Thursday, February 27, 2014

House of Cards and entitlements: embarrassing, but to whom?

UPDATED BELOW

I know I’m late to this little fracas, and I’m not yet caught up on the entire second season, but it is terribly embarrassing that characters in Netflix’s House of Cards would propose raising the retirement age from 65. Now, I understand the original novel was set in the UK. But Netflix’s version is set in the U.S. and in the near present. Were all the writers born before 1938? Because everyone born after 1937 has a Social Security retirement age greater than 65. If you are turning 54 this year, or if you are younger than that, then ever since 1983 your retirement age has been 67. Frank Underwood says the Republicans have wanted this “since Johnson” but Underwood first ran for office in 1986– three years after Republicans got their increase in the retirement age for Social Security.

Now, technically speaking, House of Cards (as far as I have watched) talks only of “entitlements” but connects it to an increase in the age for early retirement, which applies to Social Security but not Medicare. In any case, compared to the typical Medicare recipient, those in their mid-60’s are relatively healthy– while many of those especially unhealthy would be on Medicaid anyway. Consequently, raising the retirement age for Medicare doesn’t even reduce deficits by a noticeable amount. According to the Congressional Budget Office, it would save some $6.7 billion in 2023 (PDF source)– an amount less than 0.03 percent of GDP.

I wonder what the writers had in mind. I’m guessing it’s a slip on the part of the writers. Or– in an age of low employment, wrecked private pensions, and thin household savings– is 70 is just too absurd a proposal for the viewers to swallow? Is this not embarrassing to supposed reformers? Then again, with respect to Matthew Yglesias, maybe the fight over entitlements is not about deficits.

Update: Yup. In the next episode, Underwood specifically mentions Medicare. That makes the CBO report relevant. At least, as relevant as an actual CBO report can be to a fictional show. More importantly, it is not so embarrassing to single out Medicare when talking entitlements. It’s health care costs which are projected to threaten the federal budget– not Social Security. If the United States had health-care costs in line with the rest of the developed world, we would be looking at surpluses, not deficits. But raising the retirement age is no solution.

Wednesday, February 26, 2014

A note on German austerity

Over at Heritage, Salim Furth talks structural deficits. Sadly, he gets his argument backwards.
The reason Germany did not shrink its structural deficit is that Germany barely had a structural deficit! In 2009, Germany’s structural deficit was just 1 percent of gross domestic product. Greece’s deficit was 19 percent. In fact, across eurozone countries, the change in structural balance from 2009 to 2012 is largely predicted by the size of 2009 deficits—the bigger the deficit, the harder they fell.

That’s a problem for the Keynesian story. According to Krugman’s Keynesian model, government can stimulate aggregate demand by running large deficits in bad times, softening the recession. If government fails in its duty to borrow, the recession will mire on.

[snip]

What did the Germans do that put them in a position for growth right after the recession? Back in 2001, Germany and Greece had the same structural deficit—just above 3 percent. But Germany shrank its deficit from 2004 to 2008 by cutting spending on welfare, unemployment insurance, and pensions.
(source)

Um. Okay. Furth takes data from the latest IMF World Economic Outlook Database. What does the database say about economic growth in these countries over this period? From 2002 to 2009, German output increased 4.7 percent per capita. (That’s only 0.7 percent per year!) By contrast, the Greek economy grew more than three times as fast, per capita (16.3 percent, or 2.2 percent per year.)

So the big-deficit Greeks enjoyed much faster growth than the austere Germans. Now, perhaps Furth might argue the Greek growth was unsustainable on account of all that borrowing, requiring the Greeks to reverse course at the worst possible time. But that hardly represents anything like “a problem for the Keynesian story.”

Wednesday, February 19, 2014

Economists blithely write “Economists blithely draw…”

Sometimes, I’m going to have to be critical of specific people. Generally, I prefer to be critical of people who disagree with me on policy. Sometimes, a potential ally will make me wince but I let it go. Then there is Steve Keen.

Sometimes, I just don't know what the man could be thinking, driving me to rise to the defense of someone unlikely. Take, for example,
Economists blithely draw diagrams like Figure 23 below to compare monopoly with perfect competition. As shown above, the basis of the comparison is false: given Marshallian assumptions, an industry with many “perfectly competitive” firms will produce the same amount as a monopoly facing identical demand and cost conditions— and both industry structures will lead to a “deadweight loss”. However, in general, small competitive firms would have different cost conditions to a single firm—not only because of economies of scale spread result in lower per unit fixed costs, but also because of the impact of economies of scale on marginal costs.
(PDF source)

Zing! It seems Keen and co-author Russell Standish have Mankiw dead to rights. It appears that Mankiw have made a terrible mistake and did not think about the fact that the marginal cost curve would be different for the industry as a whole. Or so they would have it.

