Growthology

Modeling Insitutions, Crediting Entreprenuers

There’s a new paper out by several premier development economists, Acemoglu, Robinson and Verdier (two of whom have published a book reviewed here).

Because of their more limited inequality and more comprehensive social welfare systems, many perceive average welfare to be higher in Scandinavian societies than in the United States. Why then does the United States not adopt Scandinavian-style institutions? …we develop a simple model of economic growth in a world in which all countries benefit and potentially contribute to advances in the world technology frontier. A greater gap of incomes between successful and unsuccessful entrepreneurs (thus greater inequality) increases entrepreneurial effort and hence a country’s contribution to the world technology frontier.

We show that, under plausible assumptions, the world equilibrium is asymmetric: some countries will opt for a type of “cutthroat” capitalism that generates greater inequality and more innovation and will become the technology leaders, while others will free-ride on the cutthroat incentives of the leaders and choose a more “cuddly” form of capitalism. Paradoxically, those with cuddly reward structures, though poorer, may have higher welfare than cutthroat capitalists; but in the world equilibrium, it is not a best response for the cutthroat capitalists to switch to a more cuddly form of capitalism. We also show that domestic constraints from social democratic parties or unions may be beneficial for a country because they prevent cutthroat capitalism domestically, instead inducing other countries to play this role.

This is interesting beyond their [re]framing of inequality and technology frontiers in that they specifically mention entrepreneurs as crucial to the wealth/innovation creation process. The entrepreneur has too long been absent from discussions about development outside of specific circles and it is promising to see entrepreneurs as central to a model not explicitly designed to discuss entrepreneurship. They go on to suggest that investigating ‘institutional specialization’ is an important research direction as it may apply to other institutions like education and labor mobility. Such studies could potentially add insight into the ever difficult question of why there are higher concentrations of entrepreneurial activity and success in different areas.

Finally, the use of the word ‘cuddly’ in an academic paper is both ground-breaking and highly entertaining.

Hat tip to Chris Blattman.

First Rule of Hostage Negotiations: Don't Negotiate

By now, stadium negotiations between cities and professional sports teams have fallen into a depressingly familiar routine. The team--usually through its wealthy owner--drops hints that the current stadium isn't up to par: the locker rooms have deteriorated, training facilities are anachronistic, it is out of fashion with other stadiums, the team can't be competitive without a new stadium. The city balks at first--the present stadium is only two decades old! You are a rich team and rich league! Field a better team and you'll be competitive. The team gets pushy and may even throw a tantrum or two, which culminates in the ultimate threat: we will leave this city if we do not get a new stadium. The city (or county) puts up mild resistance, but eventually capitulates and turns around and tries to coax the public into approving new bond issues or new taxes on hotel rooms, rental cars, and so on.

And so we end up with an arms race, a parallel of the incestuous dance of executive compensation, in which compensation consultants point to CEO pay at other companies to justify a hefty pay package for an executive, which in turns becomes a further milestone for the consultant to use with another company. And, of course, one CEO likely sits on the compensation committee of another company's board, and so the incest continues. Folklore provides additional support--the coincidence of new stadiums with the resurrection of competitive baseball in Cleveland and Baltimore, for example, has now been in use for nearly twenty years in Major League Baseball as justification for newer and nicer stadiums.

Several years ago, Kauffman's home city of Kansas City, Missouri, went through something like this negotiation. The baseball and football stadiums are located across a parking lot from one another, and so the teams joined together to try to convince the county and its taxpayers to help subsidize stadium improvments. And, to be fair, the stadiums needed updates and are wonderful places to watch games. But the most astonishing part of the negotiation wasn't the upkeep; it was a proposal for a rolling roof that would roll from one stadium to another. A principal justification was that "Kansas City will never host a Super Bowl without a roof." Seriously. The improvements passed, but the rolling roof did not.

Now, Atlanta and Fulton County and St. Louis are experiencing something similar. The Falcons and Rams, respectively, are demanding new stadiums. And, sure enough, we see a rehash of the same old arguments for justifying heavy public subsidies of sports stadiums. The principal argument, of course, is that this is good for the local economy.

