Greg Mankiw Misreads Larry Summers

Are mandated benefits, such as a compulsory health insurance, simply taxes? Greg Mankiw (“Is a mandate a tax?”, his blog, Wednesday, September 23) thinks so and quotes Larry Summers’ 1989 paper (“Some Simple Economics of Mandated Benefits”, The American Economic Review, May 1989) for sustaining this point of view.

I think that Mankiw is wrong and did not read Summers thoroughly. Summers wonders indeed:”Are there differences in the real effects of mandated benefits and tax-financed programs?” And he goes on “…I find that there are important differences in the efficiency and distributional consequences of standard public provision and mandated benefits programs. Essentially, mandated benefits are like public programs financed by benefit taxes. (My emphasis. And this last sentence is the only one quoted by Mankiw).”

But then Summers adds in section 2, titled “Mandated Benefits or Public Provision”:
“It is often asserted that mandated benefits are just hidden taxes with the same efficiency and incidence implications as taxes, so that the choice between public provision and mandated benefits should depend only on the relative efficiency with which employers and the government can provide a service. I challenge the equivalence of these two methods of provision below.”

A first reason for doing so is that privately supplied mandated benefits preserve a margin of choice regarding the quality of service. Public provision supplies the same service to all, while some of the insured, given a choice, would select a lower quality and lower cost service, while others would prefer higher quality and cost. There is thus a welfare loss inherent in a one-size-fits-all insurance service and price.

More importantly,though, Summers sees differences in welfare deadweight losses:

“Another argument in favor of mandated public benefits rather than public provision is that mandated provision avoids the deadweight loss of tax-financed provision”. And he quotes various evaluations of the importance of the deadweight loss in the literature (Stuart, Browning, and others).

This is precisely the argument I use in my proposal for a reform of the health insurance systems in France and Europe (“Comment gagner plus?” Commentaire, 2009, downloadable on my personal homepage) advocating a repeal of the current dual purpose tax-financed public provision, in which the tax serves the dual purpose of covering the health care expenses (an insurance scheme) on the one hand, and redistributing income from the high wages earners to low wage earners through the payroll tax, in order to supply to the latter the same public provided health insurance coverage but at a much lower cost than to higher wage earners, on the other hand.

What I suggest is to limit the use of a payroll tax to this second, redistributive, aspect (about one third of the current tax), and to replace the publicly supplied insurance by a privately purchased but compulsory health insurance. This would reduce the payroll tax by about two third, and the deadweight loss by the same proportion. It would thus allow for a major reduction in the level of taxes in Europe, given that the payroll tax financed health insurance amounts to about 8 to 12percent of GDP. A reduction of two third of these taxes would represent a tax cut of about 5 to 8 percent of GDP -- a major tax rebate, without any cut in the services provided to insured people.

Definitely, such a mandated benefit formula cum the same income redistribution characteristics as the present systems (a health care insurance voucher for lower income households) would constitute a Paretian improvement over the present European tax financed and publicly supplied health insurance systems. And it would boost growth too.

I would be glad to know what Greg Mankiw thinks of such a reform.

Pourquoi, oh pourquoi l'Europe?

Un ami lecteur me signale la sévère critique qu’un M. Jean-Pierre Chevallier « business économiste » (sic) adresse à mon récent article « Mais pourquoi l’Europe ? », publié sur ce blog le 7 juin 2009 et disponible sur mon site. Mon analyse, affirme-t-il, ne présente « aucun intérêt » et il ajoute, dans sa réponse à l’un de ses lecteurs le 11 /06/2009 à 11h24 sur http://www.jpchevallier.com:

« Ni la réussite, le dynamisme, ni le taux d’imposition d’une nation ne dépendent de sa taille : les petits Suisses (6 millions) et les Américains (des US, 300 millions) sont performants et avec un Etat à l’optimum. Idem avec des Etats qui ont des taux de prélèvements obligatoires élevés : Suède, France, Chine » (sic).

