Tyler Cowen: Regulations Hinder Development of Driverless Cars →

Here is a key passage from Tyler Cowen’s 2011 piece on driverless cars that applies to a lot more than driverless cars:

The point is not that such cars could be on the road in large numbers tomorrow, but that we ought to give the cars — and other potential innovations — a fair shot so that a prototype can become a commercial product someday. Michael Mandel, an economist with the Progressive Policy Institute, compares government regulation of innovation to the accumulation of pebbles in a stream. At some point too many pebbles block off the water flow, yet no single pebble is to blame for the slowdown. Right now the pebbles are limiting investment in future innovation.

The lesson here is the one I emphasized in my post yesterday, “Clay Christensen, Jerome Grossman and Jason Hwang on the Agenda for the Transformation of Health Care”: allowing experimentation with innovations that at first seem like lower quality ways to do things (except for their cost and convenience) is crucial to many of the economic transformations that will do the most to improve overall standards of living. Needing a path through what seems at first like lower quality is exactly what Clay Christensen means when he says that an innovation is “disruptive.” Driverless cars provide a wonderful example. Ultimately, driverless cars will be much safer than human-driven cars, since it is unlikely that the overall skill and care of human drivers will dramatically improve from where it is now, while computers and sensors for cars can continue to get better and better and better. But we will get to those driverless cars that dominate human-driven cars in all respects (except for those who find driving recreational) if right now we allow driverless cars on the road that are better than human-driven cars in some respects and worse (within reason) in other respects.

I am saying that, because they are likely to ultimately be much safer that driverless cars should be allowed even if at first they are somewhat less safe, but in fact the relevant situation is more like this. At some point driverless cars will have a good safety performance in small-scale tests, but there will be some uncertainty about how they will do in substantial numbers in real world situations on the road. Even if at that point they would in fact have a better safety record if allowed on the road, opponents will argue that the uncertainty about how they will do means they should be banned. Such a ban–and its counterparts in other domains–are a very effective method to  slow down technological progress.

Clay Christensen, Jerome Grossman and Jason Hwang on the Agenda for the Transformation of Health Care

As I said in my post “Saint Clay," I plan to feature the work of Clay Christensen and his coauthors in a slow, thoroughgoing, methodical way, much as I have featured John Stuart Mill's On Liberty. Because of its urgency in the policy debate, I will start with Clay Christensen, Jerome Grossman and Jason Hwang’s book, "The Innovator’s Prescription.” Here is how they lay out their agenda in the introduction to the book:

  1. The growth in health-care spending in the United States regularly outpaces the growth of the overall economy. Over the last 35 years, while the nation’s spending on all goods and services has risen at an average annual rate of 7.2 percent, the amount spent on health care has grown at a rate of 9.8 percent.1 As a consequence, an increasing proportion of Americans simply cannot afford adequate care. Many efforts to contain overall costs have the effect of making care inaccessible on a convenient and timely basis for all of us—even for those who can pay for it.
  2. Second, if federal government spending remains a relatively constant percentage of GDP, the rising cost of Medicare within that budget will crowd out all other spending except defense within 20 years.
  3. The third factor that engenders fear is that the burden of covering the costs of health care for employees, retirees, and their families is forcing some of America’s most economically important companies to become uncompetitive in world markets. Health-care costs add over $1,500 to the cost of every car our automakers sell, for example.
  4. The fourth frightening factor, about which few people are aware, is that if governments were forced to report on their financial statements the liabilities they face resulting from contractual commitments to provide health care for retired employees, nearly every city and town in the United States would be bankrupt. There is no way for them to pay for what they are obligated to pay, except by denying funding for schools, roads, and public safety, or by raising taxes to extreme levels.

What can be done? It isn’t easy:

Those fighting for reform have few weapons for systemic change. Most can only work on improving the cost and efficacy of their piece of the system. There are very few system architects among these forces that have the scope and power of a commanding general to reconfigure the elements of the system.
Perhaps most discouraging of all, however, is that there is no credible map of the terrain ahead that reformers agree upon and trust. They are armed with data about the past, and they have become accustomed to reaching consensus for action when the data are conclusive. But because there are no data about the future, there is no map available to convincingly show these reformers which of the pathways ahead of them lead to a dead end and which constitute a promising road to reform. And few have a sense for the interconnectedness of these pathways. As the prophet of Proverbs said, “Where there is no vision, the people perish.”
So why this book? There is little dispute that we need a system that is competitive, responsive, and consumer-driven, with clear metrics of value per dollar being spent.9 Our hope is that The Innovator’s Prescription can provide a road map for those seeking innovation and reform—an accurate description of the terrain ahead, about which data are not yet available. Much of today’s political dialogue on health-care reform centers on how to pay for the cost of health care in the future. This book offers the other half of the equation: how to innovate to reduce costs and improve the quality and accessibility of care. We don’t simply ask how we can afford health care. We show how to make it affordable—less costly and of better quality.

To preview the main message, the number one policy in order to foster progress in most any area is to make sure that new entrants, who may initially do things worse in some dimensions, but more cheaply or more conveniently than the established incumbents, have a chance to gain a foothold in the market. Then what the new entrants do has a chance to improve in quality until in the end they bring down prices even at high quality, just as personal computers, which initially were not very good, became more powerful–as well as less expensive and more convenient–than the mainframes of old (only to be challenged in turn by smartphones and tablets).

One possible reaction to this would be to object to the idea of having anyone get medical care that is cheaper and more convenient, but is otherwise of somewhat worse quality. But the result of acting as if cost does not matter is the startling fact discussed in "Another Quality Control Failure on the Wall Street Journal Editorial Page?“ that real after-tax, after-transfer income for the poorest 20% of the population has increased by 49% since 1979. As the title of my post suggests, I thought this was a mistake. But it is not. What the Congressional Budget Office did to come up with this number was to count as part of after-tax, after-transfer income the full cost of both medical care paid for by employers and medical care paid for by the government (much of it through Medicaid). If you don’t feel that the poorest 20% of the population is as much better off since 1979 as a 49% increase in income would suggest, it is an indication that all of that money spent on medical care has not gotten the value that one would think it should have been able to purchase.

