The Captured Economy: Book Talk at U.C. Berkeley | Tu Apr 10 @ 2 PM | Blum Hall Plaza Level | 2018-04-10

HL 2018 04 10 The Captured Economy pages pdf 1 page

“The best attempt so far at a social democratic–libertarian synthesis of the origins and cure of our current political-economic ills…”—Brad DeLong

The Captured Economy: How the Powerful Enrich Themselves, Slow Down Growth, and Increase Inequality

Brink Lindsey and Steve Teles

Niskanen Center:

“A compelling and original argument about one of the most pressing issues of our time, The Captured Economy challenges readers to break out of traditional ideological and partisan silos and confront the hidden forces that are strangling opportunity in the contemporary United States.”—Matthew Yglesias

“Are you looking for how to get out of our current mess? The Captured Economy is perhaps the very best place to start.”—Tyler Cowen, Professor of Economics, George Mason University

“American politics is mired in endless arguments about how much downward redistribution we want and how to provide it. But as Brink Lindsey and Steven Teles point out in this engaging, powerfully argued book, the reality of our political economy often looks much more like upward redistribution. In one arena after another, public policy enriches the already rich and advantages the already advantaged.”—Yuval Levin, editor of National Affairs

“Steven Teles and Brink Lindsey ask one of the most important questions of our times: What are the political reforms we need to reduce the ability of the wealthy to maintain their capture of our government? Combining the analytic forces of liberalism and libertarianism, they provide a much-needed investigation into why the U.S. government works on behalf of the powerful and the steps we can take to address rising inequality and regressive regulation so that it instead acts in the public interest.”—Heather Boushey, Democratic Economic Policy Director, 2016

Available at Powell’s:

Available at Google Books:


  • Today: a stagnating economy and sky-high inequality
  • Breakdowns in democratic governance: wealthy special interests capture the policymaking process
  • Regressive regulations that redistribute wealth and income up the economic scale
  • Stifling entrepreneurship and innovation
  • New regulatory barriers shield the powerful from competition inflating their incomes extravagantly:
    1. Subsidies for finance’s excessive risk taking
    2. Overprotection of copyrights and patents
    3. Favoritism toward incumbents through occupational licensing schemes
    4. The NIMBY-led escalation of land use controls that drive up rents for everyone else.
  • Needed: improve democratic deliberation to open pathways for meaningful change


For years, America has been plagued by slow economic growth and increasing inequality. Yet economists have long taught that there is a tradeoff between equity and efficiency-that is, between making a bigger pie and dividing it more fairly. That is why our current predicament is so puzzling: today, we are faced with both a stagnating economy and sky-high inequality.

In The Captured Economy , Brink Lindsey and Steven M. Teles identify a common factor behind these twin ills: breakdowns in democratic governance that allow wealthy special interests to capture the policymaking process for their own benefit. They document the proliferation of regressive regulations that redistribute wealth and income up the economic scale while stifling entrepreneurship and innovation. When the state entrenches privilege by subverting market competition, the tradeoff between equity and efficiency no longer holds.

Over the past four decades, new regulatory barriers have worked to shield the powerful from the rigors of competition, thereby inflating their incomes-sometimes to an extravagant degree. Lindsey and Teles detail four of the most important cases: subsidies for the financial sector’s excessive risk taking, overprotection of copyrights and patents, favoritism toward incumbent businesses through occupational licensing schemes, and the NIMBY-led escalation of land use controls that drive up rents for everyone else.

Freeing the economy from regressive regulatory capture will be difficult. Lindsey and Teles are realistic about the chances for reform, but they offer a set of promising strategies to improve democratic deliberation and open pathways for meaningful policy change. An original and counterintuitive interpretation of the forces driving inequality and stagnation, The Captured Economy will be necessary reading for anyone concerned about America’s mounting economic problems and the social tensions they are sparking.

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Keynes’s General Theory Contains Oddly Few Mentions of “Fiscal Policy”

File WhiteandKeynes jpg Wikipedia

Something that has puzzled me for quite a while: Keynes’s General Theory contains remarkably few references to fiscal policy in any form:

  • “Government spending”: no matches…

  • “Government purchases”: no matches…

  • “Fiscal policy”: 6 matches:

    • Four in one paragraph about how fiscal policy is the fifth in an enumerated list of factors affecting the marginal propensity to consume…
    • One about how an estate tax changes the marginal propensity to consume…
    • One about how fiscal policy in ordinary times is “not likely to be important”…
  • “Public works”: 10 matches:
    • Three in a paragraph about how the multiplier amplifies the employment effect from public works…
    • Two in a paragraph warning that multiplier calculations are overoptimistic because of import, interest rate, and confidence crowding-out…
    • Four on how public works have a much bigger effect when unemployment is high and “public works even of doubtful utility may pay for themselves…”
    • One a criticism of Pigou’s logic…

And yet it also contains this one paragraph:

In some other respects the foregoing theory is moderately conservative in its implications. For whilst it indicates the vital importance of establishing certain central controls in matters which are now left in the main to individual initiative, there are wide fields of activity which are unaffected. The State will have to exercise a guiding influence on the propensity to consume partly through its scheme of taxation, partly by fixing the rate of interest, and partly, perhaps, in other ways. Furthermore, it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself to determine an optimum rate of investment. I conceive, therefore, that a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment; though this need not exclude all manner of compromises and of devices by which public authority will co-operate with private initiative…

Chasing back this “banking policy” that is the alternative to the “somewhat comprehensive socialization of investment”, there are three cites to “banking policy”: this paragraph is one, and the others are:

  • “to every banking policy there corresponds a different long-period level of employment…”
  • and the “it is, I think, arguable that a more advantageous average state of expectation might result from a banking policy which always nipped in the bud an incipient boom by a rate of interest high enough to deter even the most misguided optimists. The disappointment of expectation, characteristic of the slump, may lead to so much loss and waste that the average level of useful investment might be higher if a deterrent is applied…. [But] the austere view, which would employ a high rate of interest to check at once any tendency in the level of employment to rise appreciably above the average of; say, the previous decade, is, however, more usually supported by arguments which have no foundation at all apart from confusion of mind…”

The question of why “it seems unlikely that the influence of banking policy on the rate of interest will be sufficient by itself… a somewhat comprehensive socialisation of investment will prove the only means of securing an approximation to full employment…” is left hanging. And how “a somewhat comprehensive socialisation of investment” is to be implemented are left hanging as well.

So will somebody please explain to me why “fiscal policy” plays such a small part in the General Theory and yet such a large part in mindshare perceptions of “Keynesianism”?

Economic Methodology: Thinking Math Can Substitute for Economics Turns Economists Into Real Morons Department


The highly estimable Tim Taylor wrote:

Tim Taylor: Some Thoughts About Economic Exposition in Math and Words: “[Paul Romer’s] notion that math is ‘both more precise and more opaque’ than words is an insight worth keeping…”

And he recommends Alfred Marshall’s workflow checklist:

  1. Use mathematics as a shorthand language; rather than as an engine of inquiry.
  2. Keep to them till you have done.
  3. Translate into English.
  4. Then illustrate by examples that are important in real life.
  5. Burn the mathematics.
  6. If you can’t succeed in 4, burn 3.

This is sage advice.

And to underscore the importance of this advice, I think it is time to hoist the best example I have seen in a while of people with no knowledge of the economics and no control over their models using—simple—math to be idiots: Per Krusell and Tony Smith trying and failing to criticize Thomas Piketty.

(2015) The Theory of Growth and Inequality: Piketty, Zucman, Krusell, Smith, and “Mathiness”: It is Krusell and Smith (2014) that suffers from “mathiness”–people not in control of their models deploying algebra untethered to the real world in a manner that approaches gibberish.

I wrote about this last summer, several times:

  • Department of “Huh?!”–I Don’t Understand More and More of Piketty’s Critics: Per Krusell and Tony Smith
  • The Daily Piketty: Ryan Avent on Housing in the Twenty-First Century: Wednesday Focus for June 18, 2014
  • In Which I Continue to Fail to Understand Why Critics of Piketty Say What They Say: (Late) Friday Focus for June 6, 2014
  • Depreciation Rates on Wealth in Thomas Piketty’s Database

This time, [it was a] reply… to Paul Romer… with a Tweetstorm. Here it is, collected, with paragraphs added and redundancy deleted:

My objection to Krusell and Smith (2014) was that it seemed to me to suffer much more from what you call “mathiness” than does Piketty or Piketty and Zucman. Recall that Krusell and Smith began by saying that they:

do not quite recognize… k/y=s/g…

But k/y=s/g is Harrod (1939) and Domar (1946). How can they fail to recognize it? And then their calibration–n+g=.02, δ=.10–not only fails to acknowledge Piketty’s estimates of economy-wide depreciation rate as between .01 and .02, but leads to absolutely absurd results:

  • For a country with a K/Y=4, δ=.10 -> depreciation is 40% of gross output.
  • For a country like Belle Époque France with a K/Y=7, δ=.10 -> depreciation is 70% of gross output….

