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Facts or Fallacies Part III: Combinations, Murder and the Primordial Lump

Facts or Fallacies Part III: Combinations, Murder and the Primordial Lump
by Tom Walker (Sandwichman at Ecological Headstand)

In Part I, I compared the statistical fact that non-farm employment was lower in September 2010 than it had been in December 1999 with the assertions that those who believed any such thing could occur were guilty of a lump-of-labor fallacy. In Part II, I rehearsed debating points regarding Paul Krugman’s columns citing the alleged fallacy.

My intention in Part III is not to refute the fallacy claim. I believe I did that sufficiently in “Why Economists Dislike a Lump of Labor” and “The Lump-of-Labor Case Against Work-Sharing.” To date, no one has brought forward a substantive rebuttal to those articles. Instead, I will explore further the evolution of the fallacy claim.

In “The Lump-of-Labor Case Against Work-Sharing,” I established that David Frederick Schloss was the originator of the phrase designating the lump-of-labor fallacy (the term “lump work,” designating labor sub-contracting, can be traced back to Henry Mayhew’s 1851 London Labour and the London Poor). That attribution has not been challenged and has even been taken up by The Economist — without, of course, giving credit to the researcher or acknowledging his debunking of the fallacy claim. A few months ago, I discovered the probable source of the stock explanatory supplement to the fallacy claim, “their theory is that the amount of work to be done is a fixed quantity…” which appeared in a report in the New York Times on the 1871 Newcastle engineers’ strike.

The phrase and the explanation still leave questions as to the origin of the general idea, which was in some respects already a commonplace by 1871, as several precursors to that 1871 New York Times report and contemporary letters to the editor of the Times of London demonstrate. What those precursors have in common with the New York Times report and with much subsequent usage is the contention of a union principle of extortionate obstruction.

John Wilson in “Economic Fallacies and Labour Utopias” (1871) cited “the enforcement of all sorts of arbitrary restrictions on the combined workmen” attributable to a “Unionist reading of the Wage-fund theory.”

James Ward in Workmen and Wages (“What Trades-Unions Really Are”, 1868) alleged the “real cause of the objection to piecework and overtime… the fallacy which lies at the bottom of this whole system [of trade unions] as:

…the view that wages being determined in their amount by importunity and combination, they form a fund for the general benefit of all, and that the fund gained by the contributions and exertions of all ought not to be encroached upon by the superior strength and dexterity of a few.

Harriet Martineau in “The Secret Organisation of Trades,” (1859):

Their aim and object is, in every case which we have been enabled to investigate, to stint the action of superior physical strength, moral industry, or intelligent skill; to depress the best workman in order to protect the inferior workman from competition; to create barriers which no Society-man can surmount, and which few non-Society-men dare to assail; and, in short, to apply all the fallacies of the Protective system to labour.

Martineau refers to an 1838 article, “Trades Unions and Strikes,” as authoritative regarding the true motives and practice of trade unionism. The 1838 article commented on the conspiracy trial of five leaders of the Glasgow Cotton Spinners Association, which took place in the wake of a strike and the murder of John Smith, a strikebreaker. In his capacity as Sheriff of Lanarkshire, the article’s author, Archibald Alison, had conducted the raid on the union meeting and arrested the accused.

Sheriff Alison (1792-1867), historian, entrepreneur and leading figure in the judiciary, was deeply involved with measures against political activists for more than twenty years. His investigations included the demonstrations leading up to the 1832 Reform Act, the activities of individuals with trade union and Chartist sympathies, protesting cotton spinners and those involved in the 1848 bread riots. He received special commendation for his work on the latter when, following bread riots and a series of demonstrations (at which he was on occasion to be seen on his horse on the police front line), apprehended persons, seen to be ringleaders, were prosecuted and transported.

In “Trade Unions and Strikes,” Alison discussed the “leading particulars and principles on which all Trades’ Unions are founded” in detail. Among the myriad restrictions imposed by “this despotic body” “upon the freedom both of capital and labour” were regulations regarding wages and hours of work:

The ruling Committees also take upon themselves to fix the number of hours which the men are to labour, and the wages they are to receive. It would be incredible, a priori, to what a length in some trades their laws carry this restriction; and how effectually, by a compact, well organized combination, they can succeed in raising, for a long period, the price even of the most necessary articles of life.

Alison’s own political philosophy can be discerned from his observation in yet another article he wrote on the Glasgow incident, “Practical Working of Trades Unions,” that “Violence, terror, and intimidation, are in fact the foundation of all popular combination”:

No one seemed to anticipate that the workmen themselves were to be the principal sufferers by the repeal, and that the despotic authority assumed by the Managing Committees was to be the source of far greater distress and suffering to the operatives than all the Combination Laws had been, or than any government, how despotic soever, could venture to inflict. Yet all this has now proved to be the case, and the misery thus brought upon the working classes by the tyrants of their own creation far exceeds in intensity any thing which has been produced even by the combined effect of scarcity of provisions and commercial embarrassment. A more memorable commentary never has been read on the prudence of intrusting the working-classes to their own guidance, according to the approved system of Modern Political Philosophy, or of the enormous peril even to themselves, of those principles of self-government, which are at once the most popular, the most common, and the most dangerous of the many false doctrines which for the last ten years have overspread the world.