Our current medical system has too few good paths for finding ways to do things more cheaply and conveniently. If we block all paths that lead even temporarily through a region of lower cost at lower quality and greater convenience, the next 35 years may see another 49% increase in the after-tax, after-transfer income of the bottom 20% of the population that hardly feels like an improvement in living standards at all, as we head toward more and more expensive medicine that is only marginally better in quality. Alternatively, we can allow disruptive innovation that will get much better quality, much lower cost and much greater convenience 35 years from now if we avoid crushing in their infancy ways of doing things that right now are much cheaper and more convenient, but slightly lower in other dimensions of quality.

Right now, many people would gladly choose lower expense and greater convenience for some types of medical care even at slightly lower quality in other dimensions, if they were allowed (by any of half of dozen different possible mechanisms) to get a true signal about the actual tradeoffs that society faces in this regard. Too often, discussion about these tradeoffs only points out the static welfare gains from helping people to incorporate the cost of various types of health care into their decisions. I am persuaded by Clay, Jerome and Jason’s arguments that the dynamic gains are much more important.

Neil Irwin: Europe Likely to Get Negative Interest Rates. What Does That Even Mean? →

This is of special interest to me because I am giving to the European Central Bank on July 7 to explain how to eliminate the zero lower bound. If the ECB has decided to go to negative interest rates, it has already crossed the political rubicon. I will argue that eliminating the ZLB is therefore politically manageable.

Note: I have organized what I have written about facilitating negative interest rates in “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide” and wrote about it recently in “Ken Rogoff: Paper Money is Unfit for a World of High Crime and Low Inflation.”

May the Best in the Human Spirit Vanquish the Worst in the Human Spirit

It has been a year and fifty days since the Boston Marathon Bombings on April 15, 2013. The day after those events, I posted this wish:

May the best in the human spirit vanquish the worst in the human spirit.

That wish is also appropriate to the the massacre of protestors in Tiananmen Square in 1989, which–still unrepented of by the leaders of China–casts a dark shadow over China 25 years later today. (In Chinese, this is called “The June Fourth Incident,” although the crackdown began on June 3, 1989.)

As I noted in the Quartz column I published yesterday, “The Man in the Tank: It’s time to honor the unsung hero of Tiananmen Square,” the best in the human spirit is evident not only in the courage of “Tank Man,” but also in those in the tanks, who showed unwillingness to drive over the top of him.     

Thanks to Josiah Neeley for reminding me of this photo in this tweet. I have usually seen the cropped photograph. Above is the uncropped version.

The Man in the Tank: It's Time to Honor the Unsung Hero of Tiananmen Square

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Here is a link to my 48th column on Quartz “The Man in the Tank: It’s Time to Honor the Unsung Hero of Tiananmen Square.” In addition to my editor, Mitra Kalita, I want to thank my father, Edward Kimball, for excellent editorial suggestions in putting together this column.  

The Tiananmen Square Massacre is an event well-deserving in its infamy of a two-day memorial. Tomorrow’s post will also remember.

Moises Velasquez-Manoff: What Happens When the Poor Are Given a Stipend? →

This was a very interesting natural experiment. I will copy out some key passages below, but I think you will want to read the whole thing at the link above.

When the casino opened, Professor Costello had already been following 1,420 rural children in the area, a quarter of whom were Cherokee, for four years. That gave her a solid baseline measure. Roughly one-fifth of the rural non-Indians in her study lived in poverty, compared with more than half of the Cherokee. By 2001, when casino profits amounted to $6,000 per person yearly, the number of Cherokee living below the poverty line had declined by half.

She’d started her study with three cohorts, ages 9, 11 and 13. When she caught up with them as 19- and 21-year-olds living on their own, she found that those who were youngest when the supplements began had benefited most. They were roughly one-third less likely to develop substance abuse and psychiatric problems in adulthood, compared with the oldest group of Cherokee children and with neighboring rural whites of the same age.

The money, which amounted to between one-third and one-quarter of poor families’ income at one point, seemed to improve parenting quality. …

Many Cherokee worked “hard and long” during the summer, she told me, and then hunkered down when jobs disappeared in the winter. The supplements eased the strain of that feast-or-famine existence, she said. …

Mostly, though, the energy once spent fretting over such things was freed up. That “helps parents be better parents,” she said.

Maternal warmth can seemingly protect children from environmental stresses, however; at least in these communities, parenting quality seems to matter more to a child than material circumstances. On the other hand, few parents managed high levels of nurturing while also experiencing great strain. All of which highlights an emerging theme in this science: Early-life poverty may harm, in part, by warping and eroding the bonds between children and caregivers that are important for healthy development.

Timothy Dolan: The Pope's Case for Virtuous Capitalism

Cardinal Timothy Dolan is the Catholic Archbishop of New York, and was President of the United States Conference of Catholic Bishops from 2010–2013. So Timothy’s interpretation in his May 22, 2014 Wall Street Journal op-ed, The Pope’s Case for Virtuous Capitalism of what Pope Francis has said about capitalism is of some interest.

Defending Capitalism. In his op-ed, Timothy make this strong statement in capitalism’s defense:

… the answer to problems with the free market is not to reject economic liberty in favor of government control. The church has consistently rejected coercive systems of socialism and collectivism, because they violate inherent human rights to economic freedom and private property. When properly regulated, a free market can certainly foster greater productivity and prosperity.

And he writes that “The spread of the free market has undoubtedly led to a tremendous increase in overall wealth and well-being around the world.” Further, “One does not have to subscribe uncritically to the notion that ‘a rising tide lifts all boats’ to acknowledge that all people, including the poor, benefit from a general increase in the overall wealth of society.”

Why then does capitalism often have a bad name, and why does Pope Francis sometimes sound as if he is speaking against Capitalism? Timothy writes:

… what many people around the world experience as “capitalism” isn’t recognizable to Americans. For many in developing or newly industrialized countries, what passes as capitalism is an exploitative racket for the benefit of the few powerful and wealthy. Americans must remember that the holy father is speaking to this world-wide audience.

In other words, it isn’t American capitalism that is the problem, it is what passes for “capitalism” in countries that have not yet fully passed the acid test of true capitalism: making the people of a country rich, at least on average.

In this passage, Timothy even sounds like an economic libertarian:

The church believes that prosperity and earthly blessings can be a good thing, gifts from God for our well-being and the common good. It is part of human nature to work and produce, and everyone has the natural right to economic initiative and to enjoy the fruits of their labors.

