Economists frequently complain that even when 98% of the profession agrees on something (say a free-trade proposition), the media will go to lengths to dig up an economist from the 2% minority in order to balance one from the 98% majority, in their feverish and misguided attempt to appear unbiased and balanced on every issue, even issues that don’t really have two sides.   The New York Times op-ed page has outdone itself today by publishing “The 18-cent Solution” by Bryan Caplan.   The “callout” heading is “Found: an economist who backs the summer gas-tax holiday.”    The impetus, of course, was the question posed to Hillary Clinton by a reporter: can you name a single economist who supports the idea of a summer suspension of the federal gasoline tax?  Newshour  gave up on trying to find one.   

In this case, the NYT evidently couldn’t find an economist who really takes the minority position on economic grounds, or even on reasonable political economy grounds.   (The profession is all-but-unanimous on keeping the gas tax, as Greg Mankiw notes.  And for good reasons.)   Rather Caplan’s argument is a convoluted political rationalization:  (1) the high gas prices engender populist anger that might lead to bad policies, (2) yes, a gas tax holiday is a bad policy, but (3) one can make a political argument for the gas tax holiday because it is not as bad as some of the other “populist nonsense: price controls, rationing, windfall profits taxes…” that we might get instead.     This political argument is a bit of a stretch as it is, but he then goes on to make it absurd by supporting “a pairing of an excess profits tax with a gas tax holiday” on the grounds that it is not as bad as “an excess profits tax all by itself.”    Apparently two bad policies are better than none.

This sort of reasoning makes me sympathize with political scientists who tell economists to leave the politics to them.   A more straightforward political argument would have been “Hillary is the best candidate and so one can justify anything that will get her nominated.”  Or the symmetric argument for John McCain, who originally proposed the gas tax holiday in April.  But the New York Times editors, sensibly, would not have chosen to print such op-eds, out of the hundreds that are submitted every week.  So they printed instead an economist’s political argument too complicated for them to understand.    If they are going to do this, they might as well print economists’ economic arguments too complicated for them to understand, which they are seldom willing to do.

Bryan Caplan is a perfectly competent economist, with a Ph.D. and a job and everything.   (He may be a bit too desperate for publicity.  But those of us who live in glass weblogs can’t throw stones.)   Why would he spout the nonsense that is in this op-ed?    The answer is very clear:   it is the way to get into the New York Times.  He gleefully admits as much on his blog today:  “I’ve finally made the Gray Lady: Today’s New York Times features my op-ed inspired by Sunday’s post, I’ll Shill for Hillary. I hope critics don’t misrepresent me as an economic apostate; I’m not dissenting from the standard analysis…  look on the bright side: I’m in the New York Times. Sweet!”

Bryan:   A suggestion.  You should now write a letter to the New York Times retracting your op-ed on the grounds that you should have known that readers would incorrectly infer that you were supporting the policy on economic grounds.   [Arnold, can you help out here?]   If you do this, the Club of Economists might let you back in.     Plus, you will have gotten your name in the NYT a second time!  “Sweet!”

Payroll employment peaked in December, and according to numbers released today had declined by 260,000 jobs as of April. (Source: BLS.) Since we have not yet seen a single negative number on GDP growth, this job loss is easily the most tangible statistical evidence we have so far that the much-heralded recession indeed may have started in the first quarter of 2008.

It has been noted that the unemployment rate started out from a low level — averaging 4.6 % in 2007 — so that even after a period of gradual increase, it remains relatively low by historical standards: 5.0% in April. This is still inside the range that has usually been considered by politicians as too low to generate serious discontent (and by central bankers as too low to put downward pressure on wages and prices). But why, then, is there so much popular dissatisfaction with the economy?

One answer is the old “discouraged worker” effect. Workers who stop looking for a job are not counted in the labor force, and so are not counted as unemployed. There is an obvious way to capture this phenomenon. Compare employment to the entire population, rather than only to those who are actively in the work force. The chart does that. (These figures include farm jobs, as in the standard BLS employment ratio.)

The path of the employment/population ratio during the current decade has been remarkable. The steep slide in jobs that began with the 2001 recession continued thereafter, and actually accelerated in late 2002. Finally the freefall leveled out. (The Bush Administration trumpeted the turnabout in terms similar to those it now uses to sell the aftermath of the troop surge in Iraq: the response to an unacceptable casualty rate was to make things worse for a half-year, and thereafter to compare the post-surge rate of casualties to the high-point, rather than to the period that came before.)