Thankfully, the Atlanta Journal-Constitution has recently done a thorough debunking of the claim that sports stadiums are a good economic investment for municipalities. Basically: they cost cities and counties money, often for many, many years. And, before the public debt on one stadium is even paid off, teams will be demanding a new one. Oh, and the Super Bowl rationale? Hollow: Indianapolis is in the red $1.3 million for last February's affair, nearly $1 million more than anticipated. Why do cities do this to themselves? And, why do they negotiate with teams that threaten to leave the city?

Why doesn't a city or county just say no? They would clearly be better off financially. The answer, as ever, is likely prestige: it is seemingly prestigious to be host to a professional team. No mayor or county executive wants to stand for re-election and tell voters that they had to say goodbye to Team X because otherwise, in five years, they'll be cutting pensions or selling hospitals to pay for the stadium. But at a time of municipal budget crunches, can local governments afford $1 billion stadiums? Not to mention the massive shifts of wealth involved in public subsidization--already wealthy-owners and athletes benefit, and the cost is often shifted onto visitors and tourists (recall the hotel and rental car taxes) who may not  even be in the city for sports in the first place. Madness.

Economics Bloggers Forum 2012

The video from the fourth annual Economics Bloggers Forum is now available, embedded below. Thanks to all who participated. There were a few dozen participants in Kansas City, and a little less than 1,000 unique visitors to the live stream.

At the end of the last panel, Robert Litan asked for an informal show of hands--pessimistic or optimistic for the future of the U.S.'s ability to find new innovations? Most in the room responded in the positive camp. I think responses were impacted by the time of day, i.e. if the poll was asked after the end of the first session, more pessimism would be expressed.

I suspect the panel most relevant to entrepreneurs is the fourth, particularly comments on changes to patent law. The panel does cover the following point, but it's worth mentioning (again) that patents involve only a very small portion of innovations.

 

Bloggers Forum Links:

• Ezra Klein has commentary on the first half of the event.
• Josh Barro offers thoughts on the second panel, which featured John Goodman’s presentation of the Congressional Budget Office’s Long-Term Budget Outlook data (Goodman created the charts using CBO data, though I am a fan of the originals here). Matthew Yglesias comments on this session as well. Later this month, the Kauffman Foundation will be releasing a report on healthcare reform which we will talk about here on growthology.
• The Sketchbook of Tyler Cowen as shown in the welcoming remarks.

 

The list of panel participants is reprinted below for posterity:

Panel discussion – Recovery and Long-Term Growth

Brad DeLong, Grasping Reality
Scott Sumner, TheMoneyIllusion
Tyler Cowen, Marginal Revolution
Karl Smith, Modeled Behavior

Panel discussion – After the Election, How Do We Fix the Budget?

John Goodman, National Center for Policy Analysis
Ezra Klein, The Washington Post
Donald Marron, www.dmarron.com

Panel discussion – After the Election, What is the Solution to Income Inequality?

Mark Thoma, Economist’s View
Arnold Kling, EconLog
Matt Yglesias, Moneybox

Panel discussion – Intellectual Property: Protecting Rights or Protectionism?

Michael Mandel, Mandel on Innovation and Growth
Tim Lee, Disruptive Economics
Alex Tabarrok, Marginal Revolution

Boycotters Call for Whole Foods Founder to Be Removed as CEO

Guest post by Charles Johnson 

The ire over Whole Foods CEO, John Mackey's WSJ op-ed on health care has entered a new phase, with union boycotters calling for him to be removed as CEO and chairman by the Whole Foods board. I quote, 

"Mr. Mackey attempted to capitalize on the brand reputation of Whole Foods to champion his personal political views, but has instead deeply offended a key segment of Whole Foods consumer base," CtW Investment Group's Executive Director Bill Patterson said in a statement. 

Meanwhile, the United Food and Commercial Workers Union, which is part of Change to Win, said it will be giving out information to Whole Foods shoppers about health care reform. The group said Mackey's op-ed was an "attempt to undermine Obama's health-care reform."

