Uber and Occupational Licenses

I enjoy moments of agreement, and common sense in publications where it's usually absent. Eduardo Porter writing in the New York Times on the lessons of Uber vs. Taxis for occupational licensing is a nice such moment.

[Uber's] exponential growth confirms what every New Yorker and cab riders in many other cities have long suspected: Taxi service is woefully inefficient. It also raises a question of broader relevance: Why stop here?

Just as limited taxi medallions [and ban on surge pricing, and the mandated shift change  -JC] can lead to a chronic undersupply of cabs at 4 p.m., the state licensing regulations for many occupations are creating bottlenecks across the economy, raising the prices of many goods and services and putting good jobs out of reach of too many Americans.

... like taxi medallions, state licenses required to practice all sorts of jobs often serve merely to cordon off occupations for the benefit of licensed workers and their lobbying groups, protecting them from legitimate competition.

...“Lower-income people suffer from licensing,” Professor Krueger told me. “It raises the costs of many services and prevents low-income people from getting into some professions.

This is an all too often overlooked effect of so much government-induced cartelization. The costs of higher prices are paid by middle and lower income people. And many job opportunities are denied to lower income people.


Why does this happen? The public choice school points out that the government can charge, in the form of political support as well as money, the beneficiaries of its induced cartels, and that impoverishment of the unlucky breeds support for government programs for the unfortunate, whose votes it also buys.  When did you see an anti-inequality protest with signs saying "repeal occupational licensing laws?"

In a study commissioned by the Brookings Institution’s Hamilton Project, Morris Kleiner of the University of Minnesota found that almost three out of 10 workers in the United States need a license from state governments to do their jobs, up from one in 20 in the 1950s. By cordoning off so many occupations, he estimates, professional licensing by state governments ultimately reduces employment by up to 2.8 million jobs. The trend worries the Obama administration. The president’s budget, to be unveiled on Monday, will include $15 million for states to analyze the costs and benefits of their licensing rules, identify best practices and explore making licenses portable across state lines.

The rest of the budget may be DOA, but perhaps Congress will see the value in this proposal. Of course, it's not obvious new studies are needed. We have over a half century of such studies, from Milton Friedman's 1946 Ph.D Dissertation, the "Occupational licensure" chapter in his1962 Capitalism and Freedom, to, more recently (random examples via google search) a 200 page review from the Institute for Justice (Cato coverage here) and many more. Edit copy, edit paste, could save about $14.99 million bucks. Still, cheap at the price.

Portability is an interesting issue too. In the past, Americans moved a lot more. It's a lot harder to do now, especially for lower-income Americans blocked by licensing from moving to a hot state.

Only a handful of occupations are licensed in every state, according to a report by the Institute of Justice, a free-market advocacy group opposed to many occupational licenses.

Notice that the Institute of Justice is "a free-market advocacy group opposed to many occupational licenses," implicitly questioning the validity of their statements, while the Brookings Institution is just the "Brookings Institution," not a ... well, you fill in the quote.  Ah well, it's still the New York Times, don't get your hopes up too far for unbiased reporting.

... Among the tangle of regulations, it is not hard to find rules that defy common sense. An athletic trainer must put in 1,460 days of training to get a license in Michigan. An emergency medical technician needs only 26.

As we know, occupational licensing is even worse in Europe. Here we come. In slides for his paper with Lee Ohanian on European Stagnation, Jesús Fernández-Villaverde tells the Zidane story

• Zinedine Zidane is one of the top 5 soccer players of all time. He won pretty much everything (World Cup 1998, Euro Cup 2000,....)
• After retiring, in 2013-2014, he was assistant coach for Real Madrid. Extremely successful year for Real Madrid.
• In August 2014, he becomes main coach for Real Madrid B Team

but...

• ... he is sued by the director of the Spanish National Football Coach Education Centre because he does not have a three year higher education degree in Soccer coaching.
• Fined and expelled from Spanish league.

Soccer being a lot more important than taxis, it ended well for Zidane. Not so, however for Uber, now banned in Spain.

Back to the Times

Workers in licensed occupations can make up to 15 percent more than unlicensed workers with similar skills, according to research by Professors Kleiner and Krueger.

But the claim that they protect consumers often rings hollow.

A study of regulations for mortgage brokers, for instance, found that states with licensed brokers did not enjoy fewer foreclosures but did suffer more expensive mortgages.

... While the tougher restrictions add to the cost of care, they do not have any discernible effect on its quality: Well-child medical exams cost 3 to 16 percent more in states where nurses cannot issue prescriptions, according to one study, but their infant mortality rates are no better. Malpractice premiums, a measure of safety, are about the same.

“Professional organizations that push for licenses can’t say, ‘We want to erect a fence around our occupation,’ so they say it is to protect public health and safety,” said Dick M. Carpenter II, research director at the Institute for Justice. “It is an assertion with zero evidence.”

The WSJ offers a similar story by Tom Gordon about do it yourself legal clinics, no surprise under attack by lawyers on similar "protection" grounds. But of course we expect that from WSJ, a ... how did that Institute for Justice quote go?

