The Scarecrow's Lament

Fun With Graphs

2006-06-01T08:42:00.000-07:00

Here is Google's new Gapminder World 2006 (Beta). Have fun! Thanks for Brad DeLong for the tip.

National Sales Tax

2006-06-01T08:26:00.000-07:00

I was shopping for a book last night and, to my surprise, ran across several books written in support of abolishing the national income tax and replacing it with a national sales tax. I will leave the statistical compilations to others, but even in theory this is a bad idea. Why?

Because poor people consume more (if not all) of their income because they are forced to do so. For example, let's say there's a baseline of money that it takes just to survive (rent/housing, food, etc.) We'll pick a number from the air and say that amount is $10,000 per annum per person, on average. Now take Randy and Glenda. Randy makes $25,000 a year as a call center operator. Glenda makes $250,000 a year as a securities trader. Both of them must spend at least $10,000 per year to live. Under a national sales tax, 50 percent of Randy's income is taxed, but only 10 percent of Glenda's is taxed.

Glenda, in all likelihood, will consume more than Randy. So, the percentage of Glenda's income that is taxed will probably be more than 10 percent. However, she is not required to consume more than ten percent of her income. And there is the rub. The national sales tax will result in a forced tax hike on the poorer members of society, while resulting in an optional tax hike on the richer members of society. The richer members of society have the option of reducing their consumption so that the national sales tax does not affect them as much as it could. Poorer members of society have no such option.

All of this is far and away from the economic consequences. Any rise in prices, which a national sales tax would produce, will result in a loss of consumption. A loss in consumption will result in job loss. Moreover, putting all of the government's revenues in the precarious grip of consumption will frustrate policymakers as they attempt to predict future government revenue. Income is certainly more stable than consumption.

While we all may feel a kneejerk moment of joy when the phrase "Eliminate the IRS" is uttered, the consequences of such an elimination, as posited in the current books hyping the subject, would do little aside put us in a less predictable and less equitable world.

Back In The Saddle

2006-06-01T08:05:00.000-07:00

After almost a year-long absence, I have decided to return to blogging. This will mostly serve to keep me writing and thinking sharp, but I wound not mind the occasional comment.

I will also start requiring registration for comments. Sorry, but after getting inundated with lumber offers, penny stocks and travel to Great Britain, it's time to limit the forum.

Absence

2005-07-28T17:43:00.000-07:00

Sorry for the lack of posts recently. Studying for the bar exam will do that to you. In the spirit of apology, please accept the first half of a draft on the Upland Cotton decision. More updates to come as I get ready to move to China.

Upland Cotton

2005-05-26T12:02:00.000-07:00

Arguably, one of the biggest cases that the U.S. has lost in front of the WTO Appellate Body ("AB") is the Upland Cotton decision (WT/DS267/AB/R). In the post below I will summarize the important arguments, rulings, and implications.

The Agreement on Agriculture
In a very general sense, the Agreement on Agriculture ("Ag Agreement") commits WTO members to cut agricultural subsidies. To find a violation of the Ag Agreement is essentially a two-step process. The first step is figuring out what programs count as agricultural subsidies. There are three types of agricultural subsidies under the Ag Agreement: green box, blue box and amber box.

Green Box- these subsidies do not count toward the AMS and are classified as having no or little trade-distorting effects. They must be government-funded and have no price supports.
Blue Box - these subsidies would be trade distorting if they did not have conditions that mitigate resulting trade distortion. An example would be payments with production limits on specific crops.
Amber Box - these are all subsidies that do not qualify as green or amber box subsidies.

Step two addressed the question of why it matters what "box" any of these subsidies fall in. The Ag Agreement commits members to cut subsidies that only fall within the amber box. A member can spend as much as they want in blue and green box subsidies and not run afoul of the Ag Agreement. Therefore, members who are being challenged in front of the WTO over their agricultural subsidy programs will want to argue that their programs fit within the green or blue box, not within the amber box.

Background
In 1996, Congress allowed for the use of flexibility contracts for cotton growers (among other things.) The contracts essentially took a baseline amount of acres used for cotton production, and then paid farmers owning those acres a set amount per acre. The farmers were paid regardless if they grew anything on the land or not, as long as they didn't grow certain types of crops ("prohibited crops"). If they grew prohibited crops on the acres in question, the payments were reduced on a sliding scale down to a possibility of zero.

In 2002, direct payments were introduced to take the place of flexibility contracts. They worked essentially in the same fashion as the flexibility contracts, with the same prohibited crops, but also added wild rice to the list of prohibited crops.

Problem 1
The Green Box: More Than Where You Hide Your Stash
Brazil et. al. argued that these payments were inconsistent with the Agreement on Agriculture ("Ag Agreement") . Specifically, because the payments were dependent upon farmers not growing certain crops, the U.S. was in effect conditioning its support upon a type or quantity of crops grown, i.e. the prohibited crops list. That conditionality meant that the subsidies could not qualify as green box subsidies. The U.S. responded by saying that it was not positively encouraging specific crop growth, but was negatively doing so by prohibiting support if such crops are grown. The U.S. further argued that the Ag Agreement only envisioned payments made to positively affect production, not those that would negatively affect it. The AB Panel found for Brazil, finding that the text of the agreement had no "positively-affecting" language, but prohibited payments which were "related to the type of production undertaken." The payments themselves create an incentive to produce products other than those on the prohibited list, destroyiong a link between pure risk and return. Due to this incentive, the U.S. could not classify the payments made under this program as "green box" subsidy.

Problem 2
Don't Tread on My Non-Specific Support
Members cannot sue each other for product-specific subsidies in the amounts that were in effect during the 1992 marketing year. For instance, if the U.S. had $3m worth of product-specific subsidies in 1992, Brazil could not sue them for having the same amount of subsidies in 2005. However, if the U.S. had $5m in product-specific subsidies in 2005, Brazil could sue them over the difference. The U.S. therefore argued that its programs, summarized above, counted as nonproduct-specific subsidies and therefore could not be the basis for a WTO challenge.

More to come later

Papers

2005-05-20T09:41:00.000-07:00

Thanks to those of you have continued coming back during my long absence. Law school finals got the better of me. But, as promised, here are the two papers I have been working on:

So Your Kid Wants to Be An Anarchist: Separating Fact from Fiction Among Anarchist Critiques of the International Monetary Fund, World Bank and World Trade Organization

(No link yet)

Turning Offense into Defense: Making Sense of Public Citizen's Arguments Against the World Trade Organization

It should be noted that these papers are still in the 'working paper' stage, but feel free to point out errors or corrections. Stay tuned, later I will be blogging on the Upland Cotton WTO Appellate Body report, and a more abstract view on what's going on with the U.S./world economy vis a vis savings glut and comparative advantage.

The IMF Overstepping Its Bounds

2005-04-13T23:08:00.000-07:00

Reuters has it that the IMF is insisting that Argentina negotiate with the hold-outs of the country's recent debt swap. If there is a better way to reinforce the idea that the IMF is the puppet of wealthy creditors, I can't think of it.

A brief catch-up. Argentina defaulted on billions of dollars in debts. Some of this debt is owed to private creditors, such as banks, bondholders, etc. Other parts of the debt is actually owed to the IMF. Argentina defaulted on both of these forms of debt.

Recently, Argentina imposed its own sort of sovereign bankruptcy proceeding. It offered the holders of the bonds it had defaulted on a new bond for about 30% of face value. It then set a deadline for accepting the new bond and threatened that those who had not accepted by the deadline would be left with bonds that Argentina would never pay. About 3/4 of the bondholders agreed to the swap.

After the completion, Argentina began to focus on its debt to the IMF. However, the IMF has told Argentina that it must have a strategy to deal with the holdout bondholders before any restructuring of IMF debt can be considered.

Make no mistake: The IMF does not hold any of the bonds that Argentina defaulted on. It has no financial stake in the bond process whatsoever. Its role is merely to give advice on impose conditions that will put Argentina back on a path to economic growth and fiscal responsibility.

If Argentina was in trouble of scaring off a flow of foreign investment due its bond swap, then the holdout strategy might be a valid condition. But no such danger exists. Argentina is running surpluses and posting solid growth. Furthermore, the IMF bent over backwards to lend Argentina money during the run-up to its crisis. Where was this tight-fisted conditionality when Argentina was running off a financial cliff and the IMF knew it? The IMF could see that the dollar peg was unsustainable, and yet it continued to throw money at Argentina in an attempt to save it. It is irresponsible for the IMF to dig the hole Argentina fell into and to then step on its fingers as the country tries to dig itself out.

It bears repeating: The IMF has no stake in the private bond swap. It has no business demanding Argentina address the holdouts. All this demand accomplishes is the reinforcement of the image of the IMF as puppet to Wall Street. President Kirchner is right to face them down.

