The Drug Legalization Debate

Ronald Shereni Drugs, Policy, Principles of Economics 0 Comment

Two recent Economist articles, “Illegal Drugs: The Great Experiment” and “Winding Down the War on Drugs: Towards a Ceasefire” report on drug legalization programs in Colorado and Washington State in fall 2012. Economists have been on the forefront of this issue for a long time, and it is a great teaching topic that raises nice questions about the ethical interface with economics and the limitations of controlling drugs by law.

The reality is that the prohibition of drugs has done little to reduce drug production and consumption. Drug use of some illegal drugs has increased by as much as 300 percent over the past 15 years.  The effect of drug laws that prohibit drugs such as cocaine has led to an underground system in which drug sellers earn huge sums of untaxed income and create drug-running crime organizations to protect their monopoly. It has also led to millions of people, who could be productive members of our society, in jail.  The law creates criminals.

The solution to the drug problem that economists have put forward (and I think should continue to push) is legalization coupled with hefty taxes, and a strong educational program warning people about the dangers of drugs, along the lines used in the fight against smoking.  The current taxes accompanying the new legalization laws that these two states are enacting seem far too low.  Since drugs are at least as hazardous as cigarettes, they should be taxed at least as high as the taxes on cigarettes—a 500 percent tax—with some of that revenue used to significantly reduce illegal sales. That tax revenue will provide the funds for the educational programs against drugs and rigorous enforcement of tax evaders, thereby setting up a legitimate supply chain. (For a longer discussion download my more extensive analysis from an earlier edition of my principles text here: Legalizing Drugs Colander.)

First Published : February 25, 2013

Public vs Economists’ Opinions

Ronald Shereni Policy, Principles of Economics, Teaching 0 Comment

We all know that economists and the public differ in their views, but a recent study by Northwestern economist Paola Sapienza and Chicago economist Luigi Zongales (Economic Experts vs. Average Americans) quantifies those distinctions, providing a good entry into policy discussions.  It concludes that a panel of top economists and public opinions differ about 37 percent of the time. They provide a table with additional comments, which can make a great resource. I plan to incorporate it into class by asking students to characterize the differences, and to see if (1) they agree with the public or the economists, and (2) if they can explain the reasons why.  There is a summary article in the Economist Magazine, www.economist.com/blogs/freeexchange/2013/01/economists, but I would suggest exploring the Chicago website (http://www.igmchicago.org/igm-economic-experts-panel) for the original material.  For those using my Principles text book (which is now out in the 9th edition) It would be useful to use at the beginning of a Principles of Economics class or as a reference to Chapter 23,  “Microeconomic Policy, Economic Reasoning, and Beyond.”

First Published : January 17, 2013

China Falling: Is Sino euphoria Over?

Ronald Shereni China, Globalization, Trade 0 Comment

Every two years for the past decade, Richard Hornik, a retired Senior Editor at Time, Tom Hout, a business consultant who specializes in China, and I hold a “China symposium” at Middlebury College where we discuss the future of the Chinese compared to the U.S. economy. We couldn’t hold it this year because they were both teaching in China, but the publication of Jim Fallow’s article, Mr China Comes to America in the December 2012 issue of The Atlantic prompted us to hold an on-line discussion that was, I believe, useful and insightful. The on-line conversation started when Richard asked whether James Fallows’ new book, China Airborne (the gist of which is summarized in The Atlantic article) will be seen as having called the top of Sino euphoria phase just as his Looking at the Sun did for Japan euphoria back in 1993.

I responded with a quick “No way.” I wrote that, in my view, it would be at least another decade before there would be an appreciable movement of manufacturing production back to the United States other than production tied to low cost energy. The reason was the law of one price, which is economic theory’s equivalent to the law of gravity. For most business calculations, net costs of production are still significantly lower in China than in the US for a wide range, and expanding, group of goods. As long as that is the case, the law of one price will pull global production toward China. This process will continue and likely even accelerate as China moves up the value-added ladder. Low technology production will move out of China—not to the US but to other countries in Asia and Africa, and medium technology production will increasingly move to China. This process will be the same as happened with Japan—in that Fallows is correct– but because of China’s size, the time of adjustment will be a lot longer, and a lot more disruptive to the US production.

Tom agreed with me and added some specifics. He noted that while China was still not in the game in complex engineered systems, such as long haul jet aircraft, nuclear power recycling, good automobiles, or original technology creation, it was in the game in a variety of other areas. He argued that “the best of the Chinese private companies were making great progress in expanding production in higher technology areas, after 20-30 years of organization building.” He noted that China’s merchandise exports are still growing fast (8% in 2012), and that the rates of export growth were significantly higher in high value-added categories such as machinery and telecom equipment.