Not mentioned. Uber teaches us that star ratings are far more effective than taxi commissions to induce quality. I ride Uber not because of the price. But because every single driver so far is courteous, safe, and the car clean.

A Health Care Thought

The Uber analogy prompts a health care analogy. The conversation around health insurance problems routinely asserts the big problem with health care market is that people don't pay out of pocket.

But people pay for taxis predominantly out of pocket. And before Uber, we got awful service.

Health care with big copays under the ACA and ACO may look a lot like hailing a cab on New Year's eve. In the rain. Supply competition is the key to reaping the benefits of markets.

Unemployment insurance and unemployment

"The Impact of Unemployment Benefit Extensions on Employment: The 2014 Employment Miracle" by Marcus Hagedorn, Iourii Manovskii and Kurt Mitman is making waves. NBER working paper here. Kurt Mitman's webpage has an ungated version of the paper, and a summary of some of the controversy. It's part of a pair, with "Unemployment Benefits and Unemployment in the Great
Recession: The Role of Macro Effects" also including Fatih Karahan.

A critical review by Mike Konczal at the Roosevelt Institute blog, and a more positive review by Patrick Brennan at National Review Online are both interesting. Both are thoughtful reviews that get at facts and methods. Maybe the tone of the economics blogoshpere is improving too. Bob Hall's comments and response on the earlier paper are also worth reading. This is a bit deja-vu from the observation that North Carolina experienced a large drop in unemployment when it cut benefits. My post here, WSJ coverage, and I think there are some papers which google isn't finding fast enough at the moment.

The basic issue: I think it's widely accepted, if sometimes grudgingly, that unemployment insurance increases unemployment. If you pay for anything, you get more of it. People with unemployment insurance can hold out for better jobs, put off moving or other painful adjustments, and so on. The earlier paper points out that there are important general equilibrium effects as well. We should talk about how UI affects labor markets, not just job search.

Quick disclaimer. Let's not jump to "good" and "bad."  Searching too hard and taking awful jobs in the middle of a depression might not be optimal. Pareto-optimal risk sharing with moral hazard looks a lot like unemployment insurance.  Perhaps that disclaimer can settle down the tone of the debate.

But the question remains. How much?  How much does unemployment insurance increase unemployment? And the related macro question, just why did unemployment in the US suddenly drop coincident with sequester and the end of 99 week unemployment benefits?

Method is important. Too much media coverage starts and stops with "study finds unemployment insurance raises unemployment." And then the next day "study finds unemployment insurance crucial to stopping people from dying in gutters." If we focused on the facts, we'd all get along better.

In macro, we always are faced with the problem that interpreting time series, we never know what else changed. Sure, congress lowered unemployment benefits and the economy took off. But lots of other stuff happened. Maybe it's "despite" not "because."

This paper is part of a new breed trying to get around this problem by looking at cross-sectional evidence. Roughly, the evidence in this paper builds on the fact that Congress' action had different effects in different states.

Bob Hall described the strategy compactly:

They compare labor markets with arguably similar conditions apart from the UI benefits regime. In their work, the markets are defined as counties and the similarity arises because they focus on pairs of adjacent counties. The difference in the UI regimes arises because the two counties are in different states and UI benefits are set at the state level and often differ across state boundaries. The research uses a regression-discontinuity design, where the discontinuity is the state boundary and the window is the area of the two adjacent counties....

Table 3 contains the basic number, which the authors digest as

We find that a 1% drop in benefit duration leads to a statistically significant increase of employment by 0.0161 log points.  In levels, 1.8 million additional jobs were created in 2014 due to the benefit cut.

(Small complaint: economists should not write that jobs "were created," especially economists writing in the search, match and labor-supply tradition, to say nothing of passive voice and strong causal inferences.) I tried to digest the fact a bit more, but stopped here:

Column (1) of Table 3 contains the results of the estimation of the effect of unemployment benefit duration on employment using the baseline specification in Equation (6).

If commenters can vocalize the actual fact in words, fixed effects, controls and all, I'd be grateful.

Bob Hall echoes standard but important complaints.

The issues that arise in evaluating the paper are those for any regression-discontinuity research design: (1) Are there any other sources of discontinuous changes at the designated discontinuity points that might be correlated with the one of interest? (2) Is the window small enough to avoid contamination from differences that do not occur at the discontinuity point but rather elsewhere in the window?

In words, is there something else about state policies that changed at the same time in the "generous" vs. "stingy" states? And are counties really small enough to capture only the border effects?

The deeper issue in evaluating this paper, I think, comes from blowing the county results up to the aggregate, as Bob but it

The authors conclude that, absent the increase in UI benefits, unemployment in 2010 would have been about 3 percentage points lower.

