Is economic performance really better under the Democrats?

“CLEARLY, there are major differences between the economic policies of Senators Barack Obama and John McCain. Mr. McCain wants more tax cuts for the rich; Mr. Obama wants tax cuts for the poor and middle class. The two men also disagree on health care, energy and many other topics.
…
Many Americans know that there are characteristic policy differences between the two parties. But few are aware of two important facts about the post-World War II era, both of which are brilliantly delineated in a new book, “Unequal Democracy,” by Larry M. Bartels, a professor of political science at Princeton. …

I call the first fact the Great Partisan Growth Divide. Simply put, the United States economy has grown faster, on average, under Democratic presidents than under Republicans.



The stark contrast between the whiz-bang Clinton years and the dreary Bush years is familiar because it is so recent. But while it is extreme, it is not atypical. Data for the whole period from 1948 to 2007, during which Republicans occupied the White House for 34 years and Democrats for 26, show average annual growth of real gross national product of 1.64 percent per capita under Republican presidents versus 2.78 percent under Democrats.

That 1.14-point difference, if maintained for eight years, would yield 9.33 percent more income per person, which is a lot more than almost anyone can expect from a tax cut.

Such a large historical gap in economic performance between the two parties is rather surprising, because presidents have limited leverage over the nation’s economy. Most economists will tell you that Federal Reserve policy and oil prices, to name just two influences, are far more powerful than fiscal policy. Furthermore, as those mutual fund prospectuses constantly warn us, past results are no guarantee of future performance. But statistical regularities, like facts, are stubborn things. You bet against them at your peril.

The second big historical fact, which might be called the Great Partisan Inequality Divide, is the focus of Professor Bartels’s work.

It is well known that income inequality in the United States has been on the rise for about 30 years now — an unsettling development that has finally touched the public consciousness. But Professor Bartels unearths a stunning statistical regularity: Over the entire 60-year period, income inequality trended substantially upward under Republican presidents but slightly downward under Democrats, thus accounting for the widening income gaps over all.”

Alan S. Blinder, “Is History Siding With Obama’s Economic Plan?”, The New York Times (31 August 2008).

http://www.nytimes.com/2008/08/31/business/31view.html?ex=1377835200&en=b823687d148df72c&ei=5124&partner=permalink&exprod=permalink


Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.

Professor Blinder is correct to point out that measured in terms of rates of economic growth, economic performance has been better under the Democrats, in fact, much better (see Table below). I have no doubt that the changes in income inequality indicated above reflect the differences they are intended to measure but that is not saying much.



Before concluding that Republicans are economic illiterates (a conclusion I have no intention of disputing) and Democrats are economic geniuses (a conclusion I would dispute) may I point out that many factors beyond the political party in power actually shape the record of economic accomplishment of a country.

In the case of the Great Partisan Growth Divide, every country’s record of growth, for example, is affected by the general environment for world economic growth and the particular problems that arise from time to time and markedly affect its economic possibilities over the short- and the long-term, such as oil price rises and financial turmoil. The exceptional U.S. growth in the early 1950s under President Truman is a case in point as it reflects the strong recovery of the country from the devastation of the Second World War. The strong growth in the 1960s under Presidents Kennedy and Johnson benefited greatly from the enormous expansion of world trade in those years as the removal of tariffs spurred world growth and with it, U.S. growth. Similarly, when oil prices rise or foreign financial markets become unsettled, world and U.S. growth slows and may even become negative. One reason U.S. growth under other Presidents, Republican and Democrat, was much slower is because world growth in the 1950s and after the mid-1970s was slower, and hence an important source of U.S. growth was weaker. This has little to do with the domestic economic policies of either Democrats or Republicans.

It is nonetheless remains true that periods of rapid economic growth recorded under the Democrats were associated with years of rapid world growth and those recorded under the Republicans were associated with years of more modest world economic growth. While the pace of world growth must be an important factor, it cannot explain all the difference. It will be interesting to see how Republican economists explain their poor showing in comparison with the Democrats.

In the case of the Great Inequality Divide, much depends on how inequality is measured and the periods over which changes in inequality are measured. The income measure used in the analysis could be pre- or post-tax, it could include social welfare transfers or not, encompass in-kind consumption or not, and consider the effects of income mobility or not. Without knowing about the underlying data, little can be said about the particular results obtained by Bartels.

More generally, one could comment that if the comparison is made over decades it would be affected by the changing age-structure of the population and impact of immigration. My suspicion is the trend toward greater inequality is rooted in differential productivity gains across the economy, the aging of the U.S. population, and immigration. I doubt the policy orientations of the two political parties would explain much of this difference.

I would say even if it is true that the policies of the Republicans lead to slower economic growth than the policies of the Democrats, which I doubt, I would still be a (weak and questioning and at times absent) marcher with the Elephants. I would argue there is much more to politics that mere economic growth and a further rise in incomes, whether it be of the rich or the poor, while welcome, adds little to the true quality of our society. For this reason, these results settle nothing in the political realm.

Is economic performance really better under the Democrats?

“CLEARLY, there are major differences between the economic policies of Senators Barack Obama and John McCain. Mr. McCain wants more tax cuts for the rich; Mr. Obama wants tax cuts for the poor and middle class. The two men also disagree on health care, energy and many other topics.
…
Many Americans know that there are characteristic policy differences between the two parties. But few are aware of two important facts about the post-World War II era, both of which are brilliantly delineated in a new book, “Unequal Democracy,” by Larry M. Bartels, a professor of political science at Princeton. …

I call the first fact the Great Partisan Growth Divide. Simply put, the United States economy has grown faster, on average, under Democratic presidents than under Republicans.



The stark contrast between the whiz-bang Clinton years and the dreary Bush years is familiar because it is so recent. But while it is extreme, it is not atypical. Data for the whole period from 1948 to 2007, during which Republicans occupied the White House for 34 years and Democrats for 26, show average annual growth of real gross national product of 1.64 percent per capita under Republican presidents versus 2.78 percent under Democrats.

That 1.14-point difference, if maintained for eight years, would yield 9.33 percent more income per person, which is a lot more than almost anyone can expect from a tax cut.

Such a large historical gap in economic performance between the two parties is rather surprising, because presidents have limited leverage over the nation’s economy. Most economists will tell you that Federal Reserve policy and oil prices, to name just two influences, are far more powerful than fiscal policy. Furthermore, as those mutual fund prospectuses constantly warn us, past results are no guarantee of future performance. But statistical regularities, like facts, are stubborn things. You bet against them at your peril.

The second big historical fact, which might be called the Great Partisan Inequality Divide, is the focus of Professor Bartels’s work.

It is well known that income inequality in the United States has been on the rise for about 30 years now — an unsettling development that has finally touched the public consciousness. But Professor Bartels unearths a stunning statistical regularity: Over the entire 60-year period, income inequality trended substantially upward under Republican presidents but slightly downward under Democrats, thus accounting for the widening income gaps over all.”

Alan S. Blinder, “Is History Siding With Obama’s Economic Plan?”, The New York Times (31 August 2008).

http://www.nytimes.com/2008/08/31/business/31view.html?ex=1377835200&en=b823687d148df72c&ei=5124&partner=permalink&exprod=permalink


Alan S. Blinder is a professor of economics and public affairs at Princeton and former vice chairman of the Federal Reserve. He has advised many Democratic politicians.

Professor Blinder is correct to point out that measured in terms of rates of economic growth, economic performance has been better under the Democrats, in fact, much better (see Table below). I have no doubt that the changes in income inequality indicated above reflect the differences they are intended to measure but that is not saying much.



Before concluding that Republicans are economic illiterates (a conclusion I have no intention of disputing) and Democrats are economic geniuses (a conclusion I would dispute) may I point out that many factors beyond the political party in power actually shape the record of economic accomplishment of a country.

In the case of the Great Partisan Growth Divide, every country’s record of growth, for example, is affected by the general environment for world economic growth and the particular problems that arise from time to time and markedly affect its economic possibilities over the short- and the long-term, such as oil price rises and financial turmoil. The exceptional U.S. growth in the early 1950s under President Truman is a case in point as it reflects the strong recovery of the country from the devastation of the Second World War. The strong growth in the 1960s under Presidents Kennedy and Johnson benefited greatly from the enormous expansion of world trade in those years as the removal of tariffs spurred world growth and with it, U.S. growth. Similarly, when oil prices rise or foreign financial markets become unsettled, world and U.S. growth slows and may even become negative. One reason U.S. growth under other Presidents, Republican and Democrat, was much slower is because world growth in the 1950s and after the mid-1970s was slower, and hence an important source of U.S. growth was weaker. This has little to do with the domestic economic policies of either Democrats or Republicans.

It is nonetheless remains true that periods of rapid economic growth recorded under the Democrats were associated with years of rapid world growth and those recorded under the Republicans were associated with years of more modest world economic growth. While the pace of world growth must be an important factor, it cannot explain all the difference. It will be interesting to see how Republican economists explain their poor showing in comparison with the Democrats.

In the case of the Great Inequality Divide, much depends on how inequality is measured and the periods over which changes in inequality are measured. The income measure used in the analysis could be pre- or post-tax, it could include social welfare transfers or not, encompass in-kind consumption or not, and consider the effects of income mobility or not. Without knowing about the underlying data, little can be said about the particular results obtained by Bartels.

More generally, one could comment that if the comparison is made over decades it would be affected by the changing age-structure of the population and impact of immigration. My suspicion is the trend toward greater inequality is rooted in differential productivity gains across the economy, the aging of the U.S. population, and immigration. I doubt the policy orientations of the two political parties would explain much of this difference.

