Family wars

Family feuds can be terrible, and divorce is the worst. That may be because people who trusted each other find themselves victims of treason, and react violently. Does this scale up to relationships between nations?

Enrico Spolaore and Romain Wacziarg find that populations that are genetically closer tend to be more frequently at war, after obviously controlling for geographic distance. They favor the explanation that sharing genes means also sharing preferences over scarce goods. I prefer the family trust story. Seeing how vicious civil wars are does not discredit either theory as well.

Harry Reid's Wardrobe

Having learned that the U.S. olympic uniforms were manufactured in China, Senator Harry Reid said, "I think they should take all of the uniforms put them in a big pile and burn them and start all over again."

Will some enterprising reporter please ask Senator Reid for the opportunity to inspect the senator's closet and check the labels of his clothing to make sure they are all American-made?   I look forward to seeing Mr. Reid's bonfire.

In the alternative, I would be happy to send the senator of copy of my favorite textbook.  He should pay particular attention to Chapters 3 and 9.

Econophysics of growth

It is sometimes saddening to see how Economics is currently being criticized for its failure to predict this and that. While at least economists realize that things are not that simple, non-economists have been really silent in offering concrete alternatives, or at least some that would be workable within a decade. Except for the econophysicists, who have no shortage of wacky ideas. They are always good to brighten your days, making you realize that Economics is after all in much better shape than we think.

My latest read was a paper by Hans Danielmeyer and Thomas Martinetz who have come to the realization that Robert Solow's 1956 growth theory is missing leisure and Economics has been in dire straights ever since. Because, you know, there are only 24 hours in a day. How could Macroeconomics have done without labor demand and supply? How could we have missed that long-term per-capita growth depends primarily on labor hours? Actually it does not. Growth accounting reveals that the labor input plays only third fiddle to total factor productivity, physical capital and possibly even human capital. But wait, Danielmeyer and Martinetz are even more innovative than I thought. They discover human capacity, which is general knowledge embodied through education. Quick, someone call Paul Romer.

This is truly path-breaking work we have here. The consequences are immense. As human capacity is limited, after all we are not omnipotent, growth will come to a halt. I eagerly await the authors' discovery of computers and technical progress. There is even a quantitative evaluation of the theory, which has much broader scope than you would expect. Indeed, it can explain the over-valuation of real estate in Japan, the 2008 banking crash can be traced back to policy makers neglecting the trade-off between growth and national wealth, and we face a "convergence crisis" in the 2040's because of stagnant human capacity. Fascinating.

The Progressivity of Taxes and Transfers

To update one of the tables for the next edition of my favorite textbook, I have been looking at the new CBO report on the distribution of income and taxes.  I found the following calculations, based on the numbers in the CBO's Table 7, illuminating.

Because transfer payments are, in effect, the opposite of taxes, it makes sense to look not just at taxes paid, but at taxes paid minus transfers received.  For 2009, the most recent year available, here are taxes less transfers as a percentage of market income (income that households earned from their work and savings):

Bottom quintile: -301 percent
Second quintile: -42 percent
Middle quintile: -5 percent
Fourth quintile: 10 percent
Highest quintile: 22 percent

Top one percent: 28 percent

The negative 301 percent means that a typical family in the bottom quintile receives about $3 in transfer payments for every dollar earned.

The most surprising fact to me was that the effective tax rate is negative for the middle quintile.  According to the CBO data, this number was +14 percent in 1979 (when the data begin) and remained positive through 2007.  It was negative 0.5 percent in 2008, and negative 5 percent in 2009.  That is, the middle class, having long been a net contributor to the funding of government, is now a net recipient of government largess.

I recognize that part of this change is attributable to temporary measures to deal with the deep recession.  But it is noteworthy nonetheless, as other deep recessions, such as that in 1982, did not produce a similar policy response.

Update: A reader points out the CBO's transfer data includes state and local transfers, but the tax data includes only federal taxes.  If state and local taxes were included, or if state and local transfers were excluded, the middle quintile might well turn positive, though the CBO does not provide the data to establish that conclusion definitively.

Is a lost decade ahead?

