More on the new paternalism

Over at the ThinkMarkets blog Glen Whitman is continuing his series of postings on the "New Paternalism on the Slippery Slopes".

• New Paternalism on the Slippery Slopes, Part 7: The Inevitable Misinterpretation of New Paternalist Arguments
• New Paternalism on the Slippery Slopes, Part 8: Hyperbolic Discounting in Public Policy

Links to the first 6 postings can be found here. This set of posting is based on a new paper "Little Brother Is Watching You: New Paternalism on the Slippery Slopes" by Whitman and Mario Rizzo, published in the Arizona Law Review. You can find the full text here.

The abstract of the full article reads,

The “new paternalism” claims that careful policy interventions can help people make better decisions in terms of their own welfare, with only mild or nonexistent infringement of personal autonomy and choice. This claim to moderation is not sustainable. Applying the insights of the modern literature on slippery slopes to new paternalist policies suggests that such policies are particularly vulnerable to expansion. This is true even if policymakers are fully rational. More importantly, the slippery-slope potential is especially great if policymakers are not fully rational, but instead share the behavioral and cognitive biases attributed to the people their policies are supposed to help. Accepting the new paternalist approach creates a risk of accepting, in the long run, greater restrictions on individual autonomy than have been heretofore acknowledged.

It's the margin that matters

Dave Prychitko writes at the Economic Way of Thinking blog:

About twenty years ago I needed to fax to my publisher a copy of my signed book contract, or something like that. There was not a single fax machine on the SUNY-Oswego campus where I taught. It was 4:50 and the fax needed to be sent before 5:00pm.

I raced to the sole fax service provider in town, a small office supply shop. He charged two bucks. I opened my wallet and discovered that I only had a dollar. (To this day I rarely have more than five bucks in my wallet.) I asked him if he'd please fax it for a buck. He flat out refused my offer. "I have my overhead to consider."

The shopkeeper obviously didn't know he was dealing with an economist. "No, you really don't have overhead to consider. You face the same overhead expense whether or not you fax my paper. It will cost you no more than fifty cents for the phone call. Period. I give you a buck and you can make fifty cents that you can allocate to your overhead or anything else for that matter. If you keep insisting upon two bucks, you receive nothing for your overhead expenses. You lose. You don't make a penny."

He accepted my offer. I don't know if he bought my marginal cost / marginal revenue argument, or if he just wanted me out of his store. In either case, it's the margin that mattered.

Advice, don't confuse fixed and marginal costs.

Eminent domain powers and the size of government

This is not good news. This paper, Do Broader Eminent Domain Powers Increase Government Size? in the Review of Law and Economics, looks at the effects of widening eminent domain powers on the size of state and local governments in the US. It looks in particular at the 2005 U.S. Supreme Court decision Kelo v New London which allows the use of eminent domain to transfer property from one private party to another when it serves a broadly defined public purpose such as economic development. The empirical results show that states which explicitly empower their local governments to use eminent domain for private economic development have larger state and local public sectors than those that do not.

The abstract reads,

The 2005 U.S. Supreme Court decision Kelo v New London allows using eminent domain to transfer property from one private party to another when it serves a broadly defined public purpose such as economic development. This paper examines the effect of this doctrine on the size of state and local governments. In the leviathan model, constitutional constraints are needed to control government expansion. The Kelo decision removes one such constitutional constraint on how state and local governments gain command over privately owned resources. The empirical results show that the breadth of eminent domain power affects the size of the public sector; states that explicitly empower their local governments to use eminent domain for private economic development have larger state and local public sectors than those that do not.

Does voting for an inefficient government make sense?

This question is asked by the Economic Logician, he writes

Given a distribution of skills and interest in public service in the labor force, would it be best if the public-minded workers go into government or to the private sector? Essentially, this is what Esteban Jaimovich and Juan Pablo Rud ask. If the better ones go private, then the unmotivated ones go into government and wreak havoc: they seek rents, hire more public (low-skilled) employees, thus inflating their wages and depressing the returns of the most skilled private workers, which lessens their incentives to do better in terms of entrepreurship. Jaimovich and Rud also claim that this outcome is actually preferred by the (low-skilled) working class, because of the higher wage. They also support the outcomes of their model with observations from the data.

