LAUSANNE - kill your idols III, le romandie, 03/30/07

LAUSANNE - on the street, place saint-fran�ois, place de la palud and cath�drale, 03/30/07

Do we tax energy enough?

To learn the answer, you can watch a symposium at AEI, including one of my favorite economists.

Barstool Tax Policy

An ec 10 student emails me the following parable:

Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

The first four men (the poorest) would pay nothing.
The fifth would pay $1.
The sixth would pay $3.
The seventh would pay $7.
The eighth would pay $12.
The ninth would pay $18.
The tenth man (the richest) would pay $59.
So, that's what they decided to do.

The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80.

The group still wanted to pay their bill the way we pay our taxes so the first four men were unaffected. They would still drink for free. But what about the other six men - the paying customers? How could they divide the $20 windfall so that everyone would get his 'fair share?' They realized that $20 divided by six is $3.33. But if they subtracted that from everybody's share, then the fifth man and the sixth man would each end up being paid to drink his beer. So, the bar owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay. And so:

The fifth man, like the first four, now paid nothing (100% savings).
The sixth now paid $2 instead of $3 (33%savings).
The seventh now pay $5 instead of $7 (28%savings).
The eighth now paid $9 instead of $12 (25% savings).
The ninth now paid $14 instead of $18 (22% savings).
The tenth now paid $49 instead of $59 (16% savings).

Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings.

"I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man," but he got $10!"

"Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"

"That's true!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!"

"Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"

The nine men surrounded the tenth and beat him up.

The next night the tenth man didn't show up for drinks, so the nine sat down and had beers without him. But when it came time to pay the bill, they discovered something important. They didn't have enough money between all of them for even half of the bill!

And that, boys and girls, journalists and college professors, is how our tax system works. The people who pay the highest taxes get the most benefit from a tax reduction. Tax them too much, attack them for being wealthy, and they just may not show up anymore. In fact, they might start drinking overseas where the atmosphere is somewhat friendlier.

Apparently, there is some dispute about the authorship of the story.

GENEVA - on the street, vieille ville and gare de cornavin, 03/29/07

Goolsbee on Subprime Lending

Austan says:

When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages.

LAUSANNE - on the street, place saint-laurent and place saint-fran�ois, 03/28/07

Two Op-eds from Harvard

• Richard Zeckhauser (with Peter Schuck) on good programs and bad apples.
• Larry Summers on why policymakers need to look ahead.

My Father is Darth Vader

I love Alan Blinder, both as a person and as an economist. I took courses from him as an undergraduate at Princeton, wrote my undergraduate thesis under his supervision, coauthored one of my first published articles with him, and have been friends with him for more than a quarter of a century. I am therefore surprised to see him lured by the dark side of the force. You can read about it in today's Wall Street Journal:

Pain From Free Trade Spurs Second Thoughts
Mr. Blinder's Shift Spotlights Warnings Of Deeper Downside

By David Wessel and Bob Davis

For decades, Alan S. Blinder -- Princeton University economist, former Federal Reserve Board vice chairman and perennial adviser to Democratic presidential candidates -- argued, along with most economists, that free trade enriches the U.S. and its trading partners, despite the harm it does to some workers. "Like 99% of economists since the days of Adam Smith, I am a free trader down to my toes," he wrote back in 2001.

Politicians heeded this advice and, with occasional dissents, steadily dismantled barriers to trade. Yet today Mr. Blinder has changed his message -- helping lead a growing band of economists and policy makers who say the downsides of trade in today's economy are deeper than they once realized.

Mr. Blinder, whose trenchant writing style and phrase-making add to his influence, remains an implacable opponent of tariffs and trade barriers. But now he is saying loudly that a new industrial revolution -- communication technology that allows services to be delivered electronically from afar -- will put as many as 40 million American jobs at risk of being shipped out of the country in the next decade or two. That's more than double the total of workers employed in manufacturing today. The job insecurity those workers face today is "only the tip of a very big iceberg," Mr. Blinder says.