Volcker Disagrees with Greenspan

2005-04-11T05:06:00.000-07:00

Paul Volcker, former Fed Chair, writes that the United States is on an unsustainable economic path. Although Volcker doesn't directly criticize Greenspan, it's there between the lines. Essentially, he says no country can borrow $2bn per day, absorb 80% of world savings and consume 6% more than it produces forever. There will be an adjustment, and it won't be pretty.

Papers

2005-04-05T21:06:00.000-07:00

I'm currently working on a couple of papers for graduation. They are:

So Your Kid Wants to be An Anarchist: Separating Fact from Fiction Among Anarchist Critiques of Multilateral Institutions

Who's Indeed? Five Years After Public Citizen's Review of Five Years of the WTO

The first of these papers is pretty much finished, and I'll be putting a link up to it soon. The other one is in the early stages of development.

Doing research for these papers, it has become clear that the multilateral trading regime has lost the PR war in a spectacular fashion. Try doing a google search on "WTO," "World Bank," or "IMF" and see how much supportive or even blanaced content you get. I knew that it was bad, just not this bad.

Argentinian Debt Restructuring

2005-03-09T22:09:00.000-08:00

Just about everything I have to say about this has been said much better by Nouriel Roubini on his blog. I encourage everyone to read it. And if my endorsement isn't good enough (and it shouldn't be), Martin Wolf also endorsed it in today's FT (subscription required).

Chinese Import Surge

2005-03-09T21:58:00.000-08:00

The International Herald Tribune has the newest Chinese textile import numbers (although they are not official numbers.) Predictably, the imports skyrocketed after the elimination of import quotas on January 1st. However, they did jump a little bit further than what everyone expected. I think there are a couple of reasons for this.

1. Inventory - many importers may have skipped their orders in December and just ordered twice as much in January. For instance, if half of my imports were coming from China at 1.00 per unit, and I had already maxed out my quota, so the other half were coming from Mexico at 2.00 per unit, then it would make sense to wait until I could get all of my units at 1.00 from China. Hence, putting off orders until after the quotas had expired.

2. FTZs - as a corrollary to this, Free Trade Zones allow importers to either pay the rate of duty at the time of importation into the FTZ or at the time you withdraw them from the FTZ for domestic consumption. Savy importers may have been (and may still be) betting on a protectionist response from the Bush administration and the corresponding spike in prices. They would have imported the textiles at the non-quota rate and are just waiting for the prices to go up.

Still, it's too early to tell what effect the elimination of the quotas will have, except that imports will go up. Prices will go down. The domestic textile industry will take a big(ger) hit. The service sector should grow, as more disposable income is passed along to consumers (theoretically) through cheaper textiles. Or, coporate profits could hit record highs again as MNCs (Schumpter's winners) refuse to pass the savings from globalization to people who lose their jobs (Schumpter's losers.) But that's the topic of another post.

Rehnquist is Deep Throat

2005-02-07T09:20:00.000-08:00

At least that's my prediction. The Los Angeles Times has a piece in which Woodward has told his editors that Deep Throat is ill. Also, Ben Bradlee has publicly acknowledged that he has written Deep Throat's obituary.

Before being appointed to the Supreme Court, Rehnquist was an assistant attorney general. Woodward has consistently stated that he got his information from a high-ranking official in the executive branch. While the timeframes don't necessarily mesh, as Rehnquist was appointed to the Court on 1971 and Deep Throat was talking to Woodward a couple of years later, Rehnquist could have been drawing on his contacts that were still at Justice. Additionally, if Woodward had said that Deep Throat was a high-ranking member of the Judiciary, suspicion would have immediately fell at Rehnquist's feet.

I didn't think this before Woodward and Bradlee's comments. But I cannot find anyone else who was that involved in the Nixon administration that is ailing to the degree that Woodward and Bradlee would speak publicly about it.

Update: I was obviously wrong about this.

Greenspan's Wand

2005-02-05T17:39:00.000-08:00

Alan Greenspan, chairman of the Federal Reserve, has expressed his confidence that normal market forces will solve the U.S. "twin deficits" problem. The FT has the story here. I, for one, am skeptical.

"Normal market forces" generally means that the devaluation of the dollar should lead to more American export growth as well as domestic substitution for imports that become more costly. Of course, the foreign exchange (forex) markets responded in exactly the wrong way by bidding the dollar up. I think it'll go back down on Monday. Especially because Robert Rubin, the former Secretary of the Treasury, expressed the exact opposite view on the same day.

Jousting aside, is there any truth in the belief that export readjustment in the U.S. can solve the deficit problem? Can a falling dollar help the world's largest economy export its way out of its debt? The answer is, of course, yes and no.

No. There is substantial evidence that the U.S.' export supply has contracted significantly in the last decade. Simply put, having outsourced a large amount of our production facilities to capture cheap labor savings, a diminished dollar isn't going to do us as much good as it normally would. It won't change much on the services side, either, as the U.S. already has something of a monopoly on international tradeable services. A simple reliance on export-led growth isn't going to do the trick. But that's only one side of the coin.

Yes. A falling dollar means that imports become more expensive. Faced with higher prices, consumers will switch to domestic products which have become relatively cheaper. If the dollar decline is slow, then we should first see the effect at the margins. Namely, on those products which are necessary and which consumers are very sensitive to price. Shoes, textiles, food, etc. There is some debate as to why we haven't seen a bigger effect already. Some economists think it's the J curve, which contemplates a lag between currency shifts and imports. Others (including Greenspan) think that the Europeans and Japanese are absorbing losses against a falling dollar so as to not sacrifice market share.

Greenspan should have put a big "IF" in his statement. Normal market forces should start to have an effect on the deficit IF Asian central banks let the dollar depreciate and stop financing U.S. debt on the cheap. IF Geroge Bush's budget proposal shows international markets that the U.S. is committed to reining in its budget deficit (a tax increase proposal, however insignificant, would do an enormous amount to this end, but is at the outer frontiers of possibility.) The Treasury is going to have a big auction later this week. The amount of demand from the Asian banks (always a tricky proposition to measure) should add some substance to the first IF. The President is supposed to submit his budget during the same time. That will go a shorter way in answering the second IF.

The Shot Across the Bow

2005-01-26T20:56:00.000-08:00

China has fired the opening salvo on the dollar. The story is here. Speaking at Davos, Fan Gang, the Director of the National Economic Research Institute at the China Reform Foundation, said:

"The U.S. dollar is no longer -- in our opinion is no longer -- (seen) as a stable currency, and is devaluating all the time, and that's putting troubles all the time," Fan said, speaking in English.

Now, this doesn't mean that China is actually going to diversify out of the dollar reserve. It has good reasons not to do so, because it would only devalue the massive dollar reserves it currently holds. It would cause exports to become more expensive in the U.S., stunting export growth. The Asian central banks have been propping up the dollar for a while now, operating in a cartel-like fashion. And anyone who has studied cartels knows how they end: someone cheats. I think China is attempting to announce its intent to break the cartel.

If that is the case, the stampede should begin soon. Runs on currencies are not slow; usually, there's a small break in the dam and then it all comes down. Could the same thing happen to the U.S.? We're running out of people to help us out. So, what would a Chinese diversification look like?

Scenario 1: China does not noticeably dump any of its dollar reserves. Instead, it just starts buying less dollar debt. China will have to put its savings somewhere, though, and will probably go into buying Euro-debt and perhaps some emerging market debt. That'll lower interest rates in those countries, hopefully spurring more demand. Across the Atlantic, it would force the U.S. to raise interest rates to plug the capital hole from China's withdrawal. That would curb demand, and U.S. consumers would probably start substituting cheaper domestic products for more expensive Chinese imports. While the rise in interest rates would put a damper on growth, the U.S. economy is still performing undercapacity anyway. And cheaper domestic products relative to imports only helps U.S. companies and should lead to higher employment. In sum, this scenario is bad for China and good for the U.S. and EU.

Scenario 2: China starts slowly trading dollars for euros and yen. This would fulfill their goal of pegging the yuan to a basket of currencies instead of just the dollar. It'll cause the dollar to depreciate while doing the opposite to the currencies it diversifies into. It would most likely cause the yuan to appreciate along with it. This will not please the host governments of those currencies, as they're already squawking about losing export market competition in the U.S. It should be noted that this will have a more direct effect on the currency markets than Scenario 1, causing a rapid decline in the dollar and concurrent appreciation of the currencies China decides to diversify into. In sum, this scenario is (somewhat) bad for the U.S., somewhat less bad for China, and bad for the E.U.

There are a number of other ways China could move, but these would seem to be the most likely. So, which path will it chose? I'm betting on #1. Why? Because China desperately wants the arms embargo on it lifted. The EU is moving towards doing so. The EU desperately wants the dollar to stop sliding against its currency. If China is going to get out of the dollar, it has to do it in a way that minimizes the slide. The best way to do that is to leave existing reserves as they are and only start limiting future purchases of dollar debt. It will have to be done incrementally, so as to not tip off the private market. That being said, why would China publically fire this shot at the U.S. in Davos?