If, indeed, the working classes could be brought to combine without violence and intimidation to others, much of the argument urged in support of the unlimited power of combination would be well founded, and by far the greatest part of the suffering they bring upon themselves and their fellows would be avoided. But experience proves that this never is the case: and a consideration of the disposition of human nature in such circumstances forbids the hope that it ever will be otherwise. Violence, terror, and intimidation, are in fact the foundation of all popular combination; and so universally is this the case, that it may be doubted whether there has been so much as a single instance of combination, either before the repeal of the Combination Laws, or since that time, of a strike lasting for any considerable time without threats or violence to the new hands, having formed, either by express agreement or general understanding, an essential part of the system. Indeed, if you speak to an operative in any trade of striking, and conducting himself according to the principles he ostensibly professes, that is, of giving to others that liberty in disposing of their labor which he asserts for himself, he will at once, if you are in his confidence, laugh at your folly, and admit that, without intimidation and menaces to others, combination would be a mere empty name.

It needs to be emphasized that in the above passage, Alison indicts all trade unions, not only the Glasgow Cotton Spinners Association. Did the Cotton Spinners have restrictive regulations? It would appear so. A less hostile source than Alison states, “The great object of this Association, as appears from its regulations, and the Report to which we have referred, was to keep up the wages of cotton-spinning in and around Glasgow, by producing, artificially, a short supply of that class of labourers.” Can one generalize from this single observation? “Glimpses of similar organizations, among various bodies of workmen, have been obtained, from time to time, in the progress of strikes, or in the proceedings of courts of justice.” Nevertheless, the author of this milder treatise in Tait’s Edinburgh Magazine concluded, “The real cause of the misery of the working classes, is a short supply of food and employment, occasioned by artificial means, and an unjust appropriation of even of what exists by the privileged classes.”

There are still a few loose threads to be tied up regarding the tenets of classical political economy on machinery and the matter of Luddism or frame-breaking. I had earlier suspected an 1831 popular tract, The Working-Man’s Companion. The Results of Machinery, Namely Cheap Production and Increased Employment, Exhibited: Being an Address to the Working-Men of the United Kingdom, as a possible source of the fallacy claim. That book presents an amiable and didactic rebuttal to the error presumably committed by those who break knitting frames to protest their destitution. The book’s central premise was a popularization of Say’s Law of Markets:

There is no truth so clear, that as the productions of industry multiply, the means of acquiring those productions multiply also. The productions which are created by one producer, furnish the means of purchasing the productions created by another producer; and, in consequence of this double production, the necessities of both the one and the other are better supplied. The multiplication of produce multiplies the consumers of produce.

The consequence of this law is that there is no such thing as a limit to the wants of consumers or to the means available to consumers to satisfy their wants. Thus the amount of work to be done is also unlimited and, in fact, expands as a consequence of machinery. The introduction of machinery may indeed displace workers in one particular occupation but will soon open new opportunities. With regard to that temporary displacement, however, the author had a bit of advice uncharacteristic of latter-day fallacy claims: withdraw your labor from the market!

There is a glut of laborers in the market. If you continue in the market of labor during this glut, your wages must fall. What is the remedy? To go out of the market… When there is too much labor in the market, and wages are too low, do not combine to raise the wages; do not combine with the vain hope of compelling the employer to pay more for labor than there are funds for the maintenance of labor: but go out of the market. Leave the relations between wages and labor to equalize themselves…

Similarly, John McCulloch recites, in “Effects of Machinery and Accumulation,” a thoroughly orthodox version of classical political economy, refuting arguments by Malthus and Sismondi about the prospects of a “general glut” of the market. But he had some novel things to say about the hours of work:

It may, however, be asked, would the demand be now sufficient to take off the increased quantity of’ commodities?—Would their excessive multiplication not cause such a glut of the market, as to force their sale at a lower price than what would be required to-repay the diminished cost of production? But it is not necessary, in order to render an increase in the productive powers of labour advantageous to society, that these powers should always be exerted to the full extent. If the labourer’s command over the necessaries and comforts of life were suddenly raised to ten times its present amount, (and this would really be the effect of the improvement in question), the consumption as well as the savings of the labourer would doubtless be very greatly increased; but it is not at all likely that he would continue to exert his full powers. In such a state of society we should no longer hear of workmen being engaged 12 or 14 hours a day in hard labour, or of children being immured from their tenderest years in a cotton-mill. The labourer would then be able, without endangering his means of subsistence, to devote a greater portion of his time to amusement, and to the cultivation of his mind.

