coast would likely be gobbled up between LA and San Francisco. This gerrymandering would be needed to get Democrat votes who would otherwise be against losing all those electoral votes. Although Democrats would get two more seats in the Senate the Republicans could favor the deal in order to sweep extra electoral votes from the Central Valley and Southern California.
Although the split would be less than perfect, it would still grant greater say over public policy to the conservation counties.
Thoughts? Further maps on Californian public policy opinions can be found here.
P.S. In regards to the water issue, I like to think that the split of California would lead to a revision of the Colorado River Compact and related laws in order to create a more market oriented process for water allocation. I can dream can’t I?
The problems regarding the use of tax units instead of households is not new. In fact, it is one of the sticking point advanced by skeptics like Alan Reynolds (see his 2006 book) and, more recently, by Richard Burkhauser of Cornell University (see his National Tax Journal article here).
Could it be that all the differences between GDP per person and income per tax unit are caused by this problem? Not really.
There is an easy to see if the problem is real. Both measures are ratios (income over a population). Either the numerator is wrong or the denominator is wrong. Those who view tax units as the problem argue that the problem is the denominator. I do not agree since I believe that the numerator is at fault. The way to see this is simply to plot total income reported by all tax units and compare this with real GDP. What’s the result?
Even with tax-reported income being deflated with the Implicit Price Deflator (IPD) instead of the consumer price index, we end up with a difference (in 2013) of roughly 3 orders of magnitude between GDP and tax-reported income relative to the 1929 base point. Basically, GDP has increased by a factor of 14.749 since 1929 while IPD-deflated tax-reported income has only increased by a factor of 11.546.
As a result, I do not believe that the problem is the tax unit issue. The problem seems to be that tax data is not capturing the same thing as GDP is!
In the debate on inequality, I am a skeptic of how large a problem the issue is. Personally, I tend to believe that worries of inequality only increase when growth is stagnant. In fact, I also believe that there are numerous statistical biases causing us to misidentify stagnation as rising inequality. Most of the debate on inequality is plagued with statistical problems of daunting magnitudes (regional convergence in income, regional price levels, demographic changes, increasing heterogeneity of preferences, increasing heterogeneity of personal characteristics, income not being purely monetary, the role of taxes and transfers etc.)
One of them centers around the use of tax data. This has been the domain of Thomas Piketty and Emmanuel Saez. I can understand the appeal of using tax data since it is easily available and usable. Yet, is it perfect?
A year or two ago, I would have been inclined to simply say “yes” and not bother with the details. Theoretically, taxes should be an “okay” proxy for the income distribution and should follow average income even if at different levels. Yet, after reading the article of Phil Magness and Robert Murphy in the Journal of Private Enterprise, I confess that I am no longer accepting anything as “granted” in the inequality debate. So, I simply decided to chart GDP per capita with the average taxable income per tax unit. Just to see what happens. Both are basically averages of the overall population, they should look pretty much the same (theoretically). The data for the tax units is made available in the Mark W. Frank dataset based on the Piketty-Saez data (see here) and I deflated with both the CPI and the implicit price deflator available at FRED/St-Louis.
The result is the following and it shows two very different stories! Either the GDP statistics are wrong and we have average stagnation (which does not mean that there is no increase in inequality) or the taxable income data is wrong in estimating the trend of living standards and the GDP are closer to reality (which does not that there is no increase in inequality). In the end, there is a problem to be assessed with the quality of the data used to measure inequality.
The US stock market had its worst ever initial trading weeks in 2016. Speculators are alarmed by the fall in the stocks of China. The economy of China has been growing more slowly, if at all. Also, most of the economies of the world are in growth recessions, a reduction in the rate of growth. The US dollar is high relative to other currencies, which reduces exports.