A counter argument as to why inefficient government is good comes from this from an address, Economic Freedom, Human Freedom, Political Freedom, given by Milton Friedman, at the Smith Center for Private Enterprise Studies in 1991.

The United States today is more than 50% socialist in terms of the fraction of our resources that are controlled by the government. Fortunately, socialism is so inefficient that it does not control 50% of our lives. Fortunately, most of that is wasted. People worry about government waste; I don't. I just shudder at what would happen to freedom in this country if the government were efficient in spending our money.

Trade-offs are an inescapable part of the economy.

EconTalk this week

Mike Munger of Duke University talks with EconTalk host Russ Roberts about many things. Listeners sent in questions for Mike and Russ to talk about and they chose ten of the most interesting questions with the idea of talking about each for six minutes. The topics are the scarcity of clean water, asset bubbles, the role of Fannie and Freddie in the financial crisis, can a business pass a tax on to its customers (or maybe even its workers), compassionate food, the study of economics, how to choose a college, the nature of cooperation in a modern economy, the humanity of non-profits, and the American Dream.

London’s first financial markets

In this audio from VoxEU.org Anne Murphy, lecturer in history at the University of Hertfordshire and associate director of the Centre for Financial History at Newnham College, Cambridge, talks to Romesh Vaitilingam about her new book ‘The Origins of English Financial Markets: Investment and Speculation before the South Sea Bubble’.

The minimum wage, again

Trevor Mallard blogs his support for an increase in the minimum wage. He writes

Business NZ would squeal. But most employers know that lifting wage rates encourages investement in capital equipment and training to make their labour force more productive. It is all part of the movement to a high skill, high wage economy.

Yes there is a relationship between productivity and wages but it runs the opposite way to what Trevor claims. Over time if you make people more productive, wages will increase. Even Paul Krugman has noted this fact. He writes,

As it happens, the past 40 years offer considerable evidence on what happens to the wages of a country whose productivity gains on that of higher-wage nations. Four decades ago, productivity in Europe was well below U.S. levels in most industries, and Japan lagged even further; since then, productivity levels in the advanced world have converged, although most measures still suggest that the United States retains some edge. More recently, a group of "newly industrializing economies" in Asia has achieved spectacular productivity increases starting from a very low base. Given these dramatic changes in relative productivity, what has happened to relative wages?

The answer is that wages have risen in each country, more or less in line with productivity. Table 2-3 shows data on long-run increases in productivity and real wages in several representative countries. Bearing in mind that there are some slippages in the data (for example, there are a number of technical problems in the way that both productivity and real wages are calculated), the basic picture is one in which converging productivity has produced a convergence in wages, just as the theoretical analysis would predict.

Notice that we do not have good data on South Korean wages over the full sample. However, the United States government has been collecting hourly compensation (wages plus benefits) data for the industrial sector of several newly industrializing countries since the mid 1970s. According to these data, South Korean compensation rose from only 5 percent of the U.S. level in 1975 to 46 percent in 1996. An index of compensation in several newly industrializing Asian economies rose from 8 percent of the U.S. level in 1975 to 32 percent by 1996. In short, the experience to date is that wages always do move more or less in line with productivity. (Paul Krugman and Maurice Obstfeld, "International Economics: Theory and Policy", Prentice Hall.)

and in a similar vein he says,

Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. In the 1950s, when European productivity was typically less than half of U.S. productivity, so were European wages; today average compensation measured in dollars is about the same. As Japan climbed the productivity ladder over the past 30 years, its wages also rose, from 10% to 110% of the U.S. level. South Korea's wages have also risen dramatically over time. ("Does Third World growth hurt First World Prosperity?" Harvard Business Review 72 n4, July-August 1994: 113-21.)

Raising wages will just cause employers to use less labour, that is, increase unemployment. Demand curves slope downwards even for labour.