Krusell and Smith had no control whatsoever over the calibration of their model at all. Note that I am working from notes here, because no longer points to Krusell and Smith (2014). It points, instead, to Krusell and Smith (2015), a revised version. In the revised version, the calibration differs. It differs in:

  • raising (n+g) from .02 to .03,
  • lowering δ from .10 or .05 (still more than twice Piketty’s historical estimates), and
  • changing the claim that as n+g->0 K/Y increases “only very marginally” to the claim that it increases “only modestly”. The right thing to do, of course, would be to take economy-wide δ=.02 and say that k/y increases “substantially”.)

If Krusell and Smith (2015) offer any reference to Piketty’s historical depreciation estimates, I missed it. If it offers any explanation of why they decided to raise their calibration of n+g when they lowered their δ, I missed that too.

Piketty has flaws, but it does not seem to me that working in a net rather than a gross production function framework is one of them.

And Krusell and Smith’s continued attempts to demonstrate otherwise seem to me to suffer from “mathiness” to a high degree.

Here are the earlier pieces:

DEPARTMENT OF “HUH?!”–I DON’T UNDERSTAND MORE AND MORE OF PIKETTY’S CRITICS: PER KRUSELL AND TONY SMITH: As time passes, it seems to me that a larger and larger fraction of Piketty’s critics are making arguments that really make no sense at all–that I really do not understand how people can believe them, or why anybody would think that anybody else would believe them. Today we have Per Krusell and Tony Smith assuming that the economy-wide capital depreciation rate δ is not 0.03 or 0.05 but 0.1–and it does make a huge difference…

Per Krusell and Tony Smith: Piketty’s ‘Second Law of Capitalism’ vs. standard macro theory: “Piketty’s forecast does not rest primarily on an extrapolation of recent trends…

…[which] is what one might have expected, given that so much of the book is devoted to digging up and displaying reliable time series…. Piketty’s forecast rests primarily on economic theory. We take issue…. Two ‘fundamental laws’, as Piketty dubs them… asserts that K/Y will, in the long run, equal s[net]/g…. Piketty… argues… s[net]/g… will rise rapidly in the future…. Neither the textbook Solow model nor a ‘microfounded’ model of growth predicts anything like the drama implied by Piketty’s theory…. Theory suggests that the wealth–income ratio would increase only modestly as growth falls…

And if we go looking for why they believe that “theory suggests that the wealth–income ratio would increase only modestly as growth falls”, we find:

Per Krusell and Tony Smith: Is Piketty’s “Second Law of Capitalism” Fundamental? : “In the textbook model…

…the capital- to-income ratio is not s[net]/g but rather s[gross]/(g+δ), where δ is the rate at which capital depreciates. With the textbook formula, growth approaching zero would increase the capital-output ratio but only very marginally; when growth falls all the way to zero, the denominator would not go to zero but instead would go from, say 0.12–with g around 0.02 and δ=0.1 as reasonable estimates–to 0.1.

But with an economy-wide capital output ratio of 4-6 and a depreciation rate of 0.1, total depreciation–the gap between NDP and GDP–is not its actual 15% of GDP, but rather 40%-60% of GDP. If the actual depreciation rate were what Krussall and Smith say it is, fully half of our economy would be focused on replacing worn-out capital.

It isn’t:


That makes no sense at all.

For the entire economy, one picks a depreciation rate of 0.02 or 0.03 or 0.05, rather than 0.10.

I cannot understand how anybody who has ever looked at the NIPA, or thought about what our capital stock is made of, would ever get the idea that the economy-wide depreciation rate δ=0.1.

And if you did think that for an instant, you would then recognize that you have just committed yourself to the belief that NDP is only half of GDP, and nobody thinks that–except Krusall and Smith. Why do they think that? Where did their δ=0.1 estimate come from? Why didn’t they immediately recognize that that deprecation estimate was in error, and correct it?

Why would anyone imagine that any growth model should ever be calibrated to such an extraordinarily high depreciation rate?

And why, when Krusell and Smith snark:

we do not quite recognize [Piketty’s] second law K/Y = s/g. Did we miss something quite fundamental[?]… The capital-income ratio is not s/g but rather s/(g+δ) no reference to Piketty’s own explication of s/(n+δ), where δ is the rate at which capital depreciates…

do they imply that this is a point that Piketty has missed, rather than a point that Piketty explicitly discusses at Kindle location 10674?

?One can also write the law β=s/g with s standing for the total [gross] rather than the net rate of saving. In that case the law becomes β=s/(g+δ) (where δ now stands for the rate of depreciation of capital expressed as a percentage of the capital stock)…

I mean, when the thing you are snarking at Piketty for missing is in the book, shouldn’t you tell your readers that it is explicitly in the book rather than allowing them to believe that it is not?

I really do not understand what is going on here at all…

In Which I Continue to Fail to Understand Why Critics of Piketty Say What They Say: “Per Krusell II: So I wrote this on Friday, and put it aside because I feared that it might be intemperate, and I do not want to post intemperate things in this space.

Today, Sunday, I cannot see a thing I want to change–save that I am, once again, disappointed by the quality of critics of Piketty: please step up your game, people!

In response to my Department of “Huh?!”–I Don’t Understand More and More of Piketty’s Critics: Per Krusell and Tony Smith, Per Krusell unfortunately writes:

Brad DeLong has written an aggressive answer to our short note…. Worry about increasing inequality… is no excuse for [Thomas Piketty’s] using inadequate methodology or misleading arguments…. We provided an example calculation where we assigned values to parameters—among them the rate of depreciation. DeLong’s main point is that the [10%] rate we are using is too high…. Our main quantitative points are robust to rates that are considerably lower…. DeLong’s main point is a detail in an example aimed mainly, it seems, at discrediting us by making us look like incompetent macroeconomists. He does not even comment on our main point; maybe he hopes that his point about the depreciation rate will draw attention away from the main point. Too bad if that happens, but what can we do…

Let me assure one and all that I focused–and focus–on the depreciation assumption because it is an important and central assumption. It plays a very large role in whether reductions in trend real GDP growth rates (and shifts in the incentive to save driven by shifts in tax regimes, revolutionary confiscation probabilities, and war) can plausibly drive large shifts in wealth-to-annual-income ratios. The intention is not to distract with inessentials. The attention is to focus attention on what is a key factor, as is well-understood by anyone who has control over their use of the Solow growth model.

Consider the Solow growth model Krusell and Smith deploy, calibrated to what Piketty thinks of as typical values for the 1914-80 Social Democratic Era: a population trend growth rate n=1%/yr, a labor-productivity trend growth rate g=2%/yr, W/Y=3.

Adding in the totally ludicrous Krusell-Smith depreciation assumption of 10%/yr means (always assuming I have not made any arithmetic errors) that a fall in n+g from 3%/yr to 1%/yr, holding the gross savings rate constant, generates a rise in the steady-state wealth-to-annual-net-income ratio from 3 to 3.75–not a very big jump for a very large shift in economic growth: the total rate of growth n+g has fallen by 2/3, but W/Y has only jumped by a quarter.

Adopting a less ludicrously-awry “Piketty” depreciation assumption of 3%/yr generates quantitatively (and qualitatively!) different results: a rise in the steady-state wealth-to-annual-net-income ratio from 3 to 4.708–the channel is more than twice has powerful.


We have a very large drop in Piketty’s calculations of northwest European economy-wide wealth-to-annual-net-income ratios from the Belle Époque Era that ended in 1914 to the Social Democratic Era of 1914-1980 to account for. How would we account for this other than by (a) reduced incentives for wealthholders to save and reinvest and (b) shifts in trend rates of population and labor-productivity growth? We are now in a new era, with rising wealth-to-annual-net-income ratios. We would like to be able to forecast how far W/Y will rise given the expected evolution of demography and technology and given expectations about incentives for wealthholders to save and reinvest.

How do Krusell and Smith aid us in our quest to do that?

