New Economist

The great disconnect over the US economy

Do economists and policymakers speak a different language from US citizens? A new Economic Policy Institute report claim there is "a widening gap between the ways that everyday Americans and influential elites talk about the economy."

The report is Talking Past Each Other: What Everyday Americans Really Think (and Elites Don’t Get) About the Economy (full text available online) by David Kusnet, Lawrence Mishel and Ruy Teixeira. the authors argue there is a 'great disconnect' between elite opinion and the American middle class:

This disconnect is of profound importance. The elites are making and discussing economic policies in an environment in which—though they may not realize it—they are poorly informed about the views of the very people who will be affected by those policies.

This is of particular importance now that a relatively optimistic elite discourse about strong growth in the gross domestic product and other positive macroeconomic indicators coexists with a sharply negative assessment of economic conditions among the public. ...when they talk about economics, everyday Americans and influential elites seem to be describing two very different worlds and speaking two very different dialects.

This report is an effort to begin bridging the gap between everyday Americans’ understandings of economic issues and the official economic discourse. The issues that the people and the policy makers are trying to discuss are too important for them to be talking past each other.

Their conclusion?

If these findings point to a new synthesis about how policy makers should talk about and act upon the economy, it is this: The nation should provide greater economic security to hard working families so that they can make the most of expanded economic opportunity. Now, as in the eras of the Homestead Act and the G.I. Bill, Americans need to stand on a solid foundation so that they can reach for their futures. Policy makers who listen to the people will best be able lead in the years ahead.

The report includes a special section that offers 12 suggestions for how to 'speak American' when talking about economics. An interesting read.

See also a related report, The economic disconnect: How both the Left and the Right get it wrong (PDF) posted online. This is a pre-election report prepared for the EPI by Lake Research Partners based on a survey of 1,044 adults in March 2006 and six focus groups conducted with swing voters in Minneapolis, Columbus and Jacksonville in January. Among the key findings:

• While Americans are dissatisfied with the current state of the economy, neither conservative nor liberal elites speak for them. Conservative elites tout economic growth in the face of rising costs while liberal elites portray the middle class as helpless victims, causing average Americans to see both groups as out of touch.

• Over two thirds of the country view the economy negatively. At the same time, without any coherent, compelling narrative from the Right or the Left, many Americans are short on their own solutions to the economic problems facing the country. The public’s central perspective is of a middle class in decline, badly squeezed between rising costs, reduced benefits, and stagnant earnings. The public holds out little hope for the economy improving any time soon, suggesting that these current problems may reflect a structural change.

• While Americans have not quite discovered the solutions to the country’s economic challenges, they approach this debate with definite bad actors in mind. Americans see a close relationship between corporations and politicians that has created, or at least stoked, a culture of greed in America, threatening our national economy and eroding the middle class. These are the main, though not the only, culprits in explaining the current economy.

• Even while acknowledging the obstacles created by this environment of rising costs and stagnant incomes, the public is optimistic about their own chances for achieving economic stability in the future and see the American dream as a reachable goal.

• Those without a college degree are much less positive about how they are doing and hold much greater resentment toward elites and especially corporations.

• Americans see themselves as largely on their own in the current economy, but they are eager for the government to take on a more active role to help ease their financial burden in areas such as health care, energy and education and support greater regulation of the corporate interests that are seen as contributing to these rising costs.

That seems like ground for economic populism and, alas, protectionism.

Hat tip: Daniel Drezner.

Krugman on poverty in the UK

Paul Krugman has some nice things to say about the UK government's efforts to reduce poverty in his 25 December New York Times column. As usual, it's subscribers only - but Mark Thoma has some lengthy excerpts:

Helping the Poor, the British Way, by Paul Krugman, Commentary, NY Times:
It’s the season for charitable giving. And far too many Americans, particularly children, need that charity. ...

[F]our decades after L.B.J. declared war on poverty ..., I’m not sure whether people understand how little progress we’ve made. In 1969, fewer than one in every seven American children lived below the poverty line. Last year, although the country was far wealthier, more than one in every six American children were poor.

And there’s no excuse for our lack of progress. Just look at what the British government has accomplished over the last decade.

Although Tony Blair has been President Bush’s obedient manservant when it comes to Iraq, Mr. Blair’s domestic policies are nothing like Mr. Bush’s. Where Mr. Bush has sought to privatize the social safety net, Mr. Blair’s Labor government has defended and strengthened it. Where Mr. Bush and his allies accuse anyone who mentions income distribution of “class warfare,” the Blair government has made a major effort to reverse the surge in inequality and poverty that took place during the Thatcher years.