One of best discussions of the effects of the minimum wage is the book "Minimum Wages" by David Neumark and William L. Wascher, Cambridge: MIT Press, 2008. In this book Neumark and Wascher offer a comprehensive overview of the evidence on the economic effects of minimum wages. Synthesizing nearly two decades of their own research and reviewing other research that touches on the same questions, Neumark and Wascher discuss the effects of minimum wages on employment and hours, the acquisition of skills, the wage and income distributions, longer-term labour market outcomes, prices, and the aggregate economy.

Based on their reading of the evidence, Neumark and Wascher argue that minimum wages do not achieve the main goals set forth by their supporters. They reduce employment opportunities for less-skilled workers and tend to reduce their earnings; they are not an effective means of reducing poverty; and they appear to have adverse longer-term effects on wages and earnings, in part by reducing the acquisition of human capital. The authors argue that policymakers should instead look for other tools to raise the wages of low-skill workers and to provide poor families with an acceptable standard of living.

In chapter 9 “Summary and Conclusions” they write

“Three conclusions, in particular, stand out. First, as indicated in chapter 3, the literature that has emerged since the early 1990s on the employment effects of minimum wages points quite clearly – despite a few prominent outliers – to a reduction in employment opportunities for the low-skilled and directly affected workers”. (p. 286)

Also from Table 9.1 page 287 when dealing with the effects on employment, under the ‘Summary of evidence’ heading Neumark and Wascher write

“Minimum wages reduce employment of low-skilled workers; adverse effects even more apparent when research focuses on those directly affected by minimum wages.”

At The Standard we are told Kiwis back fairer minimum wage. We are told

An overwhelming 61% of people in a large (2,300 person) survey conducted by the Herald favour immediately lifting the minimum wage $15 an hour from its current $12.50.

On the other hand economist Greg Mankiw has a list of things that economists agree on in chapter 2 of his first year textbook. Number 12 on this list is “A minimum wage increases unemployment among young and unskilled workers” and 79% of economists agree. So this result is widely accepted by economists.

How not to run an economy

The Wall Street Journal reports that Venezuela Nationalizes French Retail Chain,

President Hugo Chavez ordered Sunday the seizure of a French-owned retail chain on accusations that it raised prices after Venezuela devalued the currency by half.

So much for PPP.

The Venezuelan leader said that a new law could be needed to carry out the nationalization. "I'm waiting for the new law to begin the expropriation process," he said. "There's no going back," he added.

and

Separately, Mr. Chavez also ordered the nationalization of a large shopping-mall recently built in a downtown district in Caracas. The stores controlled by Exito and the shopping mall will be used to build up Comerso, a new government-run retail chain which seeks to sell its products at "socialist" prices, according to the president.

During his 11 years in power Mr. Chavez has nationalized large swaths of the Venezuelan economy, including a Spanish-owned bank and an Argentine-controlled steel-mill.

I'm guessing foreign investment isn't at the top of Hugo Chavez's list of must haves for economic development. I'm also guessing that Robert Higg's idea of regime uncertainty isn't something Chavez is too concerned about. One wonders what effect all this will have on private investment, both foreign and local, in Venezuela.

Nazi capitalism: an oxymoron?

In a couple of recent articles in The Freeman, see here and here, Steven Horwitz asks Is the Name “Capitalism” Worth Keeping? Having just read Adam Tooze's book, “The Wages of Destruction: The Making and Breaking of the Nazi Economy” I can see why he may ask such a question.

Tooze refers, in a number of places, to the Nazi economy as a "capitalist economy". For example he writes,

Never before has national production been redistributed on this scale or with such speed by a capitalist state in peacetime.

and

To reiterate, the Third Reich shifted more resources in peacetime into military uses than any other capitalist regime in history.

and

Never before, in peacetime, had a sophisticated capitalist economy been redirected so purposefully.

A question that could be asked is What does Tooze mean by a "capitalist economy"? I would assume that, at least in part, what he means is private ownership of the means of production. This in turn raises the question of What does private ownership mean? Here I follow Grossman and Hart (1986) in defining ownership in terms of control rights. You "own" an asset insofar as you have control rights over that asset. As Grossman and Hart put it

We define a firm to consist of those assets that it owns or over which it has control; we do not distinguish between ownership and control and virtually define ownership as the power to exercise control.

