Edward Glaeser says that mobile labor constrains the effectiveness of tax rates. Since successful development relies on attracting skilled workers, it seems that raising state and local taxes deter those very workers from establishing roots.
Typically, every five years, 43 percent of Americans change houses, 18 percent of Americans change counties, and 8.4 percent of Americans change states. Mobility radically constrains the ability of geographically small governments to redistribute.
Hmmm. Maybe this is why Massachusetts has a flat tax, but it doesn't explain why Texas has no income tax at all. Anyway, the post is very highly recommended (indeed, I will probably re-read Glaeser's post and follow the links again this year).
A recent Business Week cover story asked, "What Good Are Economists, Anyway?" The online material included snapshots of the views of three macroeconomists, including Thomas Sargent:
In the 1970s, Sargent was one of the thinkers behind "rational expectations," which says that ordinary people can correctly anticipate the range and likelihood of possible future outcomes. Sargent now says that theory was an oversimplification. In real life, he explains, households and businesses are highly uncertain. Developments such as an unexpected government action or a major company going bust can cause people to drastically revise their beliefs about what might happen next. The good news: Beliefs may shift back again through unexpected positive events.
"Now a practical theory of the future based on these three principles has certain marked characteristics. In particular, being based on so flimsy a foundation, it is subject to sudden and violent changes. The practice of calmness and immobility, of certainty and security, suddenly breaks down. New fears and hopes will, without warning, take charge of human conduct. The forces of disillusion may suddenly impose a new conventional basis of valuation. All these pretty, polite techniques, made for a well-panelled Board Room and a nicely regulated market, are liable to collapse. At all times the vague panic fears and equally vague and unreasoned hopes are not really lulled, and lie but a little way below the surface."
Video of Alex Tabarrok's talk at TED. My favorite points:
"How do you get more ideas? More idea creators. ... Today less than 1/10th of 1 percent of the world's population are scientists and engineers."
"We will see an Einstein in Africa in this century."
"$200,000 ... this is a rather modest prediction."
The Tabarrok thesis is that global growth in per capita income is accelerating. This is a big, big deal ... the 0.1 percentage point increase in the growth rate every decade for the last 2 centuries has already destroyed most of human poverty, and Alex is showing how growth will finish the job in this century. By the way, the 0.1 per decade acceleration is my rule of thumb projection, so don't slam Alex if you think it is stupid, although I suspect he would agree with me. The data tell this story; it is not make-believe.
Analysis: Naturally, I loved Alex's talk and highly recommend it. But I am always stunned at the kind of reaction that optimistic economists get, and I felt it again when I read many of the comments at the TED page. For example, Jake Koethler writes, "The third world will never be developed to the extent that the rest of the world is. There aren't enough natural resources to sustain that level of development." I have been trained to impressed by lines on paper representing big abstract things like GDP per capita. But this is not natural. So Jake may be right, but I suspect he is falling for the instinctive zero sum fallacy. Division of labor disproves the limits to growth on one level, but Jake would probably say that labor is not the limiting factor here. Resources -- oil, gold, steel, agricultural capacity, water -- are the limiting factors.
I'm not sure I can disprove in this post the notion that limited stocks of any one thing limiting to overall prosperity, but it is clearly a powerful article of faith among many super smart people. Hopefully, we optimistic economists can make a convincing case that there is ultimately only one resource constraint: GDP per capita. A simple explanation: it is not the country with the most gold that dominates the world, rather it is the country that is the most productive. Every other thing's economic value derives from its balance of scarcity that ultimately rests on human demand. Because something is finite does not mean it can limit what is theoretically limitless, especially because all finite resource can arguably be reused. The execption is oil, but that's just one form of potential energy, and the sun is a lot bigger.
Those who believe in the resource constraint problem are logically arguing that too much growth causes slower growth. That reasoning is difficult to reconcile.
This may all seem trivial, but many beliefs about modern conflict hold fast to the principle of finite resource constraints. They see competing groups fighting for water, and deduce that water is a source of conflict. But poor people don't want water; it is just a proxy for what they really desire, which is prosperity.
One of the surprises in our recent surveys of blogger experts and the public (via Doug Schoen) is the importance of medical insurance as a job lock, the phrase used to describe how Americans become captured with iron (if not golden) handcuffs to their existing employers with untaxed benefits. Health benefits are arguably the most important, since they are protections against catastrophic loss, and the fact is that self-employment cannot compete on a level playing field with those protections. Entrepreneurship, from this perspective, is much more risky than it would be normally. It's one thing to risk your income, and it is something altogether different to risk the health of your family.