The government of China has yet to learn that interventions into financial markets often backfire. The Chinese chiefs have halted stock transactions when the market average falls to seven percent. They also have not allowed sales by investors who own more than five percent of a company. One problem with financial “circuit breakers” – a halt of trading – is that when stocks start to fall, speculators will panic and sell more quickly before trading halts. Restrictions on selling stocks create uncertainty when buying them. A speculator will fear being unable to sell shares later.
There is enough inherent uncertainty in markets without government adding to it. Uncertainty makes it important to let the market set the prices. Markets are a discovery process in which prices and quantities evolve through the bids of buyers and offers of sellers. When government interferes, we cannot know the price. Since the leaders of China have decided to have a market economy in goods, input factors, and financial assets, they should allow the market to do its job of setting the prices.
When I visited China three times, I saw a forest of cranes in all the cities I went to. Construction has driven the economy of China, along with exports. But, similar to real estate booms elsewhere, this construction was propelled by governmental policy. Throughout the world, cheap credit and fiscal subsidies to real estate have fueled unsustainable speculation.
Now China has much excess building capacity, and the halt in construction reduces related goods such as furniture and raw materials. The slow-down in China and sluggish growth elsewhere has resulted in a collapse of commodity prices.
The chiefs of China seek to move the country’s economy towards more domestic consumption. But they interfere with domestic spending by imposing a value-added tax of 17 percent on most goods other than real estate. The government of China probably chose to impose a VAT because the World Trade Organization allows the VAT to be subtracted from the price of exports, unlike an income tax. But Chinese consumers suffer a higher cost of living.
The Chinese leaders could have instead enacted LVT, land-value taxation, which would not add to the cost of goods. A tax on land value reduces the purchase price but not the land rent, so also not the price of goods. A tax on most of the rent or land value would stop the land speculation that has made a few people rich at the expense of the public.
The government of China still maintains tight control over the banking system. All the markets – real estate, financial, goods – would be more efficient if interest rates too were set by the market supply and demand for loanable funds. Of course the central banks of Europe, Japan, and the USA also are not letting their markets set the money supply and interest rates. But common practice does not imply optimal policy.
I don’t think the big drop in stock market averages imply impending economic doom. For 200 years, the US economy has had a real estate cycle of an average duration of 18 years. The current cycle began with the depression of 2008. The recovery has been slow, but the expansion has continued as employment and output have grown. Real estate construction has contributed to the expansion, and land values have recovered. The economy seldom has a recession while interest rates and commodity prices are low.
The economy of China has some severe long-run problems, but its economy is still developing and catching up. The government seems ready to let the currency trade more freely, and the coming acceptance of the currency (the yuan or renminbi) into the “special drawing rights” of the International Monetary Fund will boost the economy.
In the short run, the US stock market could fall some more, as markets often overreach, but over the next few years, financial markets will be consistent with the economic reality of restored world-wide economic growth, if there are no major destructive attacks. What we should be worried about is the unsustainability of debt and the next real estate speculative boom. The next economic disaster is about a decade into the future, and nobody is yet alarmed about that.
A week ago, I initiated a discussion on using another indicator of nominal spending instead of NGDP when the time comes to set monetary policy. My claim was that NGDP includes only final goods and as a result, it misses numerous business-to-business transactions. This means that NGDP would not be the best indicator. I propose a shift to a measure that would capture some intermediate transactions.
The result was a response by Nick Rowe (to which I did respond), Matt Rognlie, Marcus Nunes and Scott Sumner (to whom I am responding now). Nunes and Sumner are particularly skeptical of my claim. I am providing a first response here (and I am attempting to expand it for a working paper).