This terminology seems consistent with standard usage. For example Oliver Wendell Homes (1881) writes,

But what are the rights of ownership? They are substantially the same as those incident to possession. Within the limits of policy, the owner is allowed to exercise his natural powers over the subject-matter uninterfered with, and is more or less protected in excluding other people from such interference. The owner is allowed to exclude all, and is accountable to no one but him.

Another characteristic of ownership, I would guess, that Tooze may note is having control over residual income. Note that above ownership has been defined only in terms of control rights, not income rights. As Hart (1997) explains income rights may not be a well defined term,

A problem that one faces when discussing the notion of residual income is that in many contexts it is not well defined. For example, if two parties enter into a profit-sharing agreement, whereby party A receives log(pi+1) and party B receives pi-log(pi+1), where pi is total profit, then who is the residual claimant? The answer is both parties are. Given that profit-sharing contracts are not in principle costly to write if profits are verifiable (and it is unclear how residual income is to be allocated if profits are not verifiable), the conclusion is that residual income may not be a very robust or interesting theoretical concept.

In such a situation is hard to see how ownership can be define in terms of (undefined) income rights. That is not to say there are not good reasons for income and control rights being bundled together, as we normally see, it just means that having control rights over an asset is what makes someone the owner. Firms may, for example, have a profit sharing arrangement with their managers (effectively giving them residual income rights) without the managers being owners in the accepted meaning of the word. However the two sets rights are bundled in many contexts because they are highly complementary. To put it simply, income rights give you the incentive to use an asset efficiency, and control rights give you theability to do so. Thus having residual income rights (alone) in private hands doesn't mean ownership rights are also in private hands. The question of ownership depends on the allocation of control rights.

So did private individuals control rights over "their" assets within the Nazi economy? Tooze makes a number of comments with regard to state involvement in the economy and control over business: to take a few examples,

Now capitalism's deepest crisis left German business powerless to resist a state interventionism that came not from the left but the right

and

The first years of Hitler's regime saw the imposition of a series of controls on German business that were unprecedented in peacetime history.

and

As we have already seen, the New Plan, which effectively regulated the access of each and every German firm to foreign raw materials, created a substantial new bureaucracy, which controlled the vital functions of a large slice of German industry.

and

Managing this burdensome system of controls was the primary function of a new framework of compulsory business organizations imposed by Schacht between the autumn of 1934 and the spring of 1935. In each sector, the existing multiplicity of voluntary associations was fused together into a hierarchy of Reich Groups (for industry, banking, insurance, and so on), Business Groups (Wirtschaftsgruppen, for mining, steel, engineering and so on) and Branch Groups (Fachgruppen, for anthracite as opposed to lignite mining, and so on). Every German firm was required to enrol. Each subdivision in each Business Group was headed by its own Fuehrer. These men were nominated by the existing associations, vetted by the Reich Group and appointed by Schacht. The primary role of the Business Groups was to act as a channel between individual firms and the Reich Ministry of Economic Affairs. Decrees came down from the Ministry via the Business group. Complaints, suggestions and information travelled upwards from the firms, via the Business Groups to Berlin. The organization was tireless in the production of publications, guidelines and recommendations for the best practice. On the basis of emergency decrees first issued during the latter stages of World War I, the Business Groups were also empowered to collect compulsory reports from their members, establishing an unprecedented system of industrial statistics. After 1936 they were authorized to penetrate even further into the internal workings of their members, with the introduction of standardized book-keeping systems.

and

So far-reaching were the regime's interventions in the German economy - starting with exchange controls and ending with the rationing of all key raw materials and the forced conscription of civilian workers in peacetime - that one is tempted to make comparisons with Stalin's Soviet union.

and

[...] though there clearly was a dramatic assertion of state power over business after 1933, naked coercion was applied selectively [...]