It is quite obvious that the current economic situation in both Europe and the United States is not healthy. It has been argued that in both cases policy uncertainty or the inability of authorities to take decisions are detrimental to economic activity, and private investment in particular. It is not difficult to rationalize this with simple theory. The question is whether this could have some longer term consequences.

Kenza Benhima and Baptiste Massenot find that yes, we could be ahead of a lost decade like the one that Japan experienced in the 1990's. They take a simple real business cycle model, a model that is the least likely to produce very persistent deviations from trend or permanent departures from the growth path. They only amend the model in two ways: investors have a decreasing relative risk aversion, instead of constant, and they can choose between two technologies, a risky one with higher returns and a safe one with low returns. The model then exhibits two equilibria: the standard RBC one, and a second, self-fulfilling one, a trap where capital is mis-allocated into overly safe assets, there is little growth if any, and interest rates keep getting lower thereby reinforcing the trap.

These results are consistent with Japan during its lost decade. Total factor productivity decreases, essentially because of a mis-allocation of resources. Assets are mostly safe ones in the trap, compared to risky ones before. And the interest rate keeps declining. Interestingly, the resulting economy in the bad equilibrium looks like it had a bad technology shock, even though technology is just fine. This makes it consistent with the Hayashi-Prescott claim that Japan's lost decade was due to bad total factor productivity draws. The same applies to the Caballero-Hoshi-Kashyap claim that banks in Japan kept lending to unproductive firms, preventing better ones to enter and raise total factor productivity. Even Krugman's liquidity trap fits in the story because interest rates are very low in the trap as well.

And recent data in Europe and the US seems to be consistent with this trap as well. The only way out is a coordinated action of all market participants. The only ones that could make this happen are the authorities. Unfortunately, they seem to be quite far from that.

Anti-poverty programs raise effective marginal tax rates

Eugene Steuerle calculates the effective marginal tax rates from the system of taxes and transfers:

we calculate the effective average marginal tax rate if this household increases its income from $10,000 to $40,000. That is, how much of the additional $30,000 of earnings is lost to government through direct taxes or loss of benefits? The average marginal tax rate in the first bar of Table 3, 29 percent, is based simply on federal and state direct taxes, including Social Security and the EITC. The rate rises appreciably as the family enrolls in additional transfer programs in bars 2 and 3. For a family enrolled in all the more universal non-wait-listed programs like SNAP, Medicaid, and SCHIP, the average effective marginal tax rate could be 55 percent. Enrolling the family in additional waitlisted programs, like housing assistance and TANF, ratchets the rate up above 80 percent....

Some caveats are in order. A number of eligible households do not apply for benefits, such as the food subsidies for which they are eligible. We have performed some analyses of the population as a whole at the Urban Institute and find that the average rates across households will be lower than what you see in the table because of less than full participation in the programs. By the same token, we have not included the child care grants in these calculations. Add those in, and the rate can exceed 100 percent.

Corruption and wages of public officials

In some countries, especially in Eastern Europe, corruption in educational institutions is a serious issue, to the point that diplomas do not mean anything. One potential reason for this high level of corruption is that educators and administrators are very poorly paid, and thus are more than willing to accept bribes to let students in, to let them pass exams and graduate. While the practice is well known and even accepted, how prevalent it is is obviously difficult to figure out.

Oana Borcan, Mikael Lindahl and Andreea Mitrut look at an interesting natural experiment in Romania: the wage of all public sector workers, including education, were cut by 25% in May 2010. The cut was unexpected and happened just before exams. They study the Baccalaureate exam, which is the exam at the end of high school, is the entrance ticket to university and is actually rather difficult. Comparing results in public vs. private schools (which where not affected by wage cuts) and 2009 vs. 2010, they find that public schools had suddenly a much higher grades (by one fourth of the standard deviation) and 10-12% more students passed the exams. And this despite the fact that students of all schools were mixed in exam rooms. This could only have happened if the public students knew beforehand what the questions or answers were. And indeed, this exam has the nickname of "Xeroxed exam" in Romania. And who gave them these copies? Well, consumption expenditures of teachers seem to have been unaffected by the wage cuts, according to the Romanian Household Budget Survey...