But this should not be overinterpreted, since he also writes “abundance is for the benefit of all people” and

Fortunately, few people subscribe to an inhumane philosophy of radical economic individualism, and even fewer consider the “Wolf of Wall Street” to be a good role model.

The Duty to Take Care of the Poor. Timothy condemns fraud, which I hope even the most ardent apologist for unfettered capitalism would not try to justify. Beyond that, to the extent capitalism needs to be tempered, it is in order to take care of the poor and downtrodden, something that is also a central Supply-Side Liberal imperative, as I recently wrote in my second anniversary post “Three Revolutions." Timothy states the imperative of taking care of the poor and downtrodden in these three passages:

1. … Pope Francis is certainly correct that "an important part of humanity does not share in the benefits of progress.” Far too many people live in poverty and have few opportunities to achieve prosperity. And so the pope, and many others, are deeply concerned about the development of a “throwaway culture,” an “economy of exclusion” and a “culture of death” that corrode human dignity and marginalize the poor.

It is in this context that the holy father’s earlier criticism of “trickle-down economics” can be properly understood.

2. But the church certainly disapproves of any system of unregulated economic amorality, which leaves people at the mercy of impersonal market forces, where they have no choice but to sink, swim or be left with the scraps that fall from the table. That kind of environment produces the evils of greed, envy, fraud, misuse of riches, gross luxury and exploitation of the poor and the laborer.

3. The great Renaissance humanist Erasmus once said, “He does not sail badly who steers a middle course.” This advice would be well worth keeping in mind. By maintaining a sound middle course on economic issues, Pope Francis is able to remind us that free economic activity should indeed be pursued, but the human dignity of our needy brothers and sisters must always be at the center of our attention.

Minimizing the Need for Government Control by Realizing that Most People Do Care, and Can Be Encouraged to Care More. If government control is not the answer, then how will the poor be taken care of? Timothy emphasizes the kind of altruism that motivates voluntary efforts to help the poor. He is not clear about when a failure of individual altruism to take care of the poor would justify government intervention. My answer is a public contribution system that insists that those who are well off do in fact contribute to public goods, including especially taking care of the poor, but allows individuals to choose within broad parameters exactly how they will contribute to public goods. (Ordinarily, those contributions would be made through the nonprofit sector. A few might choose to give to particular arms of the government. This is not a libertarian solution, since if someone in the relevant income range refused to make contributions–which few would–they would be taxed the equivalent amount.) I believe such a system would be much less distortionary than the equivalent in taxes because most people really do care about others. In addition to creating less distortion, and allowing for creativity (and therefore technological progress) in providing public goods, one of the great advantages of a public contribution system is that, over time, it will encourage people to strengthen their altruism and public-spiritedness. They may grumble at the requirement to contribute, but then their minds will soon turn to the choice of exactly which cause to contribute to, and many will come to love the causes they have chosen and the people they are able to help with their contributions.

Although I am much too small a fish for Timothy to be likely to take any notice of my proposal without support from heavier hitters, I hope that if he did become aware of it, that he would favor the kind of public contribution system I am advocating. Although direct contributions to churches would not be part of this system, associated humanitarian organizations, such as Catholic Relief Services, would be included (with the usual fights about whether church-associated humanitarian organizations are pushing religion too much in the course of their humanitarian activities). I believe that a public contribution system would do a lot to foster exactly the kind of virtues that Timothy calls for. I want you to consider that as you read these passages:

1. From media reports, one might think that the only thing on the pope’s mind was government redistribution of property, as if he were denouncing capitalism and endorsing some form of socialism. This is unfortunate, because it overlooks the principal focus of Pope Francis’ economic teaching—that economic and social activity must be based on the virtues of compassion and generosity.

2. … as the pope continually emphasizes, the essential element is genuine human virtue.

3. The church has long taught that the value of any economic system rests on the personal virtue of the individuals who take part in it, and on the morality of their day-to-day decisions. Business can be a noble vocation, so long as those engaged in it also serve the common good, acting with a sense of generosity in addition to self-interest.

4. … Pope Francis recalled the story of Zacchaeus, in which Jesus inspires the repentant tax collector to make a radical decision to put his economic wealth at the service of others. This reminds us that a spirit of sharing and solidarity with others, in the words of Francis, “should be at the beginning and end of all political and economic activity."

In his final paragraph, which I will not quote here, Timothy loses focus. To summarize the message I want to get across, I instead like Timothy’s third-to-last paragraph:

In other words, virtuous people, acting justly, compassionately and honestly, are the foundation of good economic or business activity that can produce prosperity for all, and not just for a few.

Corbett Schmitz: Should Social Security Switch to a Defined Contribution Plan?

This is a guest post by my “Monetary and Financial Theory” student Corbett Schmitz. Corbett’s answer is “Yes.” Corbett argues his case well.

One issue Corbett does not address is the effect of a shift to a defined contribution plan on the amount of redistribution in social security. There, it is important to recognize that social security has much less redistribution in it than most people assume. Except at the very bottom, what redistribution seems to be there in the size of the benefit check is offset to a surprisingly large percentage by the fact that richer people tend to live longer, and therefore tend to draw on Social Security for a longer time. 

Just recently, I had the opportunity to have dinner with my dad. Given our mutual interests, our conversation naturally drifted towards finance. My dad playfully joked how excited he is to start receiving pension checks in just a few years. Even though these checks will be small, I responded jealously; when I start working this fall, there will be no pension program waiting.

This shift away from pension programs is not unique to my father and me. Over the last 40 years, many employers have switched away from pension retirement plans (more generally called defined benefit (DB) plans), for defined contribution (DC) plans (like 401K’s). Under DB plans, employers pay a predetermined amount of cash to former employees after those employees reach retirement age. Under DC plans, employers set aside a certain amount of money each year to assist employees in developing a retirement savings account. As the graph below shows, the shift away from DB plans to DC plans has been staggering. Since 1979, for employees lucky enough to have corporate-sponsored retirement plans, enrollment in DB plans has dropped 57% while enrollment in DC plans has grown 55%.

This transition to DC plans is largely due to an increase in life expectancy rendering DB plans unsustainable (ie: as people live longer they collect benefits longer, increasing the onus placed on firms and requiring progressively more cash to fund DB plans). This year, the Society of Actuaries released new life expectancies for the first time since 2000. In the last 14 years, men’s life expectancy has grown from 82.6 years to 86.6 and women’s has grown from 85.2 years to 88.8.  Driven by increases in technology and better health care, this upward trend is only expected to increase.  Prior to this revision of life expectancy, outstanding private sector liabilities related to DB plans hovered around $2 trillion. After this revision, these liabilities are expected to grow at least another 7%, bringing outstanding liabilities to $2.14 trillion, which represents over 13% of US GDP!

