Stumbling and Mumbling

What structural deficit?

Ralph Musgrave asks a good question: is the structural budget deficit a useful concept? I agree with him that it’s not.
The structural deficit is the one that would exist, if output were at its trend level. This means that its measurement depends upon three unknowns: the size of the output gap; the response of spending to moves in GDP; and the response of revenues thereto. All these are uncertain, as the OBR acknowledges:

Forecasts of cyclically-adjusted aggregates are subject to particular uncertainty, as they depend on projections of the current position of the economy relative to trend. They also rely on analysis of the effect of the economic cycle on borrowing from previous cycles, which may not hold in the future.

To get a rough idea of these uncertainties, let’s do some sums.
The OBR uses the Treasury’s procedure (pdf) for estimating the structural deficit. This says that a 1% output gap, after two years, causes current spending to rise by 0.5% of GDP and causes revenues to fall by 0.2 per cent of GDP.
Now, the OBR estimates that the output gap was 1% in 2008-09 and 4.1% in 2009-10, and that cyclical adjustment reduces the deficit from 7.6% to 5.3% of GDP.
But let’s say the output gap is one percentage point larger in both years, and that revenues and spending are each 0.1 percentage points more sensitive to the output gap.
These small tweaks reduce the deficit by a further 1.5% of GDP this year, to 3.8%.
This means that the fiscal tightening which Labour put in place is sufficient to cut the cyclically-adjusted deficit to just 0.1% of GDP by 2014-15, on the OBR‘s numbers. Which eliminates the need for a large fiscal tightening.
There’s another reason I don’t like the idea of a cyclically adjusted budget balance. It’s that, as Ralph says, the budget balance depends upon the savings of the private sector.
To see the problem, imagine output were on trend - that is, higher than it is now. This could be because the private sector  goes on an investment boom, and its investment exceeds savings. If so, the public sector will have a surplus, as the counterpart of this. By definition, this will be a cyclically adjusted surplus. However, it could also be that output is strong because of strong overseas demand and UK firms save the profits generated by this. In this case, the private and foreign sectors together might have a financial surplus, so the government will have a cyclically-adjusted deficit. But on both cases, ex hypothesi, fiscal policy is the same.
Cyclical adjustment, then, does not necessarily tell us whether fiscal policy is loose or tight.
So, could it be that the notion of a structural deficit is a pseudo-scientific concept, intended to give a cloak of respectability to what is, in essence, a narrowly political desire to cut public spending? For more on this, see this paper by Randall Wray and Yeva Nersisyan.

Rare employment

If anyone is daft enough to think that today’s fall in the claimant count measure of unemployment means that the labour market is improving, one fact should disabuse them - the number of full-time employees fell by 82,000 between November-January and February-April.
This means that only 47.7% of the working age population, and only 36.5% of the adult population, are full-time employees.
In other words, what we were brought up to think of as “normal” is, in fact, a minority activity, and is only barely a majority activity even for working-age men, only 55.8% of whom are full-time employees.
This low proportion is not merely the result of the recession. Even before the slump, the proportion of men who are full-time employees was falling slightly.
This is not because of an increase in self-employment; this ratio has hovered around 10% of the population for some time. Instead, it’s due (statistically if not causally speaking) in part to increasing numbers of students and part-timers.
I’m not sure what to make of this. It’s tempting to come over all post-Marxist, and say that it means people’s identities are no longer bound up with their workplace, if indeed they ever were.

Why history matters

The Nazi occupation of the Soviet Union left a legacy that’s still with us today, according to this new paper (pdf) by Daron Acemoglu and colleagues:

We find that cities [in the former USSR] where the Holocaust was more intense have relatively lower population today and have voted in greater numbers for communist candidates since the collapse of the Soviet Union. Similar results also hold for oblasts that were impacted relatively more by the Holocaust. Such oblasts have lower levels of per capita income, and lower average wages today. Moreover, they tended to exhibit greater vote shares for communist candidates during the 1990s and higher support for preserving the Soviet Union in the referendum of 1991.

The lower population in cities touched by the Holocaust is not a mere mathematical artefact of the massacre of Jews. Populations are even lower than can be explained by the numbers of Jews killed. Instead, it seems to be the case that they grew more slowly after the war.
Of course, this could be just a curious coincidence. But maybe it isn’t. Acemoglu and colleagues point out that, because Russian Jews were disproportionately middle class, the Holocaust, in effect, changed cities’ social structure. And cities with a smaller middle class  grew more slowly thereafter and were poorer even 60 years after the Holocaust.
The story here is not just about the USSR’s history. It’s wider than that. We should read this alongside Nathan Nunn’s work on the way in which the African slave trade still depresses African economies today; Eric Chaney’s work on the malevolent legacy of the expulsion of Muslims from Spain in 1609; and Engermann and Sokoloff’s account (pdf) of how slavery in south America led to slower growth for decades afterwards. The message is the same. Regions’ prosperity or poverty today depends on events decades or centuries earlier because these have shaped institutions now.
All this corroborates a point made by Herbert Simon. Differences in wealth between rich and poor nations, he said:

