Taxes and growth

Do lower taxes mean faster economic growth, as is so often claimed by conservatives? I mentioned this question in the context of corporate taxes recently:

Although in general low taxes do not necessarily increase growth, corporate taxes are considered “the most harmful type of tax for economic growth”, according to the OECDAnd researchhas found that decreases in the corporate tax rate spur investment, which in the U.S. has been surprisingly low in recent years.

I figured I’d post a few other resources here, along those lines. This is a review paper from Brookings on individual taxes and economic growth:

We find that, while there is no doubt that tax policy can influence economic choices, it is by no means obvious, on an ex ante basis, that tax rate cuts will ultimately lead to a larger economy in the long run. While rate cuts would raise the after-tax return to working, saving, and investing, they would also raise the after-tax income people receive from their current level of activities, which lessens their need to work, save, and invest. The first effect normally raises economic activity (through so-called substitution effects), while the second effect normally reduces it (through so-called income effects).

Here’s a Congressional Research Service report from 2012 that caused a lot of debate, and concluded that:

The results of the analysis suggest that changes over the past 65 years in the top marginal tax rate and the top capital gains tax rate do not appear correlated with economic growth. The reduction in the top tax rates appears to be uncorrelated with saving, investment, and productivity growth. The top tax rates appear to have little or no relation to the size of the economic pie.

You can read some coverage of that study here and here. And here’s an NPR fact check piece on the subject, which describes the Brookings piece mentioned above.

Here’s a survey of economists. They’re asked if, “A cut in federal income tax rates in the US right now would lead to higher GDP within five years than without the tax cut.” They’re divided between Yes and Uncertain, with only a few No’s.

And here’s a couple good pieces by Noah Smith. On individual taxes:

the best evidence that economists can muster shows that income taxes — i.e., what Republicans are always trying to cut — don’t hurt the economy very much. Microeconomic estimates of something called the Frisch elasticity of labor supply — or the amount that taxes discourage people from working — are very low. That means that income taxes do only a very little to discourage people from working. The one exception is tax cuts for the poor and working class, which really do seem to encourage more work effort. But for the upper-middle class and rich, who bear most of the tax burden and who are usually the prime beneficiaries of Republican tax cuts, the effect is very small.

And here he is on corporate taxes.

Eduardo Porter on taxes and growth, and an estimation of the optimal top tax bracket.

What’s the evidence on short-termism?

Here was my attempt to sum it all up with links a few months back, as the introduction to a Q&A with Steve Kaplan about a paper he had on the subject:

McKinsey’s Dominic Barton has made the case, as has BlackRock’s Larry Fink. Politicians like Hillary Clinton and Joe Biden have warned against short-termism, as have scholars at Brookings and the American Enterprise Institute. McKinsey has made its case empirically, finding evidence linking long-term management to superior financial performance. In 2015 Rotman’s Roger Martin reviewed the evidence on both sides here at HBR and explained why he believed short-termism is a problem.

But not everyone agrees.

Economist Larry Summers says, in response to the McKinsey data, that the jury’s still out. The Economist calls short-termism a “slippery idea” and a “distraction.” The New Yorker calls it a “myth.” And we’ve published many pieces here at HBR taking issue in one way or another with the standard short-termism critique.

In a recent paper, University of Chicago Booth economist Steven Kaplan makes his own case against worrying about short-termism.

Here’s a similar effort by Noah Smith, who makes the case that short-termism is, in fact, a problem:

Back in June, I reported on a research paper by Steven Kaplan of the University of Chicago’s Booth School of Business, saying that the threat of short-termism was either nonexistent or exaggerated. But I also argued that the reasons Kaplan gives have major caveats or are of questionable relevance.

Other research has shown important evidence on the negatives of short-termism. A 2010 paper by economists John Asker, Joan Farre-Mensa and Alexander Ljungqvist found that closely held companies tend to invest more than similar publicly listed companies, and also tend to be quicker to respond to new investment opportunities. And a 2007 paper by Rudiger Fahlenbrach found that companies run by founder-chief executive officers tend to invest more in both capital goods, and research and development — investments that are rewarded with higher stock prices over the long term.

The evidence that short-termism might be harmful continues to pile up. A 2014 paperby Stanford University’s Shai Bernstein finds that when companies go public and face pressure for quick results from investors, their best inventors tend to leave, and the ones who remain produce fewer patents. Though patenting is a poor measure of innovation at the industry-wide level (since one company’s patents can hinder innovation by other companies), it’s a good indicator of the effort a company is putting into research. Bernstein’s paper also shows that once companies go public, they plow less of their resources into far-sighted R&D investments.