The critique comes as public skepticism about allowing an unfettered flow of goods, services, people and money across borders is intensifying, including some Republicans as well as many Democrats. The rethinking is helping free-trade foes, underscoring the urgency of helping those battered by globalization and clouding the outcome of a hot debate: Should government encourage forces of globalization or try to restrain them?...

[Mr. Blinder] was silent when his former Princeton student, N. Gregory Mankiw, then chairman of President Bush's Council of Economic Advisers, unleashed a political firestorm by reciting standard theory but appearing indifferent to pain caused to those whose jobs go overseas. "Does it matter from an economic standpoint whether items produced abroad come on planes and ships or over fiber optic cables?" Mr. Mankiw said at a February 2004 briefing. "Well, no, the economics is basically the same....More things are tradable than...in the past, and that's a good thing."

Mr. Blinder says he agreed with Mr. Mankiw's point that the economics of trade are the same however imports are delivered. But he'd begun to wonder if the technology that allowed English-speaking workers in India to do the jobs of American workers at lower wages was "a good thing" for many Americans.

I believe Alan is terribly wrong-headed about this topic.

Suppose some country had high tariffs that prevented many goods and services from being imported from abroad. Then a new President eliminated the tariffs. Alan would, I believe, applaud the policy move, despite job losses for some workers in previously protected industries.

But the rise in offshoring is much the same. If changes in technology suddenly make previously nontraded goods and services tradable, that has precisely same effects as removing tariffs. In both cases, a barrier to trade has fallen. We would import more, and there would be some painful dislocations, but the nation overall would enjoy greater prosperity.

For some reason, Alan does not respond to this rise in technology-driven offshoring as he would to a rise in policy-driven trade. But economic logic suggests that if he is to embrace tariff reductions as an economic positive, he should similarly embrace technology-driven trade increases an an economic positive. But instead of recognizing this change as primarily a force for good, he offers mainly hand-wringing. In doing so, he gives, perhaps unintentially, aid and comfort to the protectionists.

Meanwhile, I am still rooting for the Jedi.

PARIS - on the street, rue de la tour des dames and le marais, 03/27/07

My Life as a Student

A reader of the blog writes:

Prof Mankiw,

Just to let you know, I'm a big fan of yours and some of your work has inspired me to pursue a career in Economics. I just have one question for you - that may seem silly, but hey, - your educational background is very impressive - but did you ever struggle with any of the courses you studied as a student?

Sometimes, an academic life can be a struggle, can't it? Or do you find it all fun?

Thanks for reading this. I know you are very busy so I'll understand if you don't reply. You are an inspiration.

[name withheld]

As a student, I had the most trouble with three kinds of courses:

1. Those that required motor skills. I was solidly in the bottom quartile of my junior high school and high school classes in shop, typing, and physical education (but somehow I managed to become captain of my high school fencing team).

2. Those that required good memorization skills. Languages in particular were a weak point in my academic career, mostly because I had trouble learning the large quantity of new vocabulary words.

3. Those that required large quantities of reading. I have always been a slow reader. This was a particular handicap when I was a law school student.

But the most difficult time for me was when I had to accept the limits of my mathematical abilities. Math was my strongest subject in high school. I got an 800 on the math SAT, won the high school math prize, and didn't really feel like I was working hard at it. I thought I was hot s***. But then I got to Princeton and met people who were really good at math, the kind who become serious mathematicians, and I began to see the limits of my aptitude in math. I took some hard math courses there and did okay at them, but I was far from the top of the class.

Many econ grad students at Harvard, maybe most, are stronger in math than I am. In recent years, some of my coauthors (such as Ricardo Reis and Matthew Weinzierl) have been Harvard students with strong technical skills. My comparative advantage in the coauthorial quid pro quo is based on experience, intuition, writing skills, and a pretty good nose for interesting questions.

One of the nice things about being a professor is that you can specialize in those things you are best at, and you can find collaborators that compensate for your weaknesses. In other words, being a professor is a lot easier than being a student.

