Bruce Bartlett’s Complete History of the Laffer Curve from Ibn Khaldun to Ronald Reagan

Posted on by Brad DeLong

If you haven’t read Bruce Bartlett’s complete history of the Laffer Curve, you should. The upshot is that you do not need special circumstances for high tax rates to be capable of inflicting significant damage on the underlying economy. But you do need exceptional circumstances to actually get a free lunch out of the Laffer Curve…

Bruce Bartlett:

  • The Laffer Curve, Part 1: “The Laffer Curve… economist Norman Ture, who worked closely with Rep. Jack Kemp, probably had more to do with popularizing the idea of a tax cut that could pay for itself than economist Arthur Laffer did…”
  • The Laffer Curve, Part 2: “The Laffer Curve from the Middle Ages through the 19th century. It begins with the work of Muslim philosopher Ibn Khaldun in the 14th century, whose work came to the attention of economist Robert Mundell in 1971. Mundell brought it to the attention of journalist Jude Wanniski of the Wall Street Journal. Ronald Reagan mentioned Khaldun by name on 11 different occasions as an influence on his thinking…. Jonathan Swift… observed in 1728 that higher tariff rates often led to a decline in revenue. Adam Smith, David Hume, Alexander Hamilton, Jean-Baptiste Say and James Madison are just a few of those who cited Swift…. [In] 19th century tariff history and notes that discussions of the revenue impact of changes in rates of duty often invoked Laffer Curve arguments…”
  • The Laffer Curve, Part 3: “Treasury Secretary Andrew Mellon often invoked Laffer Curve arguments in the 1920s. In the 1930s, economists John Maynard Keynes and Joseph Schumpeter made such arguments. In the 1960s, John F. Kennedy used the Laffer Curve to justify his 1963 tax proposal…”
  • The 1981 Tax Cut After 30 Years: What Happened to Revenues? by Bruce Bartlett :: SSRN: “The Reagan tax cut. Republicans often assert that it was so expansionary that there was no revenue loss, something the Reagan administration itself never claimed…. The tax cut lost a lot of revenue, but helped the economy transition from high inflation to low inflation at an unexpectedly low economic cost…”
  • Reagan’s Forgotten Tax Record: “Although Ronald Reagan is best known for cutting taxes, he also enacted many tax increases both as president and governor of California…. Reagan’s tax increases… were quite substantial…”

Ezra Klein of Vox.com vs. Tom Standage of The Economist

Posted on by Brad DeLong

Basically, however much money http://vox.com asks me for, I will pay it gladly. Not so with http://economist.com.

Here’s why:

Ezra Klein: How Vox Aggregates: “I started as a blogger in the pre-social web, when the only way to build an audience was to have other sites quote or link…

…Everything I wrote, I wrote in the hopes that someone else would take it and try to use it on their site, with a link back to my site. The lesson of that, to me, was that writing on the internet is a positive-sum endeavor: I was creating content that helped other people make their sites better, and in using that content, they were helping me grow my site. Vox’s approach to aggregation–which Nate Silver criticized today on Twitter–is informed by that. Our policy, to our staff, is simple: any time we use work created by someone else, we need clear attribution to the original author and a link back to the source. When appropriate, we should do more than that: we should add to the conversation with new facts, ideas, or reporting.

The problem comes when we do it poorly–and in those cases, we deserve to get called out. Take the post that frustrated Silver. The attribution there was clear…. The post went on to argue with Silver…. This wasn’t just aggregation…. The graphic itself included a FiveThirtyEight watermark…. But the post didn’t include a link. This was carelessness, not malice, but it’s a violation of Vox’s internal standards…. Silver’s right to be upset… He has my apologies….

Aggregation has been around a whole lot longer than Google. Time magazine, for instance, began its life as an aggregation shop…. If you read Alan Brinkley’s biography of Henry Luce, you’ll find a furor that feels very familiar…. I helped to create Know More, a site dedicated to aggregating in a more ethical way. We wanted a way to make clear that even when something is aggregated well, that doesn’t mean there’s not much more information at the source… a big ‘Know More’ button that would lead people back to the original source to, well, learn more….