Depreciation Rates on Wealth in Thomas Piketty’s Database:: Thomas Piketty emails:

We do provide long run series on capital depreciation in the “Capital Is Back” paper with Gabriel [Zucman] (see, appendix country tables US.8, JP.8, etc.). The series are imperfect and incomplete, but they show that in pretty much every country capital depreciation has risen from 5-8% of GDP in the 19th century and early 20th century to 10-13% of GDP in the late 20th and early 21st centuries, i.e. from about 1%[/year] of capital stock to about 2%[/year].

Of course there are huge variations across industries and across assets, and depreciation rates could be a lot higher in some sectors. Same thing for capital intensity.

The problem with taking away the housing sector (a particularly capital-intensive sector) from the aggregate capital stock is that once you start to do that it’s not clear where to stop (e.g., energy is another capital intensive sector). So we prefer to start from an aggregate macro perspective (including housing). Here it is clear that 10% or 5% depreciation rates do not make sense.

No, James Hamilton, it is not the case that the fact that “rates of 10-20%[/year] are quite common for most forms of producers’ machinery and equipment” means that 10%/year is a reasonable depreciation rate for the economy as a whole–and especially not for Piketty’s concept of wealth, which is much broader than simply produced means of production.

No, Pers Krusell and Anthony Smith, the fact that:

[you] conducted a quick survey among macroeconomists at the London School of Economics, where Tony and I happen to be right now, and the average answer was 7%[/year…

for “the” depreciation rate does not mean that you have any business using a 10%/year economy-wide depreciation rate in trying to assess how the net savings share would respond to increases in Piketty’s wealth-to-annual-net-income ratio.

Who are these London School of Economics economists who think that 7%/year is a reasonable depreciation rate for a wealth concept that attains a pre-World War I level of 7 times a year’s net national income? I cannot imagine any of the LSE economists signing on to the claim that back before WWI capital consumption in northwest European economies was equal to 50% of net income–that depreciation was a third of gross economic product.

One more remark: if more than half LSE macroeconomists really do believe that net domestic product is 28% lower than gross domestic product—for that is what a depreciation rate of 7% per year gets you with an aggregate capital-output ratio of 4—then more than half of LSE macroeconomists need to be in a different profession. I don’t believe Krusell and Smith’s survey. I don’t believe their LSE colleagues told them what they claimed they had…

Three Books for 2017: Economics for the Common Good, Janesville, Economism

3 books

Ken Murphy asked me for three books for 2017. Mine are: Amy Goldstein: Janesville: An American Story, Jean Tirole: Economics for the Common Good, and James Kwak: Economism: Bad Economics and the Rise of Inequality:

  • Amy Goldstein: Janesville: An American Story (9781501102233): The best of the very large and very uneven crop of ground-level books attempting to explain why those parts of America that are treading water or losing ground have been unable to adapt to changing technology and organization in the global economy…

  • Jean Tirole: Economics for the Common Good (9780691175164): A very wise book on what high-quality economics is and is not, from the guy who was truly the smartest guy in the room back when I spent a year as a young lecturer in the MIT economics department…

  • James Kwak: Economism: Bad Economics and the Rise of Inequality (9781101871195): How a very large part of the economics profession has failed to get the true message of economics through its own biases and the political and ideological filters…

Amy Goldstein: Janesville: An American Story (9781501102233): This is the best of the very large and very uneven crop of ground-level books attempting to explain why those parts of America that are treading water or losing ground have been unable to adapt to changing technology and organization in the global economy. General Motors closed its Janesville plant in 2008 as it teetered on the edge of bankruptcy. Students began showing up at the local high school hungry and dirty. Teachers and others started social service organizations to supply them with supplies and food. Contributions to local charities fell off just when the need spiked. The closing of the GM plant triggered the closing of its nearby supplier plants as well.

The GM assembly-line workers had earned \$30 an hour at the plant. Some—a few—maintain their paychecks by becoming “birds of passage” working at still-open GM plants in other states. Others see their paychecks collapse: settle at jobs paying half as much, and with minimal benefits. For nobody was willing to pay anywhere near \$30 an hour for the skills and the energy of ex-GM workers. And the ex-workers could not use their skills and energy themselves to find a retraining path to anywhere near the pay levels that GM had offered them.

The big flaw, of course, is Amy Goldstein’s ignorance of and unwillingness to learn about the macro picture that makes the closing of the GM plant so devastating for Janesville. Plants, after all, close all the time because the money being spent on the products they had made is diverted to purchase other commodities made more efficiently that promote greater prosperity. Why weren’t the Janesville ex-workers able to benefit from spillovers from that greater efficiency and greater prosperity? Goldstein has no clue.

Jean Tirole: Economics for the Common Good (9780691175164): This is a very wise book on what high-quality economics is and is not, from the guy who was truly the smartest guy in the room back when I spent a year as a young lecturer in the MIT economics department. “The distinctive characteristic of academics”, Tirole writes, “their DNA, is doubt”. This creates a substantial tension: economists need to teach what they know not just to their peers and their students but to the public sphere; but the public sphere today—did it ever?—does not want nuanced arguments from two-handed economists. Cable TV and Twitter do not like to be told: “It is difficult to tell”. Yet, often, that is what Tirole has to say. Nevertheless, Tirole thinks—and I agree—that we have no alternative but to try: we must imagine Sisyphus happy.

In its thoughtful discussions of market-state interactions, boundaries, and synergies; in its focus on the government’s role not in prescribing actions but remedying information and other externalities; in its pleas for a diversified portfolio of institutional forms; in its speculations about the long-run impact of information and communications technology revolutions; in its use of the economics of information as an organizing principle; in its rich institutional detail; in its application of theory to real-world examples; and in its (much appreciated) boosterism for behavioral economics—this is the best book I read in 2017.

James Kwak: Economism: Bad Economics and the Rise of Inequality (9781101871195): This is a very good book about how a very large part of the economics profession has failed to get the true message of economics through its own biases and the political and ideological filters.

First of all, I think the book is mistitled. It is not economics that becomes a misleading and destructive ideological “-ism”. Rather, it is, as my friend Noah Smith puts it, it is Econ 101—supply and demand, and where the curves cross is always the bet place to be—that became a misleading and destructive ideological “-ism”.

Second, as James Kwak writes, Econ 101 became a misleading and destructive ideological “-ism” because it suited the interest of powerful groups with megaphones that it become so: neoclassical economics badly done via those who learned little economics simplistically applying the most basic supply-and-demand models. Our large upward leap in inequality, the financial crash, and the large holes in our safety net are some of the current flaws in America that Kwak traces to 101-ism. And he is in large part correct do so. 101-ism makes people think that whatever inequality there is in the current market is natural and just, and that government policies will always reduce wealth by generating Harberger triangles. And these are very convenient beliefs for plutocrats—not for plutocrats to hold them, but for those who pay rents to plutocrats to hold in order to make plutocrats richer.

Noah Smith hopes that empirical evidence will disrupt and dismantle 101-ism:

The economics discipline itself has been shifting from theory to data for years now, and the world is taking notice. Every time studies show that tax cuts don’t do much to encourage investment, or that the impact of minimum wage hikes is modest, the public loses a little faith in the power of traditional Econ 101. The cure… is more and better economics…. Americans are now starting to question economism because of declining median income, spiraling inequality and a huge financial and economic crisis…

I think Noah is wrong here: 101-ism provides a simple and powerful intellectual framework easily grasped that makes sense of a complicated world and also works to the advantage of people with a great deal of money who benefit from its spread. Thought is vulnerable to simplistic theories which then gain an unshakeable hold. Simplistic theories are easily propagated because they are, well, simplistic. When it is in the interest of someone with resources that others believe a doctrine, they will devote their resources to spreading it. And it is very difficult to convince somebody of anything when their pocketbook or their sense of self-worth depends on their thinking otherwise. 101-ism thus has powerful material and cognitive advantages over alternatives. And the only thing that the alternatives have going for them is that they are the truth.

I think that James Kwak is showing us here both how much and how little arguments based on the truth can do in the modern public sphere.

But, as I said in talking about Jean Tirole’s Economics for the Common Good: we must imagine Sisyphus happy…

Six Tax “Reform”-Related Appeals to Various People to Do Their Jobs for Their Country’s Sake—and Even, in the Long Run, Their Selves’ Sake

Tax Foundation Score of the Tax “Reform” Conference Report


Alan Cole: @AlanMCole on Twitter: “Don’t think this one’s gonna pay for itself, guys:”

John Buhl: @jbuhl35 on Twitter: “Because of the nonstop work of @ScottElliotG @NKaeding and others, we have a dynamic score of the conference committee version of the #TaxReformBill Full report to come later today.”