Maybe China wants something from the U.S. and is attempting to flex its muscle to show how its words can effect the bond market. Maybe its making a good faith show to the EU its serious about protecting EU exports while it revalues its currency. Time will tell. But one thing is certain: it does not bode well for the value of the dollar.

Vacation

2005-01-09T16:35:00.000-08:00

I'll be on vacation for the next couple of weeks, so I won't be updating very frequently (if at all.) I'll be in Los Angeles between January 10 - 17, then in New York from the 18 - 24. Please enjoy any of the fine sites on my blogroll during my absence.

Social Security "Crisis"

2005-01-06T22:57:00.000-08:00

Some of you have noticed that I haven't posted in a while. This was partly due to an unexpected flurry of activity at work, and the holidays. Mostly, though, I wanted to think through my position on the Social Security debate that is consuming the blogosphere as of late. There are bloggers whom I thoroughly respect who come down on opposite sides of this issue and I want to give them all their due. Tyler Cowen is doing an excellent job at Marginal Revolution of arguing for the need for reform, while Brad DeLong is doing just as excellent of a job at rebutting him. There is also some good background here and here on how the indexing of Social Security benefits works and how it would work under the proposed reforms.

At the end of the day, I fall into the Brad DeLong camp. Watching Tyler and Brad debate the issue, it seems that they're arguing different things. Tyler is arguing the merits of the proposals, but Brad is arguing that the proposals aren't (yet) necessary and don't need to be as sweeping. Because the debate has the potential to be so large and encompass so much, I'd like to distill the arguments down to a few simple justifications and then evaluate them. We'll move from the general to the specific.

1. Social security needs to be reformed.
Agreed.

2. Social Security needs to be reformed now.
Disagree. Brad DeLong has an excellent post (see above) about how in the greater context of our fiscal problems, Social Security is not that big. But let me add two things: A) It's a waste of time and B) I hope the Republicans try it anyway. When I say it's a waste of time it is not because I am dooming any reform effort to failure. I'm saying it from an economic perspective. There are a finite amount of days in a legislative sessions. The debate on this problem, the work going in to solving it, the amount of media attention it captures are all investments that could otherwise be spent on more pressing issues, i.e. the twin deficit problem, a nuclear North Korea, the real fiscal crisis facing the government, the real health care crisis, etc. Every minute spent on a problem that is not that big is a minute that cannot be spent on problems that are huge. And these are problems that have timetables. That must be dealt with by a certain point. If a sustained effort is not made to get the deficit under control, we'll be adding another 600 billion to the U.S. debt. If health care is not dealt with, its inflation will be in the double digits again. If North Korea isn't dealt with, it will have a nuclear weapon pointed at the mainland U.S. These are immediate problems facing the country which require immediate debate and solutions.

That being said, I hope the Republicans try it anyway. From a policy point of view, I don't agree that benefits should be cut (more about that later.) From a political point of view, it's like watching your enemy walk off a cliff. If there's an up-or-down vote on cutting benefits, and the Republicans toe the party line for Bush, he will find out just how much his political capital is worth. I see a lot of parallels to the Democratic Congress in 1993 voting for Clinton's tax increase. They toed the party line and then got clobbered in the 1994 midterm elections. Fast-forward to 2006: Republican incumbents are vulnerable to the following charges: a) Voted to change ethics rules to allow DeLay to serve as a leader of the party even though he was under indictment (even if he hadn't yet been indicted), b) Voted to cut the benefits to poor seniors while giving itself a pay raise. Put those two arguments together and you have a compelling narrative of a Republican party that is drunk on its own power and out of touch with everyday Americans. It's the same argument the Republicans used against the Democrats in 1994 and will probably have the same results.

In conclusion, the debate over Social Security should be folded into a larger debate over America's long-term fiscal health. Even if you take the "faith-based tax cuts" at their word, there is no way the benefits from them are going to generate enough revenue to plug the hole in the deficit. That being said, there is a stark silence coming from the Hill on how we're going to keep paying for our obligations. The Alternative Minimum Tax needs to be fixed (a topic for a later post), which is going to cost even more money. Iraq is going to cost more, not less. And we're still set on a path of lowering the tax rates and starving the government of revenue. The Democrats have a strategic opportunity here to turn this whole debate into a "Show Me The Money" debate. The fiscal problems America is heading into are structural, not episodic. They require a structural change.

3. Social Security needs to be reformed by cutting benefits.
Disagree. Currently, benefits are calculated by the average of your 35 highest wage-earning years and then multiplied by the average increase in wages between then and now (a more detailed explanation is in the posts I listed above.) The Bush proposal would multiply the wages by the rise in inflation, specifically the CPI, not wages. Wage growth is typically stronger than inflation, so this results in a benefit cut.

Most of the arguments against this are premised on the theory that inflation-based indexing more accurately represents what our seniors are "entitled" to receive. I think this argument misses the boat. Who will really be affected by this change? Poor seniors. You're talking about a demographic that arguably should be receiving the most help from the government (second only to poor children.) Seniors are being eaten alive by skyrocketing medical costs, drug costs, property taxes, etc. So what if the inflation-based model is a better way to reflect what their benefits should be worth? If the seniors have to go on public assistance to make ends meet once their benefits are cut, does it really matter? Poor seniors have a fixed amount of expenses to meet and a fixed amount of income they receive. If you take away part of that fixed income, where will they make it up? Not in the workforce. So, you'll essentially be fixing the problem by saddling the general fund or the states with more expenses. Robbing Peter to pay Paul.

But what about the seniors who aren't struggling, who can make ends meet even if we shave off some of their benefits? If that's your argument, then simply raise the tax rates on benefits to generate revenue. As long as it's done in a progressive manner, it shouldn't hurt those who need the benefits most and will be a de facto benefit cut targeted at those who can most afford such a cut.

Increasing the retirement age in a staggered process could also be beneficial. People work and live longer these days then when the system was first designed, so it makes sense. What does not make sense is exempting income after 90K from Social Security tax. Make it all taxable to generate more revenue.

4. Social Security should be reformed by personal investment accounts.
Disagree. I think personal investment accounts are a wonderful idea. Anything that gives people the option to save more in a convenient way is okay by me. I would disagree with Brad's idea (on his post above) to automatically divert people's tax returns into a savings account unless they fill out a form. First off, I don't think it's a politically viable option ("Politicians telling you that you have to fill out a form to get your money, etc.") Second, it adds another level of bureaucracy between people and their money, which doesn't do much to sharpen the image of government in the minds of the people. Instead, I would offer a government form of a 401(k). A lot of small businesses don't offer 401(k)s, and this would be a good way to make such an option available to them. They would work like this:

A) Every paycheck, a certain amount is deducted. It is placed in an account that is indexed to either the NYSE or the NASDAQ. If these go up, your account goes up. If they go down, your account goes down. Your investments are pegged to a wide and deep index so that temporary swings won't wipe you out and that historically have grown in value as time went on.

B) These deductions are tax free. The accounts cannot be used as collateral for loans, cannot be attached by creditors, cannot be part of any divorce settlement and are completely portable between jobs. They are inheritable.

C) You have a limited ability to draw back out of these accounts. Once your account hits $1,000, you can never draw it back down below $1,000. Once it hits $2,000, you can never draw it back down below $2,000. If you had deposited $5,000 and Wall Street took a hit that lowered your account to $4,000, you would have to wait to get it back up to $5,001 to withdraw $1. The deducations are also tax free. This system gives a generous award of tax-free dollars while limiting its use as a tax shelter to roughly $1,000 per investor. The award would provide a powerful incentive for people to save, without forcing them to do so, and avoid the trap of being a tax haven.

D) At any time, some or all of the account may be used to fund college tuition for either the account-holder or a child. This reflects that while savings is important, it is more important for people to get a college education. Think about it. What is a tuition anyway but an investment in the future earnings potential of the student? Because college graduates earn about sixteen times more than high school graduates, it has the potential to be an even more lucrative investment than the NYSE. Economic trends almost mandate a college degree if one wants to be considered for entry into the middle class in the future.

So, that's what I think. Social Security should be reformed, but not at the expense of other problems that need our immediate attention. Whenever it is done, it shouldn't be done in a way that penalizes poor seniors when there are other options available to generate the needed revenue. Personal savings accounts are good, but should be used on top of Social Security, not in lieu of it.

New Year's Fun

2004-12-30T07:20:00.000-08:00

The Economist has an article here about the potential impacts of the elimination of textile quotas on January 1, 2005. A quota works just like it sounds; the U.S. only allows a certain amount of textiles from each country to be imported per year. The U.S. has had textile quotas in one form or another for the last 30 years. Because the domestic textile industry happens to be located in sensitive political geographic locations (like steel), any move in the industry is bound to be interesting.