Employment did indeed rise between the years 2003 and 2007. But it barely stayed ahead of population growth. It did very little to make up for the decline equal to 2-3% of the population that had taken place during the first two years of the Bush Administration. The labor force participation rate normally rises in a boom, as good labor market conditions lure workers out of homes, schools and retirement. This is certainly what happened during the record expansion of 1992-2000. But it did not happen during the most recent expansion. To the contrary, the labor force participation rate was at a minimum in 2007, even though that year appears to have been the peak of the business cycle. As a result, employment as a share of the population was well below what it had been at the preceding business cycle peak year (2000). The fraction of Americans with jobs shows a decline from 64.7% to 62.6%, which translates into 4.9 million missing jobs ! Little wonder that, as employment once again starts to decline even in absolute terms, workers are unhappy.

Nicholas Kristof’s column in the New York Times today, “Better Roses than Cocaine,” says it all.   There is no good reason for the US Congress to continue to hold up the free trade agreement that the Administration has negotiated with Colombia.   

Free trade with Colombia can’t have anything to do with loss of US jobs:   Colombia’s exports already enter the US duty-free.   Rather, the Free Trade Agreement would reduce remaining Colombian barriers to imports from the US.    It could contribute (a bit) to a surge in US exports worldwide, which in turn could once again become the engine of US growth that it was in the 1990s.  

Nor would free trade with Colombia be bad for human rights in that violent country.   No government is perfect.   But the Uribe government offers the best hope of bringing some measure of peace, prosperity and justice to Colombia.   It is fighting against the guerillas and drugs.  It wants to give farmers some security, for example, so that they know they have an assured US export market in cut flowers to replace the risky business of growing coca for cocaine.   It deserves our support.

American labor unions raise the issue of killings of Colombian union leaders.  But this is a weak reason to oppose the FTA.   For one thing, the odds of being killed if you are a union leader in Colombia are now less than the odds of being killed if you are a regular citizen.

It is hard to escape the conclusion that the main reason Congressmen are opposing the Colombian free trade agreement is to pander to ill-informed American public opinon.  (Of course the White House would have been better-advised to concentrate its energies and political capital on the multilateral level, the WTO, rather than on the negotiation of myriad bilateral FTAs with small countries.   But this is an argument of economists and policy wonks.  No politicians are opposing the Colombian agreement on these grounds.)

Kristof concludes with a challenge to Democrats. “Democrats instinctively criticize Bush when he harms America’s standing in the world.”   I assume he has in mind  Kyoto, Guantanamo, Abu Graib, land mines treaty, International Criminal Court, nuclear weapons policy, energy policy, steel tariffs, and other economic missteps I could list (see The International Economy).   He continues, “But a test of intellectual honesty is your willingness to hold your own side to the same standard and to point out pandering in those politicians you normally admire.”

He is right.  Hillary and Barack: if you are listening, SUPPORT THE COLOMBIAN FREE TRADE AGREEMENT!   Everybody else:  read Kristof.

[Source: Institute of International Finance, Washington, DC]

Continuing on the theme of the unusual spread that banks currently have to pay to borrow from each other since August (due to credit risk and liquidity concerns):  a Wall Street Journal article on April 16, the day after my last post, explained that LIBOR had recently lost some of its reliability.   The true spreads were even higher than what the panels of banks were reporting to the institution that calculates LIBOR, the British Bankers Association (BBA).    Banks can have an incentive to act strategically in the interest rates that they report to the BBA.  Even though the highest and lowest respondents are dropped from the computation, that was not enough of a correction.   But the Wall Street Journal reported the next day that the banks had immediately reacted to this news by increasing the honesty of their interest rate numbers.  The updated version of the LIBOR graph exhibits an upturn in the US interbank rate at the very end.

Good news, in that it suggests that LIBOR is again reliable, which matters because many economically important borrowing rates are keyed off of LIBOR.    But it is also bad news, in that an increase in the official LIBOR then has a contractionary impact on the real economy — again because so many economically important borrowing rates are keyed off of it.   LIBOR has risen about 50 basis points since the last Fed interest rate cut, including 25 basis points in just the last week.   It seems likely that the latter rise is the manifestation of the restoration of LIBOR’s truthfulness.

