Author: James Kwak

The Incredible, Magically Metamorphosing Taxpayer-Subsidized Executive Perk

By James Kwak

Once upon a time, the story goes, corporate America was fat and happy. Top executives worked in palatial office suites bedecked with flowers, flew everywhere in private jets, and ate every meal at the Four Seasons or Le Bernardin.

Then there was the shareholder value revolution. Michael Jensen and the rest of the Chicago School efficient-market legions showed that shareholder value was the only thing that mattered and stock prices were the only measure of shareholder value. Activist investors demanded an end to executive perks and ushered in the era of pay for performance, in which executives are paid in stock options, so they only make (a lot of) money if shareholders make money. Congress event went along by capping the tax-deductible amount of executives’ base pay, which helped along the shift to stock-based compensation.

Continue reading “The Incredible, Magically Metamorphosing Taxpayer-Subsidized Executive Perk” →

Public Service: Why Nations Fail Crib Notes

By James Kwak

I’m reviewing Why Nations Fail for a print publication, so I’m out of basic courtesy I’m not going to preempt my review here. But if you’re like me and not an expert in the history of every part of the world, sometime around page 250 you probably got confused about where Acemoglu and Robinson discussed the Kingdom of Aksum as opposed to early modern Ethiopia or the Kuba Kingdom as opposed to the Kingdom of Kongo. After a while I created my own crib sheet, which I reproduce here for those who may find it helpful.

1. So Close and Yet So Different: Spanish Conquest, Jamestown, Mexico (19th century)

2. Theories That Don’t Work

3. The Making of Prosperity and Poverty: Korea, Kingdom of Kongo

4. Small Differences and Critical Junctures: The Weight of History: Black Death (14th century), early modern Western Europe

5. “I’ve Seen the Future and It Works”: Growth Under Extractive Institutions: USSR, Kuba Kingdom, Neolithic Revolution, Mayas

6. Drifting Apart: Venice, ancient Rome, Kingdom of Aksum (Ethiopia)

7. The Turning Point: England (17th-18th centuries)

8. Not on Our Turf: Barriers to Development: Spain, Austria-Hungary and Russia, China, Ethiopia, Somalia

9. Reversing Development: Dutch East Indies, Central Africa

10. The Diffusion of Prosperity: Australia, French Revolution, Japan

11. The Virtuous Circle: Great Britain, United States (Progressive movement and 1930s), Argentina

12. The Vicious Circle: Sierra Leone, Guatemala, American South, Ethiopia

13. Why Nations Fail Today: Zimbabwe, Sierra Leone, Clombia, Argentina, North Korea, Uzbekistan, Egypt

14. Breaking the Mold: Botswana, American South, China

15. Understanding Prosperity and Poverty: China, Brazil

This Must Be a Joke

By James Kwak

From the Times article on President Obama’s signing of the JOBS Act (emphasis added):

While soliciting investment funds online has triggered fears of fraudulent schemes, the law’s backers said the greater availability of information through social media sites like Facebook would allow would-be investors to conduct their own background checks, making it difficult for such schemes to succeed.

“While it seems reasonable to worry about these issues, there is just so much more information these days,” said Timothy Rowe, the chief executive of the Cambridge Innovation Center, which provides office space for start-up firms next to the campus of the Massachusetts Institute of Technology.

The thing speaks for itself.

(True, the phrase “social media sites like Facebook” is paraphrase from the reporter, not a direct quotation, but I have no reason to believe it isn’t an accurate representation of what the act’s backers said.)

Someone Is Wrong In The Times*

By James Kwak

James Stewart has doubled down on his infatuation with Paul Ryan. Ryan’s budget, he says, is a viable centrist starting point for budget negotiations, and attacks from “left and right” are mere “partisan rhetoric.”

This is several different kinds of crazy. First, Stewart repeats his belief that Ryan’s plan would increase taxes on investment income. But that belief has no basis other than Stewart’s own belief that it would be a good idea. As I pointed out before, Ryan’s own budget argues against raising taxes on capital gains and dividends. The only thing Stewart can find is Ryan’s apple-pie platitudes about the need for tax reform. But Ryan’s own vision of tax reform, as evidenced by his budget’s own words, doesn’t include higher capital gains taxes. (In addition, as a signatory to the Taxpayer Protection Pledge, Ryan is sworn to “oppose any and all efforts to increase the marginal income tax rate for individuals and business.” That sounds to me like it includes the capital gains tax rate, which is a marginal income rate.) This is further evidence of columnists’ ability to project their own fantasies onto Paul Ryan’s handsome face.

