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Why Would a Rational Being Say That?



A few months ago, the New Republic reported on a conference, the Third Modern Monetary Theory Conference, of which it was a sponsor (Osita Nwanevu, “Spreading the Gospel of Modern Monetary Theory,” October 3, 2020). One of the participants, affiliated with the Real Progressives website, declared:

Wages are the way they are because corporations have control.

She probably did not mean to opine that wages are too high. But then, if corporations set wages, why aren’t they setting them at subsistence level, or at most, in order to avoid jail, at the government-imposed minimum wages. In America, 2.1% of all hourly-paid workers are paid the federal minimum wage or less (according to the Bureau of Labor Statistics). Adding the higher state and local minimum wages, the proportion of workers getting no more than the minimum wage clearly exceeds 2.1%, but there is no readily available estimate about how many. Even if we make the exaggerated assumption that the proportion is 13%—which was the proportion of workers paid at or below the federal minimum wage in 1979, when nobody in the land was competing with the feds’ wage-setting power—we still face the mystery of why corporations pay 87% of hourly workers more than what they are legally forced to.

Moreover, people, including employers and workers, are not plants who just remain prisoners of their roots when they have incentives to move, that is, to engage in new exchanges. One has to look at incentives to understand the market.

Our activist did not help her case by adding:

Because of money going into politics and deregulation and all that crap.

But then, who among us has never made youth errors (especially in the roaring sixties, when not being a leftist was the ultimate social sin) or said anything imprudent that went farther than his thoughts? And, of course, as John Stuart Mill argued in On Liberty, the free circulation of all ideas, including those that look false, is indispensable for discovering the truth.

Perhaps that person is right on the wage issue. Perhaps there exists, or will exist, a serious theory backed by credible empirical evidence to the effect that corporations, properly defined, control wages in America. We should not assume that we are in possession of some revealed economic truth. Perhaps I am the one who is not being rational? We should always keep that sort of question in mind and stay alert for other explanations that could account for a puzzling statement. Perhaps we should read or reread 19th-century socialists and John Kenneth Galbraith.

Assuming that these doubts are not justified in the case under consideration, the question becomes, why could our Real Progressives representative utter such a non-sensical statement? Economic theory suggests at least four answers or hypotheses.

First, there is the answer from behavioral economics: the poor thing is subject to cognitive limitations—for example, the availability bias, which leads her to consider only what she hears in her ideological silo. Rough translation: she’s an idiot. But a rational-choice economist will want to dig deeper.

Second hypothesis, this one within the purview of rational choice: “rational ignorance.” The probability that her vote will flip the outcome of any election is zero for all practical purposes, so she has zero incentive to spend time and other resources gathering and analyzing information about public issues. She thus remains rationally ignorant. She votes blind. Moreover, because her own participation in Real Progressives’ activities has only a tiny likelihood of influencing political results, she also thinks blank—and makes statements like the first one quoted above (the second one too).

A third answer, also within rational-choice economics, relates to signaling. By suggesting that employers control wages and exploit their plants (sorry, I meant “their employees”) to the stem (“to the bone”), she is simply signaling to her environment, perhaps as a matter of social survival among her peers, that she shares their opinions and sentiments. “I am one of us, not one of them.”

A fourth hypothesis is the one developed by Roland Bénabou and Jean Tirole in their article “Mindful Economics: The Production, Consumption, and Value of Beliefs” (Journal of Economic Perspectives 30:3 [2016], 141-164). Our progressive friend produced (or borrowed ready-made) and consumed her belief about corporations and wages because it makes her feel good about herself and her identity, giving her more utility than adopting a true belief would. She trades-off a better cognition against the affective or functional value of a distorted belief. In a sense, we could say that she is stupid by choice.

The fact that many people hold the political opinions they hold just to feel good is a potent argument for preventing them from imposing their beliefs on other people by force, that is, a potent argument for limiting government power. The three other hypotheses point to the same conclusion.


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Newsletter: State of the Economy



This is the web version of the WSJ’s newsletter on the economy. You can sign up for daily delivery here.

My Way or the Huawei?

