Category Archives: Economics

Economics, Public Policy

On the “optimality” of inequality

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Suppose there exists a one period society consisting of n identical individuals, each of whom is capable of producing output worth $1/n. Suppose that this society’s central planner imposes the following sharing rule: all n individuals in this society receive equal shares of total social output.

How much wealth will be created by this society? We already know that the maximum possible value for social wealth is $1. This outcome is only possible if we impose some highly restrictive behavioral assumptions. One possibility is that all n individuals’ objectives are to maximize total social wealth, and that no individual in this society suffers any “disutility” associated with putting forth the effort required in order to produce his or her maximum output. This outcome is also theoretically possible in a society consisting of self-interested individuals who suffer disutility from expending effort, so long as the central planner can not only perfectly and costlessly monitor effort, but also perfectly and costlessly enforce a “maximum effort” mandate for everyone in this society. In either case, total social wealth is $1, and everyone’s share is $1/n.

Now, suppose that there are costs to monitoring effort, and that self-interested individuals suffer disutility from expending effort. What happens then? The obvious answer is that shirking occurs, which reduces total social wealth as well as everyone’s per capita shares. Consider this problem from the perspective of one such individual who decides to shirk entirely; i.e., produce no output whatsoever. However, assume that the remaining n-1 individuals do not shirk. Then social wealth falls by $1/n, going from $1 to $(n – 1)/n; yet the shirker’s personal wealth falls by only $1/n2, going from $1/n to $(n – 1)/n2.  Thus the net benefit of shirking is substantial; the shirker only has to forgo the utility of $1/n2 in order to avoid the disutility (or, equivalently, utility “cost”) associated with expending effort. This is commonly referred to as the “free rider” problem. Therefore, it is not possible to have a free and prosperous society without some level of inequality in the distribution of income.

I became interested in this topic from listening to George Mason University economist Russ Roberts’ podcast featuring Cornell University economist Robert Frank. Although Professor Frank “…argues for a steeply rising tax rate on consumption that would reduce disparities in consumption” (cf. http://www.econtalk.org/archives/2010/11/robert_frank_on_1.html), he concedes that inequality is inevitable in a free society, based upon a similar thought experiment to the one provided here.

Economics, Financial Crisis, Foreign Policy, Public Policy

Political economy and the (inflationary) future

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A particularly important “political economy” topic these days is the unprecedented extent to which the US federal government is spending money it doesn’t have.  The federal government has historically collected about 18.4% of gross domestic product (GDP) in tax revenues and spent roughly 21% of GDP on average.  Currently, tax receipts are lower than the long run historical average, thanks to the “Great Recession” (probably around 15-16% of GDP), and federal spending is much higher than the long run historical average (upwards of 25% of GDP).  The gap between what the government takes in and what it pays out is commonly referred to as the “deficit”; for the fiscal year just ended (on August 31, 2010), the total deficit was nearly $1.6 trillion.  The annual fiscal deficit gets added to the total “national” debt, which as of October 31, 2010 stands at $13.6 trillion (cf. http://www.treasurydirect.gov/govt/reports/pd/mspd/2010/opds102010.pdf). 

The national debt of the United States (as of 10/31/2010) is split into two categories:

  1. Public Debt ($9 trillion)
  2. Intragovernmental Holdings ($4.6 trillion)

Public debt is any money that is owed to investors, foreign governments, mutual funds, hedge funds, pension funds, foreign investors, etc.; i.e., in the form of US treasury securities.  “Intragovernmental holdings”, on the other hand, is money that the government borrowed from itself.  The major “source” for this is the so-called Social Security trust fund, as well as  other government-administered programs which happen to run “surpluses” in an accounting sense.  Of course, this money will have to be repaid in the future, and demographics ensure that the Social Security trust fund surplus will soon turn into a growing deficit in the absence of any meaningful reforms (e.g., the imposition of a higher age for eligibility, allowing for private accounts, etc.). 

I’ll finish by focusing attention on the public debt.  Nearly half of the $9 trillion in public debt (actually, $4.2 trillion) is held by foreign investors (cf. http://www.ustreas.gov/tic/mfh.txt).  China is the biggest holder of U.S. public debt – 21% of all public debt held by foreigners, in fact.  One can only wonder how this fact influences US foreign policy (since we “need” China’s dollars very badly), but I digress.  Lately, the US has been putting huge political pressure on China to allow its currency (the yuan) to appreciate substantially (cf. “China Currency Bill Advances”, 9/25/2010 WSJ).  If this happens, US products will become more competitive vis-à-vis Chinese products in global markets, but it will do so at the cost of leaving the Chinese with less dollars for buying our bonds.  Since we are in the process of exhausting China’s appetite and ability to fund our deficits, we now turn our attention to the Federal Reserve.  By buying public debt from the US Treasury, the Fed is effectively expanding the money supply while also providing the US Treasury with the dollars that it needs to finance the deficit; indeed, last Wednesday the Fed announced that it would purchase up to $600 billion in US Treasury securities as part of its so-called Quantitative Easing (QE II) program.  However, this Faustian bargain will most likely come at the cost of a return of inflation at some point in the future.  The good news right now is that there is hardly any inflation at all in the economy, so the Fed is betting that the future inflation related to its large scale purchases of Treasury debt won’t be “bad”.  I hope they’re right, but history and Milton Friedman tell me that this kind of movie has been played before and that it usually turns out rather badly (in the form of inflation; see “Milton Friedman vs. the Fed”).