Economist bloggers in our survey identify the loss of benefits as the #1 barrier to starting a new company in the minds of most Americans. Similarly, they said that the #1 change to encourage more start-ups would be allowing people to "keep existing health benefits." In Kauffman's major 2007 Roadmap paper that Bob Litan assembled and published with a dozen experts, decoupling health care from employers was positioned as one the top policy changes that would enhance entrepreneurship.
Here's a quick scan of the job lock literature:
I am surely missing some other good papers and summaries (and I found the wiki page disappointing). Any suggestions?
My quick analysis of the issue, which is not set in stone ...
1. The tax treatment of health and other benefits is harmful to economic efficiency. All emplolyment benefits should be treated as income, which would be both progressive and pro-growth!
2. Job lock may be hard to identify empirically, but survey data show it to be a major concern. I suspect much early-stage entrepreneurship is hampered into a part-time activity due to job lock, which means current policy is bogging down growth and innovation.
Paul Krugman is warning that America may go the way Ireland if its not careful, pointing to that country's current economic crisis as a symptom of excessive economic freedom. His essay is a clear case of revisionist history, and as my Irish grandmother would have said, "Shame on him."
First, the context. The Economist says Ireland is in "a deeper recession than any other euro area country. The economy probably shrank by 2.5% in 2008 and may contract by another 6.5% this year. Unemployment has jumped from 5% to 10.4%, a faster rise even than in America." Further, the government may have worsened the crisis with poor policy choices. Krugman, for those just tuning in, thinks that nationalizing banks is a much better course of action than bailing them out of toxic assets. That's what Ireland did when it faced a banking crisis last year, which arguably failed, and it's what the Obama administration is essentially doing now.
Krugman may be right about nationalization; I share the same skepticism of bank bailouts and toxic asset purchases. That's not the issue. The problem with Paul Krugman is that he can't resist using a free-market straw man to make his point. Red Flag! Foul! Bad Journalism! Here's the offensive Krugmanian paragraph:
How did Ireland get into its current bind? By being just like us, only more so. Like its near-namesake Iceland, Ireland jumped with both feet into the brave new world of unsupervised global markets. Last year the Heritage Foundation declared Ireland the third freest economy in the world, behind only Hong Kong and Singapore.
Boil this down, and he is saying that economic freedom is the same as "unsupervised" laissez-faire markets, with the implicit judgment that this is dangerous. Krugman is preaching cartoon Keynesian economics, as if having state enforced contract law and property rights were somehow equal to no law. Not to mention, glibly asserting that free trade is bad and high taxes good.
Specifically, Krugman is taking aim at the Index of Economic Freedom, which most readers know that I directed in 2006-07 including a major refinement in its methodology with the 2007 edition (this chapter with Bill Beach from the 2008 version is online). And it's true, reforms in Ireland since the mid 1980s catapulted that nation from one of the least free to one of the most free places on Earth. This policy shift coincided with one of the starkest economic miracles ever.
The "Celtic Tiger" story is much different than development miracles in the Third World, say in Asia or Latin America. Those places were untouched by modernity in some sense. But Ireland was the opposite: a stagnant economy surrounded by modernity. Indeed, no country was closer to the birth of the Industrial Revolution in Britain, and yet it had still not received the diffusion of its benefits. None. So in a very powerful way, Ireland is the ultimate case study in the story of bad policy as a barrier to growth.
Let's examine the facts. First, consider Ireland's economy right now. Here is the full text of the "Economy Overview" from CIA's World Factbook page on Ireland (updated 9 April 2009):
Ireland is a small, modern, trade-dependent economy. GDP growth averaged 6% in 1995-2007, but economic activity dropped sharply in 2008 and Ireland entered into a recession for the first time in more than a decade with the onset of the world financial crisis and subsequent severe slowdown in the property and construction markets. Agriculture, once the most important sector, is now dwarfed by industry and services. Although the export sector, dominated by foreign multinationals, remains a key component of Ireland's economy, construction most recently fueled economic growth along with strong consumer spending and business investment. Property prices rose more rapidly in Ireland in the decade up to 2006 than in any other developed world economy. Per capita GDP also surged during Ireland's high-growth years, and in 2007 surpassed that of the United States. The Irish Government has implemented a series of national economic programs designed to curb price and wage inflation, invest in infrastructure, increase labor force skills, and promote foreign investment. In 2008 the COWEN government moved to guarantee all bank deposits, recapitalize the banking system, and establish partly-public venture capital funds in response to the country's economic downturn. Ireland joined in circulating the euro on 1 January 2002 along with 11 other EU nations.
