Stumbling and Mumbling

Defending spending cuts

If I wanted to defend public spending cuts, I’d use this new paper from Andreas Bergh and Magnus Henrekson.
In a survey of the research, they find that big government does reduce long-run economic growth. In developed economies, if the share of public spending in GDP is 10 percentage points higher, annual GDP growth is 0.5-1.0 percentage points lower.
This implies that the planned cut in government spending - from 47.5% of GDP in 2009-10 to 39.8% in 2015-16 - would, if it’s not reversed, make the median worker between £40 and £80 a week better off by 2035.
You don’t have to believe that high taxes have big disincentive effects to think that big government reduces growth. I’d suggest two other mechanisms:
1. A Baumol effect. Big government usually means that a lot of economic activity is concentrated in sectors where productivity grows slowly - such as education or healthcare. This drags down overall growth.
2. Huge amounts of productivity growth come from exit and entry (pdf), rather than from existing organizations upping their game. The larger is government, the smaller is the sphere where this mechanism can work.
The standard riposte to all this is usually: how is it then that Scandinavian countries have combined big governments with good macroeconomic performance?
Bergh and Henrekson suggest a number of reasons. These economies tend to have very large exposure to international trade, and this encourages innovation, the division of labour and faster productivity growth. They are high-trust societies, which reduces the rent-seeking problems which often cause big government to reduce growth. And they score very highly on other measures of economic freedom. (This could be because of high trust: with people trusting companies to behave acceptably, demand for tight regulation is lower).
None of this necessarily justifies big cuts in public spending here and now: this research is consistent with the possibility that public spending cuts reduce growth in the very short-run. Nor does it in any way justify deficit fetishism. And you might argue that, in a post-crisis economy in which firms are starved of finance, these crowding out effects of big government are smaller than they would be in normal times.
Nevertheless, it does suggest that big government, in the long-run, is bad - albeit perhaps mildly so - for economic growth. Which is a little awkward for the statist left.

Taxes and labour supply: more evidence

Do tax cuts boost labour supply and hence tax revenues? Here’s some evidence that they don’t. Pierre Cahuc and Stephane Carcillo report on an experiment* in France:

The detaxation of overtime hours introduced in October 2007 was intended to allow individuals in France to work more so as to earn more. The evaluation conducted in this article indicates that the detaxation of overtime hours has not, in fact, had any significant impact on hours worked…
Detaxation is a measure costly for the public purse, without any ascertained impact on hours worked.

We can put this alongside the evidence we have for footballers and New York cabbies, which suggests that we are on the positive side of the Laffer curve, where tax cuts do not increase revenues. It’s also consistent with the - very tentative - evidence we have from UK tax receipts this year, which suggests that the introduction of the 50p tax rate has not (yet) reduced revenues.
Now, this is not to deny that Laffer curves exist. No doubt, there is a point at which higher taxes would be counter-productive and tax cuts would pay for themselves. And I’ll concede that it’s possible that the 50p tax rate will, eventually, have adverse effects.
But where is the hard evidence that, at tax rates around current levels, there are such effects? Do the glibertarians  have anything more than prejudice, half a theory, and the post hoc ergo propter hoc fallacy?
* Here’s another (futile) Dillow campaign. Instead of using the word policy, we should use the word “experiment”.

Exploitation, Marxist & otherwise

Christie Malry has mocked my concern with bankers’ bonuses: shouldn’t the left support profits going to workers? This raises an awkward point for Marxists.
Traditionally, one of their gripes against capitalism is that capitalists exploit workers. But if positive profits are evidence of positive exploitation, aren’t negative profits evidence of negative exploitation? If so, in several industries, it is workers who exploit capitalists; banks, football clubs and (traditionally) airlines lose money over the long-run.
Even more worryingly, one could argue that public sector workers exploit tax-payers. Marx complained that workers had to work longer than necessary in order to generate money for bosses. But tax-payers have to work longer than necessary to pay public sector workers.
So, shouldn’t Marxists stand up for the interests of owners and tax-payers?
If exploitation were inherently bad, we’d have to say yes. But it’s not clear that it is.
We could argue that exploitation in these cases is acceptable because the exploitee is free to leave the arrangement. No-one forces you to buy a football club or bank shares. But ordinary workers are, in effect, compelled to sell their labour-power.
This, though, doesn’t get us far. Tax-payers are compelled to pay tax. So the right’s objection to state exploitation holds.
There is, though, an obvious retort here. Tax is a fair exchange: we get public services in exchange.
But this doesn’t get us far. The right can object that the same is true for workers under capitalism. They get higher wages and better living standards than they got under feudalism, or would get if they tried to work for themselves.
All of which leaves us with a problem: why should we care about exploitation?
There is one reason. We can think of exploitation instead as the consequence of inequality of wealth and power. The rich and powerful can use their power - which might arise from control over scarce assets and/or over the state - to obtain better terms of an exchange than the poor and powerless.  As John Roemer said (pdf):

