Economics

The Economic Illiteracy of Journalists

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“Venezuela,” reported The Washington Post, “has become a failed state.” Evidence places the blame at the feet of Hugo Chavez and his socialist policies. Yet, what have journalists over the last few years been saying about the country and its president? One post sums it up nicely:

Venezuela is collapsing, with the New York Times describing it as “uncharted territory” for a semi-developed country to be so deep in economic disaster that its hospitals, schools, power plants, and basic services are simply shutting down. So it’s a good time to reflect on the media’s previous glowing Venezuela stories. In 2013, Salon praised “Hugo Chavez’ Economic Miracle, saying that “[Chavez’s] full-throated advocacy of socialism and redistributionism at once represented a fundamental critique of neoliberal economics, and also delivered some indisputably positive results” (h/t Ciphergoth). And the Guardian wrote that “Sorry, Venezuela Haters: This Economy Is Not The Greece Of Latin America. Prediction is hard, and I was willing to forgive eg the pundits who were wrong about the Trump nomination. But I am less willing to forgive here, because the thesis of these articles wasn’t just that they were right, but that the only reason everyone else didn’t admit they were right was neoliberalism and bad intentions. Psychologizing other people instead of arguing with them should take a really high burden of proof, and Salon and Guardian didn’t meet it. Muggeridge, thou should be living at this hour…

One writer over at HumanProgress described the journalist praise for Venezuela as nothing more than “mind-bending stupidity.” Inspired by these examples, economist Scott Sumner sought out how journalists had similarly “explained away the abysmal failure of statism in Greece”:

Back in 2008, when I did research on neoliberalism in developing countries, I found that Greece was the least neoliberal economy in the developed world, according to a variety of metrics. Note that at this time Greece was booming, so this was not a question of people who liked neoliberalism calling Greece statist just because they wanted to peg that tag on a failed system. Indeed I was surprised that Greece did so well until 2008, despite being so amazingly un-neoliberal.

Of course we all know what happened next. The world discovered that the Greek boom was funded by unsustainable foreign borrowing, and that the Greek government lied about how much they had borrowed. When the huge debts were exposed, Greece had to sharply curtail its borrowing. Even worse, the eurozone crisis pushed Greek into recession. Greece is now widely seen as the worst economy in the developed world, with major structural problems.

So I wondered how the left would explain the failure of statism in Greece, and decided to google “Greece crisis neoliberalism” expecting to find lots of articles about how Greece needed to move in a more neoliberal direction, like the northern European economies, in order to recover from its statist nightmare. What I found was the exact opposite:

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Notice any familiar sources? (Hint: the first hit and the second to last hit.) And despite the evidence mentioned above that found Greece to be very illiberal, all of these sources are blaming Greece’s non-existent neoliberalism for its demise. Sumner concludes,

To be clear, there are many countries that are a mix of free markets and statism, and hence there can be honest differences as to which characteristics are the most salient. But at the extremes, reasonable people should not disagree. There is no plausible argument that Hong Kong’s success is in any way a success story for statism, and there is no plausible argument that Greece’s failure has anything to do with neoliberalism. To suggest otherwise is to engage in The Big Lie.

The Failure of Foreign Aid

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The Economist recently reported on the state of foreign aid:

Foreign aid can work wonders. It set South Korea and Taiwan on the path to riches, helped extinguish smallpox in the 1970s and has almost eliminated polio. Unfortunately, as Malawi shows, it is liable to be snaffled by crooks. Aid can also burden weak bureaucracies, distort markets, prop up dictators and help prolong civil wars. Taxpayers in rich countries dislike their cash being spent on Mercedes-Benzes. So donors strive to send the right sort of aid to the places where it will do the most good. How are they doing?

…By almost all of these measures, foreign aid is failing. It is as co-ordinated as a demolition derby. Much goes neither to poor people nor to well-run countries, and on some measures the targeting is getting worse. Donors try to reward decent regimes and punish bad ones, but their efforts are undermined by other countries and by their own impatience. It is extraordinary that so many clever, well-intentioned people have made such a mess.

