Sunday, November 23, 2014

For the Euthanasia of Kaldor-Hicks/Cost-Benefit Pseudo-Science

J. R. Hicks "The Foundations of Welfare Economics" 1939:
"Positive economics can be, and ought to be, the same for all men; one's welfare economics will inevitably be different according as one is a liberal or a socialist, a nationalist or an internationalist, a christian or a pagan. 
"It cannot be denied that this latter view is in fact widely accepted. If it is intellectually valid, then of course it ought to be accepted; and I must admit that I should have subscribed to it myself not so long ago. But it is rather a dreadful thing to have to accept. No one will question the activity of some of our 'positivists' in the criticism of current institutions; but it can hardly be denied that their authority to advance such criticism qua economists is diminished by their abnegation, so that in other hands economic positivism might easily become an excuse for the shirking of live issues, very conducive to the euthanasia of our science
"Fortunately there is no need for us to accept it. The way is open for a theory of economic policy which is immune from the objections brought against previously existing theories..."
Just a small sample of the objections Kaldor-Hicks has been immune to over the years:
"...judged in relation to its basic objective of enabling economists to make welfare prescriptions without having to make value judgments and, in particular, interpersonal comparisons of utility, the New Welfare Economics must be considered a failure." 
"Pareto is sometimes credited with an early formulation of the ill-fated Hicks or Kaldor principles of hypothetical compensation." 
"The ethical appeal of this [compensation criterion] argument, however, is weak."  
"It turns out then that Mr. Kaldor's criterion in its most general sense has not eliminated the problem of interpersonal comparison of utility. It has only subjected utility to the measuring rod of money, a measuring rod which bends, stretches, and ultimately falls to pieces in our hands."
"...implicit assumptions about the numéraire good in the Kaldor–Hicks efficiency–equity analysis involve a 'same-yardstick' fallacy..."
"For sustainability science, the Kaldor–Hicks rule runs counter to both intra- and inter-generational concerns."
"Only later would it be realized that one did not know -- indeed, one could not know -- the value of production independent of the distribution of income and the associated price vector that provided the weights to the various physical quantities being produced."
" all of this prodigious elegance, rarely is there recognition that the Pareto test remains what it has always been -- an analytical construct (inconsistent and incoherent at that) with no special claim to legitimacy beyond the tautological domain out of which it
"When the unweighted sum of net benefits from a project are used as a criterion of project evaluation, cost-benefit analysis may be sensitive to the choice of  numéraire . This is one reason, among others, why this criterion should not be used."
And yet:
"The Kaldor-Hicks criterion — a test of whether total social benefits exceed total social costs — is the theoretical foundation for the use of the analytical device known as benefit-cost (or net present value) analysis."
Not bad for an inconsistent, incoherent, ethically-weak, ill-fated tautological failure of a fallacy that should not be used!

Hicks was right. The Kaldor-Hicks theory is indeed "immune from objections."

DeLong on Hobson’s Choice v. Cochrane’s Bernie Madoff Economics

I want to highlight two interesting discussions relevant to the fiscal policy debate. First up is Brad DeLong:
The original argument was John A. Hobson’s, in his 1902 book Imperialism. The poor have to spend their incomes in order to buy their necessities. The middle class have to spend their incomes to buy their necessities and the conveniences they need in order to ensure themselves that they are not among the poor. The rich can spend their incomes or not. Hence the more unequal distribution of income, the more the potential for slack aggregate demand. With monetary policy constrained by the rules of the game that was the gold standard, Full employment in an unequal society required either unusually optimistic financiers and industrialists or something else.
Brad continues by noting that this something else could be monetary policy unless we fell into a liquidity trap. Peter Coy has a nice discussion on why Keynes’s views on fiscal policy is relevant today but alas he does have to cite something from John Cochrane:
If you believe the Keynesian argument for stimulus, you should think Bernie Madoff is a hero. He took money from people who were saving it, and gave it to people who most assuredly were going to spend it. Each dollar so transferred, in Krugman’s world, generates an additional dollar and a half of national income. The analogy is even closer. Madoff didn’t just take money from his savers, he essentially borrowed it from them, giving them phony accounts with promises of great profits to come. This looks a lot like government debt. If you believe the Keynesian argument for stimulus, you don’t care how the money is spent. All this puffery about “infrastructure,” monitoring, wise investment, jobs “created” and so on is pointless. Keynes thought the government should pay people to dig ditches and fill them up. If you believe in Keynesian stimulus, you don’t even care if the government spending money is stolen. Actually, that would be better. Thieves have notoriously high propensities to consume.
This weird tirade is just part of a very long tirade where Cochrane attacks the writings of Paul Krugman. Cochrane invokes Ricardian Equivalence as part of his case against the use of fiscal stimulus. Alas, he clearly does not understood Ricardian Equivalence or what the recent fiscal policy debate was about. First of all – the government is quite open about its finances so any suggestion that there is a Ponzi Scheme should alert the reader that Cochrane was on a silly rant. But he does admit that attempts to use fiscal stimulus amount to deficit financing. Ricardian Equivalence alerts us to the fact that the present value of all future taxes must match the present value of all future government spending as well as the current level of government debt. If no household is borrowing constrained, then the timing of taxes has no current effect on consumption demand. Brad’s post, however, should be seen as suggesting that some households are borrowing constrained. But it is this line that shows how clueless Cochrane is:
If you believe the Keynesian argument for stimulus, you don’t care how the money is spent.
Actually most Keynesians do care as we would prefer the stimulus in the form of infrastructure investment and not Hobson’ imperialism. This is also where Cochrane’s invocation of Ricardian Equivalence is most silly. Accelerating infrastructure is not a permanent increase in government spending and hence would not raise the present value of future taxes all that much. As such, any reduction in consumption would be very modest relative to the rise in government investment. And with this simple realism, Cochrane’s Bernie Madoff rant loses all relevance.