Exploitation conceived of as the unequal exchange of labour should be replaced with exploitation conceived of as the distributional consequences of an unjust inequality in the distribution of productive assets and resources.

This, I think, justifies opposition to bankers’ pay: it arises from an unjust inequality - their capture of the state. It also, arguably justifies opposition to capitalist exploitation. But it does leave open the question of whether the state exploits tax-payers.  
Whatever, the point is that it is inequality that should concern us, not exploitation. 

Osborne's exhilarationist gamble

What’s the link between profit margins and capital spending? I’m prompted to ask by Martin Wolf’s latest piece:

Against this background [of falling real wages], I find it hard to understand why the government is so confident that the economy would withstand the sharp fiscal squeeze that lies ahead. This has depended on an inordinately optimistic view: higher net exports and corporate investment will offset the contractionary impact of tough constraints on public spending.

There is, though, a possible defence of Osborne here. And it lies in the very fact that worries Mr Wolf - that real wages are falling. This old paper (pdf) by Silvia Ardagna says:

The labor market is an important channel for the transmission of fiscal policy shocks…GDP growth is higher the larger the decrease of public spending, and especially of the government wage bill.

We can put this into Marxian terminology. Government spending cuts are a weapon in the class war. In sacking public sector workers, their effect is to increase unemployment and thus shift bargaining power in favour of capitalists. This leads to lower real wages and, ceteris paribus, higher profit margins.
And here’s the thing. It is possible that this shift in the distribution of incomes raises the aggregate propensity to spend. Higher profit margins might boost capitalists’ confidence and so raise their inclination to invest, by more than lower real wages reduce consumer spending. This is what Marglin and Bhaduri called an exhilarationist regime.
This possibility has occurred in the past. It explains the expansionary fiscal contractions described by Ardagna. And it happened in the UK in the mid-late 80s. And it happened in reverse in many countries in the 1970s; a profit squeeze killed off capital spending.
The question is: can it happen in the UK here and now?
I wouldn’t rule it out entirely. The very fact that they’ve survived the recession might have increased bosses’ overconfidence and hence their tendency to see investment opportunities even where none exist.
But I have my doubts. For one thing, in the last few years - before and during the crisis - the British working class was remarkably quiescent, profit shares were high, and yet investment was low. This speaks against the idea that higher profit margins alone raise capital spending. I suspect low investment has more to do with a genuine dearth of opportunities, rather than to the fear that workers would seize the fruits of such opportunities.
And with at least some firms likely to remain credit-constrained, one vitally important channel through which increased confidence leads to increased investment - a rise in corporate debt - is blocked.
So, even if I were on Osborne’s side in the class war, I would be doubtful of whether now is the time or place to be waging it.