McCulloch also saw no threat from combinations of labor to the functioning of the laws of supply and demand, “it is obviously false to affirm that workmen are allowed to dispose of their labour in any way they please, so long as they are prevented from concerting with each other the terms on which they are to sell it.” McCulloch argued that even when workmen combine to enforce an unreasonable demand, it does no harm because they will fail in their object.

Finally, there is the curious matter of David Ricardo’s famous chapter On Machinery, added to the third and last edition of his Principles of Political Economy, in which he contended that “the discovery and use of machinery may be attended with a diminution of gross produce; and wherever that is the case it will be injurious to the laboring class, as some of their number will be thrown out of employment, and population will become redundant, compared with the funds which are to employ it.”

Ricardo’s supposition has been upheld by such worthies as Paul Samuelson (“Ricardo was Right!“) and John R. Hicks (“A Reply to Professor Beach“). Joan Robinson went so far as to suggest, “…there appears to be, from a long period point of view, very strong grounds for the popular opinion that inventions tend to reduce employment.” Samuelson, however, reiterated that, “Needless to say, the doctrine is wrong which claims that all inventions that shift resources from circulating capital to fixed capital — to durable machines at the expense of “wage funds” — must reduce the demand for labor.”

As I said at the beginning, my intention here has not been to refute the fallacy claim but to provide further background on an allegation that has already been thoroughly discredited but that keeps reappearing with impunity.

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The Pain of Economic Change

by Tom aka Rusty Rustbelt

The Pain of Economic Change

Michigan is the only state in the union showing a net negative population trend in the recent census report, and is an interesting case study of the pain of economic change.

For several decades after WWII, Michigan enjoyed above average prosperity on the backs of the Big 3 auto makers and the employment model of the United Auto Workers, with lateral benefits and trickle down to construction, tourism, retail, services and health care. Both the private sector economy and local/state government systems were built on the broad foundation of prosperity.

Tax and regulatory systems were not hospitable to non-manufacturing businesses and non-union businesses, but with enough money in the system all of this was tolerable (money can ease many hurts).

During the 70s, 80s and 90s the Big 3 and the UAW threw away about 40% of the US market share and spawned a wave of state “lemon laws,” due to consistently poor design, poor quality and poor service.

Globalization scourged Michigan with the offshoring of thousands of light and medium manufacturing jobs (your Electrolux sweeper is now made in Mexico).

Still, the Big 3 and Michigan were able to recover from every recession, until 2000-2001. By then the Big 3 was enfeebled and the transplants had tremendous momentum in many market segments. Optimism springs eternal, and every tiny sign of improvement was a reason to pine for the “good old days.” Governor Jennifer Granholm (D) (2002-2010) had terrible timing, and compounded the problems with lots of rhetoric about change but very little effort to make any substantive change, waiting for nirvana to return (I have some empathy on the timing problem, but not the inaction).

The 2008 “great recession” was a near death blow for GM and Chrysler, and only the federal government could save the two companies.

Now the pain is real and pervasive; the government sector will be shifting to a new reality and the private sector continues to deteriorate. Any “recovery” make take a generation. There will be much screaming as a new governor (Rick Snyder, R) attempts to introduce Michigan to the new reality.

Michigan is actually ahead of some states (say New Jersey) that totally denied reality until 2008, but that is small comfort. Whatever happens to the national economy though, the benefits are unlikely to roll onto the rustbelt states.

The pain is palpable.

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Duncan Black, Ph.D. who Specializes in the Economies of Cities, Explains It All to You

Bruce has made this point repeatedly. Dr. Black puts it in more direct language:

[I]nevitably the Social Security Trustees will, perfectly justifiably, tweak a few assumptions about future economic activity so that there will be a DOOM scenario, an EVERYTHING’S AWESOME scenario, and a “uh oh maybe in about 40 years we will have a problem” scenario. And then Fred Hiatt will print another million ZOMG WE MUST DESTROY SOCIAL SECURITY NOW IN ORDER TO SAVE IT FORTY YEARS FROM NOW columns and some future president will marvel at those worthless IOUS and blah blah blah.

We know how this works.

And the Sensible Centrists* are gathering behind someone who wants to do just that.

When the Voice in the Wilderness is Andrew Samwick (who is at least honest about his willingness to steal from the Trust Fund), two things are certain:

  1. Jason Furman should work on his c.v., and
  2. Even as only Nixon could go to China (because only Nixon was enough of a bastard to sacrifice Tibet to Chou En-Lai), only the Obama Administration can turn the Social Safety Net into something the Republicans “saved” (by making it look like Dresden).

UPDATE: Tim Duy at his branch of Ecoonomist’s View piles on (h/t Steve Randy Waldman‘s Twitter feed, or maybe Felix Salmon‘s), giving the lie to whatever was left of the DeLong argument that being left of a cadre of Bob Rubins makes one a “liberal.” Pull quote:

The strong Dollar policy takes shape in 1995. At that point, Rubin made it clear that the rest of the world was free to manipulate the value of the US Dollar to pursue their own mercantilist interests. This should have been more obvious at the time given that China was last named a currency manipulator was 1994, but the immensity of that decision was lost as the tech boom engulfed America.