Alan Cole: @AlanMCole on Twitter: “1.7% change in long-run GDP is a pretty bad score from @taxfoundation all things considered, given how large the tax cut is. One problem is they got rid of the shortened asset life for structures in conference…”

The rules of thumb I find myself applying to Tax Foundation numbers these days are:

  1. Their “small open economy with perfect capital mobility” assumptions together bias and triple the long run boost to the level of GDP relative to the baseline. The US is a large economy: global interest rates are not unaffected by it. International capital mobility is not perfect: home bias is a huge thing.

  2. Their “1/e time to the long run is 10 years” assumption biases and doubles their estimate of the initial growth rate boost..

  3. Their failure to distinguish between Gross Domestic Product and national income causes an additional substantial bias that depends sensitively on the details.

  4. Their failure to take account of how the tax “reform” is going to be financed—what will be the effects on economic growth of the services and public investments cut, or of the additional taxes elsewhere in the economy that will be levied—causes an additional substantial bias that depends sensitively on the details.

So if you are talking about the impact on the growth rate of national income, divide the Tax Foundation by more than six and you have what is probably a sensible estimate.

Thus take the Tax Foundation’s 0.17%/year. Cut it down. To less than 0.03% per year. Not 0.3%. Less than 0.03%.

The claim was the 0.4% per year on the growth rate would get you 1 trillion dollars in revenue over 10 years. That was always stretching it: it was 0.5% per year. But we do not have that. Even if we were a small open economy in a world with perfect capital mobility–which we are most definitely not–the Tax Foundation grants you only 350 billion dollars over 10 years. And applying my rule of thumb haircuts makes me expect 60 billion.

Notes on Gerald Friedman

Rethinking macro economics Fiscal policy

J. Bradford Delong: Notes on Gerald Friedman: Since 2010 fiscal policy austerity has been a disaster for both Europe and the United States. But how much better could things be? How much good could be done by a restoration of a sensible fiscal policy?

I take a sensible fiscal policy to be one that, in the words of Abba Lerner, recognizes the first principle of functional finance…

to keep the total rate of spending in the country on goods and services neither greater nor less than that rate which at the current prices would buy all the goods that it is possible to produce… concentrat[ing] on keeping the total rate of spending neither too small nor too great, in this way preventing both unemployment and inflation…

I think a sensible fiscal policy entailing larger deficits and much more aggressive federal spending on investment—and remember that improving public health and the human capital of twelve year olds are just as good “investments” as big pieces of useful infrastructure, and much better than border walls—would do a lot of good. Gerald Friedman thinks that it would do about four times as much good in the long run as I do. Let me try to figure out why….

At first, [Larry Summers’s and my] decision to set [our hysteresis parameter] η = 0.1 as the central case was merely a calculation followed by a belief and then extended by a guess. But the argument was strengthened by… American economic history. It is very difficult see large and permanent depression of the rate of potential output growth following any of the major and at times lengthy recessions of the pre-Great Depression period. And whatever damage had been done to long-run productive potential from the Great Depression and its decade-long output gap appears to have been offset by the boost to productive potential from the extremely high-pressure economy of World War II…. [And] previous post-WWII downturn episodes had been followed by V-shaped recoveries—after 1957, 1960, 1975, 1982, and 1992—seems to leave little space for any hysteresis coefficient η much larger than calculations, beliefs, and guesses had led to….

To me, back in the winter of 2016, projections finding large benefits that made sense only under an assumption of η = 0.4 thus seemed four times as large as was in fact likely to be the case. The world seemed to be telling us that η = 0.1 instead. It seemed—and it seems—to me that overpromising the benefits of even the best policies is not a good business to get in. Somebody like Irving Kristol could unashamedly take the Public Interest he edited and use it as a vehicle to publish things he really did not believe could possibly be true:

My own rather cavalier attitude toward the budget deficit and other monetary or fiscal problems [arose because] the task, as I saw it, was to create a new majority, which evidently would mean a conservative majority, which came to mean, in turn, a Republican majority—so political effectiveness was the priority, not the accounting deficiencies of government…

But this is not a good game to play. We seek to do better…


Brad DeLong and Charlie Deist on Austrian Economics

Bob Zadek

Charlie Deist: Brad DeLong on Austrian Economics:

Charlie Deist: Good morning everyone, and welcome to the Bob Zadek Show.

I’m Charlie Deist, Bob’s producer, once again filling in for Bob, who will be back next week to discuss the topic of morality and capitalism. Are the two compatible? Is a moral citizenry required for a capitalist system, or is it the inverse? Is capitalism the only system that does not require a moral citizenry?

I also want to wish our listeners a “seasonally-adjusted greetings.” The adjustment is both my filling in, and my special series here on the business cycle. When we talk about economics, we often refer to seasonally-adjusted statistics—business cycles fluctuate up and down, not only in these longer boom and bust cycles, but also throughout the year. Around Christmas time, consumers are running off to the store to buy the latest gadgets and gizmos, so we see a temporary spike in spending.

Last week I was joined by Robert Wenzel, who is a self-described Austrian economist. That does not mean that he is of Austrian nationality—it means he follows the ideas of libertarian economists such as Friedrich Hayek, and Ludwig von Mises. These were 20th-century economists who built a foundation for economics on a philosophical concept that is both simple and profound—that is, that humans are purposeful actors; we act with an intention to achieve certain aims, and use economic means as well as other means to achieve our desired ends.

The Austrian school is important today because everyday we see stories on the front pages of the newspapers about booms and busts, bubbles bursting, Bitcoin, etc. Is Bitcoin a bubble? We might wonder whether humans are actually rational. Are they pursuing their ends in a way that will actually best achieve them, or are they, perhaps, less than perfectly rational?

These are the kinds of questions that economists debate, and today I’m privileged to have an economist with me. I’m joined this morning by UC Berkeley economics professor, Brad DeLong. Every so often, I need to ask a favor of Brad DeLong. He’s my old teacher and undergraduate advisor, from when I was something of an aspiring libertarian economist.

While preparing for last Sunday’s show, on the hardcore libertarian Austrian theory of the business cycle, it occurred to me that I don’t actually know what I’m talking about. I don’t have a PhD, or even a Master’s degree in economics, although thanks to Brad I was able to complete an undergraduate thesis on monetary policy. But it occurred to me, if I were in almost any other field, trying to diagnose a problem—something as complex and serious as the booms and busts in the economy, my musings here would be something akin to malpractice.

Brad DeLong is the chair of the political economy major at UC Berkeley. He was deputy assistant secretary at the U.S. Treasury, and is a visiting scholar at the San Francisco Federal Reserve Bank. He joins me by phone from Berkeley, where he also writes the popular blog, “Grasping Reality with Both Hands.” Now, that’s a metaphor, so if you’re driving keep both hands on the wheel.

I’m going to try to cram in close to a whole semester of economics with Professor DeLong, and hopefully he can help to explain in layman’s terms, his academic perspective on what’s really going on in the economy when we read about the Federal Reserve and interest rates, money supply, quantitative easing, and so on. Thanks for taking the time to talk with me.

Brad DeLong: It’s a great pleasure on my part to be virtually here. Thank you for asking me.

Charlie Deist: I want to start with a quote from a blog post that you wrote all the way back in 2004. This was when Alan Greenspan was still Federal Reserve Chairman, and it echos the message of my last guest, which was that the Federal Reserve negatively influence the economy—I don’t think there’s any question about that among economists. This was the end of a post from April 2004, where you were trying to figure out what was going on with monetary policy at the time.

You said:

Alan Greenspan frightened away the evil depression fairy in 2000 to 2002, by promising—not that he would let the evil fairy marry his daughter—but by promising high asset prices, unsustainably high asset prices for a while. Whether this was a good trade or not depends on the relative values of the risks avoided and the risks accepted. And to evaluate this requires a model of some sort…

So back in 2007, you were worried, just like our last guest, about the Federal Reserve inflating a bubble. What would you say is the Keynesian perspective, if you will, on the potential for the Federal Reserve to engage in this kind of pro-cyclical monetary policy—i.e., monetary policy that, rather than smoothing out the business cycles like it’s supposed to, actually can exacerbate them and make them worse?

