Warming to the Subject

When Barack Obama clinched his party’s presidential nomination he declared, “… this was the moment when the rise of the oceans began to slow and our planet began to heal…” I believe only two other leaders have tried to command the oceans: King Canute, who failed, and Moses who succeeded briefly but only with considerable Divine assistance. Canute took his failure philosophically as a lesson in humility and the limits of a sovereign’s power.  Moses was simply glad to be rid of the pursuing Egyptian army and there is no record of his making a second attempt. So the historical record stands today at just one case of successful  command-and-control ocean management event.

President Obama ranks his odds better than Canute’s because he believes that man’s actions cause the oceans to rise and that which man creates, man can undo. Neither belief is held by all or even most of his subjects. More troubling, the number of Deniers began rising when word came from the East in Anglia and Happy Valley of false prophets who had corrupted and lost the scrolls on which the waters were recorded and who sought to ban apostates from publishing their heresies, receiving grants from the treasury, and even entering the temples of learning. Some of the apostates are men of great learning about the heavens and earth who dispute both the Apostles of Warming data and their prophecies. With the revelations from East Anglia and Happy Valley these men have been emboldened to come forth from the wilderness to challenge the Great Gorical and to speak of medieval warm periods, little ice ages, inconsistent tree rings, Milankovitch cycles, sunspots, and other arcane things. The people are confused and their faith is shaken.

The president is not confused. His faith is strong, and he means to lead the people to the promised land of lower CO2, lower temperatures, and lower oceans. He knows it will take more than forty years and we must begin soon. He has ventured to Copenhagen, home to fairy tale author Hans Christian Andersen, whose Little Mermaid swims in the cold waters of the harbor, to tell those who counsel patience and honest study ”The time for talk is over.”  The president is a very powerful man but he can neither command the oceans nor silence the people who are just warming to the subject.

Posted By Bob

It Must Be the Drinking Water

I am referring to the behavior of the folks in Washington, D.C.  They are clearly bipolar.  They profess to want to achieve a specific goal but every action they take is designed to thwart it.  Specifically, I’m talking about the avowed goal of creating jobs that this administration has bleated on about incessantly.  It says it wants to increase private sector jobs, especially in small businesses.  It and the Congress’ actions, however, will do exactly the opposite.

We had the spectacle on the Sunday morning talk shows of Larry Summers saying on ABC that the recession is over, while on NBC, Christina Romer said that it wasn’t .  Where is Harry Truman’s onehanded economist when you need him?  At least, they weren’t proposing policies that were in direct conflict with each other, although if each believes their position to be correct they will ultimately have to.

As an aside, in the late 1970s, inflation was driving up interest rates and devastating the housing market (something is always screwing up the housing market, it seems) because of the restrictions on the maximum rate that could be charged for mortgages.  At the time, six-month CDs paid more than a bank could lend the funds at.  You can’t make this up on volume.  The Carter administration, in particular the Secretary of HUD, Patricia Harris, was going to present to Congress their plan for getting mortgages flowing again.  The economists at HUD proceeded to draft a position paper that said, in essence, that what was needed to get long-term interest rates down was for inflation to be brought under control.  The way to do this was to slow the growth of the money supply which would reduce both inflation and expectations of future inflation.  Unfortunately, Mrs. Harris had taken a fancy to the views of Leon Keyserling, one of the first members of the Council of Economic Advisors back in the late 1940s.  Being an unrepentant Keynesian, his advice was to increase the rate of growth of the money supply thereby driving interest rates down, which would make mortgages affordable and available again.  The lawyers at HUD who assembled her testimony strung these two totally incompatible views into one document.

You get the picture: one paragraph would say that the growth of the money supply should be slowed, while the next countermanded that advice.  It went on like this through the whole document. Fortunately for the Carter Administration, Stuart Eizenstat read the testimony late on a Friday afternoon, it was to be given the following Monday morning, blew a gasket and had her appearance cancelled.  This type of nonsense unfortunately occurs all the time down there.

But getting back to today.  Open any graduate macroeconomics textbook and it is clear that in order to increase per capita consumption we need to increase per capita levels of capital, that is, we need to expand investment.  Can anybody name any actions taken by this Administration or Congress that would encourage firms to invest?  I say encourage because it needs to be made clear that the government cannot create jobs, it can only create an environment in which entrepreneurs will be willing to undertake risks.  The government can, and usually does, take actions that severely reduce the incentives to undertake risks and create jobs.

The most obvious current deterrents to job creation are the health care bill and the cap and trade legislation.  Both will have the effect of causing jobs to be located overseas, whether by American firms or foreign domiciled ones.  The U.S. will be viewed as offering firms fewer opportunities to earn their cost of capital while at the same time imposing severe financial burdens that will have to be met irrespective of the levels of output.  Both the costs for health care, and they are going to be much higher, and for cap and trade can be viewed as quasi-fixed costs.  These are costs that must be paid if a firm wants to open its doors.  By raising the hurdle, on the margin, firms will opt not to expand in the U.S. or opt not to locate here to start with.  Clearly, both will be job killers, especially for small businesses who don’t have the ability to absorb upfront costs such as these.