are not simply a matter of acres of land or tons of coal or iron ore, but, more important, differences in social capital that takes primarily the form of stored knowledge (e.g., technology, and especially organizational and governmental skills)…
When we compare the poorest with the richest nations, it is hard to conclude that social capital can produce less than about 90 percent of income in wealthy societies like those of the United States or Northwestern Europe.

This, he said, has implications for redistribution:

On moral grounds, then, we could argue for a flat income tax of 90 percent to return that wealth to its real owners.

Though, you might think, this conclusion requires some extra arguments.

The interest burden in context

Nick Clegg asks:

How will we pursue social justice with billions of pounds of taxpayers' money disappearing down a black hole every year, just to pay the interest on Labour's debt while our schools and hospitals fall apart?

But how great is this interest burden? The OBR today - in a report of admirable clarity - forecasts that, on Labour’s fiscal plans, government debt interest payments will rise to 3.7% of GDP in 2014-15.
On the one hand, this is a lot - it’s almost twice the ratio we had in the early 00s.
On the other hand, though, its not absurdly high. It’s less than we paid in the early 1980s, when debt was low but interest rates were high. And it’s less than we paid in the late 40s and early 50s, when debt was high but rates low*.
Of course, you could argue that the OBR’s forecasts are predicated on interest rates staying low - their forecast for gilt yields is simply taken from the current yield curve - but if action isn‘t taken to cut debt, rates will rise. I don’t know how to quantify this probability. And the burden will continue to rise after 2015, simply because debt will stay high on current plans.
And, of course, this is only one aspect of the burden we are placing upon future generations: there’s also high house prices, university tuition fees and so on.
All I’m saying is that, in historic context, that “black hole” isn’t unprecedented.
* My chart shows data for fiscal years. In the calendar year of 1948, debt interest payments were 4.3% of GDP.

Rob Green, counterfactuals & rationality

Rob Green's howler yesterday carries two lessons for anyone wanting to judge decision-makers in any field.
First, there's a difference between being rational and being right.In picking Green, Capello was making a judgment that he was less likely that Hart or James to drop a clanger.It looks as if that call was wrong.
However, even if it was wrong, it was not necessarily irrational. On the basis of the information Capello had at the time he picked Green, it was a reasonable decision.
Secondly, it's impossible to judge counterfactuals with high confidence.
Was it really wrong to have picked Green? Whilst it's unlikely that James or Hart would have made that error, it is possible that they might have made some other mistake - say, miskicking a clearance or not making the save that Green did in the second half.
We'll never know for sure. We can never see the consequences of decisions not taken.
This, of course, has implications for vast amounts of decision-making. We'll never see whether the rejected job applicant might have done a briliant job. We'll never see whether investment proposals that are rejected might have yielded great returns. And so on.
In this context, there's an analogy with the Budget. The case for slashing spending is that if we don't do so they'll be a Greek-style debt crisis which will force upon us larger spending cuts and a terrible recession.
But just as we'll never see how Hart or James would have done last night, we'll never see whether this happens.
This leaves us with a problem. Let's say we see a weak economy in 2011. Some people will blame Osborne's spending cuts. But he could reply: "If I hadn't cut spending, things would have been worse."
But it will be impossible to tell for sure whether this is right.In this sense, judgments about the Budget - even in 2011 or 2012, let alone next week - cannot be made with much confidence.

On technical regress

The other day, I got into my car to go to the gym ( it was raining and I’m a wuss) only to find that the battery had died. Which set me pondering. Whereas most of my car is vastly technologically superior to anything one could have bought in the 1970s, batteries are little different: how often do you need to recharge your phone, iPod or laptop?
There’s a moral here - in large chunks of our life, there has been little technical progress, and even regress. It takes longer to fly from New York to London now than it did in the 1970s. It takes as long to build a house now as it does then - and to no higher specification; my quite modest car doesn‘t fit into the garage. The technical quality of recorded music has declined.  And even medicine has, in many ways, not progressed; treatment for ailments such as back conditions, the common cold or gout has barely changed in recent decades.
These are no mere trivia. In the 1960s, a relatively bright person could get a free university education, with generous living expenses paid by the state; buy a house on a single only slightly-above average income even in London; and look forward to a generous final salary pension. This is fantasy  for a young person today.
You might object here that these are not examples of pure technical regress, but rather of bad social organization; for example, house prices have soared partly because of planning restrictions, and pensions have been cut because of corporate incompetence. There’s much truth in this, but little relevance. Social conditions are as much a form of technology as is scientific knowhow.
This is of course not to deny the obvious fact, that there has been enormous technical progress in many ways.  Instead, it’s merely to remind you of Baumol’s cost disease - that the counterpart of technical progress in some sectors is rising relative prices in others. And these rises can hurt.
In this context, I have some sympathy for economic illiterates. Daniel Klein says that only “unenlightened” people disagree with the claim that “Overall, the standard of living is higher today than it was 30 years ago.”
Strictly speaking, he’s right. But let’s be clear - that word “overall” is doing quite a bit of work.