Some economists (like NYU’s William Easterly) have been incredibly critical of foreign aid. Of course, not all aid is created equal, but there are better ways to help the poor abroad.

 

When Profits Are Sinister

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Profit is often a dirty word among certain political ideologies. However, for those who defend the importance of profits, it is necessary to realize that sometimes they are signs of something amiss. As economist James Bessen explains,

Profits are up. Operating margins for firms publicly listed in the US show a substantial and sustained rise. Corporate valuations are up as well. That is good news for managers and investors. But is it good news for society?

Economists such as Joseph Stiglitz and Luigi Zingales find the rise potentially troubling for two reasons. First, higher profits create greater economic inequality. Rising aggregate profits correspond to a decline in labor’s share of output, contributing to stagnant wages. Also, greater profits for some corporations but not others may create greater wage inequality.

Second, the rise in profits might represent a decline in competition and, with that, a decline in economic dynamism. While a dynamic, competitive economy rewards innovative firms with high profits and punishes poor performers with low profits, sustained aggregate profits suggest, instead, that firms are able to get away with higher prices because competition is limited. Firms engage in political “rent seeking”—lobbying for regulations that provide them sheltered markets—rather than competing on innovation. If so, then high profits portend diminished productivity growth.

However, the increase in profits could be due to firms “increasingly making profitable investments in new technology, in IT, or in their organizational capabilities.” Bessen’s new research paper gets to the bottom of it:

I find that investments in conventional capital assets like machinery and spending on R&D together account for a substantial part of the rise in valuations and profits, especially during the 1990s. However, since 2000, political activity and regulation account for a surprisingly large share of the increase.

This is how rent-seeking, pro-business (vs. pro-market) attitudes, and crony capitalism drag down our economy.

Check out the full article over at Harvard Business Review.

Digital Globalization

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A couple months ago, I had a post on research by economist Andreas Bergh which highlighted the importance of information flows in battling poverty. A new McKinsey report on digital globalization supports this view:

To measure the economic impact of digital globalization, we built an econometric model based on the inflows and outflows of goods, services, finance, people, and data for 97 countries around the world. We found that over a decade, such flows have increased current global GDP by roughly 10 percent over what it would have been in a world without them. This added value reached $7.8 trillion in 2014 alone. Data flows directly accounted for $2.2 trillion, or nearly one-third, of this effect—more than foreign direct investment. In their indirect role enabling other types of cross-border exchanges, they added $2.8 trillion to the world economy. These combined effects of data flows on GDP exceeded the impact of global trade in goods. That’s a striking development: cross-border data flows were negligible just 15 years ago. Over the past decade, the used bandwidth that undergirds this swelling economic activity has grown 45-fold, and it is projected to increase by a factor of nine over the next five years[.]

Check out the full article to see how digital globalization is reshaping business.

Have Wages Stagnated?

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The common claim that wages and living standards have stagnated in the U.S. has been disputed before, but The Washington Post recently reported on a new San Francisco Fed study that suggests the claim is based on a “statistical fluke”:

Workers continuously employed in full-time jobs received wage increases higher than inflation from 2002 to 2015. Last year, the gain was a 3.5 percent increase after inflation, up from 1.2 percent in 2010.

Typically, the median wage — the wage exactly in the middle of all wages — is cited as evidence of stagnation. Indeed, the Fed study confirms this. Median wage increases have fluctuated around 2 percent, unadjusted for inflation. But the median wage is misleading, the report argues, because it’s heavily driven by demographic changes: an influx of young and part-time workers whose relatively low wages drag down the median; and the retirement of baby-boom workers whose relatively higher pay no longer lifts up the median.

This should hopefully calm some of the public hyperventilation that has taken place over the supposed stagnation of wages.