Moreover, Rubin adds insult to injury in the Asian Financial Crisis, by using the IMF as a club to enact far reaching reforms on nations seeking aid. The lesson learned – never, ever run a current account deficit. Accumulating massive reserves is the absolute only way to guarantee you can always tell the nice men from the IMF and the US Treasury to get off your front porch.

Go Read the Whole Thing.

Full Disclosure Update: Bob Rubin’s son is a college classmate of mine. Haven’t really seen him in the past not-quite-thirty years.

*I’m 99.44% certain those are assigned correctly. The Sensible one thinks that “attempt[ing] to push Clinton administration economic policy a little further to the left” was a Liberal position, while the Centrist is stupid enough not to believe people who have said for years that they intend to pick his pocket have something valuable to contribute to a discussion of his welfare, and does not remember that he lived through a decade when “the program [was] officially in balance.”

If H*ll exists as a form of reincarnation, my next life will be spent as a Centrist. If all my sins are venial and Purgatory awaits, I could live with being Sensible. At least until my neighbors couldn’t send their academically-achieving issue to college for purely monetary reasons, after which point I would consider this post to be rampant optimism.

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The Economics of History, Douthat-Style

I try not to pay attention—and not provide a direct link—to the NYT’s Stupidest Conservative. It’s one of the greatest advantages of having Susan of Texas around: you can go there and see anything I might write, done better, and (in this case) with cute graphics.

But when Brad DeLong falls down on the job—dealing well with the social, but not at all with the economic, aspect—it is time to go once (and, I hope, only once) into the breach.

Douthat, as quoted by DeLong:

Prior to 1973, 20 percent of births to white, unmarried women (and 9 percent of unwed births over all) led to an adoption. Today, just 1 percent of babies born to unwed mothers are adopted, and would-be adoptive parents face a waiting list that has lengthened beyond reason.

First thing to note: these are not necessarily comparable sets, for reasons detailed by Amanda Marcotte (op. cit. DeLong as well). Since the babies of today are conceived more voluntarily (in concept; my perpetual caveat about access certainly abides here), you would expect those eligible to be adopted to decline as well. That is, the 19% drop (or 95% drop in percentage terms) in white babies being adopted (or maybe it’s a 8% drop from 9% to 1%, which would be 89% in percentage terms) is the effect you would expect with fewer “unwanted” births. People don’t offer children for adoption unless they can’t raise them.

So Douthat’s statistics do, if anything, show that overall life is improved since 1973. We can agree that fewer unwanted babies is a good thing, no?

But if I’m reading Douthat’s prose correctly, there’s a far greater structural problem. Concentrating only on “white” babies— that is, conceding that Douthat is considering a bare majority, if that, of the country—we see that the system he fondly remembers produced a 20% surplus of children born out of wedlock for whom the state or its equivalents needed to care.

Even ignoring the conditions under which many of those births occurred, that basically means that for one in every five children born out of wedlock, no more than four were successfully adopted.

The odds are that the ratio is much higher: after all, “births to white, unmarried women” is a large set. Some of those were likely by choice. Some of those likely were followed soon thereafter by marriage. Some of them had “pre-arranged” adoption within the family (or de facto adoption by the woman’s extended family; see Palin, Bristol, for a contemporary example).

I don’t know the numbers, but if you told me that the above accounted for slightly more than half of the category, I wouldn’t be surprised.

But that leaves about 40% of those babies needing to be adopted. And by Douthat’s own data, only 20% of them were.

So the best-case scenario is that, for each one of us who was adopted, there was a minimum of 1/4 of a person who wasn’t—and probably closer to a 1:1 ratio.

In Douthat’s world, women are supposed to feel guilty ex post because they made a decision. Does that mean that adoptees in the U.S. are supposed to feel guilty because they were adopted and someone else wasn’t? Or that our parents should feel guilty because they chose us, and not someone else?

From an economic analysis, the pre-1973 situation was one of significant excess supply, and the current 1% adoption rate is beneficial to the chances of a potential adoptee being adopted, while the “would-be adoptive parents [who] face a waiting list” have both an abundant opportunity to provide a relatively better lifestyle for children born in developing economies and to take interim steps such as fostering to ensure that they really want to change their lifestyle enough to raise children.

No economist in his right mind would consider the pre-1973 environment romanced by Douthat to be more optimal than the current one, unless he really loves human suffering and wasting human capital.

UPDATE: Tom Levenson at Balloon Juice went out and found some numbers that—to no one’s surprise, I trust—don’t support Douthat’s Delusion either.

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Central banks underpin euro and diversify toward "other currencies"

The IMF released its Q3 2010 Currency Composition of Official Foreign Exchange Reserves (COFER) report. The COFER database provides the breakdown of official central bank portfolio holdings by currency across advanced and emerging/developing market economies.