Meanwhile, economists German Gutierrez and Thomas Philippon have a recent paper investigating the causes of low business investment. They find that the more public companies are owned by institutional investors, the less they tend to invest.

Posting this mostly so I have the links to all these bits of evidence together in one place.

More on how to think about economic models

I wrote recently about three different ways to think about economic models. Here are two more. John Gruber of MIT to his undergraduate micro students:

We’re going to be modeling individual and firm behavior. Now technically, as you know, a model is any description of the relationship between two or more economic variables.But the difference from your other courses– and I’m telling you right now, it’s going to be frustrating.I’m warning you in advance, is unlike the relationship between energy and mass, there is no law that tells you exactly how things relate.We’re going to build a series of models that is going to help us try to understand the way things relate. But this is not a real science. As much as we wish we were, we are not. We’re not a real science. We are a quasi-science, social science.What we’re trying to do with our models is make assumptions that negotiate the tension between, on the one hand, explaining real world phenomena, and on the other hand, being mathematically tractable.

Here’s the CORE economics textbook The Economy:

ECONOMIC MODELS

A good model has four attributes:

  • It is clear: It helps us better understand something important.
  • It predicts accurately: Its predictions are consistent with evidence.
  • It improves communication: It helps us to understand what we agree (and disagree) about.
  • It is useful: We can use it to find ways to improve how the economy works.

What’s the case for capitalism?

People often assert that socialism doesn’t work, or at least that capitalism is superior. Yet they seldom provide evidence for that claim. How do we know it’s true? If you know some economics, you can probably list some theoretical reasons why it could be true. Or perhaps you’ve read first-hand accounts of life under communism, and consider the question settled. But what empirical or historical evidence would you point to if someone asked you to make the case for capitalism relative to other systems of economic management?

I recently happened upon two attempts to answer this question, one from the excellent new intro econ textbook The Economy, and the other from some of the essays in the fantastic Cambridge History of Capitalism Volume 2.

The treatment in the textbook looks at East vs. West Germany:

The division of Germany at the end of the Second World War into two separate economic systems—centrally planned in the east, capitalist in the west—provided a natural experiment… The East German Communist Party forecast in 1958 that material wellbeing would exceed the level of West Germany by 1961. The failure of this prediction was one of the reasons the Berlin Wall separating East from West Germany was built in 1961. By the time the Berlin Wall fell in 1989, and East Germany abandoned central planning, its GDP per capita was less than half of that of capitalist West Germany…

Unlike some capitalist economies that had even lower per capita incomes in 1950, East Germany’s planned economy did not catch up to the world leaders, which included West Germany. By 1989, the Japanese economy (which had also suffered war damage) had, with its own particular combination of private property, markets, and firms, along with a strong government coordinating role, caught up to West Germany, and Spain had closed part of the gap.

We cannot conclude from the German natural experiment that capitalism always promotes rapid economic growth while central planning is a recipe for relative stagnation. Instead what we can infer is more limited: during the second half of the twentieth century, the divergence of economic institutions mattered for the livelihoods of the German people.

That’s a good start, and one of the nice things about The Economy is that it includes a lot of economic history relative to other introductory texts. But what about the overall record of capitalism? And what about in terms of human welfare, rather than just economic growth?

In an essay titled “Capitalism and human welfare” in the Cambridge History of Capitalism Volume II, Leandro Prados de la Escosura tackles this question, using a measure of human welfare combining economic growth (adjusted for inequality), life expectancy, and educational attainment. After providing and considering the data, he writes:

How do the capitalist and socialist systems compare? It has been frequently argued that it is at low levels of economic development when socialist societies have an advantage over capitalist ones in lifting human well-being and, in particular, its non-income dimensions. A glance at the former Soviet Union shows that substantial gains in human development were obtained between the 1920s and the 1960s, which resulted in an impressive catching-up to the OECD. Since the mid-1960s, however, this progress gave way to stagnation… A preliminary evaluation suggests that, but for Russia during the central decades of the twentieth century and Cuba, socialism has not delivered higher human development for developing countries than capitalism… The results presented in this chapter suggest that, despite its initial success as provider of ‘basic needs’, socialist experiences failed to sustain the momentum and, but for Cuba, stagnated and fell behind before the demise of communism. Furthermore, its suppression of agency and freedom prevented real achievements in human development.