I would say even if it is true that the policies of the Republicans lead to slower economic growth than the policies of the Democrats, which I doubt, I would still be a (weak and questioning and at times absent) marcher with the Elephants. I would argue there is much more to politics that mere economic growth and a further rise in incomes, whether it be of the rich or the poor, while welcome, adds little to the true quality of our society. For this reason, these results settle nothing in the political realm.

Arnold Kling on Feldstein’s proposal

“Feldstein writes,

The federal government would offer every homeowner with a mortgage the opportunity to replace 20 per cent of that mortgage with a low interest government loan – up to a loan limit of $80,000. . .that reflects the government’s lower borrowing rate. Creditors would be required to accept this partial mortgage pay-down and to reduce the monthly interest and principal by the same 20 per cent. That mortgage replacement loan would not be collateralised by the house but would be a loan that the government could enforce by lodging a claim on an individual who does not pay.

Feldstein is worried about house price declines "overshooting" their proper value. If he knows what the proper value of everyone's house is, he should set up a hedge fund to buy houses that fall below that value, while shorting the market-traded house price indexes in cities where house prices are still too high.”

Arnold Kling, “Three Quick Takes”, Econlog Blog (27 August 2008).

http://econlog.econlib.org/

Arnold Kling is a noted economist who has worked for the Federal government for many years in different capacities and as a professor at several universities. He is a founder and co-editor of EconLog, a popular economics blog that reflects Libertarian thinking.

Dr. Kling comments here on the proposal by Martin Feldstein that was the subject of yesterday’s Tdj. In Feldstein’s Op Ed, as noted in the Tdj, he set forth a proposal intended to provide a floor on falling house values. The proposal advocated that the Federal government provide “mortgage replacement loans” intended to stop defaults by homeowners when their equity in their home turned negative as a result of a decline in the price of their house.

I commented in that Tdj that while the economy was weak, it was not clear we were in a recession and not clear that house prices would continue to fall and cause defaults. Today it was reported that economic growth in the second quarter of the year was much stronger than originally thought, and rose at an annual rate of 3.3 per cent, a pace somewhat above the long-term trend for the U.S. economy. Let me add, the Federal government budget is in deep deficit, and any ideas to spend more money should be scrutinized carefully.

Here Dr. Kling gives another reason to question Feldstein’s proposal: It is easy to set forth broad ideas about what we, meaning the government, might do, but it is quite another thing to actually implement any proposal. To actually implement the Feldstein proposal the government would have to know what the market value of any house would be in an undefined market. Since this is unknown, one cannot actually put the proposal into practice. Moreover, Kling notes, if anyone knew what the proper value of a house was, when it fell below that value they could buy it for less than it was worth, and later, when the price returned to its higher “proper” level, sell it for a profit.

In other words, Kling is saying the information necessary to implement this proposal is not known, and if it were, we would not need the government to implement the policy because the private sector would automatically undertake it.

Arnold Kling on Feldstein’s proposal

“Feldstein writes,

The federal government would offer every homeowner with a mortgage the opportunity to replace 20 per cent of that mortgage with a low interest government loan – up to a loan limit of $80,000. . .that reflects the government’s lower borrowing rate. Creditors would be required to accept this partial mortgage pay-down and to reduce the monthly interest and principal by the same 20 per cent. That mortgage replacement loan would not be collateralised by the house but would be a loan that the government could enforce by lodging a claim on an individual who does not pay.

Feldstein is worried about house price declines "overshooting" their proper value. If he knows what the proper value of everyone's house is, he should set up a hedge fund to buy houses that fall below that value, while shorting the market-traded house price indexes in cities where house prices are still too high.”

Arnold Kling, “Three Quick Takes”, Econlog Blog (27 August 2008).

http://econlog.econlib.org/

Arnold Kling is a noted economist who has worked for the Federal government for many years in different capacities and as a professor at several universities. He is a founder and co-editor of EconLog, a popular economics blog that reflects Libertarian thinking.

Dr. Kling comments here on the proposal by Martin Feldstein that was the subject of yesterday’s Tdj. In Feldstein’s Op Ed, as noted in the Tdj, he set forth a proposal intended to provide a floor on falling house values. The proposal advocated that the Federal government provide “mortgage replacement loans” intended to stop defaults by homeowners when their equity in their home turned negative as a result of a decline in the price of their house.

I commented in that Tdj that while the economy was weak, it was not clear we were in a recession and not clear that house prices would continue to fall and cause defaults. Today it was reported that economic growth in the second quarter of the year was much stronger than originally thought, and rose at an annual rate of 3.3 per cent, a pace somewhat above the long-term trend for the U.S. economy. Let me add, the Federal government budget is in deep deficit, and any ideas to spend more money should be scrutinized carefully.

Here Dr. Kling gives another reason to question Feldstein’s proposal: It is easy to set forth broad ideas about what we, meaning the government, might do, but it is quite another thing to actually implement any proposal. To actually implement the Feldstein proposal the government would have to know what the market value of any house would be in an undefined market. Since this is unknown, one cannot actually put the proposal into practice. Moreover, Kling notes, if anyone knew what the proper value of a house was, when it fell below that value they could buy it for less than it was worth, and later, when the price returned to its higher “proper” level, sell it for a profit.

In other words, Kling is saying the information necessary to implement this proposal is not known, and if it were, we would not need the government to implement the policy because the private sector would automatically undertake it.

Martin Feldstein on the U.S. housing crisis

“The current decline of house prices is the natural result of the bubble that by 2006 had raised house prices to 60 per cent above their long-term trend. The sharp decline since then means that today's prices are about 15 per cent above the trend level. But while a further 15 per cent decline may be inevitable, there is nothing to stop prices declining even further. ....

Negative equity mortgages are a big source of instability because US home mortgages are generally "no recourse" loans, implying that if an individual defaults on his mortgage the creditor can take the property but cannot claim other assets or income to pay the remaining loan balance. ....

This is a difficult problem and there are no easy solutions. I have proposed a programme of "mortgage replacement loans" that I believe would stop the downward spiral of house prices. The basic idea is to provide an incentive to stop defaults among those who now have positive equity but are vulnerable to a further price decline. The federal government would offer every homeowner with a mortgage the opportunity to replace 20 per cent of that mortgage with a low interest government loan .... That mortgage replacement loan would not be collateralised by the house but would be a loan that the government could enforce by lodging a claim on an individual who does not pay.

With the mortgage replacement loan, people who now have a mortgage equal to 90 per cent of their house value would see that mortgage fall to just 72 per cent of the house value, implying that it would take a very unlikely price fall of more than 28 per cent to push those individuals into negative equity.”

Martin Feldstein, "How to shore up America's crumbling housing market", Financial Times (27 August 2008).

http://www.ft.com/cms/s/0/29e69ebc-736f-11dd-8a66-0000779fd18c.html


Martin Feldstein (1939-) from 1972 to 2008 was President and CEO of the National Bureau of Economic Research (NBER), except for the period 1982-1984 when he was President Reagan's chief economic adviser. He is Professor of Economics at Harvard University.

The economy remains vulnerable to the problems of the housing sector and many other financial strains. But let us keep in mind that despite it all, to date at least, the real economy has not slipped into recession, and this despite record energy prices and rising inflationary pressures.

Perhaps Feldstein’s ideas are good, but perhaps it is too early to say we should panic and implement this or any other idea that involves spending at a time when we already have a large deficit. Granted the financial situation in the mortgage sector in precarious. But there are times when one should simply wait and see what happens. This is probably one of those times.

Thanks to Larry Willmore for this Tdj.

Martin Feldstein on the U.S. housing crisis

“The current decline of house prices is the natural result of the bubble that by 2006 had raised house prices to 60 per cent above their long-term trend. The sharp decline since then means that today's prices are about 15 per cent above the trend level. But while a further 15 per cent decline may be inevitable, there is nothing to stop prices declining even further. ....

Negative equity mortgages are a big source of instability because US home mortgages are generally "no recourse" loans, implying that if an individual defaults on his mortgage the creditor can take the property but cannot claim other assets or income to pay the remaining loan balance. ....

This is a difficult problem and there are no easy solutions. I have proposed a programme of "mortgage replacement loans" that I believe would stop the downward spiral of house prices. The basic idea is to provide an incentive to stop defaults among those who now have positive equity but are vulnerable to a further price decline. The federal government would offer every homeowner with a mortgage the opportunity to replace 20 per cent of that mortgage with a low interest government loan .... That mortgage replacement loan would not be collateralised by the house but would be a loan that the government could enforce by lodging a claim on an individual who does not pay.

With the mortgage replacement loan, people who now have a mortgage equal to 90 per cent of their house value would see that mortgage fall to just 72 per cent of the house value, implying that it would take a very unlikely price fall of more than 28 per cent to push those individuals into negative equity.”

Martin Feldstein, "How to shore up America's crumbling housing market", Financial Times (27 August 2008).

http://www.ft.com/cms/s/0/29e69ebc-736f-11dd-8a66-0000779fd18c.html


Martin Feldstein (1939-) from 1972 to 2008 was President and CEO of the National Bureau of Economic Research (NBER), except for the period 1982-1984 when he was President Reagan's chief economic adviser. He is Professor of Economics at Harvard University.

The economy remains vulnerable to the problems of the housing sector and many other financial strains. But let us keep in mind that despite it all, to date at least, the real economy has not slipped into recession, and this despite record energy prices and rising inflationary pressures.

Perhaps Feldstein’s ideas are good, but perhaps it is too early to say we should panic and implement this or any other idea that involves spending at a time when we already have a large deficit. Granted the financial situation in the mortgage sector in precarious. But there are times when one should simply wait and see what happens. This is probably one of those times.