The larger implication is that the study compromises the prevailing economic narrative, which emphasizes the stagnation of wages and living standards. Clearly, millions of households — especially the recently unemployed — have suffered large losses, and the gains of many others are underwhelming. But the impression that most people in the middle class are slipping backward seems overwrought. The anxiety about the future is real, but its causes must be more complicated than commonly thought.

How to Deal With the Top 1%: Competition

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“Curbing this inequality requires a clear understanding of its causes,” writes Brooking’s Jonathan Rothwell. “Three of the standard explanations—capital shares, skills, and technology—are myths. The real cause of elite inequality is the lack of open access and market competition in elite investment and labor markets. To bring the elite down to size, we need to make them compete.” He explains that–despite the claims of people like Robert Reich–corporate profits actually represented a lower share of GDP (4.9%) between 1980 and 2014 than between 1950 and 1979 (5.4%).

So, what’s going on here? The simple explanation is that wages and salaries are an inadequate measure of the share of economic benefits flowing to labor. Wages and salaries have declined as a share of total income, largely for two reasons. First, total national income includes government transfer payments, which are rising because of an aging population (e.g., Social Security and Medicare). Second, companies have greatly increased non-salary compensation (e.g., healthcare and retirement benefits). Total worker compensation plus transfer payments have actually slightly increased as a share of total national income, from 79 percent between 1951 and 1979, to 81 percent for the years from 1980 to 2015:

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As for the claims that elite earnings are driven by advanced skills and IQ, Rothwell states, “It is certainly true that rising relative returns to education have driven up inequality. But as I have written earlier, this is true among the bottom 99 percent. There is no evidence to support the idea that the top 1 percent consists mostly of people of “exceptional talent.” In fact, there is quite a bit of evidence to the contrary.” Finally, while some entrepreneurs grow rich by founding an innovative technology, the rich are most often found in the doctor’s office. “No industry has more top earners than physicians’ offices, with 7.2 percent. Hospitals are home to 7 percent. Legal services and securities and financial investments industries account for another 7 and 6 percent, respectively. Real estate, dentistry, and banking provide a large number, too.”

So what is leading to inequality according to Rothwell?

One way that the top 1 percent cements their position is by occupying the financial sector, and accessing above-market returns on their investments…The accredited investor rule has mostly been ignored by scholars of inequality. But legal scholars Houman Shadab, Usha Rodrigues, and Cary Martin Shelby are an exception. They have each written persuasively about how the rules contribute to inequality by giving the richest investors privileged access to the best investment strategies. Shadab points out that other countries (with less inequality) allow retail investors to access hedge funds. The law has also inflated the compensation of hedge fund workers—roughly $500,000 on average—by restricting competition. Mutual funds—which charge tiny fees by comparison—are currently barred from using hedge fund strategies because they have non-rich investors. If the law was changed to allow mutual funds to offer hedge fund portfolios, hundreds of billions of dollars would be transferred annually from super-rich hedge fund managers and investment bankers to ordinary investors, and even low-income workers with retirement plans.

But that’s not all.

At the same time, we need more competition at the top end of the labor market. As economist Dean Baker points out, politicians and intellectuals often champion market competition—but what they mean by that is competition among low-paid service workers, production workers, or computer programmers who face competition from trade and immigration, while elite professionals sit behind a protectionist wall. Workers in occupations with no higher educational requirements see their wages held down by millions of other Americans denied a high-quality education and competing for relatively precious vacancies. For lawyers, doctors, and dentists— three of the most over-represented occupations in the top 1 percent—state-level lobbying from professional associations has blocked efforts to expand the supply of qualified workers who could do many of the “professional” job tasks for less pay.

Ultimately, Rothwell suggests that we increase the competition for the top 1 percent.

Before Marx, Adam Smith provided a framework for political economy that is especially useful today. Smith warned against local trade associations which were inevitably conspiring “against the public…to raise prices,” and “restraining the competition in some employments to a smaller number than would otherwise…occasion a very important inequality” between occupations. For earnings to be distributed more fairly, our goal is not to stand in the way of markets, but to make them work better.

