Veronique de Rugy on Austerity Facts

Vero's austerity chart

First, I wish we would stop being surprised by what’s happening in Europe right now. Second, I wish anti-austerity critics would start acknowledging that taxes have gone up too–in most cases more than the spending has been cut. third, I wish that we would stop assuming that gigantic “savage” cuts are the source of the EU’s problems. Some spending cuts have been implemented in a few countries. Also, if this data were adjusted for inflation (which I would prefer but the data isn’t available) it would possibly show a slight decrease and certainly a flatter line for all countries. However, the overwhelming take away from the European experience is that a majority of governments haven’t really implemented spending cuts, large or small, and some have even continued to grow.

via Show Me the ‘Savage’ Spending Cuts in Europe, Please – By Veronique de Rugy – The Corner – National Review Online.

I suspect the entire debate hinges on a difference in assumptions about the relevant spending baseline. If your theory prescribes significantly ramping up spending during recession, low or flat spending growth can look perversely “austere,” even if absolute spending as a % of GDP is very high.

UPDATE

Veronique sends an updated PPP-adjusted chart:

She adds (via email):

I am not denying that spending has been cuts in Greece, Italy and Spain. But I don’t agree that the spending cuts were savage or that’s all that’s going on in Europe. For instance these guys never talk about the impact of tax increases. Yet, Avent is willing to say that VAT props up inflation. That makes any cuts, even the smallest ones much more painful. I think there is a misplaced obsession with spending cuts and spending cuts alone being the source of all EUzone problems.

The Trouble with Public Choice: Too Generous to Politicians

Matt Yglesias recently admitted in a blog post to increasing bafflement about “the high degree cynicism and immorality displayed in big-time politics.” Today Matt says some libertarians “responded to that post by deciding they should be condescending and give me a little less in Public Choice Economics 101. That, however, misunderstands what I’m trying to say about the subject.” Which is what?

The formal model of the self-interested legislator is very easy to understand. What I’m saying is hard to understand is the actual psychology of this kind of behavior. I think I now have a much better grasp than I once did of what’s going on inside the heads of people who have ideological beliefs I disagree with. But I find it very difficult to extend my powers of moral imagination to the kind of people who hold high political office in the United States.

I’m with Matt. I too find it hard to get inside the heads of politicians, and I don’t find rational choice assumptions very illuminating in this regard. By insisting that politicians are motivated by considerations no different than businessmen or anybody else, public choice economists have helped slay the pernicious myth that politicians are generally warmly other-regarding public servants. But the economist’s assumption of motivational uniformity fails to capture that politicians do in fact seem to be really odd people who don’t seem to be primarily motivated by the same considerations that motivate most of us most of the time. The incentives of the political process create a kind of filter that selects for individuals extraordinarily fixated on power and status and extraordinarily motivated to keep it. If this is right (anyone know of personality studies of politicans?), then the problem with standard public choice is that it gives too much credit to politicians by assuming they’re like everyone else and therefore it fails to capture just how exceptionally prone politicians are to narcissism, motivated cognition, self-deception, and brazen lying.

I find I almost always side with those defending empirically-informed motivational realism against a priorist rational choice/public choice types. (The dispute here between classic public choicers Mike Munger and Anthony de Jasay against empirically-informed political philosopher Jerry Gaus is illustrative. Jerry’s right, I think.) So I agree with Matt that politicians are probably odd, and in a bad way. But then I wonder what Matt takes the general lesson of that to be. Maybe if I thought about it longer, I could imagine a story in which this doesn’t tend to imply skepticism about the efficiency and justice of a system in which politicians are given a great deal of discretion to shape individual and public life, but I can’t think of one right now. So I’m curious what Matt takes to be the broader implications of the idea that “we’re fated to be ruled by the sort of people who are really desperate to cling to power.”

The Meaning Dodge

E.D. Kain on the fact that kids don’t tend to make us measurably happier:

The happiness we experience from our children is lasting, constant, omnipresent, and far deeper than any material gain.  It is also hard, and frustrating, and the most tiring experience of my life, which makes it all that much more meaningful. 

[…] 

Fact is, you can’t break this sort of thing down into a nice, scientific study.  It’s not so simply quantified.

