Tag: economics

A Cartoon Showing the Logic (or lack thereof) of Keynesian Economics

I’ve run across very few good cartoons about Keynesian economics. If my aging memory is correct, I’ve only posted two of them.

But at least they’re both very good. We have one involving Obama, sharks, and a lifeboat, and another one involving an overburdened jockey.

Now we have a third cartoon, by Australian freelancer Jon Kudelka, to add to the collection:

To provide a bit of additional background, the cartoon is channeling Bastiat’s broken-window insight that make-work projects don’t create prosperity, as explained in this short video narrated by Tom Palmer.

I make similar points in this post mocking Paul Krugman’s wish for an alien invasion and this post explaining why Obama’s green energy programs lead to net job destruction.

P.S. This Wizard of Id parody is the best cartoon about economics, but it teaches about labor markets rather than Keynesianism.

In Tallinn, Helping to Protect the People of Estonia from Krugmanomics

Last month, I exposed some major errors that Paul Krugman committed when he criticized Estonia for restraining the burden of government spending.

My analysis will be helpful since I am now in Estonia for a speech about economic reform, and I wrote a column that was published today by the nation’s main business newspaper.

But just in case you’re one of the few people in the world who isn’t fluent in the local language, the Mises Institute Estonia was kind enough to post an English version.

Here are some of the key points I made. I started by explaining one of Krugman’s main blunders.

Krugman’s biggest mistake is that he claimed that spending cuts caused the downturn, even though the recession began in 2008 when government spending was rapidly expanding. It wasn’t until 2009 that the burden of government spending was reduced, and that was when the economy began to grow again. In other words, Krugman’s Keynesian theory was completely wrong. The economy should have boomed in 2008 and suffered a recession beginning in 2009. Instead, the opposite has happened.

I then pointed out that Estonia’s long-run performance has been admirable.

…the nation’s long-run economic performance is quite exemplary. Economic output has doubled in just 15 years according to the International Monetary Fund. Over that entire period – including the recent downturn, it has enjoyed one of the fastest growth rates in Europe.

But I’m not a mindless cheerleader (though I might become one if any of the local women gave me the time of day), so I took the opportunity to identify areas where public policy needs improvement.

This doesn’t mean Estonia’s policy is perfect. Spending was reduced in 2009 and 2010, but now it is climbing again. This is unfortunate. Government spending consumes about 40 percent of GDP, which is a significant burden on the private sector.

Being a thoughtful guy, I then made suggestions for pro-growth changes.

Estonia should copy the Asian Tiger economies of Singapore and Hong Kong. These jurisdictions have maintained very high growth for decades in part because the burden of the public sector is only about 20 percent of GDP. …Estonia already has a flat tax, which is very important for competitiveness. The key goal should be to impose a spending cap, perhaps similar to Switzerland’s very successful “debt brake.” Under the Swiss system, government spending is not allowed to grow faster than population plus inflation. And since nominal GDP usually expands at a faster rate, this means that the relative burden of government spending shrinks over time. By slowly but surely reducing the amount of GDP diverted to fund government, this would enable policymakers to deal with the one area where Estonia’s tax system is very unfriendly. Social insurance taxes equal about one-fourth of the cost of hiring a worker, thus discouraging job creation and boosting the shadow economy.

And I elaborated on why reform of social insurance is not just a good idea, but should be viewed as an absolute necessity.

Reducing the heavy burden of social insurance taxes should be part of a big reform to modernize programs for healthcare and the elderly. A major long-term challenge for Estonia is that the population is expected to shrink. The World Bank and the United Nations both show that fertility rates are well below the “replacement rate,” meaning that there will be fewer workers in the future. That’s a very compelling reason why it is important to expand personal retirement accounts and allow the “pre-funding” of healthcare. It’s a simple matter of demographic reality.

In other words, Estonia doesn’t have a choice. If they don’t reform their entitlement programs, the burden of government spending will rise dramatically, which would mean a higher tax burden and/or substantial government debt.

