Date: Fri, 23 Jun 95 18:24:21 CST From: "jim blair" To: alt-politics-economics@cs.utexas.edu,alt-politics-greens@cs.utexas.edu Subject: PEDDLING PROSPERITY, a Book Review PEDDLING PROSPERITY a Review A recent post recommended this book by Paul Krugman (W.W. Norton & Co,1994) and I read it recently while on vacation. INTRODUCTION: An Objective Summary of the Book The first thesis, and basis of the title, is that complex ideas on economic theory are developed by academic economists (aka "professors"). These ideas are well grounded in theory and backed by evidence but are expressed with disclaimers on the limits of their validity and an understanding of their range of application. No one out side of the academic community pays much attention to them. That is, until the idea is picked up and promoted by "policy entrepreneurs" (they are the ones you see on TV and read in the press). They simplify and sell: complex concepts are transformed into slogans and sound-bites and the limitations and disclaimers are lost. Politicians run for office on this version. This happens on both the Right and the Left, and the book deals with an example from each side: SUPPLY SIDE ECONOMICS (on the Right) and STRATEGIC TRADE (on the Left). The sound bite summary of each follows. SUPPLY SIDE: taxes limit growth and retard the economy when they are too high, as is the case now (ie the stagflation of the 1970's). A tax cut will stimulate growth to the extent that government revenues will actually increase as a result. A curve by Arthur Laffer shows no tax revenue for a 100 % tax on all income (who would work?) and also no revenue for a 0 % tax. There is a maximum revenue for some intermediate tax rate, and it is lower than the (then) current rate. Ergo, reduce the rate and the revenue will rise. STRATEGIC TRADE: The way things get started is pretty arbitrary, but once locked into place they are hard to change. If a particular new industry can get started in the US, we will continue to dominate in that field, but if it starts somewhere else (Europe or Japan), we may well be locked out. The pattern of keys on the typewriter (QWERTY) came into use because it was slow and hard to use (thus reducing the jam rate of mechanical keys), but is still used on electronic keyboards today, where a more efficient arrangement would make more sense. So the government should subsidize the establishment of the key future industries in the US, and THEN support free trade. (BUT see also the link QWERTY for another opinion on this!)---jeb Both these ideas came from a solid academic background but were reduced for sale to the public. The book is divided into 3 parts: the story of the selling of Supply Side, his analysis of the result of the Supply Side policies, and the story of the selling of Strategic Trade and why it is a bad idea. MY FAVORABLE COMMENTS on the Book Part III explains why international trade is good and why the Strategic Trade policy if attempted would most likely meet with retaliation and result in a trade war (assuming politicians could correctly pick the key industries of the future in the first place). There is a good explanation of "comparative advantage" (p268-74), and how trade is especially beneficial to the poorer (ie less productive) partner, a point I have tried to make in several previous posts to this group and which has important implications for NAFTA and GATT. He also points out the curious fact that trade is higher between countries which are similar when it seems more reasonable to expect that countries which are very different would have more to gain by trading (p230). There is a short discussion of why the popular AMERICA: WHAT WENT WRONG? by Barlett and Steele and other such pictures of "loss of good jobs" in the US is wrong (p262-6). More on the "deindustrialization of America" later. He recognizes the obvious (but often misunderstood) truth that productivity is good because it means more production; not just so we can better compete in the world market. Productivity gains would be good even if there were no world market or international trade. MY CRITICAL COMMENTS on the Book: Experts vs Popularizers He claims the salesmen/policy entrepreneurs who are known to the public aren't the real experts. This claim may be true in economics; I don't know the field well enough to say. But he then makes an extension to science: Stephen Hawking is known to the public for popularizing cosmology, so he can't be a leading expert in science. The overall tone and presentation in the book seems balanced and fair, so this was my first clue that he can make errors in judgment. In science, while many major contributors ARE "ivory tower" researchers, many also CAN and DO communicate with the public. Carl Sagan, Linus Pauling, Stephen Jay Gould, Edward Teller, and Sir Francis Crick are people I have heard in person. Many others (James Watson, Richard Feynman, Hawking, etc.) write books and appear on TV. One of my personal "hot buttons" is other scientists who put them down BECAUSE they try to educate the public in their area of expertise. The general public has too little interest or knowledge of science now, and it is absurd to consider a scientist "unprofessional" for speaking in public about their research. (I too am annoyed when a "celebrity" -even a scientist celebrity-uses that status to promote a cause they know little about, but that is a different situation). Just The Facts, Mam' The "facts" that he presents in the book, are with one major exception that I will address last, pretty much in agreement with mine. But his interpretation of a fact is often different than mine. In several places (p127 & 166) he praises the interstate highway system as an example of investing in infrastructure. The "normal" 1% of GDP investment was raised to 3% during the 1950's and 60's to build it and reduce traffic congestion. I realize that I am in the minority with my view