Tag Archives: economics

The Costs of “Good” Economics

By James Kwak

If there is a central argument to 13 Bankers, it is that politics matters. The financial crisis was the result of a long-term transformation of the financial sector and its place in the overall economy, and that transformation occurred because of—and contributed to—a shift in the political balance of power.

Daron Acemoglu and James Robinson, authors of Why Nations Fail, take up this theme on a much broader scale in their recent article in the Journal of Economic Perspectives, “Economics Versus Politics: Pitfalls of Policy Advice,” burnishing their reputations as two of the most subversive thinkers around. People have always known that economics and politics are related: that economic power produces political power and that political institutions constrain economic policy choices. Still, however, at least for the past several decades, the universal assumption has been that good economic policy is always good policy, full stop: for example, that it is always good to eliminate market failures.

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Why Is Finance So Big?

By James Kwak

This is a chart from “The Quiet Coup,” an article that we wrote for The Atlantic three years ago next month. Many people have noted that the financial sector has been getting bigger over the past thirty years, whether you look at its share of GDP or of profits.

The common defense of the financial sector is that this is a good thing: if finance is becoming a larger part of the economy, that’s because the rest of the economy is demanding financial services, and hence growth in finance helps overall economic growth. But is that true?

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How Much Do Taxes Matter?

By James Kwak

Christina and David Romer’s new paper, “The Incentive Effects of Marginal Tax Rates: Evidence from the Interwar Era,” is available as an NBER working paper (if you are so lucky). Given the current debates about taxes, the paper is likely to garner some attention.

In the central section of the paper, Romer and Romer regress reported taxable income against the policy-induced change in marginal after-tax income share. The after-tax income share is the percentage of your gross income that is left after taxes; policy-induced changes are those caused by tax changes rather than be macroeconomic changes. They do this for the top 0.05% of the income distribution, broken down into ten sub-groups by income, because the income tax only affected the very rich during the interwar years.

Their headline finding is that “The estimated impact of a rise in the after-tax share is consistently positive, small, and precisely estimated” pp. 15–16). They find an elasticity of taxable income with respect to changes in the after-tax income share of 0.19.

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What Did the SEC Really Do in 2004?

By James Kwak

Andrew Lo’s review of twenty-one financial crisis books has been getting a fair amount of attention, including a recent mention in The Economist. Simply reading twenty-one books about the financial crisis is a demonstration of stamina that exceeds mine. I should also say at this point that I have no arguments with Lo’s description of 13 Bankers.

Lo’s main point, which he makes near the end of his article, is that it is important to get the facts straight. Too often people accept and repeat other people’s assertions—especially when they are published in reputable sources, and especially especially when those assertions back up their preexisting beliefs. This is a sentiment with which I could not agree more. One of the things I was struck by when writing 13 Bankers was learning that nonfiction books are not routinely fact-checked (Simon and I hire and pay for fact-checkers ourselves). As technology and the Internet produce a vast increase in the amount of writing on any particular subject, the base of actual facts on which all that writing rests remains the same (or even diminishes, as newspapers cut back on their staffs of journalists).

I’m not entirely convinced by Lo’s example, however. He focuses on a 2004 rule change by the SEC. According to Lo, in 2008, Lee Pickard claimed that “a rule change by the SEC in 2004 allowed broker-dealers to greatly increase their leverage, contributing to the financial crisis” (p. 33). That is Lo’s summary, not Pickard’s original. This claim was picked up by other outlets, notably The New York Times, and combined with the observation that investment bank leverage ratios increased from 2004 to 2007, leading to the belief that the SEC’s rule change was a crucial factor behind the fragility of the financial system and hence the crisis.

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The Smugness of Unintended Consequences

By James Kwak

After my post on Corey Robin’s new book, a friend recommended Albert O. Hirschman’s Rhetoric of Reaction. As the title suggests, the book is about the rhetorical style of conservative thought dating back to Burke. Hirschman identifies three common tropes: perversity (that great-sounding progressive idea you have will have the opposite of its intended effect), futility (that great-sounding progressive idea won’t change anything, because you don’t understand the fundamental laws of the world), and jeopardy (that great-sounding progressive idea will destroy some other thing that we all agree is valuable, making everyone worse off in the end). Hirschman doesn’t dwell on this specific point, but it’s obvious that, similar to the argument Robin makes, these rhetorical devices can only exist in opposition to some progressive reform movement.

I thought the description of the contemporary form of the perversity thesis (e.g., welfare programs create poverty) was especially good. “Here the failure of foresight of ordinary human actors is well-nigh total as their actions are shown to produce precisely the opposite of what was intended; the social scientists analyzing the perverse effect, on the other hand, experience a great feeling of superiority—and revel in it” (Belknap Press, 1991, p. 36). This seems to me an accurate description of why the Economics 101 ideology is so powerful. People get a sense of superiority from owning counter-intuitive theoretical insights—even if those insights are wrong.

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The Myth of the Natural Economy

By James Kwak

“The general equilibirum view tends to lend support to those who want to make the economy more efficient in the sense of having fewer ‘distortions’—you know, all of these neutral economic words—from taxes, from labor unions, from minimum wages, and so on. Now, what has happened in the last thirty years—and this is what Hacker and Pearson note in their book [Winner-Take-All Politics]—is we have gotten ourselves into a feedback situation. As people have gotten richer, conservative people have funded organizations which generate economic research promoting their political views.”

That’s from an excellent interview with economic historian Peter Temin in The Straddler. Temin’s main point is that what he calls general equilibrium approaches to macroeconomics have a political agenda, but they hide that agenda behind an ideology of naturalness. The “natural,” perfectly clearing, perfectly efficient economy, of course, has never existed and can never exist, but it is used to justify certain political prescriptions.

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Allocative Efficiency for Beginners

By James Kwak

I was catching up on some old Planet Money episodes and caught Allen Sanderson of the University of Chicago talking about how to allocate scarce resources. The first day of introductory economics, he says, there are always more students than seats. Say there are forty extra people, and he can only accept ten more into the class. He asks the class: how should the ten slots be allocated? You can easily guess the typical suggestions: by seniority, because seniors won’t be able to take the class later; by merit (e.g., GPA), because better students will contribute more to the class and get more out of it; to the first ten people outside his office at 8 am the next day, since that is a proxy for desire to get in; randomly, since that’s fair; and so on. Someone also invariably suggests auctioning off the slots.

This, Sanderson says, illustrates the core tradeoff of economics: fairness and efficiency. If you auction off the slots, they will go to the people to whom they are worth the most, which is best for the economy as a whole.* If we assume that taking the class will increase your lifetime productivity and therefore your lifetime earnings by some amount, then you should be willing to pay up to the present value of that increase in order to get into the class. An auction therefore ensures that the slots will go to the people whose productivity will go up the most. But of course, this isn’t necessarily fair, especially when you consider that the people who will get the most out of a marginal chunk of education are often the people who have the most already.

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