Thanks to Larry Willmore for this Tdj.

Just how capitalist is China?

“Evolution of capitalism in China is a function of a political balance between two Chinas--the entrepreneurial, market-driven rural China vis-à-vis the state-led urban China. In the 1980s, rural China gained the upper hand but in the 1990s, urban China gained the upper hand. [p. 1]

What triggered these policy reversals? ....

A reasonable conjecture is that the political and policy turning point was the 1989 Tiananmen turmoil. It is well-known that the post-Tiananmen leadership sought to crack down on the private sector, mainly on ideological grounds. The ideological assault was quickly halted as is well known by China scholars, but a longer-lasting effect of Tiananmen was a substantial change in the composition of the Chinese leadership. Suffice it to mention that the pre-Tiananmen and the post-Tiananmen leaderships differed in one critical aspect—their rural vis-à-vis urban credentials. Before Tiananmen, many of the top Chinese leaders charged with day-to-day economic management—Zhao Ziyang, Wan Li, and Tian Jiyun--hailed from rural provinces that had pioneered in agricultural reforms. They built their economic credentials by having succeeded in the management of agriculture. After Tiananmen, the top Chinese leaders in charge of the economy--Jiang Zemin and Zhu Rongji--came from the most urban and the least reformed region of China--Shanghai. We cannot know for sure whether these observable characteristics of the Chinese leaders explain their policy orientations but they are not inconsistent with the view that there was a rural policy bias in the 1980s and that there was an urban policy bias in the 1990s.

The key to getting the China story right is to understand its rural entrepreneurship. This is why the decade of the 1980s is so important in our efforts to explain China. I ... will show that rural entrepreneurship was not only vibrant but also virtuous. Rural entrepreneurs built businesses of a substantial scale in some of China's poorest provinces and after only a few years into the first decade of the reforms, the private portions of the TVEs [township and village enterprises] were extraordinarily high. [p. 42]

A central mechanism of the growth model of the 1990s was to finance state-led, urban China by heavily taxing entrepreneurial rural China. The result was the urban boom--the skyscrapers and urban amenities in Beijing and Shanghai--that many take as a sign of China's economic success. Very few observers have asked the obvious question, "What financed these expensive projects in a poor country like China?" ....

The answer is that entrepreneurial rural China paid the price. [p. 44]

[E]ven as China is about to enter the fourth decade of reforms, the size of its indigenous private sector is conspicuously small. The best way to characterize the Chinese economy today is that it is broadly similar to many of the commanding-heights economies of the 1970s. It is capitalistic to be sure, but it is a version of the oligarchic capitalism which, as Baumol, Litan, and Shramm (in Good Capitalism, Bad Capitalism, and Economics of Growth and Prosperity, 2007) argue, characterized Latin America. Today China has other attributes that also put the country closer to the Latin American end of capitalism rather than to the East Asian end--the rising income disparities and the contraction in social opportunities available to the population to attain education and health. [pp. 44-45]”

Yasheng Huang, "Just How Capitalist is China?", MIT Sloan School Working Paper 4699-08 (4 April 2008).

http://ssrn.com/abstract=1118019

Professor Yasheng Huang teaches international management at Sloan School of Management, MIT. This essay is the first chapter of his book Capitalism with Chinese Characteristics (Cambridge University Press, New York, 2008).

I know little of the Chinese economic situation so I found this interesting for several reasons. Professor Huang points out that a very large country such as China has different ideas about what it should do and where it should go economically, and that these differences may be traced to rural-urban geographic differences is very interesting. Indeed, the rural-urban difference, with one entrepreneurial and the other state-led, is one I was not aware of but do not doubt. In fact, it makes sense, and it makes sense that policy would be affected by the background of leaders coming from markedly different parts of this large country. Finally, the point of a small indigenous private sector and its oligarchic nature was also unknown to me, and also not surprising.

I take it China is less capitalist than I thought.

An interesting paper well worth reading.

Thanks to Larry Willmore for the pointer.

Just how capitalist is China?

“Evolution of capitalism in China is a function of a political balance between two Chinas--the entrepreneurial, market-driven rural China vis-à-vis the state-led urban China. In the 1980s, rural China gained the upper hand but in the 1990s, urban China gained the upper hand. [p. 1]

What triggered these policy reversals? ....

A reasonable conjecture is that the political and policy turning point was the 1989 Tiananmen turmoil. It is well-known that the post-Tiananmen leadership sought to crack down on the private sector, mainly on ideological grounds. The ideological assault was quickly halted as is well known by China scholars, but a longer-lasting effect of Tiananmen was a substantial change in the composition of the Chinese leadership. Suffice it to mention that the pre-Tiananmen and the post-Tiananmen leaderships differed in one critical aspect—their rural vis-à-vis urban credentials. Before Tiananmen, many of the top Chinese leaders charged with day-to-day economic management—Zhao Ziyang, Wan Li, and Tian Jiyun--hailed from rural provinces that had pioneered in agricultural reforms. They built their economic credentials by having succeeded in the management of agriculture. After Tiananmen, the top Chinese leaders in charge of the economy--Jiang Zemin and Zhu Rongji--came from the most urban and the least reformed region of China--Shanghai. We cannot know for sure whether these observable characteristics of the Chinese leaders explain their policy orientations but they are not inconsistent with the view that there was a rural policy bias in the 1980s and that there was an urban policy bias in the 1990s.

The key to getting the China story right is to understand its rural entrepreneurship. This is why the decade of the 1980s is so important in our efforts to explain China. I ... will show that rural entrepreneurship was not only vibrant but also virtuous. Rural entrepreneurs built businesses of a substantial scale in some of China's poorest provinces and after only a few years into the first decade of the reforms, the private portions of the TVEs [township and village enterprises] were extraordinarily high. [p. 42]

A central mechanism of the growth model of the 1990s was to finance state-led, urban China by heavily taxing entrepreneurial rural China. The result was the urban boom--the skyscrapers and urban amenities in Beijing and Shanghai--that many take as a sign of China's economic success. Very few observers have asked the obvious question, "What financed these expensive projects in a poor country like China?" ....

The answer is that entrepreneurial rural China paid the price. [p. 44]

[E]ven as China is about to enter the fourth decade of reforms, the size of its indigenous private sector is conspicuously small. The best way to characterize the Chinese economy today is that it is broadly similar to many of the commanding-heights economies of the 1970s. It is capitalistic to be sure, but it is a version of the oligarchic capitalism which, as Baumol, Litan, and Shramm (in Good Capitalism, Bad Capitalism, and Economics of Growth and Prosperity, 2007) argue, characterized Latin America. Today China has other attributes that also put the country closer to the Latin American end of capitalism rather than to the East Asian end--the rising income disparities and the contraction in social opportunities available to the population to attain education and health. [pp. 44-45]”

Yasheng Huang, "Just How Capitalist is China?", MIT Sloan School Working Paper 4699-08 (4 April 2008).

http://ssrn.com/abstract=1118019

Professor Yasheng Huang teaches international management at Sloan School of Management, MIT. This essay is the first chapter of his book Capitalism with Chinese Characteristics (Cambridge University Press, New York, 2008).

I know little of the Chinese economic situation so I found this interesting for several reasons. Professor Huang points out that a very large country such as China has different ideas about what it should do and where it should go economically, and that these differences may be traced to rural-urban geographic differences is very interesting. Indeed, the rural-urban difference, with one entrepreneurial and the other state-led, is one I was not aware of but do not doubt. In fact, it makes sense, and it makes sense that policy would be affected by the background of leaders coming from markedly different parts of this large country. Finally, the point of a small indigenous private sector and its oligarchic nature was also unknown to me, and also not surprising.

I take it China is less capitalist than I thought.

An interesting paper well worth reading.

Thanks to Larry Willmore for the pointer.

Marx and Engels in praise of the bourgeoisie

“The bourgeoisie has through its exploitation of the world market given a cosmopolitan character to production and consumption in every country. To the great chagrin of Reactionists, it has drawn from under the feet of industry the national ground on which it stood. All old-established national industries have been destroyed or are daily being destroyed. They are dislodged by new industries, whose introduction becomes a life and death question for all civilised nations, by industries that no longer work up indigenous raw material, but raw material drawn from the remotest zones; industries whose products are consumed, not only at home, but in every quarter of the globe. In place of the old wants, satisfied by the production of the country, we find new wants, requiring for their satisfaction the products of distant lands and climes. In place of the old local and national seclusion and self-sufficiency, we have intercourse in every direction, universal inter-dependence of nations. And as in material, so also in intellectual production. The intellectual creations of individual nations become common property. National one-sidedness and narrow-mindedness become more and more impossible, and from the numerous national and local literatures, there arises a world literature.

The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all, even the most barbarian, nations into civilisation. The cheap prices of commodities are the heavy artillery with which it batters down all Chinese walls, with which it forces the barbarians’ intensely obstinate hatred of foreigners to capitulate. It compels all nations, on pain of extinction, to adopt the bourgeois mode of production; it compels them to introduce what it calls civilisation into their midst, i.e., to become bourgeois themselves. In one word, it creates a world after its own image.

The bourgeoisie has subjected the country to the rule of the towns. It has created enormous cities, has greatly increased the urban population as compared with the rural, and has thus rescued a considerable part of the population from the idiocy of rural life. Just as it has made the country dependent on the towns, so it has made barbarian and semi-barbarian countries dependent on the civilised ones, nations of peasants on nations of bourgeois, the East on the West.
…
The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of Nature’s forces to man, machinery, application of chemistry to industry and agriculture, steam-navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalisation of rivers, whole populations conjured out of the ground — what earlier century had even a presentiment that such productive forces slumbered in the lap of social labour?”