Bonuses vs fines

Ben Chu says the system for paying bankers’ bonuses is “manifestly broken.” He might be right, in a different way than he thinks.
The question is: why pay bankers a bonus for doing well rather than fine them if they do badly? I ask because research at the University of Nottingham suggests that fines are better incentives than bonuses.
Economists got subjects to play an inspection game. This comprises two players - an employer and a worker. The worker can choose either high or low effort. The employer chooses whether to inspect the worker’s effort or not. Both inspection and effort are costly. The game was played under three different payoffs:
1. The control group. Workers’ payoff to high effort was 25, whether or not the boss inspected. 40 if he shirked and the boss didn’t inspect, but only 20 if he shirked and was caught.
2. The fine treatment. The payoff to high effort was the same 25. But the payoff to shirking if caught was zero.
3. The bonus treatment, the payoff to low effort was the same as in the control group, but the payoff to high effort was 45 if the boss inspected and 25 if he didn’t.
The result of this experiment were clear. Fines induce more effort than bonuses. The joint earnings of bosses and workers were 18.6% higher in the fine experiment than in the control one, and 18.1% higher than in the bonus one. Bosses’ earnings in the fine experiment were 36.5% higher than in the control test, and 80% higher than in the bonus test.
The message seems clear. Fines are more efficient in aggregate than bonuses. The effect of bonuses is not to induce more effort, but rather to siphon off cash from bosses to workers.
Which leaves the question: what possible material difference might there be between this experiment and banking?
One possibility is that in inspection games there is a probability of effort not being observed, which leads to an under-supply of it. In banking, though, effort is monitored.
I’m not sure. Yes, there is more inspection in real workplaces than experimental ones. But there is not necessarily more effective inspection. The City is full of sob stories of good hard work going unrewarded, and not all of them are self-serving pish. Bonuses are not always tied to good work; even where returns are observed, risk is often badly measured; and the allocation of overheads between departments is always a source of dispute, to name but two issues.
Another possibility is that this experiment simplifies the labour input into high and low effort. But in the real world, things are more complex. What employers want is not merely to reduce shirking, but to induce ingenuity or creativity. Perhaps bonuses are better than fines at this.
Maybe. But I’d welcome hard evidence. And I’d point you to this new paper from Dan Ariely and Francesca Gino, which says there is a correlation between creativity and dishonesty.
Perhaps, then, fines would be better than bonuses.
This issue, I stress, is independent of the question of bankers’ pay overall.  Instead of paying a man £1m a year plus a £1m bonus for meeting certain criteria, he could be paid £2m a year, with but with £1m withheld if he fails to meet those criteria.
The question is: why is the former system so much more common than the latter? It can’t be that banks are run for the benefit of employees, can it?

The wage squeeze, statism & socialism

Can capitalism work in the interests of working people? Mervyn King has, inadvertently, revived this old question*. Last night, he pointed to falling real wages and said (pdf):

The squeeze in living standards is the inevitable price to pay for the financial crisis and subsequent rebalancing of the world and UK economies.

But this just raises the question: why must the squeeze be upon workers in the form of falling wages, rather than capitalists in the form of lower profits? As Duncan says, the question of who pays that bill is a political choice.
The proximate answer is trivial: high unemployment means workers lack bargaining power. So they suffer.
But must it be so?
There are two alternatives here, one statist and one less so.
The statist answer is to engineer a higher share of wages in GDP. The hope is that this would increase aggregate demand, not just by raising consumer spending, but by encouraging investment insofar as it raises demand expectations.
I have my doubts about this. I’m not sure the state has the tools to do this. One legacy of the financial crisis and the years of under-investment that preceded it is that the economy doesn’t have that much spare capacity; this is one reason why inflation has been unexpectedly high. This means that such policies might add to inflation, which itself might depress demand by encouraging savings.
Also, it’s unclear whether higher wages - even if they could be achieved - really would boost aggregate demand. It’s possible that capitalists might reduce investment in response to higher costs rather than increase it in response to higher expected demand. These classic papers by Marglin and Bhaduri and Bowles and Boyer (pdf) elucidate this question.
There is, though, a non-statist possibility - to transfer ownership from capitalists to workers. This would have two virtues.
First, in giving everyone a share of profits, it would mean that a squeeze on wages would not necessarily mean a squeeze on overall household incomes.
Secondly, a big reason for the wage squeeze is that capitalists are spending less than they are making in profits: as I say, this is in one sense true by identity. If workers take control of investment, though, this problem would be mitigated. In choosing the (aggregate) level of investment they would choose the aggregate wage level, and so - in effect - internalize an externality.
This, of course, only raises the question. What sort of institutions might achieve worker ownership - mutualism, some version of market socialism, pension fund socialism (pdf)?
And herein lies my big gripe. There has been insufficient interest in these possibilities. The left’s faith in statism has, in effect, crowded out interest in non-statist alternatives. And this has left it with very few intellectual resources.
* Note to glibertarians. By “capitalism” I do not mean a market economy. I assume this would exist under any form of ownership. 