Continue reading “Someone Is Wrong In The Times*” →

The Impossibility of Defense Cuts

By James Kwak

Apparently the thing we need to keep ourselves safe is a fast, lightweight ship that can sweep mines, launch helicopters, fight submarines, and perform other assorted duties—but can’t withstand heavy combat. I don’t claim to know if we really need the Littoral Combat Ship to ensure our national security. According to an article in the Times, John McCain—the Republican Party’s last presidential nominees and one of the Navy’s more famous veterans—is critical, although other Republicans and the administration are in favor of it.

I do know that the Littoral Combat Ship is a classic example of why it’s so hard to reduce budget deficits. You have local politicians who want the jobs. You have a large group of representatives who are reflexively pro-military and will vote for anything the Pentagon wants, and even things the Pentagon doesn’t want. (You have Mitt Romney, who bemoans the fact that the Navy has only 285 ships, the fewest since 1917. Would he rather have the Royal Navy of 1812, which had 1,000 ships, or our navy, with eleven aircraft carrier groups—while no other country has more than one?) You have a procurement and development process that stretches on for years so that even when a weapons system turns out to be a dud, it has to be kept alive because it’s too big to fail—there is no other alternative. Both the Center for American Progress and the Project on Governmental Oversight have recommended cutbacks in the Littoral program. Yet there is no practical way to check its momentum.

Continue reading “The Impossibility of Defense Cuts” →

Something for Nothing?

By James Kwak

The so-called JOBS act is a victory of faith over basic logic. The motivating idea seems to be that if we reduce the regulations that govern the process of raising capital, small companies will find it easier to raise money, and that money will translate into jobs. Many people have pointed out some of the problems with the bill: recently, for example, Andrew Ross Sorkin highlighted the potential for companies to take advantage of investors, and Steven Davidoff pointed out that regulation is probably not the reason for the decline in the number of small company IPOs.

There are a couple of more fundamental misunderstanding I want to focus on, however. First, it’s not clear that relaxing regulations will actually make it cheaper for companies to raise money. Sure, eliminating the independent audit requirement will save companies a few bucks. But what really affects the cost of capital is not out-of-pocket fees but the price that investors are willing to pay for equity. The less confidence that investors have in a company’s prospects, the cheaper that company will have to sell its stock. If small companies are allowed to provide less information to investors, that could simply make it more expensive for them to raise money.

Continue reading “Something for Nothing?” →

Magical Investment Thinking

By James Kwak

From a Times article on pension fund investing:

Mr. Dear cautioned that there were big differences in how various alternative investments performed during the financial crisis.

He said that Calpers’s investments in real estate had been “a disaster” and that its hedge fund investments had not met their benchmarks and were under review. But he said that its private equity holdings had easily beaten public stock returns over the last decade.

“Over the longer term, that kind of outperformance represents real skill, not luck, and it’s worth paying for,” he said.

Holy confirmation bias, Batman! When one asset class beats the stock market that’s skill. But when your other asset classes do badly—that’s random variation? If high returns on private equity are evidence that you should continue investing in private equity, then low returns in hedge funds and real estate are evidence that you should pull your money out of them.

Continue reading “Magical Investment Thinking” →

What’s Liberty Got To Do With It?

By James Kwak

Constitutional law is not my field. I think we spent one day on the Commerce Clause in my constitutional law class. I’ve barely been following the Supreme Court oral arguments this week because I figured (a) they would be silly, (b) we won’t know anything useful until June, and (c) with the rest of the commentariat focusing on it I would have nothing to add. But even at that distance, I can’t help but be shocked by the ludicrous nature of the proceedings, best represented by the framing of the case in terms of individual freedom and government coercion. According to the Times, the case may turn on Anthony Kennedy’s notion of liberty.

What’s wrong with this? Liberty should have nothing to do with this case. I’ll repeat the analysis, made my dozens of law professors more expert than I (Charles Fried, for example). The question is whether Congress has the power to impose the individual mandate under the Commerce Clause, which gives it the power to regulate interstate commerce. If the individual mandate does in fact regulate interstate commerce, then it’s fine unless it violates some other part of the Constitution.

Continue reading “What’s Liberty Got To Do With It?” →

Is the GOP Still the Party of Business?

By James Kwak

Jonathan Weisman of the Times wrote an article about the reluctance of many Republicans in Congress to extend policies that are traditionally favored by big business (and the Chamber of Commerce), such as infrastructure spending and funding for the Export-Import Bank. This points to a split between the traditional corporate wing of the GOP and the newer, ultra-conservative tax revolt wing.

My guess is that this will blow over and the Republicans will figure out a way to keep big business happy without upsetting the Tea Party too much. But it points out a potential shift among the people who fund the GOP.