While aggregation has always been a clear service to readers, it can be enormously frustrating to writers…. But aggregation, when done correctly, offers value to the original source…. This informs Vox’s policies…. We want people to talk about our work, put it elsewhere, spread the Vox word. We’re currently working on products that will make it even easier for other sites to use our work…. This stuff is complex, and we don’t always get it right. So if you ever feel Vox isn’t using your work in the way you’d want, email me at ezra@vox.com and let me know. Our intention is always to do things in a way that is positive-sum, and if you ever feel we’re failing that ideal, we want to know, and we’ll work with you to change it.

Joseph Lichtenberg: Interviews Tom Standage: STANDAGE: “What we did with Espresso was instead of doing that in a weekly cadence, we should be doing it in a daily cadence…

…Espresso is again meant to be the daily desert-island briefing…. What we wanted to be was forward-looking — to give you the feeling of being ahead of the news, ‘this is what’s coming up today, and look out for this.’ Another aspect of it is… that we don’t do links…. If you want to get links you can get them from other people. You can go on Twitter and get as many as you like. But the idea was… you can get to the end of it without worrying that you should’ve clicked on those links in case there was something interesting…. We’ve clicked on the links already and we’ve decided what’s interesting, and we’ve put it in Espresso.

That’s the same that we do in the weekly as well–we’re not big on linking out. And it’s not because we’re luddites, or… don’t want to send traffic…. It’s that we don’t want to undermine the reassuring impression that if you want to understand Subject X, here’s an Economist article on it–read it and that’s what you need to know. And it’s not covered in links that invite you to go elsewhere. We’ll link to background, and we’ll link to things like white papers or scientific papers and stuff like that. The idea of a 600-word science story that explains a paper is that you only need to read the 600-word science story–you don’t actually have to fight your way through the paper. There is a distillation going on there.

That’s a big thing that we’re focusing on. How else can we apply the same values–which is the distillation and the finishability, the trend-spotting and the advocacy–how else can we apply them to new areas? So we have various things that are on the boil…

Now I read something like this from the very sharp Tom Standage, and my visceral reaction is strong and threefold:

  • Whatever the Economist wants to do, it will do it without my subscription or–if I remember to fire up AdBlock before visiting its website–the ability to sell my eyeballs to anyone.

  • Whatever the Economist wants to do, it will do it without any links back from me to them. My links are reserved for fellow gift-exchange participants in a merit-of-ideas-based positive-sum game–not for people whose business model is rather parasitic.

  • In fact, I hope the Economist fails: the world is full enough of cocksure people suffering from the Dunning-Kruger effect, and the Economist’s business model seems to be to create as many more of them as it can via providing its readers with the knowing false “reassuring impression” that a 600-word Economist article is all someone needs to know.

Is this reaction on my part too extreme? Irrational? I don’t think so. What would you do with a butcher whose business model was explicitly, publicly, and proudly to rig its scales so that they registered 15 oz. as a full lb.?

It seems to me that is what Tom Standage is promising to do…

Must-Read: Max Sawicky: Work Makes Fritos

Posted on by Brad DeLong

Must-Read: Max Sawicky: Work Makes Fritos: “I’ve gone around on the Universal Basic Income (‘UBI’) more times than I care to remember…