Karl Marx and Frederick Engels, “Manifesto of the Communist Party” (1848), Part I – Bourgeois and Proletarians.

http://www.anu.edu.au/polsci/marx/classics/manifesto.html


Karl Marx and Frederick Engels, The Great Complainer and The Great Enabler, wrote the Communist Manifesto to promote a working class revolution to overthrow the bourgeois social order and usher in a classless and stateless society based on common ownership of production and property in general. The Manifesto is a statement of ideals and purposes, a program to be implemented, and, most significant for the time, a call to action (“The Communists disdain to conceal their views and aims. They openly declare that their ends can be attained only by the forcible overthrow of all existing social conditions. Let the ruling classes tremble at a communist revolution. The proletarians have nothing to lose but their chains. They have a world to win. Proletarians of all countries, unite!”).

Although the Manifesto carries the names of both Marx and Engels, many years later, in 1883, the year of Marx’s death, Engels wrote that the Manifesto was “essentially Marx’s work” and “the basic thought … belongs solely and exclusively to Marx”. This is important because as the work of a single mind the Manifesto offers an insight into Marx’s early intellectual system and moral framework and it reflects the understanding he developed -- better, he was developing -- about the rapidly changing world of his time. It offers an opportunity to see something of the complex nature of this great scholar with his strange, dogmatic, at once repugnant system of ideas yet a vision deeply concerned with and sympathetic of the human condition. That The Great Complainer thought Capitalism was the cause of the miseries of millions certainly was understandable in the circumstances of his times; That Marx thought Socialism was the one true and destined way to overcome the poverty and despair that surrounded him was at once naïve and reflective of an inflexible mind yielding to no alternative point of view; and That he thought that the violent overthrow of the existing order, with the inevitable death and destruction and dictatorial order it would bring in its wake, would somehow inspire people to be generous and charitable toward others is unforgiveable in its misjudgment of human nature. Marx evidently came upon these views early and with little or no input from his frequent collaborator, Engels.

Although Marx is not responsible for the follies and evils committed in his name, he cannot deny the creed and gospel he founded (and evidently founded on his own) directly led to the killing of tens of millions of innocents at the hands of disciples advancing his ideas and his ideals. To that degree he is culpable for mass murder, for he set in motion something more powerful than armies: Ideas that motivate common people to act against common people, and to rationalize the evil they do as historically necessary and in furtherance of some greater good.

The seeds of the later more fully elaborated Marxist Theory of History can be seen in the praise he gives to the Capitalists. In the Marxist Theory of History the transformation of old social systems requires radical and far-reaching changes that can only be brought about when the dominate class of creators, beneficiaries, and defenders of the old system are swept away. The groups that rose under Capitalism to accomplish this task, such as the Capitalist and merchant classes that comprise the bourgeoisie, to Marx’s mind, fulfill the historic purpose of transforming Feudalism from a stagnate and aristocratic society (“The bourgeoisie, wherever it has got the upper hand, has put an end to all feudal, patriarchal, idyllic relations”) into a dynamic and productive society where employment, education, and the creation of wealth define success (“Constant revolutionizing of production, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones”). It is this historic purpose of the bourgeoisie, eliminating the lords and ladies who prevent the development of the economy while empowering the entrepreneurs who can markedly raise the productive power of society, that Marx praises in this passage.

Needless to say, Marx passionately hated Capitalism and goes on in the Manifesto to condemn the Capitalists strongly. In his view, in the process of fulfilling their role of destroying Feudalism, the Capitalists bring about the very conditions that lead to their own downfall: widening and deepening poverty on the part of the “growing masses” and greater and greater concentrations of wealth among the remaining Capitalists. The correction of Capitalism’s injustices, the Manifesto insists and some people today continue to believe, can only be attained through revolution, a revolution we have repeatedly seen in the past and are likely to see again, for the ideas behind the revolution still circulate in the minds of men.

Marx and Engels in praise of the bourgeoisie

“The bourgeoisie has through its exploitation of the world market given a cosmopolitan character to production and consumption in every country. To the great chagrin of Reactionists, it has drawn from under the feet of industry the national ground on which it stood. All old-established national industries have been destroyed or are daily being destroyed. They are dislodged by new industries, whose introduction becomes a life and death question for all civilised nations, by industries that no longer work up indigenous raw material, but raw material drawn from the remotest zones; industries whose products are consumed, not only at home, but in every quarter of the globe. In place of the old wants, satisfied by the production of the country, we find new wants, requiring for their satisfaction the products of distant lands and climes. In place of the old local and national seclusion and self-sufficiency, we have intercourse in every direction, universal inter-dependence of nations. And as in material, so also in intellectual production. The intellectual creations of individual nations become common property. National one-sidedness and narrow-mindedness become more and more impossible, and from the numerous national and local literatures, there arises a world literature.

The bourgeoisie, by the rapid improvement of all instruments of production, by the immensely facilitated means of communication, draws all, even the most barbarian, nations into civilisation. The cheap prices of commodities are the heavy artillery with which it batters down all Chinese walls, with which it forces the barbarians’ intensely obstinate hatred of foreigners to capitulate. It compels all nations, on pain of extinction, to adopt the bourgeois mode of production; it compels them to introduce what it calls civilisation into their midst, i.e., to become bourgeois themselves. In one word, it creates a world after its own image.

The bourgeoisie has subjected the country to the rule of the towns. It has created enormous cities, has greatly increased the urban population as compared with the rural, and has thus rescued a considerable part of the population from the idiocy of rural life. Just as it has made the country dependent on the towns, so it has made barbarian and semi-barbarian countries dependent on the civilised ones, nations of peasants on nations of bourgeois, the East on the West.
…
The bourgeoisie, during its rule of scarce one hundred years, has created more massive and more colossal productive forces than have all preceding generations together. Subjection of Nature’s forces to man, machinery, application of chemistry to industry and agriculture, steam-navigation, railways, electric telegraphs, clearing of whole continents for cultivation, canalisation of rivers, whole populations conjured out of the ground — what earlier century had even a presentiment that such productive forces slumbered in the lap of social labour?”

Karl Marx and Frederick Engels, “Manifesto of the Communist Party” (1848), Part I – Bourgeois and Proletarians.

http://www.anu.edu.au/polsci/marx/classics/manifesto.html


Karl Marx and Frederick Engels, The Great Complainer and The Great Enabler, wrote the Communist Manifesto to promote a working class revolution to overthrow the bourgeois social order and usher in a classless and stateless society based on common ownership of production and property in general. The Manifesto is a statement of ideals and purposes, a program to be implemented, and, most significant for the time, a call to action (“The Communists disdain to conceal their views and aims. They openly declare that their ends can be attained only by the forcible overthrow of all existing social conditions. Let the ruling classes tremble at a communist revolution. The proletarians have nothing to lose but their chains. They have a world to win. Proletarians of all countries, unite!”).

Although the Manifesto carries the names of both Marx and Engels, many years later, in 1883, the year of Marx’s death, Engels wrote that the Manifesto was “essentially Marx’s work” and “the basic thought … belongs solely and exclusively to Marx”. This is important because as the work of a single mind the Manifesto offers an insight into Marx’s early intellectual system and moral framework and it reflects the understanding he developed -- better, he was developing -- about the rapidly changing world of his time. It offers an opportunity to see something of the complex nature of this great scholar with his strange, dogmatic, at once repugnant system of ideas yet a vision deeply concerned with and sympathetic of the human condition. That The Great Complainer thought Capitalism was the cause of the miseries of millions certainly was understandable in the circumstances of his times; That Marx thought Socialism was the one true and destined way to overcome the poverty and despair that surrounded him was at once naïve and reflective of an inflexible mind yielding to no alternative point of view; and That he thought that the violent overthrow of the existing order, with the inevitable death and destruction and dictatorial order it would bring in its wake, would somehow inspire people to be generous and charitable toward others is unforgiveable in its misjudgment of human nature. Marx evidently came upon these views early and with little or no input from his frequent collaborator, Engels.

Although Marx is not responsible for the follies and evils committed in his name, he cannot deny the creed and gospel he founded (and evidently founded on his own) directly led to the killing of tens of millions of innocents at the hands of disciples advancing his ideas and his ideals. To that degree he is culpable for mass murder, for he set in motion something more powerful than armies: Ideas that motivate common people to act against common people, and to rationalize the evil they do as historically necessary and in furtherance of some greater good.

The seeds of the later more fully elaborated Marxist Theory of History can be seen in the praise he gives to the Capitalists. In the Marxist Theory of History the transformation of old social systems requires radical and far-reaching changes that can only be brought about when the dominate class of creators, beneficiaries, and defenders of the old system are swept away. The groups that rose under Capitalism to accomplish this task, such as the Capitalist and merchant classes that comprise the bourgeoisie, to Marx’s mind, fulfill the historic purpose of transforming Feudalism from a stagnate and aristocratic society (“The bourgeoisie, wherever it has got the upper hand, has put an end to all feudal, patriarchal, idyllic relations”) into a dynamic and productive society where employment, education, and the creation of wealth define success (“Constant revolutionizing of production, uninterrupted disturbance of all social conditions, everlasting uncertainty and agitation distinguish the bourgeois epoch from all earlier ones”). It is this historic purpose of the bourgeoisie, eliminating the lords and ladies who prevent the development of the economy while empowering the entrepreneurs who can markedly raise the productive power of society, that Marx praises in this passage.

