Tyler Cowen's Blog, page 549

Assorted links

1. Valentine homage to Romer, and a continuous time approach (is it?), and PubMed research papers related to Valentine's Day.   Here are data on spending.  Here is a Chris Coyne video on the economics of Valentine's Day; it is a non-Hansonian, non-Keynesian, Treasury view of the day, he is not impressed by a one-time increase in monetary velocity.

3. What science looks like.

4. Peter Conti-Brown on elective shareholder liability.

5. Flying-Bridge Motorhome.

5. Richard Thaler defends fun.

Apple fact of the day

From Matt:

Courtesy of Ajay Makan and Dan McCrum at the FT, Barclays Capital estimates that based on reporting thus far earnings growth for S&P 500 companies was 7 percent in Q4. But if you strip out Apple, that plummets to 2.9 percent.

One company, in other words, is responsible for most of the earnings growth among the large cap firms in the index.

(Pulls out Albert Hirschman for re-read…)

Seven ways to improve U.S. infrastructure spending

Here is a column full of good sense from Edward Glaeser, excerpt:

SPLIT UP THE PORT AUTHORITY: Last week gave us another painful audit of the work by the Port Authority of New York and New Jersey to manage the World Trade Center site. I'm not going to pile on, but this super-entity is too big to succeed. How can the Port Authority possibly focus on tasks such as making New York's airports more functional when it has so much else on its plate?

The problems at John F. Kennedy International Airport aren't evidence of the need for a new federal infrastructure agenda, they indicate only that the Port Authority has too much to do. Splitting off the airports, probably into two separate entities (for New York and New Jersey), could generate managerial focus and more competition. The airports can fund themselves if they are free to charge higher landing fees. Millions of fliers into New York should be perfectly willing to pay a bit more to ensure a more pleasant experience. More nimble and less restricted airports would help that happen.

It is one of my "hobby horses" to note that for all the money we spent on fiscal stimulus, air transport in and out of America's major city remains a total, unworkable mess.

A possible answer to a common European question (Atomic bread baking at home)

Thus, in 1954, USDA investigators journeyed from Chicago and Washington, D.C., to the shores of the Rock River to select two test groups, each comprising three hundred families "scientifically representative" of a typical American community. Over the next two years, the market researchers would deploy all the techniques of their emerging field on these six hundred families. They tracked bread purchases, devised means of weighing every ounce of bread consumed by the test population, conducted long interviews with housewives, and distributed thousands of questionnaires. Most important, they created a double-blind experiment that asked every member of every family to assess five different white-bread formulas over six weeks. Four years and almost one hundred thousand slices of bread after the project's conception, a clear portrait of America's favorite loaf emerged. It was 42.9 percent fluffier than the existing industry standard and 250 percent sweeter.

…In early twentieth-century consumers' minds, fluffier bread seemed fresher—even if it wasn't. Squeezable softness had become consumers' proxy for knowing when their bread had been baked. By the 1920s, market surveys revealed that consumers didn't necessarily like eating soft bread, but they always bought the softest-feeling loaf. By the 1950s, softness had become an end in itself, and savvy bakery scientists set about engineering ever-fluffier loaves—like USDA No. 1.

That is from Aaron Bobrow-Strain, interesting throughout, I just pre-ordered his new book White Bread: A Social History of the Store-Bought Loaf.  For the pointer I thank Michael Rosenwald.

Here is Alex on bread in Paris.  In the comments I wrote this:

Alex's response is, as you would expect, right on the mark. But most of the differences in ingredients *can* be traced to underlying economic causes. For reasons of rents, commuting distances, and city design, the French are better situated to consume fresh breads right after consuming them. Cheaper bread alternatives, in the U.S., also stem from economics, although this is a long and complicated story. The best salts come from France, for complex but largely economic and geographic reasons. Non-pasteurization makes French butters better, plus French farm subsidies keep many more small farmers in business. This raises price but also improves quality and shortens supply chains. Freezing foods, including dough, is much cheaper in the United States, again for economic reasons. We have a more dispersed population and longer supply lines, both of which favor freezing, plus we have much cheaper transport.

Again, I would stress that American bread is getting better and French bread is probably getting worse. We are seeing convergence, though I would not expect this to ever be exact.