…but Vox’s Dylan Matthews brings something news to the table, pointing to the contemporary Democrats’ default anti-poverty policy: get people into a job, any job. Translated that means work supports for jobs with very low pay and scant prospects for upward mobility. The genesis of this policy was the so-called Personal Responsibility and Work Opportunity Reconciliation Act of 1996, also known as “welfare reform.”… From 1996 to 2000, most of the evidence on TANF, with one important exception, showed up positive. Poverty decreased, employment and wages increased. The problem for evaluation is that this same period happened to be one of the best in U.S. history, in terms of labor market advance. In addition, the minimum wage (in 1996 and 1997) and the Earned Income Tax Credit (in 1993) increased. This makes it hard to isolate any beneficial effects of TANF. Unfortunately, the positive signs for those in the bottom income quintile (20%) of the population have crumbled since 2000. Truth is, they weren’t that positive to begin with. The impact on work in “leavers” studies (where TANF recipients were tracked after graduating from the program) tended to show work effects in the high teens. Think about that for a second. You’re working, say, one week a month. You increase work (assuming you have the option) by the top of the range, 20%. Instead of working five days a month, you work six days. Twelve extra days a year. Nor does work necessarily mean higher income, since increased earnings offset benefits, and work expenses reduce net income. The other ominous, early sign was income decline for the poorest single mothers’ families, documented by the saintly Wendell Primus and colleagues. (Primus actually resigned from his post with the Clinton Administration after the welfare was signed. How often do you see that.)…

At the time I hoped that the reform might cast a different light on welfare recipients. Instead of being bums, they would be workers. But enrollment in TANF has dropped off the table. Meanwhile, Barack Obama is slurred as “the Food Stamp president.” So the meanness has not dissipated, it has just been redirected…. All this is a lengthy prelude to Matthews’ post. His remedy for a future of lousy jobs is the UBI…. You’re not as much at the mercy of employers…. The chief benefit of the ‘exit’ option is the implied upward pressure on wages. So far, so good. But Matthews’ thrust is actually more radical than that. He is throwing shade on the moral obligation and axiomatic economic imperative of work itself, in particular employed work…. Let’s desacralize work. Dignity of work, my fanny. Work that is truly voluntary would be nice. Work that is compelled as an alternative to destitution does not comport with any reasonable concept of dignity. It’s like the dignity of kicking back to Tony Soprano…

Must-Read: Pro-Growth Liberal: Jeffrey Sachs’ Feeble Defense of David Cameron

Posted on by Brad DeLong

Must-Read: Pro-Growth Liberal: EconoSpeak: Jeffrey Sachs’ Feeble Defense of David Cameron: “Greg Mankiw reads this as a defense of David Cameron:

Finally, there is output growth. In the UK, real (inflation-adjusted) GDP fell by 3.8% from the fourth quarter of 2007 to the second quarter of 2010. It then rose by 8.1% from that point until the fourth quarter of 2014. In the US, real GDP fell by 1.6% from the fourth quarter of 2007 to the second quarter of 2010, and then rose by 10.5% from then until the fourth quarter of 2014. Thus, both countries have experienced moderately high and broadly similar growth rates since May 2010, when Cameron’s government took power.

I have no idea what Paul Krugman did to tick off Jeffrey Sachs so I’ll let him speak for himself. But let’s note the fact that the real GDP in the US was a mere 8.7% higher in 2014QIV than it was in 2007QIV. That is by any measure a terrible economic performance. We should also note that real GDP in the UK has increased only 3.7% over the same period. For anyone to suggest that such a dismal economic record justifies fiscal austerity leaves me wondering where this person learned their macroeconomics.

From my perspective, the remarkable–and remarkably stupid–thing we see here is Jeffrey Sachs’s belief claim that U.S. economic performance since the second quarter of 2010 has been in any sense praiseworthy, and that a government that accomplished that is worth voting for.

It hasn’t.

And the reason that it hasn’t has been (a) extraordinary state- coupled with moderate federal-level fiscal austerity, (b) the failure of the Obama administration to use its housing-finance regulatory powers as tools of macroeconomic management, and (c) the unwillingness and perhaps inability of the Federal Reserve to take up the slack.

In the United Kingdom, the Prime Minister who possesses a majority of the House of Commons is the government: Cameron rules fiscal policy, regulatory policy, and monetary policy. Cameron bears responsibility. In the United States, since the second quarter of 2010 Obama has had no power to pass additional fiscal stimulus and no power to reshape the FOMC. Only housing regulatory policy was under his control. Obama gets to claim nearly-full responsibility for the relatively good things. But Obama has to share only a portion of the blame for the bad things.

Today’s Must-Must Read: Gavyn Davies: Who Is Right About the Equilibrium Interest Rate?