We also need entitlement reform in the United States. Our demographics aren’t as bad as Estonia’s, but we all know - as I explained in my post about Cyprus - that bad things happen sooner or later if government spending grows faster than the economy’s productive sector.

Repealing Obamacare Won’t Solve the Health Care Mess (but It’s a Good Start)

Working in the same building as Michael Cannon, I’ve learned that government-created third-party payer is a big problem with America’s healthcare system. Simply stated, people won’t be smart consumers and providers won’t compete to keep costs low when the vast majority of expenses are paid for either by government programs or by insurance companies.

That’s why I want to see reforms to Medicare and Medicaid, not only to save money for taxpayers, but also because entitlement reform is one of the steps that is needed if we want market forces to bring down the cost of health care. And I want to see a flat tax, not only for the pro-growth impact of lower tax rates, but also because it gets rid of the Internal Revenue Code’s health care exclusion, thus ending the distortion that encourages over-insurance.

With all that in mind, I’m obviously a big fan of the new video, below, from the Center for Freedom and Prosperity. Narrated by Julie Borowski from FreedomWorks, the video explains that third-party payer has been a growing problem for decades and that it would have required fixing even if the Supreme Court hadn’t botched the Obamacare decision.

Now that we’re stuck with Obamacare, at least temporarily, it’s more important than ever to deal with this underlying problem.

P.S.: This new video expands upon the analysis provided in a previous CF&P video.

P.P.S.: Setting aside the debate over the morality of abortion, the abortion market is an interesting case study of how prices don’t rise when consumers pay out of pocket.

P.P.P.S.: Government-created third-party payer also is screwing up the market for higher education.

Another Month of Data Re-Confirms Obama’s Horrible Record on Jobs

Remember back in 2009, when President Obama and his team told us that we needed to spend $800 billion on a so-called stimulus package?

The crowd in Washington was quite confident that Keynesian spending was going to save the day, even though similar efforts had failed for Hoover and Roosevelt in the 1930s, for Japan in the 1990s, and for Bush in 2008.

Nonetheless, we were assured that the stimulus was needed to keep unemployment from rising above 8 percent.

Well, that claim has turned out to be hollow. Not that we needed additional evidence, but the new numbers from the Labor Department re-confirm that the White House prediction was wildly inaccurate. The 8.2 percent unemployment rate is 2.5 percentage points above the administration’s prediction.

Defenders of the Obama administration sometimes respond by saying that the downturn was more serious than anyone predicted. That’s a legitimate point, so I don’t put too much blame on the White House for the initial spike in joblessness.

But I do blame them for the fact that the labor market has remained weak for such a long time. The chart below, which I generated this morning using the Minneapolis Fed’s interactive website, shows employment data for all the post-World War II recessions. The current business cycle is the red line. As you can see, some recessions were deeper in the beginning and some were milder. But the one thing that is unambiguous is that we’ve never had a jobs recovery as anemic as the one we’re experiencing now.

Job creation has been extraordinarily weak. Indeed, the current 8.2 percent unemployment rate understates the bad news because it doesn’t capture all the people who have given up and dropped out of the labor force.

By the way, I don’t think the so-called stimulus is the main cause of today’s poor employment data. Rather, the vast majority of that money was simply wasted.

Today’s weak job market is affected by factors such as the threat of higher taxes in 2013 (when the 2001 and 2003 tax cuts are scheduled to expire), the costly impact of Obamacare, and the harsh regulatory environment. This cartoon shows, in an amusing fashion, the effect these policies have on entrepreneurs and investors.

Postscript: Click on this link if you want to compare Obamanomics and Reaganomics. The difference is astounding.

Post-postscript: The president will probably continue to blame “headwinds” for the dismal job numbers, so this cartoon is definitely worth sharing.

Post-post-postscript: Since I’m sharing cartoons, I can’t resist recycling this classic about Keynesian stimulus.