And Britain’s poverty rate, if measured American-style ... has been cut in half since Labor came to power in 1997.

Britain’s war on poverty has been led by Gordon Brown, ... Mr. Blair’s heir apparent. There’s nothing exotic about his policies, many of which are inspired by American models. But in Britain, these policies are carried out with much more determination.

For example, Britain didn’t have a minimum wage until 1999 — but ... Britain’s minimum wage rate is now about twice as high as ours. Britain’s child benefit is more generous than America’s child tax credit, and it’s available to everyone... Britain’s tax credit for low-wage workers is similar to the U.S. earned-income tax credit, but substantially larger. And don’t forget ... Britain’s universal health care system...

The Blair government hasn’t achieved all its domestic goals. ... But there’s no denying that the Blair government has done a lot for Britain’s have-nots. ... Providing a strong social safety net requires a higher overall rate of taxation than Americans are accustomed to, but Britain’s tax burden hasn’t undermined the economy’s growth.

What are the lessons...?

First, government truly can be a force for good. Decades of propaganda have conditioned many Americans to assume that government is always incompetent... But the Blair years have shown that a government that seriously tries to reduce poverty can achieve a lot.

Second, it really helps to have politicians who are serious about governing, rather than devoting themselves entirely to amassing power and rewarding cronies.

While researching this article, I was startled by the sheer rationality of British policy discussion, as compared with the cynical posturing that passes for policy discourse in George Bush’s America. Instead of making grandiose promises that are quickly forgotten — like Mr. Bush’s promise of “bold action” to confront poverty after Hurricane Katrina — British Labor politicians propose specific policies with well-defined goals. And when actual results fall short of those goals, they face the facts rather than trying to suppress them and sliming the critics.

The moral of my Christmas story is that fighting poverty isn’t easy, but it can be done. Giving in to cynicism and accepting the persistence of widespread poverty even as the rich get ever richer is a choice that our politicians have made. And we should be ashamed of that choice.

The British debate is much less upbeat, with most commentators from both the right and the left giving little credit to Blair and Brown for what they've achieved so far. True, low pay or child poverty or homelessness have not been eradicated in Britain - but they're considerably less of a problem now than in 1997. Some of that progress reflects specific anti-poverty programmes. Some reflects a longish period of stable growth and falling unemployment. Not all the praise should go to our political leaders - but some, surely?

The mixed joys of privatisation

As a rule, I've supported the privatisation of state-owned enterrpises - particularly underperforming ones. In many cases it has lead to more efficient provision and better financial performance than under state ownership. But there are key exceptions. The experience with privatised natural monopolies has been decidedly mixed. The key element of market competition is missing and so one has to rely on a government regulator to keep such firms honest. In Britain, for example, the performance of privatised water companies has been a disappointment, with large price hikes, growing pollution and wastage.

A more glaring concern is the growing use of private firms to finance and operate public works, such as highways or hospitals. In many cases this is done under the so-called Build, Operate and Transfer approach or some variant of it. Such a system has three major problems. First, there is an obvious moral hazard around quality. Private firms have an incentive for their work to last until it is transferred to the state - but not a day longer. That can result in cost savings through inferior materials and workmanship leading to higher maintenance costs. This poses a medium-term budget risk to governments.

Second, in most cases if the venture fails, the taxpayer ends up bailing it out. Just as central bankers are lenders of the last resort, so too governments have often had to come to the rescue. As blogger and economics professor John Quiggin has noted:

..these episodes underline the point that, for essential services, government is the provider of last resort. It can sell the assets, and forgo the associated earnings, but it can’t divest itself of the obligation to step in (and pay up) when something goes badly wrong.

A popular alternative has been for governments to agree to vary the terms of the contract to allow firms to impose higher rentals or charges - for example, for a tollway that is losing money. Of course, either outcome undermines the claim that private firms reduce public risk or deliver more efficient services.

The third, and most fundamental, problem with privately financed public works are that they invariably cost more. Not only do firms have to ensure they make a profit, but they also face a higher cost of capital. This is a point that John Quiggin has been making for many years. Meanwhile, Kelvin Hopkins writes in today's Guardian that the cost of privatisation will haunt us for years to come. He makes the point well:

The illogic of private investment being given incentives to replace public investment is compounded by the fact that the cost of government borrowing is much cheaper than servicing private capital investment. The money markets are generally enthusiastic about lending to government because such lending is secure, which is why the interest charged is low. By contrast, private-sector investment always requires a risk premium and profit-taking.