Posted on by Brad DeLong

Gavyn Davies: Who Is Right About the Equilibrium Interest Rate?: “Bernanke believes that the equilibrium real rate is currently abnormally low, but that it will rise gradually in the next few years as economic ‘headwinds’ abate…

…This justifies a large part of the rate increase shown in the dots chart, a view also explicitly stated by Ms Yellen in her speech on policy normalisation. Mr Summers agrees that the Fed will be forced to deliver the equilibrium rate most of the time, but argues that it cannot do so at the moment because of the zero lower bound…. Summers implies that the equilibrium real rate is not only extremely low… [but] may stay there for many years, thus failing to validate the rise in the equilibrium rate implied by the Bernanke/Yellen view. One interpretation of the market’s pricing of forward short rates is therefore that investors lean on the side of Mr Summers…. The resulting abnormally low real bond yields are obviously a critical under-pinning for buoyant asset prices…. If the FOMC were to make it crystal clear that investors are just downright wrong about the forward path for interest rates, the resulting correction in both bond and equity markets could be severe….

The FOMC… are certainly willing to publish the dots, and to spell out their views on the most likely path for the equilibrium real rate. But they are far from ready to risk a major disruption in the markets by telling investors explicitly that they have misjudged the hawkishness of the Fed. Why is this? Presumably it is because the Yellen camp concedes that there is great uncertainty about the equilibrium real rate…. The Bernanke/Yellen belief that the equilibrium rate will rise in the next 3 years as headwinds diminish is at best conjectural….

What would cause Ms Yellen to act more decisively by ‘shocking’ the market’s path for forward short rates? The equilibrium rate is not directly observable, and is very hard even to estimate within a narrow range. This invites caution. The only reliable signal that the equilibrium rate is rising would be upward pressure on inflation. The so-called ‘whites of their eyes’ policy stance, supported by Mr Summers and several members of the FOMC, would therefore wait until there is clear evidence of rising inflation before becoming confident that the equilibrium rate is rising. Fortunately for global asset prices, Ms Yellen is not yet willing to oppose that point of view with any real conviction.

Determining the optimal U.S. tax rate for higher earners

Posted on by Nick Bunker

There are two constants in life: death and arguments about the optimal top marginal tax rate. The proper level of income taxation in the United States has been a hotly contested topic since the creation of the first federal income tax more than a century ago. The debate over the optimal tax rate has only intensified in recent years, as income and wealth inequality in the United States increases while taxes on the rich decline. Policymakers need an empirical answer to the question of the optimal level of taxation on top incomes.

How exactly do economists calculate an optimal level? Until very recently, economic research sought to determine the optimal rate by using just one concept—the highest tax rate that would maximize the amount of revenue collected, bearing in mind the disincentive to work created by taxation. Yet the most cutting-edge evidence tells us that our current estimates of the optimal tax rate are inaccurate because they’re missing important additional pieces of information about the behavioral response to taxes.

View full PDF here alongside all endnotes

So what is the optimal tax rate for top incomes? In order to determine that rate, policymakers should instead consider the following three ways that top earners might respond to tax changes:

  • by varying the supply of their own labor (working less)
  • by shifting between different types of income (wages and capital) to avoid taxes
  • by bargaining for different compensation levels from their employers

 

In this brief, we examine these three possible responses to higher taxes among the wealthy—responses that economists call elasticities—as posited by economists Thomas Piketty of the Paris School of Economics, Emmanuel Saez at the University of California-Berkeley, and Stefanie Stantcheva of Harvard University. Cutting to the chase, the three authors find that the optimal rate of taxation is much higher when we consider the responses quantified by three different elasticities as compared to one elasticity.

The analysis by Piketty, Saez, and Stantcheva finds that the optimal top tax rate is 83 percent. In contrast, the optimal rate using only one elasticity is 57 percent, which in turn compares to the current higher marginal tax in the United States of 39.6 percent. While 83 percent seems like a very high number, the underlying analysis of the paper is persuasive. Yet, the real take-away is the way the three authors calculate the much higher tax rate, and the importance of top earners bargaining for their compensation in calculating the optimal rate. U.S. policymakers need to understand the more complex responses of high earners to different tax rates. This new understanding is important given the country’s rising economic inequality and the relationship this rising inequality has to economic growth.