Assorted links

1. There is a great stagnation.

2. There is no great stagnation (the new world of private drones).

3. How good a signal is a virtual rose?

4. Everyday life as an intelligences test (118 pp. pdf).

5. MITx to open formally.

6. Why the Greek "deal" may not work.

Bubbles and economic potential and potential gdp

Here is a Krugman post on the question, here are earlier posts from Sumner and Yglesias.  I will put my remarks under the fold…This topic is easiest to understand if you sub out the United States and sub in Greece.  There is no AD boost that can (anytime soon, without a lot of extra growth kicking in), restore Greece to its previous output peak and its previously expected performance-to-come.  Circa 2006, Greece was in an unsustainable position, if for no other reason the market didn't understand the correct risk premium for Greece.  Once the correct risk premium is applied, Greek output falls and furthermore numerous (related) bad events kick in and also a whole set of previous plans are shown to be unsustainable (and no this doesn't have to be an Austrian argument!).  The gap between Greece's current path, and the path previously envisioned for Greece is thus:

a. part AD gap which can be fixed by AD policy

b. part a difference in risk premia, and for Greece the old risk premium, when the country borrowed at very low rates, was wrong and is gone more or less forever.  The concomitant financial and fiscal stability is gone too.

c. part a difference in enthusiasm in supply, based on the differences between earlier expectations that "get rich quick" really does apply to Greece, and the current more pessimistic expectation that "get rich quick" is now unlikely, and thus "smaller-scale, scrabble-around projects just to make ends meet" are the order of the day.  DeLong gets at some of this here.

Greece does have to rebuild a) — don't get sucked into aggregate demand denialism! — but it also has to rebuild b) and c) and perhaps other factors too.  This follows rather directly from — dare I breathe the words? — the synthetic real business cycle/neo Keynesian models which form the backbone of contemporary macroeconomics and which Krugman apparently still doesn't wish to recognize.  (To various commentators and other bloggers: when I write macro on this blog I usually take knowledge of these models for granted; if you don't know those models that is fine, call me arcane, but it doesn't mean I am the one who is wrong.)   Krugman runs through a bunch of weak arguments and responses, and counters them well enough, but he doesn't see or consider the baseline response that would follow from standard contemporary macro, with the possible exception of his brief parenthetical phrase about credit conditions.

Turning for a moment to broader points, the astute reader will note that in this framework the current sluggishness of recovery need not be evidence for Old Keynesianism.  An ineffective response to fiscal policy does not per se have to mean we just didn't do enough fiscal policy.  And so on.  Maybe yes, maybe no, but all of a sudden there is a lot more room for agnosticism about macroeconomics and more broadly there is more room for epistemic modesty.

Contra Tim Duy, you can hold this mixed view without wanting to see the Fed raise interest rates.  Just avoid the AD denialism.

Krugman defines "potential GDP is a measure of how much the economy can produce" but keep in mind that this quite possibly won't be a unique number.  With what risk premium?  With what enthusiasm of supply?  See my Risk and Business Cycles for an extended discussion and also numerous citations.

It's also worth noting that while gdp is a useful "we can all agree upon what to measure" kind of concept, its real meaning is conceptually fairly slippery and "potential gdp" is not likely to be better pinned down at its foundations.  Let's not reify that concept above and beyond what it is worth.

In any case, we can be agnostic about the size of the potential gdp gap with regard to the United States today and indeed my original post very carefully used a question mark in its title.  But there is no incoherence to assert that part of the apparent gap is due to the real side.  The new learning about America is not about the correct risk premium for our debt (not yet at least), but about our financial fragility, how well our politics responds to crises, some worrying long-term trends in the labor market, possible misreadings of the productivity numbers, and a few other real factors.  It really is possible that previous investment plans were based on expectations of the real economy that were wrong and unsustainable and now have been (partially?) corrected, with negative growth penalties looking forward.

Stephen Williamson offers very detailed comment, noting also that the recession started well over four years ago, which gives plenty of time for nominal resets, and we've seen no downward cascading spiral, so maybe there is a non-AD problem with getting back on track at the preferred rate.  He also eschews AD denialism.  Today Krugman has a brief note along the lines that the views of his opponents on these questions are "even worse than your first impression" but that is best thought of as a) his occasional churlishness, and that b) his writings on this topic do not, at least not to date, reflect a very thorough knowledge of the relevant literature(s).

Dividends and taxation

President Obama wants to tax dividends at ordinary income rates.  These results, from Marcus and Martin Jacob, should not come as a huge surprise:

We compile a comprehensive international dividend and capital gains tax data set to study tax explanations of corporate payouts for a panel of 6,416 firms from 25 countries for 1990-2008. We find robust evidence that the tax penalty on dividends versus capital gains is statistically significant and negatively related to firms' propensity to pay dividends, initiate such payments, and the amount of dividends paid. Our analysis further reveals that an increase in the dividend tax penalty raises firms' likelihood to repurchase shares, initiate such repurchases, and the amount of shares repurchased. This is strong confirming evidence that when listed industrial firms globally design their payout policies, they take into careful consideration the relative tax implications of their payout choices.