Among some of the attention-grabbing findings is that China could gobble up about half of the U.S. market and more than 30% of the EU market. This would, of course, wipe out the economies of Bangladesh, Cambodia and a group of other countries. However, those numbers are based on cost alone and don't take other relevant circumstances into account (i.e. proximity, scale, etc.) Moreover, I don't think China wants the textile market. Textiles are how poor countries enter the world market; China is not a (relatively) poor country and is already in the world market. Moreover, textile dominance would be a step back for China. They're currently moving into manufacturing with an eye to jump into tech and services sometimes in the next decade. Exerting their influence in textiles would be a step back, not a step forward.

Russia's Devolution

2004-12-21T16:04:00.000-08:00

The New York Times (free registration required) has the latest installment in the Yukos saga here. This story has interested me for a while.

In the old days, Russia would just send soldiers to a business when they wanted to take it over. However, that tends to make foreign shareholders a little edgy these days. So, today Putin uses taxes. It's not exactly parking a tank outside the storefront, but the effect is the same. Here's how they do it:

All of the sudden, you get an enormous bill for back taxes. "Absurd," you say to yourself. "Tax rates aren't this high, and I paid all my taxes." You try to work this out with the tax agency, but to no avail. You go to court, which is a joke. The judge easily finds for the government. So, how will the government collect its money? They'll auction off your business, of course. But wait, the government can't just auction the business to itself. Instead, it gets a couple of buddies to stand at the auction and make the bid for the government. To add insult to injury, the bid is less than the company is valued. It's all a sham, of course, these guys are going to transfer your business to a government-owned subsidiary pretty quick. But, at least it looks more official than a tank outside your storefront.

Who does this ultimately hurt? The Russian people. Foreign investment is critical for job creation in Russia. But no one is going to invest in Russia if they think the Kremlin can confiscate their investments at the drop of a hat. The blind spot for this Kremlin has always been their inability to connect the dots between domestic sovereign action and foreign private reaction. Like it or not, Russia depends on the rest of the world. It cannot continue to act as if it governs in a vacum. Doing so will only exacerbate their problems, not solve them.

Absence

2004-12-20T13:59:00.000-08:00

Sorry for the lack of posting for the last few days. I have been in the middle of finals and my time was needed elsewhere. Now, happily, finals are over and I'll resume posting tomorrow. Thanks for your patience.

China Slaps Export Tax on Textiles

2004-12-12T21:57:00.000-08:00

China has announced that it will put an export duty on textile imports to compensate for the dismantling of textile import quotas under the WTO, Yahoo is reporting here. The duty will be on a quantity, rather than value, basis.

Why is China doing this? They've had no qualms about undercutting other countries on manufacturing, so why should textiles be any different? I have a couple of theories.

First, they're probably trying to avoid a flurry of anti-dumping actions in the U.S. Companies in the U.S. can file anti-dumping actions if they believe a foreign company is charging monopoly profits in its home market to subsidize lower cost exports into the U.S. market. It normally works by finding the ex ante price out of the warehouse, and comparing price in the home market and the U.S. market. However, because China is a non-market economy (NME), the Department of Commerce (DOC) will use prices in a surrogate country (Japan is normally substituted for China.) So, if comparable textiles that are produced in Japan are being sold to Japanese consumers for more than what Chinese companies are charging the U.S. for its textile imports, the Chinese company will get slapped with a duty to compensate for the difference. Even worse, under the Byrd Amendment, the proceeds from the duty put on the Chinese imports will go to the company who brought the anti-dumping petition. This effectively subsidizes inefficiency, but that's a subject for a different day. My take: the Chinese figured the anti-dumping duties were inevitable, so instead of having the money flow to U.S. competitors, the Chinese government decides they'd rather just keep it themselves. This is evident by how the tax is structured: quantity, not quality. This will encourage higher-end textile exports because they'll face less of a real duty compared to the value of the export. My worry is that other countries will catch onto this, and start their own export duties to raise their prices enough to get around a positive dumping determination. This will have the effect of raising world-wide prices, mostly on lower-cost goods. Another reason why the U.S. needs to get rid of the Byrd Amendment.

My second theory is that the Chinese probably don't want to get sucked into low-end textile manufacturing. Given enough latitude, China could easily become the entire world's textile producer. I don't think that's what China wants. Instead, they'd like to branch into more capital-intensive manufacturing and build enough infrastructure to compete as a first world power. The road to doing so does not lead through textiles. They get an added benefit of earning themselves some elbow room on their currency undervaluation, too.

UPDATE: New York Times (registration required) has a somewhat more expansive article here.

Health Care Reform

2004-12-11T16:38:00.000-08:00

Andrew Samwick makes a compelling case for eliminating the deductability of health care premiums, both on the employer and employee side, here and here. Tyler Cowen weighs in here. Brad DeLong signs on with Samwick here. The crux of Samwick's argument is:

Who benefits from this deductibility [of insurance]? ...the average family with $100,000 or more in income receives a benefit of $2,780. Compare this to an average benefit of $1,231 for a family with $30,000 - $39,999 in income. Because tax rates are higher at higher income levels, and those with higher incomes are more likely to have coverage, the benefit goes up with income...

The portion of this disparity that is due to the progressivity of the tax system is ridiculous. Subject it all to tax, and take some portion of the $100 - $200 billion saved and use it to provide refundable tax credits to purchase health insurance, whether through an employer or an individual policy. The credits should phase out at higher income levels.

I have a few reservations, myself.

The above is a good argument for ending the deductability at the the employee end. If you look at the deductability as a government payout rather than an exclusion (which it is, the government is forgoing a tax it could have employed, and in doing so is putting money in your pocket) the deduction makes no sense. It does not encourage anyone to do anything. It is skewed toward the higher income brackets. Furthermore, and most importantly, the deduction has little to no effect on whether employees opt for coverage. Employees don't get to decide whether their employer offers health care. And if it's offered to them, they certainly aren't going to turn it down simply because their income gets taxed before their premium is withdrawn, instead of after. The current deduction does nothing but give people a break on however much their insurance plan might charge for a premium. Taking the deduction away allows the government to target new money towards programs that might actually fix the health care market (overconsumption and inefficient choice of services). It also puts a little bit more of elasticity on the demand side for premium increases, as employees will feel them more than they do now.

The deduction for employers needs to stay. Eliminating it means that the cost of providing health care to employees goes up. Small employers are having a hard enough time keeping up with premium increases already. Making it even more expensive by eliminating the deduction means pricing more employers out of the market, and that means more employees will be unable to receive health care. Many low-wage employees simply cannot afford private health insurance if it is not provided by their employer.

Instead of using the money saved by eliminating the deductions to create tax credits for the purchase of health insurance, as Andrew argues above, I'd rather see them put into Health Savings Accounts. The goal of the HSA is to allow employees to divert some of their paycheck, on top of their higher deductible health care premiums, to a savings account which will cover out-of-pocket expenses until the insurance kicks in. Instead, eliminate the deductibility at the employee level, but use the new tax dollars as a transfer into the person's HSA. For instance, Andrew quotes above that the average family of four in the 30-39K tax bracket gets $1,231 from the deductability. Instead of that deductability, which doesn't give the family an incentive to do anything, why not put it in their HSA? This means the family that can't afford to divert any of their paycheck to contribute to their HSA can now forego the benefit of deductability and contribute directly into the HSA. Admittedly, all this is doing is switching around the time the benefit is realized, but it ties the benefit more directly towards health care spending.

Let's take it one step further and see if we get more benefit from means-testing it. This means we provide more of the benefit to people making less money. How to do it? Well, this is the tricky part, because again there's no way to judge health care spending or family size off of income tax bracket alone. Well, first off we can cap the automatic distribution of the deduction at age 65, because that's when Medicare kicks in. You'd still be able to withdraw from the HSA, but no more automatic contribution. This will give us some more money because people at age 65 and above will still be working, but we'll be transferring the benefits of the deduction to someone who doesn't have Medicare to back them up. Second, we can correlate a number of dependents that a household has to the number of children it has. The more people in the house, the more medical expenses there should be. We tie the amount of the benefit to the number of dependents claimed. So, for every dependent a person claims in addition to themself, they get a certain multiplier of their deduction contributed into their HSA. For instance, if you only claim yourself, you get the benefit of the deduction placed into your HSA. If you have claim head of household, have a wife and three kids, you'd get your deduction benefit times X, where X = the mutiplier assigned to 4 dependents, contributed into your HSA. The money saved by means testing means we can afford to give poorer families more than their automatic deduction contribution, which means they have more money to spend on health care.