Government's natural advantage is in raising money cheaply. The private sector's is in running organisations efficiently. Public-private ventures should capitalise on these core strengths, with the government raising the money - perhaps via bonds, as Ken Livingstone has suggested - and the private sector partner running the operation. This makes economic and fiscal sense - but has the key failing of not taking government capital spending 'off the books'.

Labour takes stock

The Prime Minister's Strategy Unit published a presentation on its website yesterday. Strategic Priorities for the UK: The Policy Review (PDF) is described as "background for Cabinet discussion of the policy review programme on 19th October 2006". It's quite an interesting, albeit discursive, overview of what the government sees as its key achievements and challenges. Economics editor Larry Elliott summarises the economic material in today's Guardian:

Tony Blair and Gordon Brown believe the economic stability the government has presided over since 1997 is a necesssary but insufficient condition for the big challenge of the next decade - tackling the threat posed by the big emerging economies of China and India.

Over the past decade and a half, the size of the global labour force has doubled to three billion as a result of the collapse of communism in the Soviet Union, China's embrace of the market and the arrival of India as a global economic force.

With the fast-growing developing economies having far lower levels of wages than those in the UK, Labour says the only option is a "knowledge economy" which specialises in sectors such as pharmaceuticals, biotechnology, environmental protection, nanotechnology and financial services.

These are areas where the UK has a tradition of strength, where the profits margins are high, and where the competition from India and China has so far been less evident than in low-cost manufacturing.

Labour has identified two areas that need to be addressed. The first is ensuring that Britain can compete in the lucrative high-skill sectors, where there is some concern that the UK spends less on research and development than its main rivals; that Britain's level of skills compares badly to those in the United States, Germany and Japan; and that the flow of new scientists may be drying up.

Although the government says educational standards have been rising, there are 7 million adults who are unable to read and write. At the other end of the spectrum, the number of undergraduates reading the physical sciences, engineering and technology has been falling, while fewer children have been taking maths and science at A-level.

The government's second concern is to ensure that growth benefits all groups in Britain. Labour admits the very poorest have not shared the benefits of growth, while inequality is more pronounced than it was in 1997.

New book: 'Inside the Economist's Mind'

Published earlier this week, Inside the Economist's Mind: Conversations with Eminent Economists has all the hallmarks of an economic bestseller. The book is published by Blackwell and edited by Paul Samuelson and William Barnett. There is even a book weblog, maintained by Barnett.

Interviews were conducted with (in alphabetical order) Robert Aumann, David Cass, Jacques Drèze, Martin Feldstein, Stanley Fischer, Milton Friedman, János Kornai, Wassily Leontief, Robert E. Lucas, Jr., Franco Modigliani, Paul A. Samuelson, Robert J. Shiller, Christopher A. Sims, Paul A. Volcker, Thomas J. Sargent and James Tobin. That's quite a cast!

In his introduction, Samuelson bemoans the near disappearance of economic history in graduate economics:

When a discipline—economics, chemistry, or acupuncture—is in a dynamic stage of rapid growth, its up-front cyclists care little whether it was Newton or Leibniz who “invented” the calculus. The economics profession is in such a dynamic stage of rapid growth, as made clear by the interviews in this book. The book permits us to step back and view the whole of the field in a revealing context that otherwise is easily missed in the narrow focus of individual expert researchers.

...This helps explain the historical fact that the role in the graduate curriculum once played by “History of Economic Thought” has eroded down to a narrow cadre of learned experts. An unearned snobbery ensues, as is well illustrated by Bernard Shaw’s canard: “Those who can, do. Those who can’t, teach.” Good history of science deserves a non-zero weight in the university curriculum. The dynamic growth in individual subfields of the economics profession needs to be supplemented by overviews of the whole, not just as the sum of its normally separated parts. This book provides such a view of the whole of the modern field of economics and the connection of that whole with the life experiences of famous economists whose work was seminal to the field.

This book won’t fill that gap. But it's a good place to start.

UPDATE: This post has sparked a lively debate in the comments below. William Barnet himself offers these intriguing comments:

This exchange is productive and very interesting.  But I'd like to point out to those who may not yet have seen Inside the Economist's Mind that what it contains is much more than history of thought.  From the time that I began this project about 10 years ago, what I did was to arrange with the two publishers involved (Cambridge U. Press and Blackwell) that interviews be viewed as quotations and thereby not subject to any kinds of copy editing or refereeing by referees, editors, or publishers.  In usual peer reviewed publications, even the most famous Nobel Laureates do not have the freedom to say whatever they want without required revisions (i.e., censorship). 