The jump back from micro to macro isn't so easy either.  For example, suppose the expansion came from selling more goods from expanding states to contracting states. Then you'd see a micro effect but no macro effect. I don't think that's the case, but I have been skeptical about other papers jumps from micro to macro. For example, if the Federal government spends a trillion dollars in the desert, and a bunch of businesses move to sell donuts to the construction workers, you get a nice stimulus. That doesn't mean stimulus works for the economy as a whole.

This is a small nitpick. The basic fact is interesting, and I think a lot harder to dismiss.

It's interesting that so much of the pushback, both from Bob and from Mike Konczal's critical review comes down to theory, not the fact.

Update: Wednesday's Wall Street Journal covers the paper. The WSJ spends more time on the macro question, the claim that unemployment insurance actually boosts the economy via stimulus. 

SNB, CHF, ECB, and QE

The last two weeks have been full of monetary news with the Swiss Franc peg, and the ECB's announcement of Quantitative Easing (QE). A few thoughts.

As you have probably heard by now, the Swiss Central Bank removed the 1.20 cap vs. the euro, and the franc promptly shot up 20%.

To defend the peg, the Swiss central bank had bought close to a year's Swiss GDP of euros (short-term euro debt really) to issue similar amounts of Swiss Franc denominated debt.

This is a QE -- a big QE. Buy assets, print money (again, really interest-paying reserves). So to some extent the news items are related. And, it's pretty clear why the SNB abandoned the peg. If the ECB started essentially the opposite transaction -- buying debt and selling euros -- the SNB would soon be awash.

A few lessons:


A peg depends on credibility. The dollar is pegged to 4 quarters. The Fed is not racking up huge dollar for quarters QE, because everyone knows it will always be thus. The fact that the SNB had to buy euros at all is a great signal that everyone knew the peg was temporary. As, in fact, the SNB had made pretty clear. Sometime or other, probably when it's most important, investors thought, Swiss Francs will shoot up again. Might as well buy more of them.

An exchange rate peg is fiscal policy.  Really, the "credibility" a country needs is fiscal credibility.

The peg fell apart because the SNB was trying to do it alone. On the day of abandonment, the SNB lost about 20% of its balance sheet, since it owns Euros and owes Swiss Francs. Had things gone on any more before the plunge, they would have had to go begging to the Treasury for a recapitalization. "We just lost 20% of GDP, could you please send us some fresh government bonds to back our CHF debt issues?" That works seamlessly in economic models, but would be a political nightmare for a central bank.

So, if you want to run a peg, it should be done jointly with the Treasury. The central bank buys euros, sells francs, but immediately swaps the euro debt to the treasury for CHF debt. That at least is removes the first fragility, by taking the fiscal risk off the central bank balance sheet.

From the point of view of the nation as a whole, a strong demand for your government debt (that's what this is) is an invitation to profligacy, not a fiscal danger. That's why pegs usually break in the other direction: The central bank tries to peg a currency, let's call them pesos, against another, let's call them dollars. (Or gold.) People start to ask for dollars in exchange for pesos, the central bank starts to run out of reserves. At this point the treasury has to either tax, reduce spending, or credibly promise future taxes or spending reductions to borrow some dollars, and given them to the central bank in exchange for the bank's government debt. When that can't happen, the peg breaks. The essential problem is fiscal.

Switzerland had this in reverse: The Swiss were too darn thrifty.  Americans and Greeks know what to do if world capital markets come knocking and want to buy boatloads of your government debt. Print debt, give it to them, and send us Walmarts full of goods, or driveways full of Porsches.  Norway had a similar issue, with the world wanting to buy its oil. Norway decided not to go on a consumption binge, so their sovereign wealth fund buys equities; rights to future consumption.

Switzerland could have done the same: sell CHF bonds, use the proceeds to go on a consumption binge or buy about a year's GDP of foreign stocks. Instead, a referendum threatened a return to the gold standard.

Or, they could have said, "and by the way, we declare that we have the right to pay off our government debt in euros at 1.20, or to swap CHF debt for euro debt at that rate." Now that would have really enforced the peg. Devaluing the currency means engineering a partial default on government debt. Its fiscal policy and can't be done by the central bank alone.

QE and the ECB

Ben Bernanke famously said that QE works in practice but not in theory.  What that means, of course, is that the standard theory is wrong, and to the extent it "works" at all, it works by some other mechanism or theory. Permanent price impact by changing the private sector portfolio composition is the "theory" that Bernanke acknowledges really makes no sense. So why might a QE work?

In the US case, QE was arguably a signal of Fed intentions. Buying a trillion dollars of bonds and issuing a trillion dollars of, er... bonds (reserves are floating-rate debt) is a way for the Fed to tell markets that it will be years and years before interest rates go up. As I chat about QE with economists, this pretty much surfaces as the most plausible story for QE effects (along with, there weren't any long lasting effects.) Greenwood,  Hanson, Rudolph, and Summers make this point nicely, showing that Fed-induced changes in maturity structure have about twice the effect that Treasury selling more bonds does -- though exactly the same portfolio effect.

