Tyler Cowen's Blog, page 187

Aaron Hedlund on Piketty

He writes me in an email:

…the thesis that r > g is the explanation for inequality or an ominous predictor of future inequality is, to be blunt, ridiculous.

1) Consider the most basic economic growth model: the Solow model where households arbitrarily follow a constant savings rate rule. In that model, the long-run growth rate equals the rate of technological progress, and the rate of return to capital is constant and completely independent of that growth rate. Therefore, you could have r > g, r = g, or r < g, simply because there is NO relationship. In that model, the capital/output ratio is stable in the long-run, again regardless of what r is relative to g.

We could beef the model up a bit by allowing households to actively choose how much to save (rather than impose a constant savings rate rule on them). In that model, the economy will also get to a point with stable long-term growth where the growth rate is determined purely by technological progress. In that model under log utility, 1 + r = (1 + g)*(1 + rate of time preference). As long as people are at all impatient, the implication is r > g. Therefore, the economy will have r > g, stable growth, and a stable K/Y ratio.

The flaw with both of these models, of course, is that they are representative household models where there is no inequality. Therefore, we can go a step further and add uninsurable risk to the model (whether that be health risk, earnings risk, or any other important source of economic risk). In *these* models, households also engage in precautionary savings, so in equilibrium r is lower than it is in the rep agent models. In fact, the greater amount of risk, the more wealth inequality and the SMALLER the gap between r and g.

2) Another huge fallacy is to translate “r > g” as “the return to capital is greater than the rate of return to labor.” The notion “rate of return” indicates an intertemporal dimension: for example, if I invest $1, how much do I get back in return a year later? The growth rate of the economy is not the return to labor. In fact, the “return” to labor is static: I give up x units of time in exchange for y dollars.

The RELEVANT comparison would be to compare the rate of return on capital to the rate of return on investing in human capital (ie you go to college and then reap labor market rewards in the future). The rate of return on human capital is most definitely not just “g.” In fact, the college premium is at an all-time high, which suggests that the rate of return on human capital is quite high and very possibly higher than the rate of return on physical capital.

3) The r > g –> inequality thesis is also based on ignoring the fact that r and g are both determined in equilibrium. Here’s what I mean: it is bad economics to say “Look, r > g, therefore IF people behave in such and such manner, their wealth will grow at a higher rate than g indefinitely.” The reason it is bad economics is because you can’t take the “r > g” as given and THEN impose whatever behavioral assumptions you want. The fact is, people’s behavior affects r and g. In the heterogeneous models I mentioned above, r > g, inequality is STABLE, and the behavior of households is determined by their desire to maximize utility. If I were to go to the model and arbitrarily force the households to behave differently, then the equilibrium r would change.

Here is Hedlund’s home page.

What is the Billion Prices Project showing us about inflation?

The Twitter source is here.  I would stress this is speculative, and I am not trying to argue we should panic about higher inflation.  I do, however, take this as additional evidence against the view that these days lack of nominal aggregate demand is a major problem.

Assorted links

1. Inequality and artistic dynamism.

2. Movies of the future will be paid for by the inch.

3. Profile of Bill Simmons.

4. Ryan Avent on whether Americans care about inequality.

5. China vs. Hong Kong.

Is China now the world’s largest economy?

Christopher Ingraham at The Washington Post has a good short piece on this:

Is China’s economy really set to overtake the United States this year, as manynewsoutletsreported Wednesday morning? Not exactly.

Those headlines come from a new World Bank report that looks at the  purchasing power parities (PPP) of world economies. It’s a way of standardizing GDPs across different currencies and economies by “the number of units of a country’s currency required to buy the same amounts of goods and services in the domestic market as U.S. dollar would buy in the United States,” according to the Bank’s definition.

On that measure, China is looking pretty good. As of 2011 (the latest year data are available), its GDP stood at about 87 percent of the U.S. GDP, or 15 percent of the world’s total economic output. This is a huge increase from 2005, when China’s economy was less than half the size of ours.

But there’s a reason that standard measures of GDP don’t use the PPP conversion. As the Wall Street Journal’s Tom Wright explains:

“China can’t buy missiles and ships and iPhones and German cars in PPP currency. They have to pay at prevailing exchange rates. That’s why exchange rate valuations are seen as more important when comparing the power of nations.”

Standard GDP measures take these exchange factors into account. And here, China is doing about as well as one would expect. They’re still the world’s second-largest economy, but their GDP is less than half the size of the U.S. GDP.

This piece is also a good example of just how much economics and financial journalism has improved, post-blogosphere.

The wisdom of Scott Sumner

Some on the left argue that consumption taxes will favor the ultra-rich because they consume a very small share of their income.  But if that’s so, then no tax regime will put much of a tax burden on the ultra-rich.  Just as you can’t squeeze blood from a stone, you can’t put a tax burden on misers.  As Steven Landsburg pointed out in one of my all time favorite posts, society views misers like Scrooge as being selfish individuals, when actually it’s people who consume a lot who are selfish. Misers leave more for others to consume.

In my only slightly cynical view, a lot of the debate about taxation is more about showing the wealthy that they need to lose (or win, on the other side of the debate) a few political battles than it is about actual canons of efficiency or for that matter even well-specified theories of egalitarian justice.  For instance I find that few proponents of a higher inheritance tax realize it will increase current consumption inequality, by encouraging the wealthy to consume more rather than paying the tax.  Nor do they seem to care, once this is pointed out.  I call this “the comeuppance” theory” and it is another example of Robin Hanson’s motto that “politics isn’t about policy,” but rather is a spat about which monkeys should have a higher or lower status.