The case against NGDP
GDP has important shortcomings. First of all, thanks to the work of Prescott and McGrattan (2012 : 115-154), we know that a sizable part of capital goods acquisition fails to be included inside GDP. That sizable part is “intangible capital” which Prescott and McGrattan define as the “accumulated know-how from investing in research and development, brands, and organizations which is the most part expensed rather than capitalized” (p.116). Yet, investments in research and development are – in pure theoretical terms – like the acquisition of capital goods. However, national accounts exclude those. Once they’re included in papers like those of Prescott and McGrattan and those of Corrado, Hulten and Sichel (2009), increases in productivity were faster prior to 2008 and that the collapse after 2008 was much more pronounced. In addition, this form of capital is increasing much faster than tangible so that its share of the total capital stock increases. Thus, the error of not capturing this form of capital good investment is actually growing over time causing us to miss both the level and the trend.
A second shortcoming of importance is the role of time in production. Now, just the utterance of these words makes me sound like an Austrian. Yet, this point is very neoclassical since it relies on the time to build approach. In the time-to-build model of the real business cycle approach, production occurs over many periods. Thus changes in monetary policy may have some persistence. The time-to-build model proposes that firms undertake long projects and consume more inputs. In terms of overall transactions, this will mean more and more business to business (B2B) transactions. Hence if an easy monetary policy is inciting individuals to expand their number of projects that have more distant maturities, then a focus on GDP won’t capture the distortionary effects of that policy through. Similarly, if monetary policy tightens (either directly as a fall of the money supply or through an uncompensated change in velocity), the drop in economic activity as projects are closed down will not equally well captured. While this point was initially advanced by Kyland and Prescott (1982), some Austrians economists have taken up the issue (Montgomery 1995a; 1995b; 2006; Wainhouse 1984; Mulligan 2010), several neoclassicals have also taken it up (Kühn 2007; Kalouptsidi 2014; Kyland, Rupert, Sustek, 2014).
Why shift to another measure
My contention is that NGO (Nominal Gross Output) allows us to solve a part of that problem. First of all, NGO is more likely to capture a large share of the intangible capital part since, as a statistic, it does not concern itself with double counting. Hence, most of the intangible capital expenses are captured. Secondly, it also captures the time-to-build problem by virtue of capturing inputs being reallocated to the production of projects with longer maturities.
Thus, NGO is a better option because it it tries to capture the structure of production. The intangible capital problem and the time to build problem are both problems of intermediate goods. By capturing those, we get a better approximate idea of the demand for money.
Let me argue my case based on the Yeager-esque assumption that any monetary disequilibrium is a discrepancy between actual and desired money holdings at a given price level. Let me also state the importance of the Cantillon effects whereby the point of entry of money is important.
If an injection of money is made through a given sector that leads him to expand his output, the reliability of NGDP will be best if the entry-point predominantly affects final goods industry. If it enters through a sector which desires to spend more on intangible investments or undertake long-term projects, then the effects of that change will not appear as they will merely go unmeasured. They will nonetheless exist. Eventually firms will realize that they took credit for these projects for which the increased output did not meet any demand. The result is that they have to contract their output by a sizable margin. In that case, they will abandon those activities (imagine unfinished skyscrapers or jettisoned research projects).
In such situations, GO (or even a wider measure of gross domestic expenditures) are superior to GDP. And in cases where the effects would start in final-goods industry, then they have the same efficiency as GO (or the wider measure of gross domestic expenditures.
The empirical case
The recurring criticism in most posts is that NGO is volatile over the period when the data is available (2005Q1-today). True, the average growth rate of NGO is the same as NGDP over the same period, but the standard deviation is nearly twice that of NGDP. However if you exclude the initial shock of the recession, the standard deviations converge. In a way, all the difference in volatility between the two series is driven by the shock of the recession. Another way to see it is to recompute two graphs. One is an imitation of the graphs by Nunes where NGDP growth in period T is compared with growth in the period T minus 1, but we add NGO. The second is the ratio of NGO to NGDP.
As one can see from the first figure, NGO and NGDP show the same relation except for a cluster of points at the bottom for NGO. All of those lower points are related to the drop from the initial recession. All concentrated at the bottom. This suggests that the recession had a much deeper effect than otherwise believed. The second graph allows us to see it.