As anyone familiar with a balance sheet knows, liabilities must be paid, and doing so is no easy task. Considering that life expectancy is expected to grow further, it’s not surprising that firms are switching to DC plans from DB, as doing so helps reduce total liabilities. Specifically, the switch to DC from DB helps reduce liabilities by shifting investment risk away from firms and to retirees. Under a DB plan, firms are responsible for paying a set amount of retirement income in the future. To generate this future outflow, firms invest cash now, hoping it will grow enough to fund the promised pension payments. Unfortunately, very few firms invest enough to meet the entire defined benefit payment, as most firms assume unrealistically high returns when making investments. Doing so causes many firms to drastically underfund their DB plans, generating enormous liabilities (with potentially crippling consequences) in the process. In contrast, a DC plan is much more sustainable because it does not promise any future cash payments, and therefore does not create any liabilities. Rather, a DC plan only requires firms to presently invest cash on behalf of its employees, with the future retiree bearing the investment risk.

Does this mean that the switch from DB to DC is a bad thing for retirees? After research, I believe it’s a wash. That said, I did find some strong evidence suggesting that, under the right circumstances, DC plans can offer higher returns than DB. A study by Dartmouth College found that the typical DC 401K-retirement plan, “provides an expected annuitized retirement income that is higher across nearly every point in the probability distribution than the typical defined benefit plan.”

If you check my sources, however, you’ll see that this study was performed before the Great Recession, when the market collapse took a huge toll on many nest eggs. But even with such a dramatic downturn, DB and DC plans still perform similarly; over the last ten years, DB benefits have only outperformed DC plans by 0.86%. Furthermore, most of this underperformance is due to a failure of individuals to make maximum contributions to their plan.

Based on this data, I should be indifferent between DB and DC plans because I know my retirement income will be similar under both optionsHowever, I am largely in favor of DC plans because they eliminate the liabilities associated with DB payments. So how is this conclusion relevant to social security? Personally, I believe a gradual shift from government-sponsored DB payments (ie: social security payments) to government-mandated DC contributions could help solve social security’s sustainability issue.

According to the Heritage Foundation, the expected insolvency date of social security is approaching faster and faster; in the last five years, this date has declined 8 years and is currently set at 2033. However, given current conditions, the Heritage Foundation predicts that insolvency could come as early as 2024 (when originally started, social security was designed to remain solvent until 2058). Given that social security represents 22% of the US federal budget, insolvency is no trivial issue, and reform is needed sooner rather than later.

I propose that this reform should include a switch from a DB plan to a DC plan. While social security payments should remain intact for current and soon-to-be beneficiaries, I believe that social security tax should gradually be replaced with a social security “withholding.” For example, if social security tax is currently 10% of income, I propose it should be reduced to 5% of income in, let’s say, ten years. In those ten years, the social security withholding should grow to 5% of income. Eventually, social security tax should fall to 0% of income and be replaced entirely by the withholding (Personally, because I think savings is so important, I think that this withholding should ultimately represent a higher percentage of income than social security tax ever has or will).

Like a 401K contribution, I propose that this withholding should be invested, tax-free, in a retirement account on an individual basis. Essentially, this withholding is equivalent to automatic-enrollment in a government-mandated 401K plan. As individuals continue to work, instead of paying taxes to fund social security, they will pay withholdings to help fund their own retirement.

With respect to investment decisions, the government should have a default option requiring individuals to purchase relatively safe, well-diversified indexes (like a global fund). If individuals would like, they should be allowed to invest up to half of their withholdings on indexes of their choice (I limit investment to indexes because, as Malkiel makes obvious in A Random Walk Down Wall Street, indexes are the safest way to make money. On average, even professional money mangers cannot outperform indexes that track the aggregate market). Once individuals reach retirement age (ie: the age they would have qualified for social security) they can begin making withdrawals from this retirement account.

My proposed plan has some similarities to George W. Bush’s proposal of private savings accounts in early 2000. Under the most successful of Bush’s privatization proposals, taxpayers could divert 4% of taxable wages or a maximum of $1000 from FICA payments to fund personally managed retirement accounts. These contributions would not replace, but rather would offset, social security’s existing DB payments. Workers would then have the option to invest their private accounts in 5 different funds.

The key difference between my proposal and Bush’s proposal is the long-term implications for social security. Bush’s proposal aimed to prolong, not eliminate, the insolvency date of social security by offsetting social security’s DB payments with some DC payments. In contrast, my plan proposes a gradual but complete transition of social security from a DB plan to a DC plan, thereby rendering insolvency irrelevant.

While my plan is not perfect, I believe it effectively addresses the sustainability of social security by gradually eliminating government-paid DB benefits. Furthermore, it forces individuals to save for retirement by replacing a significant portion of their taxable income with government-mandated savings. I believe this system, by eliminating the liabilities related to DB retirement plans, is much more sustainable than social security, and it has the double-benefit of encouraging savings and investment literacy. As always, I welcome any and all suggestions as we collectively try to address the issue of social security sustainability.

Update by Miles: I had a Twitter exchange with Andrew Burton about financing the transition, where I was thinking of the capital budgeting principles you can see in “Capital Budgeting, the Powerpoint File.” In addition, Gary Burtless gives some great comments on the Facebook version of this post.

Gary Burtless: First off, I think Mr. Schmitz is wrong about this: “This transition to DC plans is largely due to an increase in life expectancy rendering DB plans unsustainable.” The shift was due instead to (#1) ERISA’s requirement that employers fund their DB plans and pay for insurance in the event the employer entered bankruptcy with an underfunded plan; and (#2) Employers’ recognition of the risks they were taking on by guaranteeing future annuities with risky assets (60% equities). The rise in longevity has been underway for 100 years, and there have been no surprises since the early 1980s, when the phase-out of DB plans got underway.