What is an elasticity?

Economists often seek to examine how responsive one economic variable will be to a change in another: What is known as an elasticity. Often they’ll explore the elasticity of Variable A to Variable B, such as the elasticity of employment to changes in the minimum wage or the elasticity of work hours to increases in the marginal tax rate. The resulting calculation of that elasticity would tell you how responsive the one variable is to changes in another. The larger the magnitude of the number, the larger the change.

In the case of the employment and the minimum wage, think of an elasticity of -0.1. This would mean a 10 percent increase in the minimum wage would result in a 1 percent decline in the level of employment. Or consider the elasticity of work hours to increases in the marginal tax rate, which economists calculate at -0.2—meaning a 10 percent increase in the marginal tax rate would result in a 2 percent decline in hours worked.

Obviously, many variables are at play in the complex U.S. economy. This is why factoring in other elasticities is important for economists to explore and for policymakers to understand.

A new approach to the problem

In their paper “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” economists Piketty, Saez, and Stantcheva overturn conventional wisdom on optimal taxation by introducing empirical tests of three key ways that taxes can affect the behavior of top earners. The authors argue that the optimal tax rate for top earners isn’t the result of just one kind of response to taxation, but rather three different kind of behavioral responses, or three elasticities.

When the authors calculate the optimal tax rate using only the criteria that the rate not reduce the amount of time top earners spend working, they find that the optimal top tax rate would be 57 percent. But the authors argue that using just one elasticity misses out on too much that’s going on with the behavior of top earners when tax rates are changed. Instead, we should consider three elasticities.

Elasticity 1: Labor supply response

The labor supply of top earners is economic parlance for the amount of time wealthy individuals will put into work instead of leisure. To find the elasticity of their working hours to the tax rate  they pay, the authors first calculate the “supply side” elasticity, which measures the sensitivity of the labor supply of top earners to changes in the top tax rate. As the tax rate increases, individuals start to re-evaluate the trade-off between working and earning more money and not working and enjoying leisure time. If top earners were to stop working then the reduction in the labor supply would not only reduce the amount of taxes collected but, more importantly, could be harmful to economic growth.

That’s why policymakers need to know how responsive to taxation top earners are when it comes to their willingness to work. If they are very responsive, then the optimal tax rate could be lower, all other things being equal. If they are less responsive, the rate could be higher.

The authors calculate this first elasticity by looking at how both the share of income going to top earners in the United States, and U.S. economic output (measured by gross domestic product per person) changed as the top tax rate changed. They find that as the top tax rate went down between 1960 and the end of 2012 the top 1 percent of earners were able to keep more of their income but the growth of GDP per capita didn’t increase. That means this first elasticity is pretty low, at most 0.2.

In short, top earners do not substantially vary their labor supply in response to tax rates.

Elasticity 2: Tax avoidance

Another way that top earners can respond to taxation is to change the kind of income they receive so that they can avoid a higher tax rate. If the tax rate on labor income increases then top earners might shift their income toward capital income that is taxed differently. A chief executive officer at a big corporation, for example, might get his compensation shifted from purely salary to include stock options, which when exercised are treated as capital income. This doesn’t mean the top earners are changing their behavior. Rather they are trying to shelter their money from taxation.

A higher elasticity, or responsiveness, means that an increase in the tax rate would make the earner very likely to change the kind of income they earn. A low elasticity means that an earner would not change her source of income based on changes in the tax rate. In a situation where this elasticity is high, top earners will simply shift all their income away from labor and toward capital—so a high tax on the labor income of top earners would yield little revenue.