The ratio of NGO to NGDP shows that the two evolved roughly the same way over the period before the recession. However, when the recession hit, the drop was more important and the ratio never recovered! This suggest a much deeper deviation from the long-term trend of nominal spending which is not seen at the final level but would be seen rather in the undertaking of long-term projects and the formation of intangible capital (the areas that NGDP cannot easily capture).
The case for NGO over NGDP is solid. It does not alter the validity of the case for nominal spending stability. However since the case for nominal spending stability hinges on total transactions of inputs and outputs more than it does on the final goods sold, NGO is a better option.
For example, value added for durable-goods manufacturing dropped 15 percent in 2009, while gross output dropped 19 percent. The decline in gross output is much more pronounced than the decline in value added because it includes each of the successive declines in the intermediate inputs supply chain required to manufacture the durable goods.
In Canada, I have the frustrating habit of criticizing government support to the agricultural sector especially entry-barriers in the form of production quotas. Most of those policies are regressive in the sense that they reallocate income from the poorest to the richest. In fact, their entire aim is to artificially increase the income of farmers (especially dairy and poultry farmers) at the expense of the rest of the population. However, when lobbyists for these subsidies come out in public, they do so under different disguises. Their favorite? Farms are dying.
In each radio debate where that boogeyman is raised, I reply that “yes, they are dying and its a good thing”. If we can feed more and more people with less and less farmers using less and less land, that’s a good thing. In fact, it’s the greatest thing that happened in economic history. Less two centuries ago, 90% of the workers in some western economies were involved in agricultural activities. Today, that proportion has fallen to less than 1.5%. Thousands of farms disappeared, we liberated millions of acres of land to return to their natural state and in the process, we became rich and well-fed!
In testimony of this fact, which is my favorite economic history fact, I decided to recompute a graph by Mark Perry of the American Enterprise Institute but I added the GDP per capita figures for the same period (1790 to 2013).
Yes, let the farms die. Let the most productive stay in the fields and let them feed humanity while the others become engineers, doctors, teachers, businessmen, welders, carpenters or whatever trade they are best at!
For a few months now, the case for the basic income has resurged (I thought it died with Milton Friedman in 2006, if not earlier). In the wake of this debate, I have been stunned by the level of disconnect between the pundits and what the outcome of the few experiments of basic income have been. The most egregious illustration of this disconnect is the case of the work disincentive.
To be clear, most of the studies find a minor effect on labor supply overall which in itself does not seem dramatic (see Robert Moffitt’s work here). Yet, this is a incomplete way to reflect on the equilibrium effect of a massive reform that would be a basic income.
Personally, I think that there is a good reason to believe that the labor supply reaction would be limited. At present, many tax systems have”bubbles” of increasing marginal tax rates. In some countries like Canada, the phasing out of tax credits for children actually mean that the effective marginal tax rate increases as income increases from the low 20,000$ to the mid 40,000$. As a result, a basic income would flatten the marginal tax rate for those whose labor supply curve is not likely to bend backward. In such a situation, labor supply could actually increase!
Yet, even if that point was wrong, labor supply could shift but without any changes in total labor provided. Under most basic income proposals, tax rates are dropped significantly as a result of a reduced bureaucracy and of a unified tax base (i.e. the elimination of tax credits). In such a situation, marginal tax rates are also lowered. This means greater incentives to invest (save) and acquire human capital. This will affect the demand for labor!
I have surveyed the articles compiled by Widerquist and added those who have emerged since. None consider the possibility of a shift of the demand curve. Even libertarian scholars like Matt Zwolinski (who has been making the case forcibly for a basic income for sometime now) have not made this rebuttal point!
Yet, the case is relatively straightforward: current transfers are inefficient, basic income is more efficient at obtaining each unit of poverty reduction, basic income requires lower taxes, basic income means lower marginal tax rates, lower marginal tax rates mean more demand for investment and labor and thus more long-term growth and a counter-balance to any supply-side effect.
