We can’t engineer our way out of this

Folks on the left have been getting more interested in science lately (though history tells us that might be something to worry about). They’re right to celebrate the incredible results of scientific progress–but scientific victory isn’t uniform across disciplines.

In some areas (including just about all areas on the cutting edge), scientists disagree with one another.It’s a big, complex world we live in, and we don’t understand it fully. That disagreement doesn’t mean we should discount science entirely, but it does mean we should be careful with it.

Imagine a world where engineers disagreed about the capabilities of their techniques and the strength of the materials they use. Some might be beholden to special interests (which gives me an idea for a public choice version of the Three Little Pigs), others might be dogmatic/superstitious. But even without concerns of systemic issues, we should be hesitant to try to get to the moon. That disagreement should tell us that we aren’t certain enough in our knowledge to make anyone but volunteers put their lives in the hands of those engineers.

Social scientist in particular frequently disagree with each other. Most are trying earnestly to apply the scientific way of thinking to understanding the social world, and it’s worth considering their view points. But applying that knowledge should only be done in a decentralized way. Applying the incredible insights of behavioral economics from the top down is appealing, but it’s probably best to do it piecemeal.

Social engineering and social science are harder than physical engineering and the physical sciences. Part of the problem Western governments face is that they’re trying to engage in social engineering. And politicians are promising them greater degrees of social engineering to improve the well-being of their constituents.

The trouble is two-fold: 1) those social engineering techniques aren’t good enough, even if they’re sometimes appealing. 2) The cost to decision makers of buying snake oil is too low in voting booths.

To my friends who are looking to the government to make things better: whether your hope is for government to help people be better versions of themselves, or to stop bad guys, we should push as much of that policy to the local level as possible. It might be nice if the whole country were more like Berkeley or Salt Lake City, but trying to make it happen at the national level is a recipe for conflict, disorder, and doing more harm than good. Keep policy local.

The Great Blessings of Cash

Paper money offers the benefits of anonymity, immediate payment, no identity theft, and no transaction charges. Government also benefits by printing notes with much greater value than the cost of the paper. However, some economists argue that cash has social costs that outweigh these blessings, and advocate the reduction and eventual elimination of paper cash. Several countries are planning to discontinue their largest currency notes. The European Central Bank is phasing out its 500-euro note; it will stop issuing new ones in 2018. The Scandinavian countries are reducing their paper cash.

Kenneth Rogoff, professor at Harvard University, has written a book, The Curse of Cash, in which he argues that the elimination of large-denominations of paper money would be good for society. Cash is a curse, he says, because criminals use the large bills, and because it limits the ability of central banks to have negative interest rates.

The use of cash by the underground economy is a symptom of bad policy, and the elimination of cash treats the effects rather than the causes. The reason economic activity goes underground is that governments have prohibited economic transactions.

Although some U.S. states have decriminalized medical marijuana, the substance remains illegal in federal law, which prevents the sellers from using the normal banking system. Therefore they use paper money. The prohibition of drugs generally drives the industry towards the use of large denominations, especially “Benjamins,” the US $100 bill depicting Benjamin Franklin. The elimination of Benjamins would make it less convenient to sell illegal drugs. The higher cost would raise the price of illegal drugs, but since the quantity demanded by addicts is not very responsive to a change in price, the drug dealers would find ways to do their transactions.

The legalization of drugs would eliminate the cause of the high demand for paper cash. Just as with alcohol, producers would then use the normal banking system.

The underground economy uses cash also for activities that are legal if taxes are paid on the income and sales. Again, the elimination of cash would make tax evasion less convenient, but not eliminate the incentives to evade having substantial amounts of gains taxed away. Rogoff thinks that if the government prohibits the legal use of Benjamins, the remaining notes would lose value, as they would no longer be legally convertible into small denominations and not be legally payable for goods. But large notes could circulate as a medium of exchange within the underground economy as an alternative currency. Moreover, there are underground currency traders in all countries that impose artificial currency exchange rates.

The problem originates in evadable taxation. The remedy that eliminates the cause is to make taxation unevadable. The main resource that cannot hide is land. The taxation of land value, based on its best possible use regardless of current use, cannot be evaded. The elimination of all other taxes would bring production, trade, and consumption above ground and eliminate the current high demand for paper cash.

Another “curse of cash” argued by Rogoff is that paper money prevents central banks from lowering the transaction rate of “interest” much below zero. Suppose a bank has a negative 5 percent charge on deposits, so that the depositor has to pay $5 per year per $100 deposited. Many people would withdraw the money and hold it in paper cash. Companies would offer to securely store your cash in insured vaults. If all notes above $10 were made illegal, the storage and insurance costs would rise substantially, and the banking system would be better able to have the negative rates.