To calculate this elasticity, the authors compare the trends in the share of labor income going to the top 1 percent to the trends in the share of income that includes capital gains. What they find is that the trends of the two data series are nearly identical. In fact, Piketty, Saez, and Stantcheva say their estimate for the second elasticity is 0. Top earners in the United States do not tend to shift their income sources in response to changes in the tax rates.

Elasticity 3: Executive compensation bargaining

Many top earners are corporate executives. According to one estimate, 41 percent of the top 0.1 percent of income earners are executives, managers, or supervisors. A growing body of research demonstrates that corporate CEOs and other members of the corporate “C suite” (chief financial officers, chief information officers, chief operating officers, and the like) are not  responsible for all the gains in the company’s economic performance for which they are compensated. In other words, a substantial share of top corporate executives’ earnings are comprised of funds from the firm that might otherwise go to other workers, investments in the firm, or to shareholders.

When tax rates are lower, executives have a stronger incentive to bargain for higher compensation. And since this compensation isn’t necessarily due to higher productivity, the struggle is zero-sum—if executives receive compensation for productivity gains they aren’t responsible for then funds that would go toward other ends get diverted. Piketty, Saez, and Stantcheva explain that a higher elasticity means that executives are more likely to bargain for higher pay when tax rates are lower and therefore receive funds that might go elsewhere within the firm.

In order to calculate this elasticity, the economists look at international data to determine the relationship between top tax rates and CEO pay. The data show that in countries with lower tax rates, CEOs have higher average incomes after accounting for the kinds of industries in which their companies compete. Piketty, Saez, and Stantcheva interpret this finding as the sign of a high third elasticity, which they calculate conservatively at 0.3 at the lowest. This would mean a higher tax rate on top earners would reduce what economists call rent-seeking—the taking of undue compensation—within the firm, potentially increasing wages for average workers.

Conclusion: The optimal rate?

The research presented in “Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities,” by economists Piketty, Saez, and Stantcheva, suggests that the conventional wisdom around optimal taxation rates for top earners is missing some nuance in how top earners respond to taxation. Including the bigger picture would seem to leave substantial room for an increase in rates on top earners. Piketty, Saez, and Stantcheva’s calculate that the optimal top tax rate comes out to 83 percent, once their three elasticities—labor supply, tax avoidance, and bargaining—are combined.

Compare that result to the result of 57 percent when economists only consider the overall elasticity of income to tax rates. This level is also much higher than the current top federal income tax rate of 39.6. This isn’t to say that our current top tax bracket should be raised to 83 percent tomorrow. Rather, this is the optimal rate for those at the very top of the income ladder. The top tax bracket would have to be changed in order to tax only those individuals or households at the very tippy top at this new 83 percent rate.

The results of this research also indicate that the rise in income inequality at the very top of the income spectrum was driven primarily by the decline in tax rates, which allowed top earners to get higher incomes without increasing the pace of economic growth. So the main take-away from latest research is clear: Tax rates in the United States on incomes at the very top could be much higher without affecting output growth and potentially boost wages for average workers.

Intangible assets and the labor share of income

Posted on by Nick Bunker

Here are a few trends that have been going on in the United States over the past several decades: The share of income going to labor has declined. Corporate profits as a share of the economy have increased. And net investment (outside of the construction industry) has stagnated. Explaining all three of these facts in one coherent story about what’s happened to the economy since the late 1970s doesn’t necessarily fit with a few well-known hypotheses about the relationship between labor and capital.

First, take the research of Loukas Karabarbounis and Brent Neiman, both of the University of Chicago. In their view, the share of income has declined because capital has become less expensive due to technological progress. Computers have become much cheaper, so companies have responded by buying more computers and displacing workers. In economic models, this would require the elasticity of substitution between capital and labor to be greater than 1. In other words, companies being able to readily switch between capital and labor.

Karabarbounis and Neiman’s hypothesis makes sense when accounting for the decline in the labor share. But if that share were going down because firms were buying more capital equipment such as computers, then investment would be increasing as a share of the economy. But it’s not. We know that the price of investment goods is declining, so it looks like firms are just keeping the savings from the decline in the prices instead of investing more. That would explain the increasing profit share as well.