Want to know the in-depth story of Ireland? Ask the Irish. In 2006, I authorized the publication of a Heritage report written by Sean Dorgan, the Chief Executive of IDA Ireland since January 1999. Dorgan shows that the decades of nationalism, massive government social programs, and protectionism were simply abject failures. Only when Ireland slashed its corporate tax rate to 12.5 percent - one of the lowest in the world - did its economy boom. But before thinking about what worked, step back and consider what did not:
The role of the state also increased during the 1960s. Public expenditure grew from 32 percent of GNP in 1960 to 42 percent in 1973. Social services and education, in particular, expanded with the state. ...
Between 1980 and 1986, total government expenditure grew from 54 percent to 62 percent of GNP, and public debt increased from 87 percent to 120 percent of GNP while annual budget deficits exceeded 10 percent of GNP.
And then the party Fianna Fail won the 1987 general election and began "a program of severe cuts in expenditure." Reform after reform was emboldened by growth, which kept the critics on their heels, if not silenced outright.
The same story told by the Heritage/Wall Street Journal Index is also told by the World Bank's Doing Business Report. It's a story that shows with data that government spending to make economies grow is an empirical failure. The story of economic freedom explains how to fight global poverty. And it's pretty clear that Paul Krugman does not like that story. While the current market and government failures deserve scrutiny and correction, we have to be wary of ideologues like Krugman who will use the crisis to smear all pro-growth policies (and other ideologues who will smear all government solutions). The only way to do that is with the perspective of history.
Using purchasing-power-parity data from the latest IMF World Economic Outlook, Ireland had per capita GDP of $6613 in 1980. That means the typical family of four had $2000 a month to survive on. By 1996, that number had tripled. In 2007, it peaked at $43,414. All of Krugman's fury boils down to the fact that GDP per capita in Ireland fell in 2008 to $42,780. It may drop further, maybe below $40,000, but it is criminal to suggest that Ireland should return to its auld ways.
In their new book and in their prior work, Claudia Goldin and Lawrence Katz have convincingly demonstrated the enormous boost the U.S. economy received in the last sixty years from increasing investments in education. For the last two decades, anxiety has risen that the United States has reached some sort of education plateau or decline and that economic growth will accordingly suffer.
A great essay by Phil Auerswald and Zoltan Acs:
"Continued institutional innovations will be required to ensure that democratic societies with market-based economies are as resilient in the future as they are prosperous. . . . Unfortunately, political action to support entrepreneurship is stymied by a political system still living in the past. On the one side is a party committed to economic liberty, a party which has an historic affinity to entrepreneurs, but which today is analytically handicapped by its 19th-century interpretation of the nature of markets and market failure. On the other side is a party committed to economic rights, a party which has an historical appreciation for the benefits that can derive from enlightened government action, but which today is functionally handicapped by its 20th-century (Galbraithian) interpretation of American capitalism. The result is a debate in which both parties are well intentioned and both are programmatically wrong. This has produced a depressing stalemate in which neither side of the aisle produces the policy initiatives required for a renewal of sustainable prosperity."
Tyler Cowen's review of the documentary THE END OF POVERTY is fun, priceless, hopefully an important step forward in the coversation about global development in the public arena, and a piece that I suspect will be remembered for many years. Quoting heavily:
I can only report that The End of Poverty, narrated throughout by Martin Sheen, puts Ayn Rand back on the map as an accurate and indeed insightful cultural commentator. If you were to take the most overdone and most caricatured cocktail-party scenes from Atlas Shrugged, if you were to put the content of Rand’s “whiners” on the screen, mixed in with at least halfway competent production values, you would get something resembling The End of Poverty. If you ever thought that Rand’s nemeses were pure caricature, this film will show you that they are not....
In this movie, the causes of poverty are oppression and oppression alone. There is no recognition that poverty is the natural or default state of mankind and that a special set of conditions must come together for wealth to be produced. There is no discussion of what this formula for wealth might be. There is no recognition that the wealth of the West lies upon any foundations other than those of theft, exploitation and the oppression of literal or virtual colonies.
The history in this movie starts, not coincidentally one may assume, in 1492 with the arrival of Columbus in the New World. The phrase “natural economies” is used repeatedly to refer to the conduct of the since-despoiled noble savages, and we are told that the Europeans destroyed the natural economies of the countries they conquered. Never mentioned is the fact that these so-called natural economies were themselves based on prior conquest and oppression. ...