But what is the signal in ECB QE? Well, a decidedly different one. The signal is, I think, not about interest rates, but that the ECB will buy government debt. "What it takes" is now taken. Yes, there is this lovely pretense that national central banks buy the bonds, so the ECB doesn't hold credit risk. But if a country defaults, where is the national central bank going to come up with funds to pay the ECB?

So, when we think of what expectations people derive from ECB QE, and with that how it might or might not "work," the obvious conclusion is that the Eurobonds are now being printed. Like all bonds, they will either be repaid, inflate, or default.

Torsten Slok sends on this interesting graph. 80% of Greek debt is now in the hands of "foreign official." Now you know why nobody is worrying about "contagion" anymore. The negotiation is entirely which government will pay.

Autopsy -- the Op-Ed

This was an Op-Ed in the Wall Street Journal December 22 2014. WSJ asks me not to post them for a month, so here it is now. I was trying for something upbeat, and to counter a recent spate of opeds on how ISLM is a great success and winning the war of ideas.


An Autopsy for the Keynesians

Source: Wall Street Journal

This year the tide changed in the economy. Growth seems finally to be returning. The tide also changed in economic ideas. The brief resurgence of traditional Keynesian ideas is washing away from the world of economic policy.

No government is remotely likely to spend trillions of dollars or euros in the name of “stimulus,” financed by blowout borrowing. The euro is intact: Even the Greeks and Italians, after six years of advice that their problems can be solved with one more devaluation and inflation, are sticking with the euro and addressing—however slowly—structural “supply” problems instead.

U.K. Chancellor of the Exchequer George Osborne wrote in these pages Dec. 14 that Keynesians wanting more spending and more borrowing “were wrong in the recovery, and they are wrong now.” The land of John Maynard Keynes and Adam Smith is going with Smith.

Why? In part, because even in economics, you can’t be wrong too many times in a row.

Keynesians told us that once interest rates got stuck at or near zero, economies would fall into a deflationary spiral. Deflation would lower demand, causing more deflation, and so on.

It never happened. Zero interest rates and low inflation turn out to be quite a stable state, even in Japan. Yes, Japan is growing more slowly than one might wish, but with 3.5% unemployment and no deflationary spiral, it’s hard to blame slow growth on lack of “demand.”

Our first big stimulus fell flat, leaving Keynesians to argue that the recession would have been worse otherwise. George Washington’s doctors probably argued that if they hadn’t bled him, he would have died faster.

With the 2013 sequester, Keynesians warned that reduced spending and the end of 99-week unemployment benefits would drive the economy back to recession. Instead, unemployment came down faster than expected, and growth returned, albeit modestly. The story is similar in the U.K.

These are only the latest failures. Keynesians forecast depression with the end of World War II spending. The U.S. got a boom. The Phillips curve failed to understand inflation in the 1970s and its quick end in the 1980s, and disappeared in our recession as unemployment soared with steady inflation.

Still, facts and experience are seldom decisive in economics. Maybe Washington’s doctors are right. There are always confounding influences. Logic matters too. And illogic hurts. Keynesian ideas are also ebbing from policy as sensible people understand how much topsy-turvy magical thinking they require.

Hurricanes are good, rising oil prices are good, and ATMs are bad, we were advised: Destroying capital, lower productivity and costly oil will raise inflation and occasion government spending, which will stimulate output. Though Japan’s tsunami and oil shock gave it neither inflation nor stimulus, worriers are warning that the current oil price decline, a boon in the past, will kick off the dreaded deflationary spiral this time.

I suspect policy makers heard this, and said to themselves “That’s how you think the world works? Really?” And stopped listening to such policy advice.

Keynesians tell us not to worry about huge debts, or to default or inflate them away (but please, call it “restructuring” or “repairing balance sheets”). Even the Obama administration has ignored that advice, promising long-run solutions to the debt problem from day one. Europeans have centuries of memories of what happens to governments that don’t pay debts, or who need to borrow for a new emergency but have stiffed their creditors once too often. More debt? Nein danke!

In Keynesian models, government spending stimulates even if totally wasted. Pay people to dig ditches and fill them up again. By Keynesian logic, fraud is good; thieves have notoriously high marginal propensities to consume. That’s a hard sell, so stimulus is routinely dressed in “infrastructure” clothes. Clever. How can anyone who hit a pothole complain about infrastructure spending?

But people feel they’ve been had when they discover that the economics is about wasted spending, and infrastructure was a veneer to get the bill passed. And they smell a rat when they hear economic arguments shaded for partisan politics.

Stimulus advocates: Can you bring yourselves to say that the Keystone XL pipeline, LNG export terminals, nuclear power plants and dams are infrastructure? Can you bring yourselves to mention that the Environmental Protection Agency makes it nearly impossible to build anything in the U.S.? How can you assure us that infrastructure does not mean “crony boondoggle,” or high-speed trains to nowhere?

Now you like roads and bridges. Where were you during decades of opposition to every new road on grounds that they only encouraged suburban “sprawl”? If you repeat in your textbooks how defense spending saved the economy in World War II, why do you support defense cutbacks today? Why is “infrastructure” spending abstract or anecdotal, not a plan for actual, valuable, concrete projects that someone might object to?