While the mechanics of how the labor share decreased are different, Research by Thomas Piketty of the Paris School of Economics also depends upon the elasticity of substitution between capital and labor to be greater than 1 to show that the labor share of income is declining, but he posits different reasons for this happening. His mechanism is that the rich increasingly save their income and the resulting deepening in capital results in a declining labor share. In his research with Gabriel Zucman of the London School of Economics, Piketty finds an elasticity greater than 1, but like Karabarbounis and Neiman, this result comes from looking at macroeconomic aggregates.

When the elasticity is estimated at a micro level, however, it looks like the elasticity is lower than 1, meaning that switching capital investments for human labor is not as productive. Ezra Oberfield of Princeton University and Devesh Raval of the Federal Trade Commission looked at how individual firms substitute between labor and capital and built that up to an aggregate elasticity that is less than 1. Yet they also found that the labor share has declined.

What could explain a declining labor share with an elasticity lower than 1? A look at the assets of corporations reveals a potential answer. Economist Robin Hanson at George Mason University reports on data that shows that 5/6ths of market valuation of the S&P 500 companies are now “intangible assets” such as patents and trademarks, intellectual property and, importantly in this case, brand names and business methodologies.

To understand this concept, imagine that you want to replicate a company. Let’s say it’s Facebook. You go out and buy all the assets of the company: servers, real estate, and the firm’s employees. But Facebook’s large amount of “intangible assets” means that if you purchase all these physical assets you’d only have a firm that was less than the original firm. The original Facebook obviously has something intangible that can’t be replicated. For the S&P 500 overall, the replicated firm would only be worth 1/6 of the original firm.

Hanson runs through potential explanations for why these intangibles have increased in importance. They include patents, branding, and monopoly power. His colleague at George Mason University, Tyler Cowen, does warn that part of this increase in intangible assets could be from measurement error, but still it seems that any one of these reasons would mesh with the three theoretical explanations above about why capital investments are low yet the labor share of income is still declining (with an elasticity below 1).

Especially when it comes to monopoly power, increased profits and stagnant investments are the sign of monopolies. In his widely read research on the labor share, Massachusetts Institute of Technology PhD. student Matt Rognlie points to a potential increase in market power among companies.

If market power is a significant reason for the increase in intangibles, then this means economists need to focus on understanding how market power and monopolies work in the modern age. Can we do anything about the natural monopolies that arise from social networks companies? Would we want to? Those and many more questions would have to be dealt with.

Things to Read on the Evening of April 12, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of:

Morning Must-Must-Read: Noah Smith: What Causes Recessions?

Posted on by Brad DeLong

Noah Smith: What Causes Recessions?: “Some people–the types who think the market is self-adjusting and wonderful and doesn’t need any government help…

…believe that recessions are a natural, even healthy process… responses to changes in the rate of technological progress, or to news of future progress, or even bursts of creative destruction. Others… believe that there’s something blocking the market from adjusting to the shocks that buffet it. The market adjusts by the price mechanism…. So if you want to show that the market doesn’t naturally self-regulate, the simplest and easiest way is just to show that prices themselves can’t adjust in response to events. This phenomenon is called ‘sticky prices.’… Greg Mankiw and Lawrence Ball wrote an essay for the National Bureau of Economic Research entitled ‘A Sticky-Price Manifesto.’…

The economic establishment reacted harshly…. ‘Why do I have to read this?’ fumed Robert Lucas, the dean of macroeconomics. ‘This paper contributes nothing.’ He went on to accuse the sticky-pricers of being opposed to science and progress:

But Lucas fumed in vain…. Sticky-price theorists proved that you didn’t need a lot of price stickiness to mess up the smooth working of the economy. Even the tiniest dash of stickiness would turn all kinds of theories on their heads…. Sticky-price models still have their dogged opponents here and there throughout the macroeconomics world. Steve Williamson of the Federal Reserve Bank of St. Louis dismisses sticky prices on his blog, saying that the Great Recession went on too long to have been caused by price stickiness, and that sticky-price models have conquered central banks mainly due to slick marketing…. The moral of the story is that if you just keep pounding away with theory and evidence, even the toughest orthodoxy in a mean, confrontational field like macroeconomics will eventually have to give you some respect.