It is not simply quantified. But perhaps it is quantifiable. So we should try to quantify it. Fact is, one can blather about meaning any time one’s preferences or prejudices come under pressure from science. But in the end it’s mostly irrelevant whether something is quantifiable or not. There are some things some people are going to do no matter what. So that’s what I think those people should say: “I am going to do this no matter what.”

As I wrote in the ill-fated Culture11:

Appeals to meaning are nice, but they just push the lump in the rug. What’s so great about meaning, anyway? For that matter, what is it? How does one validate that x is in fact meaningful, or more meaningful than y? If meaning is going to carry a justificatory load in weighty personal and political deliberation, we can’t just wave our hands about it. Intellectual virtue requires care. We need to get started on measuring meaning. There are many questions. How much is meaning worth to us in terms of happiness? How much is happiness worth in terms of meaning? There are no doubt many and varied sources of meaning. With science on our side, we are sure to discover that some of them are corrosive to other of our cherished values while some enhance them. Then we’ll be well-situated to say goodbye to toxic meaningfulness. Goodbye national identity? Goodbye God? Who knows what we might find? Science is a source of excitement as well as wonder.

I don’t anticipate the new field of “meaning research” will be warmly received by those with a refined taste for meaning. Many of these fine folks say that the very attempt to measure happiness scientifically — not to mention the effort to put meaning itself under the microscope — saps life of… meaning. But how do you know? Anybody can say this. You can say it while waving a copy of The Closing of the American Mind. You can say it smoking a pipe. But it doesn’t help. 

I am going to continue making this point no matter what.

Hey Kids! Transactions Costs!

In this macro-brutalizing post, William Buiter lays down many passages I agree with. I don’t believe it was offered in this spirit, but I think Buiter does a servicable job of explaining why my fave econ gurus — F.A. Hayek, James M. Buchanan, Douglass North, and Vernon Smith — will make you smarter than your local macro textbook. Buiter:

[M]ost of the New Classical and New Keynesian macroeconomics assumes away the problem of contract enforcement.  This problem is especially acute in trade over time or intertemporal trade, where the net value to each party to a contract of fulfilling the terms of the contract varies over time and can change sign.  In a world with selfish, rational, opportunistic agents, able and willing to lie and deceive, only a small set of voluntary transactions will ever be observed, relative to the universe of all potentially feasible transactions.

The first set of voluntary exchange-based transactions we are likely to see are self-enforcing contracts – those based on long-term relationships, repeated interactions and trust.  There are some of those, but not too many.  The second are those voluntarily-entered-into contracts that are not self-enforcing (say because interactions between the same sets of agents are infrequent and market participants have a degree of anonymity that prevents the use of reputation as a self-enforcement mechanism) but are instead enforced by some external agent or third party, often the state, sometimes the Mafia (sometimes it’s hard to tell who is who).  Third party enforcement of contracts is again often complex and costly, which is why it covers relatively few contracts.  It requires that the terms of the contract and the contingencies it contains be third-party observable and verifiable.  Again, only a limited set of exchanges can be supported this way.

The conclusion, boys and girls, should be that trade – voluntary exchange – is the exception rather than the rule and that markets are inherently and hopelessly incomplete.  Live with it and start from that fact.  The benchmark is no trade – pre-Friday Robinson Crusoe autarky.  For every good, service or financial instrument that plays a role in your ‘model of the world’, you should explain why a market for it exists – why it is traded at all. Perhaps we shall get somewhere this time.

[…]

The future surely belongs to behavioural approaches relying on empirical studies on how market participants learn, form views about the future and change these views in response to changes in their environment, peer group effects etc. 

Yeah! Do some real science, economists!

Let me point out that Buiter badly oversteps his line of reasoning when he says that voluntary exchange, as such, is the exception rather than the rule, because trade is in fact a ubiquitous feature of human society. The baseline is not “no trade” but the far from negligible level of exchange in hunter-gatherer societies. What Buiter might have said had he not himself wasted so much time with macroeconomics textbooks is this: There are transactions costs. These limit the trades it makes sense to make. But a vastly greater number of trades can be made (and vastly greater gains from exchange realized) when transactions costs — such as the costs of enforcing complex contracts — fall. The complex order of spatially and temporally extended impersonal exchange is the exception, not the rule. And that’s why almost all of humanity has been poor for almost forever.