Here are some Finnish results:

Using register-based panel data covering all Finnish firms in 1999-2004, we examine how corporations anticipated the 2005 dividend tax increase via changes in their dividend and investment policies. The Finnish capital and corporate income tax reform of 2005 creates a useful opportunity to measure this behaviour, since it involves exogenous variation in the tax treatment of different types of firms. The estimation results reveal that those firms that anticipated a dividend tax hike increased their dividend payouts by 10-50 per cent. This increase was not accompanied by a reduction in investment activities, but rather was associated with increased indebtedness in non-listed firms. The results also suggest that the timing of dividend distributions probably offsets much of the potential for increased dividend tax revenue following the reform.

Here are more results from Finland.  In the UK dividend tax increase of 1997 it seems pension funds were the marginal investor and they bore much of the burden from that particular reform.

Innovation Nation v. Warfare-Welfare State (more)

The New York Times has a lengthy piece on the expansion of the welfare state:

The government safety net was created to keep Americans from abject poverty, but the poorest households no longer receive a majority of government benefits.

…Dozens of benefits programs provided an average of $6,583 for each man, woman and child in the county in 2009, a 69 percent increase from 2000 after adjusting for inflation.

…The recent recession increased dependence on government, and stronger economic growth would reduce demand for programs like unemployment benefits. But the long-term trend is clear. Over the next 25 years, as the population ages and medical costs climb, the budget office projects that benefits programs will grow faster than any other part of government, driving the federal debt to dangerous heights.

In Launching the Innovation Renaissance (and here) I argue that the warfare-welfare state is crowding out other areas of spending, even when such spending could be highly valuable.

Wealth externalities and limited liability in banking

Arnold Kling writes:

Suppose that you sell your shares in Shakee Bank to me today, and tomorrow Shakee has to be taken over by the FDIC. Am I liable for losses, which probably were caused by decisions made before I bought my shares? Suppose that Shakee has accumulated $8 billion in losses, and all its shareholders of record obtained their shares for a collective $0.10. What happens then?

I don't envision the FDIC being eliminated, but say the government is in a position to be picking up some potential bondholder losses.  Under one version of the reform, bank shareholders already have posted extra collateral, by requirement of the law.  That is somewhat like higher bank capital requirements, with the twist that there is now a new legal class of bank capital.

That is an improvement over the status quo, but it's not the most innovative form of the proposal.  One alternative version is for the government to outsource the enforcement to the bank itself.  For instance the regulator can say: "as insolvency approaches, the bank is liable for 1.5 to 1, it can come up with the money any way it wants. If it can't come up with the money, we will take the major shareholders of record, say a year before the event (or consider a more complicated weighted average of this variable) and send them an income tax assessment for 2-1."

The bank might preemptively organize like a partnership, or it might apply its own collateral and capital requirements to the shareholders, or it might find some other way of meeting the obligation.  Banks would compete to find the better solutions.

In response, many people fear banks trying to set up with only hobo shareholders.  That would avoid the 2-1 or 1.5 to 1 or whatever, because hobos don't have extra assets to attach.  I just don't think those banks will become major money center institutions because the quality of shareholders really does matter at some level.  For instance such banks could not have wealthy, highly motivated, equity-holding CEOs.  Most likely hobo banks would stay small and thus skirt the too big to fail problem or maybe they would not exist in the first place.

One problem with traditional capital requirements is that the government ends up making comovement-inducing ex ante decisions about which assets count toward satisfying the capital requirement.  Remember AAA CDOs in America and AAA government securities in Europe?  Under non-limited liability, only cash is accepted but it only has to be delivered ex post in the case of failure.  The regulations themselves need not create the same kinds of uniformity, misjudgments, and excess systemic risks up front.

One tricky question is how to apply non-limited liability to foreign banks operating in the United States.  This is a problem with all regulatory schemes based on less than perfect international coordination.  The first cut approach is to insist on non-limited liability for U.S. operations, though of course evasion and reclassification of operations may occur.

Mark Thoma adds lengthy comments.  Here is a very relevant paper by Claire Hill and Richard Painter, and a blog post by them.  Here is Suzanne McGee.  Here are some debates on non-limited liability in economic history, including work by Lawrence H. White.

Gordon Tullock is 90 years old today

Here are previous MR entries concerning Gordon.