The picture is roughly half complete, as 44% of the global reserve positions go unallocated. But the trend in reported FX holdings indicates that central banks are supporting the euro, giving it a lower bound. Furthermore, there has been a shift in portfolio holdings toward “other currencies” in advanced and emerging market central bank portfolios.

According to the report, Q3 2010 total central bank reserve holdings increased to $9.0 trillion, up by $564.4 billion over the quarter. $317.7 billion of the increased asset holdings are not “allocated” a currency denomination (“unallocated reserves” in the charts below), but the rest, $247 billion new portfolio holdings, were denominated in the following currencies:

  • $107.7 billion in new assets denominated in US dollars
  • $3.4 billion in new British pound assets
  • $24.2 billion in new Japanese yen assets
  • $0.3 billion in new Swiss franc assets
  • $87.5 billion in new Eurozone euro assets
  • $23.6 billion in new “other currency” assets

Of note, the quarterly increase in euro assets is the largest since Q2 2009. Central banks saw the weak eurodollar as a buying opportunity, down to 1.2238 on 6/30/2010. Central bank demand at low prices will likely be an important buffer to eurodollar weakness going into 2011.

Central bank portfolio assets denominated in US dollars plummeted in late 2008 and early 2009, as global central banks faced sharp capital account outflows. Since then, US dollar-denominated assets have recovered, and so have those that are “unallocated”(those reserve portfolio holdings that go unreported), which surged $881 billion since Q1 2009.

Another important point, is that the share of allocated reserves for “other currencies” has increased from 1.8% in Q4 2007 to 4% in Q3 2010. This trend will likely hold into 2011, as global central banks diversify reserve assets. Candidates for “other currency assets” likely include those denominated in commodity currencies, Australian dollar or Canadian dollar, and those of strong Asian economies, perhaps Singapore dollar. The breakdown is unavailable.

A look at the Advanced reserve assets is interesting, since just 12.3% of total portfolio holdings go unallocated.

The chart illustrates the annual change in central bank portfolio holdings in the Advanced economies denominated by currency. Advanced central banks increased their US dollar assets by $196 billion (64% of reported reserves) since Q3 2009, and further increased euro asset holdings by $76.9 billion. The annual euro asset accumulation is down from the $146 billion peak in Q1 2010, but still above the decade average of $43 billion. Interestingly, advanced economies are accumulating assets denominated in “other currencies”, a new $42 billion over the year and well above the $5.8 billion average.

Emerging market central banks loaded up on US dollar assets in 2010, $137.9 billion over the year in Q3 2010 and further accumulated “other currency” assets, $25.7 billion over the year. Finally, emerging market central banks increased their holdings of euro assets in Q3 2010 after reducing euro positions for two consecutive quarters previously. Again, a lower bound seems to have been set to underpin the euro.

The annual increase in unallocated reserve assets in the emerging market space is large, $498 billion in Q3 2010. If history is any guide, though, then 65% of the new positions are denominated in US dollars. It’s also likely that a sizable portion is denominated in euro, since the euro had a very good run against the dollar in Q3, up 11.4% over the quarter.

We’ll see, but this analysis suggests that global central banks will underpin the eurodollar in the 1.20-1.25 range. Furthermore, commodity currency assets are very likely becoming more of a reserve position to central banks.

Rebecca Wilder

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Make yourself heard on mortgage abuses

Naked Capitalism points us to a letter to ‘sign’ today in support of the FDIC and Congressman Brad Miller’s advocacy for servicer regulation:

This time, though, there is a way to stand up against the banks. And the reason is because in this case, Sheila Bair at the FDIC actually wants to do the right thing. There’s an open letter from Wall Street reformers to regulators advocating a wide range of new measures on the mortgage and securitization fronts. Congressman Brad Miller, who has been on predatory lending since 2004, penned a letter to the regulators. His effort is getting traction.

And now there’s a petition that you can sign, at If you missed it before the holidays, sign it now. We will be submitting the signatures today by the end of the day today. We up to 12,000, which is a large number for this sort of initiative, thanks to the efforts of Credo, FireDogLake, Mike Konczal, Chris Whalen, and Josh Rosner (the total on the site does not reflect the signatures obtained through some of these channels). We added a comment field, so your comments will be delivered to Geithner, Bair, Bernanke, and Walsh. Tweet it. Put it on Facebook. Send it to your friends and family.

This is meaningful action that every citizen can take.

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The Tax Rate that Maximizes Economic Growth, Part 2… With Tax Burdens Too

by Mike Kimel

The Tax Rate that Maximizes Economic Growth, Part 2… With Tax Burdens Too!Cross posted at the Presimetrics blog.

This post continues my look at the relationship between taxes and growth (what I modestly called the “Kimel curve”), which I will continue expanding on over a series of posts. Today I want to look at marginal rates, effective tax burdens, and how each or both affect growth rates. As an added bonus for non-economists and folks who don’t deal with statistics on a daily basis, I will also expand a bit on regression analysis and the process of building a rigorous “econometric model.” (Some basic material appeared at the Presimetrics and Angry Bear blogs).