While some aspects of the subprime mortgage crisis were predictable, the freezing up the most liquid risk-free markets in the world was not.   The illiquidity has been especially striking in the interbank market.    The following chart was kindly made available by the Institute of International Finance, an association of international banks and other financial institutions, in Washington, D.C.    Their Capital Markets Monitor reports in April: “Credit and equity markets have recovered somewhat, after a series of central banks’ moves to provide liquidity and safeguard systemic stability. However, tension in term interbank markets remains.”

I see three interesting lessons from the chart. 

·        The most important one, of course, is simply that the spreads shot up so abruptly last August, and that they remain very high.    The have come down twice, most sharply in response to central bank measures in December-January, but they have also relapsed twice.  It is extraordinary that even large banks are still so uncertain of their environment that they are reluctant to lend to each other.    Not a good sign. 

·        The second interesting point one might glean from the chart is that each of the three times that the spreads have risen sharply over the last year, the spread in the UK has gone up somewhat more than the Euroland spread, with the Fed somewhere in between.   One might use these differences to pass invidious judgment on how well the three central banks have handled the crisis.    

·        The third point, which dominates the second, is that the correlation across countries is very high.   The three lines overall move closely together.   This means that even though the interbank market has broken down in an important way that we did not think could happen, the banking system internationally is as tightly linked as ever.   Contagion is everything.   Even though the problem originated in the US (the sub-prime mortgage crisis last summer), you couldn’t prove it by this graph !

In my earlier post, I catalogued some quotes from high Bush Administration officials asserting the Laffer claim that a cut in US tax rates stimulates income so much that the Treasury ends up taking in more revenue than before.   I didn’t then quote in detail the extensive statements made by the Director of Office of Management and Budget, Joshua Bolten, in July 2005.    

Director Bolton’s statements are of particular interest for several reasons.     First, by 2005 it had become obvious to any objective observer that (1) the record budget surplus inherited by the Bush Administration had been quickly converted into a record budget deficit, and that (2) the aggressive Bush tax cuts were a major cause of that swing (as was the sharp acceleration in federal spending, both domestic and international, relative to the 1990s).  Second, while the utterings of President Bush himself can in general perhaps be dismissed as not to be taken seriously,  Bolten was the professional whose job is to be responsible for the integrity of the budget process.  (Indeed, he is a higher-quality civil servant than some in the Bush Administration who have been quick to “bolt on” crazy ideological propositions to what should be serious positions.)

Here is what the OMB director had to say about the Laffer proposition:

“And with all those economic gains, we are also seeing more revenues coming into the Federal Treasury.  We have arrived at this point largely because of this President’s and this Congress’ pro-growth policies, especially tax relief.  Those policies have strengthened the economy, which is now producing better-than-expected revenues.”  –   Testimony of Joshua B. Bolten, Mid Session Reivioew of the President’s FY 2006 Budget Requst, Committee on the Budget, U.S. House of Representatives, page 1, para. 3.

And lots more:
“The tax cuts proposed by the President and enacted by Congress are not the [budget] problem.   They are, and will be, part of the solution…Had Congress not enacted the President’s three tax relief packages, moreover, the economy would be substantially weaker than it is…The most effective way to lower future deficits is to grow the economy.  And the President’s tax packages have been well designed to do precisely that.”

“…all economists, I think will agree very strongly that when you reduce taxes, put more money back into the economy, that has a feedback effect in the economy that causes growth and in turn increases receipts.  And being able to measure those receipts, to see how much better the government’s fiscal situation is as a result of the tax cuts would be something I’d very much like to include in the numbers….We think we’ve done the right things by making the tax cuts to restore the economy to growth, because what got us into the difficulty deficit situation in the first place is the flagging growth, flagging receipts in the economy.  We think the best way back is to restore the economy to growth, and restore receipts that correspond to it…. ”

Q: “…you’ve got a substantial drop in the deficit [forecasted] in 2005…”
A:  “…there are other factors involved, and one of them is the ‘03 tax cut.”

–  Press Briefing by OMB Director Josh Bolton, The White House, July 15, 2003.