First of all, the boycott is clearly failing. Whole Foods's stock hasn't fallen a bit since the boycott began. If anything, it's increased! (Which, incidentally, is welcome news to this Whole Foods admittedly extremely small scale stock owner.)

Second of all, why don't we want entrepreneurs injecting their politics into the national debate? If it is acceptable for entrepreneurs to inject their politics into the debate in favor of increasing marginal tax rate, increasing the gax tax, and removing subsidies on fossil fuels? Why isn’t it okay for one entrepreneur, who by all accounts has helped his employees get some of the best coverage available, to weigh in on the health care debate? 

We should be thanking Mr. Mackey for bringing his expertise to bear on a problem of national import, particularly given his experience insuring his own work force!  

(For those interested in greater detail, be sure to check out Megan McArdle's excellent post explaining why the Whole Foods boycott is really a non-starter.)

The Agony and Irony* of Taxes

Since the release of President Obama's budget preview there's been a lot of noise made over the question of taxes, specifically relating to two issues. First, the federal government's long-term fiscal problems, which Tim wrote about yesterday. The second issue is the question of what impact higher taxes will have on entrepreneurship.

There's no doubt that Uncle Sam is flirting with budgetary fire--the numbers being thrown around about the long-term deficit are almost beyond belief. And quite frightening. It seems likely that some combination of higher tax rates and trimmed entitlements will be unavoidable. But it is also doubtful that higher taxes can make much headway against the enormous mountain of government debt, particularly given the towers of debt that households will continue to struggle with. California, moreover, is Exhibits A through Z as to the effects of relying solely on higher taxes to prop up the governmental edifice. 

Thus, it would seem that some sort of entitlement restructuring will end up being the only conceivable way to boost fiscal health. (I must admit, however, to being a tad mystified at the proposal to make Pell grants an entitlement--the rationale of making college more affordable for more people doesn't hold water against the evidence that rising tuition costs have been, in part, a product of expanded federal aid.)

The second tax issue--the effect on entrepreneurship--is much more ambiguous and thus emotionally-freighted. Will higher taxes on those with incomes over $250,000 dampen the entrepreneurial spirit? There is certainly reason to think it will: lots of small businesses, for example, file individual income tax returns and thus would face higher taxes. (Secretary Geithner maintains that this would be an incidentally small number.) The always-perspicacious Jim Manzi makes a persuasive case that higher taxes will in fact affect the probability calculations made by prospective entrepreneurs and dissuade many from taking the plunge.

Yet that can't be the whole story. For one thing, William Nordhaus has calculated that entrepreneurs capture only about two percent of the surplus they generate--consumers (society) capture the rest. Entrepreneurs take risks, to be sure, but it just doesn't seem quite right that they go through the analytical  probability calculations that Manzi outlines. In many cases, they are explicitly pursuing "psychic rewards," knowing that the pecuniary payoff might be less than that.

In a larger sense, let's put the whole tax issue in perspective: taxes might actually be one type of undergirding for entrepreneurship, so the dampening effect of a slight uptick in tax rates may be overstated. Last month there was a fantastic essay in The New Yorker on the struggles of free-market economists in Iran against the statist Islamic regime, which doesn't seem to understand anything close to basic economics. By depending almost exclusively on oil revenues, the Iranian government does not have any incentive to cultivate productive entrepreneurship--the citizenry depends on the government. In countries like the United States, the government depends on the people and entrepreneurs, and taxes are the mechanism of that dependency. This, needless to say, is much more salutary for economic growth and democracy.

*with apologies to Alkaline Trio

Is Prevention Worth It?

An interesting discussion in the most recent Health Affairs on whether or not preventive medicine is all it's cracked up to be.

Green, Healthy, and Educated

That was the basic thrust of David Leonhardt's cover story in this past weekend's New York Times Magazine, "The Big Fix." Given that this blog is devoted to matters pertaining to economic growth, it seems appropriate that we offer some commentary on Leonhardt's essay.