Second, I think Mr. Schmitz is probably wrong about the potential welfare gain from converting Social Security from a DB to a DC plan. Rising longevity is essentially irrelevant in thinking about this question. I suspect the great majority of working citizens prefer DB to DC pensions, because they believe their retirement incomes will be more predictable (and they like that predictability). While individual employers, including private, municipal, and county government employers, cannot guarantee future DB pensions, the U.S. government can (at least up to a limit) given its ability to tax residents, few of whom are likely to move out of the country to avoid this tax. In other words, whereas it may be hard for the overwhelming majority of individual employers to guarantee future DB pensions without backing that guarantee with very, very safe (and low return) assets, it is easier and more credible for our national government to do the same thing. In light of the fact that workers seem to prefer DB over DC-style pensions, why shouldn’t rational citizens support national provision of such pensions? I think polling evidence supports the idea that U.S. citizens strongly favor continuation of Social Security as it currently exists, that is, as a DB plan, even if they have to pay higher payroll taxes to maintain the system. My guess is that converting the system to a DC plan, and reducing the assurance of a (semi-) guaranteed flow of future benefits, would reduce rather than increase worker and citizen welfare.

My answer there is this: “The government definitely has a comparative advantage in providing annuities, but it could do so in a market way.” What I have in mind is that on its liability side, in addition to Treasury Bill’s, the US Sovereign Wealth Fund I advocate should provide a variety of different kinds of annuities at prices that give the taxpayers implicitly providing those annuities a fair shake. See

Ken Rogoff: Paper Money is Unfit for a World of High Crime and Low Inflation

The day when the zero lower bound is finally eliminated continues to inch closer. Ken Rogoff–who is not only a deep-thinking economist, but continues to be a policy heavyweight despite the weak hand he and Carmen Reinhart made the mistake of playing in relation to national debt and economic growth–has come out in favor of eliminating the zero lower bound.  He followed up a new NBER Macroeconomics Annual Chapter “Costs and Benefits to Phasing Out Paper Currency” with a May 28, 2014 article in the Financial Times: “Paper money is unfit for a world of high crime and low inflation.” Ken’s argument is straightforward:

Has the time come to consider phasing out anonymous paper currency, starting with large-denomination notes? Getting rid of physical currency and replacing it with electronic money would kill two birds with one stone.

First, it would eliminate the zero bound on policy interest rates that has handcuffed central banks since the financial crisis. At present, if central banks try setting rates too far below zero, people will start bailing out into cash. Second, phasing out currency would address the concern that a significant fraction, particularly of large-denomination notes, appears to be used to facilitate tax evasion and illegal activity.

As disadvantages of eliminating paper currency, Ken lists loss of seignorage and loss of anonymity where anonymity might be socially valuable in allowing personal experimentation that does not harm others. On both of those counts, keeping paper money in a subsidiary role can avoid these disadvantages. In particular, if paper currency is allowed to depreciate in relation to electronic money, it is possible to have seignorage without inflation, since if there is no inflation relative to the electronic money that serves as the unit of account, inflation relative to paper money is not really inflation at all.

Ken gives appropriate credit to Willem Buiter for working out theoretically the basic options of eliminating the zero lower bound:

The idea of finding creative ways to get around the zero bound on interest rates has been championed for more than a decade by Willem Buiter, a former UK Monetary Policy Committee member. Phasing out paper currency is by far the simplest. With electronic payments mechanisms becoming increasingly prevalent even in small transactions, and with the supply of paper currency overwhelmingly top-heavy with large-denomination notes, the case for keeping the currency status quo has weakened.

In my own recognition of Willem’s contributions, Willem appears as “Willem the Wise Warlock” in “The Story of Ben the Money Master.” (See also “Henrik Jensen: Willem and the Negative Nominal Interest Rate”

Ken argues that, of the options Willem lays out “Phasing out paper currency is by far the simplest.” Simplest is not necessarily best in this case. Although phasing out of paper currency may well be the ultimate destination for our monetary system, I continue to believe that at least as a transitional phase, it is attractive to start with monetary system that is as close as possible to the current system, consistent with eliminating the zero lower bound: the system I have written about repeatedly, in some detail, and have been explaining at central banks around the world.

Once the zero lower bound has been eliminated with a system as much like the current monetary system as possible, it is easy, if desired, to make a transition toward less use of paper currency by allowing paper currency to depreciate without ever appreciating it back to par. The quicker the depreciation of paper currency, the bigger the tax on activities that depend on then anonymity of paper currency–many of which (like criminal activity) do indeed deserve to be taxed. The higher the tax on paper currency (that is, the quicker the depreciation), the closer the monetary system would approximate the abolition of paper currency.

Note: Negative interest rates themselves are not a tax. When interest rates are negative, the money paid by the lender as a “carry charge” goes to the borrower, not the government. But setting a paper currency interest rate below the central bank’s target interest rate is a tax. In the system I have been advocating, the tax on paper currency is actually less than under the current system, since (a) inflation would be lower and (b) there would only be negative interest rates on paper currency when the central banks’ target rate was also negative, and the paper currency interest rate would be kept very close to the target interest rate during that period of negative rates.)

Three Revolutions

Today it has been two years since my first post: “What is a Supply-Side Liberal?"  My first anniversary post, ”A Year in the Life of a Supply-Side Liberal,“ provides an introduction to this blog and tells of the exhilarating experience of my first year of blogging. Today, I wanted to talk about some of the pictures in my mind of possible futures that keep me going.  

As for the blog itself, one of my standards of excellence for an independent economics blog is Tyler Cowen and Alex Tabarrok's Marginal Revolution blog. Day after day, Tyler and Alex give people reason to come back and learn more. Their tagline to explain their title "Marginal Revolution” is “Small Steps Toward a Much Better World.” Although there would have to be many small steps along the way to each of these, I tend to think of the revolutions I want to see happen in a more discrete way. Let me talk about three revolutions I hope to see, in order of how fast I think they could happen. 

1. The Electronic Money Revolution. The world’s attempts at economic stabilization since 2008 have left much to be desired. The main reason has been the partial crippling of monetary policy due to the difficulties of making interest rates negative when paper currency guarantees to all an interest rate of at last zero (minus storage costs). This difficulty is called the zero lower bound. Since I published “How Subordinating Paper Currency to Electronic Money Can End Recessions and End Inflation” in November 2012, I have been writing and traveling the world speaking to spread the word that the zero lower bound is a policy choice, not a law of nature. I argue that it is a bad policy choice. The benefits of economic stabilization without needing to have long-run inflation far outweigh the inconveniences of dealing with negative interest rates and an exchange rate between paper currency and electronic money that is sometimes away from 1-for-1.