My friend Barry Eichengreen, together with Marc Flandreau, has written a column in today’s Financial Times, that appears under the headline “Why the euro is unlikely to eclipse the dollar.”     The body of the article is a claim that network externalities and tipping points are not important, or perhaps that they once were but no longer are.   

The first two steps of their argument are:
(1) a multiple-currency system is the historical norm.   The dollar-denominated system that we have experienced for more than 60 years is an aberration, so network externalities (aren’t) important.
(2)  The dollar surpassed the pound in the 1924-25, not in 1948, so lags and tipping phenomena are not important.

Regarding (1), I have always thought that Barry has a good point that a multiple-currency system has one advantage, that it gives the lead currency some competition, which discourages it from abusing its position by excessive deficits, money creation, inflation and depreciation.   But I disagree that network externalities are not also important:  there will always be an advantage to having a lead currency internationally, just as there is an advantage to having a single money within each country.

Regarding (2), I have no problem dating the pound’s loss of supremacy from the 1920s, if that’s what the eminent economic historians say.    But I don’t see how this affects any of the arguments.   For one thing, the US surpassed the UK in economic size in 1872, and in exports in 1915.    So there is still a lag of between 10 and 53 years.    

More importantly, these propositions have no bearing on the central claim that Menzie Chinn and I have made:     based on our statistically estimated effects of economic fundamentals, such as the size of euroland — which has recently passed the US economy — the euro now has the potential to rival or even displace the dollar as lead currency.  We think we have also found statistical evidence of inertia and non-linearity, which imply a tipping point.   But this doesn’t really matter. The scenario that we most emphasize leaves the dollar with an estimated share of central bank reserves only a little less than that of the euro even in the long run.   Regardless what one believes about how fast it will occur or how complete the de-throning will be, our claim that the euro will challenge the dollar stands.

Following up on my preceding post, I will here document who has said what.    

High officials in the Reagan Administration apparently did subscribe to the Laffer Hypothesis:
•         Reagan himself: “…our kind of tax cut will so stimulate the economy that we will actually increase government revenues…” July 7, 1981 speech 1/
•         His Secretary of the Treasury, Don Regan, even after events had falsified the proposition to the satisfaction of most observers, wrote of his “very strong opinion that a tax cut would produce more revenue than a tax increase.”2/
   Also:  “The increase in revenues should be financed not by new and higher taxes, but by lower tax rates that would produce more money for the government by stimulating higher earnings by corporations and workers…” (p.173).  

Similarly, high officials during the Bush era have also have been quoted saying that tax cuts, via faster growth, lead to higher tax revenues:
•         President George W. Bush :    “The best way to get more revenues in the Treasury is not raise taxes, slowing down the economy, it’s cut taxes to create more economic growth. That’s how you get more money into the U.S. Treasury.” –  July 24, 2003.
•         OMB Director Joshua Bolten, press conference July 2003;       & WSJ, Dec. 10, 2003
•         Majority Leader Tom DeLay: “We, as a matter of philosophy, understand that when you cut taxes the economy grows, and revenues to the government grow.”  NYT, 3/31/04.
•         Treasury Secretary John Snow, Congressional testimony, Feb. 7, 2006:  “Lower tax rates are good for the economy and a growing economy is good for Treasury receipts.”
•         CEA Chair Ed Lazear, press conference 2/12/07, “revenues have come in…higher than we predicted…because the economy has grown at a rate higher than we predicted…[T]he tax cuts…[were] at least in part responsible for making the economy grow.”

Most leading Republican economists who served as chief economic advisers to Presidents Reagan and Bush during their tax cutting frenzies, however, do not subscribe to the Laffer Hypothesis, and did not compromise their beliefs while in office.  Three examples:

•         Martin Feldstein:   “I objected therefore to those supply-siders like Arthur Laffer who argued that a 30 percent across-the-board tax cut would also be self-financing because of the resulting increase in incentives to work.”3/
•         Glenn Hubbard:   “Although the economy grows in response to tax reductions… it is unlikely to grow so much that lost tax revenue is completely recovered by the higher level of economic activity.”4/   
•         Greg Mankiw:    “Subsequent history failed to confirm Laffer’s conjecture that lower tax rates would raise tax revenue.  When Reagan cut taxes after he was elected, the result was less tax revenue, not more.” 5/  

1/  Feldstein, American Economic Policy in the 1980s (U. Chicago Press) 1994, p.21.
2/ Regan, For the Record (St. Martin’s Press: New York) 1988, (p.214).
3/  American Economic Policy in the 1980s ( U. Chicago Press) 1994, p.24 . 
4/   Economic Report of the President (Government Printing Office) 2003, p.57-58.
5/   Principles of Economics (Dryden) 1998, p. 166.