The alleged benefit of negative rates is that, because the banks also pay negative rates on their deposits with central banks, financial institutions would scramble to loan out the money to investors who would pay a positive rate, or become partners in ventures.

It is bad enough now that savers, especially retired folks, are getting close to a zero return on their retirement savings. Negative returns on, say, large certificates of deposit would further ruin those who depend on income from savings. Again, the artificial device of pushing the nominal rate of interest below zero is an attempt to treat the symptoms rather than cure the causes.

Some blame a glut of global savings for the low rates of interest. But technology is marching forward, to artificial intelligence, robots, medical advances, better batteries, and many other frontiers. There is no shortage of possible investment projects. But governments world-wide stifle investment with taxes and restrictions. The USA, for example, has choked investment since 2008 with tighter banking restrictions and higher costs such as medical mandates.

What is needed is the ultimate supply-side policy, cutting marginal tax rates on labor and investment yields to zero, with a prosperity tax shift, replacing all other taxes with a single tax on land value. The land-value tax would also push land to its most productive use, stimulating productive investment and employment.

As to money, attempts to skew markets almost always fail, so it would be best to eliminate central banks and their manipulations of nominal interest rates. Let markets set the money supply and restore the positive natural rate of interest based on the human-nature tendency to prefer to have goods sooner rather than later.

Controlled market manipulations are failing, and so statist advocates propose even more artificial controls such as eliminating paper money and pushing interest rates below zero. But the further we get from economic freedom, the worse the outcome. Interest rates and money evolved in markets; let them return to their natural base.

Note: this article is also in http://www.progress.org under the title The Blessings of Cash.

Still thinking about the Olympics

Rio Olympics are close to the end, and so far it has been a wonderful time for Brazilian athletes: the country is scoring 15 total in the medal table, quite high in its historical record. Brazil’s first Olympic medal in 2016 was won by Felipe Wu right in the first day of competition: silver in Shooting, 10m Air Pistol Men. Wu was followed by Rafaela Lopes Silva, who won gold in Judo, Women -57 kg, and then by Mayra Aguiar, who won bronze, also in Judo, Women -78 kg. Rafael Silva won another bronze for Brazil in Judo, Men +100 kg, and then Arthur Mariano won still another bronze, this time in Gymnastics Artistic, Men’s Floor Exercise. Diego Hypolito won silver in the same competition. On the tenth day of competition Poliana Okimoto won Bronze in Marathon Swimming, Women’s 10km and Arthur Zanetti won Silver in Gymnastics Artistic, Men’s Rings. The next day, Thiago Braz da Silva surprised everyone by beating favorite French Renaud Lanillenie and winning gold in Athletics, Men’s Pole Vault.

In the last few days other athletes followed the ones mentioned in this opening paragraph, but I limit the text to them for a reason: one highlight of these first 9 Brazilian medalists is that, with the exception of Hypolito, all of them are in the military, and some of my friends on what is considered “the right” in the Brazilian political spectrum are using this information to poke (in good spirit) my friends on the left. On the other hand, my friends on the left highlight that many of the Brazilian medalists also have in common coming from very poor backgrounds, and finding in government social programs the chance to become professional athletes. I want to be careful to say that both are wrong and I want to explain why (I hope I will still have some friends after this). Basically both ignore the concept of opportunity cost.

The concept of opportunity cost postulates that spending in one direction means not spending in another. In other words, that every choice comes with the cost of forgoing the next best alternative. It was developed in all but name by 19th century French economist Frédéric Bastiat in the parable of the broken window (also known as the broken window fallacy or glazier’s fallacy) that appeared in his 1850 essay Ce qu’on voit et ce qu’on ne voit pas (That Which Is Seen and That Which Is Not Seen). The parable goes somewhat like this: a boy breaks a window. The window owner gets upset, but someone tries to comfort him by saying that this will give the window manufacturer the opportunity to work. In the end, the economy wins. Bastiat shows that this is a fallacy: the money spent in a new window could have been spent in another way, say, with new shoes. The world would have new shoes and still have a window, but now the world has a new window and no shoes. Bastiat proceeds to show the law of unintended consequences, or how our actions can affect the economy in ways that are “unseen” or ignored, and also to apply the concept to several areas of public policy. Two of these happen to be military expenditure and “Theatres, Fine Arts.”