The White House is working with U.S. technology companies to create advanced software for next-generation 5G telecommunications networks as it seeks to blunt the dominance of China’s Huawei Technologies. The plan would build on efforts by some U.S. telecom and technology companies to agree on common engineering standards that would allow 5G software developers to run code on machines that come from nearly any hardware manufacturer. That would reduce, if not eliminate, reliance on Huawei equipment. “The big-picture concept is to have all of the U.S. 5G architecture and infrastructure done by American firms, principally,” White House economic adviser Larry Kudlow said. “That also could include Nokia and Ericsson because they have big U.S. presences.” Huawei won’t be easy to unseat as the global leader. It is the world’s top seller of telecom equipment, and has won fans globally—including small rural telecom carriers in the U.S.—for the quality of its equipment and technical support, Bob Davis and Drew FitzGerald report.


European Central Bank President Christine Lagarde speaks in Paris at 7:15 a.m. ET.

The ADP employment report for January is expected to show a net gain of 150,000 jobs from the prior month. (8:15 a.m. ET)

The U.S. trade deficit for December is expected to widen to $48.3 billion from $43.09 billion a month earlier. (8:30 a.m. ET)

IHS Markit’s U.S. services index for January is expected to hold steady at 53.2. (9:45 a.m. ET)

The Institute for Supply Management’s nonmanufacturing index for January is expected to hold steady at 55.0. (10 a.m. ET)

Federal Reserve governor Lael Brainard speaks on payment innovation at 4:10 p.m. ET.


Delayed Gratification

White House National Economic Council Director Larry Kudlow said fallout from the deadly coronavirus would delay—but not derail—the economic boost the U.S. anticipated from the first phase of the trade deal with China. Last month, President Trump and China’s Vice Premier Liu He signed a deal that called for China to increase its purchase of U.S. goods and services by $200 billion over the next two years. Mr. Kudlow and others say the purchases could be affected by the economic strains on China, where business and industry has been widely idled as efforts continue to prevent the virus from spreading, Katy Stech Ferek and William Mauldin report.

Two major U.S. airlines suspended flights to Hong Kong because of coronavirus. United Airlines and American Airlines said they were halting flights until Feb. 20, citing a lack of demand. Both airlines and several other global carriers had previously halted service to the Chinese mainland. More Chinese cities, meanwhile, imposed restrictions on movement meant to help contain the fast-spreading pathogen that has killed nearly 500 people.

OPEC and its allies are debating more aggressive oil output cuts than previously considered after reviewing new data showing the coronavirus’s deepening impact on global oil demand. The virus has already contributed to a sharp decrease in demand for crude, driving oil prices to bear-market territory on Monday. One projection, which assumes the virus outbreak will be severe and last six months, suggests the market would be oversupplied by 1 million barrels a day in the second quarter if the cartel and its allies fail to act, Benoit Faucon and Summer Said report.

Investors appear to be repricing virus-related uncertainty. Global stocks rose Wednesday and oil posted its biggest gain in more than a month, further erasing earlier losses.

Raining on the Parade

Macy’s plans to close 125 department stores over the next three years, an admission that a fifth of its locations cannot thrive as shoppers buy more online and make fewer trips to malls. The company is also cutting roughly 2,000 corporate jobs, or 10% of corporate and support staff, and closing several offices. Macy’s will keep running about 400 of its namesake stores. Once the backbone of America’s shopping malls, department-store chains like Macy’s, J.C. Penney and Sears have been losing customers to the convenience of and the discounts found at off-price chains like T.J. Maxx, Suzanne Kapner reports.

Tiny Bubbles

Tesla’s shares rose 14% Tuesday to $887.06. They have surged 56% in the past week and have nearly quadrupled since early October. Those outsize gains don’t match Tesla’s more modest fundamentals, which include annual losses. They do, however, resemble any number of other assets that have experienced prolonged bubbles, including tech stocks of the dot-com era; oil in 2008; bitcoin in 2017; and any number of other assets that traded at excesses—going all the way back to the South Sea Bubble of the 1720s, Paul Vigna writes.