Alright, you might say, but this is not going to help out anyone during Year One of the program. The contributions into the HSAs are going to be so small that they can't possibly cover ongoing first dollar expenses. You may be right. So, let's give everyone an up-front deposit of what their estimated deduction value would be. For instance, based on the deductions you had last year, let's say you're going to get X amount of dollars next year. We'll just give it to you now. Obviously, you'd want to make the means testing for eligibility for this program tighter than you would for the ongoing program. The most effective way to do this would probably be tie eligibility to eligibility for the Earned Income Tax Credit. It's going to cost you a few billion, but it's only a one-time expense and there are worse ways to spend the money.

Finally, you might ask, how does this combat the real problems in the health care market: overconsumption and inefficient decision-making? The same way regular HSA's do, by making consumers more price-sensitive to initial expenditures. The theory goes that once you've spent enough that your insurance is kicking in, you've become less price-sensitive because there's something seriously wrong with you. The key difference in the plan above is that it allows more participation in the program by diverting a benefit no employee pays attention to, deductability of premiums, into one they can use, their HSA. It allows poorer employees with more medical liability to actually realize more than their respective benefit by means-testing it to target it to those families who need it the most. Those who are so price sensitive that they've sensitized out of the market.

Bad Moon Rising

2004-12-09T14:45:00.000-08:00

The Financial Times has it that weak demand for ten year T-Bonds has pushed yields up by five basis points. This might be a good time to explain how the bond market works:

When the U.S. government (or anyone, for that matter) decides they want to borrow money from the public at large, they have a number of different options. One way is to issue bonds. The U.S. Treasury issues what are called 'zero-coupon bonds.' This means they don't pay out a stream of money over the life of the bond (or coupons.) Instead, they offer bonds at less than face value which are redeemable at some other point in time for full face value. This is like asking a friend for an IOU: "Hey, Mike, if you buy me lunch today I'll take you out to dinner next week." Dinner normally costs more than lunch, so most friends would go along. Buying bonds is the same thing. When you make this offer, however, you don't know where your friend is going to pick for dinner. You may get lucky, and he might decide he just wants a peanut butter sandwich. Or, he might decide he wants dinner at Spago's. People buying bonds are depending on the sandwich answer, because then they realize a gain. (Lunch out typically costs more than peanut butter and a couple of slices of bread.)

What determines the Spago's v. sandwich decision in the bond market is not your friend's preferences, but the rate of inflation. How much the face value of the bond is discounted depends on what the buyers' consensus of future inflation will be. If a bond will pay me $100 in ten years for a price today of $60, that might sound like a good deal. But if my present $60 is going to be worth $120 in ten years, then I've actually lost money. Typically, if the bond issuer does not get enough to demand, they have to raise yields. What this really means is that they're lowering the price (if this sounds counter-intuitive, it is.) Let's go back to our dinner example. Let's say you're asking your friend for another IOU. "Nope," Milke says. "I got burned by you one time before. You said you would buy me dinner, and then tried to pass off that sandwich as payment." Well, now you're either going to have go lunch-less or sweeten the deal (maybe with dinner and dessert.) When bond yields go up (and bond prices go down), the bond issuer is sweetening the deal by offering a deeper discount for a guaranteed payment at some point in the future. If the issuer discounts the bonds too much, then the bearer gets a pot of money at the end of the bond term, or maturity. If the issuer discounts the bonds too little, then the issuer gets the gain. At the end of the day, the bond market is an attempt by people to predict the future and capitalize off of what they believe to be misconceptions.

Given the above, the bond market should be an accurate predictor of future inflation. After all, you have all these savy traders who make a living off of trading these things and staying immersed in the current economic data. Well, you'd only be partially right. It gets trickier when the bonds are government bonds. While they are viewed as the safest investment, actors sometimes have ulterior motives in buying and selling bonds. This takes us to central banks and the currency market. It took about twenty times of reading this stuff to make me understand it, but a good maxim to keep in mind is the following: The value of something is directly dependent upon its scarcity. Grains of sand are everywhere, not very valuable. Gold is not everywhere, very valuable (sometimes.)

This goes for currency, too. The more dollars out there, the less valuable it is against other currencies. But how do more dollars get out there? The U.S. Treasury issues bonds. The more bonds it issues, the more dollars (theoretically) that are in circulation. So, why would the Treasury be issuing all these bonds if all it does is make the dollar less valuable. This is where deficit spending comes in. The U.S. government has to pay its bills somehow. And when its income doesn't meet its expenses, it has to borrow, just like everybody else. Typically, this has the effect of raising bond yields. Why? Remember, the value of something is dependent upon its scarcity. So, if we assume there's a finite amount of money out there to be borrowed, the less there is, the more expensive it gets to borrow it. Let's go back to our lunch example. You still want Mike to buy you lunch, but you've had to offer him dinner at McDonald's to get him to even consider it. Unfortunately, Mike is the only one of your friends who has any money, and a bunch of your friends want him to buy them lunch, too. Mike can only afford to buy one person lunch. So, a bidding war ensues. Mike will buy the person lunch who 1) makes the most lucrative offer and 2) has the most potential of fulfilling that offer. This is what happens in the bond market. In order to attract people to buy the bonds, the issuer has to offer lower prices that reflect the scarcity of available capital. So, if the government is in a record deficit (which it is) bond prices should be falling, yields should be rising and the dollar should be losing value. However, they aren't. Why not? Remember: more bonds = higher yields = lower bond prices = more dollars = less valued dollar.

Because actors in the market aren't making decisions purely out of self-interest. Central banks are typically large institutions that belong to or are controlled by governments. The Federal Reserve is the U.S. central bank. Because these banks are either de facto or de jure controlled by their host governments, they sometimes act in the interest of the government rather than the bank. For instance, Japan and South Korea's export markets are very sensitive to U.S. demand for their exports. The most direct way to value a currency is to measure its value against other currencies. A dollar that is declining in value means that their exports get more expensive. How? Because their exports are valued in their own currency. If the dollar will buy 1 won on Tuesday, but only 1/2 of a won on Wednesday, whatever I'm buying has just become more expensive if its valued in wons. Let's say that I want to buy a Sony Discman which is made in Japan. It costs Sony 1000 yen to produce the Discman, get it to the U.S. and realize a reasonable pocket. I, however, do not get paid in yen. I get paid in dollars. So, I will have to exchange my dollars for yen to buy the Discman (this will be done for me by the importer.) If the dollar has lost value, then the functional impact to me is that the Discman has become more expensive. So, I might decide to take a look at a Phillips brand instead (provided it is made in a U.S. dollar-denominated currency country.) Because the Phillips brand is made with its value denominated only in dollars, and it never has to be exchanged for a stronger currency, the Phillips brand Discman will be cheaper. And I will buy it. A falling dollar therefore makes foreign exports more expensive, driving down demand for them here in the U.S. So, central banks that are linked to governments that have export markets particularly sensitive to U.S. demand have the most to lose from a falling dollar. But what does all of this have to do with the bond market?

Hopefully, you're beginning to see the picture now. Central banks with strong U.S. export markets will intervene to prop up a dollar that is on the decline. Why? If the U.S. government is in record deficit territory, with no real end in sight, why buy bonds when the prices don't reflect the risk? Part of this is because there is no real risk that the U.S. will default on its bonds. It is the economic superpower, and its word is generally risk free. Remember criterion number 2 from the lunch example: Mike will lend to the person who has the greatest potential to actually deliver on their promise. If you offer Mike a lamborghini next week and have no job, and John offers him a steak dinner and has rich parents, which do you think he'll pick? Being the dominant economic power allows the U.S. to avoid some of the risk premium it would have to offer were it another country running the deficits that it is. But this only accounts for some of the irregularity. Bond prices should still be at record lows, with yields at record highs. The other reason is blanket self interest. A strong dollar is in the interests of governments who's economies are sensitive to U.S. demand for their exports. A drop in the dollar means a drop in demand. So, these banks will often buy undervalued bonds just to keep the dollar from sliding further. Because the banks generally buy through indirect buyers, so as to keep their motives secret, no one knows exactly how much they are buying for sure. But they are buying.

So, where does that leave us? central banks bought up the majority of the last two major bond issuings by the Treasury. We know central banks have incentives other than self-interest to buy these bonds. Those incentives lead them to push for an (over)valued dollar. Their buying resources cannot (ordinarily) be matched by the private sector. Conclusion: The central banks have propped the dollar up above its actual value. In doing so, they have depressed bond yields and inflated bond prices. Whether they can do this sustainably is open for debate. If they cannot, get ready for another global recession.

Snow Stays in the Forecast

2004-12-09T06:16:00.000-08:00

It looks like John Snow will be staying at Treasury, according to many sources. Tyler Cowen and Brad DeLong have a discussion up at the WSJ's econblog (subscription not required). They do an excellent job of listing the qualities desired in an ideal SecTreas.

I would just add one more, and I think it's the most crucial: credibility.