As an economic historian, I’ve always had a hard time with the idea of secular stagnation. After all, one decade of slow growth is merely a blip on the twelve millenniums of economic history (I am not that interested with the pre-Neolithic history, but there is some great work to be found in archaeology journals). Hence, Robert Gordon’s arguments fall short on me.
That was until I was sparked to react to a comment by Emily Skarbek at Econlib. Overall, she is skeptical of Gordon’s claims of secular stagnation. But not for the same reasons. She claims that there are many improvements in welfare that we are not capturing through national income accounts. This is basically the same point as the one made by the great Joel Mokyr (the gold standard of economic historians).
It is true that national accounts have some large conceptual problems regarding measuring output when there are massive technological changes. Yet, all these problems don’t go in the same direction. More precisely, they don’t all lead to underestimation of growth.
My favorite example of one that leads us to overestimate growth is the one I keep giving my macroeconomics students at HEC Montreal. Assume an economy with a labor-force participation rate of 50%. Basically, only males work. All women stay at home for household chores and childcare. In that case, all measured output is male-produced output. Since national accounts don’t consider household production, all the output of women in the households of this scenario is non-existent.
Now assume a technological change causing a shift of 10% of women to the workforce at the same wage rate as men. That boosts labor participation rate to 55% and output by 5%. However, that would largely overestimate growth caused by this shift. After all, when my grandmothers were raising my parents, they were producing something. It was not worthless output. Obviously, if my grandmothers went to work, there was some net added value, but not as much as 5%. However, according to national account, the net increase in GDP is … 5%.
Obviously wrong right? Now, think of the economic history of the last 100 years. Progressively, female labor-force participation increased as marriages were delayed and family sizes were reduced. Unmarried women stayed on the market longer. Then, the introduction of new household technologies allowed some married women to join the labor force more actively. Progressively, women accumulated more human capital and became more active in the labor force. So much that in many western countries, both genders have equal labor-force participation rates.
As they shifted from household production to market production, we considered that everything they did was a net added value. We never subtracted the value of what was produced before. Don’t get me wrong, I am happy that women work instead of toiling inside a household to handwash dirty clothes. Yet, it would be both statistically incorrect and morally insulting to say that what women did in the household had no value whatsoever.
Sadly, I do not possess a continuation of such estimates to later points in time for the United States. I know there is an article by the brilliant Valerie Ramey in the Journal of Economic History, but I am not sure how to compute this to reflect changes in overall output. I intend to try to find them for a short piece I want to submit later in 2016. Yet, I do have estimates for my home country of Canada. Combining a 1979 paper in the Review of Income and Wealthwith a working paper from Statistics Canada, it seems that the value of household production falls from 45% of GNP in 1961 to 33% in 1998. When we adjust GDP per capita to consider the changes in household work in Canada, the growth path remains positive, but it is less impressive.
I am not saying that Gordon is right to say that growth is over. I am saying that the accounting problems don’t all go in the direction of invalidating him. In fact, if my point is correct, proper corrections would reduce growth rates dramatically for the period of 1945 to 1975 and less so for the period that followed. This may indicate that “slow growth” was with us for most of the post-war era. That’s why I reacted to the blog post of Skarbek.
It also allows me to say the thing that is the best buzz-kill for economics students: national accounting matters!
What a title for a blog post right? Where am I going with this? A few days ago, I debated a few of my academic colleagues who tend towards libertarianism in the predominantly left-leaning province of Quebec. The topic? How the rise of Uber is killing the taxi cartel? I authored a paper on ride-sharing a year ago and I cannot be more enthusiastic towards such technologies that are allowing consumers much more choices at lower prices than with the taxi cartel. Thus, we were all in agreement. The point of contention appeared when the topic of compensation was raised. I favor partial compensation of the owners of taxi licences. Instantly, I was cast in the minority position and branded as a statist. A debate ensued and I made the case that it was not acceptable to right a wrong by committing another wrong (how Christian of me).