that the massive subsidy given to highway construction in this country INCREASES traffic congestion, and is harmful in various other ways as well. See "Raise the Gas Tax?" in the Economics section of my web page. He criticizes the Thatcher government in England for shifting power production from coal to gas thus causing unemployment among coal miners. (p181). No attempt to evaluate the environmental impact of gas vs coal. In these and other situations, he explains things from only a narrow economic perspective and does not attempt to consider environmental factors. Most of part II is devoted to explaining how the Supply Side policies of the Reagan Administration didn't work. You can see he has his work cut out for him from Figure 1. It shows both "actual" GDP and "potential" GDP vs time from 1973 to 1991 (all inflation corrected to 1987 dollars). "Potential" GDP is the projected 2.5% growth he thinks is realistic since it is the growth rate from WWII until 1973. Why is it realistic now? More on this later. The figure (p25) shows "actual" GDP falling below "potential" immediately in 1973 and is furthest below in 1982 when the Supply Side policies start to phase in. The gap closes and by 1989 "actual" catches up to "potential" for the first time since 1973. Then it starts falling again in 1990 when Bush rescinds the Supply Side and is falling now. So why is this a failure? Because "actual" was EXPECTED to catch up to "potential", but it failed to SURPASS the "potential" curve! He does admit that the Reagan tax cuts didn't ruin the economy as some have charged. Most Supply Siders didn't claim that their policies would transform the economy onto a whole new growth curve, just that Federal tax revenue would rise if rates were cut. Federal tax revenues were $618 billion when Supply Side started in 1982 and were $991 billion in 1989. Correcting the $618 for the average inflation rate of 3.6%/year makes it $772 billion 1989 dollars or a 128% increase in constant dollar revenue at the lower tax rates. Krugman doesn't mention this, and in fact says (p157) that since there was a deficit increase revenue must not have increased! For the pro-supply side view, see the REAGAN Home Page on the world wide web; there is a link from my web page. WHAT ABOUT THE REAGAN DEFICIT? The book points out that the deficit did rise during the Reagan years, but the increase does not look so big when divided by the also growing GDP, and was not enough to do serious harm to the economy. His figure 9 (p153) shows that when Reagan left office, the federal debt/GDP (ie the debt as expressed in time- the time needed to pay it) was about the same as when JFK was president. (I had an earlier post on the topic: should debt be expressed in dollars or in years, and Krugman is correct on this point: years is the answer.) Two more comments here. Figure 9 of the book is from 1960 to 1993. Why 1960? The same curve looks rather different when plotted from 1920. To see that, look at "Picture the National Debt" on my web page. When evaluating a debt, one should ask what it was used to buy. For many families in the 1960's going heavily into debt to buy a house was the best financial move they ever made. Did we buy anything with the Reagan Debt? Yes. First there was a recession early in the 1980's and deficit spending is recommended by J.M. Keynes and others to deal with recession. A deep recession was ended quickly. But of much more importance, Reagan ran a deficit to win the Cold War and save the world from nuclear destruction! (or at least give the world a CHANCE to avoid it). I know some say that the USSR just happened to collapse while Ron was asleep, and the US military build up, Star Wars, covert help to Solidarity, etc. had nothing to do with it. But a least read "Who Broke the EVIL EMPIRE?" by Peter Schweizer in National Review, May 30, 1994, before flaming me for this claim. PRODUCTIVITY, PARTICIPATION RATE & DEINDUSTRIALIZATION There are various references made to productivity changes, and to employment changes. He recognizes that increased productivity is a GOOD THING, but does not seem to be aware of an important aspect of it. When more workers enter the labor force at lower than average productivity (and wages), average productivity (and wages) go down relative to what they would otherwise be. This happened during the Supply Side years when lower tax rates made the incentive better for working, especially for married women. The top rate tax increase in 1990 and other changes which increased the "marriage penalty" for wives of high income men, coupled with the 100 hour per month limit imposed on AFDC-UP benefits now make working less attractive for women at both the top and the bottom of the income range. As these workers (whose pay and productivity are below the national average) drop out, there is an increase in the average productivity (and wage). This does NOT mean anyone is more productive or is being paid more. It is like "average" Mexicans getting younger in the 1960's. See the Alan Renolds article in National Review, October, 1994 on this point, and my web page file USE of STATISTICS, about how the average Mexican got younger. Krugman seems to expect that productivity (and wages) should continue to increase at the post WWII rate, but he is also aware that the composition of the economy is changing. Just as the agriculture component has dropped during the history of the country, so the manufacturing sector has been falling, not just in the US, but in the industrial world. Figure 12 (p 263) shows this. An example (p 278) illustrates that in the current economy, an increase in service productivity has more impact than a larger increase in manufacturing productivity, since services comprise about 80% of the total economy (and rising) while manufacturing is 20 % (and falling). But the potential for productivity gains is greater in manufacturing. I can imagine that