Democracy vs justice

There’s a common theme underlying several of my recent posts - one that I’ve discussed before but which doesn’t get much attention elsewhere. I mean the conflict between democracy and justice.
Why are people supporting shadow cabinet quotas for  women when there are equally good arguments for quotas for other under-represented groups? Why isn’t intergenerational justice more widely discussed? Why do people think immigration controls are a good way to raise the living standards of poorer workers when they give less vocal and widespread support to other policies, such as genuine redistribution?
The answer to all these questions is that democracy gives us a set of filters which exclude or weaken some demands for justice whilst accepting others.
I’ll suggest three such filters. There may be more.
1. What groups are large and/or organized and respectable? Democracy is better at meeting the needs of the marginally oppressed than of the genuinely, seriously oppressed. For example, no-one advocated shadow cabinet quotas for women in the 1960s, even though women suffered vastly more injustice then (indeed, they didn‘t advocate them precisely because women suffered so much injustice). It is only as women’s position has improved that discrimination in their favour becomes acceptable.
Or take another example. In the 60s, when unions were powerful, white unskilled workers got a better hearing from governments than they do now, whilst ethnic minorities and women had a bad time. As the power of unskilled whites has declined, so governments now pay them less attention - whether justice requires this or not.
Democracy gives to those who have political power. But those who need justice most, by definition, don’t have political power.
2. Who exists? Future generations don’t exist, or are too young to be organized and powerful. So democracy gives them a bad deal. It also gives a bad deal to other non-voters, such as immigrants or foreigners. National democracy rules out global justice.
3. What’s “credible“?  Bashing immigrants is a mainstream policy. Demands for a significantly more redistributive tax system are not. Similarly, quotas for women is mainstream, but quotas for people who went to state school is class war. Democracy - aided by the media you might add - makes some policies respectable and others not.  This leads to a feedback loop: people only support policies they are familiar with; parties don’t therefore want to propose new radical policies, so radical policies remain unfamiliar and therefore unpopular.
It would be tempting to give you some Marxist theory about how democracy serves the interests of capitalists. I don’t want to argue against that, but it’s not what I have in mind. Sometimes, it can be right-wing policies that get marginalized: for example, in the 60s and 70s, demands to privatize utilities were regarded as eccentric lunacy - except that in a short time they became mainstream.
All I’m saying here is that under democracy, justice gets a raw deal. And I fear it is too glib to say that this is because democracy is capitalistic or inadequately realized.
In this context, I’m wary of “progressives”. The notion that one can make piecemeal, gradual progress towards justice, I fear, means that one rectifies minor injustices which win votes whilst ignoring larger injustices which the public tolerate.

Justice & the deficit

Nick Clegg’s promise of “progressive cuts” in public spending has met justified scepticism. But there is a trick he and Cameron are missing here. There is an argument, in justice, for cutting the deficit. If I were they, I’d argue thusly:

Keynesians are right - government debt is a means of protecting people’s incomes today. However, it does this by imposing a burden upon future generations who have to pay the interest bill. In this sense, government debt is a form of exploitation. It allows today’s generations to live well at the expense of future generations. But it’s widely thought that exploitation is unjust. Marxists complain that capitalists exploit workers. Libertarians complain that the state exploits tax-payers. So, shouldn’t we also complain when present generations exploit future ones?
This is especially true because, as David Willetts points out, debt is not the only burden we are putting upon future generations. High house prices enrich today’s old at the expense of the young. Final salary pensions are being denied to younger workers. We’ve under-invested in transport and energy. And this is not to mention climate change.
We are, then, ripping off future generations. It’s got to stop.
You might object that ordinary economic growth means they will be richer than us and so can afford to bear these burdens.
This fails on two counts. First, this recession could be a supply shock as well as a demand one; it might have permanently reduced potential GDP, and so made future generations worse off than would otherwise be the case. It’s only fair that we share at least some of this pain, especially as our generation caused it.
Secondly, it’s not obvious that this objection has moral force. Workers in the west can afford to be exploited by bosses, but this doesn’t stop Marxists complaining. Nor do libertarians stop complaining just because rich people can afford to pay taxes. If exploitation is wrong, it doesn’t become right simply because it’s victims are rich.