First, let me lay out some facts first and some assumptions
A taxi licence restricting competition is a subsidy. But it is a strange type of subsidy that occurs through a redistribution of property rights (limiting the right to use one’s own car to carry individuals in exchange for payment to those who buy the transferable right to do so). Unlike cash subsidies, quotas, trade barriers and tax credits, it is the only form of income transfer that exists that is a property. You can abolish any cash subsidy, tariff, quota, tax, tax credits or legal monopoly without having to compensate since no one has property of such things. That is the source of the odd nature of the taxi licence – a subsidy with a property deed.
The two benefits from these licences occur through limiting competition and thus allowing higher prices/quality ratios and through higher asset value (the permit’s value). The extent of those benefits depends on the extent of the curtailment of the liberties of other to compete. The more restrictive the policy, the greater the redistribution from consumers to producers in the long-run.
However, new drivers have to pay a high price and they must have some time to recoup the acquisition of the asset. Their recovery will take some time as they also hike prices and lower quality.
So, if you want to abolish a taxi licensing scheme, is it acceptable not to compensate? According to my colleagues, yes it is. Since the benefits of higher prices were so considerable to those drivers (at the expense of consumers), compensation is not necessary.
Yet, the drivers do own property don’t they? The licence is worth many thousands of dollars, basically the value of a small house. Many drivers rely on this asset for their retirement. Now, let me make another presumption which is crucial to this discussion: the change is caused by legal changes, not technological changes.
I believe that, in the presence of the technological change, there is no case for compensation. Nobody would compensate telecoms companies for the rise of Skype since it is a process of entrepreneurship. However, the case is different if a government decides to abolish the licences. So here, my entire reasoning for compensation is contingent to a case where the state abolishes the licences, not a situation where technologies render the licences worthless like the car killed the street horses.
Clearly, it was unjust for consumers to deal with a cartel that gouged them and which was legally sanctioned to do so. But can you right an injustice by committing another injustice (the de facto dispossession of an asset)? Normatively speaking, I simply believe that using the monopoly of violence of the state to right the abuses caused by past uses of the monopoly of violence of the state is not that productive. Why? Because I have this assumption lodged firmly in my head as a result of my training in public choice theory: rent-seeking matters.
Rent-seekers will always exist. They are the social-science equivalent of gravity in physics. You just have to deal with their existence. Rent-seekers are basically political entrepreneurs who have very concentrated benefits from applying policies whose costs are not that obvious or that important for a large population. These political entrepreneurs are very alert to opportunities and they will seize them. Sometimes, they discover that their preferred course of action leads to resistance. They will automatically shift gear and find another way to obtain an unearned reward thanks to the complicity of those they bargain with (politicians and bureaucrats). Their rhetoric will change, their narratives will change, their arguments will evolve, but at the core, they will continue to rent-seek. True, you can conceive constitutional rules that limit rent-seeking (I am a big fan of that). However, one way or another, it will remain and some will find ways to connive with politicians and bureaucrats to obtain undue rewards. And even if there was such a utopia free of rent-seekers (I just won’t buy that for a dollar) where a constitution would ban their activities or even a stateless utopia (again, I am not buying it), is it acceptable to justify all means possible to reach such a destination?
What if associations of cab drivers lobby for special tax discounts on gasoline since they provide a public service? What if they lobby for stricter security checks on drivers (needless security checks) which end up having the same effects? What if they convinced regulators that only certain types of vehicles (less than 5 years old for example) should be allowed to operate? What if they mandated association with a dispatcher to better avoid traffic jams? How could a politician oppose special tax treatment for drivers, better security for consumers or all these other bogus motives? In the end, they will find a way to rent-seek. However, by dispossessing them of an asset worth many hundred of thousands of dollars, you are basically creating the certainty that they will aggressively rent-seek to recuperate their losses. Thus, you don’t end up breaking a vicious policy cycle, you end up encouraging its continuation in stranger, hidden and subtle manners whose perniciousness continues equally.