So how then do we explain the movement back of manufacturing that Fallows notes? Some is for PR and political reasons—some is for diversification, and some is because of the low cost energy that the US is now experiencing. But most of this U.S. manufacturing growth is not in production that competes head to head with Chinese and other developing country’s production; it is in those areas that compete with other developed countries where due to the natural gas boom in the US and the current relatively low value of the dollar, the US has cost advantages.

The bottom line: non-energy intensive US manufacturing will be under pressure from Chinese competition for at least the next decade, and if China can hold its political system together, for longer. Even if it can hold it together, China will not take over the world economy. Globalization will spread out production throughout the world as the globalization tides equalize. The US is still facing an ebb tide which will likely continue for another decade. If the business press is telling you anything else, it is misleading you.

First Published : December 9, 2012

Economists Aren’t Cool, and Shouldn’t Try To Be

Ronald Shereni Teaching 0 Comment

What is in the water at Harvard? It seems that Harvard economics is at it again even after their disastrous 2006 attempt at a recruiting video remains a standing joke within the profession. (It has since been removed from the web, but you can see spoofs of it on YouTube and read about it in “Remedial Recruiting–At Harvard” in Inside Higher-Ed) A group of Harvard professors seems out to outdo Harvard’s previous attempt. Their new attempt (sent to me by another economist) was reported by Business Insider and can be found at CRINGE: Greg Mankiw and the Harvard Economics Department Do “Call Me Maybe.”   If the video is still up when you read this, it is worth a look. (It even includes John Campbell who, after his role in the last video, promised to run from the camera like Borat should any camera come close again.)

Harvard doesn’t ask me for a lot of advice, but I will offer some anyway—stick with economics; forget the videos. Let’s face it, even at their coolest, economists aren’t cool, nor should they try to be. Just the theory, facts, and empirical evidence, please.

So, why do economists rank so low on the coolness factor? One reason is that the job selection process weeds out coolness. In a time-honored tradition, job candidates for teaching jobs are asked boring questions about their dissertations and are judged on a boredom scale.  For research economists and those who will primarily teach graduate students, such interviews make sense—researchers and grad teachers are supposed to be boring. Asking only such questions doesn’t make sense, however, for the largest segment of the market–undergraduate teachers. So in the next January’s program (the job market will be at the ASSA meetings in San Diego in early January), I took out an ad, suggesting that those interviewing ask some additional questions that show what the candidate knows about the economy and about issues relevant to their teaching. Here’s the ad:

Bored to death at yet another interview?

Are you hiring people who are going to teach Principles of Economics? Instead of just asking “Tell us about your dissertation,” ask questions that relate to teaching. Questions like . . .

  • How would you explain to a class why current economic policy isn’t pulling the economy out of the doldrums?
  • How would you integrate Card and Krueger’s findings into a principle’s level discussion of the minimum wage debate?
  • How is QE3 different from operation twist?
  • What did Keynes mean when he wrote to Hayek, “morally and philosophically I find myself in agreement with virtually the whole of [The Road to Serfdom] and not only in agreement with it, but in deeply moved agreement.”
  • What is likely to happen with the euro, and what policies would you suggest to deal with the European financial problems?
  • Do you favor using a Marshallian or a Walrasian approach to teaching micro?
  • How would you explain to students Michael Sandel’s views on the limits of markets as explained in What Money Can’t Buy?
  • How would you integrate Thaler and Sunstein’s concept of nudges into the micro principles course?
  • How does Adam Smith’s Theory of Moral Sentiments change the interpretation of the Wealth of Nations?
  • If the money supply has expanded so much recently, why hasn’t there been any inflation?
  • How should Coase’s Theorem be integrated into the standard policy model?
  • Should we teach the multiplier model, the AS/AD model, or both?
  • Can markets fail if there are no externalities?
  • What is your view of Reinhart and Rogoff’s argument of the limits of government debt?

Being a good economics teacher involves much more than just being a good researcher or knowing the models. A good teacher questions what he or she is learning, reads outside the classroom, and relates the abstract models she or he learns to the real world. Too often the initial interview doesn’t select for these qualities in a candidate. It should. Make the interview more interesting—along with the standard questions, ask a few “outside the box” questions.

I admit, these are not “cool” questions, but at least they are relevant to teaching, and economists who can answer such questions are likely to be good teachers. What students want from their teachers is someone who both knows the material in the textbook backward and forwards, and can relate it to current events. They care less whether their teachers are cool or can lip sinc “Call Me Maybe.”

First Published : December 8, 2012

 

Why the U.S. Unemployment Rate Is So Hard to Reduce?