Needless to say, Marx passionately hated Capitalism and goes on in the Manifesto to condemn the Capitalists strongly. In his view, in the process of fulfilling their role of destroying Feudalism, the Capitalists bring about the very conditions that lead to their own downfall: widening and deepening poverty on the part of the “growing masses” and greater and greater concentrations of wealth among the remaining Capitalists. The correction of Capitalism’s injustices, the Manifesto insists and some people today continue to believe, can only be attained through revolution, a revolution we have repeatedly seen in the past and are likely to see again, for the ideas behind the revolution still circulate in the minds of men.

Are we approaching “The End of the World”?

“Will the U.S. Treasury repudiate its obligations to its creditors, be they citizens or investors around the world? Most observers would answer "no" without hesitation. But Congress, with the complicity of the White House and the Fed, has arguably embarked on a stealth repudiation.

In his famous treatise, "The Wealth of Nations," Adam Smith noted there had never been a "single instance" of sovereign debts having been repaid once "accumulated to a certain degree." We may have reached Smith's threshold.

The bond markets are certainly not protecting creditors from the risk of what Smith called "pretended payment" through inflation. Nor did they do so until far into the great inflation of the 1970s. Not until late 1977 and into 1978 did the bond market fully incorporate the reality of the debased dollar, by demanding higher long-term interest rates.

How can this happen? Markets are supposed to be forward-looking and efficiently price in all relevant risks. Yet monarchs have been repudiating debt explicitly and implicitly throughout recorded history.

Many years ago, the Austrian economist Ludwig von Mises offered an explanation. He suggested that while you can't, in Abraham Lincoln's words "fool all of the people all of the time," you can fool all of the people at least some of the time. And this is easier to do if a central bank has in the past earned credibility in fighting inflation.

In the 1980s, Ronald Reagan and Paul Volcker worked together to get inflation under control. They were greatly assisted by the "bond vigilantes," traders who were by then exerting discipline in bond markets by bidding up interest rates to double-digit levels. The outcome of the Reagan/Volcker policy of tight money and low marginal tax rates was not only a great economic expansion, but also a great boost to the Fed's credibility. The Fed proved it was able and willing to withstand political heat in the fight against inflation.
…
The markets have long assessed the debt of [Fannie Mae and Freddie Mac] at AAA because of the Treasury's guarantee, now explicit. But no one has ever seriously assessed the Treasury's creditworthiness with Fannie and Freddie on its books. The public guarantee is entirely open-ended and unbounded. The appetite of the two companies to balloon their balance sheets and take on risk has not been curtailed. Meanwhile, Congress spends apace with new programs for constituents in an election year.

We are at a Smithian moment, in which the temptation for the Fed to spend its last dime of credibility may prove irresistible. Investors are already being taxed by inflation and can rationally expect that tax rate (the inflation rate) to be raised going forward. Wages are not keeping up. Main Street is being taxed to fund Wall Street excess. Anyone who works, saves and invests is exposed to confiscation of his capital and earnings through inflation.

If the Fed maintained its independence of action and said no to the inflationary finance of Congress's profligacy, we wouldn't have reached this point. But the Fed has forsaken that independence amid an absence of leadership.

Perhaps, as rarely happens, Adam Smith will be proven wrong. Let us hope so, because hope appears to be all we have.”

Gerald P. O’Driscoll, Jr., “Washington Is Quietly Repudiating Its Debts”, Wall Street Journal (22 August 2008).


Mr. O'Driscoll is a senior fellow at the Cato Institute and a former vice president and economic adviser at the Federal Reserve Bank of Dallas.

In a post on his blog, Marginal Revolution, at the end of July, found here, Tyler Cowen of George Mason University reviewed the cost of the mortgage agency bailouts undertaken by the Federal government in response to the financial crisis now affecting the U.S. economy. Among the points he made was that the bailouts themselves, should they prove to be necessary, represent a transfer payment to debt holders from taxpayers, not an actual economic cost to society since no resources are destroyed. However, in the event of a bailout, there would be a deadweight loss to the economy in terms of the actual cost to effect the transfer from taxpayer to debt holder. Moreover, the burden of the tax necessary to pay the bailout would probably be regressive, in the sense that those that would be taxed to pay for the transfer are less wealthy than the debt holders who would be reimbursed. He also pointed out that the equity holders would no doubt be wiped out and that the borrowing costs required to implement the bailout would depend on how quickly it was undertaken. In other words, even if a bailout does not entail the actual loss of real productive capacity, it still places a very big burden on the economy.

Professor Cowen also expressed the view that the government has no real choice but to bail out the debt holders of the mortgage agencies. The alternative would be financial chaos and a run on the dollar, which he termed “the end of the world”. By this is meant a financial collapse where the Treasury could not sell its bonds, the dollar would drop on world markets, credit would dry up to the private sector and interest rates would rise greatly, and the economy could enter a deep recession as business firms, government agencies and households all found themselves without the ability to borrow the funds they need to continue their regular operations. The adjustment would be incredibly painful and it would take many years to restore confidence in the financial markets, both those here and those abroad. Professor Cowen has said did not believe “the end of the world” was upon us but noted the possibility of ongoing financial problems.

In this article, Gerald O’Driscoll asks the question of whether the accumulating debt obligations of the Federal government are now reaching Smith’s threshold and the process of debt repudiation through inflation is about to begin. In the view of O’Driscoll and others, even if the Federal Reserve does not resort to the printing press to pay the Treasury’s growing obligations, , the Fed is now constrained in raising rates to fight inflation by the negative effect rate increases would have on the mortgage-backed securities in the portfolios of these government-sponsored agencies. This gives an inflationary bias to the Fed’s monetary policy at a time of rising inflationary pressures. One might add to this the fact that the economy appears to be faltering, and if it continues to slow mortgage delinquencies will rise, placing even greater pressure on Fannie and Freddie and other financial institutions. Given our dependence on foreign sources of financing for the Federal government's budget deficit, we are at a time of vulnerability to the uncertainties of world financial markets. Finally, we are at the start of a Presidential election season and any agreement between the Treasury and the Fed and the Administration and the Congress will be hampered by the uncertainties and confusions surrounding the election.

Even if “the end of the world” does not occur before Inauguration Day, the next President, whoever he is, will come to office at a time of a very bad economy with a bleak short-term outlook, a banking system weakened by housing price declines, foreclosures, and bankruptcies and requiring a large-scale bailout, and growing financial imbalances in Social Security, Medicare and Medicaid. Add to this the demands created by a slowing world economy and a deteriorating international political environment. Why, one might ask, would any sane person want to be President of the United States at this time?

Are we approaching “The End of the World”?

“Will the U.S. Treasury repudiate its obligations to its creditors, be they citizens or investors around the world? Most observers would answer "no" without hesitation. But Congress, with the complicity of the White House and the Fed, has arguably embarked on a stealth repudiation.

In his famous treatise, "The Wealth of Nations," Adam Smith noted there had never been a "single instance" of sovereign debts having been repaid once "accumulated to a certain degree." We may have reached Smith's threshold.

The bond markets are certainly not protecting creditors from the risk of what Smith called "pretended payment" through inflation. Nor did they do so until far into the great inflation of the 1970s. Not until late 1977 and into 1978 did the bond market fully incorporate the reality of the debased dollar, by demanding higher long-term interest rates.

How can this happen? Markets are supposed to be forward-looking and efficiently price in all relevant risks. Yet monarchs have been repudiating debt explicitly and implicitly throughout recorded history.

Many years ago, the Austrian economist Ludwig von Mises offered an explanation. He suggested that while you can't, in Abraham Lincoln's words "fool all of the people all of the time," you can fool all of the people at least some of the time. And this is easier to do if a central bank has in the past earned credibility in fighting inflation.

In the 1980s, Ronald Reagan and Paul Volcker worked together to get inflation under control. They were greatly assisted by the "bond vigilantes," traders who were by then exerting discipline in bond markets by bidding up interest rates to double-digit levels. The outcome of the Reagan/Volcker policy of tight money and low marginal tax rates was not only a great economic expansion, but also a great boost to the Fed's credibility. The Fed proved it was able and willing to withstand political heat in the fight against inflation.
…
The markets have long assessed the debt of [Fannie Mae and Freddie Mac] at AAA because of the Treasury's guarantee, now explicit. But no one has ever seriously assessed the Treasury's creditworthiness with Fannie and Freddie on its books. The public guarantee is entirely open-ended and unbounded. The appetite of the two companies to balloon their balance sheets and take on risk has not been curtailed. Meanwhile, Congress spends apace with new programs for constituents in an election year.

We are at a Smithian moment, in which the temptation for the Fed to spend its last dime of credibility may prove irresistible. Investors are already being taxed by inflation and can rationally expect that tax rate (the inflation rate) to be raised going forward. Wages are not keeping up. Main Street is being taxed to fund Wall Street excess. Anyone who works, saves and invests is exposed to confiscation of his capital and earnings through inflation.

If the Fed maintained its independence of action and said no to the inflationary finance of Congress's profligacy, we wouldn't have reached this point. But the Fed has forsaken that independence amid an absence of leadership.

Perhaps, as rarely happens, Adam Smith will be proven wrong. Let us hope so, because hope appears to be all we have.”

Gerald P. O’Driscoll, Jr., “Washington Is Quietly Repudiating Its Debts”, Wall Street Journal (22 August 2008).


Mr. O'Driscoll is a senior fellow at the Cato Institute and a former vice president and economic adviser at the Federal Reserve Bank of Dallas.