I have collected links to everything I have written about eliminating the zero lower bound in my post “How and Why to Eliminate the Zero Lower Bound: A Reader’s Guide.” On why to eliminate the zero lower bound, let me recommend

On how to eliminate the zero lower bound, let me recommend this presentation that I have given in various versions at the Bank of England, the Bank of Japan, Japan’s Ministry of Finance, Danmarks Nationalbank, the Banque de France, the Federal Reserve Board, and the US Treasury:

I have seminars scheduled in July at the ECB, the Bundesbank, the Banca D'Italia and the Swiss National Bank. In addition to the posts above, this presentation relies on what I say in these fairly technical posts:

I believe a transition to a monetary system based on electronic money that avoids creating a zero lower bound is almost inevitable. The electronic money revolution will happen. The question is when. The more people there are who understand the principles and reasoning involved, the quicker that day will come. Some countries may lag behind, but some country will lead the way.

2. The Supply-Side Liberal Revolution.  Posts about policies to foster economic growth, while taking care of the poor, are the heart of this blog, as you can see from looking down my list of most popular columns and posts. For economic growth, beyond the basics I wrote about in “The Government and the Mob,” the key policies are those I wrote about with Noah Smith in “One of the Biggest Threats to America’s Future Has the Easiest Fix” (followed up by “Capital Budgeting: The Powerpoint File”), the kind of individual effort Noah and I recommended in “There’s One Key Difference Between Kids Who Excel at Math and Those Who Don’t” and blocking attempts to squash the kind of disruptive innovation that Clay Christensen talks about. (See my post on Monday: “Saint Clay.”)  It also doesn’t hurt to understand the key role that knowledge plays in economic growth, something I talk about in my post “Two Types of Knowledge: Human Capital and Information." 

For taking care of the poor, many of the key issues are political. First, as I argue in "Inequality Aversion Utility Functions: Would $1000 Mean More to a Poorer Family than $4000 to One Twice as Rich?” it is crucial not to be distracted by a fascination with the division of wealth and income between the middle class and the rich from the primary task of taking care of the poor. Besides a safety net focused on helping the poor rather than unsustainably trying to give large amounts of money to the middle class, key policies to help the poor are 1. more open immigration, 2. job freedom, and 3. school reform:

  1. The Hunger Games is Hardly Our Future: It’s Already Here
  2. When the Government Says “You May Not Have a Job”
  3. Magic Ingredient 1: More K-12 School.

One key to sustainably getting resources for helping the poor is to do it in a way that causes the fewest economic distortions. In addition to focusing on the right kinds of taxes, to the extent that there must be taxes, I believe that there is great potential in the kind of public contribution system that I talk about in the links in my post “The Red Banker on Supply-Side Liberalism."  People often hate taxes, so they try to avoid them. Those efforts at tax avoidance are a social waste. So it makes sense to get many of the resources for helping the poor from public contributions that people won’t want to avoid as much as taxes, and that allow those contributing to be creative in making the world a better place. The creativity and flexibility fostered by a public contribution system are also bound to lead to technological progress in ways to help the poor. 

3. The Heroic Revolution. By making the right choices, anyone can be a hero in the sense of making the world of the future a significantly better place than it otherwise would have been. For many, the objective of making the world a better place takes on a religious flavor, as it does for me (though for me in a resolutely non-supernaturalist way). See for example my sermons

 and see Noah’s wonderful religion guest post

But regardless of one’s views on religion, hope and faith that one can make things better is the key to actually making things better. This is a principle I write about in

There are reasons to have hope that one can make the world a better place. The most basic is the argument that all it takes is to durably convince the younger generation that there is a better way:

But there also the power of gratitude, as I write of in

However, in the end, our success at making the world a better place will depend crucially on our ability to see clearly what is better and what is worse. Whatever its flaws, and despite all the ways it goes astray, religion has something to say about this. But so does the economics of happiness–in particular the work drawing on the intuitions of many people about what "better” means that I write of in

Summing Up. I believe in the potential of the blogosphere to change the world. I hope my view of the good of our noble species and the rest of the universe is clear enough that I am pushing in the right direction rather than in the wrong direction. My gut-level reaction to partisan politics in the United States is that enormous time and effort is wasted by Republicans and Democrats as they cancel each other out in opposition to one another. A key source of this wasted effort is that people are much too quick to assume they know the right direction to go. Many partisans assume they know the right direction to go, despite failing to undertake thoroughgoing discussions according to the principles of open, heated, but respectful discussion laid out by John Stuart Mill. (Those principles are familiar to those of you who follow my every-other-week series of posts on John’s book On Liberty, such as "John Stuart Mill’s Brief for Freedom of Speech.“) The blogosphere can help forward that kind of discussion, and get us a little closer to the truth.

Matthijs Lof and Tuomas Malinen: The Growth and Sovereign Debt Correlation →

It is close to the anniversary of the revelations of problems in the Reinhart and Rogoff data, which also inspired many substantive reanalyses. The article linked above cites my column with Yichuan Wang, “After Crunching Reinhart and Rogoff’s Data, We Found No Evidence High Debt Slows Growth.” For more links, see my followup column with Yichuan: “Examining the Entrails: Is There Any Evidence for an Effect of Debt on Growth in the Reinhart and Rogoff Data?”

See also Salim Furth’s article “Reinhart, Rogoff and the Spreadsheet Error a Year Later,” noting how few economists seem to have publicly admitted to changing their minds. In a tweet, Salim specifically exempts me from that criticism, in view of my column “An Economist’s Mea Culpa: I Relied on Reinhart and Rogoff” and my work with Yichuan, inspired in part by my chagrin at my mistake.

Saint Clay

Update: Here is a link to my sub-blog of posts about Clay’s work. 

There are many Supply-Side Liberal Heroes (1, 2, 3, 4, 5, 6, and with some additional fortitude, 7), but up until now, there was only one declared Supply-Side Liberal saint: Adam Smith, the Patron Saint of Supply-Side Liberalism. (Since July 30, 2012 no one has ventured a serious devil’s advocate case about Adam Smith.) Today, I want to declare another: Clay Christensen. To be a Supply-Side Liberal Saint, one must be both a Supply-Side Liberal hero and of unimpeachable character.