Most of all, the Robert Schalkenbach Foundation should be ashamed for having funded this movie. The Schalkenbach Foundation was set up in 1925 to promote the thinking of Henry George, best known as the author of Progress and Poverty and advocate of a tax on land. George was a flawed but brilliant and incisive thinker. He understood that wealth needs to be produced, and he also understood the strong case for free trade, most of all to protect the interests of labor. His 1886 book Protection or Free Trade remains perhaps the best-argued tract on free trade to this day; in that book George refutes exactly the arguments put forward by The End of Poverty. Has Diaz, Sheen, Portello or anyone working today at the Schalkenbach Foundation read it? One has to wonder if anyone who has read George could lend a hand to the production of the screed of mistruths and error that is The End of Poverty. I prefer to be subtler, but this movie does not allow it.
Kudos to the American Interest for publishing this (and a few other) great pieces.
And yes, I too was curious about the Schalkenbach Foundation. Calling them out was something of a surprise that certainly catches the attention of places like Kauffman where our support is rarely noticed so openly. I'll be curious to see if and how they reply.
A recent Time magazine article pointed out that many people see the recession as a good opportunity to start a new company: "At no other time in recent history has it been easier or cheaper to start a new kind of company. Possibly a very profitable company. Let's call these start-ups LILOs, for 'a little in, a lot out.' These are Web-based businesses that cost almost nothing to get off the groundyet can turn into great moneymakers."
Strong banks will be allowed to repay federal bailout funds, but only if such a move passes a test to determine whether it is in the national economic interest, the Financial Times reported on Sunday, citing a senior U.S. administration official.
This story about North Korean defectors in the Washington Post is riveting (hat tip Paul Kedrosky):
They filter into South Korea at the rate of about 35 a week, usually after months or years in China and an arduous detour through Vietnam, Burma or Thailand. About 15,000 defectors have settled in the South, with 4,000 arriving in the past two years.
Seoul does not encourage North Koreans to defect. But once they arrive, the South Korean government quietly grants them citizenship, gives them an apartment and tries to teach them how not to sink in an education-obsessed capitalist culture.
* * *
A new U.N. human rights report describes North Korea as a place where ordinary people "live in fear and are pressed to inform on each other. The state practices extensive surveillance of its inhabitants. . . . Authorities have bred a culture of pervasive mistrust."
The story references a survey of North Korean defectors published by the Peterson Institute last January, which I just discovered. (Disclaimer: it ws co-authored by one of my dissertation advisers, Stephan Haggard). The conclusion that "When questioned about governance and the economy, the refugees’ collective evaluation of the regime, its intentions, and accomplishments is overwhelmingly negative..." tells us that even the most oppressive state control has not been able to maintain popular support.
Why is North Korea important?
One might argue that the hell that is North Korea is unimportant, a sad reality that some places are just not as prosperous and fortunate as others. But its existence is profound, confirming that an Orwellian state is possible.
It is a haunting place to contemplate, North Korea. The level of poverty may be no worse than the average country in 1500. Perhaps better. However, if human misery is measured by oppression and fear, it is difficult to imagine a sadder place in all of history.
The situation is such not just because there is an absence of prosperity, but because the country is ruled by tyranny in a world of plenty. Visions of plenty are intolerable to impoverished tyrants, and either they give way to change (and economic revolution easily spills over to political revolution) or they intensify their oppression with extreme propoganda and paranoia. Indeed, development economists often speak of poverty traps, but North Korea is a special case. It is a tyranny trap. And how can we resolve a tyranny trap?
The contrast between two economic philosophies could not be starker than North and South Korea. The North's stagnation confirms in my mind how extreme governance must be to deny the natural experience of economic growth. So often we frame growth as a question of what a soceity can do, when the real challenge is to identify government-sanctioned barriers to growth.
How high can marginal tax rates rise until the loss of work incentives becomes unbearable? Unbearable for citizens is one aspect, but the operational aspect is probably the tolerance of governments. Taxes so high that revenues decline? Unlikely a society can reach that point, unless of course the society is globalized. When high tax rates chase out entrepreneurs, societies will notice. This notion of tax competition is the motivation of Chris Edwards and Dan Mitchell's book Global Tax Revolution.
Though the book focuses mainly on the mobility of capital rather than labor, Chapter 5 is all about "Mobile Brains and Mobile Wealth." It starts with the surprising fact that "the number of people living outside their country of birth has doubled since 1980, from 100 million to 200 million."