In a post on his blog, Marginal Revolution, at the end of July, found here, Tyler Cowen of George Mason University reviewed the cost of the mortgage agency bailouts undertaken by the Federal government in response to the financial crisis now affecting the U.S. economy. Among the points he made was that the bailouts themselves, should they prove to be necessary, represent a transfer payment to debt holders from taxpayers, not an actual economic cost to society since no resources are destroyed. However, in the event of a bailout, there would be a deadweight loss to the economy in terms of the actual cost to effect the transfer from taxpayer to debt holder. Moreover, the burden of the tax necessary to pay the bailout would probably be regressive, in the sense that those that would be taxed to pay for the transfer are less wealthy than the debt holders who would be reimbursed. He also pointed out that the equity holders would no doubt be wiped out and that the borrowing costs required to implement the bailout would depend on how quickly it was undertaken. In other words, even if a bailout does not entail the actual loss of real productive capacity, it still places a very big burden on the economy.

Professor Cowen also expressed the view that the government has no real choice but to bail out the debt holders of the mortgage agencies. The alternative would be financial chaos and a run on the dollar, which he termed “the end of the world”. By this is meant a financial collapse where the Treasury could not sell its bonds, the dollar would drop on world markets, credit would dry up to the private sector and interest rates would rise greatly, and the economy could enter a deep recession as business firms, government agencies and households all found themselves without the ability to borrow the funds they need to continue their regular operations. The adjustment would be incredibly painful and it would take many years to restore confidence in the financial markets, both those here and those abroad. Professor Cowen has said did not believe “the end of the world” was upon us but noted the possibility of ongoing financial problems.

In this article, Gerald O’Driscoll asks the question of whether the accumulating debt obligations of the Federal government are now reaching Smith’s threshold and the process of debt repudiation through inflation is about to begin. In the view of O’Driscoll and others, even if the Federal Reserve does not resort to the printing press to pay the Treasury’s growing obligations, , the Fed is now constrained in raising rates to fight inflation by the negative effect rate increases would have on the mortgage-backed securities in the portfolios of these government-sponsored agencies. This gives an inflationary bias to the Fed’s monetary policy at a time of rising inflationary pressures. One might add to this the fact that the economy appears to be faltering, and if it continues to slow mortgage delinquencies will rise, placing even greater pressure on Fannie and Freddie and other financial institutions. Given our dependence on foreign sources of financing for the Federal government's budget deficit, we are at a time of vulnerability to the uncertainties of world financial markets. Finally, we are at the start of a Presidential election season and any agreement between the Treasury and the Fed and the Administration and the Congress will be hampered by the uncertainties and confusions surrounding the election.

Even if “the end of the world” does not occur before Inauguration Day, the next President, whoever he is, will come to office at a time of a very bad economy with a bleak short-term outlook, a banking system weakened by housing price declines, foreclosures, and bankruptcies and requiring a large-scale bailout, and growing financial imbalances in Social Security, Medicare and Medicaid. Add to this the demands created by a slowing world economy and a deteriorating international political environment. Why, one might ask, would any sane person want to be President of the United States at this time?

Robert Barro on Bono and foreign aid

“Barro: There is a common element in all these areas [of debt relief and foreign aid]--they all look like money for nothing. And I don't think money for nothing is the way to get economic development. That's why even though I like [Irish rock star] Bono--I think he's very smart, a well-meaning person, and he's amazingly influential--I think his whole project of debt relief is so woefully misguided. This well-meaning assistance will not be the way to get poor African countries to do better.

Region: So you and [Columbia University economist] Jeff Sachs don't see eye-to-eye?

Barro: We had a wonderful lunch back in 1999 -- Sachs, Bono and I. It was clear that they invited me not to get information or advice. Instead, Bono wanted to learn the conservative, free-market objections to his approach so that he could come up with better counterarguments.

Then he could be more persuasive, as he turned out to be, even with Republican officials in Washington. I'm sure I had no impact on the policies that Bono ended up proposing. It's amazing what kind of influence he's had. He really did manage to convince many people in Washington to carry out substantial debt relief. It's a shame that we could not harness his talents for persuasion in more productive directions.”

"Interview with Robert Barro", The Region (September 2005).

http://woodrow.mpls.frb.fed.us/pubs/region/05-09/barro.cfm


Robert Barro teaches at Harvard University.

This wide-ranging interview covers many topics, including deficit spending, medicare, the equity premium puzzle, inflation targeting, monetary union in Europe, religion and economic growth, inequality and growth, and the IMF.

On the IMF, Barro is characteristically blunt: "I'm often asked by government policymakers what the IMF should do better or how it should be reformed, and I think there's no answer to that--other than going out of business."

Thanks to Larry Willmore for this Tdj.

Robert Barro on Bono and foreign aid

“Barro: There is a common element in all these areas [of debt relief and foreign aid]--they all look like money for nothing. And I don't think money for nothing is the way to get economic development. That's why even though I like [Irish rock star] Bono--I think he's very smart, a well-meaning person, and he's amazingly influential--I think his whole project of debt relief is so woefully misguided. This well-meaning assistance will not be the way to get poor African countries to do better.

Region: So you and [Columbia University economist] Jeff Sachs don't see eye-to-eye?

Barro: We had a wonderful lunch back in 1999 -- Sachs, Bono and I. It was clear that they invited me not to get information or advice. Instead, Bono wanted to learn the conservative, free-market objections to his approach so that he could come up with better counterarguments.

Then he could be more persuasive, as he turned out to be, even with Republican officials in Washington. I'm sure I had no impact on the policies that Bono ended up proposing. It's amazing what kind of influence he's had. He really did manage to convince many people in Washington to carry out substantial debt relief. It's a shame that we could not harness his talents for persuasion in more productive directions.”

"Interview with Robert Barro", The Region (September 2005).

http://woodrow.mpls.frb.fed.us/pubs/region/05-09/barro.cfm


Robert Barro teaches at Harvard University.

This wide-ranging interview covers many topics, including deficit spending, medicare, the equity premium puzzle, inflation targeting, monetary union in Europe, religion and economic growth, inequality and growth, and the IMF.

On the IMF, Barro is characteristically blunt: "I'm often asked by government policymakers what the IMF should do better or how it should be reformed, and I think there's no answer to that--other than going out of business."

Thanks to Larry Willmore for this Tdj.

Would Obama’s tax plan actually raise taxes on the poor and the middle-class?

“Senator Barack Obama declared recently that he wants to “reform our tax code so that it rewards work and not just wealth.” We think that is a great goal if it means a simple tax system with low marginal tax rates. Unfortunately, a close inspection of Obama’s proposals reveals something disquieting: he would raise marginal tax rates for many middle-income taxpayers …

Although Obama is offering a new series of tax breaks, they undermine rather than improve economic incentives.

First, whether or not you get those breaks will depend on your income. In Washington, taking away tax breaks as families work harder to make more money is called a “phase-out.” Economists have a different name for it—we call it a tax. …

Second, Obama would make some credits refundable for families with credits bigger than their tax liability, which would also have the nefarious effect of raising marginal tax rates. …

Although Obama is offering a new series of tax breaks, they undermine rather than improve economic incentives.

The solid line in the nearby chart illustrates the effective marginal tax rate under Obama’s tax proposals (based on the authoritative “Preliminary Analysis of the 2008 Presidential Candidates’ Tax Plans,” published by the Brookings Institution/Urban Institute’s Tax Policy Center). These are the marginal rates in 2009 for a two-earner couple with two children—a college freshman and a 12-year-old receiving after-school care—under some specific assumptions. For comparison, the dotted line on the chart illustrates the effective tax rates under current law. The rates shown in the chart are not spelled out in the tax code; they are the result of giving and taking away tax breaks as the household’s income changes.

As the chart shows, Obama’s give-and-take tax policy results in marginal tax rates of 34 percent to 39 percent in the $31,000 to $45,000 income range for this family. That’s an increase of 13 percentage points or more from the current rates.
…
While both candidates will reduce their tax plans to clever sound bites, voters should consider how those plans would affect incentives to earn income. Unfortunately, Senator Obama’s proposed “tax cuts for the middle class” are actually marginal rate hikes in disguise.”

Alex Brill and Alan D. Viard, “The Folly of Obama’s Tax Plan” , The American: A Magazine of Ideas (8 August 2008).

http://www.american.com/archive/2008/august-08-08/the-folly-of-obama2019s-tax-plan


Alex Brill is with the American Enterprise Institute. He was a former senior adviser and chief economist to the Committee on Ways and Means of the U.S. House of Representatives, and served on the staff of the President's Council of Economic Advisers. Mr. Viard is also with the American Enterprise Institute. Prior to joining AEI, Alan Viard was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also worked for the Treasury Department’s Office of Tax Analysis, the White House’s Council of Economic Advisers, and the Joint Committee on Taxation of the U.S. Congress.

The American tax code is so convoluted that I do not believe anyone really understands it or could defend it. Fiddling with it to make it “better” has become a hopeless exercise because any proposal to change it becomes a political exercise subject to all the irrationalities introduced by special interests. Nonetheless, Americans, especially Presidential candidates, insist on trying.

We can learn something about the complexity of the U.S. tax code from the efforts of the Presidential candidates to change the it in directions they regard as more equitable or more efficient. I am sure Barack Obama wants to shift taxes from lower income to higher income groups, and his full proposal, not discussed here, would likely do that. In the first instance, this simply means Obama wants the SHARE of tax revenues paid by lower income groups to be reduced and the SHARE paid by higher income groups to increase.

I will go further than this: I would guess he wants the AVERAGE tax burden of, perhaps even the ACTUAL AMOUNT of taxes paid by, lower income groups reduced, and his tax proposals will probably accomplish this, assuming the political process enacted it exactly as he proposed it. So far, so good.

