Thursday, November 30, 2006

Friedman and Keynes

I agree with most of what Brad DeLong has to say at
except for the following bit:

"Keynes saw himself as the enemy of laissez-faire and an advocate of public management. Clever government officials of goodwill, he thought, could design economic institutions that would be superior to the market — or could at least tweak the market with taxes, subsidies, and regulations to produce superior outcomes. It was simply not the case, Keynes argued, that the private incentives of those active in the marketplace were aligned with the public good."

If DeLong means that Keynes believed the government should intervene to stabilize aggregate demand, I would agree. However, if DeLong means to imply Keynes was fond of micro-economic interventions, the following quote of Keynes should be considered:

"To put the point correctly, I see no reason to suppose that the existing system seriously misemploys the factions of production which are in use. There are, of course, errors of foresight; but these would not be avoided by centralizing decisions. When 9,000,000 men are employed out of 10,000,000 willing and able to work, there is no evidence that the labor of these 9,000,000 men is misdirected. The complaint against the present system is not that 9,000,000 ought to be employed on different tasks, but that tasks should be available for the remaining 1,000,000 men. It is in determining the volume, not the direction, of actual employment that the existing system has broken down."

That is, Keynes was voicing faith markets on a microeconomic scale. So I do not believe DeLong is accurate if he means Keynes was an across-the-board skeptic about the invisible hand.

Wednesday, November 15, 2006

Only the Democrats can fix Social Security

Only Nixon could go to China. Only the Democrats can fix social security. The quality of the fix will depend on whether the moderate or left wing of the party is ascendant at the time.

The best case scenario would involve:
1) Sliding-scale indexation, where payments to top earners are indexed to prices, payments to low earners stay indexed to wages. This could be written so that all payments eventually converge to today's maximum payments, and thus come uncoupled from income. This could be politically palatable because we'd be rising to the highest common denominator.
2) Implementing actuarially fair pension accrual, thus strengthening the incentive to keep working.
3) Indexing the normal retirement age to life expectancy. Sweden did it -- surely any Democrat can emulate the Swedes with pride.
4) Abolishing the regressive payroll tax and funding SS out of general tax revenue. Al Gore has proposed something like this this, with a CO2 tax to make up the lost revenue.
5) Add-on general-purpose providential accounts that merge the features of a Health Savings Account and an IRA, with possible mandatory contribution. Choice of index funds, with some limits on excessive risk-taking. For political palatibiilty, perhaps we eliminate the worker portion of the payroll tax, then redirect the employer portion into the providential account.

But I'm not holding my breath for any of those. And I don't see any politically palatible way of fixing Medicare.

Tuesday, November 14, 2006

The Economist, George Orwell, the Irving Fisher Award, and WWII Economies

Like Fisher, Orwell was generally a clever and insightful fellow worth listening to. And, like Fisher's 'plateau' remark, this utterance of Orwell's is mostly nonsense, for all the reasons cited above. So the remark is quite the fitting recipient of the Fisher award. We can only hope that Free Exchange will attain such a high sense:non-sense ratio.

I'll defend the opening post in the following sense. For the 1920-1939 period, the US was significantly more free market than either Germany or the USSR. Even during the Great Depression and New Deal, the US economy was significantly more free market than either, especially once we get past the farcical 1st New Deal National Industrial Recovery Act, which was unmourned by Roosevelt when it was struck down by the Supreme Court. In the crude but measurable sense of federal government spending, the New Deal maxes out at 10.2% of GDP. Extending the analysis to planning and regulation, I would argue that (again, leaving aside the NIRA), the New Deal was more free market than the contemporary US economy.

By 1939, real GDP was $111b, as compared to $105b in 1929 (both in 1929 dollars). The economic strength built over the years before 1939 was built under a system that was more free market than Germany or the USSR. When the war came, this vast economic strength could be turned to munitions.

The following data may be helpful, taken from Mark Harrison's "Resource Mobilization for World War II" in the Economic History Review, 41 (1988): 172. When reading them, remember that the Hitler invades Russia in early 1941 (thus affects USSR production), and Pearl Harbor occurs in late 1941 (thus does not).