Keynesians tell us that “sticky wages” are the big underlying economic problem. But why do they just repeat this story to justify inflation and stimulus? Why do they not advocate policies to undo minimum wages, labor laws, occupational licenses and other regulations that make wages stickier?

Inequality was fashionable this year. But no government in the foreseeable future is going to enact punitive wealth taxes. Europe’s first stab at “austerity” tried big taxes on the wealthy, meaning on those likely to invest, start businesses or hire people. Burned once, Europe is moving in the opposite direction. Magical thinking—that, contrary to centuries of experience, massive taxation and government control of incomes will lead to growth, prosperity and social peace—is moving back to the salons.

Yes, there is plenty wrong and plenty to worry about. Growth is too slow, and not enough people are working. Even supporters acknowledge that Dodd-Frank and ObamaCare are a mess. Too many people on the bottom are stuck in terrible education, jobless poverty, and a dysfunctional criminal justice system. But the policy world has abandoned the notion that we can solve our problems with blowout borrowing, wasted spending, inflation, default and high taxes. The policy world is facing the tough tradeoffs that centuries of experience have taught us, not wishing them away.

Mr. Cochrane is a professor of finance at the University of Chicago Booth School of Business, a senior fellow at Stanford University’s Hoover Institution and an adjunct scholar at the Cato Institute.

Update: "The Keynesian Shell Game" by Scott Sumner over at econolog has a nice collection of recent Keynesian doom-mongering, and makes the nice point that the definition of "G" shifts conveniently over time.

Asset Pricing Mooc

The new and improved online version of my PhD class "Asset Pricing Part 1" will open for business January 18.

You can learn more about the class and sign up for it on the Coursera website here. (Part 2, which follows this spring is here. Part 1 and 2 will be completely separate Coursera classes, so take what you want.)

The videos and quizzes have been useful for people who are not "taking" the class, or as supplementary materials for people teaching regular classes. I taught my PhD class by asking the students to watch the videos before coming to class, which allowed a higher level discussion. Feel free to use these resources any way you wish!

While we're at it, I maintain a section of my research website with extra materials for people using the Asset Pricing book in classes, here, and my teaching materials from MBA and PhD classes are here

To whet your appetite, here is the syllabus from the two classes.

Part 1 syllabus:

• Week 1: Stochastic Calculus Introduction and Review. dz, dt and all that. 
• Week 2: Introduction and Overview. Challenging Facts and Basic Consumption-Based Model. 
• Week 3:
  • Classic issues in Finance
  • Equilibrium, Contingent Claims, Risk-Neutral Probabilities.
• Week 4: State-Space Representation, Risk Sharing, Aggregation, Existence of a Discount Factor.
• Week 5: Mean-Variance Frontier, Beta Representations, Conditioning Information. 
• Week 6: Factor Pricing Models -- CAPM, ICAPM and APT. 
• Week 7: Econometrics of Asset Pricing and GMM.  
• Final Exam

Part 2 syllabus: 

• Week 1: Factor pricing models in action
  • The Fama and French model
  • Fund and performance evaluation.
• Week 2: Time series predictability, volatilty and bubbles.
• Week 3: Equity premium, macroeconomics and asset pricing.
• Week 4: Option Pricing.
• Week 5: Term structure models and facts.
• Week 6: Portfolio Theory.
• Final Exam

Deflating Deflationary Fears

Source: Charles Plosser

From a nice paper by Charles Plosser with that catchy title.  Yes, it's 10 years old, but the lesson is appropriate in today's hysteria. That dreaded deflationary spiral is always just around the corner.

Piketty Facts

Most Piketty commentary (like the Deridre McCloskey review I blogged earlier) focuses on the theory, r>g, and so on. After all, that's easy and you don't have to read hundreds of pages.

"Challenging the Empirical Contribution of Thomas Piketty's Capital in the 21st Century" by Phillip W. Magness and Robert P. Murphy is one of the first deep reviews of the facts that I have seen. I haven't read it yet, but the abstract looks promising:

Thomas Piketty's Capital in the 21st Century has been widely debated on theoretical grounds, yet continues to attract acclaim for its historically-infused data analysis. In this study we conduct a closer scrutiny of Piketty's empirics than has appeared thus far, focusing upon his treatment of the United States. We find evidence of pervasive errors of historical fact, opaque methodological choices, and the cherry-picking of sources to construct favorable patterns from ambiguous data. Additional evidence suggests that Piketty used a highly distortive data assumption from the Soviet Union to accentuate one of his main historical claims about global “capitalism” in the 20th century. Taken together, these problems suggest that Piketty’s highly praised and historically-driven empirical work may actually be the book’s greatest weakness.

Comments on the paper welcome. If I get a chance to read it I'll post some.

Time use of the non-employed

Source: New York Times

The decline in labor force participation means that a larger and larger fraction of the population, including many prime-age men, are not working and not actively looking for work.