Saturday, November 22, 2014

#NUM!éraire, Shmoo-méraire: Nature doesn't truck and barter

The commodity in terms of which the prices of all the others are expressed is the numéraire. -- Leon Walras, Elements of Pure Economics.
But the numéraire is a purely technical device, introduced simply for the purpose of making exchange values explicit. In no way does the introduction of a standard of value alter the fundamental nature of the economy in question. It remains a barter economy, since goods are exchanged solely for other goods. André Orléan, The Empire of Value.
In a previous post, Public Works, Economic Stabilization and Cost-Benefit Sophistry, the Sandwichman introduced David Ellerman's argument that the supposed efficiency/equity distinction underlying the Kaldor-Hicks compensation criterion is a "same-yardstick" illusion created by the tautological use of a numéraire (or "standard commodity") to evaluate its own value. One oyster is worth exactly one oyster in oysters. Ellerman demonstrated that simply switching the numeraire could have the effect of reversing which outcome is held to be efficient.

This discrepancy is not some curious foible of arcane economic theory. The Kaldor-Hicks compensation criterion is "the theoretical foundation for the use of the analytical device known as benefit-cost (or net present value) analysis" (emphasis added, Stavins 2007)

Ellerman documented the numéraire illusion (or fallacy) in a working paper dated ten years ago. Since then, he has presented several versions of his refutation of Kaldor-Hicks. According to Google Scholar, there has been one non-self citation -- in a 2014 Masters thesis -- of the five versions listed in Google Scholar.

There is a long and futile history of pointing out flaws in Kaldor-Hicks. In their 1978 review of the Kaldor-Hicks inspired "New Welfare Economics," Chipman and Moore declared it a failure, "...judged in relation to its basic objective of enabling economists to make welfare prescriptions without having to make value judgments and, in particular, interpersonal comparisons of utility." They concluded their review with the following assessment:
After 35 years of technical discussions, we are forced to come back to Robbins' 1932 position. We cannot make policy recommendations except on the basis of value judgments, and these value judgments should be made explicit... When all is said and done, the New Welfare Economics has succeeded in replacing the utilitarian smoke-screen [of technical jargon] by a still thicker and more terrifying smoke-screen of its own.
Thirty-six years on, that thicker, more terrifying smoke-screen prevails.

In a paper published in 1997. Kjell Arne Brekke presented an analysis that highlighted a different aspect of the importance to the outcome of cost-benefit analysis of the choice of numéraire. Brekke showed that, when public goods are involved, the sign (plus or minus) of the sum of net benefits is not independent of the choice of numéraire.

Brekke's discussion is marred by the peculiar conclusion that "[t]he choice of money as numéraire is systematically favourable to those who value money the least, relative to alternative numéraire." "Why do money and not environmental units as numéraire favour the environmentalist?" Brekke asked. His answer confuses the result of incoherent calculations with actual outcomes:
The net benefits of the project is positive for the environmentalist. If this net benefit is expressed in money terms, then it becomes a large number because money is of low value to the environmentalist. However, if the net benefit is expressed in environmental quality units, then the net benefit would be a small number, since environmental quality is important to the environmentalist.
Contrary to what Brekke argued, the choice of numéraire makes no difference to the net benefits from a project -- it only changes how those benefits are represented. In fact, by (mis)representing an environmentally-harmful project as unduly financially-beneficial, such "positive" results would support a decision that is less favourable to the environmentalist. Brekke also crucially misstated the Kaldor-Hicks compensation criterion as "the winners should compensate the losers."