Munitions Production in Billions.
1940 1941 1942 1943 1944
US 1.5 4.5 20 38 42
UK 2.5 3.5 9 11 11
USSR 5 8.5 11.5 14 16
Germany 6 6 8.5 13.5 17
Japan 1 2 3 4.5 6

Several points stand out:
1)The USSR's astonishing success in not only recovering the industrial capacity lost to German invasion/occupation, but increasing production (all at tremendous human cost).
2) The fact that the US produced at least 50% of all allied munitions after 1941, large portions of which went to the UK and USSR via Lend-Lease.
3) The fact that the USSR and Germany produced roughly the same amounts of armaments. Combined with the 2nd front problems of Germany, the greater Russian population, and the homefield/winter weather advantages of Russia, this probably meant that the Germans would have been at least stalemated by the UK and USSR without US help.
4) Japanese munitions production was incredibly feeble. Even in 1940 and 1941, the peacetime US out-produced them. They never stood a chance.

Monday, May 22, 2006

Medicare Drug Implicit Debt

The elephant in the room is Medicare of course, since its spending is growing much more quickly than GDP.
In one fell swoop, adding Medicare part D (the drug benefit) added about $10 trillion dollars of implicit debt! If I remember right, the implicit debt for the rest of Medicare comes to about $35 trillion. The pre-funding "trust fund" for Medicare is tiny compared to Social Security. So, overall, we're talking an implicit debt from Medicare of around 3.5 times GDP. Ouch.
What does this mean? There will be rationing, either on prices and income or administrative-bureaucratic. There will also be large tax increases.
Everyone ignores Medicare because there are no good ideas for dealing with it. Every potential solution is a huge vote loser.

Brad DeLong discovers the Classical Dichotomy!

Brad Delong posts that $200 billion of the $600 billion increase in the implicit debt of Social Security between is nominal rather than real.

1) Is that true?
Implicit debt for 2005 = $4.318
$200 increase due to inflation would imply an inflation rate of (4518-4318)/4318 = 4.63%
Using the data at
we get year on year inflation (q1-to-q1 or feb-to-feb 2005 to 2006) of 3.15 for the GDP deflator, 3.59 for the CPI, and 6.8% for the PPI.
Of these, arguably the GDP deflator is the best choice. Of course, if you wanted to pull a Krugman (or a bizaaro-world Lazear) you could cherry-pick the 6.8% PPI number... then you get almost $300 of the increase in implicit debt as merely nominal rather than real.

2) Is Brad's post spin? I'd say no: the most appropriate measure of the size of the problem is the ratio of the implicit debt to GDP, just like with explicit debt. The nominal correction only is only half-right. We need to adjust for the growth in real GDP too. By this measure, the implicit debt has gone from 3.54% of GDP to 3.79% of GDP.
I'll look forward to Brad talking about how the most appropriate measure of Bush's fiscal irresponsibility is not the increase in the nominal value of the federal debt/deficit, but rather either the real increase (which will be smaller) or the ratio of debts/deficits to GDP (which will be even smaller).
For example, if Iraq is costing $10 billion per month, we're talking 0.92% (120b/13020b) of GDP. That's the best measure of the war's direct economic burden.

Or, to be truly provocative: Defense spending is now about 4.7% of GDP, compared to a range of 3.7-5.4% in the Clinton administration, 5.6--6% in the Carter administration, or 10.4% for Kennedey in 1961, descending to a Vietnam-era high of 10% in 1967.

Mankiw, Krugman, Lieberman and the Implicit debt

Greg Mankiw's blog

has a post reacting to Krugman's reaction to some comments by Joe Lieberman about Social Security's implicit debt.
And while I have the greatest respect for Greg as an economist (if only for the Mankiw, Romer and Wiel 'taking Solow seriously' paper) and use his textbook in my economics class, I think he's a little off-the-mark here.
Krugman, on the other hand, either is totally ignorant of what he's talking about (and is showing gross negligence by not phoning up Peter Diamond, left-of-center Social Security expert) or is engaging in deliberately deceptive spinning. I can only hope that the pressure of a weekly column is so large that a once-great scholar like Krugman just doesn't have time to take the 60 minutes I took to write this blog post.

Greg's explanation for the $600 billion growth in the Social Security implicit debt is that it's all about discounting. To put it very rudely, much like Krugman, he's outside his area of expertise, and he didn't look up the facts. However, Greg Mankiw and doesn't descend into ad hominem attacks. His larger point about civility and intellectual integrity require is 100% right though.

The meat of the matter:
Social Security calculates its forecasts on a 75 year time horizon. All years beyond 202x show Social Security spending greater than revenue. The farther in the future you go, the bigger than gap is. So, when we go from Social Security calculation for 2004 to its calculation for 2005, we now include 2080 in our forecast. Since that's way beyond 202x, it adds a lot to the implicit debt. To paraphrase Greg's example, we're adding $2 owed in year 21 to the $100 we already owe in year 20.