Elinor Ostrom, RIP

Elinor Ostrom, the first woman to receive the Nobel Prize in economics—though that is hardly the most significant aspect of her work—has died at 78. My old friend Mario Rizzo of New York University examined her scholarly accomplishment in 2009 when she won the Prize:

The work of Elinor Ostrom, the first woman to receive the Nobel Prize in economics, is not very well-known among economists. In fact, I would venture the guess than most economists had not heard of her before the prize was announced yesterday morning.

Two reasons for this are that her degree is in political science and she has written for publications outside of the mainstream economics journals. Additionally, her work, by and large, lacks the high degree of mathematical formalism now so characteristic of economics.

Yet the Nobel Prize Committee has done a great service to economics and the greater social-scientific community. When a well-known economist receives the prize little is gained apart from the recognition of a job well done and perhaps some wider public recognition. I do not think that great contributions are made in any discipline because of the incentive effects of an improbable prize. However, in this case the Nobel Committee has brought extraordinary work to the attention of an economics discipline that has become excessively specialized and, perhaps increasingly irrelevant to the real world, as Paul Krugman and others have recently suggested.

Professor Ostrom’s work is highly relevant to important issues in economic development, common-pool resources, the development of social norms, and the solution of various collective action problems. Her work is also methodologically diverse. She uses experimental methods, field research, and evolutionary game theory. She is not afraid to draw on various disciplines when appropriate: economics, political science, evolutionary psychology, cultural anthropology and so forth.

She is a very worthy intellectual descendant of Adam Smith who realized that the study of trade based on self-interest needed to be supplemented by a broader view of humankind – individuals capable of the so-called “moral sentiments” like honesty, benevolence, and loyalty, as well as the standard vices.

Much of Ostrom’s work centers on developing and applying a broader conception of rationality than economists usually employ. The standard conception of rationality is not the rationality of real human beings but the rationality of cognitively-unlimited lightning-fast calculators. This is a purely imaginary construct. On the other hand, Olstrom’s “thick rationality” is the result of trial and error, use of relatively simple heuristics, employment of rules, and the embodiment of cultural norms. To reject standard, improbable rationality is notto reject rationality. It is rather to develop more sophisticated, and yet more realistic, models of rationality.

“Thick rationality” is a bottom-up phenomenon. It recognizes the importance of local knowledge and diverse approaches in the management of resources. For example, many top-down irrigation projects in developing countries have failed because they have concentrated on the physical aspects of water delivery. Ostrom believes that the institutional aspects are more important. Irrigation systems built by farmers themselves are often more efficient. They deliver more water, are better repaired, and result in higher farm productivity than those built by international agencies. Often these agencies take no notice of local customs, knowledge and incentive structures; the knowledge of the bureaucrat is inferior to the knowledge of the individuals on the ground.

The central problem on which her employment of the notion of “thick rationality” can shed light is what she calls “social dilemmas.” These are circumstances in which interacting individuals can easily succumb to maximizing their short-term interests to the detriment of their long term interests. To return to our irrigation example, suppose farmers share the use of a creek for irrigation. They face a collective problem of organizing to clear out the fallen trees and brush from the previous winter. Each farmer would like to have the others do it. There are incentives to free-ride on the “public spiritedness” of others – however, everyone may think this way and nothing will get done. Ostrom finds that cooperation will often take place while the “thin” theory of rationality predicts that it will not. She finds that factors such as face-to-face contact (likely when there are small numbers), the equality of each farmer’s stake in the benefits of irrigation, and the ease of monitoring the farmer’s contribution to brush removal all make the likelihood of cooperation greater.

Elinor Ostrom has and continues to expand the power of a broader conception of rationality – one that Adam Smith would have recognized and been comfortable with – to explain the multifarious forms of human cooperation that conventional economists have been unable to explain. This is a major contribution.

Paul Dragos Aligica and Peter Boettke of George Mason University showed excellent prescience in publishing a book in the summer of 2009, just a few months before the Nobel Prize was awarded, on the work of Ostrom, her husband Vincent, and their colleagues at Indiana University, Challenging Institutional Analysis and Development: The Bloomington School.