Overall, I thought it was a refreshing and much-needed essay on economic growth and how to boost it. This long-term objective easily gets lost in the breathless daily reporting on bad banks, failed administration appointments, octuplets plus sextuplets, and how much stimulus money to allocate to mass transit systems.

Not that toxic assets and the stimulus package are irrelevant to growth--there won't be a need to ponder long-term economic growth if we don't adequately address the current financial crisis. Leonhardt began with a reminder of why growth is so important: "the consequences of a country's growth rate are not abstract at all. Slow growth makes almost all problems worse." This is reminiscent of the single best sentence in Paul Collier's insightful book, The Bottom Billion: "Growth is not a cure-all, but lack of growth is a kill-all."

Leonhardt's concern in this essay is to explore the implications of President Obama's statement in his inaugural address that we must "lay a new foundation for growth." For Leonhardt, it appears, the United States has reached a watershed moment, beyond which Wall Street and Silicon Valley will no longer anchor the country's growth, but we don't yet seem to have anything else in place for generational growth. The reason, he says, is one long ago identified by Mancur Olson--too many interest groups have made America rigid. In the spirit of Rahm Emanuel, Leonhardt points to England's crisis in the 1970s as an example of a country using a crisis to transform its economy. (In an analogy that stretches credulity, Leonhardt also notes that the total devastation of World War Two "wiped away" the accumulated interest groups in Germany and Japan, giving the countries a fresh economic start, as it were. I hope no one thinks we should welcome utter calamity.)

Leonhardt then proceeds to examine the three major categories that currently dominate discussions of growth: energy and the green economy; health care costs; and falling educational achievement. Overall, Leonhardt's discussion is very balanced--he points out, for example, the difficult trade-offs involved in moving to a completely clean energy economy. The health care section is the highlight of the article, and made me very glad that Peter Orszag is at OMB.

But I did have three problems with Leonhardt's essay. First, he neglected immigration, the expansion of which is a sine qua non of long-term growth. I'd really like to get Bob Litan's perspective on this in a blog post. Second, I don't know if his perspective on how growth happens is quite accurate: "For centuries, people have worried that economic growth had limits--that the only way for one group to prosper was at the expense of another. The pessimists . . . have been proved wrong again and again. Growth is not finite. But it is also not inevitable. It requires a strategy."

True, economic growth has perpetually proved pessimism ill-considered. But growth is also not inevitable, as Leonhardt notes. Where I part ways is the averment that growth "requires a strategy." Whence a strategy? The government? That seems to be Leonhardt's implication when he subsequently discusses the need for more federal investment. I won't ever deny that government can play a positive role in economic growth--indeed, that government is actually essential to growth. And yet, it seems that history also disproves the idea that growth derives from strategic planning. This is fodder for a separate post, but I invite reader comments.

Finally, I was slightly disappointed with Leonhardt's discussion of education. Yes, college and high school graduation rates have stalled. Yes, there are many innovative educational experiments that seem to work: KIPP is one Leonhardt mentions. But he underplays two points. One, that the causes of American education's stagnation are much more complex than simply lamenting graduation rates. Nobel-laureate James Heckman has done fascinating work in this area. And two, the "high school movement" that Leonhardt mentions--indeed one of the most important events of the 20th century--holds important lessons. It was grassroots, as Leonhardt acknowledges; but, as he also notes, it was a specific response to a transforming economic structure, the rise of the industrial economy. This laid bare the inadequacies of the established system of education (such as it was, or was not). 

If we are in the midst, or on the cusp, of a similarly far-reaching transformation today, then we need to think completely outside the boundaries of our current educational institutions, including high schools. This, too, is ripe material for future posts. 

Leonhardt is an insightful commentator, and I enjoyed his piece. But if our concern is long-term economic growth and the transformation of our economic institutions, than we need to heed Olson and somehow leapfrog (first conceptually, then practically) the established ways of doing things. I know of no natural law that decrees high schools or even Medicare to be unquestionable and untouchable.