Boom Time

A U.S. construction boom is driving up lumber prices. Lumber futures are up more than a third from lows reached last June, when bad building weather and overstocked yards caused an unseasonable slump. Though relatively high, current prices are still well below a May 2018 peak spurred by wood-boring beetles, wildfires and tariffs on Canadian imports, Ryan Dezember reports.

State of the Economy

President Trump kicked off his State of the Union address highlighting economic gains under his administration and trying to draw a contrast with the Obama administration. “Jobs are booming. Incomes are soaring. Poverty is plummeting,” he said. “The years of economic decay are over.” The U.S. economy has been growing since the end of the last recession in 2009, albeit at a pace that lagged behind previous economic expansions. Mr. Trump argued that his policies have given the economy an extra boost, Catherine Lucey and Lindsay Wise report.


Pandemics are breeding grounds for trade wars. “As coronavirus continues to spread outward from China, it’s tempting to see this as a uniquely modern problem, born of the unprecedented ease with which goods, information and people move around the world. In reality, such outbreaks have flourished for centuries thanks largely to a single factor: international trade, the original pandemic superhighway. … In the 20th century, the vexed historical relationship between trade and disease largely fell away, save for a few isolated episodes. But what’s happening now suggests that this relationship may be resurgent,” the University of Georgia’s Stephen Mihm writes at Bloomberg Opinion.


Real Time Economics has launched a downloadable calendar with concise previews, forecasts and analysis of major U.S. data releases. To add to your calendar, please click here.

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In praise of trade frictions



Are restrictions on free trade a better idea than generally thought? I ask because, despite his lauding of it, it is reported that Johnson will impose customs checks upon goods imported from the EU. This lends credence to the estimate (pdf) by The UK in a Changing Europe that Johnson’s plan might eventually cut UK GDP by over six per cent.

But might this estimate miss an important mechanism and thus over-state the costs of us leaving the single market?

What follows cuts against all my instincts in favour of free trade and EU membership. My gut tells me to agree with Martin Wolf’s claim that Johnson’s proposals mean shooting ourselves in both feet. But we should always question our beliefs. And there is, I suspect, more to be said in favour of trade frictions than we have heard so far.

My story starts in a strange place, with the Feldstein-Horioka puzzle. This is the fact (pdf), pointed out in 1979, that net capital flows between countries are much smaller than you would imagine or, to put it another way, that current account imbalances are surprisingly small.

One reason for this is that financial markets, on their own, cannot achieve any net transfer of capital between countries This is simply because every seller needs a buyer: I can only dump my holdings of UK equities if somebody buys them. My effort to shift capital out of the UK is therefore offset by somebody else shifting it in. Instead, a net transfer of capital out of the UK requires that there be a trade surplus. This, by definition, entails an offsetting outflow of capital: if we are selling more goods and services to foreigners we are earning more than we are spending – ie saving, and these savings must be invested abroad.

So, what is it that limits trade imbalances and therefore current account imbalances? The answer, said Maurice Obstfeld and Kenneth Rogoff in a famous 2001 paper (pdf), are trade frictions. By these they mean not just tariffs but also non-tariff barriers such as the red tape of border checks, regulatory differences or simply customers’ preferences (pdf) for home-made goods. It’s difficult for a country to export or import a lot simply because trade costs (pdf) are high. Trade imbalances, therefore, tend to be small.

One Big Fact supports Obstfeld and Rogoff’s theory. It’s that the EU’s single market reduced trade costs - and this led to a rise in countries’ external imbalances. For example between 1980 and 1997 (when Schengen came into effect) Germany ran an annual average current account surplus of just 0.9% of GDP. Since then, though, it’s run an average surplus of 4.7% of GDP. And since 1997 the external deficits of Spain and Greece have been twice what they were in the previous 17 years.

Trade frictions, therefore, reduce current account imbalances.

Which can be a good thing. To see why, remember that a current account deficit means – by definition – that a country’s domestic investment exceeds its domestic saving. But think about what this means for its banking system. If investment exceeds savings, the growth in bank lending might well exceed the growth in deposits or the purchase of bank equity by domestic savers. Which means banks might well be becoming riskier – either because they are becoming more highly leveraged, or are more dependent upon wholesale funding to plug the growing gap between loans and deposits. It is for this reason that the NIESR (pdf) and Dallas Fed (pdf) have both found that big current account imbalances help predict financial crises.