This book's conversations, from their first publication in the CUP journal that I edit, to their current appearance in this Blackwell book, have permitted eminent economists to "let loose."  It became difficult to maintain that degree of freedom, when one of the participants (David Cass at the U. of Penn.) used the four letter f--- word to refer to a former dean by name.  But I stuck to my original commitment and made that commitment known to all participants, including the great Paul Samuelson.  As a result, in this book you will find revelations that will astonish you about such topics as economics, politics, governments, religion, oppression, assassinations, discrimination, wars, kings, presidents, the stock market, communism, fascism, and globalization, and often from first hand sources. 

I was myself amazed by what came out in these conversations, when the participants recognized that they could say anything.  Although the book can be ordered from Blackwell, the book will not be widely available in bookstores until December.  You will find statements in that book that could motivate astonished bloggers for months.

So order the book, and be prepared to be astonished.

Blanchard on current accounts

MIT's Olivier Blanchard presents his views on current account deficits later this week in the annual Mundell-Fleming lecture, at the IMF Seventh Jacques Polak Annual Research Conference in Washington, DC. This year the theme is capital flows, and Blanchard's papers is on Current Account Deficits in Rich Countries (PDF).

In this lecture he takes "a step back from current policy debates" and looks at "the case for policy intervention in the face of large current account deficits in rich countries." While "reducing these distortions ..is clearly desirable", he argues that the focus for policy should be on the distortions and "not the reduction of current account deficits per se." Blanchard concludes on this note:

If such measures were taken, existing simulations by the Fed and by the IMF suggest that imbalances will indeed be reduced, but will still remain large. The question is then whether more should be done. This is where this lecture is most relevant. The answer is maybe not, unless and until we have a good understanding of remaining distortions, and how they justify further policy intervention.

New blogs: The Economist, Richard Florida

Tyler Cowen at Marginal Revolution points us to two new belogs: Free Exchange by The Economist journalists, and Richard Florida: The Creativity Exchange. As Tyler points out, one of the Economist bloggers is Megan McArdle; her alter ego Jane Galt explains:

...So now, the great unveiling:  why have I been neglecting you?  Am I giving up blogging? (Or at least cutting back?) Hell no. Cutting back may be fine for some people, but blogging is like cigarettes for me; it's whole hog or cold turkey. And I'm not quitting.

In fact, the reason I've been neglecting you is that I've been feeding my habit in another venue:  The Economist's new economics blog. After 160+ years of superlative print journalism, we're bringing our mad skillz onto the web. I'll be spending a significant portion of my work time blogging there, which means more scintillating economic bloggery for you--plus all my super-smart, witty, and oh-so-very-British colleagues.

Meanwhile, I'll still be blogging all my non economic stuff here, so don't abandon me . . . think of me as having a split personality. In which you'd be ever so right. In fact, come back later for my exciting tale of being robbed for the first time in 33 years of urban living.

Also, while you're checking out snazzy new blogs from The Economist, we've also got a new American politics blog for the election, called Democracy in America. 

And because we bloggers are all about feedback, please let me know what you think of the new blogs here.

Climate change: "the greatest market failure the world has seen"

The Stern Review, the most comprehensive review ever on the economics of climate change, was published today (as I previewed yesterday). The report is nothing if not thorough. All 27 chapters are now available on the Treasury website to download - or I guess you can wait until January and pay Cambridge University Press £29.99 for the book (CUP obviously don't believe in print on demand!). Also available is today's Press notice, along with Sir Nicholas Stern´s presentation (PDF), and speaking notes (PDF).

Sir Nicholas said in his presentation that "we have to muster all the economics we can bring to bear" on climate change - a sentiment few readers would disagree with. Here is a short excerpt from his presentation:

The science tells us that GHG emissions are an externality; in other words, our emissions affect the lives of others. When people do not pay for the consequences of their actions we have market failure. This is the greatest market failure the world has seen. It is an externality that goes beyond those of ordinary congestion or pollution, although many of the same economic principles apply for its analysis.

This externality is different in 4 key ways that shape the whole policy story of a rational response. It is: global; long term; involves risks and uncertainties; and potentially involves major and irreversible change.

Although the press have highlighted some of the doomsday warnings in the report, these are based on the 2100 'business as usual' scenarios - not on likely developments anytime soon. As Sir Nicholas said today, the Review's conclusion are "essentially optimistic. There is still time to avoid the worst impacts of climate change, if we act now and act internationally. He spelled out three strands to policy:

First, we must establish a carbon price via tax, trade and regulation – without this price there is no incentive to decarbonise. Second, we must promote technology: through research and development. Further, private sector investors need confidence that there will be markets for their products: that is why deployment policy also makes sense. And third we must deal with market failure; for example problems in property and capital markets inhibit investments for energyefficiency.