Another essay in the same volume provides some detail, context, and theory to support the conclusion above. The essay is titled “Modern capitalism: enthusiasts, opponents, and reformers” by Jeffry Frieden and Ronald Rogowski. They write:

The centrally planned economies achieved rapid growth in the twenty years after World War II, as they drew underutilized resources into production. But Soviet-style planning had many limitations. As was true of the import-substituting economies, the Soviet bloc found that it increasingly needed imports — not only of food, but of technology and precision parts — that it lacked the hard currency to buy. Collectivized agriculture proved massively inefficient, forcing the formerly grain-exporting USSR to expend scarce foreign currency, year after year, on imported cereals. Recurrent campaigns to increase manufactured exports, particularly from the bloc’s most advanced economies (e.g., East Germany), brought little success. Only the bloc’s raw materials and a few artisanal products found ready purchasers in the West. The absence of incentives gave workers and managers little need to monitor quality, or to innovate either in the production process or with new products. Over time, the industrial plant fell farther and farther behind the technological and quality criteria prevailing in the West, and by the 1980s growth had slowed dramatically. With Western Europe within easy reach of people in the Soviet bloc’s central and eastern European nations, it was easy for citizens to see the relative failure of the system.

Together, it seems reasonable to conclude that the conventional wisdom is roughly accurate. But each source provides reasons for humility. The success of capitalism over socialism may be apparent, broadly and in aggregate. But the historical record contains various partial exceptions. We ought to be cautious about overly sweeping generalizations.

For one thing, the chapter mentioned above on capitalism and human welfare provides an important reminder that the victory of “capitalism” is really a victory for the mixed economy. The author documents “a positive non-linear association between the expansion of social protection and the improvement in human development… Small changes in social transfers are associated with large increases in human development. Then, as we move to the right, we observe that increases in social transfers are associated with smaller, but still positive, increases in human development. As social transfers reach 25 percent of GDP the curve tends to flatten, suggesting a reversal for levels above 30 percent.”

IMG_20170930_142141

But does social spending actually cause improvements in human welfare? Or is it merely correlation? The answer comes from yet another essay in the volume, “Private welfare and the welfare state” by Peter H. Lindert. Yes, he says, at least historically:

The modern rise of public social spending probably brought considerable gains in efficiency, GDP, and the larger concepts of human welfare quantified in Chapter 15 in this volume by Leandro Prados de la Escosura. These investments in humans were blocked for millennia by weak and rapacious governments, and by a concentration of political power that rejected universal public schooling, family assistance, and public health insurance…

Yet since about the 1960s, the expansion of public social programs has probably stopped reaping efficiency gains, due to what journalists would call ‘mission creep.’ Several countries, most notably Japan, the United States, Italy, and Greece, have drifted away from their original mission of investing in the young, while at the same time maintaining intergenerational transfers in favor of the elderly. This drift did not bring any obvious net loss of GDP in the late twentieth century, but further population aging in the twenty-first will force reforms that hold support for the elderly within sustainable steady-state limits.

To summarize, then: We can be reasonably confident that capitalism is broadly superior to socialism and state planning, with the caveat that by capitalism we mean a mix of free but regulated markets and a significant welfare state. The historical evidence strongly suggests that social transfers improve human welfare. And some of those transfers — specifically transfers to the young — also improve economic efficiency and spur economic growth.

The linear regression economy

This is a point I meant to blog about, but a new piece from Tech Review led me to more or less sum it up in tweets:

A related point: models are not the constraint for most data science projects. My thinking in all of this is informed by Kalyan Veeramachaneni of MIT, who’s written about some of these issues here.

Amazon, Sears, and market power

Derek Thompson has a nice piece at The Atlantic about the uncanny similarities between Amazon and Sears (a point Benedict Evans has also made):

It’s remarkable how Sears’s rise anticipates Amazon’s. The growth of both companies was the result of a focus on operations efficiency, low prices, and a keen eye on the future of American demographics.

Might this comparison say anything about recent concerns over Amazon’s market power?

Well, you might think the story of Sears illustrates the problems of market power — a big company extends its tentacles, competing with much smaller ones, and controls an extremely large part of the market for lots of different stuff.

But here’s Robert Gordon on what Sears replaced:

In the America of 1870, local merchants had local monopolies, and their customers had little ability to compare prices. Thus there was constant tension between the rural customers and the merchants, for there were few guidelines for judging whether a price was fair… In this environment, we can understand why mail-order catalogs were such a salvation for rural customers.

The Sears story, then, is about the creation of a big, powerful company that, yes, probably gained all sorts of market power via its scale. But it replaced lots of little geographic monopolies — small firms that each had substantial market power and used it to extract rents from customers. The change wasn’t about moving from a competitive environment to a less competitive one. It was about changing from one form of imperfect competition to another one.

