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.

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.

Are there two Adam Smiths?

“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Of this kind is pity or compassion, the emotion which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive sorrow from the sorrow of others, is a matter of fact too obvious to require any instances to prove it; for this sentiment, like all the other original passions of human nature, is by no means confined to the virtuous and humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it.”

Adam Smith, The Theory of Moral Sentiments (London: A. Millar, Sixth edition, 1790; first published, 1759) Part I. Of the Propriety of Action, Section I. Of the Sense of Propriety in paragraph I.I.1.

“Nobody ever saw one animal by its gestures and natural cries signify to another, this is mine, that yours; I am willing to give this for that. When an animal wants to obtain something either of a man or of another animal, it has no other means of persuasion but to gain the favour of those whose service it requires. A puppy fawns upon its dam, and a spaniel endeavours by a thousand attractions to engage the attention of its master who is at dinner, when it wants to be fed by him.

Man sometimes uses the same arts with his brethren, and when he has no other means of engaging them to act according to his inclinations, endeavours by every servile and fawning attention to obtain their good will.

He has not time, however, to do this upon every occasion. In civilized society he stands at all times in need of the cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons. In almost every other race of animals each individual, when it is grown up to maturity, is entirely independent, and in its natural state has occasion for the assistance of no other living creature. But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (London: Methuen and Co., Ltd., ed. Edwin Cannan, Fifth edition, 1904; first published, 1776), Book I, Chapter 2, “Of the Principle which gives Occasion to the Division of Labour”, paragraph I.2.2.

Adam Smith (1723 – 1790) was of course the great Scottish moral philosopher and some might say father of modern economics. He was one of the key figures of the intellectual movement known as the Scottish Enlightenment.

Smith wrote two great books, The Theory of Moral Sentiments (1959) and The Wealth of Nations (1776). For two centuries economists and others, beginning with some minor German scholars in the nineteenth century and coming down to the present day, have commented on what some call “the Adam Smith problem”, that is, what appears to be a puzzling conflict between the essential themes of these two books. The Adam Smith problem has been raised again by Bill Gates in his recent speech at Davos and, commenting on Gates’ remarks and the problem, by Clive Crook, Gavin Kennedy and others.

Moral Sentiments is a book about the history of ethics. In it, Smith reviews the ideas of moral philosophers from Greco-Roman times until his own, and focuses on mankind’s ability to form moral judgments in spite of his self-centeredness. In his review, he stresses the importance of the “sympathy” one man feels for another – of seeing oneself in the other person’s shoes – and how the sentiments of sympathy form a moral bond among members of a community rooted in three cardinal virtues – “Prudence, Justice, and Benevolence”. Prudence, to Smith, is the intelligent care of one’s own health, wealth, and happiness. It is the wise management of one’s private affairs, and he saw it as a moral virtue. By Justice, Smith means an individual’s attitude and behavior toward another human being, reflected in “a scrupulous refusal ever to hurt or injure anyone else, in the pursuit of one’s own interest or advantage”. Justice in his view was the virtue of treating others fairly. Benevolence was going beyond simple Justice into positive efforts to help another. To Smith’s mind, benevolence was a lesser virtue and, although desirable, was not central to what he called an “agreeable” society. In short, it is the “sympathy” of one man for another that forms the basis for a common morality and yields a moral climate and legal framework for a stable, just and prosperous society.

The Wealth of Nations is a book about the history of economic ideas and a critique of political economy. As such there is a striking change in tone and focus away from expressions of sentiments and piety and toward hard-headed realism and a discussion of the economics of production, exchange, and distribution, and the problems of increasing material output from a reluctant earth and harsh world of scarcity meeting never ending and never satisfied wants. Here the emphasis is on the need for efficient production that advances the economic welfare of society and all its members. Smith stresses that the “natural” propensities of man, working through their intelligence, experience and growing knowledge, impelled and directed by their “self-interest” yet controlled and limited by their “sympathy” for others, yields both economic advance and political freedom. It is the market – the invisible hand, to use Smith’s metaphor – that not only guides production and consumption to its highest level but harmonizes the self-interest of each individual with the general interest of society as a whole. In Smith’s mind, it can do so precisely because markets are predicated on the moral virtues of Prudence, Justice and Benevolence.

The debate we see today about “the Adam Smith problem” is not about two books written by a long dead author. It is about the moral basis of Capitalism. Is Capitalism a system, as its critics contend, devoid of a moral foundation which allows rapacious exploiters of the weak and the poor to amass wealth and power to oppress others? Or is it system, as its supporters say, which presumes each and every one of us has both an inner dynamic that impels us forward to accomplish great things and a moral compass that checks our selfish ambitions through the operation of the impersonal mechanism we call markets?

To Smith, ordinary profit-seeking commerce carried out in a manner consistent with the rules of Prudence, enforced by known and stated laws of Justice, and encouraged by acts of private and public Benevolence leads to the most agreeable society. Equally, while not objecting to either property or wealth, Smith objected to the idea that the pursuit of wealth as the primary purpose of life. He argued that a modest income is all a person really needs and that the accumulation of wealth as an end in itself left a human being a moral shell.

I would say the two books are not at all at odds with each other and that Smith understood very well the true nature the economic system he set out to describe. I would also say that his words about the ultimate purpose of life are even more true than his comments on philosophy or economics.

Are there two Adam Smiths?

“How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Of this kind is pity or compassion, the emotion which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive sorrow from the sorrow of others, is a matter of fact too obvious to require any instances to prove it; for this sentiment, like all the other original passions of human nature, is by no means confined to the virtuous and humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it.”