Brad DeLong: Well, I would say that it’s not so much a Keynesian perspective as a Keynesian–Monetarist perspective. Or rather, since Keynesianism, Monetarism, and Austrianism are all very large and vague, unsettled creatures with very fuzzy borders, such that it’s not clear where the core is, let’s say John Maynard Keynes himself rather than the Keynesians, Milton Friedman himself rather than the monetarists, and Friedrich Von Hayek himself rather than the Austrians.

Here Keynes and Friedman would have been on the same side, approving of Greenspan’s policies. That is, Keynes thought the most important thing for monetary policy was to manipulate the economy so that the level of spending in the economy—the level at which the government plus private actors wanted to spend—was large enough to be able to put everyone to work, who wanted to work, at the prevailing wage level, without creating an excess of demand, over the amount that could be produced that would produce inflation. That, as he said, inflation is unjust in that it robs the saver of the returns that they’re expecting, and deflation is inexpedient. Perhaps deflation is worse in an impoverished world, but these are both evils to be shunned.

Milton Friedman was very much the same. That is, Milton Friedman thought that the right policy for the Federal Reserve to follow was for it to be constantly intervening in asset markets in order to keep the money supply from falling—even if private actors wanted to shrink their holdings of money—or keep the money supply from rising if private investors and private actors wanted to increase the supply of money. Also, Friedman thought that if there were to ever be sharp shifts in the velocity of money—sharp changes in how much people wanted to hold in terms of dollars in their bank account for every dollar they spent—the Federal Reserve should offset those too.

So in both Friedman and Keynes’ view, the right strategy for the Federal Reserve was the Greenspan strategy of “act to try to keep inflation and unemployment as stable as possible, by doing whatever is necessary in terms of buying and selling assets, and pushing asset prices up and down.” It’s just that Friedman called it a neutral monetary policy, and Keynes feared that the Federal Reserve would not be able to do enough, and that you’d have to bring in other tools as well.

I think Keynes has won this one after 2007 to 2009, when the Federal Reserve did everything and it didn’t work. But they’re on one side agreeing with Greenspan.

Hayek, and I suppose also Hyman Minsky—who are on the other side—were saying back in the 1930s, the 1950s, the 1960s, that no, this is a very dangerous policy to pursue.

Charlie Deist: So there’s a lot to unpack here. We have four names: Keynes, Friedman, Hayek and now Minsky, who we’ll try to get to later. And each of them is telling a different story, and proposing a different remedy for this problem of the business cycle.

You used the word “manipulation”, and that seems to be where the Austrians would have the biggest disagreement with even the monetarists like Milton Friedman, who was one of the most famous libertarians—maybe the most famous libertarian. Yet, in this one area, Friedman did favor a role for government manipulation: of the money supply. This gets to the core of the technical debate in monetary policy, which is, what is the Fed actually doing on a day to day basis? How do they adjust, both through direct action and through the influence of expectations of the actors in the economy? Let’s summarize for listeners in layman’s terms how they influence the economy. Economists talk about a transmission mechanism. This is just the direction of causality from one action to the results that we see. Could you break down how the Federal Reserve actually achieves the smoothing of the business cycle, in either the Keynesian model, the Monetarist model, or whichever hybrid of the two you think makes the most sense?

Brad DeLong: Well, as early liberal John Stuart Mill put it back in 1829—and I think he got it right and Keynes and Friedman would agree—that the economy is in balance, in a business cycle sense, if the supply and demand for money are equal. That is, if demand for money is greater than supply, then people are cutting back on their purchases because they want to hold more money than they can find. Then you have what they used to call in the colorful language of the early 19th century call a “general glut of commodities”: high unemployment, idle factories, cotton goods going begging as far as Kamchatka, in Thomas Malthus’ phrase. That’s a bad thing. And if the supply of money is greater than the demand, well that’s inflation, which is also a bad thing.

To keep the economy in balance, you need to match the supply and demand for money. But since the demand for money is somewhat erratic, the Federal Reserve or the Bank of England always have to be in there, buying and selling, pushing and shoving, increasing and decreasing the supply of money in order to keep there from being either unwanted inflation or unwanted deflation. That is just the way things are, if you are going to keep the economy stable.

Now this is a somewhat awkward position for Milton Friedman to be in because when you ask Uncle Milton about practically any other market, his response is, “The market will sort it out optimally. And even if the market wouldn’t sort it out optimally, building up any government bureaucracy to try to do better is doomed to failure.” Yet somehow, with respect to monetary policy, Uncle Milton goes very far towards saying that there are major institutional or cognitive human deficits in how the market for money works. So, we have to have this form of extremely soft, light-fingered central planning for the money supply—which he hoped could be done by a rule. That the Federal Reserve is going to say, “We’re going to let the money supply increase by one percent every quarter.” But it turned out that such rules don’t work very well. We need much more complicated rules—we need feedback rules, and even with the feedback rules, we have to deviate from them substantially on occasion.

So that is very much what Friedman and Keynes think is going on there. Minsky thinks that’s going on too, but Minsky also thinks that the same current of thought and institutions that lead to episodes of deflation and inflation in the private market—to financial over-speculation and so forth—that those are also going to affect the minds of policy makers. So, it’s just when asset prices are rising and people are enthusiastic and getting over-leveraged, then you’re going to find large political calls for deregulation of finance and for a reduction in regulatory requirements for collateral and down payments. And, conversely, just when the economy is in serious trouble and people are depressed, that’s when you’re going to have the Dodd-Frank bills imposed. That’s when you’re going to have governments demanding lot higher down payments. That’s when you’re going to have collateral requirements required by the Bank of International Settlements go through the roof.

Charlie Deist: So Minsky tells another story of the pro-cyclical policy where government, rather than smoothing out the business cycles, is tracking with either the people’s confidence of lack of confidence in the financial system. It’s a case where human irrationality and the lack of a sound technician at the board, so to speak, is leading to these wild fluctuations.

Brad DeLong: Well in Minsky’s view it’s a logical impossibility. Right? That, as William McChesney Martin—Fed Chair in the 1960s—said, “The purpose of the Federal Reserve is to take the punchbowl away just when the party gets going.” But just as the party gets going, that’s when absolutely nobody wants to take away the punch bowl.

Basically, Minsky had all kinds of hopes about how—because we would understand this cycle—we could transcend it, and moderate it, and deal with it. But those are basically unconvincing. If you take a Minsky point of view, we’re pretty much hosed, and all we can do is remember the historical parallels and analogies, and whimper and complain whenever this cycle gets going.

Charlie Deist: Tell us Hayek’s story—how Hayek relates to Minsky, and how it might echo it in some ways, or vice versa.

Brad DeLong: With Hayek, it’s in some sense very apocalyptic. It’s that everything would be fine if the market were just working well. It’s that you do not have a sudden large increase in the demand for money—the kind of thing that produces a depression—unless you had a large previous episode in which too much money has been created; in which the economy has somehow found itself with lots of liquid assets, which do not correspond to any fundamental values, either because the government has previously been printing a lot of money and generates an episode of inflation, or because the banking system has gone absolutely haywire, and private agents are facing bad incentives. Banks have extended many, many, too many loans thinking that they’ll reap fortunes if there are no bankruptcies for as long as they’re president of Bank of X. And if there should be bankruptcies, well, they’ll probably have moved on to another job by now.

So it’s a combination of fecklessness on the part of politicians who print extra money to spend or to lower taxes and so produce inflation, plus a principle–agent failure in the banking system, in which bankers make loans that are really lousy business in the long run because, hey—the long run might not come until they’ve moved on to another job.

That creates the inflation, and only after the inflationary boom comes is there ever a chance of being a large recessionary crash. So, for Hayek it becomes somewhat of a moral answer: that you have to keep the government a kind of moral, budget-balancing government, and you have to keep the bankers from grabbing us by the plums. And if we can have moral bankers and a moral government, somehow, then everything will be fine.

Charlie Deist: That’s an interesting interpretation—I want to pause on this question of market failure versus government failure. It’s a mixed story that you’re telling, where on the one hand there are the politicians and their short-sightedness—their money printing. On the other hand, there’s what economists call a “market failure,” which is where private actors supposedly acting in their own best interest, either short-term or long-term, make loans that will not bear the fruit necessary to pay back those loans.

So we end up with people, not only borrowing, but leveraging or borrowing with the money that they’re making initially off asset price increases.

They inflate this bubble, and get overly optimistic about the proceeds from this investment initially, so they’re doubling up, until we reach what’s called the “Minsky moment,” where everyone suddenly looks around and realizes that the punch bowl has been taken away, or that these investments are clearly not sound. And then we get a sudden crash.
Hayek said that this would not happen if government was not inflating a bubble, but Minsky considered himself a Keynesian, I believe, and argued that this would happen in the absence of that fecklessness on the part of the politicians. There is something inherent in human nature about being overly optimistic in these boom times.