What Brill and Viard focus on, however, are MARGINAL tax rates, the rate paid on any additional dollar earned. Now we enter an area where maintaining equity is difficult -- read impossible -- once one makes any exception to the strict application of dollar-for-dollar taxation. This is not what Obama wants to do. Rather, he wants to give “tax breaks” for this and that to low income groups. When you give tax breaks -- especially tax breaks intended to lower the actual amount of taxes paid -- you introduce tremendous marginal tax rate distortions when the tax breaks are phased out. In other words, when the tax break ends, any addition income earned is taxed at a very high rate, at least for a time.

This is important because economic theory suggests that most decision-making is made on the margin, not on the average. We do not decide whether to work harder on the basis of the average tax rate we pay but the marginal rate. We compare the addition effort we must make against the additional income we might receive. Similarly, we decide whether to save and invest on the basis of the additional spare income we have available for this purpose, not on our average income, and we compare against the income we are likely to receive were we to put funds to use, not against the income we have received from our previous investments.

According to Brill and Viard’s analysis Obama’s tax proposals are full of special tax breaks, and therefore full of marginal tax distortions. The marginal tax rates shown in the chart above for lower income groups are very high. If you add state income taxes and the Social Security contributions the full marginal tax rate under Obama’s proposal is probably well above 50 per cent of their income. It is fair to say that Obama’s proposal represents a large tax increase on poor Americans, at least in terms of the loss of any additional income they might earn from working.

Before we call Obama’s tax proposals equitable and helpful to the poor and lower income groups, it would be wise to remember E. R. A. Seligman’s words on the economics of taxation:

“The problem of the incidence of taxation is one of the most neglected, as it is one of the most complicated, subjects in economic science. It has indeed been treated by many writers; but frequently been marked by what Parieu calls the ‘simplicity of ignorance.’ Yet no topic in public finance is more important; for, in every system of taxation, the cardinal point is its influence on the community. Without a correct analysis of the incidence of a tax, no proper opinion can be formed as to its actual effect or justice.”

Let me suggest that lacking “a correct analysis of the incidence of” Obama’s proposal, “no proper opinion can be formed as to its actual effect or justice”. The same would be true of McCain’s.

Thanks to Greg Mankiw for the pointer.

Would Obama’s tax plan actually raise taxes on the poor and the middle-class?

“Senator Barack Obama declared recently that he wants to “reform our tax code so that it rewards work and not just wealth.” We think that is a great goal if it means a simple tax system with low marginal tax rates. Unfortunately, a close inspection of Obama’s proposals reveals something disquieting: he would raise marginal tax rates for many middle-income taxpayers …

Although Obama is offering a new series of tax breaks, they undermine rather than improve economic incentives.

First, whether or not you get those breaks will depend on your income. In Washington, taking away tax breaks as families work harder to make more money is called a “phase-out.” Economists have a different name for it—we call it a tax. …

Second, Obama would make some credits refundable for families with credits bigger than their tax liability, which would also have the nefarious effect of raising marginal tax rates. …

Although Obama is offering a new series of tax breaks, they undermine rather than improve economic incentives.

The solid line in the nearby chart illustrates the effective marginal tax rate under Obama’s tax proposals (based on the authoritative “Preliminary Analysis of the 2008 Presidential Candidates’ Tax Plans,” published by the Brookings Institution/Urban Institute’s Tax Policy Center). These are the marginal rates in 2009 for a two-earner couple with two children—a college freshman and a 12-year-old receiving after-school care—under some specific assumptions. For comparison, the dotted line on the chart illustrates the effective tax rates under current law. The rates shown in the chart are not spelled out in the tax code; they are the result of giving and taking away tax breaks as the household’s income changes.

As the chart shows, Obama’s give-and-take tax policy results in marginal tax rates of 34 percent to 39 percent in the $31,000 to $45,000 income range for this family. That’s an increase of 13 percentage points or more from the current rates.
…
While both candidates will reduce their tax plans to clever sound bites, voters should consider how those plans would affect incentives to earn income. Unfortunately, Senator Obama’s proposed “tax cuts for the middle class” are actually marginal rate hikes in disguise.”

Alex Brill and Alan D. Viard, “The Folly of Obama’s Tax Plan” , The American: A Magazine of Ideas (8 August 2008).

http://www.american.com/archive/2008/august-08-08/the-folly-of-obama2019s-tax-plan


Alex Brill is with the American Enterprise Institute. He was a former senior adviser and chief economist to the Committee on Ways and Means of the U.S. House of Representatives, and served on the staff of the President's Council of Economic Advisers. Mr. Viard is also with the American Enterprise Institute. Prior to joining AEI, Alan Viard was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. He has also worked for the Treasury Department’s Office of Tax Analysis, the White House’s Council of Economic Advisers, and the Joint Committee on Taxation of the U.S. Congress.

The American tax code is so convoluted that I do not believe anyone really understands it or could defend it. Fiddling with it to make it “better” has become a hopeless exercise because any proposal to change it becomes a political exercise subject to all the irrationalities introduced by special interests. Nonetheless, Americans, especially Presidential candidates, insist on trying.

We can learn something about the complexity of the U.S. tax code from the efforts of the Presidential candidates to change the it in directions they regard as more equitable or more efficient. I am sure Barack Obama wants to shift taxes from lower income to higher income groups, and his full proposal, not discussed here, would likely do that. In the first instance, this simply means Obama wants the SHARE of tax revenues paid by lower income groups to be reduced and the SHARE paid by higher income groups to increase.

I will go further than this: I would guess he wants the AVERAGE tax burden of, perhaps even the ACTUAL AMOUNT of taxes paid by, lower income groups reduced, and his tax proposals will probably accomplish this, assuming the political process enacted it exactly as he proposed it. So far, so good.

What Brill and Viard focus on, however, are MARGINAL tax rates, the rate paid on any additional dollar earned. Now we enter an area where maintaining equity is difficult -- read impossible -- once one makes any exception to the strict application of dollar-for-dollar taxation. This is not what Obama wants to do. Rather, he wants to give “tax breaks” for this and that to low income groups. When you give tax breaks -- especially tax breaks intended to lower the actual amount of taxes paid -- you introduce tremendous marginal tax rate distortions when the tax breaks are phased out. In other words, when the tax break ends, any addition income earned is taxed at a very high rate, at least for a time.

This is important because economic theory suggests that most decision-making is made on the margin, not on the average. We do not decide whether to work harder on the basis of the average tax rate we pay but the marginal rate. We compare the addition effort we must make against the additional income we might receive. Similarly, we decide whether to save and invest on the basis of the additional spare income we have available for this purpose, not on our average income, and we compare against the income we are likely to receive were we to put funds to use, not against the income we have received from our previous investments.

According to Brill and Viard’s analysis Obama’s tax proposals are full of special tax breaks, and therefore full of marginal tax distortions. The marginal tax rates shown in the chart above for lower income groups are very high. If you add state income taxes and the Social Security contributions the full marginal tax rate under Obama’s proposal is probably well above 50 per cent of their income. It is fair to say that Obama’s proposal represents a large tax increase on poor Americans, at least in terms of the loss of any additional income they might earn from working.

Before we call Obama’s tax proposals equitable and helpful to the poor and lower income groups, it would be wise to remember E. R. A. Seligman’s words on the economics of taxation:

“The problem of the incidence of taxation is one of the most neglected, as it is one of the most complicated, subjects in economic science. It has indeed been treated by many writers; but frequently been marked by what Parieu calls the ‘simplicity of ignorance.’ Yet no topic in public finance is more important; for, in every system of taxation, the cardinal point is its influence on the community. Without a correct analysis of the incidence of a tax, no proper opinion can be formed as to its actual effect or justice.”

Let me suggest that lacking “a correct analysis of the incidence of” Obama’s proposal, “no proper opinion can be formed as to its actual effect or justice”. The same would be true of McCain’s.

Thanks to Greg Mankiw for the pointer.

Private schooling in India

“Recent research documents the flight of the poor from state schools to `budget' private schools. On the one hand, governments are incapable of improving state schools, largely due to the power of teacher unions, and on the other hand, their regulatory systems are stifling private initiatives, condemning most private schools to illegal/informal status where they are unable to access formal capital to expand. The continuing decline of the quality of the state education system has led, by default, to one of the highest levels of privatization of education in the developing world. The proportion of students in private schools in urban areas of many states in India is higher than that in any developed country. ....

Interestingly Kerala (India), where the Left parties have strong presence, provides an interesting perspective on the role of private entrepreneurs in education. Kerala has the highest proportion of private primary schools (60% in rural areas) in the country. Many of these are aided by the government, which allows citizens to choose equally between private and state schools. The government provides the highest number of scholarships and transport subsidies that enlarge school choice. Moreover the competition for the soul has compelled the Christians, Hindus, and Muslims to run schools. So it is not so much the Left politics, but the private management and competition that has given Kerala the highest literacy rate in India literacy rate in India.”

Parth J Shah and Vipin P Veetil, "Entrepreneurial
Approaches to Education for the Poor", Centre for Civil
Society (15 December 2006), pp. 2, 17.

http://ssrn.com/abstract=957097


Parth J. Shah is president of the Centre for Civil Society,
an independent, nonprofit, research and educational organization
think tank in New Delhi, India. Vipin P Veetil is also associated
with the Centre for Civil Society.

Kerala is a state in the Indian Union located in the Southwestern part of the country on the Indian Ocean. The region has been economically progressive and heavily engaged in trade since the time of the Greeks and the Romans. Some of the early communities in the region were Christian, and it is believed that St. Thomas the Apostle visited Kerala in the First Century, where he proselytized among Kerala's Jewish settlements. Today Kerala's principal religions are Hinduism (56%), Islam (25%), and Christianity (19%). The Indian state is a leader in educational performance in the country and has one of its most advanced educational systems. As noted above each of these religions has established schools to teach their children.