But the main idea here is right, and it’s good to see a central banker grasp it: economics that leaves out transactions costs simply assumes what humanity has only rarely managed to approximate. Modern economies are weird, pulsing, unsteady achievements of ongoing cultural evolution. Economies certainly aren’t machines governed by physics-like regularities. Nor is “an economy” the creature of specious nationalist bookkeeping studied in textbooks. There are lots of things we need to grasp if we are to “get somewhere this time.”

Defending the Study of Race and IQ

Cornell University psychologists Stephen Ceci and Wendy Williams defend the study of group difference in IQ against Steven Rose in today’s Nature. Ceci and Williams’ view is pretty much my own. They argue that, as often as not, claims about group differences in innate cognitive ability can be proven to be untrue. Actually debating the issue, and discussing the best new research, does more to defuse harmful misconceptions than a censorious egalitarian refusal to even publicly contemplate natural inequalities. Moreover, an ethos of punishing political correctness is inconsistent with the norms of open inquiry upon which communities of scientific discovery depend to produce new knowledge. 

Of the James Watson imbroglio, Ceci and Williams write:

Watson’s first assertion could be read as scientifically supported: black Africans’ IQ scores are lower than those of white Europeans. But Watson’s use of ‘intelligence’ was interpreted as meaning ‘intrinsic cognitive ability’, ignoring how unfamiliarity with testing format, low quality of schooling, or poor health might depress IQ scores. There have been analyses showing average national IQs for sub-Saharan Africa to be approximately 30 points lower than average IQs for predominantly white European nations, and drawing a racial conclusion from those results1, 2. A refutation of these analyses would provide an opportunity to advance understanding. Sadly, although these analyses can be refuted, as we and others have done3, most of those who scorned Watson never knew they existed.

They go on to discuss interesting new work that is blowing away old stereotypes about the mathematical abilities of women:

Regarding gender, no one now claims women are unable to excel at complex maths: 48% of US mathematics majors are female, and women earn higher maths grades than men throughout schooling5. The maths gender gap among the top 0.01% of students, which 30 years ago favoured males 13-to-1, now favours males only 2.8-to-1 (ref. 5). Some nation’s women (including those in Singapore and Japan) outscore US males on maths tests by an amount far larger than the gender gap within the United States5.

So, vigorous debate has resulted in great progress in our understanding, and more breakthroughs will come — if we allow free speech in science. 

The fact that that the gap between males and females at the top .01% has narrowed so dramatically so quickly is extremely strong evidence for the claim that prior gaps were a reflection of widespread sexist assumptions about female capacities. The clear implication of this kind of rapid convergence is that it is mistaken to take today’s snapshot of the distributions of various cognitive skills as indicative of innate or natural difference in capacities. Given a little more time, and little more erosion in sexist social expectations, we might find that females are as good or better than males at things like math — long thought to be a special male strengths. And the same argument applies just as well to preferences. One can’t take current patterns of occupational self-selection as dispositive evidence of “natural” differences in men’s and women’s preferences given the rapid past and current shifts in the gender composition of many occupations.

Here’s Cato Unbound‘s debate on the science and politics of IQ, featuring James Flynn, Stephen Ceci, Linda Gottfredson, and Eric Turkheimer.

Chait Empiricism Watch

I like how Jonathan Chait wrote a whole book accusing right-wingers of braindead supply-sider free-lunchism and now induldges in left-winger braindead demand-side free-lunchism with all the zeal of bizarro Jack Kemp on meth. 

I mean, check it out!

The point of stimulus spending … is simply to spend money–on something useful if possible, wasteful if necessary. Keynes proposed burying money in mineshafts, so that workers would be hired to dig it out. (Imagine what the GOP could do with material like that.) World War II was an effective stimulus that, economically speaking, consisted of 100 percent waste. If war hadn’t broken out, we could have enjoyed the same economic benefit by building all those tanks and planes and dumping them into the ocean. 

Oh my. Since Chait’s a pure empiricist with no agenda but truth, I’m sure he’ll be receptive to the facts revealed in Robert Higgs’ Depression War and Cold War. Here’s Price Fishback’s summary.

[UPDATE: Also see Tyler Cowen.]