Although the authors hold that tax competition is the driving force in knowledge economy immigration, but much of this chapter is a review of the many factors that favor higher rates of immigration. The fall of communism (which walled in its citizens) is surely one key factor. The new economy with higher rates of churn is another. But the basic forces of globalization - cheaper intercontinental travel and internet communication - are a third force that promises to intensify. Trade agreements and political unions (like the EU) are a fourth factor. Finally, the fifth factor is the policy innovation of immigration "points" systems in places like Australia, Britain, Canada, and New Zealand. Notice how these are English-speaking nations aiming, presumably, for English-speaking (American) brains.
One might read the chapter more as a critique of restrictive immigration policies than tax policies, but the authors turn to the competition among nations for wealthy people. With 31 percent of the world's 10 million millionaires, America has much to lose. But countries like Britain, with light taxation toward non domicile migrants or "nondoms" understand that only a small portion of wealth is inherited. Most wealth is created by first-generation earners / entrepreneurs. Thus, it is not the estate tax which is the most important, or even the nefarious wealth tax, but the most basic tax of all: the burden on current work and investment.
As a throwaway observation, I've long pondered the phrase "capital gains." It's a puzzle to me why gains made from investing in a firm are treated as "capital gains" just the same as gains made from creating that firm. Newsflash: I'm not an expert on this, but I can't help but wonder if an economy encourages more entrepreneurship if its tax code distinguishes between the two types of gains: capital and creative.
Back to Edwards and Mitchell ... the remainder of their Chapter 5 is a stunning world tour. The French state's hunger for tax revenue is appalling and not a little sad. With 300,000 French citizens living in Britain, numerous stories about fleeing young workers, and an internal advisory report to the government in Paris that "10,000 business leaders have left France in the last 15 years," one can't help but shudder. The wealth tax translates into an immediately unpayable burden on successful entrepreneurs whose illiquid firms are valued highly.
Germany, Italy, even Britain have their own weaknesses, but America is one the least responsive to the growing policy competition. The U.S. still has powerful advantages, but it does not seem to realize how quickly they are eroding.
The chart above comes from our recent survey of economics bloggers. For me, the results showed what I hope but were disappointing in that every source of innovation that we listed got a "Gentleman's B" or higher.
The good news is that all of our policymakers think innovation is a good thing, growth is a good thing, and so on. The bad news is they still act on that instinct with classic "spend more" solutions. Innovation is not a rope that can be pushed. If it was, then funding more R&D would make sense. But in isolation, R&D spending won't get an economy very far.
Our panel of experts believes that the most important source of innovation is the "small start-up firm" which is in contrast to the venture-financed firms. In all fairness, the panel did not rate users, tinkerers, and garage entrepreneurs very highly either. That viewpoint is epitomized by the excellent research from Eric Von Hippel, and my guess is that still not enough people are familiar with it. Here's a quote from his 2005 book (which is freely available as a PDF at the link above):
The manufacturer-centric model does fit some fields and conditions. However, a growing body of empirical work shows that users are the first to develop many and perhaps most new industrial and consumer products. Further, the contribution of users is growing steadily larger as a result of continuing advances in computer and communications capabilities.
As Tyler mentioned first on his blog, our video team assembled this 8-minute video of highlights from his interview at the Economics Bloggers Forum. It's tremendous (kudos to Matt Pozel and Matt Long) and we sure appreciate Tyler taking time to sit down with us.
Bob Litan and I have a new policy paper on high-skill immigration downloadable as of today
and I'm coincidentally doing a presentation on Capitol Hill on Monday late morning (somewhere ... my PC started hacking a few hours ago -- so am unable to figure out the exact location. I believe the time is 1115 or 1130, and Vivek Wadwha will be presenting as well). In any case, here is my powerpoint. Your thoughts, as always, are welcome.
UPDATE: The event, organized by the public forum institute (http://www.publicforuminstitute.org/pde/) is here:
April 6, 2009
11:15a - 12:30p
Rayburn House Office Building, Room 2318
(House Committee on Science and Technology)
A colleague recently suggested that what the United States and global economies are experiencing is no mere cyclical contraction of ordinary proportions. It is, instead, a large-scale structural shift in the underlying character of economic activity. There does appear to be, at all levels, a recognition that what some have called the "Great Recession" is a transition, that the U.S. economy on the other side of this looks much different from what came before. This perhaps helps explain the ambition of President Obama's inaugural budget.