I thought it would be useful to get all this into the record, since some observers have claimed that Reagan and Bush never subscribed to the Laffer hypothesis, while others have inaccurately accused Feldstein, Hubbard and Mankiw of selling out on this score.

So Arthur Laffer – still arguing the improbable “supply side” proposition that cutting income tax rates generally raises total tax revenue – is apparently now a special adviser to John McCain.   And McCain has taken on a big consignment of the snake oil, to Greg Mankiw’s dismay.   The political temptation for a Republican candidate to promise both lower tax rates and higher revenues is irresistible.   The policy-makers who cut taxes when Ronald Reagan and George W. Bush, respectively, came to power subscribed to this claim.  Remarkably, at the same time, the economists who were the chief economic advisers to Reagan and Bush during these tax cuts disavow the proposition that they increase revenue (Murray Weidenbaum, Martin Feldstein, Glenn Hubbard, Mankiw…) .    Almost all serious economists – let us say Ph.D. economists  – disagree with this proposition, with only a microscopic handful of exceptions like Laffer.   Indeed some of the advisers who defend the Reagan and Bush economic policies claim that this formulation of supply side economics is a caricature, and was not the true rationale of the tax cuts.   This wishful thinking is directly at odds with quotes from the presidents themselves and their Treasury secretaries and other economic officials, to the effect that tax cuts stimulate income so much as to produce more tax revenue.  Laffer is not a straw man.  (See my next post.)

Even more interesting, the academic defenders of the Republican tax cuts often offer a proposition that is diametrically opposed to the defense offered by their political masters.  This is the famous “starve the beast” hypothesis:  the claim that if you deprive the government of tax revenue, it will reduce government spending, which is of course viewed as a worthy objective.    If this proposition were true, and the supply side hypothesis were also true, it would lead to the nonsensical proposition that Republican presidents should raise tax rates in order to reduce tax revenue (Laffer) and thereby reduce government spending (Starve the Beast).   I challenge some candidate to run on that platform !

As it happens, there is abundant empirical evidence against both the Lafferite hypothesis and the Starve the Beast hypothesis.     In other words, just because two propositions are diametrically opposed doesn’t mean they are not both wrong.  I hope that in this election campaign, the media do something they have failed to do in the past.   If McCain proposes extending the Bush tax cuts, he should at least be forced to choose between the Lafferite defense, which tends to be driven more by political expediency, and the “Starve the Beast” defense, which has more support among at least some reputable Republican economists.    Only then can the rest of us know which of the two propositions to refute.

At the 5th anniversary of the war in Iraq, estimates of its long-run cost range from $1.2-$1.7 trillion by my former colleague Peter Orszag, now Director of the Congressional Budget Office, to $2 - 3 trillion by my current colleague Linda Bilmes with another former colleague Joe Stiglitz (in a book that is appropriately getting lots of attention, including for example from John Cusack).  The important point is that the costs far exceed the $50-$60 billion that the White House predicted ahead of time.  

A story in today’s New York Times proclaims “Estimates of Iraqi War Cost Were Not Close to Ballpark.”     It turns out that the pre-war estimates they are talking about are those that came from the Bush Administration.   At the very end, the article finally mentions “Only one economist, William D. Nordhaus of Yale, seems to have come close. In a paper in December 2002, he offered a worst-case scenario of $1.9 trillion, ‘if the war drags on, occupation is lengthy, nation building is costly.’”   You might not guess from the NYT story that Bill Nordhaus’s study was the only thorough independent professional attempt to estimate the cost of invading Iraq ahead of time.  (At least it is the only one that I was aware of.)  

The question is why the media did not give more attention to the Nordhaus estimates, and less attention to the Administration’s crazily over-optimistic forecasts, while there was still time for the nation to make an intelligent policy choice.   The media’s omission was all the more conspicuous in that by December 2002 the White House’s crazily over-optimistic forecasts of the federal budget overall had already become apparent.   And they are all still at it.