What his points to is a high level of state control over business. While control over business was widespread, ownership was not taken over by the state in the manner of the Soviet Union. In Germany ownership remain in the hands of private individuals. While it is true that "formal" ownership remained with private individuals, a question has to be asked as to what happened to "real" ownership. As Aghion and Tirole (1997) point out for the case of organisations, there is a difference between formal authority (the right to decide) and real authority (the effective control over decisions). Formal authority need not confer real authority. A similar situation can occur with ownership when the state regulates business activity. Formal ownership (the right to decide) may not confer real ownership (the effective control over decisions) in so much as many of the control rights normally associated with ownership are not in the hands of the formal owners. Formal owners may be left with only residual income rights and a limited range of control rights. Given the level of regulation of the Nazi economy many of the rights usually thought of as making up (real) ownership had been effectively usurped by the state. Avraham Barkai writes in his book "Nazi Economics: Ideology, Theory, and Policy", Oxford: Berg Publishers Ltd., 1990.

In an off-the-record talk with a newspaper editor in 1931, Hitler defined the basic principle of his economic project: "What matters is to emphasize the fundamental idea in my party's economic program clearly-the idea of authority. I want the authority; I want everyone to keep the property he has acquired for himself according to the principle: benefit to the community precedes benefit to the individual ["Gemeinnutz geht vor Eigennutz"]. But the state should retain supervision and each property owner should consider himself appointed by the state. It is his duty not to use his property against the interests of others among his people. This is the crucial matter. The Third Reich will always retain its right to control the owners of property.

So while formal ownership remained with the private sector, this was little more than just an empty shell since real ownership had been (mis)appropriated by the state.

Also if we think of capitalism as an institutional arrangement involving the use of free markets, a common assumption, then clearly the Nazi economy was not capitalist.

Thus what meaning does the term capitalist retain in this example? If an economy that was so purposefully redirected by the state as the Nazi economy was, is capitalist, then the difference between socialism and capitalism becomes burred, to say the least. This burring of boundaries suggests that there is justification in Horwitz's call for a replacement for the word "capitalism" (and socialism).

Suggestions?

References:

• Aghion, Philippe and Jean Tirole (1997). ‘Formal and real authority in organizations’, “Journal of Political Economy”, 105(1): 1-29.
• Grossman, Sanford J. and Oliver D. Hart (1986). ‘The costs and benefits of ownership: a theory of vertical and lateral integration’, “Journal of Political Economy, 94(4): 691-719.
• Hart, Oliver (1995). “Firms Contracts and Financial Structure”, Oxford: Oxford University Press.
• Holmes, Oliver Wendell (1881). “The Common Law”, Reprint. Boston: Little, Brown, 1946.

Interesting blog bits

Fun for the weekend.

1. Mark Perry points out that Higher Education Is Failing Men, Not Women.
2. Brian Monteith suggest we See beyond glass to get Smith's house in order. It would be a pity, and ironic, if Adam Smith's house could not be used for the sort of discussions he used to hold in it, just because of modern-day bureaucracy.
3. Michael Enriquez notes that Fed Chairman Bernanke Chosen as Time Magazine's Person of the Year. For good or bad Bernanke had a big effect in 2009.
4. John Cassidy interviews John Cochrane. The real Chicago is about thinking hard and arguing with evidence.
5. John Cassidy also interviews Eugene Fama. The man who promulgated the efficient markets hypothesis.
6. Arnold Kling on Market Failure. Kling want to propose a new definition of market failure.
7. Freakonoimcs on When Radio Kills. During the 1994 Rwandan genocide, Radio Télévision Libre des Mille Collines (RTLM) broadcast anti-Tutsi propaganda and called for violence against Tutsis, which many experts believe significantly contributed to the violence.
8. Kristian Niemietz asks Should private schools be nationalised? After all, an invasion of South Korea by North Korea would not spread the South’s prosperity northwards, but the North’s misery southwards.
9. John Yaylor gives us More on "Too Low For Too Long". Much continues to be written about whether interest rates were too low for too long in the period 2003-2005 .
10. Liberty Scott says Pity Haiti and the Vatican's hypocrisy. If ever there was a country that long needed rule of law,a culture of reason and respect for individual liberty and property rights, and the end of kleptocratic violent government, it would be Haiti.