Ronald Shereni Current Events, Economic Education, Policy 0 Comment

Macro policy has focused on driving the unemployment rate back down to a desired rate, about 5 percent. That policy is, in large part, misplaced. The reason can be explained with some textbook microeconomics. In the microeconomics texts we drill into students that excess supply is meaningful only in relation to price. For example, there could be excess supply at a price of $10 and excess demand at a price of $8.00. In macro we seem to forget this central notion when we talk about the unemployment rate. Unemployment is excess supply so to talk about unemployment, you have to have some achievable equilibrium wage in mind. But that wage is not part of the discussion in macro policy discussions, where we discuss unemployment as if it were independent of the wage rate. If people are holding out for a job at $30 an hour, they may not be able to find one, but they might easily get a job at $9 an hour. Are they unemployed, or are they choosing not to work? You can’t answer that without specifying the equilibrium wage for a person with that skill set.

Historically, the macroeconomic concept of the unemployment rate was developed in reference to a non-globalized world in which the wage/price relationship was assumed to be relatively constant. In such a world, it is possible to define domestic unemployment independently of the wage rate since the wage was a constant reference point. The only relative wage that mattered in a non-globalized world was the wage relative to price, and that was assumed to be constant. In a globalized world, that is not the case. When a company can locate production globally, wages, unemployment, and hence the unemployment rate has to be defined in relationship to wages in other countries. The global relative wage will largely determine the sustainably achievable unemployment rate. If non-wage productivity advantages are not enough to offset wage differentials, then a person’s reservation wage can be too high for the market conditions.

Unfortunately, for many of the unemployed in the United States that is precisely the case. Their wage is above the globally competitive wage for their skill set. Such unemployment is not solvable with increases in domestic demand, and we should stop pretending that it is. There may be global demand for their work at a lower wage, but not at their current reservation wage. Increased demand will simply create jobs abroad, and worsen the U.S. trade deficit. It won’t lower the U.S. unemployment rate.

What will solve the problem? Lower wages, higher skills, a fall in the exchange rate, or in increase in general advantages in U.S. productivity. None is likely to change soon, so it is time for policy makers to accept this reality and stop trying to achieve the unachievable.

First Published : December 4, 2012

Which Fiscal Cliff Do We Want to Jump Off?

Ronald Shereni Current Events, taxes 0 Comment

Policymakers are currently focused what has come to be known as the fiscal cliff. This fiscal cliff was created by the Budget Control Act of 2011 that triggers spending cuts and tax increases in January 2013 that is likely to set the economy into a tailspin. The problem is that the cliff was there long before the Budget Control Act; all the act did was to say, “If you don’t at least start edging your way down the cliff by December 2012, you’ve going to have to do so beginning in 2013.  That part of the story—that the cliff cannot be avoided—has been lost in the fiscal cliff metaphor.

Political posturing, negotiations, recommendations and commentary make it sound as if Congress can avoid the fiscal cliff just by agreeing on some relatively minor spending cuts and tax increases that will replace the relatively small  tax increases and spending cuts that have become known as the fiscal cliff.  That’s not true. The cliff is unavoidable, and it is steeper than policy makers have been willing to admit.  And to get down it, and eventually we must if we are to get the economy back on a sound fiscal and monetary ground, we will have to increase taxes and cut spending much more than the political discussion to date would have you believe. The reason is not the cliffs we currently see. The problem is that there are additional hidden cliffs embedded in existing demography and government accounting practices.   So, the real issue is how and when to jump off the cliff, not whether we have to jump.

What policy makers and economists are not telling the public is that whenever and however we jump, there is going to be a lot of pain. If we jump quickly, the economy will fall into a deep recession, lots of people will be hurt.  If we jump slowly, the economy will remain mired in its current structural stagnation, with slow growth and high unemployment continuing for decades or more.  The most an agreement on the fiscal cliff can do is to spread out that pain, and perhaps cushion the fall somewhat.

What’s keeping us from a recession in the near term is unsustainable fiscal and monetary stimulus—the equivalent to an economic oxycodone—a narcotic to avoid pain. The problem with the narcotic of government stimulus is that, as is true with any “fix”, for the economy to gets off the stimulus fix, it will have to go through withdrawal. We can postpone it, but eventually, withdrawal won’t be a choice. The increasing government debt, and the coming due of government obligations that are aren’t even included in the current measures of the government debt, will force monetary and fiscal authorities to reverse course. As Stein’s Law tells us, “If something cannot go on forever, it will stop.”

The policy debate should not be about whether the United States can avoid the fiscal cliff.  It’s part of the landscape. The question they should be debating is, “How and when should we jump off?”  Do we want to go cold turkey—and take the deep recession that will accompany sudden monetary and fiscal withdrawal, in the hope of a faster recovery?  Or do we want to withdraw more slowly, extending the fall off the cliff for another decade.   Whichever we choose, the pain is going to be a lot greater than politicians on either side of the aisle are preparing people to endure.