In a commentary on Brekke's article, Jean Drèze acknowledged that "Brekke’s interpretation of his own result is indeed somewhat misleading" but argued none-the-less that these lapses shouldn't detract from the important insight that, "[w]hen the unweighted sum of net benefits from a project are used as a criterion of project evaluation, cost-benefit analysis may be sensitive to the choice of numéraire." With regard to the ethical status of the [Kaldor-Hicks] compensation criterion, Drèze observed that "[i]f compensation is only hypothetical, it is irrelevant. If it is actual, it should be counted as part of the project, which becomes a Pareto-improving project so that its desirability is not an issue." In a passage, Drèze speculated on the reasons for the persistence of the ethically vacuous, analytically incoherent "aggregate benefit criterion" (ABC) touted by the compensation criterion:
In short, Brekke’s analysis does highlight a major problem with the ABC criterion, which adds to its other theoretical flaws. In the light of these flaws, it may be asked why the ABC criterion is so widely used in practice. Several possible reasons come to mind. First, the practitioners may not appreciate these flaws. Second, they may be aware of them, but use the ABC criterion for convenience. Third, they may be reluctant to contemplate the value judgments involved in choosing distributional weights. Fourth, they may hold the normative view that marginal social utilities are equal in terms of their chosen numéraire. Fifth, they may simply be siding with the rich.
Drèze missed a sixth possible reason: acknowledging these iatrogenic flaws in the aggregate benefit criterion may have profound implications for the theoretical foundations of neoclassical economics that can't be papered over with distributional weights, as Drèze seems to think, or by reversion to an "actual" Pareto-improving standard instead of a hypothetical one. To put it bluntly, all the stuff and nonsense about numéraires proceeds from the a priori assumption of a barter economy -- that "goods are exchanged solely for other goods."

As Orléan puts it, Leon Walras's numéraire "is a purely technical device..." What "counts" is not money but some presumably intrinsic value that is held to inhere in the goods themselves -- "behind the veil of money," so to speak. "Real money," Orlean continues, "money that 'not only supplies a unit of account but also actually circulates and in addition functions as ‘a store of value'—does not exist." The incoherence of the aggregate benefit criterion and its corollary of hypothetical compensation is a symptom of the fundamental incoherence of the barter metaphor. "The most serious challenge that the existence of money poses to the theorist," according to Hahn (1982), "is this":
...the best developed model of the economy cannot find room for it. The best developed model is, of course, the Arrow-Debreu version of Walrasian general equilibrium. A world in which all conceivable contingent future contracts are possible neither needs nor wants intrinsically worthless money.
One has to wonder, though, just what is "best developed" about a model of the economy that can't find room for the existence of money. In his review of Hahn, Minsky referred to that model more bluntly as "rubbish that prevents the flowering of new theory."

Of Sealing Wax and Cell Phones...

Arguing against perfect foresight is as embarrassing as it is futile. To borrow Robert Solow's image, it's like debating cavalry tactics at the Battle of Austerlitz with a lunatic who thinks he's Napoleon Bonaparte. But the hypothetical prescience of the numéraire is both fundamental and lethal to the Kaldor-Hicks compensation criterion. The mix of commodities available in the future will be radically different than the commodities available today, just as today's commodities are radically different from those of fifty or a hundred years ago. 

Without perfect foresight (and without money -- real money) prices in a barter economy existing sometime in the future would be incommensurable with prices in a barter economy today. There could be no "standard commodity," no numéraire. The question of the choice of numéraire would be moot because there are no candidates to choose from. 

With perfect foresight, however, market actors would know whether or not compensation is/was/will be paid to the losers in a "potential" Pareto improvement. In other words, the addition of the word "potential" makes the phrase an oxymoron that violates the model's specifications.

No doubt Cost-Benefit Analysis gets around this dilemma by smuggling in a "common-sense" notion that money is nevertheless performing its magic in spite of the value theoretical "rigor" that has banished that supposedly illusory veil. With such a hybrid of theoretical abstraction and absent-minded distraction, neoclassical value theory gets to barter off its cake and eat it too.

Try not to think of an elephant. Money is essential to a market economy. "Market economies based on barter are inconceivable..." André Orléan argues in "Money: Instrument of Exchange or Social Institution of Value?" That "inconceivable" must be taken literally. The attempt to conceive of a market economy based on barter flounders on the shoals of cognitive dissonance. "Don't think of money," the theory commands. But you think of money. As Hyman Minsky wrote 30 years ago, "the Emperor of today's theory, the Arrow-Debreu version of Walrasian general equilibrium, has no clothes." 

The Kaldor-Hicks compensation criterion proclaims that we can all get richer by laundering the Emperor's invisible new clothes.
In 1952 the Bureau of the Budget, in a Budget Circular [A-47] that neither required nor invited formal review and approval by the Congress, nailed this emphasis into national policy, adopting it as the standard by which the Bureau would review agency projects to determine their standing in the President's program. And soon thereafter agency planning manuals were revised, where necessary, to reflect this Budget Circular. In this way benefits to all became virtually restricted to benefits that increase national product. The federal bureaucrats, it should be noted, were not acting in a vacuum; they were reflecting the doctrines of the new welfare economics which has focused entirely on economic efficiency.
When all is said and done, the New Welfare Economics has succeeded in replacing the utilitarian smoke-screen by a still thicker and more terrifying smoke-screen of its own.

Thursday, November 20, 2014


Why is there no English translation of this important work by François Simiand?

Tuesday, November 18, 2014

Protect the Free Market from those Anarchists!

Whew!  Here's Robert Anton Wilson trying to get people into a state of generalized agnosticism, not agnosticism about God .... but agnosticism about the everything; even the free market!