New Study from UK Think Tank Shows How Big Government Undermines Prosperity

It seems I was put on the planet to educate people about the negative economic impact of excessive government. I must be doing a bad job, because the burden of the public sector keeps rising.

But hope springs eternal. To help make the case, I’ve cited research from international bureaucracies such as the Organization for Economic Cooperation and Development, International Monetary Fund, World Bank, and European Central Bank. Since most of those organizations lean to the left, these results should be particularly persuasive.

I’ve also cited the work of academic scholars from all over the world, including the United States, Australia, and Sweden. The evidence is very persuasive that big government is associated with weaker economic performance.

Now we have some new research from the United Kingdom. The Centre for Policy Studies has released a new study, authored by Ryan Bourne and Thomas Oechsle, examining the relationship between economic growth and the size of the public sector.

The chart above compares growth rates for nations with big governments and small governments over the past two decades. The difference is significant, but that’s just the tip of the iceberg. The most important findings of the report are the estimates showing how more spending and more taxes are associated with weaker performance.

Here are some key passages from the study.

Using tax to GDP and spending to GDP ratios as a proxy for size of government, regression analysis can be used to estimate the effect of government size on GDP growth in a set of countries defined as advanced by the IMF between 1965 and 2010. …As supply-side economists would expect, the coefficients on the tax revenue to GDP and government spending to GDP ratios are negative and statistically significant. This suggests that, ceteris paribus, a larger tax burden results in a slower annual growth of real GDP per capita. Though it is unlikely that this effect would be linear (we might expect the effect to be larger for countries with huge tax burdens), the regressions suggest that an increase in the tax revenue to GDP ratio by 10 percentage points will, if the other variables do not change, lead to a decrease in the rate of economic growth per capita by 1.2 percentage points. The result is very similar for government outlays to GDP, where an increase by 10 percentage points is associated with a fall in the economic growth rate of 1.1 percentage points. This is in line with other findings in the academic literature. …The two small government economies with the lowest marginal tax rates, Singapore and Hong Kong, were also those which experienced the fastest average real GDP growth.

The folks at CPS also put together a short video to describe the results. It’s very well done, though I’m not a big fan of the argument near then end that faster growth is a good thing because it generates more tax revenue to finance more government. Since I’m a big proponent of the Laffer Curve, I don’t disagree with the premise, but I would argue that additional revenues should be used to finance lower tax rates.

Since I’m nit-picking, I’ll also say that the study should have emphasized that government spending is bad for growth because it inevitably and necessarily leads to the inefficient allocation of resources, and that would be true even if revenues magically floated down from heaven and there was no need for punitive tax rates.

This is my message in this video on the Rahn Curve.

When the issue is government, size matters, and bigger is not better.

In the Lake Wobegon Fantasy World, All Investments Make Money

I sometimes wonder whether journalists have the slightest idea of how capitalism works.

In recent weeks, we’ve seen breathless reporting on the $2 billion loss at JP Morgan Chase, and now there’s a big kerfuffle about the falling value of Facebook stock.

In response to these supposed scandals, there are all sorts of articles being written (see here, here, here, and here, for just a few examples) about the need for more regulation to protect the economy.

Underlying these stories seems to be a Lake Wobegon view of financial markets. But instead of Garrison Keillor’s imaginary town where “all children are above average,” we have a fantasy economy where “all investments make money.”

I don’t want to burst anyone’s bubble or shatter any childhood illusions, but losses are an inherent part of the free market movement. As the saying goes, “capitalism without bankruptcy is like religion without hell.”

Moreover, losses (just like gains) play an important role in that they signal to investors and entrepreneurs that resources should be reallocated in ways that are more productive for the economy.

Legend tells us that King Canute commanded the tides not to advance and learned there are limits to the power of a king when his orders had no effect.

Sadly, modern journalists, regulators, and politicians lack the same wisdom and think that government somehow can prevent losses.

But perhaps that’s unfair. They probably understand that losses sometimes happen, but they want to provide bailouts so that nobody ever learns a lesson about what happens when you touch a hot stove.

Government-subsidized risk, though, is just as foolish as government-subsidized success.