Resale Price Maintenance

A classic topic in Industrial Organization is in the news. From today's Wall Street Journal (subscription required):

MSRP Case Seems to Split Justices
Rule Barring Manufacturers From Dictating Prices To Retailers Is Challenged

Hearing arguments in a case about retail prices, the Supreme Court's justices seemed divided over whether to overturn a 96-year-old antitrust ruling intended to promote competition.

In yesterday's case, Leegin Creative Leather Products of Industry, Calif., challenged the ruling, which prohibits manufacturers from requiring retailers to sell their products for a set minimum price. A Texas federal district court cited the 1911 precedent in tossing out the "resale price maintenance" policy Leegin had imposed on Kay's Kloset, a Dallas-area boutique.

Kay's Kloset, owned by PSKS Inc., brought the suit so it could sell Leegin's Brighton line of women's accessories at a discount.

Leegin's attorney, Theodore Olson, argued in briefs that discount prices "degrade" the Brighton brand. And yesterday he said forcing retailers to charge higher prices could benefit consumers by helping ensure the stores would have enough money to provide attractive services to shoppers.

Justice Antonin Scalia agreed. If the set prices give "the consumer a choice of more service at a somewhat higher price, that would enhance consumer welfare, so long as there are competitive products at a lower price," he said. Later, he said overturning the 1911 precedent could solve the "free rider problem," when "customers shop at the place that has the big showroom" to learn about a product, but then buy it at a lower price from somebody else who has not incurred that expense."

The precedent, known as Dr. Miles for the manufacturer that sought to fix retail prices of its patent medicines, helped shape the 20th-century marketplace....

The Bush administration, along with the National Association of Manufacturers and other business groups, backed Leegin. But 37 states, represented by New York, and the Consumer Federation of America urged the court to retain Dr. Miles.

Here is what my favorite economics textbook says about the topic:

Resale Price Maintenance

One example of a controversial business practice is resale price maintenance, also called fair trade. Imagine that Superduper Electronics sells DVD players to retail stores for $300. If Superduper requires the retailers to charge customers $350, it is said to engage in resale price maintenance. Any retailer that charged less than $350 would have violated its contract with Superduper.

At first, resale price maintenance might seem anticompetitive and, therefore, detrimental to society. Like an agreement among members of a cartel, it prevents the retailers from competing on price. For this reason, the courts have often viewed resale price maintenance as a violation of the antitrust laws.

Yet some economists defend resale price maintenance on two grounds. First, they deny that it is aimed at reducing competition. To the extent that Superduper Electronics has any market power, it can exert that power through the wholesale price, rather than through resale price maintenance. Moreover, Superduper has no incentive to discourage competition among its retailers. Indeed, because a cartel of retailers sells less than a group of competitive retailers, Superduper would be worse off if its retailers were a cartel.

Second, economists believe that resale price maintenance has a legitimate goal. Superduper may want its retailers to provide customers a pleasant showroom and a knowledgeable sales force. Yet, without resale price maintenance, some customers would take advantage of one store's service to learn about the DVD player's special features and then buy the item at a discount retailer that does not provide this service. To some extent, good service is a public good among the retailers that sell Superduper products. As we discussed in Chapter 11, when one person provides a public good, others are able to enjoy it without paying for it. In this case, discount retailers would free ride on the service provided by other retailers, leading to less service than is desirable. Resale price maintenance is one way for Superduper to solve this free-rider problem.

The example of resale price maintenance illustrates an important principle: Business practices that appear to reduce competition may in fact have legitimate purposes. This principle makes the application of the antitrust laws all the more difficult. The economists, lawyers, and judges in charge of enforcing these laws must determine what kinds of behavior public policy should prohibit as impeding competition and reducing economic well-being. Often that job is not easy.

Update: Here is the NY Times article on the case.