Concerning military expenditure, Bastiat argues that spending money in order to defend the country against foreign aggressors can be a good investment, but that any money that goes beyond this necessity would have been better spent in other way. This argument goes against Bastiat’s contemporaries who argued that money spent on the military had the benefit of creating jobs, even if defense was not a real necessity. Bastiat’s conclusion is that if the money was left with the taxpayer, this person would find ways to spend that would create more and better jobs. Applying to current events, if Brazil is spending money in the military in order to protect its borders, this is a good investment. If instead it is spending money in the military in order to get Olympic medals, the money should be spent elsewhere.

Bastiat lived before modern Olympic Games, so he has nothing directly to say public spending in this kind of event, but I guess that what he says about “Theatres, Fine Arts” also applies here. Some of his contemporaries defended that the government should invest in Theatres and Fine Arts, because these things are good in themselves, created jobs, and so on. Bastiat was once more against what he saw as excessive public spending. This time his answer exposed him to the logical fallacy of the straw man, or misrepresenting one’s argument in order to make it easier to attack: his critics accused him of not caring about Theatres and Fine Arts. But if we examine the evidences carefully, that is not the case at all: to say that the government should not invest in Theatres and Fine Arts is not to say that nobody should invest in it. It is just to say who is supposed to make the investment, the government of individuals. I am not equalizing Theatres and Fine Arts with sports, but I believe the lesson applies in this field as well: to say that the government should not invest in sports is totally different from saying that nobody should invest in it.

In conclusion, it seems that public investment in the military and social programs is helping Brazil to win medals in this Olympics. But we can ask ourselves where would that money have gone had this investment not been made. Based on Bastiat, I believe that if the money spending was left for the individuals, Brazil would have better military, more Olympic medals, and less necessity of social programs, not to mention better jobs, and a better overall economy. Perhaps after this Olympic Games my friends both on the left and on the right can feel like investing more in sports. Or maybe they will realize they prefer to spend on something else.

The minimum wage still bites

Politicians, pundits and activists jumped on a new literature that asserts that there no negative effects of substantial increases of the minimum wage on employment. Constantly, they cite this new literature as evidence that the “traditional” viewpoint is wrong. This is because they misunderstand (or misrepresent) the new literature.

What the new literature finds is that there could be no significant negative effects on employment. This is not the same as saying there are no negative effects overall. In fact, it is more proper to consider how businesses adjust to different-sized changes by using various means. Once, the minimum wage is seen in this more nuanced light, the conclusion is that it still bites pretty hard.

The New Minimum Wage Literature

Broadly speaking, the new literature states that there are minimal employment losses following increases in the minimum wage. It was initiated twenty years ago by the works of Alan Krueger and David Card who found that, in Pennsylvania and New Jersey, a change in the minimum wage had not led to losses in employment. This caused an important surprise in the academic community and numerous papers have found roughly similar conclusions.

These studies imply that the demand for labor was quite inelastic – inelastic enough to avoid large losses in employment. This is a contested conclusion. David Neumark and William Wascher are critical of the methods underlying these conclusions. Using different estimation methods, they found larger elasticities in line with the traditional viewpoint. They also pointed out Card and Krueger’s initial study had several design flaws. With arguably better data, they reversed the initial Card and Krueger conclusion.

These critics notwithstanding, let us assume that the new minimum wage literature is broadly correct. Does that mean that the minimum wage is void of adverse consequences? The answer is a resounding no.

This is because of an important nuance that has been lost on many in the broader public. In a meta-analysis of 200 scholarly articles realized by Belman and Wolfson, there are no statistically discernable effects of “moderate increases” on employment. The keyword here is “moderate” because the effects of increases in the minimum wage on employment may be non-linear. This means that while a 10% increase in the minimum wage would reduce teen employment by 1%, a 40% increase will reduce teen employment by more than 4%. A recent study by Jeremy Jackson and Aspen Gorry suggests as much: the larger the increase of the minimum wage, the larger the effects on employment.

If labor costs increase moderately, the strategy to reduce employment may be relatively inefficient. The increase of labor costs needs to reach a certain threshold before employers choose to fire workers. Below such a threshold, employers may use a wide array of mechanisms to adjust.

Adjustment channels

Employers on their respective markets face different constraints. This diversity of constraints means that there is no “unique” solution to greater labor costs. For example, if the demand for one’s products is quite inelastic, labor costs can be passed on to consumers through an increase in prices. While this may not necessarily hurt workers at the minimum wage, it impoverishes other workers who have fewer dollars left to spend elsewhere. This is still a negative outcome of the minimum wage – its just not a negative outcome on the variable of employment.

