Alan Krueger, Assistant Secretary of the Treasury for Economic Affairs, suggested in a recent speech a useful metaphor to distinguish different kinds of economic indicators. Some indicators are like the gauges on the dashboard of the car — industrial production, unemployment, inflation and so on.  They give the latest bits of information on the business cycle outlook, for businesspeople, government policy-makers, economic forecasters, and anyone else who wishes to follow such developments at high frequency. Many of these numbers are collected on a monthly basis. Other statistics are like the results of 10,000 mile checkups – the poverty rate, infant mortality, life expectancy, carbon emissions, natural resource depletion, the crime rate, traffic congestion, leisure time, and other measures of inequality, health, the environment and the quality of life.  They supplement market-measured activity and are needed in order to get a comprehensive feel for welfare and the longer term sustainability of the economy. This second category of statistics is more often collected on an annual basis.

GDP is the single indicator that gets the most attention. Lately much of that attention has been very critical. In late September, the most recent in a long line of critics weighed in. This group was weighty indeed: the Commission on the Measurement of Economic Performance and Social Progress was created by French President Nicolas Sarkozy, chaired by Joseph Stiglitz, chair-advised by Amartya Sen, and coordinated by Jean-Paul Fitoussi.  Nobel-Prize winners abound. The Commission believes that we have been focusing too much on market-measured output:   “By their reckoning, much of the contemporary economic disaster owes to the misbegotten assumption that policy makers simply had to focus on nurturing growth, trusting that this would maximize prosperity for all. “What you measure affects what you do,” Mr. Stiglitz said…”If you don’t measure the right thing you don’t do the right thing.” (New York Times, Sept. 23, 2009.)

I certainly agree that the non-market variables are important, both in the sense that they should be measured well and in the sense that policy-makers should put some priority on them as objectives. But I question whether the measurement issue and the objective issue are as closely linked as many would have it. I especially question any claims that the role of GDP should be in practice be replaced with a single concept that factors in these other measures of the health, inequality, the environment, etc.    GDP is a comprehensive measure of market output, is available quarterly, and belongs on the dashboard. The other variables are typically available only annually, and there is no way to know how to aggregate them into a single number, let alone to aggregate them together with the standard economic measures. By all means, take the 10,000 mile checkups seriously. But don’t remove GDP from the dashboard.

I am not sure I see the claim that the measurement problem is the reason for the myriad errors our national policy makers have made in recent years (notwithstanding the Bush Administration’s notorious downgrading of science). We have perfectly good tools for helping to make decisions about environmental regulation, for example, in the form of cost benefit analysis.  GDP measurement issues have nothing to do with that. Perhaps you believe that a Republican Administration may want to pressure the EPA to count some environmental damages at zero or suppress the evidence entirely; perhaps you believe that a Democratic Administration may want to count some economic costs at zero or abandon cost benefit analysis entirely. Yes, that would have a big effect on the policy decision. But what does any of it have to do with GDP?

In the same newspaper reporting Joe’s comments, I read of a development that has received mysteriously little attention: according to numbers from the Energy Information Agency, greenhouse gas emissions fell sharply in 2008 (by more than 2 ½ %), are falling even more in 2009 (about 6%), and in the next few years are almost certain to remain easily below the levels of 2005.   (See the chart below.)  The oil price spike in 2008 deserves some credit. Some might wish to try to give some credit to policy too. But there can be no doubt that the main reason for the sharp fall in emissions is the recession. A simple statistic for the unitiated: although CO2 emissions in an average year rise by 0.8%, they fell that much in both 1991 and 2001, the last two recessions, in addition to the much larger drop in the much larger recent recession. That is not a coincidence.

How should one value a 9 percent fall in emissions against a 3.8% fall in real GDP (from the 2007Q4 peak to the 2009Q2 apparent-trough)? I strongly suspect that a majority of Americans, no matter how well-informed regarding the science, would think that the output loss outweighs the climate benefit by far. A minority, in favor of very drastic action on climate change, might implicitly choose the other way. (I myself am in favor of pretty serious action, but not in favor of policies that impose huge economic costs, either because they are too drastic or are designed in an inefficient way. And of course engineering a recession would be a very inefficient way to do it.) Are Joe Stiglitz and Amartya Sen among those who think we are better off on balance? I have no idea. To ask the question is to help illuminate why attempts to sum everything up into a single number, such as “Green GDP,” fail.

Incidentally, if Joe does think that the estimated 9 percent fall in emissions outweighs the 4% loss in GDP, then he doesn’t think that our current situation constitutes a “contemporary economic disaster,” but, rather, a gain in welfare.  It would then logically follow that any policy decisions that got us into this situation (whether attributable to incomplete information about banking activity or inequality or anything else), were good, not bad!