Continue reading “Is the GOP Still the Party of Business?” →

Insurance or Redistribution?

By James Kwak

Mark Thoma makes an important point about the “individual mandate” that applies equally well to health care and to Social Security:

“I don’t see anything wrong with asking people to pay the expected value of their health care — a mandate to get insurance to cover the catastrophic things that society would cover in any case — to avoid this type of gaming of the system. Yes, it’s true that many healthy people will pay, remain healthy, and seem to get nothing. But that’s the wrong way to look at it. They have insurance whether they pay for it or not. Society will not let them die of a standard, treatable illness so insurance services are present. In fact, it’s the knowledge that society is providing these services that motivates many people to take a chance and go without.”

This is the relatively common argument that, since people already have guaranteed access to a basic level of emergency care, they should have to pay for it.

There’s a slightly different point in there that I emphasized above and that I want to focus on. Health insurance, like any kind of insurance, can be framed after the fact as redistribution. You pay health insurance premiums, you stay healthy, and therefore you “lose”—your money goes to pay for other people’s losses. But this is true of any kind of insurance. It’s equally true of homeowner’s insurance: if your house doesn’t burn down, you are the victim of redistribution from you to the people whose houses do burn down.

The other way to think of insurance is, well, as insurance. We want and value insurance in the current period, before we know if we’ll be “winners” or “losers” in the future period. The insurance itself has value to us. In fact, whenever you buy insurance, you are hoping that you will end up as a loser.

The framing of the health care individual mandate as a transfer from the healthy to the sick is the exact same as the framing of tax-funded social insurance programs as a transfer from the rich to the poor. At the time you enter the system, you probably don’t know which category you will fall into. You might have some knowledge of the probabilities, but you could turn out to be very wrong: there are plenty of people who are healthy in their twenties but get very sick later. In either case, the framing as redistribution and the focus on winners and losers is a way of making something that all people value—protection from risk, backed by the federal government’s balance sheet—seem like a from of zero-sum redistribution brokered by that evil, meddling federal government.

New “Debt for Beginners” Section

By James Kwak

I created a new “Debt for Beginners” page on the White House Burning website. It’s a collection of previous articles, mainly written for a general audience, on deficits, the national debt, government spending, taxes, and the politics thereof. It’s intended as a starting point for people who want to get up to speed on these issues.

Loyal readers are probably familiar with all the material already.

Why White House Burning Is Wrong, Liberal Edition

By James Kwak

Dean Baker, a leading economic commentator and author of the Beat the Press blog, has written a review of White House Burning for the Huffington Post. Baker manages the admirable feat of being gracious and complimentary while delivering several serious criticisms of the book.

I’ll skip over the nice things he said and get to Baker’s main objections, of which I think there are three. The first is that long-term fiscal sustainability is the wrong problem to be focused on:

 “While the solutions do not especially upset me, I do very much disagree with the diagnosis of the problem. The most immediate issue is that we have a fire at the moment in the form of too little demand leading to too much unemployment. This is wrecking the lives of millions of workers and their families.

“Johnson and Kwak understand this and certainly do not argue for deficit reduction in the short-term, but their focus on a longer-term deficit problem can be distracting from the more urgent problem.”

Continue reading “Why White House Burning Is Wrong, Liberal Edition” →

Why Do New York Times Columnists Keep Swooning for Paul Ryan?

By James Kwak

After David Brooks last year, now it’s James Stewart who has fallen for Paul Ryan’s rugged good looks. He attempts to defend Ryan’s tax proposals against charges that they favor the rich:

“To me it sounds like a proposal to raise [the wealthy’s] taxes by depriving them of cherished ‘loopholes,’ to use the proposal’s word. . . .

“There’s no getting around the fact that a 25 percent rate on the top earners would nearly double Mr. Romney’s effective rate and more than double it for the 101 of the top 400 taxpayers who pay less than 10 percent, assuming the loopholes are indeed closed.”

Continue reading “Why Do New York Times Columnists Keep Swooning for Paul Ryan?” →

How Long Can We Finance the Debt?

By James Kwak

Everyone should know by now that the Treasury Department can borrow money at historically low rates. That is a major reason why some very smart economists think that the federal government should borrow more money in the short term (i.e., this year and next) and use that money to boost economic growth.

In the medium term (say, the next decade), however, the big question is how long we will be able to finance new government borrowing at such low rates. Today’s low rates are a product of several factors. One is certainly the slow rate of economic growth, in particular the depressed housing market, which has reduced demand for credit. But another factor is the Federal Reserve’s aggressive moves to keep long-term interest rates down; another is foreign central banks’ appetite for Treasuries.

Continue reading “How Long Can We Finance the Debt?” →