"“Privilege implies exclusion from privilege, just as advantage implies disadvantage," Celine went on. "In the same mathematically reciprocal way, profit implies loss. If you and I exchange equal goods, that is trade: neither of us profits and neither of us loses. But if we exchange unequal goods, one of us profits and the other loses. Mathematically. Certainly. Now, such mathematically unequal exchanges will always occur because some traders will be shrewder than others. But in total freedom—in anarchy—such unequal exchanges will be sporadic and irregular. A phenomenon of unpredictable periodicity, mathematically speaking. Now look about you, professor—raise your nose from your great books and survey the actual world as it is—and you will not observe such unpredictable functions. You will observe, instead, a mathematically smooth function, a steady profit accruing to one group and an equally steady loss accumulating for all others. Why is this, professor? Because the system is not free or random, any mathematician would tell you a priori. Well, then, where is the determining function, the factor that controls the other variables? You have named it yourself, or Mr. Adler has: the Great Tradition. Privilege, I prefer to call it. When A meets B in the marketplace, they do not bargain as equals. A bargains from a position of privilege; hence, he always profits and B always loses. There is no more Free Market here than there is on the other side of the Iron Curtain. The privileges, or Private Laws—the rules of the game, as promulgated by the Politburo and the General Congress of the Communist Party on that side and by the U.S. government and the Federal Reserve Board on this side—are slightly different; that's all. And it is this that is threatened by anarchists, and by the repressed anarchist in each of us," he concluded, strongly emphasizing the last clause, staring at Drake, not at the professor.” 
― Robert Anton WilsonThe Golden Apple

Sunday, November 16, 2014

The Ultimate Irrelevance of Grubergate

So, many people have gone hysterical over the publicity surrounding revelations of embarrassing quotations and video clips from Jon Gruber talking about aspects of Obamacare.  SCOTUS is taking on a case that might remove federal subsidies from individuals on state exchange insurance plans that are not linked to the federal system thanks to some publicized remarks by Gruber, even though he has never been a member of Congress, and numerous commentators are carrying on about how Obamacare would never never never have passed Congress if people had known what Gruber said about how those fines are really taxes just like SCOTUS later said, not to mention how much he looks like the epitome of pompous arrogance when he declared that "voters  are stupid."  Hot stuff.

So, if SCOTUS decides that those subsidies won't get paid if the state exchanges do not hook up with the federal one, well, there is apparently some easy way to do this without changing how the state's system works.  Of course, there may be some states with exchanges run by tea party GOPsters who may just take advantage of this to actually let insurance premia from their state exchanges go up sharply for their citizens just to show how anti-Obamacare they are.  Of course, it is harder to raise such premia on people with insurance than simply refusing to extend coverage to people who do not have it as is going on in lots of those states where local anti-Obamacarers are refusing to accept money from the federal government to extend Medicaid to their poorer citizens who do not have any, which option would not even be happening if SCOTUS had not broken precedent to let states opt out of this Medicaid expansion.

As for  this matter of how revealing that those fines are really taxes way back when would have killed the possibility of passing Obamacare, one should keep in mind that it had been revealed by opponents that Obamacare would give us death panels, would never work because nobody would sign up for it, and it would cause insurance premia to soar to infinity, not to mention that the medical profession would probably not take any patients with such plans. This probably explains why all along polls have shown that when asked, most Americans say they oppose "Obamacare," even as they say they support all of its individual provisions. And, hey, if it had been known that the fines were taxes, all those Republican congressional representatives and senators who voted for Obamacare because Obama had granted their requests for changes in the law would not have done so, thereby tanking it, given how we know that Republicans are so against tax increases (just kidding, folks, for anybody who thinks that I thought there were any Republicans who did vote for it... )..

 Barkley Rosser

Saturday, November 15, 2014

Wrath of the Yurt

I like a lot of what John Quiggin has to say. That's why I find it disturbing when he lapses into an unprovoked ad hominem swipe at people living in yurts. Not only is it disturbing but distinctly peculiar.

Of course we're all supposed to understand that Quiggin isn't really talking about yurt dwellers when he refers to yurt dwellers. It's code. The label of yurt dweller is supposed to allude to some undefined fringe of political-economic non-conformists.

I have a problem with that. It is holding people up to ridicule, not for what they believe but for a mocking image of their (presumably) idiosyncratic personal attributes that is arbitrarily substituted for their opinions. This is what we used to refer to as stereotyping.

Exactly who is being ridiculed is left ambiguous. By a process of elimination, it is not the climate-change deniers on the right nor is it the "sensible" ecological modernizers in the center who Quiggin is mocking. That leaves the tree-hugging enviros on the left metaphorically dwelling in those patchouli-infested yurts. Like Naomi Klein. Or Herman Daly. Or Tim Jackson. Or Duncan Foley.

The trouble with the yurt dweller label is that it is infinitely expandable. To Senator Inhofe, people who accept the scientific consensus on climate change are yurt dwellers. Nicholas Stern, John Quiggin, William Nordhaus, Al Gore, the IPCC. Yurt dwellers all.

A Reverse Milgram

No, it’s not a wrestling move.  I’m wondering if anyone else has noticed that the collaboration of a portion of the psychology profession with state-sponsored torture during the Bush Jr. years is like the famous Stanley Milgram experiments, except that the psychologists are the ones turning the dials.