What do they do all day? The New York Times has a lovely article answering that question.

I took a screenshot at left to advertise the post, but go to the Times where the graph is interactive.

Next question, where does the money come from?

Understanding the lives of people in this predicament seems to me a useful step to understanding the big decline in participation.

Strange Bedfellows

Jeff Sachs has written a very interesting Project Syndicate piece on Keynesian economics. It's phrased as a critique of Paul Krugman, but his message applies much more broadly. Krugman was mostly articulating fairly standard views on stimulus, "austerity'' and so forth. (We need a better word than "Keynesian'' for what Jeff calls "crude aggregate-demand management.'' But I don't have one handy.)

This is a good example for people outside economics (and quite a few inside) who think all economists line up on an easy right-left divide. If you expected Sachs to support the standard Keynesian consensus because he's "liberal," or to use his words, in favor of "progressive economics," you would be wrong. He looks at the facts, the forecasts, and the Krugman's curious rewriting of history in a "victory lap," and comes to his own conclusions.

Needless to say, I'm happy to find someone else making many of the basic points in my
Autopsy for Keynesian Economics (ungated version). I'm even more happy that someone of a "progressive" political orientation comes to the same conclusions that I do from a more libertarian orientation.  I'll be curious to see if Sachs comes in for the same sort of venomous personal attacks -- with essentially no attempt to argue the content -- as my piece attracted from the politicized lefty economics blogosphere. Do they treat "friends" more nicely, or "traitors" more harshly? We'll see.

On infrastructure, Sachs writes

To be clear, I believe that we do need more government spending as a share of GDP – for education, infrastructure, low-carbon energy, research and development, and family benefits for low-income families. But we should pay for this through higher taxes on high incomes and high net worth, a carbon tax, and future tolls collected on new infrastructure. We need the liberal conscience, but without the chronic budget deficits.

Here too, we can almost agree. We can agree on the principle that infrastructure spending is important, and should be evaluated on the basis whether its benefits exceed its costs, not on the "stimulative" powers of its spending. Then we can go back to evaluating whether all of these particular investments have benefits greater than costs, and whether those particular taxes merit their distortions.

Carbon Tax or Carbon Rights?

Larry Summers has a very nice Financial Times oped, "Let this be the year when we put a proper price on carbon" Greg Mankiw has also written extensively and eloquently in favor of a carbon tax, for example here.  Jeff Miron has some interesting skeptical thoughts, recently here.

I agree in principle.  But I have some important qualifications, and some suggestions for framing to broaden the appeal of the proposal substantially. I also think that individual rights may be better than a tax. What matters, really, is a carbon price, and there are different ways to bring that about.

I don't want today to get in to the debate about climate science. How big of a problem is human released carbon and other greenhouse gasses? Are the big computer models accurate? I don't want today to debate the larger economic and policy questions:  How much economic cost is there really? Are there mitigation strategies? Are there more pressing environmental or economic problems? (Species extinction due to habitat loss, old fashioned water and air pollution, etc.)

Too much of the policy discussion focuses on the scientific debate, as if the economic and policy answers follow unequivocably once that is settled. They are not. Let's talk about the second half today.

A Trade

The strongest case for a carbon price is, I think, that if we're going to have anti-carbon policies and energy conservation policies -- and we do, and we are, like it or not -- then a carbon price is a far better way to implement them than direct regulations.

Prices aggregate information. Should you buy a second electric car for short trips? It costs carbon to build a car. Prices tell you. Prices are powerful incentives, which get people to do on their own what they resist by fiat. Prices induce all sorts of creative responses, and regulations induce creative countermeasures. (My daughter, then 8, turned to me one day and said, "Dad, if they make people buy high mileage cars, won't people just move further away from work because it's cheaper to drive?" Proud dad story.) And a uniform price makes sure you spend money efficiently.  If you spend a hundred billion dollars on a high speed train that saves a thimbleful of carbon, that's a hundred billion dollars that could have saved a lot more carbon.

Phrasing the issue my way should help to sell the carbon-price project should to people a bit doubtful about the climate projections. In the extreme, one could argue to the most anti-carbon group, "look, if we're going to waste money, let's minimize the damage."

So I think Larry and the other carbon tax proponents would get further if they were to offer a deal: Let us have a carbon tax, and in exchange we will get rid of all the other horrendously inefficient laws, regulations, tax credits, and other attempts to nag us inefficiently to lower energy consumption and carbon emission.

Accept a carbon tax, and in return, we dismantle gas mileage regulations, electric car lanes, electric car credits (every $100,000 Tesla driving down Sand Hill Road is the beneficiary of $7,500 Federal tax credit), mandates to install recharging stations, ethanol and biofuel mandates, windmill credits, subsidized loans, alternative energy boondoggles, energy efficiency standards on appliances (by which Whirlpool reportedly pays no taxes), solar panel credits, the incandescent light ban, and so on ad infinitum.

A taste from the 2014 tax extenders -- these are only some extenders, not the baseline!