Cultural Intelligence

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In the Spring 2016 issue of National Affairs, economist Arnold Kling has an engaging article on the concept of cultural intelligence:

Thanks to work in a number of related fields, collected in some exceptionally important books published in just the past few years, it is becoming increasingly apparent that progress tends to arise from the evolution of decentralized trial-and-error processes more than from grand schemes launched by planners and revolutionaries.

Economists and scholars of public policy are not the only ones conducting this research; students of human behavior are also finding support for Burke and Hayek’s theses — that the knowledge embedded in social norms and practices is vast compared to the knowledge of even the brightest, most educated individuals. As individuals, we cannot figure out very much by ourselves, but we learn a remarkable amount from others. In short, some social scientists in recent years have been building (or rebuilding) a powerful case for cultural intelligence.

One implication of their findings and arguments is that two sets of institutions in particular — markets and traditional social and familial practices — are the most important products of the process of social evolution building on cultural intelligence because they are the foremost means by which that process operates in free societies. It should hardly surprise us, therefore, that these two sets of institutions are also the foremost targets and objects of scorn of today’s progressive planners.

Drawing on the work of cultural psychologists and anthropologists like Joseph Henrich, Kling argues against the the heavily centralized, top-down worldview of the “engineers” and instead embraces the bottom-up adaptability of the “ecologists.” One school of thought centralizes power and decision-making into the hands (minds?) of a few intelligent elites, while the other recognizes that the collective brain matters more than individual ones in terms of knowledge. “Henrich,” Kling writes,

even goes so far as to argue that, as isolated individuals, humans are not particularly intelligent in comparison with chimpanzees. It is not the hardware of our brains that makes us superior. It is instead the software that is loaded into our brains by cultural learning. In fact, Henrich’s central thesis, in terms of this metaphor, is that the hardware of human brains evolved to be able to run the software of cultural learning, and that we are the only species that evolved in this manner. To use a different computer metaphor, we are not born with much in the way of individual intelligence and knowledge. Instead, we download cultural information from the “cloud”: our family and friends, teachers and mentors, books, electronic media, markets, and other cultural institutions.

…This…is highly reminiscent of Friedrich Hayek’s views about how markets work. Markets coordinate across many people the tacit knowledge that resides with individuals. In contrast, the would-be economic planner, who makes decisions by “applying causal models, rational thinking, or cost-benefit analyses,” works with an information set that is woefully inadequate to the task.

The whole thing is worth reading.

Mass Flourishing: A Lecture by Edmund Phelps

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This is part of the DR Book Collection.

In debates over capitalism and everything else, it is easy to forget that economies do far more than merely provide goods, services, and wages. Innovation doesn’t just apply to the iPhone, but to art, literature, jobs, etc. According to Harvard’s Edward Glaesar, this is one major takeaway from Nobel economist Edmund Phelp’s Princeton-published book Mass Flourishing: How Grassroots Innovation Created Jobs, Challenge, and Change:

The book eloquently discusses the culture of innovation, which can refer to both an entrepreneurial mind-set and the cultural achievements during an age of change. He sees modern capitalism as profoundly humanist, imbued with “a spirit that views the prospect of unanticipated consequences that may come with voyaging into the unknown as a valued part of experience and not a drawback.” The dismal science becomes a little brighter when Mr. Phelps draws the connections between the economic ferment of the industrial age and the art of Beethoven, Verdi and Rodin.

The book also provides an epic takedown of the enemies of economic dynamism: socialism and corporatism. Even though this is well-traveled ground, it is nice to have a Nobel laureate addressing these ideologies head-on in an academic publication given their growing popularity among young people. For those who may wonder about the connection between “the good life” (flourishing) and economics, this book is for you.