It’s an interesting question I suppose, if you put aside the fact that this torture, unlike Milgram’s, was real, whether the guys in the white coats are as susceptible to violating fundamental human rights if those in authority tell them to.  And the results of this experiment confirm and extend Milgram’s original findings.

Professional psychologists were brought in to assist the Bush administration’s torture program, and there was apparently no shortage of willing participants.  But the American Psychological Association has a code of ethics that would seem to make torture a form of professional misconduct.  To address this problem, the APA amended its code in 2002 to say that whenever ethics come into conflict with legally issued instructions, psychologists could just follow orders.  The sorry tale is summarized in this important article in the New York Times by James Risen, who has played a large role in uncovering the dark side of the “war on terror”.

A modern Milgram experiment would never pass an institutional review board, but we can now have this natural quasi-experiment with real subjects and real torture.

Friday, November 14, 2014

Daesh/ISIL/ISIS Calls For Terror Attacks On Saudi Arabia And Plans To Mint Money

Juan Cole has reported on a just released recording that may be by recently wounded Ibrahim al-Samarra'i, more widely known as Abu-Bakr al-Baghdadi, although apparently reverting to "Irahim" since he declared himself Caliph (Khalifa) of the Islamic State (Ibrahim is the Arabic version of Abraham).  He calls for terror attacks to be made on Saudi Arabia, for Shi'a to be specifically attacked both in Saudi Arabia and also in Yemen where the Houthi Zaydi Shi'a have seized control of Sana'a, the capital of Yemen, and also their plans to "mint money" to save the Islamic state from the "infidel finance" imposed on "Muslims by the West." It has not been verified that the recording is by him, but at least probably reflects his thinking, and also does seem to be his response to being wounded in the US attack near Mosul, which Daesh now recognizes happened.

One remark on this is that Saudi Arabia is arguably the fountainhead of the particular brand of Islam that al-Samarra'i espouses, Wah'habism.  I have posted here previously on the close relationship between it and Salafism, which is regularly muddled in most ignorant western commentary.  They overlap, but have some differences and origins, and while Daesh is clearly influenced by both, it looks like the Saudi Wah'habism is more important.  So, Saudi Arabia's alliance with the US makes them the "head of the snake" according to this message that must be "cut off."

On the matter of minting money, there are two aspects of this.  Of course, strict Islamists support interest-free banking, so-called Islamic banking,which in fact exists in many countries, including the US.  It is well established, although only a handful of countries impose it as the only allowed form.

The other aspect is probably bullionism, which is found in the Qur'an.  Money should only be gold and silver.  Indeed, the very strict Saudis have silver threads in their paper money to obey this, and the late Nelson Bunker Hunt got current Saudi King Abdullah to lose a few billion in the great silver bubble and crash of the early 80s on a claim that the world was going to go on a silver standard.  I do not know what form this Islamic State money will take, but I suspect they may imitate what the Saudis do and adhere to bullionism.

Barkley Rosser

Hatch’s Excuse to Repeal the Medical Device Excise Tax

I recently noted a report by Jane G. Gravelle and Sean Lowry of the Congressional Research Service:
A July 2014 report issued by the Treasury Inspector General for Tax Administration (TIGTA) found that the number of medical device excise tax filings and the amount of associated revenue reported are lower than estimated … The IRS estimated between 9,000 and 15,600 quarterly Form 720 tax returns with excise tax revenue of $1.2 billion for this same, two-quarter period. In other words, actual medical device tax collections were 76.1% of projected collections during this period.
I suggested that the shortfall could have been the result of transfer pricing abuse with respect to the constructive price – that is the arm’s length price that the manufacturing division of the larger medical device companies would charge the wholesale distribution division. If a wholesale distributor would get between a 25% and a 35% gross margin, then this constructive price would be between 65% and 75% of the actual price, which means the effective tax rate is really between 1.5% and 2.5% of the actual price and not 2.3%. I then asked how some of the major medical device companies might get away with paying half this estimated amount?
Because the Big Four accounting firms are arguing for discounts that are twice my answer. How on earth do they justify this extreme result? It is called the Cost Plus Method with production costs being 25% of sales and a contract manufacturer return equal to 5% of sales. Of course, the $3.5 billion difference between the Big Four answer and the 35% discount rate under the Resale Price Method represents the value of the product intangibles of the medical device manufacturer. Under arm’s length pricing, no manufacturer would fail to include this amount in their price to a distributor. So how are the Big Four writing these reports with a straight face? The answer is simple – they are advocacy reports based on the assumption that the IRS is stupid.
It seems the senior Senator from Utah has a different take, which reminds me why I tend to call him Whorin Hatch. From a recent Bloomberg BNA story:
“They'll say they need the money for Obamacare, but in all honesty they're going to get less money than they ever thought because a lot of the companies that can't make a profit but have this tax on their sales, they're going out of business or going offshore,” Hatch said.
Rest assured – Covidien, J&J, and Medtronic are not going out of business as they are incredibly profitable. And it does not matter that Covidien did a corporate inversion, the excise tax applies to any U.S. sales regardless of where the device is manufactured. But are we surprised that a Republican Senator turns a blind eye to tax evasion via manipulative transfer pricing and then uses the revenue shortfall as an excuse to gut the tax? While the rest of the world is concerned about Base Erosion and Profit Shifting, Republicans have gut the IRS budget and advocate getting rid of the repatriation tax. We have the ability to enforce the tax laws on the rich and the powerful providing we have the political will to do so. But with the Republicans in charge, this political will is nonexistent.