From conversations, I have found that Clay Christensen is not well known among economists, but he should be. First of all, in our sister field of business, Clay is at the very top. For example, in November 2013, Clay won the award for top management thinker in the world for the second time in a row in the once-every-two-years Thinkers50 award. Andrew Hill described it this way in the Financial Times: 

But the climax was Thinkers50′s “Best Picture” award – for the management thinker judged most influential – which went to Clayton Christensen, author of The Innovator’s Dilemma and perhaps the nicest man ever to lecture at Harvard Business School.

Second, Clay’s theory of disruptive innovation counts as powerful economic theory that explains much about the world we live in. There is a rigor to it that goes far beyond all the other bits of management theory I have encountered. But it is reading his books that will convince you. Here is not only great insight, but also helpful approaches to many of our most pressing problems. In the last few months I have devoured this much of his body of work:

All of that is enough to make Clay a hero, but how does Clay pass the devil’s advocate’s gauntlet to be made a saint? That is, how can I be so confident I won’t be embarrassed by a future revelation about some skeleton in Clay’s closet? First, as you can see from the quotation above, many people think Clay is one of the nicest men they have ever met. I am among them. Back in 1977, when I was headed to Harvard as a freshman, and Clay was headed to the first year of his MBA program,  I carpooled across the country from Utah with him, and then stayed with him for a week or so until I could get into my new dorm room. That time with Clay made an unforgettable impression on me. I had no idea how eminent he would become, but I knew how good he was. I have hardly seen Clay since then, and haven’t had any serious conversations with Clay since 1977, but other observers (including my daughter, Diana, who was a student in his class in the second year of her MBA program) still attest to his goodness. And I have the advantage of the vetting he has undergone for relatively high office in the Mormon church, which screens for many types (though not all types) of sins.

In the coming months (which may stretch into years given the volume of his work) I plan to feature the work of Clay and his coauthors in a slow, thoroughgoing, methodical way, much as I have featured John Stuart Mill's On Liberty. Like On Liberty, Clay’s work is worth cutting to pieces–blog-post-sized morsels, ready for delectation.

Schumpeter: Digital Disruption on the Farm | The Economist →

It is always good to see real-world examples of technology shocks. Here are some key excerpts from this article:

Farmers can be among the most hidebound of managers, so it is no surprise that they are nervous about a new idea called prescriptive planting, which is set to disrupt their business. In essence, it is a system that tells them with great precision which seeds to plant and how to cultivate them in each patch of land. …

Prescriptive planting is catching on fast. …

The benefits are clear. Farmers who have tried Monsanto’s system say it has pushed up yields by roughly 5% over two years, a feat no other single intervention could match. The seed companies think providing more data to farmers could increase America’s maize yield from 160 bushels an acre (10 tonnes a hectare) to 200 bushels—giving a terrific boost to growers’ meagre margins. …

Farmers might be expected to have mixed feelings about the technology anyway: although it boosts yields, it reduces the role of discretion and skill in farming—their core competence. However, the bigger problem is that farmers distrust the companies peddling this new method. They fear that the stream of detailed data they are providing on their harvests might be misused. Their commercial secrets could be sold, or leak to rival farmers; the prescriptive-planting firms might even use the data to buy underperforming farms and run them in competition with the farmers; or the companies could use the highly sensitive data on harvests to trade on the commodity markets, to the detriment of farmers who sell into those markets.

I view aggregate technology shocks as primarily representing the steep part of an S-shaped adoption curve for a technology. As such, most aggregate technology shocks should be predictable in advance if the natural logarithms of [(market share/ (1 - market share)]  for promising techniques are graphed against time. (Such graphs are something Clay Christensen and coauthors recommend to predict the future course of disruptive innovations. Watch for my post on Clay Christensen, tomorrow morning, at half-past midnight EDT.)

 

Another Quality Control Failure on the Wall Street Journal Editorial Page?

Crucial Update: Donna D'Souza, who worked with me on an electronic money storybook, tweeted the CBO document to which Neil Gilbert refers in claiming that the bottom quintile’s average disposable income us up 49% since 1979: page 18 here. But she also tweets that, puzzlingly, the CBO numbers for bottom-quintile income growth from 1979 to 2007 are much lower at 18% as you can see here. It seems unlikely that the real disposable income of the bottom quintile has shot up dramatically in the last 7 years without all of us noticing. Like Donna, I would be glad for any clarification of what is going on. 

Donna’s Clarification: Donna tweets that on closer study of the CBO’s documents, what happened is that the CBO recently (since 2007) started to include more fully the value of government-provided health insurance, such as Medicaid. The bottom line, I think, is that to the extent the bottom quintile can be said to have 49% higher real disposable income now than in 1979, more than all of the increase in imputed disposable income is in the increased value of the medical care that they get.  

On December 31, my post “The Wall Street Journal’s Quality-Control Failure: Bret Stephens’s Misleading Use of Nominal Income in His Editorial “Obama’s Envy Problem” amplified David Beffert’s tweet that the Wall Street Journal had let Bret Stephens inappropriately use nominal income figures to suggest that the middle class has seen truly dramatic economic improvements over the last few decades. He wrote:

Besides which, so what? In 1979 the mean household income of the bottom 20% was $4,006. By 2012, it was $11,490. That’s an increase of 186%. For the middle class, the increase was 211%. For the top fifth it’s 320%. The richer have outpaced the poorer in growing their incomes, just as runners will outpace joggers who will, in turn, outpace walkers. But, as James Taylor might say, the walking man walks.

Paul Krugman further amplified our complaint at this serious misuse of statistics in his post "Disinformation on Inequality.” 

I followed up later with the post “Bret Stephens and Paul Krugman: What Should a Correction Look Like in the Digital Era?” talks about how Paul Krugman further amplified this complaint. Since then, I have noticed that as I recommended, the Wall Street Journal does seem to be posting corrections at the end of the online version of the original article, where it is easier for those who most need to know about the correction to see it.

Although the numbers are not ones that would suggest a use of nominal income, the numbers Neil Gilbert's op-ed piece “The Denial of Middle-Class Prosperity” in the May 16, 2014 Wall Street Journal seem very far off to me–perhaps indicating another serious quality-control failure on the part of the Wall Street Journal. Neil writes:

Countless reports now claim that the middle class is being crushed by inequality, declining mobility and diminishing income. A closer look at the facts suggests otherwise: Members of America’s middle class are better off than they were 30 years ago, and they live much more comfortably than counterparts in other countries.