People need to know that they can trust the Secretary when he calls and assures them the President is serious about deficit reduction. Or a strong dollar policy.

I don't think Snow has that credibility. He's only been a cheerleader for economic policy that's developed wholly in the White House instead of with input from the OEOB. There is no evidence that he has a substantive impact on policy formulation, or that the President seeks out, much less listens to, his advice.

Not that it would be easy for anyone to be Bush's Treasury Secretary. Their policies would be a joke if they weren't so tragic. At every juncture, the Bush Administration has chosen to pursue reckless policies in order to shore up a political constituency. It's just too bad the future doesn't have a vote, because they'll be the ones paying for it.

The BoSox Model

2004-12-07T21:02:00.000-08:00

The New York Times (registration required) has an interesting story on the Sox's model of acquiring and retaining players. I found the following particularly noteworthy:

"The 2004 championship has emboldened the Red Sox, so far, to stick to club policies: no player is given a no-trade clause or a contract that guarantees more than four years."

Any personal service contract is an attempt between the principal and agent to predict future performance. The team (principal) has a number of options if a player (agent) performs at a level lower than that anticipated. One of those is trading the player to another team for different players, money, or both. The player who gets traded often has to shoulder the costs of relocation and something of a stigma that goes along with being traded. Another option the team has is to release a player at the end of the contract. By dealing only in (relatively) short-term contracts, the team takes less of a risk on a player by minimizing the team's exposure to a smaller number of years. This provides less stability for a player who may perform at lower level for reasons beyond her control.

No-trade and long-term clauses also create disincentives for players to perform at their best. After the level of compensation has been set, a team retains very little in terms of sanctions to address a player who is not giving enough effort. The ability to trade a player is one of those sanctions. If a player knows that her position on the team is not definite, she has an incentive to perform better than a player who believes her position is definite. Imagine you couldn't get fired from your job or get a pay-cut. How would it effect your job performance? (Be honest.)

A short-term contract also gives a player more of an incentive to perform well during the entirety of the contract term. If a player performs with an eye to increase her market value, she will perform well when that performance has the greatet impact on said value. Other teams aren't looking at how a player performs during the first year of ten year contract. But they'll be paying special attention to how she plays in the ninth and tenth year for two reasons. 1) The more recent trend in performance is more likely than less-recent trends to reflect future performance. 2) Other teams will assess their own needs as the player gets nearer to market availability. Because a player's performance will have a greater marginal impact on her market value towards the end of the contract than its beginning, short-term contracts should encourage better average performance than long-term contracts.

The downside of this policy lies in the potential impossibility to lure Tier I players to the Red Sox. Because high-value players are in a relatively better bargaining position than their lesser-valued peers, they have greater options for contract terms. If teams other than the Red Sox are willing to offer no-trade clauses or long-term contracts, Tier I players may disproportionately avoid the Red Sox for other teams. This would leave the Red Sox at a competitive disadvantage due to their inability to attract top tier talent. (The article does mention that the Sox made an exception for Ortiz.) However, the Red Sox have apparently decided that flexibility in their lineup is more important than attracting such talent. Time will tell if it becomes a dominant strategy.

Zoellick's Strategy

2004-12-06T22:18:00.000-08:00

Sebastion Mallaby has an excellent op-ed in The Washington Post (registration required) about United States Trade Representative's Robert Zoellick's pursuit of not only multilateral, but also bilateral trade liberalization initiatives. The piece praises Zoellick's energy in promoting the Doha round of WTO trade negotiations, but strikes a cautionary note regarding bilateral agreements.

Mallory does a good job of listing the dangers inherent in bilateral trade treaties, but I'd like to add a couple more. Trade fortresses and rent-seeking.

Trade fortresses: There is a possibility that pursuing bilateral treaties will lead to the formation of regional trade blocs. The EU is already a customs union, and there is talk of reviving the Free Trade Area of the Americas along the same lines (although MERCOSUR seems to make this a long-shot.) The fear is that these regional customs unions will turn into regional trade fortresses, with trade free amongst their members but prohibitively high outside them. This is the flavor that international trade had taken in the run-up to World War I, and we saw how that worked out for everyone. Economic stability feeds into military stability. An open and level multilateral trading system is preferable to spheres of influence anchored by economic superpowers. No one needs an economic Cold War.

Rent-seeking: Creating different tariff levels for goods originating in different countries distorts commercial flows by making it more profitable to commit resources to an area where they would not normally generate the highest return. For instance, let's say our tariff rate on shoes originating in China is 5% ad valorem, consistent with our WTO obligations (I'm pulling these numbers out of the air, by the way.) So, a shipment of shoes from China valued at $100 will be assessed a $5 duty at import. This cost will be passed on to the consumer at the checkout line. Now, let's say we sign a regional free trade agreement with Haiti, the Dominican Republic and Grenada which commits us to a bound tariff rate on shoes at 2% ad valorem. A comparable shipment of shoes at $100 will only be assessed a $2 duty, and that cost will also be passed on to the consumer at the checkout line. China only remains competitive if its product costs are 3% or less than in the Carribean countries. This means that even if China could produce and sell the shoes for 1% or 2% less than the Carribean countries, it will still be less expensive for consumers to buy Carribean-made shoes. Therefore, capital will flow to Carribean shoe manufacturers, even though they are not the most efficient producer of shoes. This is a trade distortion, and works against the theory of comparative advantage that the multilateral trading system is based on.

Mallaby mentions it in his article, but I think it's worth mentioning again: there is a limited amount of enthusiasm for trade liberalization. Negotiations are an exhausting process of nailing down a deal that doesn't rob you blind and then selling it to a protectionist electorate. By using this limited enthusiasm for bilateral, rather than multilateral negotations, we may be taking the wind out of the sails for a successful conclusion to the Doha round. And the Doha round is critical to restoring developing coutries' faith in the WTO.

Superstring Theory 101

2004-12-06T21:09:00.000-08:00

The sub-title of my blog says that I will occasionally discuss superstring theory. This is not my field of expertise, but something I keep up on in my free time. Expect the lack of knowledge that I exhibit in economics tol be compounded in superstring theory. Just a heads up.

You may be asking yourself why a blog that's concerned with international economics would post about theoretical physics. After all, I've never taken Chemistry, much less Physics. Both generally make my eyes glaze over and triggers an impulse to run. But, I read a couple of articles out of interest and got hooked on it. Why? Because it's a theory of everything.

The theory attempts to unite the theories of quantum mechanics and Einstein's general relativity. Those two theories are both consistent with what they describe, but force you to make opposite assumptions about how the world works. Quantum mechanics describes how things act at very small scales while general relativity describes how things act at very large scales. String theory started off as an attempt to make the two theories consistent. It evolved into a grand, unifying theory.

The superstring theorists have their critics, but its advocates insist that the theory is simply too beautiful to be wrong. Unfortunately, although it's explained many things, science does not yet have the capability to perform the sorts of experiments that would verify it. Or falsify it, for that matter. Alternative theories that challenge superstring theory normally end up getting absorbed into the theory itself. This has led some critics to call superstring as more of a philosophy than a theory.

At its core, superstring theory postulates that the fundamental element of the universe is not a spherical particle, but a loop of string. We just always thought it was a particle because our microscopes aren't powerful enough to peer to the side of the loop. The loops of string all vibrate at a certain resonance and tension, much like the strings on a violin. The type of vibration determines what form of matter the string takes. The universe is an infinite symphony of different strings vibrating at different frequencies.

It also postulates nine spatial dimensions and one temporal dimension, but that's a topic for another post. The New York Times (registration required) has an excellent introduction, as well.

I think superstring is to physics what comparative advantage is to economics. In physics, our intuition tells us that there are three spatial dimensions and one temporal dimension. In economics, our intuition tells us that protectionism is good because it encourages domestic job growth (at first). In physics, superstring was first postulated as a theory. In economics, so was comparative advantage. In either case, we don't have enough data to say that either theory is a law. But we know that they have to because we've tried everything else and it doesn't work.

Becker and Posner

2004-12-05T22:57:00.000-08:00

Turns out I won't get the 'Brand New Blog' newscycle to myself this week. Some guys named Gary Becker and Richard Posner decided to start their own blogs. They'll be posting once a week (Monday) and apparently each posting separate entries instead of collaborating. Their first post is up here. You can read my comment here. Their first post is about Pre-emptive (preventitive) war and is (obviously) pretty good.

As a side note, if I encounter one more Federalist-Society-wannabe-first-year-law-student signing weblog comments as 'Cincinnatus' one more time, I think I'll be sick.

Blood Jumps on the Bandwagon

2004-12-04T23:13:00.000-08:00

I just saw a commercial that demonized globalization to try and get people to give blood. It was from a first-person perspective about a guy who was writing to a company about its child labor/sweatshop practices and kept getting coupons instead of responses. Then talked about child labor and deforestation as it pertained to the paper for all the letters he was writing. The upshot is that, get this, 'saving the world' is hard but you can do a little by giving blood. As if saving the world meant putting an end to globalization?