To begin… its no secret that marginal tax rates don’t always have all that much to do with the amount that taxpayers actually pay. This is especially true for folks with extremely high incomes, particularly if a big chunk of their income doesn’t come with a W-2 attached. (Don’t take my word for it – I’ll give you a number later in the post.)

So, while the Kimel curve equation I provided last week dealt with the effect of the top individual federal marginal tax rate on economic growth, this week I want to throw the federal “tax burden” into the mix. The tax burden is simply the percentage of income that actually gets paid in taxes, which we can calculate as the personal current federal taxes divided by personal income. The former comes from line 2 of NIPA Table 3.2. The latter came from line 1 of NIPA Table 2.1.

(If you’re new to my posts, the NIPA tables, or National Income and Product Accounts tables, are computed by the the Bureau of Economic Analysis of the Commerce Department, the agency responsible for computing GDP. They also keep track of a lot of other interesting data about the US economy.)

Real GDP comes from any number of tables on the BEA website – let’s just pull ‘em from here this time around. And of course, we need top individual marginal tax rates IRS’ Statistics of Income Historical Table 23.

Before we go on, let’s just note that the correlation between the tax burden and the top marginal rate from 1929 to 2008 is 4.5%, which is to say, pretty close to zero.

Now, I’m setting up a simple model of growth as follows:

Growth in Real GDP, t to t+1 = B0 + B1*Top Marginal Tax Rate, t

+ B2*Top Marginal Tax Rate Squared, t

+ B3*Tax Burden, t

+ B4*Tax Burden Squared, t

As I mentioned in the previous post, I’m throwing in the X and X squared terms to account for the fact that the effect of variable X on growth rates can change as X rises or falls. For example, maybe when tax rates are low, increasing taxes has only a small effect on growth, but as tax rates rise, further increases in those tax rates can have a very big effect on growth. I’m also fitting the model using a regression. If none of this makes sense, or you don’t remember how to interpret a regression, please take a look here again.

OK. So we let it rip, and get this ouput:

Figure 1, Regression 1 Output

So now we can just go ahead and compute the optimal tax rate and optimal tax burden, right? Well, not so fast. Just because we ran a regression doesn’t mean its any good. Last week we discussed some of the diagnostics you can find in the output above, but what I didn’t mention is that you really should look at the error terms of the regression as well. The errors, or residuals, in a “good” regression look like they came out of a shotgun – they don’t have any obvious patterns. Patterns in the residuals from a regression mean something is systematically wrong with the way the model being estimated fits the data, and if something is systematically wrong, it can (and should be) fixed. Worse still, one of the mathematical assumptions of regression analysis is that you didn’t specify a model that has something systematically wrong with it, which means that the output of a regression is misleading in various ways if you there is something systematically wrong with the model. (In practice, you will never see a perfect shotgun pattern, but you want to shoot for something close.)

But, errors in this regression do show a pattern:

Figure 2, Residuals Diagram 1

As the graph above shows, the errors tend to be pretty big in the beginning, and they tend to shrink over time. Since OLS regressions maximize the sum of squared errors, big errors early on mean the model is putting an overemphasis on the early years. Additionally, the correlation between the errors in one period and the errors in the next are about 50%; big errors tend to be followed by big errors, small errors by small errors, positive errors by positive errors, and negative errors by negative errors. Now, if you’re in a Ph.D. program where showing you have chops is a big deal, you’ll deal with this using any number of cool sounding techniques, each of which is built on a number of assumptions that are truly horrifying if you stop and think about it. But if you’re long gone from academia, and spent a decade post grad school working with these cool sounding techniques, you might have gotten smart and comfortable enough to have rediscovered the KISS rule. If that’s the case, you’ll take a look a second look at the residual graph, and conclude a few things:

1. The 1929 – 1932 recession was a major outlier early on

2. The early part of the US’ involvement in WW2 (starting in 1940- think lend lease, and other gov’t expenditure) is a major outlier

So you might, as a first pass, create a couple of dummies – one for the 1929 – 1932 recession, and another for “major US involvement in WW2” aka 1940 – 1944. A dummy variable takes a value of 1 or 0, which amounts to “yes the condition is met” or “no the condition is not met.”

Rerun the regression with those dummies and you get a regression with these residuals:

Figure 3, Residuals Diagram 2

I’ve kept the scale in this graph the same as on the other. Notice… most of the big errors have dropped away, much of the “heavy early on” pattern is gone, and the correlation between errors in one period and errors the next has dropped quite a bit. A simple fix, and we’re good enough to move on for now. Here’s the output:

Figure 4, Regression 2 Output

Notice… the new model (using tax data and a couple dummies alone) explains about 57% of the variation in the growth in real GDP. Also… the tax burden is not significant. (The P-values are too far above a “significant” value such as 0.01, 0.05, or 0.1 depending on how strict you want to be, or how many asterisks you want to put in your paper.) The two dummies, not surprisingly, are significant; growth was slower than the model would otherwise predict during the 1929-1932 recession/depression, and faster than the model would otherwise predict during the 1940-1944 period when the US gov’t ramped up its involvement in the War. (BTW… anyone thinking that war is a way to promote economic growth should consider we’ve had a number of other wars during this period. What was unique about 1940-1944 was the degree to which the government decided to run the economy.)