In other cases, employers might reduce employment indirectly by reducing hours of work. This is an easy solution to use for employers who cannot, for a small increase in labor costs, afford to fire a worker. Even Belman and Wolfson – who are sympathetic to the idea of increasing the minimum wage – concede that increases in the minimum wage do lead to moderate decreases in labor hours. More skeptical researcher, like Neumark and Wascher, find that the effects on hours worked is much larger. Again, the variable affected is not employment measured as the number of people holding a job. However, a reduction in the number of hours worked is a clearly a perverse outcome.

Another effect is that employers might reduce expenses associated with their workers. Even Card and Krueger, in their book on the minimum wage, recognize that employers may opt to cut on things like discounted uniforms and free meals. An employer facing a 5% increase in the minimum wage will see his labor costs increase, but firing an employee means less production and lower revenues. Thus, firing may not be an option for such a small increase. However, cutting on the expenses associated with that worker is an easy option to use. This means fewer marginal benefits and on-job training. Employers adjust by altering the method of compensation.  For example, economist Mindy Marks estimated that a 1$ increase of the minimum reduced by 6.2% the probability that a worker would be offered health insurance.  Again, employers adjust and the effects are not seen on employment. Nonetheless, these are undisputedly negative effects.

The effect may also be observed on the type of employment. Employers may decide to substitute some workers by other types of workers. Economist David Neumark pointed that, subsumed in the statistical aggregate of “labor force” is a shift in its shift. In his article, written for the Employment Policies Institute, he stated that “less skilled teens are displaced from the job market, while more highly skilled teens are lured in by higher wages (even at the expense of cutbacks in their educational attainment)”. Another example could be that a higher minimum wage induces retired workers to return to the labor force. Employers, at the sight of a greater supply of experienced workers, prefer to hire these individuals and fire less-skilled workers. In such case, “total employment” does not change, but the composition of employment is heavily changed. The negative effects are clear though: less-skilled workers are not allowed to acquire new skills through experience.

Conclusion

None of these adjustment mechanisms in response to “moderate increases in the minimum wage” are desirable. Yet, all of these channels would allow us to conclude that there are no effects on employment. To misconstrue the ability of employers to select multiple channels of adjustments other than reducing employment as the proof that the minimum wage has no negative effects is perverse in the utmost. The statement that “moderate increases in the minimum wage has no statistically significant effects on employment” is merely a positive scientific statement with no normative implications whatsoever. If anything, the multiple adjustment mechanisms suggest that the minimum wage still hurts and that is both a positive and normative statement.

Muddy thinking on child care

Five Thirty Eight had a disappointing discussion of an interesting issue: the cost of child care for working parents. The basic issue is that kids are expensive in time and money. Unfortunately, the discussion mostly revolved around questions of how to engage in economic engineering by government in order to expand access to child care and parental leave.

The hosts see these policies as having costs and benefits, and they see the value in studying alternatives empirically, but they miss an important issue: providing these sorts of goods doesn’t require screwing up markets by adding an extra layer of complexity to the tax code. If these goods are worth providing (that’s another couple of cans of worms) then just give money to new parents. Better yet, move to a basic income guarantee.

Another important point they miss is that if some good is difficult to get, it’s worth figuring out what to do about the root problem rather than just throwing money at the issue and hoping someone will figure out the important stuff later.

A response to a student

Each week I assign some reading or video. Recently I assigned a series of videos where Bryan Caplan discusses common biases, including the anti-foreign bias

One student questioned the benefits of expanded immigration, wondering if the costs to American workers might be too great. Below is my response:

My understanding of the evidence is that immigrants to the US are almost always complementary to US labor (e.g. Indian doctors that keep American designers healthy, or Salvadorian cooks who feed American engineers). The area where your suspicion is true (again, based on my limited understanding of the data) is with high school dropouts.

High school dropouts face competition from immigrants (who are often unable to apply their skills due to regulations or attempts to avoid being caught by immigration authorities) because relatively low-skilled immigrants face similar disadvantages in labor markets (i.e. they have a similar comparative advantage but their alternative options are even worse).

“Just Leave Me Alone Goddammit!”*

The basic argument I want to make is that we’ve been thinking about labor and human capital imprecisely,** and we would do better to think of labor as the selective application of attention, and habit (which economizes on attention) as the basic essence of human capital.