Hence my case that you can’t right a wrong by committing a wrong. Respect the rule of law, liberalize the market and compensate and attempt to rewrite constitutions to prevent arbitrary redistribution of property rights.
Murphy was not alone in predicting this, I distinctly remember a podcast between Russ Roberts and Joshua Angrist on this where Roberts tells Angrist he expected high inflation back in 2008. Their claims were not indefensible. Central banks were engaging in quantitative easing and there was an important increase of the state money supply. There was a case to be made that inflation could surge.
It did not. Why?
In a tweet, Caplan tells me that monetary transmission channels are much more complex than they used to be and that the TIPS market knew this. Although I agree with both these points, it does not really explain why it did not materialize. I am going to propose two possibilities of which I am not fully convinced myself but whose possibility I cannot dismiss out of hand.
Imagine an AS-AD graph. If Murphy had been right, we should have seen aggregate demand stimulated to a point well above that of long-run equilibrium. Yet, its hard to see how quantitative easing did not somehow stimulate aggregate demand. Now, if aggregate demand was falling and that quantitative easing merely prevented it from falling, this is what would prove Murphy wrong. However, all of this assumes no movement of supply curves.
While AD falls and before monetary policy kicks in, imagine that policies are adopted that reduce the potential for growth and productivity improvement. In a way, this would be the argument brought forward by people like Casey Mulligan in work on labor supply and the “redistribution recession” and Edward Prescott and Ellen McGrattan who argue that, once you account for intangible capital, the real business cycle model is still in play (there was a TFP shock somehow). This case would mean that as AD fell, AS fell with it. I would find it hard to imagine that AS shifted left faster than AD. However, a relatively smaller fall of AS would lead to a strong recession without much deflation (which is what we have seen in this recession). Personally, I think there is some evidence for that. After all, we keep reducing the estimate for potential GDP everywhere while the policy uncertainty index proposed by Baker, Bloom and Davids shows a level change around 2008. Furthermore, there has been a wave – in my opinion of very harmful regulations – which would have created a maze of administrative costs to deal with (and whose burden is heavy according to Dawson and Seater in the Journal of Economic Growth). That could be one possibility that would explain why Murphy lost.
There is a second possibility worth considering (and one which I find more appealing): the role of financial regulations. Now, I may have been trained mostly by Real Business Cycle guys, but I do have a strong monetarist bent. I have always been convinced by the arguments of Steve Hanke and Tim Congdon (I especially link Congdon) and others that what you should care about is not M1 or M2, but “broad money”. As Hanke keeps pointing out, only a share of everything that we could qualify broadly as “money” is actually “state money”. The rest is “private money”. If a wave of financial regulations discourages banks to lend or incite them to keep greater reserves, this would be the equivalent of a drop of the money multiplier. If those regulations are enacted at the same time as monetary authorities are trying to offset a fall in aggregate demand, then the result depends on the relative impact of the regulations. The data for “broad money” (Hanke defines it as M4) shows convincingly that this is a potent contender. In that case, Murphy’s only error would have been to assume that the Federal Reserve’s policy took place with everything else being equal (which was not the case since everything seemed to be moving in confusing directions).
In the end, I think all of these explanations have value (a real shock, a banking regulation shock, an aggregate demand shock). In 25 years when economic historians such as myself will study the “Great Recession”, they will be forced to do like they do with Great Depression: tell a multifaceted story of intermingled causes and counter-effects for which no single statistical test can be designed. When cases like these emerge, it’s hard to tell what is happening and those who are willing to bet are daredevils.
P.S. I have seen the blog posts by Scott Sumner and Marcus Nunes regarding my NGO /NGDP claims. They make very valid points and I want to take decent time to address them, especially since I am using the blogging conversation as a tool to shape a working paper.