This is the kind of stuff that really pisses me off. In law, it's akin to what we would call inference stacking. Fact A would lead you to draw Inference 1. If you assume Inference 1 is a fact, then you can draw Inference 2. The flaw being that Inference 1 is not a fact. This is why it isn't allowed in courtrooms. This commercial does the same thing. Fact A: global trade means that children will be making our jeans. Inference 1: Children are forced to work. Inference 2: The factories that employ them are heartless and exploitive. See where the flaw is here? And the worst part about is that it fans the flame of misinformed passion in order to get people to donate blood. Metamessage: If you give blood, you're one of the good guys. Global trade is the bad guy.

Children aren't forced to work at the barrel of a gun. They're forced to work because their families are poor. The parents wouldn't send them to work if they had a choice, but they don't. The working conditions in foreign-owned factories are often remarkably better than any available in domestic industries. And wages are higher. Doctors and lawyers are leaving their practices in Vietnam to go work in foreign-owned factories. Would these people rather these children go back to the farm and starve to death? Take a good look at Sub-Saharan Africa. See what happens when people can't work for a living to put food on their table. The girls become prostitutes and boys end up riding in the back of a Nissan pickup truck with an AK-47.

If you want to register your complaint with the Ad Council, who published the commercial, email them here. You can view the ad here.

Gains From Trade

2004-12-04T09:06:00.000-08:00

The Economist has a story citing a new study* by Scott Bradford, Paul Grieco and Gary Hufbauer, of the Institute for International Economics (to be published in January.) The study attempted to measure the gains that the U.S. has realized through increased global trade.

This can be something of a Herculean task. Attempting to isolate out historical gains that are due only to global trade, rather than say productivity increases or transportation cost decreases, is rather daunting. The authors of this study attempted a couple of different methods, but the one I like the most is the counterfactual: Where would the U.S. be if it hadn't opened itself up to trade after WWII?

If the same protectionist tariffs were in place today, it would knock off 2.4% of GDP. If our neighbors responded with their own escalated tariffs, it would knock 2.1% of our GDP. Taken together, tariff and non-tariff barrier liberalization can be thanked for about 7.3% of GDP.

The authors then combined this finding with their macroeconomic and microeconomic modeling, and took the average of the gains to come up with about $1 trillion per year in benefits to the U.S. That's an extra $9000 per person per year due to free trade. The study goes on to say that there's at least a comparable amount to be gained by further trade liberalization, not just in the U.S. (which has an average bounded tariff rate of 3%, but an actual average tariff rate of about 2%) but in the developing countries as well.

I'll just say to those of you who might think globalization is bad for the world's poor, you are utterly incorrect. The developing world is craving increased opportunities for trade. More has been done in the last 50 years, more people brought up out of poverty, than the last 500. China alone has lifted over 100 million people out of poverty since it began adopting market reforms. Other countries are desperate to do the same. The blind spot in most people's thinking is that trade is somehow a zero sum game. If the U.S. is winning, then someone must be losing, and it's probably the poor. But trade is not a zero sum game. It can be a positive sum game.We all make positive sum trasnactions every day, teading our labor for coffee, food, computers, etc. Developing countries just want that same opportunity.

* “The Payoff to America from Global Integration”. Forthcoming in “The United States and the World Economy: Foreign Economic Policy for the Next Decade”, edited by Fred Bergsten, to be published in January by the Institute for International Economics

Property Taxes Inspiring 'Revolt'

2004-12-03T08:16:00.000-08:00

CSM has a story about rising state property taxes and their impact on low-income retirees. Personally, my knee-jerk reaction to people who complain about taxes is just tell them to quit whining and go live in Uganda if they think the tax rate here is too high. Go ahead, see what kind of government your lower tax rate gets you iin Uganda.

However, this should not discount the argument that tax revenues are spent inefficiently. Of course they are. But, like any undertaking the size of the U.S. government, inefficiency is to be expected. Inefficiency isn't a reason for abandonment. If so, we should all be bailing out of our HMO's (20% spent on administration) in favor of government-run Medicare/Medicaid (3% spent on administration.)

Property taxes are a regressive tax that looks like a progressive tax. In most states, it's based on the valuation of the property. Because of the housing boom, valuations have been rising at double digit rates. But that doesn't mean people are getting a double digit increase in accompanying income. Normally, taxes based on value are progressive because they go up as revenue goes up. But there's no income stream tied to home ownership, it's largely a fixed asset. So, people are paying more taxes but not seeing any (real) value accuring out of it.

My advice?

Sell now! It's called a "bubble" for a reason. When interest rates start rising, housing prices will start falling, and then you won't have an opportunity to recapture some of that excess property tax. Sell now, while prices are still inflated.

State governments need to reform their property tax systems to deal with a bubble-prone market (remember the S & L's?) Instead of basing the tax on valuation, I would like to see one based on square footage. That way, people wouldn't get hit with a wildly fluctuating tax bill every year. They'd know if their taxes were going up because they'd know if they added anything to their house. You'd still have governments able to change how much they taxed per a square foot. At the very least, this would provide some needed stability in an uncertain system.

Comparative Advantage and China

2004-12-02T21:09:00.000-08:00

Business Week has an excellent article on the costs of Chinese manufacturing labor. The Bureau of Labor Statistics hired Judith Bannister, a Beijing-based American consultant, to ferret out these costs. Why hire a consultant? Because China does a poor job of publishing these statistics, of course. Remember, these numbers aren't bulletproof, but probably represent the best information available. Among the most interesting findings for 2002:

1. The average cost of an hour of manufacturing labor in China is 64 cents an hour. This, of course, means nothing. Translated into purchasing power, it becomes $2.96 per hour. As a basis for comparison, Mexico averages $2.48 per hour. But, lest you think China is lowest, Sri Lanka is at 49 cents (courtesy of the Bureau of Labor Statistics.) This is about what you expect. China has an enormous pool of cheap labor that it can use, and its costs are consistent with that supply.

2. Inflation-adjusted compensation in cities doubled from 1990 to 2002. This is also what you would expect. As the cities experienced hyper-growth, competition and accompanying tightening in the labor market drove wages up.

3. Between 1995 and 2002, cities shed 11 million factory jobs while the countryside gained 5 million factory jobs. And, the trifecta. As a result of the accompanying tightening of the labor market in the cities, operations with low fixed-costs moved to where the labor was cheaper.

Bottom line: Chinese manufacturing labor costs are going to be low for at least a generation. China's trying to balance modernizing with not upsetting the countryside too much. The spread of the factories away from the coasts is a good thing. It will help lift subsistence farmers out of poverty and bring needed infrastructure. Every Chinese revolution has originated in the countryside, so the government has good reason to foster such an outcome.

An interesting thought occurred to me as I was writing this post. Does purchasing price parity (PPP) really matter for labor costs? The Chinese analysis focused on what employers had to pay workers, including government benefits, etc. The real cost imposed is the opportunity cost, i.e. what the employer could have done with that money if it didn't have to pay its employee. But, what an employer could have done with its money is different from what the employee could have done with the money. For instance, if the employer could have invested the money and earned interest on it, this would be different from the employee buying a boat. Especially if the employer invested the money abroad. Because PPP is usually used to compare currencies based on the consumer transaction, is it really that relevant when translated into what labor costs the employer? If anyone knows about literature addressing this topic, please drop me a line.

The Dollar's Freefall

2004-12-02T19:12:00.000-08:00

The Economist (subscription required) has an excellent article on the falling dollar. Of course, they explain it in a much better way than I ever could:

"THE dollar has been the leading international currency for as long as most people can remember. But its dominant role can no longer be taken for granted. If America keeps on spending and borrowing at its present pace, the dollar will eventually lose its mighty status in international finance. And that would hurt: the privilege of being able to print the world's reserve currency, a privilege which is now at risk, allows America to borrow cheaply, and thus to spend much more than it earns, on far better terms than are available to others. Imagine you could write cheques that were accepted as payment but never cashed. That is what it amounts to. If you had been granted that ability, you might take care to hang on to it. America is taking no such care, and may come to regret it."

It goes on to cite unnamed experts who predict a further 30% decline in the dollar's value. However, experts are never of one mind, as an article in the Financial Times points out.

“People are beginning to wonder whether this [dollar sell-off] has gone too far and that there might be some kind of correction before the year-end,” said Aziz McMahon at ABN Amro.

South Korea also jumped on the coordinated currency intervention bandwagon with EU and Japan, although they have yet to make a move.