Attention

The kernel of this idea was planted when I read Pragmatic Thinking and Learning a few years ago. An important point it makes is that whenever our work is interrupted it takes something like 15 minutes to get back to work. Mental work is like barbecuing (or what the uninitiated erroneously call “smoking”). After 8 hours of cooking your guests are impatient (and drunk) and want you to check the meat. So you open up the barbecue and a plume of smoke billows out. You put in a meat thermometer and sure enough, the meat isn’t done. But now it’s going to take another 15 minutes for enough to smoke to build up to get the process moving again. 20 minutes later people want you to check again. (And that’s why our parties back in San Jose so often dragged on so long.) Showing up to work for 8 hours a day isn’t sufficient for getting your work done; sometimes you just need your boss to leave you alone long enough for you to focus deeply enough to solve the problem you’re facing.

Or we could think of work like juggling. Working on some difficult problem, you’ve got a few pieces of mental material in the air. When someone knocks on your door (or you take notice of an email notification on your phone) you drop the balls. Getting them going again takes some effort, so even a one second interruption sets you back a few minutes. Those of us who work at desks are familiar with how difficult thinking can be. Managing our attention takes effort. But with practice we can get better at coping with distractions and skipping the easy, but unproductive paths offered to us.

And what about grunt work? There’s less attention necessary (perhaps rhythm serves a role in maintaining that minimal bit of attention), but nobody gets paid for not doing what they’re told. Your job is to keep applying effort in the appropriate way. The only human capital you really need is what is necessary to get out of bed and get to work every day.

Habit Capital

People who smoke cigarettes, they say “You don’t know how hard it is to quit smoking.” Yes I do. It’s as hard as it is to start flossing.

Mitch Hedberg

Habit offers a means of economizing on attention. Instead of using up our mental capacity to decide to brush my teeth every day, I just do it automatically. Flossing is not so easy… except that I was able to make it a habit by piggybacking it on an existing habit.

Many of the skills we have are built on a collection of complex little habits, whether it’s muscle memory (you must watch the video above), understanding how to read graphs, or bearing in mind that everything has an opportunity cost.

(Obviously) getting a college degree is not the same as accumulating human capital. What college does (we hope) is inculcate students with critical thinking habits and some basic knowledge deemed necessary or particularly helpful for navigating the world. Learning on the job is similarly about providing workers with habits, and both positive and normative knowledge (i.e. factual knowledge and norms/beliefs/corporate culture). Growing up is about building up human capital largely in the form of internalized norms (moral habits). Habits are everywhere and they’re at the core of what we mean when we use the term human capital.

Habit capital allow us to direct our attention to critical areas in the same way physical capital allows us to leverage (and ultimately replace) our physical effort. By establishing habits we can get certain things done (teeth brushed, books read, etc.) while conserving attention. This takes more attention upfront just as physical capital requires upfront investment.

Anticapital

Economists generally don’t think much about bombs as an investment. Bombs require foregoing current consumption, but once they’re made, they’re intended to get a negative return by destroying something of value. Physical anticapital, as a social scientific idea, falls primarily in the domain of International Relations. Which isn’t to say economists haven’t thought about investments that destroy value. The idea of rent seeking is an important one, but it’s one that has been rationalized.

There’s probably not much to gain by thinking about rent seeking as investment in anticapital.*** But we can bring bad habits out of the purview of irrationality and bring it into the warm, rational glow of economics with the concept of human anticapital.

Just like in biological evolution, we’re satisficing, not optimizing. Habits may initially be adaptive and turn bad as circumstances change. We should expect a tendency towards “good” habits–and how those habits propagate is certainly an interesting question–but we should also expect the odd bizarre byproduct, misfire, and obsolete habits to emerge.

“We are still very close to our ancestors who roamed the savannah. The formation of our beliefs is fraught with superstitions–even today (I might say, especially today). Just as one day some primitive tribeman scratched his nose, saw rain falling, and developed an elaborate method of scratching his nose to bring on the much-needed rain, we link economic prosperity to some rate cut by the Federal Reserve Board, or the success of a company with the appointment of the new president “at the helm.”

Nassim Taleb

tl;dr:

Attention matters more than time. Habit economizes on attention. Mental work involves applying mental tools to particular problems and habit allows us to do so more or less automatically. In other words, habit is human capital.****

*That’s one possible title for the next paper I want to write. A more boring but descriptive possibility is “Habit Capital.” Another with more regional flavor is “Hey! I’m Working Here!” Maybe I’m not very good at titles…

**This follows in a similar vein as my entrepreneurship research which basically boils down to: entrepreneurship theory is good, but our empirical measures suck.

***Although I should mention that thinking about rates of depreciation will surely shed light on rent seeking questions.

****I’ll leave it for the comments to sort out whether it’s the only sort of human capital. Maybe you can also help me sort out how to wrap belief, understanding, and learning into this view.