• the tax credit for residential energy efficiency improvements;
• the tax credit for second generation biofuel production;
• the income and excise tax credits for biodiesel and renewable diesel fuel mixtures;
• the tax credit for producing electricity using Indian coal facilities placed in service before 2009;
• the tax credit for producing electricity using wind, biomass, geothermal, landfill gas, trash, hydropower, and marine and hydrokinetic renewable energy facilities;
• the tax credit for energy efficient new homes;
• the special depreciation allowance for second generation biofuel plant property;
• the tax deduction for energy efficient commercial buildings;
• tax deferral rules for sales or dispositions of qualified electric utilities; and
• the excise tax credit for alternative fuels and fuels involving liquefied hydrogen.

If you accept a carbon tax, the proposal should be, we will permanently dismantle all of this. Yes, this means dismantling much of the department of energy and EPA.

(We could also stop subsidizing energy use first, including zoning laws that force a lot of needless driving, housing policies that encourage too-large houses, and so forth.)  

Why are some economists still skeptical about carbon-price proposals? I think that many are rightly wary that the carbon tax will just be added on top of this rot, and worse that the proceeds of the carbon tax will be used to funnel more money to crony energy boondoggles. At a minimum, that is a strong reason to offer a revenue-neutral tax rather than to bundle it with plans to spend the revenues on "infrastructure." Let infrastructure live on cost-benefit analysis not a dedicated stream.

To get a carbon tax, I'd like to hear proponents loudly offer this deal, in a way that skeptics will perceive as enforceable.

A Uniform Tax

Larry touches on an important issue that will pollute the debate:

On the other side of the ledger, there has always been the concern that raising carbon taxes would place an unfair burden on some middle- and low-income consumers. Those who drive long distances to work, say, or who have homes that are expensive to heat would be disproportionately burdened.

Economists understand that a tax like this is all about incentives and substitution, not about transferring income. The public and political system see taxes all about transferring income and tend to forget incentives. This will be a big problem.

The natural political life of any "tax," including the carbon tax, will lard it up with exemptions. People who "need" to "drive long distances to work," and "can't afford" new energy-efficient cars, farmers, small business, people who live in cold climates (we already have a home heating oil subsidy), high energy industries (aluminum, concrete), and so on and so forth will all clamor for exemptions. And will get them.

But this tax, of all taxes, must be uniform at the margin, with no exemptions. Its purpose is incentives, not revenue raising or redistribution. The planet doesn't care how worthy was the carbon emitter.  People who drive a long way to work should move to smaller more expensive houses closer to work. That's the point of a carbon tax. Or shift to smaller cars, or carpool, or make other unpleasant substitutions. That's the point of a carbon tax. Farmers should find less carbon-intensive ways to plow and plant crops. People who live in cold places in the winter or warm places in the summer should move, and use less energy.  Businesses that have to use a lot of carbon should contract. Those on the margin will close. That's the point of the carbon tax. If this pain is not felt, the change in behavior won't happen.

People are hurt. And they can be helped, just not on the margin. People who are hurt can get lump sum checks, or vouchers. If the overall distribution of income is substantially made worse by carbon pricing, let the regular tax system redistribute more.  (If you think about it, that's pretty unlikely. I don't have numbers, but poor people may well use less carbon. Yes, they drive, but they don't fly and especially not in private jets. And getting rid of crony boondoggles in my deal above would help a lot too.)

Larry makes a good and revealing point about the nature of redistribution:

Now these groups have received a windfall from the drop in energy prices so it would be possible to impose substantial carbon taxes without them being burdened relative to where prices stood six months ago. As an example, the price of petrol has fallen by over $1 per gallon. A $25 a tonne tax on carbon that would raise over $1tn during the next decade would lift petrol prices by only about 25 cents.

That is a  very interesting view of just how short-lived this sense of our political system's desire for insurance and redistribution is. If we bring you back to where you were last year, you won't complain.  It's not about the overall distribution of income -- it's about middle income people's right to the gas price they paid last year.

But I'm dubious. Given how long a debate over something this big will take, and how many people will dislike a carbon tax, I'm not persuaded Larry's argument will be enough.  The demand for "transition assistance" and help to pay the carbon tax will likely not be silenced by "well, it just brings gas to what you were paying in 2013."

Furthermore, it's a good bet that the same forces that will undermine my first caveat will be at work on the second one. If I install solar panels on my roof, can't I get a break on the carbon tax?

In sum, I think the carbon tax proposal needs a second deal to be offered. The  carbon tax will be a uniform tax. Everyone pays the same rate on the margin, the tax does not get riddled with loopholes and exemptions.

To get a carbon tax, I'd like to hear proponents loudly offer this deal, in a way that skeptics will perceive as enforceable.

It's not that unrealistic. Gas taxes and tobacco taxes are administered pretty uniformly.

Tax vs. Rights

The economic point is a carbon price. There are lots of ways to implement a carbon price. Instead of a tax, one can have carbon rights.  The cap and trade schemes are the natural alternative, based on the latter idea. They don't seem to be catching on, for reasons that I won't go in to here.