I find this highly unlikely. Their claim that their paper shows that “given Marshallian assumptions, an industry with many ‘perfectly competitive’ firms will produce the same amount as a monopoly” is a matter for another time. For now, it suffices to note that in presenting this figure Mankiw is not referring to “perfect competition” at all. Mankiw leads his discussion saying
We begin by considering what the monopoly firm would do if it were run by a benevolent social planner. The social planner cares not only about the profit earned by the firm’s owners but also about the benefits received by the firm’s consumers. The planner tries to maximize total surplus… the socially efficient quantity is found where the demand curve and the marginal-cost curve intersect. [bold added to original, italics in original]
(source)

The framework for the discussion is monopoly. The discussion concerns the deadweight loss of a profit-maximizing monopoly in contrast to a socially-planned monopoly. In such a context, the monopoly is the industry, so there is no confusion regarding costs. The “efficient quantity” is “efficient” because no monopoly can produce larger total surplus. Mankiw's figure simply does not “compare monopoly with perfect competition” as suggested. Keen and Standish grossly misrepresent Mankiw.

Multiple Identities Can Deceive Even More

Consider a closed economy (no international transactions) so that \begin{equation} Y=C+I+G \end{equation} Savings is defined as unconsumed income, so national savings ($S$)-- which counts both private and government consumption-- is given by \begin{equation} S=Y-\left(C+G\right)=I \end{equation} Thus, the mystical “savings-investment identity” is born. In a closed economy, savings must equal investment. You like investment, don’t you? You believe that increasing the capital stock makes us more productive, right? So we should strive to increase national savings, don’t you think? And since we only can consume or save our income, we ought to consume less.

Not necessarily. It depends on the model. Suppose I gotta install microwave ovens. Custom kitchen deliveries!1 If you unexpectedly fail to buy a new oven then very likely I am stuck with a larger inventory and the immediate effect is to increase $I$ by the same amount as the fall in $C$, leaving $Y$ unchanged. Or maybe I will then fail to buy from the manufacturer who then slows production, lowering both $C$ and $Y$. These are not the only possible results, but the point is it matters because equation (2) says that lowering your consumption increased savings only in the former case.

And even then the increased investment came as an inventory increase-- which is nice because it allows for additional future consumption, but it doesn't actually increase productivity.

The bottom line is that while it is tempting to argue from an accounting identity, it is the story that matters. The identity just helps keep the story straight.

1 Back in 1984, someone totally could have kept his issues to himself instead of calling a guitarist on your MTV a “f****t”.

Identities Can Be Deceiving

Many an economist may be heard complaining that accounting identities are not models. And about this, many an economist is correct. Unfortunately, this sad refrain bears repeating. Accounting identities are not models. In fact, they can be downright misleading. Take for example, the basic national accounting identity defining GDP: \begin{equation}Y=C+I+G+X-M\end{equation} Clearly, imports $M$ count against GDP. But does an increase in imports lower GDP? It looks like imports reduce GDP, but the equation does not tell us this. To see why this might be so, let us divide expenditures into domestic production and foreign imports. That is, $C=C_d+C_m$, $I=I_d+I_m$, $G=G_d+G_m$, $X=X_d+X_m$, and finally $M=C_m+I_m+G_m+X_m$. Then \begin{equation}Y=C_d+I_d+G_d+X_d\end{equation} It appears that imports do not enter into GDP at all. Yet it is no less correct to write \begin{equation}Y=\left(C-C_m\right)+\left(I-I_m\right)+\left(G-G_m\right)+\left(X-X_m\right)\end{equation} which again suggests that imports reduce GDP one-for-one. Which equation is correct? They all are. They all provide exactly the same information, yet invite the reader to different interpretations. Equation (2) invites the reader to believe that $C_d$ is independent of $C_m$ (which may or may not be true.) Equation (3) invites the reader to believe that $C$ is independent of $C_m$ (which also may or may not be true.)

Rather, we require a model to tell us how the various parts move. For example, we might say $G$ and $X$ are fixed, but an additional dollar of $M$ increases $C$ by \$1.50 and reduces investment by \$1.00. The accounting identity would then tell us GDP falls by 50 cents for every dollar of additional imports. Is it true? The result depends on the model, and the model need not be reasonable. Suppose instead that an additional dollar of imports leads to a million dollars of additional consumption. Garbage in, garbage out. But the identity must hold.

As we will see in a future post, identities get more deceptive when used in combination with other identities.

-1/12 is a large friggin’ number

Suppose $$S_n\equiv\sum^n_{i=1}{i}=1+2+\cdots+\left(n-1\right)+n$$ You may have figured out that you can rearrange the sum as $$S_n=n+\left(n-1\right)+\cdots+2+1$$ This is interesting because the first terms in each arrangement sum to $n+1$, the second terms also sum to $n-1+2=n+1$. In fact, this is true of all $n$ terms so we find that $$ S_n+S_n=n\left(n+1\right) $$ Fine. But what about $S_\infty$? The sum of all natural numbers, it is obviously bigger than any natural number. Can we more precisely describe $S_\infty$? Perhaps.