The top marginal tax rate and top marginal rate squared are both significant, and we can use them to compute a top marginal rate that maximizes growth (at least in this model). That figure is (drumroll): 62%. Pretty close to the 67% we computed using last week’s model. And nothing like what Congressman Ryan is likely to glean from reading Atlas Shrugs…

By the way, the list of things I want to look at in future posts, in no particular order, includes:

1. Is the post-WW2 (or post 1963, or post 1981, or post 1986) era different?

2. What is the effect of different demographic groups?

3. Does this work for other forms of growth?

4. Does this type of model always provide an “optimal” result? Does this apply to states? What about other countries?

5. What about other types of taxes, such as corporate taxes? Should we focus on the tax rates paid by middle income earners rather than (or in addition to) tax rates paid by folks at the top?

6. What about the national debt? Or government spending? Or other variables?

7. Does the political party of the President or the Congress matter?

8. What is the effect of the Fed on all of this?

9. How do we know whether this is all merely correlation or is there any sign of causality going on here?

10. Given that this isn’t rocket science, why aren’t “real economists” doing stuff like this? (I would be derelict in not mentioning this paper by Pietro Peretto at Duke, which provides a model showing that “the endogenous increase in the tax on dividends necessary to balance the budget has a positive effect on growth.”)

This seems to have the potential to become the Mike Kimel full-employment act, though sadly, it isn’t my job and it doesn’t pay. Running regressions is quick and easy, and interpreting them (and spotting pitfalls) is second nature to someone who works with them on a daily basis, but pulling data, sorting it and organizing, and even just thinking about that data is very, very time consuming. So please have some patience as its going to take a while to get somewhere. Also… I will probably have occasional posts on other topics in the meanwhile as well.

All that said, one of my goals with these posts is to give non-economists a view of the way this sort thing is (or should be) done in the profession. If I’m not explaining enough, or not keeping it intuitive enough, let me know.

Finally, as always, my spreadsheets are available to anyone who wants ‘em. This one has some cool info that I didn’t get a chance to use in this post, including corporate income, corporate taxes, and some demographic information. If you want to play along at home, or even move ahead of my posts, drop me a line and I’ll send you what I have. Até à próxima, pessoal.

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The Rich Stay Healthy, the Sick Stay Poor

Health and Economic Development Primer in one easy lesson (via SocProf’s Twitter feed):

This is not surprising to see the contrast between the prosperous (at least until now) areas, in green where chronic illnesses prevail but are diseases tied to aging, as opposed to the semi-periphery and periphery where infectious / parasitic diseases are prevalent along with accidental deaths. Obviously, to be born and live in a prosperous society makes life more secure on different levels.

Extending lifespans and expanding health has been, for the most part, a Macro story of discontinuities.

The rise of vaccines (with a possible contribution from the coincident rise of people getting a high school education) got the Developed World to the point where Major Organ Failure became a primary factor.

Lungs are first: pneumonia and tuberculosis don’t kill the young so often as they did. (Vaccines, testing).

The heart was next. Major advances in the immediate post-WW II (what the Europeans tend to call “post-war”) period—up to and through transplants and ever-advancing bypass surgeries—made it more difficult to die because your heart was weak or flawed.

The next step is the brain; rather more problematic, though progress gets made.

Note that the key assumption in all of the above is access to and use of the available advances. In a system that de facto rations by ability to pay (the U.S.), there is a greater likelihood that the rich will live longer—or, more accurately, that the poor will die unnecessarily sooner. Which is what has been happening.

This post dedicated to the memory of Isaac Asimov, who survived a heart attack for fifteen years and a triple-bypass that gave him nine more years of writing (though with collateral effects that would not occur today).

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Hey anti socialist! You really don’t want to sit on UHC, Cigna, Microsoft, Walmart, Koch brother’s, GE, Boeing or Buffet’s corporate boards?

By Daniel Becker

Just thought, being the new year, we might want to start it off with some actual new thinking about how to make our economic system better. I have been meaning to purchase the book: Were you born on the wrong Continent. I’m just a very slow reader though and have to finish what I have. So, I found this Book TV interview to satisfy my “should I buy it” meter. Yes I should, and will.

Here in this country, it’s unthinkable that you would have a high school graduate on the corporate board of a major corporation. And there it happens, I don’t want to say routine, it happens a lot. You know, at least in terms of the supervisory board.

My favorite example, which I give in the book is, is this ah, nascent global bank which was just starting up and I asked a young banker there about co-determination, how it worked and he said well ah, “I’ll tell you how it works. The guy who brought us the plants, around the bank building, he’s on the corporate board.” Well what do you think about? “Well I think it’s very funny.” He said “the other thing I think about, is that they can’t hold the meetings in English” which is the global language … because this guy only speaks German. Everybody has to go at the pace of the gardener on the… corporate board.