And how do the Austrians solve that? They might say, “Well, we should go to a gold standard so that banks have to back up their deposits with some sort of hard money, precious metals and the like, and that will limit the loans.” Or they argue that in a free market banking system, agents would, on the whole, make more rational decisions. But this is an open question. Maybe it’s an empirical question. Maybe it’s a philosophical question. But you think that the preponderance of evidence is, empirically, on the side of people like Keynes and Minsky, who would still give some role for a wise and benevolent leader at the helm of the Federal Reserve, who could make corrections.

I think I remember a Keynes quote, and I don’t remember the exact quote—this might have been your email signature for a time—but it stuck in my mind, and it was something to the effect of, “We should hope that one day, economists will be as useful as dentists.” It’s “economists as technicians” rather than economists as “worldly philosophers.” People like John Stuart Mill seem to be more in the model of philosophers, but they also had economic theories, and these two things do seem to dovetail. What do you think is the proper role for economists, and are they more like dentists or they more like philosophers?

Brad DeLong: Well, we’re not terribly good as philosophers. As far as philosophers are concerned, we’re either third-rank libertarians or third-rank utilitarians. Or we used to have—I don’t know what you want to call it—third-rank Hegelians, talking about the necessity of freedom and the nurturing of humanity’s species-being, or identity as a species in one way or another. We’re not terribly good at any of those, and I think we’re better when we try to be technicians. Unfortunately, we’re lousy technicians.

Now let’s take this kind of question for example: Keynes, Friedman, Hayek and Minsky are all extremely smart and are all trying extremely hard, and indeed their positions bleed into each other. When Hayek stops talking about government engaging in deficit spending as the [sole] source of the boom that produces the bubble, and then slides over into banks that are improperly regulated for individuals who really do not understand that, say, the fact that Bitcoin has gone from 1,000 to 16,000 this year, does not mean that Bitcoin is likely to rise in the future—then, all of a sudden, Hayek starts moving over into Minsky. And when Keynes talks about how a boom leads to an increase in capital investments, that then reduces the rate of profit that can be earned on new investments, he starts sliding in the direction of Hayek.

Friedman’s hopes that you could make good Federal Reserve policy not automatic, but close to automatic, has pretty much been dashed, and that’s a big victory for Keynes. Keynes’ belief that you could have wise technocrats running the government does not look so hot, and that’s a victory for Minsky. And Hayek’s belief that, in some sense, the bubble is the cause of the depression and that if you avoid the boom in the bubble, you manage to avoid the depression, that really doesn’t look so good these days. Largely, because the two biggest depressions we’ve had in the past century—the 1930s and then the past decade—are far, far greater in magnitude than the previous bubble to which Hayek wants to blame them on. But I was much more of a monetarist 15 years ago than I am now. I thought Friedman looked much better than Keynes, and Minsky worse. Reality has a way of teaching you lessons.

Charlie Deist: Yes, and this is a nuanced perspective. We’re not calling names, or it’s not those bad guy Austrians or those good guy Keynesians. It’s a much more complicated picture with a lot of different shades and overlap between the theories. That’s what I’ve always appreciated about your blog and your writing is that it does seem like an earnest attempt—and even if we might disagree on some philosophical issues, there does seem to be this good faith effort to actually get to the truth. We have a caller on the line, so I want to hear from them and see if we can maybe bring this conversation back to some fundamentals.
Michael, let’s hear your question.

Michael: Hi Charlie. Thanks for a fascinating show. I was going to bring up some fundamentals. When you talk about the Austrian school, a fundamental aspect of it is praxiology, and I was wondering how praxeology fits into the discussion?

Brad DeLong: Praxeology, at least as I understand it, at one level it is sheer and total genius. I was reading a piece last night by three left-wing economists at—Sam Bowles, Rajiv Sethi, and I’m blanking on the name of the third author. [It] said that Hayek’s decisive and positive contribution to economics was in fact his rejection of Walrasian static, and also general equilibrium theory, as developed by Arrow and Debreu, [along] with the idea that the justification for the market is that it produces the best equilibrium. Because there’s never an equilibrium. Because all human action is a discovery and interaction process, in which people have different plans that are extraordinarily often inconsistent. And it’s the right way to analyze economics, and indeed all social life, is to look at how agents behaving in a disequilibrium situation, learn and react and adapt to each other.

Michael: I think the first step in criticizing praxeology is defining it. So why not just tell the listeners what it consists of.

Charlie Deist: Sure. Thanks, Michael.

Brad DeLong: As I’m saying, that’s my view of what praxiology is.

Charlie Deist: Praxeology being, most simply, the study of human action. Mises, in his book “Human Action” defines—I don’t know if he originated the word—but basically it’s “how do humans act?” It’s not necessarily what should they desire, but given that humans have certain ends, and that they use certain means, what can we say?

Whereas the typical classical economic approach to studying markets doesn’t necessarily begin with these assumptions about human action—these axioms that can be laid out just by going inward and thinking about the structure of the mind. It starts more with what [DeLong] is talking about: this Walrasian idea of an equilibrium (Leon Walras, not to be confused with the marine mammal, was the guy who basically invented supply and demand curves).

You have supply, where people will be induced to produce more of a good if there’s a higher price, and then demand, people will demand more if it’s a lower price. That gives you an upward-sloping supply curve and a downward-sloping demand curve, and where those meet, you have an equilibrium price and quantity. That’s what the market will produce. But, in praxeology, can we use supply and demand curves or do we need a completely different model?

Brad DeLong: Well, we can use supply and demand gingerly, because they do have very stringent underlying assumptions that most of the discovery that is the core of the market process have already been accomplished. I think that view, that rejection of Walrasian general equilibrium as a road that may well mislead us—that’s going to miss most of what is going on—is the very good part of praxeology.

The bad part of praxeology is simply when one tries to reduce what is, after all, an empirical study of how markets behave, to a set of logical consequences of looking inward and trying to assess one’s own motives. Even what I see as the Hayekian side of praxeology moves us towards creating a reified theoretical superstructure that then has little to do with how markets actually operate in the world. So I think the internal, psychological side of praxeology kind of leads away from the world, into another, different, abstract theoretical structure.

That’s why I would prefer to say Hayek rather than the Austrians, because I think Hayek has by far the better of the arguments here. I find Hayek’s viewpoint, which is focused on the market as discovery process, much more congenial to how I think than saying that we will take another step back from empirical reality, and try to derive laws of thought and human action from introspection.

If the psychologists tell us anything, it’s that we’re pretty bad at introspection. We vastly overestimate how smart we are—even how much of the world we see around us—and that can lead us wrong.

Charlie Deist: We should be more humble with regard to what we can know, and I think that the Austrian school tends to emphasize this in one area—mainly with respect to what government can know about the economy and thus what it can manipulate, so it’s very skeptical of the sort of technocratic economist-as-dentist paradigm. But you’re offering, with the same logic, a counterpoint which is that when we try to build our foundations for economics on this logical deduction, based on the logical structure of the human mind, that can also take us in a direction where we might have the overconfident in our models.

Brad DeLong: Did you receive the gorilla basketball video?

Charlie Deist: I believe so, but describe it for our listeners.

Brad DeLong: It was a psychologist’s experiment. They take the students to the professor to be experimented on and they set them in front of a TV screen and they say, “A basketball team is going to come out, and they’re going to practice, and they’re gonna pass the ball to each other, and your job is to count how many times they pass the ball to each other. And we’re trying to assess how smart people are, and how well they can deal with rapid information, so you’re trying to count accurately. And of course, we’ll judge you as if you get it wrong, et cetera, et cetera.”
And so then the basketball team comes out and they begin passing. And after about a minute, a person in a gorilla suit walks into the field of view from the left, slowly, and in the middle of the field of view, he beats his chest, and then walks off to the right, and then the video ends and people report how many times the ball was passed.

And then the experimenter asks, “Was there anything else about the video that struck you as remarkable?” And recorders of the people, they know, and then they say, “Did you notice the gorilla? The person in the gorilla suit?” And two-thirds of the people say no. That always struck me as a statement, not just about how focused humans are on whatever they’re focused on, but also how much we overestimate how aware of what’s going on in the world around us we can possibly be.

You can get the same experience by going to magic shows, by the way, in terms of just how unaware the people they are conducting their tricks on are—how unable to follow everything that’s going on. Especially, if you’re Penn and Teller and you have three different levels of misdirection there.

