Greece has a newly-elected government which campaigned on the promise that, if elected, it would renegotiate the bailout terms that previously were imposed upon the Greek economy by a previous government and its financial bailout partners. The reason for the desire to renegotiate terms is that Greece has been in recession with high unemployment and declining output for some time and the terms of the bailout require higher taxes and reduced spending, among other things, as a requirement for loans to keep the government from defaulting on its debt. This drama seems to me to offer a number of lessons for the U.S. and other countries running persistent government deficits.
The Fallacy of Composition
Economists know that what is true for an individual in an economy is not necessarily true in the aggregate economy. This fact is known as the Fallacy of Composition. So if Greek politicians promise transfer payments to some Greek citizens, this does not imply that those politicians can promise such payments to all citizens. Once you add up all the promises, one needs to ask how this will be financed and in many countries, such as the U.S., the answer is borrowing to keep these promises. Each individual wants what he or she has been promised but, if a government is unable to borrow, then what is true at the individual level cannot be true in the aggregate. Greece cannot keep all of the promises that it has made because it will not be able to continuously borrow to do so.
Greece and the EU
Greece is a member of the EU and so it cannot print money to cover its deficits if it is unable to borrow. The reason is that Greece does not control the EU Central Bank. If it did control its own money stock, it would undoubtedly be in the throes of a hyperinflation because it would be printing money to finance its deficits. Since it cannot print money, it sought loans to keep the party going but reduced spending and higher taxes were the price it paid for its bailout. The recession resulting from these terms are what has prompted the desire to renege on its previous agreement.
Ultimately, structural reforms are needed to promote economic growth, much like those discussed previously in this blog in connection with Italy which has problems similar to Greece (see Why Italy Declines). These reforms are so-called supply-side policies that remove regulatory and other impediments that reduce economic growth. These reforms appear not to be part of the bailout requirements but these reforms are the only way that the Greeks can achieve real economic progress.
I recently saw an amusing and informative article by Michael Munger, an economist at Duke University (the article is here). The article concerns how one can explain the behavior of people who advocate more government while, at the same time, expressing disgust with many government policies, politicians, and so on.
Professor Munger has observed academic economists regularly express their disapproval of government actions and then, once they observe what they perceive to be poor policies, advocate more government to fix the perceived problems. This is logically inconsistent in the extreme and he puzzled over this (as I and other colleagues have done over the years) and finally realized that those who advocate more government, after expressing disapproval of government, expect a government that does not exist to solve problems they see. Thus Professor Munger sees his colleagues as wishing for a unicorn to exist. They want government to be what they imagine that it should be, not the one that we have.
For some recent evidence supporting this detachment from reality, consider a liberal economist who recently wrote that we should want the government to narrow the income distribution because this will improve the “supply-side” of the economy. How you ask? Well doing so, which I presume will follow an increase in tax rates paid by the rich however defined, will lead to some programs, programs unspecified by the liberal economist engaging in this advocacy, that will improve the quality of the workforce, thus raising productivity in the economy. So the same government that brought us healthcare.gov, the site so successful that people could not use it, will then turn around and successfully design programs to raise the human capital of the impoverished. To me, this “supply-side” story reveals a staggering ignorance of the reality of government.
I have been an academic economist for many years and I can say, based upon my own observations over the years, that Michael Munger has it right. Many academics are oblivious to the real world that surrounds them.
I have regularly seen statements in the press suggesting that many writers in the media think that we should have open borders, an immigration policy that literally allows anyone to enter the U.S. Indeed there are people who correctly point out that the U.S. had open borders in the past and they use this fact to argue that this evidence implies that we should do this now. The fact that we did this in the past is irrelevant for the following reasons.
In the nineteenth century, my ancestors came to the U.S. knowing that they would need to fend for themselves once they got here. There was no welfare that they would get and the state was not going to provide health care without requiring payment. Many immigrants did not attend public schools or did so for only a short time. In short, coming to the U.S. meant that the individual was on his or her own to survive once in the U.S. Compare that to the situation now.
Illegal aliens can now get health care, school access, food stamps, and other benefits once they are in the U.S. How does the existence of these subsidies affect the characteristics of the the potential immigrants to the U.S.? Clearly we will attract some people willing to get on the public dole once they are in the U.S. Those people will ultimately draw public resources, raising government deficits or requiring increases in marginal tax rates. The latter reduce Potential GDP. So the existence of the welfare state makes past immigration policies irrelevant to what would happen now if the U.S. had open borders. More generally, why do we want people to come here who only have an interest in getting on the government dole?
Once again, policy design requires thinking about economic incentives. Open borders is a bad idea because of the incentives that it creates.