Instead of the current business focus of cap and trade, suppose that every citizen has a right to emit x tons of carbon per year. In order to emit carbon (methane, etc.), or to sell fuel or electricity that emits carbon, a business must purchase those rights.  You can receive your rights with your annual tax filing, and sell them on electronic exchanges. A market will spring up quickly, offering citizens cash for their pollution rights.

It strikes me that this system obviates many of the political problems with carbon taxes.

• It's by construction revenue neutral, and the flows of money can't go into boondoggles. All the money paid in carbon taxes goes into the pockets of citizens. 
• It's by construction greatly progressive. Everyone gets the same right. Private-jet fliers and McMansion heaters/coolers will be lining the pockets of poor people who don't travel much and live in small homes. Progressives who bemoan the loss of energy policy at least can console themselves with this grand redistribution. 
• Environmentalists and those in pursuit of "climate justice" should like it. Everyone gets rights to a clean planet. 
• If you really don't like carbon, you can choose not to sell. Or buy up other's carbon rights and burn them. (Sorry, compost them.)  
• Every voter will have a strong incentive not to let anyone off the requirements to buy carbon rights. If favored industries come by and complain how much the carbon rights are costing and want a tax break,  every voter knows that money is coming straight out of their pocket. 
• Every voter now is an enemy of command and control energy regulation, which lowers the demand for his or her carbon rights.

The last two forces are imperfect, and it will still be important to pair this system with at least a formal promise to use the carbon (methane, etc.) price as the only instrument of energy policy, and with a formal promise to apply the requirement to purchase carbon rights uniformly. But the concentrated interest of voters will help.

This is no panacea, to be sure. Enforcing that businesses buy rights takes much the same bureaucracy as enforcing tax payments.  Whether our political system does a rights scheme better than a tax scheme is a bit of a conjecture.

But take one look at the US tax system. What started in the academic blackboard as the sensible idea "hey, we can all chip in some fraction of our income to pay for the Federal government" has turned in to the monster we see before us. A carbon "tax" also seems nice on the academic blackboard. But I worry that it will suffer the same fate.

Interest-paying money is not inflationary

(With credible fiscal policy, of course.)  Another interesting case, from JP Koning's Blog "Moneyness"

RBNZ decided to 'flood' the system with balances to make things more fluid. This involved conducting open market purchases that bloated the monetary base (comprised of currency plus deposits) from around NZ$6 billion in mid-2006 to just under NZ$14 billion by December of that year. See chart below. 

(Note that the RBNZ's problems began far before the credit crisis and were due entirely to the peculiar structure of the clearing system, not New Zealand's economy.)

Koning describes the lack of inflation as a result of the perceived "permanence" of the increased reserves. I think it comes from the fact that reserves pay interest -- as they do in New Zealand. Either way, the point is that banks and people are happy to sit on interest-paying money, in enormous quantities, just as they are on bonds.



The corresponding inflation and interest rates:

Source: Reserve Bank of New Zealand
http://www.rbnz.govt.nz/statistics/key_graphs/inflation/

Source: Reserve Bank of New Zealand
http://www.rbnz.govt.nz/statistics/key_graphs/90-day_rate/

More Cash and Zero Bound

In my last post I started thinking about how options other than currency enforce a zero bound. Imagine there is no more currency, and the Fed tries to impose -5% interest rates. You put in a dollar, you get out 95 cents. What other ways are there to guarantee that if you put in a dollar you get back a dollar? (In my last post, I also pointed out that in each case rules or laws could be changed, but that the magintude of the required changes was pretty big.)

 From Kenneth Garbade and Jamie McAndrews in a nice Liberty Street Economics blog post

• Certified check. Go to the bank, tell the bank to write you a $10,000 certified check. Put it in your sock drawer. (More: "Certified checks, which are liabilities of the certifying banks rather than individual depositors, might become a popular means of payment, as well as an attractive store of value, because they can be made payable to order and can be endorsed to subsequent payees.")

Or, inspired by that: 

• Don't cash checks. Every 90 days, call up, say you lost the check, ask them to reissue it. 

Clumsy. But as Ken and Jamie point out, it's very easy for a company to get started that does this, and offer fixed-value accounts to clients, beating the -5% at banks. Or, even in today's super-regulated environment, maybe banks could figure out to do this. After all, the Medici figured out in the 1400s to write offsetting bills of exchange to synthesize interest.

So, the project will mean changing the rules and laws governing checks, going back hundreds of years.

An earlier post by Todd Keister:

• Money market mutual funds.

Currently money market funds promise fixed value, and pay positive interest.  They are not set up to charge negative interest, or to allow capital losses. Maybe they should -- I've argued for floating NAV -- but they don't. The Fed kept the 0.25% rate on reserves precisely so banks and money market funds didn't have to reinvent themselves in ways that allow capital losses or negative rates. 

Miles Kimball has also been writing in favor of negative nominal rates and thinking about the zero bound. One post is here.