The single market, therefore, might well have led to the euro crisis by fuelling greater external imbalances.

Was it really an accident that developed economies saw almost no banking crises during the Bretton Woods era, when current account imbalances were small, but saw plenty before and since?

In limiting current account deficits, then, trade frictions help preserve financial stability.

This is a great prize. Coen Teulings and Nick Zubanov have shown that financial crises lead to a huge and permanent loss of GDP. And this can be multiplied, because crises can lead to bad policy. Nick Crafts points out that the last one gave us austerity and hence Brexit. “The economic costs of the banking crisis are much larger than is usually supposed” he says. An important transmission mechanism here has been proven by Ben Friedman: economic stagnation, he has shown, leads to intolerance, xenophobia and anti-democratic sentiment.

Against all this is the fact that trade frictions create lots of deadweight losses. But even summed across countless goods, these can be small. So much, in fact, that Arnaud Costinot and Andres Rodriguez-Clare have estimated (pdf) that if the US were to shift to autarky it would only cost it 2-8% of GDP: for the UK, the cost would be around four times as much but for the EU much the same. As James Tobin used to say – rightly – “it takes a heap of Harberger triangles to fill an Okun gap.” And an Okun gap is what we get from a banking crisis.

Of course, Harberger triangles aren’t the only cost of trade frictions. There is also the fact that, in reducing competition, they retard productivity and innovation. But banking crises also do so. It’s a wash.

So, what can be said against this argument for trade frictions? I don’t think it’s sufficient to say that banks are sufficiently strong now that a crisis is unlikely. Even if this is true now, it might not remain the case in coming years. Over long enough periods, small probabilities become big ones.

Instead, you could argue that we are trading off a certain loss – all those Harberger triangles – for what is only a reduced probability of disaster. Your attitude to this trade-off will depend upon your taste for risk.

A stronger argument though is simply that there is a cheaper way than trade frictions of reducing the probability of a crisis – to impose higher capital requirements upon banks. But what if the power of the banking lobby prevents this?  

All this suggests there might be more to be said for trade frictions than supposed. Which poses the question: why have we not heard an argument along these lines, when we have heard so many much weaker ones?

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Presidential Campaign Can Help Americans Learn about Social Security



Mark Weisbrot
The Guardian, February 2, 2020

See article on original site

Social Security has become an issue in the presidential election campaign. Democratic candidate Joe Biden has come under criticism from his competitor, Bernie Sanders, for his past advocacy of cuts to Social Security benefits. Donald Trump has made headlines for recent comments suggesting he’d be open to cutting Social Security.

There is no doubt that Biden has
in the past supported
to Social Security. But there are other reasons, too, that Social
Security should really be a prominent issue in this presidential
campaign. Despite the fact that about one-sixth of Americans get a
check from Social Security ― and millions more, including poor
children, are helped immensely by it ― the nation’s largest
anti-poverty program
remains vastly misunderstood by
most of the country.

In March, a Pew Research poll found
that only 16 percent of Americans believed that the Social Security
system would be able to pay promised benefits to older Americans when
they retire. Polls showing majorities who do not believe that they
will see anything from Social Security are common.

In reality, there is no reason for
anyone to believe such wild nonsense. Social Security has paid all
promised benefits for more than 75 years, and there is nothing in its
finances indicating that the future will be different. Current
projections show
an eventual gap between forecast resources and promised benefits. But
that gap going forward is much smaller than what was closed in the
past. Anyone with knowledge of the subject matter can tell you with
“high confidence,” as the UN climate reports like to say about
global warming, that this relatively small gap will also be closed.
And there is no need, or reason, to close it with any kind of benefit

The surreal polling data on Social
Security is a result of many years of effective public relations
work, financed by billions of special interest dollars, including
political campaign contributions. The American right has always hated
Social Security, from its origin in the New Deal of the 1930s. Social
Security is based on an ethic of solidarity: we are all in this
together, so it is in our collective and individual interest to pay
into a social insurance fund when we are young, healthy, and working,
and draw upon it when we need it. This does not fit well with the
right-wing narrative of society as a collection of atomized,
self-interested individuals.