First Published : November 30, 2012

 

Deduction Phaseouts and Marginal Tax Rates

Ronald Shereni Current Events 0 Comment

In the current negotiations to raise government revenues, politicians on both sides of the aisle seem to be pushing for phase-outs of deductions and credits rather than raising marginal tax rates. Somehow they seem to think that eliminating phase-outs will not raise marginal tax rates. That is not true. Phaseouts are simply a backdoor method of increasing marginal tax rates. The problem is that phaseouts increase marginal tax rates in a manner that most would consider unfair. Specifically, phaseouts raise the marginal tax rate on the middle class while keeping marginal tax rates lower for the very rich.

That’s not what people have in mind when they call for tax fairness. Most Americans would prefer a flat or progressive tax system. A phase-out of a deduction might sound progressive, but it is actually a regressive marginal tax system. Within the income range where the deductions are phased out the marginal tax rate rises, and at higher income levels when the phase-out is complete, it falls.

To see this, suppose that there is a flat 20 percent rate with various deductions capped at $50,000. If you earn $150,000 you owe $20,000 in taxes, (20% x $150,000-50,000). If you earn $250,000 you’d owe $40,000, (20% x $250,000-50,000). For both, an extra $1,000 of income means $200 more in taxes-the 20% marginal tax rate. Now suppose that the $50,000 deduction is phased out at a rate of 5% per $1,000 beginning with those earning more than $150,000 (that is, the deduction falls by $50 for every thousand dollars earned over $150,000). With this phase-out rate, the deductions will be totally phased out at an income of $250,000. Now consider the marginal tax rate of someone earning between $150,000 and $250,000 compared to the marginal tax rate of someone earning more than $250,000. He or she will be paying the equivalent of a marginal tax rate of 25%–when he earns another $1000 he pays 20%  ($200) in marginal tax, and 5% ($50) in what might be called phase-out marginal tax. Any person earning more than $250,000 only pays a 20% marginal tax rate. So in that range the tax system becomes regressive. That’s not my, and what I think are most people’s, view of what society wants in its tax system.

What’s a better alternative?  To be honest about what you are doing. Increasing tax revenues through tax reform requires an increase in the marginal tax rate on someone. There is no way around it, so don’t pretend you’re not raising marginal tax rates when you are.   If a deduction makes sense, then keep the deduction, and institute higher overall marginal tax rates. If the deduction doesn’t make sense, then dump it totally; don’t phase it out under the pretence of not increasing marginal tax rates.  Because with phase-outs you are increasing marginal tax rates, but you are doing it in a regressive fashion:

First Published: November 30, 2012

 

Why Are Financial Panics Scary?

Ronald Shereni Current Events 0 Comment

Why so much fear about a credit crisis? And why so much effort to keep financial companies afloat? The financial sector got itself into this mess. Why not just let the Wall Street bigwigs go bankrupt? After all, the financial sector is not all that big; we worry far less about the automobile or computer sectors. The answer is simple: We worry about the financial sector not because of its size, but because all the other sectors rely on it to function. The failures of other big sectors would be painful, but, unlike a financial sector collapse, they would not bring all other sectors crashing down with them. That’s why one of the roles of a central bank is to be a lender of last resort. 

Think about what would happen if your credit dried up. Say even though you’re every bit as trustworthy as before, you suddenly find you can no longer borrow money, which means no credit cards. Some things might still work just fine: You could just use cash at the local grocery store. Some things would be harder: If you didn’t have credit, you’d have to pay all your bills in advance. And to do this by check you’d still need a well-functioning financial system. Some things would be downright impossible: Forget about buying anything on the Internet. Paying for college? No problem… as long as you’ve saved enough to pay up front and in full.

The situation is even worse for companies. While they might not use credit cards, they use lines of credit to buy the raw materials for production and to pay their workers. If that credit line disappears, many—perhaps most—companies would essentially be forced to close, leaving their workers out of a job. That’s why a severe financial crisis can bring the entire real economy to a halt.

So when credit freezes up, the real economy can quickly freeze up. It’s not slow like the effect of a contractionary demand shock. It is fast, like a heart attack. Think of credit as financial oil. If the economy were an automobile engine, the financial system would be the motor oil. While oil is a relatively minor part of a working engine, it is absolutely essential. Try driving your car without oil for 10 miles. I can tell you from experience, the engine seizes up and is ruined. It cannot be salvaged. The fear in October 2008 was that the entire credit system would stop. If that happened, what had started as a financial crisis on Wall Street would spread from Wall Street (the financial sector) to Main Street (the real sector), creating not a recession but a depression.

First Published: 08/11/2012