There's a little table Social Security has drawn up to show "Reasons for Change in the 75-Year Actuarial Balance" at

Social Security prefers to report their actuarial imbalance in terms of percentage of total expected future payroll over their 75-year time period. I'd argue this is cheesy spinning it to make it look smaller, just as Cheney's discussion of the non-discounted shortfalls are scare-tactics spin to make it look larger.

The expected PDV of the shortfall is 1.68% of expected future payroll, up from 1.60 last year. That looks small. Of course, their expected future payroll is $275 TRILLION, so it's actually quite large. If we didn't add 2080 to our forecast window, the increase would only have been 0.03% of payroll rather than 0.08%. So, adding 2080 explains roughly 5/8ths of the increase in the gap.

2) Now, let me make myself look like an ass by criticizing Greg Mankiw's discussion of discounting. Greg's example implicitly assumes the liabilities in question are non-interest bearing.
But that's not the case for Social Security. Both its assets and its liabilities are interest-bearing.
If the federal government balances its budget and pays the interest on its debt, the debt stays unchanged. If the federal government borrows to cover the interest on the debt, but otherwise balances its budget, the debt increases.
If the discount rate and the interest rate are equal, which Social Security assumes they are (both 5.7% nominal), delaying paying back principal and interest leaves the PDV (as calculated from year zero) of the debt unchanged. Why? Because the PDV of owing $105.7 nine years from now is the same as owing $100 now. The growth in the amount owed and the decrease in the discount factor balance out.
I think Greg's example implicitly assumes we're comparing the PDV owed today to the PDV owed tomorrow when we haven't discounted for the fact that tomorrow is one day later. But the Trustees report doesn't make that mistake. The 2004 report values the liabilities in 2004. The 2005 report values the liabilities owed in 2005. The change in the PDV of the liability is done correctly by just comparing the two reports.

Wednesday, May 17, 2006

Oil Elasticity

I've found an estimate for the price elasticity of world oil demand (circa 1990) of 0.1, which is pretty darn inelastic. It seems plausible that new technologies (hybrids, brazilian sugar-ethanol) might have reduced that elasticity.

So, if Iran's 5% of world production were removed from the (decrease in quantity supplied by 5%), we should expect oil prices to go up about 50%.

$100 a barrel won't be fun, but the $30 increase should only put gas prices up another $0.75.

Still though, the key question seems to be the elasticity of Aggregate Supply with respect to oil prices.

AMT cont'd

I suspect that if the AMT displaced the normal tax system, the AMT would start getting modified/complexified.

But at least
1) The status quo would be simple and flattish, as compared to
2) The current status quo, which is hideously complicated.

It'd be a lot easier to protect a simple/flat status quo than to clawback all the deductions and exemptions out of the current tax system's status quo.

Saturday, May 13, 2006

The Alternative Minimum Tax

By special request, a short post on the AMT.

The AMT is slowly displacing the normal tax system. As I understand it, it is less loophole ridden than the normal tax system and also somewhat flatter. If my understanding is correct, I am all in favor of letting it slowly and stealthily displace the normal tax system.

The politics of actually simplifying and/or flattening our current tax system seem to be a Gordian knot. AMT-creep may be the way around this.

Friday, May 05, 2006

Russia and Iran

Russian self-interest would seem to favor sanctions on Iran.

On the one hand, they'd lose some nuclear contracts, worth (IIRC) about $2 billion per year. On the other hand, Russia's oil exports are somewhere around $100-120 billion per year, IIRC.

Iran has about 5% of world oil production. Given the current state of the markets, I'd be willing to bet that if UN sanctions take that 5% off the market, oil prices would increase at least another 10%. (In a quick and sloppy search, I didn't find any estimates of the elasticity of demand for oil. We're all told that oil is inelasticly demanded, so I'll assume an elasticity of 1/2.) That'd be about $10-12 in export revenue, far outweighing the value of the nuclear contracts.

So, what up with this? I've heard it alleged that Russia's foreign policy tries to aim for a state of controlled tensions, which maximizes their usefulness (UN veto, etc) to the West, thus allows them to get favors from the West in other areas.

Is that what's going on here? Russia is just holding out for a bigger bribe before it is persuaded to back the EU and US? Surely the Russians can't be wild about the idea of a nuclear-armed Iran, given their close proximity and their troubles in Chechnya.