Power, science & media bias

Lots of people have objected to Mad Mel’s whine about “the seemingly all-­powerful gay rights lobby” and Dominic Raab‘s claim that it is men, rather than women, are “victims“ who get a raw deal. But I don’t think anyone has quite nailed the problem here - that both are guilty of an anti-scientific ignorance of the nature of power.
I’m thinking of something Sir Paul Nurse said last night - that a scientific attitude looks at the whole body of evidence, and does not cherry-pick a few anecdotes. This, though, is what Phillips and Raab do not do.
Of course, there are individual instances of men getting a bum deal and of gays brow-beating straights. The question is: are these instances representative of the wider, fuller sample of experience?
There are good reasons to think not, in two ways:
1. There’s an availability heuristic at work here. The gobby gay and the “obnoxious bigot” of a feminist get noticed by virtue of being loud. But the gay who is tormented by the threat of homophobic bullying, or the battered wife, are quiet and go unnoticed. There’s therefore a natural tendency to over-estimate the power of the gay and feminist lobbies, and to under-estimate the extent of their victimhood.
Right-wingers who look at a few gay or feminist activists and infer that gays and women generally have power are as daft-headed as left-wingers who look at Toby Young or James Delingtwat and infer that all right-wingers are whiny, vacuous, self-promoting little pricks.
2. Power does not operate only - or even mainly - through visible, newsworthy, channels. It works more subtly, in unseen ways - for example by generating and sustaining social norms in which gays feel guilty for being who they are, or in which women are dissuaded from entering careers for which they would otherwise be suited.
Given these problems, the only way to assess whether gays or women have power is to look at the totality of evidence. Do gays (pdf) and women suffer (pdf) more discrimination in the workplace?  Are they disproportionately likely to be victims of serious violence? Do they, on average, suffer worse life chances?
It is only statistical evidence that can adjudicate here. Anecdotes cannot be sufficient because they are highly likely to come from an extreme end of the statistical distribution.
Herein, though, lies the problem. It is in the very nature of the media to prefer the anecdote over statistics: human interest wins over numbers every time. This preference, however, generates a systematic distortion in the way the media portrays inequality.

Untruth in politics

Paul Sagar says that Tony Blair “initiated an era in British politics where the truth was a worthless commodity”, an era which Cameron and Clegg are continuing.
For me, this raises two questions: why is there so little demand for the truth, and why should we care?
I suspect there are two mechanisms which lead to a tolerance of untruth. One is that people - quite rationally - don’t pay much attention to party politics. This means that it is only strong, bold claims - “we want to abolish tuition fees”, “45 minutes from doom” - that grab their attention. But strong, bold claims are apt to be wrong.
Secondly, voters, or at least journalists, want certainty, or at least the illusion thereof - a desire compounded by a statistical illiteracy which renders them incapable of understanding confidence intervals or probabilities. This too generates a demand for clear but wrong statements rather than unclear but accurate ones.
But why should we care if there‘s a demand for untruth? Surely, all sides are equally capable of promulgating lies, half-truths and misrepresentations. So what’s the damage?
It would, I think, be a simple category error to complain that untruths degrade public discourse and increase distrust. Politics is about power, not fluffy things like truth and trust. Instead, I suspect the problem is that politics doesn’t just value untruth, but does so asymmetrically. I’m thinking of three biases here:
1. Some claims are more closely scrutinized than others, so it‘s harder to get away with inaccuracies. Propositions which fall outside the Overton window get a rougher ride than “mainstream” ideas.
The bias here is not just against leftist ideas, but against libertarian ones too: proposals to legalize drugs, say, get a harder time from the media - if they get any time at all - than does a defence of the drugs war.
2.  To utter an untruth convincingly - a lie, or a simple statement shorn of caveats - requires self-confidence. It is public schoolboys who are more likely to have this. It’s no accident that the men Paul accuses of promoting untruth into politics were expensively “educated.”
3. We tend to trust others more if they are like us. Given that the media is dominated by people from rich backgrounds, this means that untruths from politicians from similar, rich, backgrounds are less closely scrutinized. Just compare the chummy tone of so many interviews with politicians to the rougher rides that protestors or union leaders get.
The upshot here is that the demand for untruth leads to a bias in favour of the status quo and of inequality, even if the particular untruths are not explicitly used to argue for inequality.