But it was in the ‘90s that many
liberals began to accept, and even promote, the arithmetically false,
right-wing talking points that Social Security was going broke.

The verbal and accounting tricks were
swallowed by much of the media and proved effective. There was a
demographic time bomb, we were (and continue to be) warned. In 1999,
there were 3.3 workers paying into the Social Security system for
every retiree drawing benefits. But the Baby Boomers are going to
retire! And by 2030, it was estimated, this ratio would shrink to
2.1, they said.

Hardly anyone, outside of those of us
who looked at the numbers, seemed to notice that this is just one
side of the balance sheet. The other side shows that productivity and
wages also grow, and hence it takes fewer workers per retiree to
finance any given level of benefits. That’s one reason why, for
example, the ratio of workers to retirees fell from 8.6 in 1955 to
3.3 in 1999 and nobody missed a Social Security check. And people
accepted that payroll taxes increased, because their wages increased
vastly more.

The “granny-bashers,” as we
affectionately called them, created a phony intergenerational war out
of something that was very much a war waged by the rich against all

And guess what, the much-dreaded
retirement of the Baby Boom generation has come to pass ― about 58
percent have already become eligible for Social Security benefits ―
and the sky did not fall. OK Boomers, thanks for not destroying our
economy by collecting a modest average
of $1,471 per month, which you have fully paid
for out of your wages over the past few decades.

That brings us back to Joe Biden, who
has supported cuts to Social Security benefits in the past. Maybe he
has come to see the error of his ways, without saying so. Like many
other Democrats, he has followed Bernie Sanders in now supporting the
expansion of Social Security benefits instead of cutting them.
Although not nearly as much expansion as Sanders. Still, people can

But a look at the Social Security
section of the Biden campaign website leaves cause for skepticism and
concern. “The impending exhaustion of the Social Security Trust
fund imperils American retirement as we know it.” Um, not really:
the Trust Fund sits
at $2.8 trillion right now, and it’s got 15 years before it
would be exhausted. And it’s never going to be the main source of
Social Security benefits, 77 percent of which would still be paid
when it’s used up. And as noted above, revenues will inevitably be
increased before this catastrophe could materialize.

But the Biden campaign is presenting
that 1990s alarmist picture adopted by the people who have long
wanted to cut and/or privatize Social Security. There’s more: “With
Social Security’s Trust Fund already in deficit and expected to be
exhausted in 2035, we urgently need action to make the program
solvent and prevent cuts to American retirees.”

To say that the Trust Fund is “in
deficit” doesn’t have an actual meaning in accounting or
arithmetic. For the reader who is left to guess what it means, it
sounds like an overdrawn checking account. What they are trying to
say, with a conceptual error and a dose of unnecessary fright, is
that Social Security will be taking in less revenue than it is
spending on benefits, and therefore drawing on the Trust Fund. But
that’s no reason to panic ― that’s what the Trust Fund was
accumulated for: to give us some time to make the political decisions
about how to maintain (or expand) benefits.

A better approach to this problem is to
first acknowledge that we have been
a load of cow manure about Social Security’s
finances for decades, and then show how it is affordable to expand
Social Security so that people who depend on it for their retirement
can escape poverty. That has been Sanders’ approach.

There’s a lot at stake, and a lot
could go wrong, as policy-makers decide how to close the gap that is
continuously brought about by people living longer. Social Security
keeps more than 27 million people above
the poverty line, including at least 1.5 million children. A lot of
people could get hurt by changes that don’t make headline news. So,
it might be good to have someone at the helm who has seen through the
false narrative that we have been fed, has a consistent record on the
issue, and a clear picture of what to fight for.

Mark Weisbrot is an economist and
co-director of the
for Economic and Policy Research
in Washington,
D.C., and co-author, with Dean Baker, of
Security: The Phony Crisis
(2000, University of
Chicago Press).

The post Presidential Campaign Can Help Americans Learn about Social Security appeared first on Center for Economic and Policy Research.

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