Adam Smith, The Theory of Moral Sentiments (London: A. Millar, Sixth edition, 1790; first published, 1759) Part I. Of the Propriety of Action, Section I. Of the Sense of Propriety in paragraph I.I.1.

“Nobody ever saw one animal by its gestures and natural cries signify to another, this is mine, that yours; I am willing to give this for that. When an animal wants to obtain something either of a man or of another animal, it has no other means of persuasion but to gain the favour of those whose service it requires. A puppy fawns upon its dam, and a spaniel endeavours by a thousand attractions to engage the attention of its master who is at dinner, when it wants to be fed by him.

Man sometimes uses the same arts with his brethren, and when he has no other means of engaging them to act according to his inclinations, endeavours by every servile and fawning attention to obtain their good will.

He has not time, however, to do this upon every occasion. In civilized society he stands at all times in need of the cooperation and assistance of great multitudes, while his whole life is scarce sufficient to gain the friendship of a few persons. In almost every other race of animals each individual, when it is grown up to maturity, is entirely independent, and in its natural state has occasion for the assistance of no other living creature. But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them. Whoever offers to another a bargain of any kind, proposes to do this. Give me that which I want, and you shall have this which you want, is the meaning of every such offer; and it is in this manner that we obtain from one another the far greater part of those good offices which we stand in need of. It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages.”

Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (London: Methuen and Co., Ltd., ed. Edwin Cannan, Fifth edition, 1904; first published, 1776), Book I, Chapter 2, “Of the Principle which gives Occasion to the Division of Labour”, paragraph I.2.2.

Adam Smith (1723 – 1790) was of course the great Scottish moral philosopher and some might say father of modern economics. He was one of the key figures of the intellectual movement known as the Scottish Enlightenment.

Smith wrote two great books, The Theory of Moral Sentiments (1959) and The Wealth of Nations (1776). For two centuries economists and others, beginning with some minor German scholars in the nineteenth century and coming down to the present day, have commented on what some call “the Adam Smith problem”, that is, what appears to be a puzzling conflict between the essential themes of these two books. The Adam Smith problem has been raised again by Bill Gates in his recent speech at Davos and, commenting on Gates’ remarks and the problem, by Clive Crook, Gavin Kennedy and others.

Moral Sentiments is a book about the history of ethics. In it, Smith reviews the ideas of moral philosophers from Greco-Roman times until his own, and focuses on mankind’s ability to form moral judgments in spite of his self-centeredness. In his review, he stresses the importance of the “sympathy” one man feels for another – of seeing oneself in the other person’s shoes – and how the sentiments of sympathy form a moral bond among members of a community rooted in three cardinal virtues – “Prudence, Justice, and Benevolence”. Prudence, to Smith, is the intelligent care of one’s own health, wealth, and happiness. It is the wise management of one’s private affairs, and he saw it as a moral virtue. By Justice, Smith means an individual’s attitude and behavior toward another human being, reflected in “a scrupulous refusal ever to hurt or injure anyone else, in the pursuit of one’s own interest or advantage”. Justice in his view was the virtue of treating others fairly. Benevolence was going beyond simple Justice into positive efforts to help another. To Smith’s mind, benevolence was a lesser virtue and, although desirable, was not central to what he called an “agreeable” society. In short, it is the “sympathy” of one man for another that forms the basis for a common morality and yields a moral climate and legal framework for a stable, just and prosperous society.

The Wealth of Nations is a book about the history of economic ideas and a critique of political economy. As such there is a striking change in tone and focus away from expressions of sentiments and piety and toward hard-headed realism and a discussion of the economics of production, exchange, and distribution, and the problems of increasing material output from a reluctant earth and harsh world of scarcity meeting never ending and never satisfied wants. Here the emphasis is on the need for efficient production that advances the economic welfare of society and all its members. Smith stresses that the “natural” propensities of man, working through their intelligence, experience and growing knowledge, impelled and directed by their “self-interest” yet controlled and limited by their “sympathy” for others, yields both economic advance and political freedom. It is the market – the invisible hand, to use Smith’s metaphor – that not only guides production and consumption to its highest level but harmonizes the self-interest of each individual with the general interest of society as a whole. In Smith’s mind, it can do so precisely because markets are predicated on the moral virtues of Prudence, Justice and Benevolence.

The debate we see today about “the Adam Smith problem” is not about two books written by a long dead author. It is about the moral basis of Capitalism. Is Capitalism a system, as its critics contend, devoid of a moral foundation which allows rapacious exploiters of the weak and the poor to amass wealth and power to oppress others? Or is it system, as its supporters say, which presumes each and every one of us has both an inner dynamic that impels us forward to accomplish great things and a moral compass that checks our selfish ambitions through the operation of the impersonal mechanism we call markets?

To Smith, ordinary profit-seeking commerce carried out in a manner consistent with the rules of Prudence, enforced by known and stated laws of Justice, and encouraged by acts of private and public Benevolence leads to the most agreeable society. Equally, while not objecting to either property or wealth, Smith objected to the idea that the pursuit of wealth as the primary purpose of life. He argued that a modest income is all a person really needs and that the accumulation of wealth as an end in itself left a human being a moral shell.

I would say the two books are not at all at odds with each other and that Smith understood very well the true nature the economic system he set out to describe. I would also say that his words about the ultimate purpose of life are even more true than his comments on philosophy or economics.