Thursday, November 13, 2014

Rules and Standards

Peter's discussion of policy rules reminds me of the tale of the highway design standard reputedly based on the height of dead dog in the middle of the road. University of Toronto Civil Engineering Professor, Ezra Hauer tells this story:
Recall that one of the parameters in the design procedure [for highway crest curves] is the height of the obstacle to be seen by the driver in time. Originally (already in 1940) American engineering standards set the obstacle height at 4". Those who wrote this standard did not have any particular obstacle in mind (although, rumour has it that some refer to it as the ‘dead dog’ criterion). …the 4" was selected not because lower obstacles are not a threat to safety but because the selection of a higher obstacle would not save much in construction cost. Since, at that time, nobody knew how many crashes are due to obstacles on the road, what kinds of obstacles these are, and what fraction of crashes would not have occurred had the crest been flatter, the standards committee did what was sensible. They made a decision on the basis of what was known, namely the cost of construction. 
For two decades everybody was designing roads using exacting calculations to make 4"-high obstacles visible in time to stop. Then, around 1961, it became apparent that in the newer model cars the average driver's eye was much lower than a decade or two earlier. Thus, drivers of newer cars could not really see 4" objects at the prescribed stopping sight distance... The solution to the predicament was not difficult. Since the 4" obstacle neither was some real object nor has it been selected on the basis of some factual relationship to safety, the Committee on Planning and Design Policies had no compunction noting that "the loss in sight distance resulting from lower eye height could be offset . . . by assuming an object higher than four inches . . . ” Indeed in the 1965 AASHO Blue Book, 6" obstacles became the standard of design. 
At the time the standard for the design of crest curves came into being, little was known about safety. Today we know that only 0.07 percent of reported crashes involve objects less than 6" high. We also know that, till today, no link has been found between the risk of collisions with small fixed objects on crest curves and the available sight distance. On the contrary, “Crash rates on rural two-lane highways with limited stopping sight distance (at crest curves) are similar to the crash rates on all rural highways.” Thus, the assumption invoked at the dawn of highway design history which allowed the formulation of a design procedure based on the avoidance of dead dogs in the middle of the road seems to have little to do with real road safety. Still, till today, the same standard stands, the same exacting but illusory constructs are used in the design of crest curves. Only the size of the dog and of other parameters is changing.

Rules versus Discretion in Macropolicy

Economists really like policy rules.  Remember the monetarist bubble of the late 70s?  Just follow a rule for steady expansion of M2, and let the rest of the economy take care of itself.  That didn’t turn out very well, partly because no single measure of the money stock is tightly linked to the outcomes people care about, like inflation and output.  So then we had inflation targeting (and still do in the eurozone), but it turned out there wasn’t a fixed long run NAIRU (non-accelerating inflation rate of unemployment) like we were promised, and simple inflation targeting was leaving too many outcomes of concern unmanaged.  More recently we’ve had the Taylor Rule, targeting inflation and unemployment.  Like the other rules, it aspires to robotic implementation: just multiply the output and inflation gaps by their corresponding coefficients, and out spits the central bank’s policy interest rate.  Simple!

Unfortunately, the evidence is piling up that this formula doesn’t do the job either.  Without endorsing their particular policy shifts, it’s clear that some central bankers, along with many economists, are now worried about the impacts of monetary policy on the potential for asset price bubbles.  Forestalling bubbles wasn’t a feature of policy prior to 2008, but now it has grabbed a lot of attention.  Meanwhile, it is clear that the Fed is unhappy with the headline unemployment rate as an indicator of labor market conditions, especially since stagnant wages seem to signal continuing slack.

The problems with policy rules are many.  The goals of macropolicy—the things we care about, like low unemployment, price stability, financial stability, satisfactory growth—don’t all move together, and their co-movements change over time.  The usefulness of the available indicators for progress on these goals fluctuates as well, since there is no single, perfect measurement of any of them, and the relationship between different indicators keeps changing.  What, for instance, is full employment, exactly?  Is it the same today as it was five years ago?  How should the target reflect  the changing composition of jobs, wage rates and labor force participation?  In addition, the effectiveness of policy instruments, like open market operations and fiscal balances, is contextual and uncertain; for a run of years slight alterations in central bank bond purchases can have powerful impacts on expectations and economic performance, and then you are in a zero lower bound world in which all sorts of exotic measures—the various types of quantitative easing—go mainstream.