Ronald Coase: "markets, firms and property rights"

This address by, the then 98 year old, Ronald Coase (Clifton R. Musser Professor Emeritus of Economics at the University of Chicago Law School) to the conference "Markets, Firms and Property Rights: A Celebration of the Research of Ronald Coase" was recorded November 23, 2009.

Wealth and earthquakes

Donald J. Boudreaux makes a good point about the recent tragedy in Haiti,

Registering 7.0 on the Richter scale, the Haitian earthquake killed tens of thousands of people. But the quake that hit California’s Bay Area in 1989 was also of magnitude 7.0. It killed only 63 people.

This difference is due chiefly to Americans’ greater wealth. With one of the freest economies in the world, Americans build stronger homes and buildings, and have better health-care and better search and rescue equipment. In contrast, burdened by one of the world’s least-free economies, Haitians cannot afford to build sturdy structures. Nor can they afford the health-care and emergency equipment that we take for granted here in the U.S.

The benefits of economic freedom and the wealth that it helps generate are sometimes not seen until tragedy befalls us.

You may argue that stricter building codes are a major reason why the 1989 Bay Area quake killed far fewer people than did this week’s Haiti quake. But stricter building codes increase the cost of building and if you are poor and cannot afford expensive buildings you build cheap, less safe, ones. So you can have all the building codes you like, but people have to be wealthy enough to be able to afford to obey them, for them to work. Also buildings will get safer, even without building codes, as people get wealthier. The more wealth you have the more you have to protect and thus the more you are willing and able to spend on protecting it.

Mechanism design and terrorism

Fareed Zakaria gives us another reason (if you need one) not to torture people:

As for the calls to treat the would-be bomber as an enemy combatant, torture him and toss him into Guantanamo, God knows he deserves it. But keep in mind that the crucial intelligence we received was from the boy's father. If that father had believed that the United States was a rogue superpower that would torture and abuse his child without any sense of decency, would he have turned him in? To keep this country safe, we need many more fathers, uncles, friends and colleagues to have enough trust in America that they, too, would turn in the terrorist next door.

Incentives matter even in terrorism.

(HT: Jeff Miron)

Evil shortage

Bryan Caplan argues that the Soviet Union fell because of a shortage of evil. In his blog posting Evil Shortage: Why the Evil Empire Fell Caplan writes,

So why did the USSR fall? Because a new generation of half-hearted Communists like Gorbachev were allowed to take the reins - and they just weren't evil enough to retain power. If Stalin had been in Gorby's shoes, he would have reinforced the foundations of totalitarianism by murdering a few million people - beginning with active dissidents and gradually expanding to anyone who'd ever visited the West. And like Kim Jong Il, he would still be in power today. Gorbachev's generation of leaders were far from saints, but as tyrants go, they were wimps.

Of course it could have been that the economy had turned to crap and just couldn't keep on working.

Economics 101 moral hazard

This Center for Freedom and Prosperity Foundation 's Economics 101 video discusses the Moral Hazard, which occurs when bad choices are subsidized. This often happens when government intervention lets people take risks while having little or no skin in the game. Housing policies, for instance, subsidized mortgages, thus enabling irresponsible borrowing and leading to bubbles and bailouts. Politicians may be setting the stage for the next crisis with a too big to fail policy that will subsidize the biggest financial institutions.

Unwinding the monetary and fiscal stimulus

In this audio from VoxEU.org Pablo Guidotti, Director of the School of Government at the Universidad Torcuato Di Tella and former deputy minister of finance in Argentina, talks to Romesh Vaitilingam about the challenges facing monetary and fiscal policy-makers as they plan their exit strategies from the extraordinary measures taken to deal with the global crisis.

Why "Buy American'' is a bad idea but politicians still like it

and, of course, its not just "Buy American" that's a bad idea, all "buy local" campaigns are dumb. This point is made in a new working paper by Mario Larch and Wolfgang Lechthaler called Why Buy American'' is a Bad Idea but Politicians Still Like it, Kiel Institute for the World Economy, Kiel Working Paper No. 1570, November 2009.