The usual suspects have rushed to condemn the report - some even before it was published. Like Sunday Times journalists and blogger David Smith, I won't comment on it in detail until I've had a chance to read it. But I certainly agree with David's comment that:

..the broad thrust of his report, that money spent now will save much bigger costs later, makes sense, as does his emphasis on carbon trading.

Tories reject flat tax

Britain's Conservative Party has just published the 200-page report of their Tax Reform Commission today. Though presented as an 'independent' report, the Commission was headed by former Cabinet minister Michael Forsyth and was stacked full of Tories.

Tax Matters: Reforming the Tax System (PDF) covers a lot of ground, including cutting the main rate of corporation tax from its current level of 30% to 25%. This would be funded by scrapping a range of reliefs and exemptions for business. But what caught my eye was the report's rejection of proposals for a flat tax. The authors argue that a flat tax "is the right direction but not the right solution for the UK":

While theoretically attractive, moving directly to a “pure” flat tax in the UK would not in practice be viable. Financing current levels of government expenditure would require a flat tax rate which would entail either undue risk with the public finances or major cuts in expenditure or a steep increase in tax rates for those on low incomes or for middle earners. Nevertheless, many of the features of flatter taxes – simplicity, stability, a broader base, higher thresholds, fewer rates – can and should be actively pursued.

Precisely. Let's hope that Britain's flat earth tax advocates read and digest these findings.

IMF: Flat taxes have no Laffer curve effect

Flat taxes are associated with a reduction in personal income tax, and "in no case does there ..appear to have been a Laffer effect". That is the most striking conclusion from a new study by IMF economists Michael Keen, Kevin Kim and Ricardo Varsano in The "Flat Tax(es)": Principles and Evidence (Working Paper No 06/218). The authors summarise the paper thus:

Discussion of these quite radical reforms has been marked, however, more by assertion and rhetoric than by analysis and evidence. This paper reviews experience with the flat tax, seeking to redress the balance. It stresses that the flat taxes that have been adopted differ fundamentally, and that empirical evidence on their effects is very limited.

This precludes simple generalization, but several lessons emerge: there is no sign of Laffer-type behavioral responses generating revenue increases from the tax cut elements of these reforms; their impact on compliance is theoretically ambiguous, but there is evidence for Russia that compliance did improve; the distributional effects of the flat taxes are not unambiguously regressive, and in some cases they may have increased progressivity, including through the impact on compliance; adoption of the flat tax has not resolved common challenges in taxing capital income; and it may have strengthened, not weakened, the automatic stabilizers. Looking forward, the question is not so much whether more countries will adopt a flat tax as whether those that have will move away from it.

The impact of a flat tax on work incentives "is not clear cut in principle, and there is no evidence that it has been strong in practice." Likewise, the distributional effects of movement towards a flat tax "are potentially complex", especially for reforms that involve an increase in the basic tax-free amount.

Keen, Kim and Varsano argue that although "the question has received little attention in the debate, ..movement to a flat tax may plausibly strengthen the automatic stabilizers, not weaken them." They also find the introduction of a flat tax has been a useful signal of reform:

The flat tax has commonly—almost universally—been adopted by new governments anxious to signal a fundamental regime shift, towards more market-oriented policies. In several cases, the signal appears to have been well-received. Where no such reputation needs to be acquired, the appeal of the flat tax is consequently less.

The authors conclude by questioning the political sustainability of the move towards flat taxes:

What remains unclear is the sustainability of the flat tax. Structurally, the flat taxes that have been adopted do not provide a coherent framework for dealing with the difficulties that almost all countries now perceive in taxing internationally mobile capital income.

...Political economy considerations point towards the adoption of rate schedules that tend to benefit middle income earners: exactly the group that tends to lose most from the adoption of a second wave flat tax. Moreover, the very spread of the flat tax in itself undermines its value as a signal: it may prove too easy to mimic. While there will no doubt be new members of the flat tax community, in some respects the more interesting question is whether there will be any defections.

Most flat tax structures benefit lower and/or upper income earners at the expense of those on middle incomes - a point I have made before. Such tax structures are hard to 'sell' to predominanatly middle class swinging voters in marginal electorates. In the end it is likely to be the median voter that stops the flat tax movement advancing.