Charlie Deist: It’s a fascinating example of how we can have these huge blind spots, and it’s another good lesson about the humility that we should bring to any academic or philosophical enterprise. So thank you, Michael ,for your question, and I believe we have another caller on the line. Let’s hear from John.

John: I have a question for the professor. I assume that housing values and stock values represent much of the wealth in America and those values have fluctuated widely in the last ten years from high to low, now to very high. Has our society gotten wealthier or is this purely a monetary phenomenon? I’ll take the answer off the air.

Brad DeLong: Has our society gotten wealthier? Well, I would say yes and no. I would say the best way to look at it right now is that high stock and housing prices more reflect a low expected private rate of return on investment so that companies that have earnings right now, plus some that don’t like Amazon, plus houses that are built and are providing satisfaction to human beings, have a relatively high price relative to currently produced goods and services because there’s little opportunity to build new buildings and take new machines and use them to create enterprises that will be equally profitable. So that in one sense, it reflects not that we’re rich now, so much as though we’re not expected to become that much richer, faster in the future.

And you can go down to Silicon Valley and find Google’s Chief Economist Hal Varian, and he’ll say that what’s really going on is we’re becoming more prosperous at an amazing rate. Look at how much people like their cell phones, look at access to information and communication. It’s just that these particular sources of human well-being are not ones that are really being created and transferred by the market process. That is, that rather than selling what it produces, which is information, Google is running off of the fumes created by selling your eyeballs to advertisers, and the value it earns by selling your eyeballs to advertisers is much, much less than the value you receive from the access to information that Google gives you.

So, the fact that it isn’t expected that future investments will be very profitable doesn’t mean that they won’t be very productive or very welfare-enhancing, but Hal is a minority point. The majority point is that we seem to have entered a world in which people are less optimistic about the future of economic growth than they were. That’s the thing that’s pushing up housing prices, and currently installed housing prices and current stock prices, because those companies have made their investment.

And what it’s really saying is investments in the past were more valuable than the investments you make today, and that’s why they’re so high.

There’s a second sense in which high housing prices in greater San Francisco are a sign of our poverty. That is, in a better functioning world—in a world without my crazy NIMBY neighbors, there’d be no way that a house like mine—a mile south of the University, a mile north of the Rockridge BART—there’s no way that the neighborhood of Elmwood now would still be composed overwhelmingly of houses like mine rather than of triple-deckers like the small apartment buildings surrounding Harvard, or like the ten-story apartment buildings surrounding Columbia, or like the 25-story stuff surrounding NYU. But [given] the population of greater San Francisco, if San Francisco development in the land of Silicon Valley had followed the standard American pattern, we’d have seen its population grow from five million to ten million over the past 25 years.

Instead, it’s only grown from five to 6.5 million due to NIMBY development restraints.

And that means that the houses that exist are extremely valuable. But the reason they’re so valuable is because they’re so scarce. It’s a monopoly rent. And we’re poorer by the fact that we ought to have 3.5 million dwelling units in greater San Francisco that we do not have because we have seriously screwed up our land-use governance over the past 25 years. So.. all of this is a standard economist’s answer: on the one hand, on the other hand; yes and no.

Charlie Deist: Right. Another axiom that economists are fond of is that there are always trade-offs. One of the points that the Austrians maybe internalized, but maybe still have a ways to go in incorporating into their thinking is the idea that planning has to take place at some level. There’s no such thing as a purely neutral zoning policy, for example, and if we want to come up with the ideal regulations, well, maybe there is no such thing as an ideal regulation, because there will always be trade-offs. So economists have to be the wet blankets to inform people that they can’t have everything that they want.

Sadly we’re coming close to the end of the hour.I’m speaking with professor Brad DeLong. He is at UC Berkeley, where he is the chair of the political economy department. He’s also a visiting scholar at the Federal Reserve Bank in San Francisco and served as deputy assistant secretary at the U.S. Treasury, so he’s an expert in the matters of monetary policy as well as economic history and a variety of other things.

I wish I could pick his brain all morning, but in these last ten minutes, I want to come back to what you were saying about Hal Varian and this world that we’re entering, where more of the value is coming from our smartphone technology, from information technology. On the one hand, this can give us an incredible amount of satisfaction. I’ve found blogs and Twitter and all these things to be a source of incredible education. But at the same time, they can also be… it’s a mixed bag. And in this new economic system, maybe there’s less emphasis on physical stuff and things.

But the Austrian business cycle theory places a big emphasis on these long-term capital malinvestments—these are the areas where we tend to see inflation having the greatest effect. We get inflation from the long-term areas because cheap credit encourages a sort of … Hayek talks about the structure about production, meaning certain investments take longer to materialize … and if we’re injecting money into credit markets first, then you will tend to incentivize people to develop longer-term things.

Is there any kind of application for that model in your mind to the current world that we live in?

Most of these Austrians were writing well before the 1960s. Hayek and Mises were early 20th-century economists. Is there anyone doing work in your mind that brings these ideas into the 21st century? Or, what areas do you think would be most fruitful for someone who is interested in an Austrian approach to focus on, without getting to thick into the weeds?

Brad DeLong: Well, with respect to that of over-investment in the structure production, I think the Minskyist current is winning and is the most productive one to pursue now. That is, if you’ve made investments and if you did make them assuming long-term interest rates will be lower than they in fact are now, and if they are now unprofitable, that doesn’t mean we should shut them down. To say we should shut them down is the sunk cost fallacy, to which I think Hayek and Von Mises fell subject to, to a large degree. What it does mean is that our future investments should be focused on things that have short-term payoff.

Then the question is, “Well, if we shouldn’t shut down long-term investments that are now unprofitable because we’ve already made them (and we might as well get something out of them), why is the reaction to a period of prolonged sub-normal interest rates a depression?”

And the Minskyite answer is that it’s the financial system that messes up. That there’s no good way to quickly allocate the losses. The core of it is the fact that losses have not been allocated, and people wanting to commit new money are scared their new money will go to pay for old losses.
And that, I think, is a very fruitful line of investigation—that it’s not so much a hangover of excess buildings and excess machines, because we can always find uses for buildings and machines. It’s a hangover of bad assets—of bad debt that somebody is going to have to pay, or swallow and eat—and social disagreement over who has to eat them.

So, I would say investigating the structure of bankruptcy and principal–agency finance, and how to quickly resolve situations in which debts go bad is the most fruitful thing to pursue.

If I can also give a commercial?

Charlie Deist: Absolutely.

Brad DeLong: I had dinner last week in San Francisco with a guy named Jerry Taylor, who used to be a vice president at the Cato Institute, and he now has split off and has his own libertarian think tank called the Niskanen Center in Washington D.C., which has a lot of smart people doing a lot of interesting thinking. If you’re looking for a set of people thinking and arguing about libertarian ideas in the 21st Century, and want to put them on your Christmas list, I think the Niskanen Center ought to be first among your choices.

Charlie Deist: Those who listen to this show know that we often host guests from the Cato Institute—sometimes we’ll have a month where half our guests or more will come from Cato. Jerry Taylor, as Brad DeLong is mentioning, is someone who fits that mold, but he has come up with a new intellectual venture. This is the Niskanen Center, and they are producing ideas—would you characterize them as a moderate, centrist, technocratic Libertarian perspective or … what is their byline or subtitle?

Brad DeLong: Their byline is to explode the center and to kind of ask, “What does libertarian mean, not in the 19th, not in the 20th, but in the 21st century?”

Charlie Deist: I had also hoped to ask you—this is one of those questions that I could talk about for hours, and we’ll just have to keep it to a few minutes—but to your mind, what is the different between a liberal and a classical liberal, and do you identify as one or the other, or both?

Brad DeLong: The shortest way I’d put it is:

Suppose you’re locked in a cage and suppose there’s a key that someone outside the cage is holding. The classical liberal would say, “You’re free as long as there’s a key and there’s somebody you could buy it from.” A New Deal liberal would say, “Wait a minute, you’re only free if you have the money to buy the key from the person holding it.”

I would say I’d identify myself as a modern liberal—a New Deal liberal—for that reason, but I’d also say that New Deal liberals, traditionally, have an appalling disregard for the magnitude of government failure and for the damage caused to the economy by rent seeking.

If I find myself in a group of too many social democrats, I’ll actually start calling myself a neoliberal. And if I find myself in a group of too many liberals, I’ll start calling myself a social democrat.

Charlie Deist: So kind of a natural contrarian—I like that.