Could something similar be true of Amazon? Who knows — all this is speculative at best. But the Sears comparison clearly helps understand Amazon in other ways, so perhaps it’s at least worth thinking about.

Can you trust your feelings?

A few paragraphs from Robert Wright’s new book Why Buddhism is True.

  1. Our feelings weren’t designed to depict reality accurately even in our “natural” environment. Feelings were designed to get the genes of our hunter-gatherer ancestors into the next generation. If that meant deluding our ancestors — making them so fearful that they “see” a snake that isn’t actually there, say — so be it. This class of illusions, “natural” illusions, helps explain a lot of distortions in our apprehension of the world, especially the social world: warped ideas about ourselves, about our friends, our kin, our enemies, our casual acquaintances, even strangers. (Which about covers it, right?)
  2. The fact that we’re not living in a “natural” environment makes our feelings even less reliable guides to reality. Feelings that are designed to create illusions, such as seeing a snake that isn’t there, may at least have the virtue of increasing the organism’s prospects of surviving and reproducing. But the modern environment can take various kinds of feelings that served our ancestors in this Darwinian sense and render them counterproductive in the same sense — they may actually lower a person’s life expectancy. Violent rage and the yearnings of a sweet tooth are good examples. These feelings were once “true” at least in the pragmatic sense of guiding the organism toward behaviors that were in some sense good for it. But now they’re likely to mislead.
  3. Underlying it all is the happiness delusion. As the Buddha emphasized, our ongoing attempts to feel better tend to involve an overestimation of how long “better” is going to last. What’s more, when “better” ends, it can be followed by “worse” — an unsettled feeling, a thirst for more. Long before psychologists were describing the hedonic treadmill, the Buddha saw it.

I’m enjoying the book so far. Here’s The New Yorker on it, and The New York Times — one, two —  and here’s a piece Wright wrote about meditation for The Atlantic almost five years ago.

The arc of the social universe is long, however it bends

Technology can be used for good or ill, but over the course of human history it’s clearly been a source of major progress. (If you’re not convinced, Robert Gordon’s book is one of my favorites to make the case.) But even if technology ultimately contributes to progress, it can cause a lot of harm along the way. I’ve just happened across a couple of reminders of that lately, and so wanted to put them (along with some others) together.

John Lanchester writing about the transition to agriculture in The New Yorker:

So why did our ancestors switch from this complex web of food supplies to the concentrated production of single crops? We don’t know, although  Scott speculates that climatic stress may have been involved. Two things, however, are clear. The first is that, for thousands of years, the agricultural revolution was, for most of the people living through it, a disaster. The fossil record shows that life for agriculturalists was harder than it had been for hunter-gatherers…Jared Diamond called the Neolithic Revolution ‘the worst mistake in human history.’ The startling thing about this claim is that, among historians of the era, it isn’t very controversial.

And here is Leandro Prados de la Escosura, writing in the Cambridge History of Captialism Volume II. The chapter is on capitalism and human welfare:

Trends in human development do not match closely those observed in real GDP per head. More specifically, phases of economic globalization have a dramatic impact on per capita income growth but not on the progress of human development. A counterintuitive lack of association is observed between human development and per capita income prior to World War I. Although the initial large-scale progress in health can be traced back to the late nineteenth century, with the diffusion of the germ theory of disease, and primary education experienced a significant advance in the era of liberal capitalism, the progress in human development dimensions fell short on the economic advancement resulting from globalization and industrialization. The negative impact of urbanization on life expectancy and the lack of public policies on education and health may account for human development’s slower progress in the late nineteenth century. More significantly, while real GDP per head stagnated or declined during the globalization backlash of the interwar years, human development progressed steadily. Health and education practices became increasingly globalized during the economic backlash of the period 1914 to 1950. Could a delayed impact of economic globalization on human development be, perhaps, hypothesized? Since 1950, advancement in human development has been hand in hand with growth in the world economy, although at a lower pace during the Golden Age (1950-1973) and, again, since 2000.

The bit on urbanization echoes Robert Gordon’s account, in The Rise and Fall of American Growth, that America’s shift toward cities in the 19th century “brought with it a host of public health problems.” From our vantage today, urbanization looks like a good and necessary thing. But for many if not most people, things got worse before they got better.

The last thing I’ll add here is James Bessen’s book Learning by Doing, which looks at the wages of weavers during and after the Industrial Revolution. His thesis:

Workers can benefit by acquiring the knowledge and skills necessary to implement rapidly evolving technologies; unfortunately, this can take years, even decades.