India in general and Kerala in particular point out that one of the most important reforms that would benefit children today in every country is the introduction of competition into the education industry. This can be done, among other ways, by vouchers, which in my opinion would markedly improve the state of education in the U.S., as it has done in India. Many years ago Milton Friedman argued for vouchers in the following words:

“I want [education] vouchers to be…available to everyone. They should contain few or no restrictions on how they can be used. We need a system in which the government says to every parent: “Here is a piece of paper you can use for the educational purposes of your child. It will cover the full cost per student at a government school. It is worth X dollars towards the cost of educational services that you purchase from parochial schools, private for-profit schools, private nonprofit schools, or other purveyors of educational services. You may add from your own funds to the voucher if you wish to and can afford to.”

Empowering parents would generate a competitive education market, which would lead to a burst of innovation and improvement, as competition has done in so many other areas. There’s nothing that would do so much to avoid the danger of a two-tiered society, of a class-based society. And there’s nothing that would do so much to ensure a skilled and educated work force.”

If other countries can support private schools of all persuasions and by doing so improve the quality of education available to all, why can’t we?

Private schooling in India

“Recent research documents the flight of the poor from state schools to `budget' private schools. On the one hand, governments are incapable of improving state schools, largely due to the power of teacher unions, and on the other hand, their regulatory systems are stifling private initiatives, condemning most private schools to illegal/informal status where they are unable to access formal capital to expand. The continuing decline of the quality of the state education system has led, by default, to one of the highest levels of privatization of education in the developing world. The proportion of students in private schools in urban areas of many states in India is higher than that in any developed country. ....

Interestingly Kerala (India), where the Left parties have strong presence, provides an interesting perspective on the role of private entrepreneurs in education. Kerala has the highest proportion of private primary schools (60% in rural areas) in the country. Many of these are aided by the government, which allows citizens to choose equally between private and state schools. The government provides the highest number of scholarships and transport subsidies that enlarge school choice. Moreover the competition for the soul has compelled the Christians, Hindus, and Muslims to run schools. So it is not so much the Left politics, but the private management and competition that has given Kerala the highest literacy rate in India literacy rate in India.”

Parth J Shah and Vipin P Veetil, "Entrepreneurial
Approaches to Education for the Poor", Centre for Civil
Society (15 December 2006), pp. 2, 17.

http://ssrn.com/abstract=957097


Parth J. Shah is president of the Centre for Civil Society,
an independent, nonprofit, research and educational organization
think tank in New Delhi, India. Vipin P Veetil is also associated
with the Centre for Civil Society.

Kerala is a state in the Indian Union located in the Southwestern part of the country on the Indian Ocean. The region has been economically progressive and heavily engaged in trade since the time of the Greeks and the Romans. Some of the early communities in the region were Christian, and it is believed that St. Thomas the Apostle visited Kerala in the First Century, where he proselytized among Kerala's Jewish settlements. Today Kerala's principal religions are Hinduism (56%), Islam (25%), and Christianity (19%). The Indian state is a leader in educational performance in the country and has one of its most advanced educational systems. As noted above each of these religions has established schools to teach their children.

India in general and Kerala in particular point out that one of the most important reforms that would benefit children today in every country is the introduction of competition into the education industry. This can be done, among other ways, by vouchers, which in my opinion would markedly improve the state of education in the U.S., as it has done in India. Many years ago Milton Friedman argued for vouchers in the following words:

“I want [education] vouchers to be…available to everyone. They should contain few or no restrictions on how they can be used. We need a system in which the government says to every parent: “Here is a piece of paper you can use for the educational purposes of your child. It will cover the full cost per student at a government school. It is worth X dollars towards the cost of educational services that you purchase from parochial schools, private for-profit schools, private nonprofit schools, or other purveyors of educational services. You may add from your own funds to the voucher if you wish to and can afford to.”

Empowering parents would generate a competitive education market, which would lead to a burst of innovation and improvement, as competition has done in so many other areas. There’s nothing that would do so much to avoid the danger of a two-tiered society, of a class-based society. And there’s nothing that would do so much to ensure a skilled and educated work force.”

If other countries can support private schools of all persuasions and by doing so improve the quality of education available to all, why can’t we?

Is the world economy growing too fast?

“The global economy is a runaway train that is slowing, but not quickly enough. That is what the extraordinary run-up in prices for oil, metals, and food is screaming at us.

The spectacular and historic global economic boom of the past six years is about to hit a wall. Unfortunately, no one, certainly not in Asia or the US, seems willing to bite the bullet and help engineer the necessary co-ordinated retreat to sustained sub-trend growth, which is necessary so that new commodity supplies and alternatives can catch up.

Instead, governments are clawing to stretch out unsustainable booms, further pushing up commodity prices, and raising the risk of a once-in-a-lifetime economic and financial mess. All this need not end horribly, but policy makers in most regions have to start pressing hard on the brakes, not the accelerator.

Don’t look to the US for leadership in a presidential election year. On the contrary, the US government has been handing out tax-rebate cheques so that Americans will shop until they drop .

Don’t look to emerging markets, either. Desperate to sustain their political and economic momentum, most have taken a wide variety of steps to prevent their economies from feeling the full brunt of the commodity price hikes. ....

I am puzzled that so many economic pundits seem to think that the solution is for all governments, rich and poor, to pass out even more cheques and subsidies so as to keep the boom going. Keynesian stimulus policies might help ease the pain a bit for individual countries acting in isolation. But if every country tries to stimulate consumption at the same time, it won’t work. A general rise in global demand will simply spill over into higher commodity prices...
...
No, this time, commodity resources are the primary constraint, rather than a secondary problem, as in the past. That is why commodity prices will just keep soaring until world growth slows down long enough for new supply and new conservation options to catch up with demand.

This runaway-train global economy has all the hallmarks of a giant crisis in the making — financial, political, and economic. Will policy makers find a way to achieve the necessary international co-ordination? Getting the diagnosis right is the place to start. The world as a whole needs tighter monetary and fiscal policy. It is time to put the brakes on this runaway train before it is too late.”

Kenneth Rogoff, “Time To Put the Brakes on This Runaway Train”, Posted on RealClearMarkets Blog (7 July 2008).

http://www.realclearmarkets.com/articles/2008/07/time_to_put_the_brakes_on_this.html


Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University. He was formerly Chief Economist at the International Monetary Fund.

Rogoff’s argument can be summarized as follows: Over the past five years, the world economy has grown so fast that it has outrun the world’s capacity to increase its production of key primary commodities and, as a result, prices for food, oil, and metals and minerals have all risen markedly on international markets. To reduce the demand-pull pressures on existing productive capacity generated by rapidly rising incomes across the globe, Rogoff says world growth will have to be slowed, and it will take at least several years of sub-trend growth to rebalance commodity demand and supply. If, to the contrary, as they are now, governments everywhere insist on trying to promote growth rather than adjustment, the consequences, in his view, will be accelerating inflation and a deep worldwide crash. While he recognizes there is no painless way out of the present situation and reversing policy will bring its own problems, Rogoff is of the view that the worldwide boom of the past few years must be brought to an end.

There is no question the world economy has enjoyed a robust expansion in recent years, with real world output increasing 3.8 per cent on average each year from 2003 to 2007. World growth was centered in the developing countries, where the annual pace of the expansion exceeded 5½ per cent in all main geographic regions; in Asia, it often exceeded an 8 per cent increase in one year. The volume of world trade – a major spur to the rapid increase in world production – rose during this period about 9 per cent a year. With the brisk rise in output has come a corresponding increase in incomes and spending in support of higher levels of living being created, especially in developing countries, where the demand for food and petroleum has soared in recent years. As Rogoff notes, new supply needs long lead times and it appears supply has not been able to keep up with the demand generated by a rapidly growing world economy. This tension shows up as global commodity price inflation.

Before one agrees that too rapid world growth is the root cause of the inflation the world has suffered the last few years it would be interesting to compare recent rates of world growth with longer-term trends in order to see exactly how unusual the recent spurt of growth was. As above, world growth averaged 3½ to 4 per cent a year for the past four or five years. This is somewhat above the long-term rate of growth of the world economy, which has average 3.4 per cent since 1950. This long-term average, of course, masks periods of rapid growth and periods of slow growth. World growth, for example, averaged 5 per cent annually from 1950 until the mid-1970s – a much faster pace than recent growth for a much longer period. Over the course of the past quarter century world growth has averaged over 3 per cent a year. It is true that growth during the global upturn that began early in this decade has been strong, but past booms have been even stronger, and for over a half century the world was able to raise output more of less in line to match the rise in incomes.

Having said that, all booms come to an end, and recent growth has been above trend. And global booms sometimes come to an end because, among other reasons, the pressures caused by the upswing in world demand overwhelms existing supply capacity, and the current additions to capacity are too small and come too late to meet the growing demand. In recent years, there is no doubt that the U.S. and other countries have dithered when it comes to increasing the supply of oil and other primary commodities, dreaming that high prices will dull the demand for commodities and encourage a rapid shift to alternatives. Consequently, high prices have cut our incomes and employment and economic growth and they will continue to do so until we increase actual supply so that it meets actual demand. One could also add that the world as a whole and this country in particular has followed expansionary fiscal and monetary policies promoting aggregate demand at the same time they have discouraged increases in aggregate supply. One should not be surprised the result may well be stagflation.

Slowing down world growth, as Rogoff advocates, no doubt would help rebalance demand and supply, but at the price of reducing the incomes in the poorest countries where demand for food and oil is increasing the fastest and need the most. Better to focus on increasing supply, which in the end we must do if we are to maintain our standard of living and raise that of the world’s poor.