So why are economists enamored of policy rules?  One reason is that they are seen as more efficient, since policy impact depends on how much sway it has over the public’s expectations of future variables, like inflation and aggregate demand.  Rules are favored, since they ostensibly remove uncertainty from policy stances.  You can trust the central bank or fiscal authorities to not reverse tomorrow what they’ve announced today because they’re just following rules that govern their actions, and the rules don’t change.  That’s a nice theory, but it doesn’t make the problem of policy credibility disappear; it just loads it all onto the commitment of policy-makers to follow whatever rule is currently in force.  But as we’ve seen, the rules have never performed in a predictable, satisfactory way, so simply pledging allegiance to the latest iteration doesn’t remove the rational doubt that today’s rule will be superceded by tomorrow’s, with corresponding skepticism toward policy consistency.

A darker motive is distrust of “politics”.  If we don’t constrain authorities to follow fixed rules, won’t they do stupid things under the influence of whatever special interests have captured them?  For some time the ruling fear was populism: if we don’t have ironclad policy rules, the temptation will always be for monetary and fiscal authorities to reach for short run, unsustainable increases in incomes.  The result will be periodic inflationary surges accompanied by boom-and-bust cycles whose harm vastly exceeds the momentary benefits of populist expansion.  (This was what Timothy Geithner no doubt had in mind when he told Christina Romer back in 2010 that fiscal stimulus is “sugar”.)  Ironically, however, the overriding political failure post-2008 has not been populism but its opposite, the craving for investor “confidence” by way of austerity.  Does this mean there is now a reason for the expansionistas to demand their own policy rule?

But rules don’t bypass politics; they are politics.  There are, after all, many candidate rules, and all of them have a tenuous relationship to how real economies function.  What’s the point of making rule selection rather than policy selection the object of political contest?

Make these arguments in the company of economists, and you are almost certain to hear, so wise guy, what’s your alternative?  If there are no rules, doesn’t this mean policy-makers are free to follow whatever absurd theory supports their own prejudices?  This is a bit like the claim, variously attributed to Dostoevsky and Nietsche, that if god is dead all is permitted.  But just as moral reasoning is possible without a sacred text, so is rational macropolicy without fixed rules.

It should be obvious, in fact.  Economies are extremely complex, evolving systems.  Interventions have uncertain consequences, and what holds at time A does not necessarily hold at time B.  Even observation is uncertain, and the relationship between what you think you see and what’s actually going on can change unexpectedly.  But this is also true for the natural world, and in the domain of restoration ecology and similar fields we have the paradigm of adaptive management.  This is an approach that takes complexity and evolution as starting points, emphasizing the role of learning and the need for flexible decision-making in response to ongoing feedback.  I would argue that, whether they know it or not, central bankers and other policy authorities are already operating in that mode.  The god of policy rules died some time ago, and they have no choice but to weigh data according to their current understanding and reconcile themselves to the error part of trial-and-error.  Bringing transparency and open debate to this process will make it better, and this means dropping the pretense, finally, that authorities can or should follow fixed rules.

Wednesday, November 12, 2014

Planning, the Theory of Growth and the Myth of Decoupling

Guardian: Rich countries subsidising oil, gas and coal companies by $88bn a year

Put in perspective, eighty-eight billion dollars probably isn't all that much compared to Gross World Product of roughly 1000 times that amount. It's the principle of the thing. And as Kin Hubbard has taught us, "When a fellow says, 'It ain't the money but the principle of the thing,' it's the money."

It IS the money. Subsidizing expanded fossil fuel extraction is consistent with economic growth theory. The subsidies are rational, given the priorities of the rich countries' governments (say what you will about $20 bottles of Two Buck Chuck and the tribal moralism of preaching against big cars).

Faced with the dilemma of building socialism in a backward, peasant society, Soviet economists in the late 1920's hit on the idea of accelerating investment in the means of production, Marx's Department I. "But it would be absurd to say that economic growth is a new subject," Evsey Domar confessed long ago:
In economic literature, growth models, interpreted broadly, have appeared a number of times, at least as far back as Marx. Of the several schools of economics the Marxists have, I think, come closest to developing a substantial theory of economic growth, and they might have succeeded had they given less time and effort to defending their master's virtue. Some highly elaborate and interesting growth models did, however, appear in Soviet literature.
"These Soviet models are more fully developed than similar attempts made in the West..." Domar continued in a footnote, "See, for instance, G. A. Feldman [Fel'dman], "K Teorii Tempov Narodnogo Dokhoda," Planovoe Khoziaistvo, November, 1928, pp. 146-170, and December, 1928, pp. 151-178... They were evidently written in response to immediate practical problems of planning."
The present interest [May, 1952] in growth is not accidental; it comes on the one side from a belated awareness that in our economy full employment without growth is impossible and, on the other, from the present international conflict which makes growth a condition of survival.
Our problem can now be formulated as follows: assuming that output and capacity are in balance at the outset, under what conditions will this balance be preserved over time, or in other words, at what rate should they grow to avoid both inflation and unemployment.
Sounds like a plan! Now Sandwichman is not hostile to the idea of planning. After all, where would the Panama Canal be without a plan? Sandwichman just thinks that when you have a plan, you call it "The Plan," not "Growth." as if it is some spontaneous organic process that happens all by itself.