We’re gonna have to cut off my conversation here. If you are interested in following Brad DeLong’s work, you can find him at He’s also on Twitter at @delong. And once again, I’m Charlie Deist, filling in for Bob, who will be back next week.

We’ve just spent the hour discussing the Austrian theory of the business cycle, in contrast with the Keynesian perspective, as well as the Friedmanite, the Minskyist, and there’s probably many other perspectives that we didn’t get to. This is an area that anyone who’s interested can get online and do their own homework, and form their own conclusions. We’ve been fortunate to have someone who has a nuanced perspective, and can treat this issue with the full intellectual weight it deserves. So stay tuned next week, Bob will be back. And you can always catch this episode and any others at Once again, thanks Brad for taking the time to talk with me.

Brad DeLong: You’re welcome. It’s been a great pleasure.

Charlie Deist: Alright, well have a great rest of your day and to all the listeners out there, enjoy the weekend. We’ll talk to you soon.

Hoisted from the Archives: Night Thoughts on Dynamic Scoring

Should-Read: I say it is time to promote this guy to Admiral: AdmiralPAYGO!: Ed Lorenzen: @CaptainPAYGO on Twitter: “The Treasury Department dynamic ‘analysis’ of tax reform makes a mockery of dynamic analysis and does a disservice to those who advocate for serious dynamic estimates…”

Brad DeLong: @de1ong on Twitter: This is a surprise? Static analysis was always about making a bias-variance tradeoff: A static analysis would be biased, but have lower mean-squared error because the “dynamic” terms would inevitably be overwhelmingly large-magnitude political-partisan-lobbyist-ideologue noise:

Hoisted from the Archives from 2015: Night Thoughts on Dynamic Scoring: Live from DuPont Circle: Last Thursday two of the smartest participants at the Brookings Panel on Economic Activity conference—Martin Feldstein and Glenn Hubbard—claimed marvelous things from the enactment of JEB!’s proposed tax cuts and his regulatory reform program. They claimed:

  • that it would boost economic growth over the next ten years by 0.5%/year (for the tax cuts) plus an additional 0.3%/year (for the regulatory reforms).

  • that it would leave the U.S. economy in ten years producing $840 billion more in annual GDP than in their baseline.

  • that over the next ten years faster growth would produce an average of 210 billion dollars a year of additional revenue to offset more than half of the 340 billion dollars a year ‘static’ revenue lost from the tax cuts

  • that the net cost to the Treasury would thus be not 340 but 130 billion dollars a year.

  • that in the tenth year—fiscal 2027—the 400 billion dollar ′static′ cost of the tax cuts would be outweighed by a 420 billion dollar faster-growth revenue gain.

The problem is that if I were doing the numbers I would reverse the sign…

I would say that:

  • On net, deregulatory programs have been very costly to the U.S. economy in unpredictable ways
    witness the subprime boom and the financial crisis.
  • The incentive effects would tend to push up growth by only 0.1%/year
  • That would be more than offset by a drag on the economy that would vary depending on how the tax cuts were financed:
    • If they were financed by issuing debt, I would ballpark the drag at -0.2%/year.
    • If they were financed by cutting public investment, I would ballpark the drag at -0.4%/year.
    • If they were financed by cutting government programs, there might be a small boost to growth–0.1%/year–but any societal welfare benefit-cost calculation would conclude that the growth gain was not worth the cost.

And there is substantial evidence that I am right:

  • You cannot find a boost to potential output growth flowing from either the Reagan or the Bush tax cuts.
  • You cannot find a drag on growth from the Obama tax increases.
  • You can find an effect of the Clinton tax increases—but it is that, thereafter, growth was faster, because the reduction in the deficit powered an investment-led recovery.
  • Over the past thirty years, the agencies that do the government’s accounting have tried to reduce their vulnerability to the imposition of a rosy scenario by their political masters by claiming as a matter of principle that they do not calculate positive growth impacts of policies. This is clearly the wrong thing to do—policies do affect growth rates. But is overestimating growth effects in a way that pleases one’s political masters a less-wrong thing? There is a bias-variance tradeoff here.

[Name Redacted] suggested at the conference that the right thing to do is probably to apply a substantial haircut to the growth-boost claims of political appointees.

The problem is that when I look at the example of ‘dynamic scoring’ that was on the table at Brookings—the 0.8%/year growth boost that I really think should be a -0.1%/year growth drag—the haircut I come up with, for Republican policy proposals at least, is 112.5%.

Yet the near-consensus of the meeting was that dynamic scoring—done properly—was a thing that estimating agencies like JCT and CBO (and Treasury OTA) should do. If there were to be a day on which the news flow was less favorable to such a consensus conclusion, I do not know what that day would have looked like.
Twenty-two years and one month ago, after an OEOB meeting I spent carrying spears for David Cutler in one of his hopeless attempts to warn certain Assistant to the President for Health Policy precisely what reception his policy proposals would get from a CBO where Doug Elmendorf piloted the health-care desk, I returned to my office at the Treasury, and one of our career economists lectured me thus about dynamic scoring:

Brad, you people come in with your exaggerated belief in the productivity benefits of public investment. And so you command us to score your policies as having a very favorable impact on the deficit. They come in with their exaggerated belief in the benefits of tax cuts. They command us to score their policies as having a very favorable impact. We cannot say we disagree with our bosses’ analytic judgments. But by holding the line and stating that we do not consider any macroeconomic effects of policies, we can at least prevent being whipsawed by this partisan rosy-scenario ratchet.

Thus I find myself worrying about this:

  • I find myself thinking of CBO Directors past and future.
  • I think of June O’Neill, talking over and over again about how her model showed substantial disemployment effects of universal health coverage, without ever letting past her lips any acknowledgement that the people whose jobs her model showed as ‘destroyed’ had in fact voted with their feet and moved to a higher utility level by quitting.
  • I find myself thinking of the persistent rumors that after Doug Elmendorf and company had wreaked their analytic wrath on Ira Magaziner, Majority Leader Mitchell had said to Bob Reischauer: ‘You are gone on January 4, 1995’.

One unintended side effect of the budget process introduced in the 1970s and the 1980s has been to give CBO and JCT great power—has given their analytic decisions the importance of the unanimous coordinated votes of twenty senators over and above the impact of their estimates on members’ minds. They have by and large shouldered that great power with great responsibility. But with great power also comes great pressure. And it is not at all clear to me that, given the magnitude of this pressure, we want extra degrees of freedom in which these organizations can respond to the pressures they are under.

Yesterday, after all, I saw estimates of the dynamic revenue impact of Jeb!’s tax proposals that varied from negative—that the reduction in national savings would outweigh any positive incentive effects—to recouping 2/3 of the static revenue loss. And I imminently expect to see an ‘estimate’ today that it will produce 4%/year real growth and thus raise revenue–perhaps from someone at Heritage, perhaps from someone at Cato, perhaps from John Cochrane. It’s opening a can of worms. Doug and Peter may think the worms are dead. I fear they are not…

Doug Elmendorf wrote:

Based on my experience as the director of CBO from January 2009 through March 2015, the principal concerns expressed about estimated macroeconomic effects of proposals apply with equal force to other aspects of budget estimates or can be addressed by CBO and JCT. In my view, including macroeconomic effects in budget estimates for certain legislative proposals would improve the accuracy of those estimates and would provide important information about the economic effects of those proposals. Moreover, if certain key conditions were satisfied, those estimates would meet the general goals of the estimating process that estimates be understandable and resistant to misinterpretation, based on a consistent and credible methodology, produced quickly enough to serve the legislative process, and prepared using the resources available to CBO and JCT.

Doug has it wrong: they do not apply “with equal force”. As we have seen today, Monday, December 11, 2017, with the Treasury tax “reform” “study”.

America’s Broken Political System: Fresh at Project Syndicate

Project Syndicate: America’s Broken Political System: Whether or not the tax bill survives the conference process and becomes law, the big news won’t change: the Anglo-Saxon model of representative government is in serious trouble. And there is no solution in sight. For some 400 years, the Anglo-Saxon governance model–exemplified by the republican semi-principality of the Netherlands, the constitutional monarchy of the United Kingdom, and the constitutional republic of the United States of America–was widely regarded as having hit the sweet spot of liberty, security, and prosperity. The greater the divergence from that model, historical experience seemed to confirm, the higher the likelihood of repression, insecurity, and poverty. So countries were frequently and strongly advised to emulate those institutions.

Nobody would dare offer that same advice today… Read MOAR at Project Syndicate