Katz vs Lazear

In yesterday's Wall Street Journal, Larry Katz takes on Eddie Lazear:

"The term 'income inequality' is a bit misleading because it suggests in a somewhat pejorative way that the rich are getting richer at the expense of the poor," Edward Lazear, a Stanford University labor economist who is now chairman of Mr. Bush's Council of Economic Advisers, said last May. While it's a concern that some people are being left behind, he said, "There is some good news...most of the inequality reflects an increase in returns to 'investing in skills.'"...

Some economists question Mr. Lazear's assertion that, for instance, raising taxes on higher-wage earners will reduce individuals' incentive to acquire new skills. Lawrence Katz, a Harvard University labor economist who served in the Clinton Labor Department, says there's "not a shred of evidence" lower taxes boost educational attainment. "That's first-order goofball."

Like Larry, I also don't know of any evidence for the impact of taxes on educational attainment. On the other hand, producing evidence would not be easy, as current taxes are less relevant for educational choice than expected future taxes. That is, in deciding how much to invest in skill acquisition, a young person would have to consider expected tax rates that would apply over the next several decades of working. Eddie's view that taxes matter for human capital accumulation seems like a plausible hypothesis. Reasonable people can disagree about the likely magnitude of the effect.

This situation exemplifies a common conundrum for policy advisers like Eddie. In the absence of hard evidence, should he act as if there is no effect, as Larry seems to be suggesting here? Or should Eddie rely on the general principle that people respond to incentives and make an educated guess about the magnitude?

In this case, as in many others, being an economist involved in the policy process is harder than being an economist in academia. Academics can easily say "I don't know" and move on to another question. Policy advisers are often required to take a position on the key issues of the day, sometimes in the absence of reliable evidence.

Update: Larry Katz emails me:

Dear Greg,

I noticed that you have a posting on the quotes from me in yesterday's WSJ piece on inequality. In fact, the quotes are taken out of context and not quite accurate based on my memory of my conversation with Greg Ip from a couple weeks ago. I know this does not affect the themes of your posting, but I do want to clarify what I believe I actually said and meant.

Most of my interview with Greg Ip of the WSJ focused on how I substantially agreed with Eddie Lazear's view that a major part of the growth of U.S. earnings inequality is driven by rising returns to skills and the interaction of sharp secular increases in skill demand combined with slower growth in the supply of skills (education) in the U.S in recent decades relative to the past.

(I actually have almost completed book on these themes with Claudia Goldin and a couple new papers making these points: here and here.)

A tiny part of my discussion with the Ip involved my reaction to the notion that cutting tax rates for top end (top 1%) earners would reduce inequality by stimulating college enrollments. The "goofball" quote is actually not about the notion that the supply of skills might be somewhat responsive to tax rates but about the notion that the main strategy for addressing the U.S. inequality problem is the lowering of marginal tax rates on the top 1% of earners. I did suggest that small increases in top marginal rates to fund a more generous or broader EITC (to expand the EITC to cover poor singles without kids) or to help with college access could have the potential to play a small role in reducing inequality without large efficiency costs (and possibly even with efficiency gains by improving work incentives versus crime incentives through a broader EITC or by helping overcome capital market/information constraints for college investments).

I also noted (and believe) that we have pretty good evidence that college entry decisions respond to the college wage premium but scant evidence on the effects of top end tax rates on college enrollment decisions. I never said anything about general educational investments and tax rates, I specifically talked about college enrollments and marginal tax rates at the very top end of the distribution.

Furthermore, I was (and am) skeptical that given the huge increases in private sector returns to skills in the past 25 years (a doubling of the college premium for young workers and even larger increases for post-college training) that modest changes in tax rates at the top end would be salient to students on the margin considering whether or not to make college investments. I suspect than college financial aid is much more salient than future top end tax rates to high school seniors on the margin of whether to invest in college. Top end tax rates are relevant for many things but those who are likely to be affected by them are not likely to be "marginal" with respect to going to and completing college.

But it is interesting how much attention one can get if one uses the phrase "goofball." I'll need to remember to use this phrase again if I actually want to get attention.

Best,
Larry

Thanks, Larry, for allowing me to share your insights.