These examples are worth bearing in mind when we think about human progress in relation to things like globalization and technology today. Arguably, many ‘elites’ are waking up to the fact that they ignored the possibility that the benefits from economic changes that seemed likely to be net positive (trade with China, the adoption of IT) would cause dislocations measured not in months but in decades. But the historical record suggests that these painful lags are the rule rather than the exception. The discovery of agriculture was net positive, as were urbanization, the industrial revolution, and global trade. But every one of them came with massive suffering, experienced over long periods of time. The answer isn’t to be complacent and wait it out. It’s to undertake the necessary actions to lessen this suffering. To make the investments in public health that improved urban life; to erase the lag between the financial benefits of globalization and the benefits to overall well-being.

Nowhere is this more important today than with technology. Overall, technology has been a force for good. I think it can continue to be. But if we are not vigilant — if we do not pay attention to the harms that it causes, and do not prioritize investments to deal with them — then it will cause a lot of suffering along the way.

What is financial innovation?

Emphasis mine:

Whatever the cause or focus of financial innovation, it involved four basic forms, namely product, market, organization, and regulation. Product innovation was the design of a financial instrument to meet a specific need. Market innovation was the creation of a trading system through which these financial products could be bought and sold. Organizational innovation involved the grouping of separate financial activities together in such a way as to be greater than the sum of their parts. Regulatory innovation was a response to the need to reduce the risks involved and so increase the use made of the product, market, or organization.

That’s from the financial capitalism chapter in the Cambridge History of Capitalism, Volume II. The author is Ranald Michie. That last line is worth keeping in mind during the continued debates over how we regulate the financial system.

Nobel Prize-winning psychologist Dan Kahneman: AI will surpass humans in emotional intelligence

Some economists with whom I work hosted a conference on the economics of AI in Toronto last week, and while I couldn’t attend, some of the videos are online. And Brad Delong has provided a “rough transcript” of psychologist Dan Kahneman’s remarks, which include this bit about emotional intelligence:

[????] said yesterday that humans would always prefer emotional contact with with other humans. That strikes me as probably wrong. It is extremely easy to develop stimuli to which people will respond emotionally. A face that changes expressions, especially if it’s sort of baby-shaped, are cues that will make people feel very emotional. Robots will have these cues. Furthermore, it is already the case that AI reads faces better than people do, and can and undoubtedly will be able to predict emotions and their development far better than people can. I really can imagine that one of the major uses of robots will be taking care of the old. I can imagine that many old people will prefer to be taken care of by robots by friendly robots that have a name and that have a personality that is always pleasant. They will prefer that to being taken care of by their children.

Now I want to end on a story. A well-known novelist—I’m not sure he would he appreciate my giving his name—wrote me some time ago that he was planning a novel. The novel is about a love triangle between two humans and a robot. What he wanted to know is how would the robot be different from the individuals. I propose three main differences:

  1. One is obvious the robot will be much better at statistical reasoning and less enamored with stories and narratives than people.

  2. The robot would have much higher emotional intelligence.

  3. The robot would be wiser.

More from Kahneman at the link. This seems like an underrated possibility to me. Too often commentary on AI assumes that as machines take over analytical tasks, humans will focus on emotional ones. All this reminded me of a piece I wrote for HBR a couple years back that included this bit:

In his own research Gratch has explored how thinking machines might get the best of both worlds, eliciting humans’ trust while avoiding some of the pitfalls of anthropomorphism. In one study he had participants in two groups discuss their health with a digitally animated figure on a television screen (dubbed a “virtual human”). One group was told that people were controlling the avatar; the other group was told that the avatar was fully automated. Those in the latter group were willing to disclose more about their health and even displayed more sadness. “When they’re being talked to by a person, they fear being negatively judged,” Gratch says.

This is something we’d traditionally think of as interpersonal or emotional work, and yet people preferred machines because they didn’t come equipped with certain types of social/emotional reactions. That suggests to me that the bar is even lower than we think. Machines will get better at EQ, but they’ll also be able to respond differently than most people do, in ways that give them an edge. A machine that’s almost as good at listening and perceiving might still be preferable to a human in some cases if the machine also knows, for example, not to be judgmental. A machine that is nearly as good as a human at having a conversation might be preferable in some situations if it’s a more generous conversationalist and asks you more about yourself. AI may one day pass an emotional Turing test. But I expect we’ll start using them in social contexts well before then because of the other advantages they bring.