Source: US Energy Information Agency

[Readers wishing to post comments are referred to SeekingAlpha.]

I propose that the Congressional leadership re-introduce the Trouble Asset Relief Program accompanied by a major new policy: a small tax on securities market transactions. This will accomplish the political goal of aiming a silver bullet into the heart of the (understandable) popular outrage that blocked passage of the TARP bill on Monday. It will simultaneously accomplish the fiscal goal of raising revenue in the future. This is revenue that the federal government would have sorely needed even before the bailout arose and will need even more if the taxpayer is to be protected against the risk of heavily subsidizing the financial sector.

A tax on securities market transactions might sound like a wild populist policy that would damage the functioning of the economy. But in fact it is probably more sensible than such populist measures as banning short sales, which has already been tried (to no avail).

Proposals for financial transactions taxes have a distinguished pedigree, going back at least as far as Keynes.  Best-known is the Tobin tax proposal, by Nobel Prize winner James Tobin, which was specifically aimed at volatility in foreign exchange markets. More relevant to what I am proposing are two articles by the pre-Treasury Larry Summers: “A Few Good Taxes” and “When Financial Markets Work Too Well: A Cautious Case for a Securities Transactions Tax” (1989).   Add to the list of proponents another Nobel Prize Winner, Joe Stiglitz.

There is extensive experience with securities transaction taxes (STTs), especially in other countries.  There have also been quite a few studies of their effects. Often the motivation for such proposals is to reduce short-term speculative turnover:   a tax of 0.1% means nothing to a long-term investor, but is a strong disincentive to those traders who hold their positions for only minutes or hours.  The idea is that reducing short-term speculation will reduce volatility.  On the other hand, defenders of unfettered financial markets often argue that such a tax will reduce liquidity and thus hurt the customers who depend on the market.

The general historical experience seems to be that there is no discernible effect on volatility (though a couple of studies find effects on volatility, either upward  or downward).   In other words, the tax might not help the functioning of the financial markets — the original motivation – but neither does it hurt, according to a majority of the studies.  In some cases the volume of trading within the country is affected.  But what the tax does does usually do is raise money for the Treasury.  

The UK long had a securities transactions tax, known as a stamp duty, which was set at 0.5% in 1986.  Sweden introduced a 0.5 per cent tax on the purchase and sale of equities in 1984 — prompting some financial trading to move offshore – and kept it until 1991.  (Froot and Campbell, studied these two examples in a 1994 book that I edited.   The Swedish case is particularly relevant to the current US context because the popular motivation there was to “take down a peg” high-earning speculators.)    Japan, Korea, Taiwan and Hong Kong have a long history with securities transactions taxes, and India introduced one in 2004; in these cases there were not significant reductions in either price volatility or market turnover.  Other countries that have had financial turnover taxes of at least 0.1% include Australia, Austria, Denmark, Finland, France, Germany, Malaysia, and Singapore.  (Germany abolished its turnover tax in 1991, and Japan in 1999.)   In addition there are other countries that impose smaller fees.

Even the United States had a STT until 1965, and to this day imposes an SEC fee of .0033%.  Thus we have already lost our virginity !

An important potential drawback, if the US were to impose a more substantial transactions tax alone, is that it might drive financial business offshore.   There is an answer to this point.  As noted, many countries already have taxes on financial transactions. Furthermore, lots would love to cooperate with the United States in an international program to harmonize such taxes internationally. This is precisely the sort of project in which many abroad have long asked Americans to participate, but which we have not hitherto wanted to do.

The level and longevity of the tax might be adjusted to achieve the goal of Section 134 of the TARP bill: that the taxpayer recoup the costs of the bailout. A 2004 study by the Congressional Research Service reported that an 0.5% tax on stock transfers could raise $65 billion a year.  Others have produced higher revenue estimates.   A tax extended to bonds and derivatives (especially derivatives!) would of course raise more.   Remember that one does not compare this annual revenue to the $700 billion headline cost of the bailout.  Rather, one compares the present discounted value of the annual flow of revenue to however much of TARP’s $700 billion is left over after the government (we hope) collects something on the troubled loans and also recoups something on warrants obtained from the participating banks.

The tax might on the margin contribute to a shrinking of the size of the financial sector; but this shrinking needs to happen anyway, as Ken Rogoff has pointed out. And most important politically, it would give expression in a non-damaging way to the blood lust that the public feels toward Wall Street, a venting that needs to take place if the bailout bill is going to be approved.

[To any readers who wish to post comments:  I suggest you go to the RGE version of this post.]

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.