Larch and Lechthaler are interested in whether it is a good idea to respond with protectionism in the case of a negative productivity shock. They analyse the dynamics of transitory changes to trade barriers as a short-run response to an economic downturn in a dynamic, general equilibrium new trade theory model with heterogenous firms. They look at a number of different scenarios, where they distinguish whether the trading partner responds to increased trade barriers or not. The main conclusion is that protectionism hurts all countries, including the country imposing the protectionist measures, even if the other countries do not react with protectionism by themselves. Thus they show that the beggar-thy-neighbour policy does not work. A country cannot shield itself from an economic downturn of its trading partners by imposing temporarily higher trade barriers, but rather hurts itself. Thus, the results from their model yields a powerful argument against any kinds of protectionism.

But politicians still seem to like protectionist measures, Why? Is there a way to rationalise the actions of politicians? The answer from Larch and Lechthaler is yes. There are two rationales that help to understand why countries consider protectionism to be a good idea as a response to a recession: Firstly, even though higher trade barriers deter the gains from trade, they mitigate the negative spill-over effects from shocks in other countries. Secondly, firms are hit differently by protectionism. Domestic firms that do not export at all gain in terms of total profits from raising trade barriers, whereas exporting firms loose. Governments may raise trade barriers in order to support local firms, which may be important campaign contributors and voters in the next election. So rent seeking by non-exporters influences politicians.

$123,000,000,000,000 question

Will China's economy be worth $123 trillion by 2040? The Nobel Prize winning economist Robert Fogel says yes. In the journal Foreign Policy he writes,

In 2040, the Chinese economy will reach $123 trillion, or nearly three times the economic output of the entire globe in 2000. China's per capita income will hit $85,000, more than double the forecast for the European Union, and also much higher than that of India and Japan. In other words, the average Chinese megacity dweller will be living twice as well as the average Frenchman when China goes from a poor country in 2000 to a superrich country in 2040. Although it will not have overtaken the United States in per capita wealth, according to my forecasts, China's share of global GDP -- 40 percent -- will dwarf that of the United States (14 percent) and the European Union (5 percent) 30 years from now. This is what economic hegemony will look like.

A big call, but not one I would argue is necessarily wrong. China has been growing fast and will continues to do so. But there are problems ahead: rising income inequality, potential social unrest, territorial disputes, fuel scarcity, water shortages, environmental pollution, and a still-rickety banking system, for example.

For Fogel there are five main reasons for thinking China can overcome these problems and become a world economic superpower.

The first essential factor that is often overlooked: the enormous investment China is making in education. More educated workers are much more productive workers. (As I have reported elsewhere, U.S. data indicate that college-educated workers are three times as productive, and a high school graduate is 1.8 times as productive, as a worker with less than a ninth-grade education.) In China, high school and college enrollments are rising steeply due to significant state investment. In 1998, then-President Jiang Zemin called for a massive increase in enrollment in higher education. At the time, just 3.4 million students were enrolled in China's colleges and universities. The response was swift: Over the next four years, enrollment in higher education increased 165 percent, and the number of Chinese studying abroad rose 152 percent. Between 2000 and 2004, university enrollment continued to rise steeply, by about 50 percent. I forecast that China will be able to increase its high school enrollment rate to the neighborhood of 100 percent and the college rate to about 50 percent over the next generation, which would by itself add more than 6 percentage points to the country's annual economic growth rate. These targets for higher education are not out of reach. It should be remembered that several Western European countries saw college enrollment rates climb from about 25 to 50 percent in just the last two decades of the 20th century. [...]

The second thing many underestimate when making projections for China's economy is the continued role of the rural sector. When we imagine the future, we tend to picture Shanghai high-rises and Guangdong factories, but changes afoot in the Chinese countryside have made it an underappreciated economic engine. In analyzing economic growth, it is useful to divide an economy into three sectors: agriculture, services, and industry. Over the quarter-century between 1978 and 2003, the growth of labor productivity in China has been high in each of these sectors, averaging about 6 percent annually. The level of output per worker has been much higher in industry and services, and those sectors have received the most analysis and attention. (I estimate that China's rapid urbanization, which shifts workers to industry and services, added 3 percentage points to the annual national growth rate.) However, productivity is increasing even for those who remain in rural areas. In 2009, about 55 percent of China's population, or 700 million people, still lived in the countryside. That large rural sector is responsible for about a third of Chinese economic growth today, and it will not disappear in the next 30 years.