You can see Edmund Phelps present at the Royal Society for the Encouragement of Arts, Manufactures and Commerce (RSA) below:

Anti-Trade Ancient Greeks

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Can the ancient Greeks teach our present-day, anti-trade politicians anything? According to Cornell historian Barry Strauss, they sure can. In a recent article in The Wall Street Journal, Strauss explains that, at first, “Athens’s free-trade zone fostered prosperity, democracy and the soaring confidence that built the Parthenon and fired the Golden Age of Greece. Athens also had a magnetic appeal to immigrants. They came from far and wide and represented rich and poor. Immigrants competed with natives for jobs but not for political power since they were rarely allowed to become citizens.” But the backlash produced three disheartening developments:

  • Nativism: “Athens’s old landed elite disliked democracy and despised the immigrants. So, when extreme conservatives seized power in a coup d’état after Athens lost the Peloponnesian War (431-404 B.C.), they evicted immigrants from the city limits and targeted the wealthiest for murder and property confiscation.”
  • Demagoguery: “In Athens, for the first time in history, demagogues emerged. They were popular leaders of unrestrained vulgarity and crassness. They shouted, used abusive language, and instead of keeping their hands modestly tucked inside their cloaks, they raised their garments and introduced hand gestures into oratory. Although wealthy and well educated, they spoke in populist accents and criticized the establishment.”
  • Endless conflict: “Athenian foreign policy should have built an international order that shared prosperity and encouraged allies to stay loyal. Instead, it chose Athens First.”

In short, “Athens had given people an impossible choice: prosperity or freedom. In the end, all they got was the more than quarter-century-long Peloponnesian War, the ancient Greek equivalent of our world wars. The long struggle weakened all of Greece but especially Athens, which by 404 B.C. lost its alliances, its ships and its prosperity.”

Political leaders take note.

Bourgeois Equality and Economic Betterment

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Two centuries ago, the average world income per human (in present-day prices) was about $3 a day. It had been so since we lived in caves. Now it is $33 a day—which is Brazil’s current level and the level of the U.S. in 1940. Over the past 200 years, the average real income per person—including even such present-day tragedies as Chad and North Korea—has grown by a factor of 10. It is stunning. In countries that adopted trade and economic betterment wholeheartedly, like Japan, Sweden and the U.S., it is more like a factor of 30—even more stunning.

And these figures don’t take into account the radical improvement since 1800 in commonly available goods and services. Today’s concerns over the stagnation of real wages in the U.S. and other developed economies are overblown if put in historical perspective. As the economists Donald Boudreaux and Mark Perry have argued in these pages, the official figures don’t take account of the real benefits of our astonishing material progress.

…Nothing like the Great Enrichment of the past two centuries had ever happened before. Doublings of income—mere 100% betterments in the human condition—had happened often, during the glory of Greece and the grandeur of Rome, in Song China and Mughal India. But people soon fell back to the miserable routine of Afghanistan’s income nowadays, $3 or worse. A revolutionary betterment of 10,000%, taking into account everything from canned goods to antidepressants, was out of the question. Until it happened.

So argues economic historian Deirdre McCloskey in the past Saturday Essay of The Wall Street Journal. How did this Great Enrichment happen?:

The answer, in a word, is “liberty.” Liberated people, it turns out, are ingenious. Slaves, serfs, subordinated women, people frozen in a hierarchy of lords or bureaucrats are not. By certain accidents of European politics, having nothing to do with deep European virtue, more and more Europeans were liberated. From Luther’s reformation through the Dutch revolt against Spain after 1568 and England’s turmoil in the Civil War of the 1640s, down to the American and French revolutions, Europeans came to believe that common people should be liberated to have a go. You might call it: life, liberty and the pursuit of happiness.

Check out the rest of McCloskey’s piece and be sure to pick up the last in her trilogy on the Bourgeois Era: Bourgeois Equality: How Ideas, Not Capital or Institutions, Enriched the World.