I am at the moment enjoying my end-of-year-holidays in Macau, a micro-state next to Hong Kong and like Hong Kong also a Special Administrative Region (SAR) of China. Being a SAR basically means that Macau is allowed political and economic autonomy, but still belongs to the People’s Republic of China. This construction is also known as the “One Country, Two Systems” constitutional principle. Being here makes me realize once again the unique position of micro-states. Although I understand that GDP per capita is no measure of everyone’s personal income, I would still like to stress that Macau has the second highest GDP per capita income in the world in 2014 according to the World Bank and that the CIA has placed Macau at spot number 3. Macau has furthermore the 2nd highest life expectancy rate (CIA, 2012). Some other interesting facts about Macau:
0% VAT;
max. personal income tax rate of professional practices is 12% and only for incomes above MOP424,000 (~ 53,000USD);
currently 30% of this professional tax is waived;
tax free income threshold stands at MOP144,000 (~ 18,000USD);
Macanese residence in possession of an ID-card receive a yearly refund of 60% of the professional tax paid, subject to a cap of MOP12,000 (~ 1,500USD);
Macau is also known as a gambling/entertainment hub of Asia with the gambling/entertainment industry making up around 50% of the economy.
It is sometimes claimed that small autonomous political units are economically unviable, but Macau – like Hong Kong, Singapore, Monaco, Liechtenstein, Luxemburg and more – disprove this claim. Two reasons that are often given for the unviability of small autonomous political units are (a) economies of scale is difficult to realize in small states, and (b) they are vulnerable to trade shocks because their size prevents the states from wide diversification in economic activities. If these reasons would hold, then we would certainly find that micro-states are generally poorer than larger states. However, Easterly and Kraay (1999) have empirically found that micro-states[1] are 40-50% richer than other states when controlled for location by continent, controlled whether they are oil producers, and controlled whether they are members of OECD. In addition, Easterly and Kraay have found that life expectancies in these states are about four years higher and that the under-five infant mortality is lower by 22 per thousand. This suggests that micro-states do not suffer from developmental disadvantages.
Micro-states have been particularly more successful, because without abundant access to land and labour they are pressured to specialize their national economies[2] and to engage in international trade. International trade is particularly important in order to acquire goods that cannot be produced nationally. This pressure to trade encourages peaceful inter-state cooperation. Moreover, due to its small size, public policies are easier to follow which tends to result in greater political transparency. It hence increases the incentives of citizens to become politically involved. The rule over a small territory makes public policy targets also more efficient, and as a result fewer taxes are required. Nevertheless, one could still argue that micro-states in Easterly and Kraay’s research are large enough to be economically viable, but that especially those states that consist of maybe as few as 100 members would suffer from developmental disadvantages. This however, is a question of what the smallest possible size is for an economically well-functioning state. It is an interesting question that I unfortunately cannot answer. I will nonetheless leave a note from Plato on the subject to emphasize the importance of the division of labour in any well-functioning state. In Plato’s Republic, Socrates asserts that the state arises from the division of labour through which goods are efficiently supplied so that its citizens’ needs are fulfilled. The smallest notion of the state, as Socrates then asserts, exists of at least four persons who can produce the greatest human necessities: a farmer, builder, weaver, and shoemaker. I do not share the opinion that these specific four occupations are necessities for a small state, but I think you get the gist: for a (minimal) state to function well, you need at least division of labour.
Reference Easterly, W., & Kraay, A., (1999). Small States, Small Problems? The World Bank.
Footnotes [1] Micro-states are defined by Easterly & Kraay as states with populations of 1 million or less. Some examples of the 33 investigated states are Belize, Cyprus, Gabon, Iceland, Luxemburg and Suriname. [2] Specialization increases productivity, and hence competitiveness.
Notes On Liberty 