Third, though it's a common refrain that Chinese data are flawed or deliberately inflated in key ways, Chinese statisticians may well be underestimating economic progress. This is especially true in the service sector because small firms often don't report their numbers to the government and officials often fail to adequately account for improvements in the quality of output. In the United States as well as China, official estimates of GDP badly underestimate national growth if they do not take into account improvements in services such as education and health care. (Most great advances in these areas aren't fully counted in GDP because the values of these sectors are measured by inputs instead of by output. An hour of a doctor's time is considered no more valuable today than an hour of a doctor's time was before the age of antibiotics and modern surgery.) Other countries have a similar national accounting problem, but the rapid growth of China's service sector makes the underestimation more pronounced.

Fourth, and most surprising to some, the Chinese political system is likely not what you think. Although outside observers often assume that Beijing is always at the helm, most economic reforms, including the most successful ones, have been locally driven and overseen. And though China most certainly is not an open democracy, there's more criticism and debate in upper echelons of policymaking than many realize. Unchecked mandates can of course lead to disaster, but there's a reason Beijing has avoided any repeats of the Great Leap Forward in recent years. [...]

Finally, people don't give enough credit to China's long-repressed consumerist tendencies. In many ways, China is the most capitalist country in the world right now. In the big Chinese cities, living standards and per capita income are at the level of countries the World Bank would deem "high middle income," already higher, for example, than that of the Czech Republic. In those cities there is already a high standard of living, and even alongside the vaunted Chinese propensity for saving, a clear and growing affinity for acquiring clothes, electronics, fast food, automobiles -- all a glimpse into China's future. Indeed, the government has made the judgment that increasing domestic consumption will be critical to China's economy, and a host of domestic policies now aim to increase Chinese consumers' appetite for acquisitions.

Crime and the economy 2

Earlier I noted the article by Heather MacDonald from the Wall Street Journal which raised the question, in terms of the US, If poverty is the root cause of lawlessness, why did crime rates fall when joblessness increased? Fred Hansen at the ASI blog notes a similar trend for the UK. He writes,

If you look at the latest crime statistics you are probably in for a surprise. Recorded crimes fell 5% to 4.7 million in 2009. Here are the latest stats for the UK:

* Violence against the person down 6%
* with injury down 7%
* Domestic burglary up 1%
* Offences against vehicles down 10%
* Theft from the person down 12%
* Criminal damage down 10%
* Robbery down 5%
* Drugs offences up 6%

But unemployment is also up in the UK, so we have the same question for the UK as for the US.

But perhaps we shouldn't be too surprised that the current data show something different from past data. As Papps and Winkelmann, who looked at the relationship between unemployment and crime in New Zealand, put it

The unemployment-crime relationship is an old issue. No consensus has been reached by economists during the last three decades, nor does one seem likely to emerge in the near future. (Papps and Winkelmann p. 68)

Those words were published in 2000 and if we accept 2010 as the near future, the current debate just proves Papps and Winkelmann right.

• Papps, Kerry and Winkelmann, Rainer. 'Unemployment and Crime: New Evidence for an Old Question', New Zealand Economic Papers, June 2000, v. 34, iss. 1, pp. 53-71.

EconTalk this week

Michael Belongia of the University of Mississippi and former economist at the St. Louis Federal Reserve talks with EconTalk host Russ Roberts about the inner workings, politics, and economics of the Federal Reserve. Belongia talks about the role that power and politics play in Federal Reserve decision-making and how various Fed chairs used their power to suppress dissent within the Fed that was critical of Fed policy. He argues that the Fed faces an unresolvable dilemma when asked to achieve the multiple goals of full employment and price stability using only the federal funds rate as a policy lever. The discussion concludes with Belongia's indictment of the monetary data that the Fed produces.