I know – you are wondering if there is a misprint in the title. While I have been a frequent critic of economic policy by the government, I am here to write about an example of good behavior by the House of Representatives. Specifically, a bill has been introduced (read BILLS-113-hr5018-10-pages) which would require a policy rule to be used by the Fed as it conducts monetary policy.
Economists have devoted a great deal of research to the study of rules-based policymaking by the monetary authorities. Here is an example of a rule that might be used.
i = π + .5·(Y – YP)/YP + .5·(π – 2) + 2
In the above equation, i is the interest rate controlled by the Fed (such as the Federal Funds rate), π is the inflation rate, and YP is the level of real output at full employment. There are a number of advantages to using this rule. Read more…
This week brings us media reports of two conflicting decisions by federal appellate courts regarding the Affordable Care Act. The issue in each decision is whether subsidies may be provided in states that do not run their own insurance exchange where policies may be purchased. One court decided that the law was unclear and that the IRS was therefore justified in making the decision to permit subsidies in all states. Another court decided that the law was clear and that subsidies could not be given to people in states that do not run their own insurance exchange. What accounts for this conflict? Several possibilities come to mind.
One possibility is that the Congress was unable to write a document that makes clear its intentions. This is always a possibility of policy by committee. Whenever a large number of individuals get involved in a policy process, there is always the possibility that what comes out, intended to accommodate everybody on the committee, is so confusing that the end product is a logical mess.
A second possibility is that the people drafting the legislation are simply incompetent and did not notice the inconsistencies built into the law. Related to this is the fact that the law ran thousands of pages and was not read by many who voted for it. It is hard to be sympathetic with any politician voting for a law when he or she has no clue as to the law’s contents.
Finally, there is always the possibility that judges just “make it up” to satisfy their prior policy preferences.
My own belief is that the conflicting legal decisions speaks to the complete breakdown of the federal government’s ability to function. No sane person can read a document that is two thousand pages long while having any real idea about what is in the law. In addition, why even construct laws that are this long and detailed? Surely the size of the law by itself reveals profound incompetence since it is incomprehensible to the politicians asked to consider it. Or perhaps the law is so large precisely to prevent many politicians from knowing what is in it to allow the few who do know to have an unduly large effect on the law’s contents.
Whatever the explanation, it is hard to put a good face on the Affordable Care Act. Whatever the economic merits of the law (and I have written frequently about how bad it is as economic policy), this is a prime example of incompetent policymaking, no matter how you slice it. The spate of lawsuits generated by this law, while a great boost to the incomes of lawyers, partly reflects policy differences between political parties but it also reveals that the law is dreadfully constructed.
Economics research heavily involves the use of mathematics. The late Paul A. Samuelson, the first Nobel laureate in economics, is widely credited (or sometimes criticized) for starting the trend towards the use of math. It is now the case that all quality graduate economics programs stress mathematical models in almost every course that is offered. Economists are very good at developing mathematical models for business cycles and many other subject areas. For example, my text in macro describes four models of business cycles and each of those models builds in somewhat different assumptions about how the various sectors of the economy operate.
But one unfortunate side effect of the talent for model-building is that it is possible to find a model that will provide almost any answer that one may want on a topic. A well-known economist was once quoted as saying that he had desk drawers full of economic models and, if he were given any result that a person thought to be true, he could find a model in one of his desk drawers that would produce the desired result. As a result, it is far too often the case that, on a given subject, one economist will appeal to some model of his/her choosing to justify a position. Another economist may use a different model, justifying another position that he or she prefers. As a result, it is possible to find all sorts of policy recommendations that differ across economists. To a lay person, this may seem bewildering but this multiplicity of opinions actually reveals the importance of empirical work.
One of the primary purposes of applied testing of economic theories is to allow economists to choose among alternative economic theories. Without the ability to discriminate, economics becomes much like a religion where anything goes. Just pick your preferred model, and one may believe almost anything. One of the unfortunate aspects of macroeconomics is that there is no widely agreed upon model of the business cycle and aggregate economies. It is difficult to test models of the business cycle and so statements about policy in a business cycle setting are frequently without substance. They are “religious” exercises based upon the preferred model of the economist pontificating on a topic.
My advice to the lay person is this. Pay almost no attention to business cycle statements since, most of the time, they are without serious empirical support.
A recent study by the Pew Research Center (the study may be found here) provides some interesting data on the public’s political views. The data reveals that there is increasing polarization among U.S. voters as compared to earlier polling that they have done. This is interesting because it reveals the causal link between the polarization in Congress and that of the public.
In an earlier blog post, I pointed out that elections are what economists call an agency problem. In that setting, the voters are the principals who elect agents, the politicians, to represent their interests. So it follows that if government is polarized, so too are the voters who elected them. The Pew study essentially provides the empirical support for this scenario.
Tooting my own horn, I told ya’ so!