PARIS - on the street, le marais, 03/26/07

Happy Anniversary

This blog started exactly one year ago today.

Dear readers: Please use the comments section of this post for general comments and suggestions. What do you like? What do you not like? How can the blog be improved (recognizing that resources, including my time, have opportunity costs)?

A year ago, when this started, I never would have guessed that the number of visits would now have passed 1.7 million. Thank you all for coming.

PARIS - open mic, pop in, 03/25/07

PARIS - on the street, le louvre and saint-germain-des-pr�s, 03/25/07

Is the Fed complacent?

In ec 10 over the next few weeks, we will be talking a lot about the role of inflation expectations. Over the past few weeks, Fed governors Rick Mishkin and Randy Kroszner have given talks about inflation dynamics. Both talked about inflation expectations and raised the issue of complacency on the part of the Fed:

Here is Mishkin:

if the monetary authorities were to become complacent and to think that they could get away with not reacting to shocks that, in their mistaken view, no longer have the potential to cause inflation to rise persistently, then inflation expectations would surely become unhinged again. In short, complacency that might arise from the current low inflation persistence might result in deja vu all over again and return us to an era like the Great Inflation.

Here is Kroszner:

The stability of inflation could lead to complacency. As long as inflation expectations are well anchored, actual inflation will have a natural tendency to revert to the anchor of long-run inflation expectations. Under such circumstances, policymakers may be tempted to relax their resolve in responding to potentially inflationary developments. Such relaxation could be costly, however. Inflation expectations have become well-anchored because the public has become confident that the Federal Reserve will do the right thing. But this belief will persist only as long as we on the Federal Open Market Committee continue to ratify the public�s expectations that inflation will remain low and stable. Thus, complacency would be a threat to the credibility that the Federal Reserve has worked so hard to acquire, and its loss would likely mean the reversal of many of the favorable inflation developments seen over the past two decades.

Why all this talk about complacency? Maybe, by talking about the risk of complacency, Rick and Randy are trying to tell people that they are not complacent in order to influence inflation expectations. Or maybe they are trying to persuade the other members of the FOMC to take a more hawkish stand against inflation.

Striking Health Care Fact

Tyler Cowen reports:

As of 2003, the average income of a French physician was estimated at $55,000; in the U.S. the comparable number was $194,000....Did I mention that health care is a labor-intensive industry? This is the major reason why French health care is cheaper than U.S. health care.

Eichengreen on Europe

Economic historian Barry Eichengreen has a new book on Europe. Here is a review. Here is the first chapter.

PARIS - on the street, beaubourg + arts et m�tiers, 03/24/07

Easterly on Africa

Here, as a pdf file, is development economist Bill Easterly's recent oped on Africa's poverty trap.

PARIS - born bad records party, navy club + le marais, 03/23/07

That explains it: I'm 49

Over at Slate, Joel Waldfogel writes:

While income and wealth tend to rise steadily over the life cycle, peaking around retirement, happiness follows a U-shaped age pattern....for both men and women in the United States and throughout Europe, happiness starts off relatively high in early adulthood, then falls, bottoming out on average around age 45, and then rises after that year and on into old age....In the United States, the steady decline in happiness from age 16 to age 45 has an effect that's larger than a 50 percent reduction in income�that is, happiness varies more as people get older than it does if you compare significantly richer people to poorer ones. And, equivalently, the 15-year upswing in happiness that follows age 45 is stronger than the upswing that tracks doubling of income.

Banerjee on Development

MIT economist Abhijit Banerjee writes about the new development economics in the new issue of the Boston Review. Thanks to Tyler Cowen for the pointer.

PARIS - opening of "nouvelles du monde renvers�", palais de tokyo + birthday party, l'�claireur, 03/22/07

Age 53 is optimal...

...for making financial decisions. So say David Laibson, Xavier Gabaix, John C. Driscoll, and Sumit Agarwal.

PARIS - colette 10th anniversary birtday dinner & party, hotel particulier & la scala, 03/21/07