The problem with the research showing middle-class stagnation is that it looks at market incomes, which exclude taxes, government transfers and adjustments for household size. Market income is an accurate gauge of employment compensation but a misleading way to consider a family’s financial resources. It overlooks the welfare state’s enormous power to redistribute income.

The Congressional Budget Office’s 2011 report on income inequality trends offers a more precise accounting, dispelling the notion that the past three decades have been characterized by the rich getting richer at the expense of the poor while the middle class stays about the same. The CBO adjusts market income by subtracting taxes and adding the cash value of social benefits. When households are then divided into five equal income groups, the data reveal that average disposable household income has increased across all groups since 1979. The average household income grew by 40% for the middle quintile and increased by 49% for the bottom quintile.

The numbers I am familiar with suggest that at the bottom, things have gotten a bit worse in the last few decades before fringe benefits are taken into account and marginally better if the increasing value of fringe benefits (especially medical benefits) is added in. Neil emphasizes income after taxes and transfers, but I just don’t see taxes and transfers as having become so much more redistributive since 1979 that they could generate the 49% increase in the average disposable income of the bottom quintile since 1979. Thus I suspect some non-random error is at work on Neil’s and the Wall Street Journal's part.

Amanda Foreman: When Justice Drowns in Law →

I agree with what Amanda says about the damage done when laws are written in an attempt to micromanage things–as many laws now are. Here are some key excerpts:

1. In “The Federalist Papers,” No. 62, James Madison warned his readers against drawing up laws that were unnecessarily dense or complicated: “It will be of little avail to the people…if the laws be so voluminous that they cannot be read, or so incoherent that they cannot be understood.”

2. “The more laws,” Cicero said, “the less justice.”

3. Palmerston replied, “Well, you know, we have been adding a great many laws to the Statute Book every year, and we can’t go on passing law after law. I think we have almost done enough. A little law reform, a little bankruptcy legislation, and"—he cheerfully rubbed his hands—"I think that will do.” Three years later, Parliament repealed more than 1,300 statutes.

Progress Without Individuality?

I always worry when, instead of laying down general rules of the road or specifying one key thing, a government program or law spells out in detail what people must do. In On Liberty,Chapter III: “Of Individuality, as One of the Elements of Well-Being,” paragraph 17, John Stuart Mill explains why you should worry along with me: 

We have discarded the fixed costumes of our forefathers; every one must still dress like other people, but the fashion may change once or twice a year. We thus take care that when there is change it shall be for change’s sake, and not from any idea of beauty or convenience; for the same idea of beauty or convenience would not strike all the world at the same moment, and be simultaneously thrown aside by all at another moment. But we are progressive as well as changeable: we continually make new inventions in mechanical things, and keep them until they are again superseded by better; we are eager for improvement in politics, in education, even in morals, though in this last our idea of improvement chiefly consists in persuading or forcing other people to be as good as ourselves. It is not progress that we object to; on the contrary, we flatter ourselves that we are the most progressive people who ever lived. It is individuality that we war against: we should think we had done wonders if we had made ourselves all alike; forgetting that the unlikeness of one person to another is generally the first thing which draws the attention of either to the imperfection of his own type, and the superiority of another, or the possibility, by combining the advantages of both, of producing something better than either.

Here is the message I take away:

It is not enough to be for improvement.

Let us also be for the freedom

that allows the experiments

that make it possible for us to improve!

Wei Zhu: Zipper Projects in China

When talking about large Keynesian multipliers, professors often talk about how even “having workers dig a ditch and filling it in” could under certain circumstances, and with certain parameter values, be a good idea. Make work projects like that can also be a way to credibly identify people who desperately need money (who are willing to do hard, meaningless work) from people who only claim to desperately need money. So make work projects have some importance in economic theory. I learned from Wei Zhu’s guest post below that make work projects have a very descriptive name in China: zipper projects. (Although I have heard of make work projects in India, I am not sure they go this far in explicitly undoing things.) If you like this post, you should definitely read Wei’s other guest post, which appeared last Saturday: “The Sharing Economy.”

When we talk about unemployment in the U.S., we’re talking about economic conditions. When it comes to unemployment in China, it’s a social problem. When 1.35 billion people live in an economy second to the U.S.’s, how many jobs do you think that are available to the country? Yet China’s unemployment rate is as low as 4.1%. Despite the fact that labor-intensive manufacturing has provided abundant positions to hold the figure, during the process of urbanization, however, there are still a considerable number of farmers turning into jobless workers. In order to sponge out these extra workforces, local governments invented a special kind of projects – “Zipper” projects.

So what really is zipper project? Like a zipper, which is frequently zipped and unzipped, zipper project is a kind of frequently repeated construction or maintenance project. Most of the zipper projects are labor intensive, cheap and time-consuming. If you’ve been to China, you should’ve seen workers planting rode-side trees or fixing roads, those are most frequently used zipper projects. The reason I’m so sure that you have seen them is because they are there all the time – not long after the projects are finished, the same or another group of workers will be sent back to tear everything down and start over. It’s kind of like “the Myth of Sisyphus” in real life, only that it’s not a punishment but a way to provide temporary job opportunities.

“Zipper” project, is yet another unique social phenomenon in China. It exists to solve a social problem, but it’s not a real solution, because zipper projects can’t eliminate the migrant worker problem from the root. If anything, it’s a compromise.

It’s a compromise between keeping the rapid growth of China’s economy and maintaining the stableness of China’s society. You have to admit the difficulty of running a country is not linear to its population. Feeding the biggest population in the world while keeping up with the world’s economy growth is not an easy task. Many think the idea of zipper projects sounds ridiculous, as it makes no sense for a city to waste resources on prying and patching the same part of the road repeatedly. The reality is, however, if it weren’t for the zipper projects, there would be hardly enough temporary jobs to buffer the huge number of incoming migrant workers. When these people coming into the city without jobs, trouble comes, too. Between putting the the society at risk and wasting resource, it’s wiser to choose the latter.

This reminds me of the famous “Trolley Problem”: you see a trolley running towards five people out of control and there’s lever that can divert the trolley to a sidetrack where there lies one person, what would you do? I guess for the Chinese decision makers who shoulder the responsibility of 1.35 billion people, utility beats morality.