Microfoundations of domino theory

It looks as if the Tunisian revolution might be spreading. Which raises the question: what are the micro foundations of such a domino effect?
That there are such effects is clear. They explain why the English ruling class was terrified by the French revolution; why the US was so desperate to resist Vietnamese communism; and why Georgia’s rose revolution inspired uprisings in the Ukraine and Kyrgyzstan. But what exactly is the mechanism here?
This paper (pdf) sheds some light. Consider someone pondering whether to protest. The gain from doing so is the probability of achieving your objective. The cost is the risk of being arrested or beaten up. How you weigh up these costs and benefits depends upon your belief about the strength of the government. If you think it’s strong enough to resist the protests, you might not bother. But if you think it’s weak enough to either give in or not punish protestors, you will protest.
And here’s the thing. The reaction of neighbouring governments to similar protests affects your judgment of your own government’s strength or weakness. If it is weak, you figure: “Maybe protests will work here as well.” At the margin, this gets more people onto the streets. One government’s reaction to protests has “reputation externalities” for other governments.
As it stands, there are a couple of holes here. One is the problem of collective action. To the individual, the potential costs of protesting are high - possibly death - whilst the benefits are spread over millions. So why doesn’t he just free-ride on others’ protests? If everyone does this, there’ll be no protests.
The very fact that there are protests shows that there’s something wrong with this. The answer, I suspect, is that some people - “extremists”! - gain symbolic utility from protesting. If they are not beaten up and arrested, other, less fanatical, people join them. This is why the size of protests sometimes snowballs. (A further mechanism here is Timur Kuran's theory of availability cascades: seeing others protest makes us think that protesting is a reasonable thing to do).
The second hole is: what exactly is going on the mind of the marginal protestor who sees a successful revolution in a neighbouring country? The paper seems to suggest that he has been always conducting a rational cost-benefit analysis of whether to protest or not. But I suspect what might instead be happening is a form of attention effect. The thought of protesting simply doesn’t occur to him, until he sees others - people like him doing so. And when he sees this, he figures: “I can do that.”
I draw two conclusions here.
First, domino theory is very similar to peer effect and role model theories. Similar mechanisms are at work.
Secondly, state power operates in two different ways. On the one hand, its use or threat of force (or not) affects people’s incentives to protest. But on the other hand, power operates by keeping some thoughts out of people’s heads; one reason why folk don’t protest more is that the idea of doing so doesn’t occur to them. And this raises the question: what other thoughts that might threaten those in power never occur to us?

Unemployment: prejudice vs curiosity

This piece by Sam Bowman irritates me. He says:

The minimum wage is pricing young people out of the market…
All the job schemes in the world wouldn't give young people as much of a fighting chance as letting them compete freely for jobs.

Let’s ignore, as Sam does, this paper which argues that “It does not appear that youths are pricing themselves out of work” and that there is “little or no evidence” that the minimum wage is responsible for youth unemployment. And let’s also ignore this paper, which finds “no compelling evidence” that the NMW has raised youth unemployment.
Instead, let’s do some sums. There are 4.34 million 18-24 year-olds not in full-time education (table 14 of this pdf). Of these, 2.87m are in work and 1.47m are unemployed or inactive. This means that to get youth joblessness down to 5%, employment must increase by over 40%. What sort of wage fall is required to achieve this?
It depends on the price elasticity of demand. If this is unity, we need a 40% wage cut. This would mean that 18-20 year-olds now on the minimum wage of £4.92 an hour would get less than £3.
This raises lots of questions. What exactly is the price elasticity of demand for labour? Would people really accept such low pay? And even if they did, would employers really want to hire them, given that such workers are poor quality anyway (watch Michel Roux’s Service), and low wages would further demotivate them? In light of these questions, mightn’t there be other reasons for youth unemployment, and other solutions than wage cuts?
However, Sam not only ignores the academic research, but ignores these questions too. All he gives us is a glib Econ 101 assertion. What we have here is a lack of curiosity about the economy, a belief that the assertion of prejudice is sufficient.
And herein lies my irritation. This egomaniac elevation of prejudice over curiosity is far too common, and not just on the right.