This Is What I Am Talking About

The New York-based blogger for The Economist‘s Free Exchange replies to my lament by arguing that economists do have a theory of the psychology of coordinated expectation. They do, sort of. But they don’t have the kind of theory that I have in mind. Harvard’s Gregory Mankiw admits as much when he blogs:

Yale’s Bob Shiller argues that confidence is the key to getting the economy back on track.

I think a lot of economists would agree with that. The question is what would make people more confident. Bob thinks that confidence would rise if the government borrowed more and spent more. Other economists think that confidence would rise if the government committed itself to, say, lower taxes on capital income. The sad truth is that we economists don’t know very much about what drives the animal spirits of economic participants. Until we figure it out, it is best to be suspicious of any policy whose benefits are supposed to work through the amorphous channel of “confidence.” [emphasis added]

In what macro textbook can one find references to empirical psychological work on confidence? On individual-level variability in confidence, on the conditions under which the confidence of various personality types is affected by economic variables, on the relationship between changes in condfidence and changes in economic behavior, on the social “infectiousness” of changes in confidence, etc.

I have a lot of respect for Shiller, but Mankiw is right. Shiller doesn’t have any real evidential basis for claims about what policies will induce confidence. And neither does anyone else.

What's Fair?

In a fascinating guest spot over at The Atlantic’s new Brave New Deal blog, my friend Bart Wilson — an actual economic scientist — digs deep into the question of the meaning of a “fair” distribution in the experimental economic games he studies. Drawing on the work of linguist Anna Wierzbicka, Bart reports that the English word ‘fair’ doesn’t really translate one-to-one into any other language. I did not know that! And he argues that fairness judgments are made relative to an implicit or explicit set of customary rules: 

No matter how much we may feel that fairness is a pure principle, it’s really a regular social rule, a custom.   (Another surprispingly revealing word:  you have probably seen the words “customary rates” applied to gratuities and sales commissions).  Fairness really boils down to an issue of agreement: can we agree on what rules this particular context calls for? In a future post, I’ll expand on what this means for markets and public policy.

Remember, Bart’s not riffing from the armchair. He’s run a mindnumbing number of experimental games meant to elicit judgments of fair distribution. If he’s right, this is pretty interesting. One thing it seems to me to  imply is that a “theory of justice” built on intuitions about fairness is likely to be pretty conservative, echoing the conventional rules underlying fairness judgments, and at best ironing out their inconsistencies. Whether that’s a feature or a bug depends on what kind of work you would like a theory of justice to be do. 

Anyway, Bart’s work is an outstanding example of what economics looks like when it is also science.

Christina Romer to Head the CEA

Christina Romer’s appointment to the chair of the President’s Council of Economic Advisors is excellent news. Her recent papers on taxation with David Romer represent a real advance in blending economic theory with rigorous and ingenious historical research. Of course, good economics isn’t always good politics, which leaves high-ranking academic economists in a bit of a tight spot as they attempt to help the administration meet its aims while also attempting to maintain their professional reputation as social scientists. (This is, I imagine, rather harder for right-leaning economists such as Mankiw and Holtz-Eakins, already a distinct minority even in economics.) I’m interesting to see the extent to which Obama’s excellent economic team will and won’t be willing to diverge from their expert opinion in order to provide political cover for bad economic ideas. Goolsbee’s truth-telling campaign gaffe about Nafta comes to mind. 

In honor of Romer’s appoinment, I reprint the post I wrote about her and David Romer’s recent work on taxes over a year ago for Free Exchange:

The unbearable lightness of being Martin Feldstein

Posted by: 
Free Exchange | Washington, DC
Categories:
Taxation

JONATHAN CHAIT apparently is unimpressed by citations to the work of personages such as Martin Feldstein, the president of the prestigious National Bureau of Economic Research and the George F. Baker Professor of Economics at Harvard University. Indeed, Mr Chait has a knack for drawing the bounds of intellectual respectability so tightly around himself that by late afternoon even his shadow falls outside the charmed circle. Even so, one must admit that Mr Feldstein’s Clark medal and his endorsement by the New York Times for the job of Chairman of the Federal Reserve does leave one with a residue of suspicion. The Bank of Sweden has not bestowed upon him its coveted prize—though it’s true he has been mentioned, specifically for his work on the theory of taxation. So let’s not be too hasty to take him seriously. 