the widget factory can make ever more (and better) widgets with ever fewer hours of effort per widget by the use of ever better tools, automation, robots etc. But think about services. It takes four musicians about 30 minutes to play a Haydn string quartet, now just as in 1790. The "productivity gains" have been through larger auditoriums to perform to a larger audience, and this has reached a limit if the nature of the concert experience is to be preserved. Recording and CD's can make the music available to more people but this is also a different experience. Can a barber use ever better tools to give ever faster haircuts? Can a councilor or psychologist learn to listen to patients faster? Or will the patients learn to talk faster? While there are productivity gains to be made in the service economy, I think they are reaching a limit. This means that the overall productivity gains of the economy (and the potential wage gains) should be EXPECTED to slow down as services play an ever larger role. INCOME DISTRIBUTION: Did the Rich get Richer, or just pay more Taxes? One of the major criticisms of the Reagan Era Supply Side policies is that THE RICH GOT RICHER and this is BAD. This book also raises this point (p136), and offers some discussion of it (p140-50). One section is missing from the discussion: to what extent is the increase in top income levels an increase in TAXABLE income. The figures I have seen are based on IRS data. During the 1970's and before, the top tax bracket (94% falling to 70% and later to 50%) was high enough that high income people developed many ways to avoid having high "taxable income". Money went to trust funds for the children, tax exempt bonds, etc. It was common to form a corporation which consisted of only one person or a small professional staff. Income went to the corporation which used it to pay expenses (tax deductible) and send the "employee" on business trips (vacations) etc. I recall two conversations from that era. A doctor friend commented that his corporation had done very well that year. Naive me asked him if that meant his corporation had made a big profit? He laughed and said that if his corporation EVER made a profit he would fire his accountant! Profits are taxable. The owner of a small corporation that I know had a nice car but sold it to get a new sports model. His comment was "I liked the car, but my accountant says my corporation needs this change for tax purposes". Now, I am sure this sort of thing is still common, and is making a comeback since top rates increased. But with the 28% top rate and simpler tax laws there was less incentive to spend it on (high salary) accountants and more of the rich just took money as income and paid the tax. In the IRS data, they got "richer". Now, since the increase in the top bracket, they are "poorer" again, (and paying a smaller percent of the income tax bill), so the egalitarians can be happy. INCOME MOBILITY: Can YOU be Rich Someday? And finally, the one "fact" in the book that I think is WRONG, not just misunderstood. How much income mobility is there in US society? It makes the way a wide income distribution is viewed completely reversed. If the RICH, the POOR, and the MIDDLE are the SAME people all the time, then most, especially those who are not rich, would think that fairness would favor a narrower range between RICH and POOR. But, considering that the spread is due to the rich being moved up, rather than to the poor being poorer, (don't we all agree the in the US the poor today are both richer and fatter than ever?), if there is income mobility most would favor an even GREATER spread. See my web page file "Stratification" for more on this. Consider the most extreme case of income mobility: each year you have a 20% chance of being in any one of the 5 "quintiles" of income distribution. If they differ by only a few hundred dollars it doesn't make much difference which. But if the top 20% is way more than the low ones, when you draw that one you win BIG. Lotteries draw the most ticket sales where the top prize is highest, not where the average payback is higher. Krugman discusses income mobility (p141-5) and claims little mixing. He claims most stay in the same bracket from year to year, and says after a decade only 3-6% rise from bottom to top. He does not cite any specific source for this, or say WHICH decade he is referring to. My information on this is from a Treasury Department study of 14,351 taxpayers tracked from 1977 to 1988, and reported in National Review, August 31, 1992, and in the Wall Street Journal, Tuesday, June 21, 1992. It is summarized on my web page under "Income Mobility", (in the economics section). They claim that of those who were in the bottom fifth by income in 1997, 86% had moved up, (65% moved up 2 or more quintiles) and more of them were in the TOP fifth by 1988 (14.7%) than remained in the bottom fifth (14.2%). My guess is that this corresponds to greater income mobility than is to be found in any other country. What is the truth here? I would like to follow up on it. If it turns out that BOTH are correct (by referencing different time frames), it would mean the Supply Side policies increased income mobility. This would be even more important than the increased tax revenue or GNP growth! In my own case, I have probably been in 4 of the 5 income quintiles during my life, starting at the bottom while a graduate student, and moving to probably the next-to top while working for a big company (the least happy years of my life), then down to next-to-bottom while teaching (the best time in life), and now in the middle. . ,,,,,,, ____________________ooo__(_O O_)__ooo_________________________ (_) Jim Blair (jeblair@facstaff.wisc.edu) University of Wisconsin, Madison (USA). For a good time, call http://www.execpc.com/~jeblair/ "This message is brought to you using biodegradable binary bits and 100 % recycled bandwidth."