Economics, Financial Crisis, Public Policy

Hayek vs. Keynes Sequel "Sneak Peak"

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‘Fear the Boom and Bust’ Hayek vs. Keynes rap video“, I reference and link to the very clever (and popular –  more than 2 million views on youtube.com) video production by filmmaker John Papola and economist Russ Roberts which compares and contrasts the ideas of two “famous” dead economists, John Maynard Keynes and Friedrich von Hayek.  Here’s a “sneak peak” of the “sequel” (hat tip to Russ Roberts): ]]>

Economics, Financial Crisis, Public Policy

Hayek vs. Keynes Sequel “Sneak Peak”

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In an earlier (January 27, 2010) blog posting entitled “‘Fear the Boom and Bust’ Hayek vs. Keynes rap video“, I reference and link to the very clever (and popular –  more than 2 million views on youtube.com) video production by filmmaker John Papola and economist Russ Roberts which compares and contrasts the ideas of two “famous” dead economists, John Maynard Keynes and Friedrich von Hayek.  Here’s a “sneak peak” of the “sequel” (hat tip to Russ Roberts):

Art, Music, and Culture, Economics, Foreign Policy, Health Care Reform, Politics, Public Policy, Religion, Technology, Terrorism

Assorted Links (10/13/2010)

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Here’s a list of articles that I have been reading lately:

Christien Meindertsma: How pig parts make the world turn | Video on TED.com

ted.com

“TED Talks Christien Meindertsma, author of “Pig 05049” looks at the astonishing afterlife of the ordinary pig, parts of which make their way into at least 185 non-pork products, from bullets to artificial hearts.”

Google to map inflation using web data

ft.com

“Data could provide an alternative to official statistics.”

Higher Taxes Mean I’ll Work Less

nytimes.com 

“A personal case study looks at some of the ways higher taxes may affect the earnings of high-income taxpayers.”

Review & Outlook: The 2010 Spending Record

online.wsj.com

“The Wall Street Journal on the 21.4% federal spending increase in two years.”

Boehner’s ‘Plan B’ for ObamaCare

online.wsj.com

“In the Wall Street Journal, Main Street columnist William McGurn writes that congressional hearings can be used to sell market-friendly fixes.”

Europe the Intolerant

online.wsj.com

“In the Wall Street Journal, James Kirchick writes that the continent’s progressive image is a fabrication of the American liberal mind.”

NFL vs. ‘TV Everywhere’

online.wsj.com

“In The Wall Street Journal, Business World columnist Holman Jenkins, Jr. says that TV’s fight to preserve its power in the face of digital ubiquity may be a lost cause.”

Book Review: Roosevelt’s Purge

online.wsj.com

“Jonathan Karl reviews Susan Dunn’s Roosevelt’s Purge: How FDR Fought to Change the Democratic Party.”

Irwin on France’s role in the Great Depression

cafehayek.com

“In the latest EconTalk, Doug Irwin argues that France played a much larger role than previously thought in causing the Great Depression. We talk about how the gold standard worked and how French monetary policy forced deflation on the rest of the world.”

The Decline of Cursing

online.wsj.com

“Bad words, once glorious, have been emptied of meaning by common use, argues Jan Morris in a Wall Street Journal op-ed.”

The Weekend Interview with Scott Rasmussen: America’s Insurgent Pollster

online.wsj.com

“In the Wall Street Journal, OpinionJournal columnist John Fund interviews Scott Rasmussen, who says that understanding the tea party is essential to predicting what the country’s political scene will look like.”

Paul Johnson – The Quest For God – The ReAL Book Review

torenewamerica.com

I really like Gerard Reed’s book reviews; here’s one about British historian Paul Johnson’s new book entitled “The Quest for God”. I first became aware of Paul Johnson more than 20 years ago, when I became deeply influenced by Paul Johnson’s essay entitled “The Heartless Lovers of Humankind” (see http://www.fortfreedom.org/h11.htm).

The Fed Compounds Its Mistakes

online.wsj.com

“In The Wall Street Journal, Carnegie-Mellon University economist Allan H. Meltzer says the Federal Reserve shouldn’t deliberately use inflation to reduce unemployment.”

Diamond, Mortensen, Pissarides Share 2010 Nobel Economic Prize

bloomberg.com

“Peter Diamond, Dale Mortensen and Christopher Pissarides shared the 2010 Nobel Prize in Economic Sciences for their work on the efficiency of recruitment and wage formation as well as labor-market regulation.”

Four Lions: The Absurdity of Terror

www.thepublicdiscourse.com

“In the British film Four Lions, five Muslim men from Sheffield, England—four from immigrant families along with an English convert—seek to break out of their ho-hum average-ness by doing something which they think will launch them into hero status in their community.They plot a terrorist attack in the name of “jihad” in the U.K. In this farcical film, black satire meets terror-jihad and it is a match made almost in heaven. The would-be jihadists, however, end their lives only in tragedy, not in paradise.”

The MBA Oath

www.tutor2u.net

“At a time when capitalism, free markets, corporate greed, (WallStreet 2), bankers’ bonuses, is making headlines, here is the MBA Oath. The oath is a voluntary pledge for graduating MBAs and current MBAs to “create value responsibly and ethically’.”



Joe Queenan on Jimmy Carter’s Addiction to Writing Books

online.wsj.com

“The American people wanted Jimmy Carter out of office in the worst way, and to this day they are paying the price. If we had to do it all over again, I think a lot of people would vote to amend the Constitution and allow presidents to run for five, six—as many terms as they wanted. That wouldn’t leave them much spare time to write books.”