Imagine that! Mr. Smith actually does go to Washington. As a lobbyist.  Daily even, if he were a German citizen.

The author, Mr Geoghegan goes on to say that Germany was punished for the conception and implementation of co-determination by the boycott of international capital. The Financial Times, the Economist all editorialized against it. Thus, their people have to be on guard for those who want to bring it down. However, he notes that the post 1945 constitutions that were adopted came out of the New Deal, consequently they have in stone rights to healthcare, employment and education. Things our New Deal could not get constitutionally in-scripted. Under their constitution the courts have to look at whether the law will help or hurt the family. Is education free or not free?

Ultimately, Mr. Geoghegan sees Germany having an advantage in their system because the people are pulled into the system and thus are responsible for the results of their decisions. He notes that in the US we have no real power (at least as it relates to economic outcomes via labor) which allows one to talk irresponsibly about power. Remember that gardener? He is at the table of economic policy decisions. Kind of makes you realize just what we’re about to experience now that the Tea Party is calling some major shots. All of a sudden a group of people who have been able to sit on the outside in their own circle of reality is at the table of the worlds circle of reality. Think there is not going to be some major crashes? Even Carl Rove understood the danger in O’Donnell’s limited understanding of power because of lack of exposure and all it experiences. The issue we should all have with Rove et al though, is that he does not want to helper her learn about real power and thus truly be able to make decisions that enhances her life and reduces the risk of living.

In Germany, because of their system that makes it hard for even the least educated to sit on the outside, and the most powerful to ignore or leverage the least knowledgeable for their own gain, they have a better chance of surviving those who would create the world in their own vision.

 One caution when asked what the down side is of the German system? The least knowledgeable being employed. Here, we have a service economy as the solution. That is personal service to those who have the where for all to buy personal service. This leads to a crack in the foundation of an egalitarian mind set and thus the policy that follows.  

Truth is, not everyone is born to go and get a traditional BS type college education.  Germany obviously is going to struggle as we have with making sure the lowest common denominator and not the highest is the the standard for acceptable earning capacity.  Sure, promote being the best you can be.  Great as an individual motto, but not as a minimum standard for policy setting.  We need to understand that the best for some is simple manual labor.  If we don’t, then we are only left with welfare policy, which I have no problem with if that is what we choose.  One way or the other, people who for what ever luck in life they have or have not been blessed with have to be able to receive enough money to live in the society we have set up.  Either we allow this to happen by assuring “living wages” for the lowest work society needs accomplished or we do it by welfare.  Preferably not the penal kind of welfare we seem to be choosing.  It cost the most to society and not just in money.

Besides, is it not what made us the model for and the envy of the world that we had created an economy which allowed such capacity to be considered valuable enough to earn the basic American Dream of a house, car, education and retirement without being broke or broken?

Do watch the interview.

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MLR Provisions Kick in Today

From Open Congress Nov 15, 2009 The Most Important Health Care Reform Provision You’ve Never Heard Of

For months, Bruce Webb has been tracking a provision in the House’s health care bills that has flown mostly under the radar. He calls it the “most important and most overlooked” aspect of the bills, and he may be right.
The provision in question is entitled “Ensuring Value and Lower Premiums.” In all of Congress’ health care bills it reads more or less like this:
“In General- Each health insurance issuer that offers health insurance coverage in the small or large group market shall provide that for any plan year in which the coverage has a medical loss ratio below a level specified by the Secretary (but not less than 85 percent), the issuer shall provide in a manner specified by the Secretary for rebates to enrollees of the amount by which the issuer’s medical loss ratio is less than the level so specified.”

In the end after much travail the Senate settled on a last minute 85/80 MLR between group and individual coverage, but the overall effect should be the same. And if anyone in the blogosphere beat me to this piece from July 28th, 2009 HR3200 Sec 116: Golden Bullet or Smoking Gun I’d like to hear it. With effective MLR regulation HCR works, without it it doesn’t. Which may explain why AHIP was broadly supportive of the bill until the MLR provision was restored at the last minute. And have been howling ever since.

This provision, if implemented correctly, almost totally strips the ability of insurance companies to combine cherry picking and premium increases to continue the huge profits they garner today. What it does is to establish a minimum ‘medical loss ratio’ which in simpler terms means a set ratio of care actually paid for to premiums collected. If by whatever means whether that be gaming the risk pool so an to only insure people unlikely to make claims or by denying coverage to insurees on a case by case basis your medical loss ratio drops below an established level the insurance company has to rebate the difference. In practice this prevents insurance companies from just arbitrarily jacking up rates and simultaneously takes the profit out of cherry-picking the risk pool. In a word this Sec automatically limits profits by establishing indirect price controls. Which is not going to make the insurance industry happy.

And no it didn’t. You read it here first. If you read it.

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