Now, feel free to object to this reasoning. I’m not sure about it myself - mainly because I'm not sure that efforts to cut the deficit will succeed, if they merely weaken the economy and hence reduce tax revenues. But this argument is surely stronger than brainless wibble about the “overdraft”, and indeed, more convincing than other arguments Cameron has given. What’s more, it also gives the coalition a strong reason to complain about Labour’s loose fiscal policy - because, as Ray Barrell and Martin Weale have argued, it was inconsistent with inter-generational justice.
Which makes it curious that the government is not using it. But then, maybe they are scared to open the can of worms involved in complaining about exploitation.

Emigration & wages

It’s strange that it takes a guy who doesn’t own a passport to ask this - but isn’t the debate provoked by Ed Balls’ call for restrictions on intra-EU immigration rather parochial? I mean, it’s been about the effect of migration on the UK, and isn‘t asking: what impact does emigration have upon eastern European economies? This new paper  by Benjamin Elsner starts to fill this gap.
He looks at Lithuania, which experienced especially large emigration after 2004.
Now, if migration has a big impact upon wages, you’d expect Lithuanian wages to have risen in response to the fall in their domestic labour supply. 
So, did they? Yes - up to a point. Mr Elsner estimates that unmarried Lithuanian men saw their wages rise 1.4% for every percentage point of comparable workers who emigrated. This implies that it would require 2.5% of Lithuania’s workforce to emigrate to raise wages by as much as they would rise through one year of ordinary economic growth. I’m not sure whether this is a big effect or not.
For other workers, the effect is smaller. Mr Elsner found no effect of emigration upon women’s wages. And he found only a teeny effect for married men’s wages. This, he says, could be because married men have stronger ties that stop them emigrating and so cannot credibly tell their employer that they will migrate if they don’t get a pay rise, in the way that footloose single men can.
You can interpret this in three different ways.
First, insofar as there is a negative effect, Balls’ demand for immigration controls - which are, of course, emigration controls too - amounts to an attack upon the living standards of poor workers; Lithuanian incomes are only around half the UK’s. One might wonder how socialist this is.
Secondly, insofar as there is an effect, there’s a question for people like me who have been relaxed about the impact of migration upon host country‘s wages: if emigration raises wages, why doesn’t immigration reduce them?
Well, for one thing it does - there is a small adverse effect upon unskilled wages. And for another thing, there are selection effects. Immigrants fill jobs that others can’t or won’t do, so they don’t compete much with indigenous workers, and might actually raise their wages if there are complementaries between jobs - if, say, immigrant roofers allow native plasterers to get more work done. By contrast, emigrants are a more mixed bag.
I, though, would prefer to stress that we are talking small effects here. The debate about migration should not rest much upon its impact on wages. And if you are seriously worried about the living standards of working class Britons, immigration should, surely, be low on your list of concerns. Or am I being too technocratic?

Lembit Opik, armed robbery & genes

Imagine you were to commit an armed robbery with Lembit Opik. (I know, you might think the contingency  a remote one, but remember Mocan and Tekin’s famous paper). Imagine then that you were fingered by the Dibble, and held in separate cells. The Dibble then make you an offer: you can confess and shop Mr Opik, in which case you’ll be freed and he’ll face a long sentence unless he also confesses. Or you can keep quiet in which case you’ll be charged with the lesser offence of possessing weapons. You know the Dibble are putting the same offer to Mr Opik.
Do you grass him up?
According to this recent paper (pdf), you should. It shows that, in standard prisoners’ dilemma games such as I‘ve described, men with asymmetric faces are significantly more likely to co-operate than symmetric ones. With the lop-sided Mr Opik likely to keep quiet*, you can walk free by grassing him up.
Never let it be said this blog doesn’t offer practical advice.
What’s going on here? The thing is that facial symmetry is an indicator of genetic fitness. Men who have it are, therefore, more willing to compete against others and less willing to co-operate because they would usually win competitions.
There’s other evidence  for this. This paper (pdf) finds that symmetrical men make lower offers in ultimatum games - they are more selfish.
The point here is a simple one, which some will find trivial but others not. Our behaviour responds not merely to incentives - the incentives are the same for everyone in the prisoners’ dilemma game - but to our genes. And, I suspect, the way they do so is sub-rational. Few symmetric men consciously think “I‘m genetically fit, so I‘ll defect in this game”. Instead, it‘s their selfish genes that do the work.
* My more literal-minded readers might object, with their tedious love of accuracy, that in fact we know other things about Mr Opik which might influence his and our decision to co-operate or not. But imagine that all we knew about him was his appearance.