Scott’s post is here, and it contains other points of interest.

Not what I expected from the culture that is Japan

 In a bid to be more globally competitive and raise the level of English education in the country, the Japanese Ministry of Education will soon begin conducting their meetings in the language. As using English in meetings is highly unusual in the country, the ministry will start implementing it slowly, beginning with high-level officials in their department.

To help them with this, the ministry has sought for an English Education Project Officer that will be in charge of coming up with strategies and plans pertaining to English education. The post, though on a part-time basis, would require someone who has taken an English proficiency test called TOEIC with a score of at least 800. The ministry has chosen a candidate who was successful in integrating the English language as a corporate official language to a private company, and will stay with the ministry for a one-year contract. The English Education Project Officer will join top-level meetings within the ministry to assess their capability and suggest improvements. An official from the Education Ministry said, “By using English among ourselves, we hope we will be able to broaden our perspectives on English education.”

The story is here, via the excellent Mark Thorson.

Would net neutrality hurt the poor?

Eli Dourado has a new piece of note:

In much of the world, the net is not neutral, thanks to companies like Facebook and Google.Facebook Zero is an initiative launched in 2010 to give customers of 50 carriers, mostly in the developing world, access to a lightweight version of Facebook on their WAP-enabled feature phones at no charge. Users can post, like, poke, and comment to their hearts’ content, but if they want to view photos or access non-Facebook sites, they incur the usual data charge. The model has been so successful at growing Facebook adoption in Africa that Google followed suit with a competing offering, Google Free Zone in 2012. Lest anyone think that this is a cruel ploy by evil, for-profit corporations to trap the poor inside their walled gardens, the non-profit Wikimedia Foundation also copied Facebook’s idea with Wikipedia Zero, to great effect.

…non-neutrality can also help to fund necessary network buildouts on an ongoing basis. By giving access to Facebook, Google, and Wikipedia away as a loss-leader, carriers are serving with their basic tier of service those who can’t afford more, and habituating those who can afford to click beyond the walled garden to using the mobile web. This price discrimination not only increases access but also raises more revenue than a neutral strategy would. Developing-world carriers need that revenue if they ever intend to build the kinds of networks that will support widespread Internet use. Net neutrality, in other words, would not only keep the poorest offline, it would keep investment in poor-country telecom infrastructure down for longer.

A similar, but less stark, dynamic is playing out in rich countries. Anyone who has ever used their Kindle’s included 3G service has benefited from network non-neutrality; after all, you can’t use it to access non-Amazon services. Absent Amazon’s non-neutral arrangement with wireless carriers, you’d have to pay a nontrivial monthly fee to access books via the cellular network, which would mean that most people would forgo cellular and stick to Wi-Fi. Again, we observe a non-neutral arrangement expanding access and saving people money.

Read the whole thing.

Poll data on how much Americans care about inequality — not much

Joseph Lawler reports:

Respondents were not particularly worried about income inequality, which President Obama identified in December as the “defining challenge of our time.” Just five percent said that inequality was a major problem needing attention. And nearly all — 93 percent — of those who listed inequality as a problem said they were not at all or only slightly confident that the government could make real progress in addressing inequality in 2014.

Here is my post from earlier today.

Assorted links

1. Good interview with Michael Strain.

2. Raw data from Piketty, lots of it.  And confronting the Texas police with Bayesian reasoning.  And how Paul Krugman views his own endeavors.

3. When do men not want a pretty face? (speculative)

4. My 2005 post on whether or not we should tax capital.  And the bad rentier?

5. Very good Edward Luce FT piece on Modi.

6. Andrew Gelman on Seth Roberts, great piece.

7. Al Roth predicts 98 years out (seems more like thirty years out to me, or even less).

The Son Also Rises

Economist and Australian politician Andrew Leigh has a very informative review of Gregory Clark’s The Son Also Rises:

If you want to know who made up Australia’s elite in the nineteenth century, a useful place to look is the Australian Dictionary of Biography. In its many volumes, you’ll find business leaders, scientists, media barons and politicians who have featured among the upper echelons of Australian society.

Now, suppose we take the first cohort of significant Australians – those who died before 1880 – and identify those with unusual surnames like Ebden or Maconochie. People with those names were overrepresented among the elite in the nineteenth century. Are they still at the top of society, or are they mixed through?

The answer to this question will depend on the level of social mobility we have in Australia.

…For Australia, it turns out that if we look at the register of modern-day medical practitioners, we find the privileged names of the nineteenth century overrepresented by a factor of nearly three. In other words, if your ancestor was at the top of Australian society six generations ago, you are three times more likely to be a doctor today than the average Australian.

…if we accept Gregory Clark’s methodology, his results imply a very static society. For Britain, the United States, India, Japan, Korea, China, Taiwan, Chile and even Sweden, he concludes that the intergenerational elasticity is between 0.7 and 0.9. This would mean that social status is at least as hereditable as height. It suggests that while the ruling class and the underclass are not permanent, they are extremely long-lasting. Erasing privilege takes not two or three generations, but ten to fifteen generations.

Read the whole thing.