If the foreign central banks start buying greenbacks to weaken their own currency and strengthen the dollar, they're going to have to print their own money to do it. The EU would be better off cutting its own interest rates, and hence spending the newly printed money, on stimulating domestic consumption. Additonally, any intervention by these banks are only going to prolong the problem. Winston Churchill once said "The Americans always do the right thing, after they've tried everything else." The U.S. will continue to print money until the rest of the world forces economic reality upon it.

Japan and the EU Creating A Moral Hazard?

2004-12-01T17:28:00.000-08:00

Japan and the EU are considering harmonizing an interventionist response to the falling dollar, Financial Times reports. Apparently, they believe that the increases in U.S. growth aren't properly reflected in its currency valuation. I think that's an excuse to try and snatch the dollar out of an inevitable freefall. When the U.S. (or any other country) prints money wholesale, its value is going to go down. The certainty of this law is somewhat tricky when it comes to the U.S. because of its (present) economic dominance. However, this trickiness is probably more of a suspension than an exception. Printing dollars makes their value slide, and eventually there will be a reckoning.

What would this look like? Probably a coordinated campaign to buy dollars with euros and yen. Japan already holds most of the U.S. debt, so their activities can be somewhat discounted. The EU holds less. If they go on a coordinated buying campaign, all they're doing is staving off the inevitable. Foreign central banks can't keep encouraging the U.S. to run unsustainable deficits by artifically propping up its currency to protect their own exports. Eventually, they'll run out of savings to finance our consumption. Better a little bit of pain now than decades spent on the rack.

If the Japanese and the Europeans do start this, I think it might also push the private holders to start betting against them. Possibly, it could lead to a showdown of the type last seen since Soros took on the Bank of England. And we all remember how that turned out.

Consumers Demand to Pay More For Shrimp

2004-12-01T16:34:00.000-08:00

...or so the Commerce Deparment would have you believe. The Washington Times (which I deplore linking to) has the story. Now's a good time to give a functional analysis of anti-dumping law.

Dumping occurs when a foreign company sells its exports at a cheaper price than in its home market. The price in the home market price is referred to as normal value (NV) and the export price is referred to as (surprise) export price (EP) or constructed export price (CEP). Constructed export price is only used if the foreign company and the importer are somehow related. Both prices are subject to a number of adjustments in order to try to reach an ex-factory price, or the price at which the good would fetch as soon as it left the factory (or fishery). The difference between the price in the home market (NV) and the export price (EP) is called the dumping margin (DM). If Commerce finds a dumping margin above a certain level, they impose duties on the imports which make up the difference.

So, here's what we have: Foreign companies are offering consumers lower prices than are available in our domestic market. Our government responds by slapping a duty on the products to artificially raise prices. How is this not a tax?

Well, the principal way that it differs from a tax is the most appalling. The proceeds from the additional duty assessed against the imports is then given to the party who petitioned Commerce in the first place! This is the Byrd Amendment. For instance, let's say Shrimpcatcher, based in Louisiana, petitions Commerce that Shrimpexporter, based in Vietnam, is dumping shrimp in the U.S. Then, Commerce finds a positive dumping margin (which it does in more than 90% of the cases). If the International Trade Administration (another branch of Commerce) finds that the dumping is causing material injury to the U.S. shrimping industry, then the duties are assessed. Shrimpimporter has to pay more to Shrimpexporter because of the duty, which means it has to charge more to the consumers. The extra cost, in the form of the higher duties, gets sent in the form of a check from the U.S. Treasury to Shrimpcatcher in Louisiana. Essentially, Shrimpcatcher is imposing a regressive tax on shrimp consumers with the support of the U.S. government. Under these circumstances, why not bring an anti-dumping petition to Commerce? If the potential payoff is in the millions and the cost is substantially less, why not roll the dice?

EU Sees China As A Threat

2004-12-01T06:51:00.000-08:00

The EU released a report today that warns member countries of a coming Chinese storm, the Telegraph reports. While most of this is the same boilerplate "anti-China" stuff, there is an interesting finding: that Chinese are taking advantage of a protected home market in electronics to dump cheaper products on EU. If this is true, the report is essentially encouraging anti-dumping petitions to be filed. I don't know enough about EU anti-dumping law to speak intelligently about it, but it should work similarly to U.S. law.

Dumping occurs when a foreign competitor is exporting products at a price lower than what it sells the products for in its home market. For example, if the Chinese are selling PC's in Germany for $100, and selling them in Shanghai for $300, that's dumping. (Of course, China is a non-market economy [NME] so the caculus gets a little trickier, but you get the idea.) The worry is that the producer is using monopoly rents in their home market to finance below-cost sales in the export market in order to capture market share and drive competition out of business.

Check back later for a longer post on anti-dumping law and its problems.

Why Hasn't The Other Shoe Dropped Yet?

2004-11-30T21:28:00.000-08:00

Alot of people have been wondering why the U.S. dollar is only sliding now, after a few years of the government printing a mountain of money. After all, it should simply be a matter of supply and demand: more dollars on the market means less demand for them and scarcity equals value. So, why just now? Brad DeLong thinks the private holders are waiting for the central banks to make a move, because the value of betting against the dollar before they do is small. The bond market, however, remains a mystery. My proverbial two cents (if worth even that):

1. I think some of the central banks have already started making these moves through private channels (undisclosed principal transactions.) Russia has even made a public announcement of its abandonment of the dollar.

2. The holders of most of the debt (Japan and China, respectively) cannot afford to let the dollar go into a free fall. Their economies are too tied into U.S. demand. Let's focus on China. Because the Chinese peg their currency to the dollar, slides in one are slides in both. This smooths out (theoretically) any demand problems for Chinese exports in the U.S. and vice versa. However, it makes third country imports into China more expensive. This lowers their savings rate, as more Chinese liquidate savings into consumption to pay for the higher cost goods. Their lower savings rate means they can't purchase as much U.S. debt. U.S. debt is partially driving U.S. demand for Chinese exports, and a drop in exports leads to increased unemployment. So, China would be facing lower export demand, higher real prices for imports, and increased unemployment. As long as Chinese savings is financing U.S. consumption of Chinese exports, the Chinese will continue to lend as much as they can. However, stories like this don't bode well.

3. It's also possible that foreign central banks thought Kerry had more credibility than Bush on reducing the deficit and are now reacting accordingly to a Bush re-election. A run on a currency typically trickles for a while until something happens that unleased the tsunami. It's possible that we're just watching the trickle right now and the tsunami is on its way.

4. I share Brad's mystification as to the bond market. The only other explanation I can give is that there's a capital glut right now that's giving bond traders a cushion against future risk. Other than that, no clue.

Will A VAT Spur Economic Armageddon?

2004-11-30T20:50:00.000-08:00

The Bush Administration is rumored to be considering a value added tax (VAT) to replace the current income tax. A VAT is essentially a national sales tax, assessed at every point there's a cash transaction. Apart and away from the regressive nature of such a tax, I have the following concerns.

1. While I agree that something needs to be done to spur more national saving in the U.S., I am not convinced a VAT is the way to go. I think the national savings needs to occur more at the governmental, rather than the individual, level. Individuals can save all they want, but if the government keeps borrowing it for unsustainable deficits, then it really doesn't do any good. Does it really matter if the governmental debt belongs to Americans or Chinese?

2. A VAT will functionally increase prices for everything. This will drive down demand for non-essential goods. A chunck of non-essential goods are manufactured in China. A shortage of demand for Chinese produced goods will have a significant impact on their economy. If Chinese employment slackens because of downward demand for their goods manufactured for export to the U.S., then China's savings rate will go down. This will mean they will lose their ability to absorb our debt at current levels. That means higher interest rates in the U.S. to try to attract others to absorb the debt. So, we have higher prices across the board and higher interest rates.

3. A VAT is going to put upward pressure on wages because prices for almost every product will go up. An increase in wages without a corresponding increase in productivity means that companies will have to increase their prices irrespective of the VAT to afford to keep the workers they don't end up laying off. This looks like it could set off a dangerous cycle of inflation. Think of a VAT like the Oil Shocks of the 1970's. Both have the effect of suddenly reducing disposable income by increasing prices for essential products.

4. The U.S. seems to have adopted an implicit policy of demand and consumption-led growth. A VAT dampens demand.

5. A recession is defined as when demand falls below supply. The U.S. has just clawed itself out of a relatively shallow recession partly by (extemely inefficiently) cutting taxes and printing money. The recovery to this point has been fragile. Anything that serves to dampen demand at this point would probably plunge the economy back into a recession.

How far off base am I here?

Inaugural Post

2004-11-30T20:17:00.000-08:00

Welcome to the newest blog to join the fray. Having been inspired by such blogs as www.marginalrevolution.com, I have decided to launch my own. I have an abundant interest and no formal training in economics. Never taken an econ class in my life, although I have taken some related classes in law school. I hope to bring some fresh eyes to traditional economic thought and hope to stimulate discussion in some small way. So, to those of you happen to traipse across my blog, welcome and bear with me.

-B