There is another job killer stalking the land, I’m afraid to report.  In the 1980s, Ronald Reagan reduced the capital gains tax from 70% to 28%.  The U.S. economy surged in that time period, growing by a third.  In the 1990s, Bill Clinton, against his wishes, signed legislation reducing it further to its current 15%.  Tax revenue poured into Washington’s coffers to such an extent that we actually had a budget surplus for a fleeting moment.  The clear evidence is that a low capital gains tax rate is good for capital formation.  The President wants to increase the rate which is clearly counterproductive if he wants to increase jobs.  And by jobs, I mean well-paying ones.  If our sole goal is to drive the reported unemployment rate to zero, including discouraged workers, a two sentence law could accomplish that.  To wit:

All foodstuffs sold in the U.S. shall be produced here.  No mechanized equipment can be used in the production of foodstuffs.

While this will guarantee full-employment, it probably won’t guarantee full bellies.  Our standard of living would revert to that of the early 1800s.

Congress recently voted to extend the inheritance tax at its current rate through 2010 after which it is to return to its pre-2001 level of 55%.  Say what you will about the inheritance tax, it acts like a capital gains tax.  If it is increased, capital formation is reduced.  In this case it is a bit more insidious because it takes the form of allowing the existing capital stock to disappear via lack of reinvestment.  Further, small businesses, those that are impacted by this legislation, will divert resources to tax and estate attorneys to devise ways to protect at least a portion of their life’s work.

I recognize that there are some very vocal opponents of eliminating this tax, Warren Buffet and Bill Gates, Sr. being quite prominent.   I don’t understand Mr. Gates problems with it. Nothing by the way prevents anyone from writing the U.S. Treasury a check for more than legally obligated amount of taxes if they feel that they under-taxed.  I do understand Buffet’s.  His companies sell life insurance which is one of the preferred means of dealing with the tax bill.  If the tax bite is reduced, so is the demand for life insurance.  He also has another incentive for keeping it high.  His firm acquires many privately-held firms.  He offers shares in his firm in payment and is able to split, if you will, the tax saving from postponing its due date (the 3 Ls of taxes: least, latest, and legal.) The higher the tax rate, the more there is to split.  If the tax rate was zero, these firms would opt for the highest cash offer which would mean Buffet might have to compete harder for these acquisitions.

Unfortunately (for me), the inheritance tax is pretty much of a non-issue.  As a matter of public policy, though, it is of great importance.  The firms most affected by the tax are those that are most likely to invest in the U.S.  They are the largest job creators, by a long shot, in our economy.  I find it sad that our politicians will opt for a tax that really doesn’t generate that much revenue, while its impact is concentrated on some of the most productive people in our society.  It garners headlines; it is making those “fat cats” pay their fair share, whatever that means (other than shilling for votes.)

As the economy slowly grinds forward in the coming year or so and one asks why aren’t things improving faster, one need look no further than the impact of health care legislation, cap and trade, and the increases in the capital gains tax, including the inheritance tax.

Posted by Jim

Scrooge You

My friend Gerbs, an otherwise kind and generous man, is somewhere between ambivalent and hostile about the gift-giving process. He outsources most of his giving to his wife who undoubtedly does a better job than would he. So I was not surprised when he recommended that I read George Wills’ recent column, “The gift of not giving” that recounts the book Scroogenomics: Why You Shouldn’t Buy Presents for the Holidays by Joel Waldfogel.

Waldfogel, an economist at the University of Pennsylvania’s Wharton school, confirms everyone’s impression of economists as clever but soulless jerks by pointing out that a gift usually provides less value (utility) to the recipient than would whatever else they would purchase at an equal price for themselves. The long lines at the returns desk following Christmas provide ample empirical evidence, if any was needed, that many of us prefer to make our own decisions about what to buy.

Waldfogel estimates that about 18 per cent of the approximately $66 billion of December gift purchases is wasted. He first explained the phenomena in his December 1993 article in the American Economic Review, “The Deadweight Loss of Christmas.” Waldfogel’s argument is familiar to economists who recall the article or as a variation of the loss of welfare attributable to providing in-kind products and services rather than money to the poor – a subject to which he devotes considerable space in his book. My only quibble is that his findings are based on surveys of college students whom he asks to evaluate the value/price ratio of gifts compared to self-purchases. This cohort may be among the least grateful and most self-centered in the population and I suspect that if parents and grandparents were polled, the value ratio might have been higher.

Our culture (and so far as I know almost all others) celebrates giving as a way of expressing affection or respect but we don’t seem to be particularly good at it. Christians recall the curiously age-inappropriate gifts of the Magi to the baby Jesus and perpetuate the custom of mis-giving every Christmas. Our president gives presents on our behalf to foreign leaders; most recently an iPod to Queen Elizabeth who already had one, and a set of DVDs incompatible with British players to Prime Minister Brown. We could have been embarrassed but we understood the problem of picking out something for someone who inherited a whole country and for the man who runs it for her.

The real economic issue here is: why does the practice persist if it destroys economic value and frequently leads to embarrassing results? Waldfogel suggests that our gift giving incentive system is distorted by social conditioning that prevents the principal (child) from fully disciplining the agent (grandma). When Grandma misses all the hints and clues to buy Grand Theft Auto, the child is still (just barely) able to look overjoyed with his new Parcheesi set, thereby pleasing his parents and letting granny off the hook and free to destroy value next year.

My own gift-giving strategy is to assume that my friends like what I like and so my shopping list and wish list are essentially the same. Refreshingly, Gerbs has evolved past value-destroying hypocrisy. His enthusiasm for the George Will article was especially rewarding to me since it coincided with his confession that my most recent birthday gift to him was redundant – he had possessed one for a decade and had never used it. So, he gave it back to me and I love it.

Posted by Bob