Because Mr Chait is a self-avowed empiricist, perhaps he will favour this new NBER paper (free version here) by Christina and David Romer of the Univesity of California, Berkeley (despite somewhat embarrassing credentials, even slightly more lackluster than Mr Feldstein’s). It is a dazzling empirical investigation of the effects of tax cuts and increases on economic output in the United States since the end of the second World War—one that significantly improves on the methodology of earlier attempts to estimate the effects of tax changes. They find that tax increases appear to have a very large, sustained, and highly significant negative impact on output. Since most of our exogenous tax changes are in fact reductions, the more intuitive way to express this result is that tax cuts have very large and persistent positive output effects.

The economists Romer looked at every tax change legislated at the national level since WWII.  Impressively, they scoured “presidential speeches, executive-branch documents, and Congressional reports … to identify the size, timing, and principal motivation for all major postwar tax policy actions.” They then categorized each tax change based on whether or not it was intended as a forward-looking correction to the direction of the economy (they call these “endogenous” changes), or intended for other reasons, such as to reduce an inherited deficit or to boost long-run growth (the “exogenous” changes.) This allows them to tease out the output effects of tax cuts and tax increases set in place for different reasons.

Those interested in raising taxes, but unwilling to take seriously Martin Feldstein’s estimate of the deadweight loss of tax increases, will need to grapple with Mr and Ms Romers’ new findings. For example:

Our baseline specification suggests that an exogenous tax increase of one percent of GDP lowers real GDP by roughly three percent.

This is bad news for those with aspirations to higher levels of tax-financed spending. However, they find that not all tax hikes hurt the same. Tax increases specifically intended to offset budget deficits largely avoid the negative effects of other kinds of increases, in part by improving the climate of investor confidence.

In another fascinating new working paper on the “starve the beast” hypothesis (it is false, FYI), the Romer duo directly discuss the revenue effects of tax cuts. So, the question at the heart of Mr Chait’s attack on supply side economics: do tax cuts pay for themselves? 

[A]lthough a tax cut leads to a sharp fall in revenues in the short run, it does not have any clear impact on revenues at horizons beyond about two years. Second, roughly half of the tax cut is offset by legislated tax increases over the next several years. Taken together, these findings suggest that a substantial fraction of the rebound in revenues is the result of non-legislated changes. The key source of the non-legislated changes in revenues is almost certainly the effect of the tax cut on economic activity. In Romer and Romer (2007b), we find that a tax cut of one percent of GDP increases real output by approximately three percent over the next three years. Since revenues are a function of income, this growth undoubtedly raises revenues. 

So there you have it. Tax cuts don’t exactly “pay for themselves”, but they also don’t diminish revenue after about two years. That is, after about two years, the government receives revenues equal to what it would have received at the higher rate, but taxpayers enjoy a lower burden. It is an important advance to discover that because cuts do lead to an immediate dip in revenue, they often inspire offsetting tax increases that retard the growth effect of the original cut. Nevertheless, the effect of cuts on output is generally strong enough to bring revenue back to where it would have been otherwise.

They do, however, add “an important caveat” to their “finding that tax cuts partially pay for themselves through more rapid growth”: the output effects of a tax cut may not last forever, in which case the cut could lead to shortfalls over the long run “in the absence of other legislative changes.”

The lesson, then, is that it is indeed irresponsible to think of a tax cut as a free lunch. If citizens wish to enjoy lower taxes, and do not wish to foist their debt on the next generation, they cannot avoid the responsibility of also cutting spending. This is how it should be. Truly “free” tax cuts make big government too much of a bargain. If you care about nothing more than getting out from under high tax rates, then self-funding tax cuts are a political dream come true: you don’t have to ask anyone to give anything up. But if you worry about the intrusions, abuses, and injustices other than the confiscatory tax rates enabled by a massive state, you should not want too much slack in the relationship between the spending levels and tax rates. 

For their part, empirically-minded champions of the welfare state like Mr Chait should be encouraged to discover that taxpayers seeking relief are not in fact the mortal enemy of government spending. The real nemesis of both government revenue and individual well-being is a slowed rate of economic growth, which, research shows, tax increases generally deliver.