People should read Robert Lucas’s unhinged discussion of Ball-Mankiw:

Robert E. Lucas, Jr. (1994), “Comments on Ball and Mankiw,” Carnegie-Rochester Conference Series on Public Policy 41, pp. 153-155….

Why do I have to read this? The paper contributes nothing not even an opinion or belief–on any of the substantive questions of macroeconomics. What fraction of U.S. real output variability in the postwar period can be attributed to monetary instability? Cochrane’s paper addresses this question, as have Barro, Kydland and Prescott, Shapiro and Watson, and many other recent writers. It appears to be a very difficult one. Ball and Mankiw have nothing to offer on this question, beyond saying, trivially, that they believe the answer is a positive number and suggesting, falsely and dishonestly, that others have asserted it is zero. Yet monetary non-neutrality is the intended subject of their paper!

One can speculate about the purposes for which this paper was written–a box in the Economist?–but obviously it is not an attempt to engage other macroeconomic researchers in debate over research strategies. The cost of the ideological approach adopted by Ball and Mankiw is that one loses contact with the progressive, cumulative science aspect of macro-economics. In order to recognize the existence and possibility of research progress, one needs to recognize deficiencies in traditional views, to acknowledge the existence of unresolved questions on which intelligent people can differ. For the ideological traditionalist, this acknowledgement is too risky. Better to deny the possibility of real progress, to treat new ideas as useful only in refuting new heresies, in getting us back where we were before the heretics threatened to spoil everything. There is a tradition that must be defended against heresy, but within that tradition there is no development, only unchanging truth. Research that was in fact directed at difficult questions becomes trivialized, no matter which side it is on. Hume, Friedman, Schwartz, Keynes, Hicks, Modigliani become merely interchangeable spokesmen for a fixed set of ideas.

Why does it matter that Friedman and Schwartz carefully assembled and examined data on U.S. monetary history, if the real effects of changes in money were evident to Hume, who had no systematic data on either money or production? Why does it matter that Hicks and Modigliani showed us how to distill intelligible equation systems out of the confusions of Keynes’s Genera/ Theory? Why does it matter that theorists today are developing new models of pricing? If work like this represents progress, it must be because it contributes to resolving some difficulty or deficiency with earlier theory or evidence or both. If the IS/LM model as passed on to us by Hicks and Modigliani is all we need, why do I need to work through hard papers by Caballero or Caplin and Leahy? If these papers offer nothing more than debating points against heretics, I would rather do something else!…

For Ball and Mankiw there can be no real progress, so real business cycle theory is only a threat: It must be defeated, and then we can go back to where we were “a generation ago” (to quote from the draft given at the conference). The possibility of a synthesis of old and new ideas that might leave us better off cannot be envisioned. A few years ago, one of my sons used the Samuelson-Nordhaus textbook in a college economics course. When I visited him, I looked at the endpaper of the book to see if actual GNP was getting any closer to potential GNP than it had been in the edition I had used many years earlier. But the old chart was gone, and in its place was a kind of genealogy of economic thought, with boxes for Smith and Ricardo at the top, and a complicated picture of boxes connected by lines, descending down to the present day. At the bottom were three boxes: On the left, a box labelled “Communist China”; in the center, and slightly larger than the rest, a box labelled “Mainstream Keynesianism.” The last box, on the right, was labelled “Chicago monetarism.”

Times change. Accordingly, to Ball and Mankiw, Chicago monetarism (or at least Milton Friedman) now shares the middle, mainstream box, and there is a new group for the right-hand box, to be paired with the Chinese communists. But the tradition of argument by innuendo, of caricaturing one’s unnamed opponents, of using them as foils to dramatize one’s own position, continues on. I am sorry to see it perpetuated by Ball and Mankiw, and I hope they will put it behind them and return to the research contributions we know they are capable of making.