The problem with economics as a "positive science" is that it is no less prescriptive for all its disavowal. Economists lie. They wrap their ethical judgements in a patriotic flag of euphemism. Full employment is GOOD, right? Growth is GOOD, right? Therefore full employment is IMPOSSIBLE without growth! Growth is impossible without investment. Investment is impossible without profit. And profit is impossible without tax breaks to encourage fossil fuel discovery and development. What's normative about that? It is just the way it is.

In some Cloud Cuckoo Land it would be possible to decouple economic growth from greenhouse gas emissions. But in the planned economy we occupy, where full employment depends on growth, which depends on fossil fuel consumption, "decoupling" is a euphemism for "we have a secret plan to end the war."

A Double Irish Dutch Sandwich for EconoKash

Kash is back to blogging with a focus on transfer pricing:
Ireland has long been a favorite country for multinationals to set up shop in, thanks in part to its 12.5% corporate tax rate – one of the lowest in the world. A typical situation would be for a multinational based in the US or Asia to set up an Irish subsidiary as the principal entity from which to run its European business, thereby allowing it to legally record a significant portion of its European income in Ireland.
Actually 12.5% is far from being one of the lowest in the world but I’ve interrupted:
why does Germany treat Ireland so differently from Cyprus when it comes to providing financial assistance? One possible explanation is that the corporate tax rate in Cyprus, which had been set at 10%, was seen by Germany as being more egregious than Ireland’s rate.
But Cyprus may not be more egregious than Ireland as explained by Jesse Drucker:
Google cut its taxes by $3.1 billion in the last three years using a technique that moves most of its foreign profits through Ireland and the Netherlands to Bermuda. Google’s income shifting -- involving strategies known to lawyers as the “Double Irish” and the “Dutch Sandwich” -- helped reduce its overseas tax rate to 2.4 percent
The rest of this discussion is well worth the read. Look – international tax law can be challenging at times as effective rates can be much lower than statutory rates. A bigger challenge is why the national tax authorities allow transfer pricing mechanisms to shift so much income to places like Bermuda.

Tuesday, November 11, 2014

Two Types of Preferences and the Relevance of Cost-Benefit Analysis

Here is another in the string of posts inspired by my weekly class on cost-benefit analysis.  Last night’s topic was stated preference methods, like contingent valuation.  These are controversial because they are often used to put prices on things people don’t normally think of as having prices, like the “existence value” of whole species, pristine natural environments or the avoidance of risks to public health.

My view is that many of the confusions in economics can be traced to ambiguities in language.  We often use words to mean multiple things and then try to apply what works for one meaning to a different meaning, where it doesn’t.  Case in point: preferences.  I prefer A to B means I want state-of-the-world A to occur rather than state-of-the-world B, whether A and B are two pairs of shoes that could sit in my closet or two destinies for wild salmon along rivers that drain the Olympic mountains in northwestern Washington State.  They are similar in the sense that both pertain to my wanting something, but they are also different.

I propose two kinds of preferences based on different motivations.  One I will call normative; this reflects my judgments regarding what I deem to be right or wrong.  The other is experiential, what I want based on how I would personally benefit from it.  Economists sometimes say that ethical judgments are essentially experiential, since you derive pleasure from seeing right triumph over wrong, but I disagree.  Experiential preferences cause you to want A over B because A makes you happier or gives you more “utility”.  Normative preferences give you happiness or utility if a choice process selects A, and you believe A is ethically preferred to B.  These are clearly not the same thing.  In the first case utility is a cause, in the second an effect.

An example of a fundamentally normative preference is the one exercised by a jury deliberating a civil or criminal dispute.  It would be absurd to have verdicts determined by jurors expressing a willingness to pay to convict or acquit, and then adding up the totals to see which is greater.  This is because juries are supposed to deliberate based on a conception of justice, not on what’s in it for them, personally.  An example of a fundamentally experiential preference is the question of whether to publicly subsidize a sports stadium in a city.  Taxpayers’ preferences will be based on the degree to which the team that plays in the stadium gives them some sort of personal excitement, satisfaction or pride.  This could well be captured by a technique that measures their willingness to pay for the stadium.

Of course, preferences that are primarily normative can have a secondary experiential component, and vice versa.  In the stadium example, for instance, one effect of a subsidy is to transfer public money to private investors in professional sports teams.  This has an ethical aspect, which may play a role in how preferences are established.  In fact, in a society with glaring shortfalls in public programs for health, education and other essential services, like Brazil, the ethical component may become primary, as we saw in the protests over the World Cup.  Where public funds are not so constrained and the gaps not so severe, the decision turns on what the local population expects to derive, personally, from better facilities for professional sports, and questions of ethics are secondary.

Most existence values for environmental goods, I would argue, are essentially normative preferences.  They are about what people believe to be right or meritorious, not what gives them personal satisfaction.  Willingness to pay in these circumstances makes about as much sense as a decision tool as it does in jury trials.  We might be misled by elements of experiential preference that enter the mix, but our well-being as members of a society that makes choices of this kind is an effect, not a cause of what we wish to see happen.

If this analysis is correct, CBA can help us put numbers on the experiential aspects of a policy choice, recognizing that some other process is needed to assess its normative merits.