Grand merci à M. Chevallier pour le soutien qu’il apporte à mon argumentation. J’explique en effet qu’un grand marché intérieur n’est pas nécessaire, aujourd’hui, à la prospérité de l’économie puisque les entreprises d’un petit pays ont accès au grand marché mondial du fait de la libéralisation générale des échanges (la mondialisation). Il s’ensuit que là où la grande dimension de la nation, et donc du marché intérieur, constituait un avantage certain pour les grandes entreprises américaines dans une ère de protectionnisme et de cloisonnement de l’économie mondiale, au cours du « premier vingtième siècle » allant jusqu’aux années 60, le grand marché « intérieur » européen, qui a été très utile à ses débuts, n’apporte pas de contribution significative à la prospérité des entreprises aujourd’hui. On ne peut donc pas fonder une argumentation favorable à la construction d’un grand ensemble européen sur cet argument obsolète.

D’autre part, M. Chevallier nous assure (comment le sait-il ?) que la dimension des divers Etats, de la Suisse à la Chine et de la France à l’Allemagne, est partout « optimale » et que d’ailleurs elle n’affecte en rien la performance économique de ces nations.

Mais alors, question sans doute trop naïve de ma part, pourquoi vouloir intégrer à toute force les Etats de la France, de l’Allemagne, et de quelques autres pays européens en un grand Etat continental commun puisque chacun de ces pays bénéficie déjà de la dimension optimale de son appareil étatique?

Il s’ensuit que, selon M. Chevallier, la construction européenne n’est nécessaire ni à la productivité des entreprises, ni à l’efficacité des Etats. C’est le point de vue que je défendais dans l’article qu’il juge sans aucun intérêt.

Peut-être n’ais-je pas saisi sa critique ?

The US Recession and the Demand for Money

For a clear statement of the problem read David Beckworth's blog Macro and Other Market Musings here .

Banker Pay NOT the Problem

Tyler Cowen (Marginal Revolution, September 21) is quite right to raise the question: everybody now says it caused the crisis. But is this new conventional wisdom, embraced by President Obama and the leaders of France and Germany, true?

John Kay’s argument, for instance, about the “New Peter Principle” (Financial Times, August 25) according to which top managers (and bankers) always reach their incompetence level and then waste shareholders’ wealth by mismanaging, thus leading the economy into crisis, is based on a faulty understanding of the classical agency problem well known to financial economists. The loss of control by shareholders was there on a permanent basis well before the crisis. It explained some waste but at a steady level. In order to cause the excesses of the recent years it should have been increasing steeply, all of a sudden, and there is no evidence of such an increase in the loss of shareholders'control.

Moreover, the fact that managers reach their level of incompetence does not mean that from that point on they will systematically make all the wrong decisions, ruining the firms they manage. It is a mechanism for allocating scarce talent among firms, not a macroeconomic decrease of the agregate amount of talent in the economy.It means on the contrary that the allocation of managers to positions is optimal, i.e. maximizing the total wealth they create for their firms.

The reason is that their incompetence is marginal. At the margin of the amount of business they supervise, their marginal productivity is decreasing up to the point where the value that they create is just equal to the payment they receive from the firm. Thus they should not be allowed to develop the volume of business under their control any more. But this is true of all contributions from factors of production in the neoclassical analysis. It does not lead to any “crisis”.

True, there is indeed a large responsibility of banks in the current crisis (excess diversification in risky activities, too big to fail problem) but excessive payments to greedy bankers is not central, and one can fear that it is used to draw attention away from the main difficulties and possible solutions.

Read the Cowen post here .

Krugman Proved Wrong : Levine

In an Open Letter not to be missed, David K. Levine chastises Paul Krugman, who accuses the economic profession (and especially Chicagoan and financial economists) of failure, for his ignorance of the work of a large number of contemporary economists. In the Huffington Post (September 19) here .

Hat tip to Greg Mankiw.

A Critique of the European Central Bank

Rebecca (NewsNEconomics) argues that the ECB didn’t do enough to support the Eurozone economy. She posts an interesting graph (above). The point is well taken, but disequilibrium, within zone, implicit exchange rates exert an even worse effect on activity.

Read the paper here .

The « Great Recession » in Perspective

Above is a Bureau of Economic Analysis (BEA) presentation of the history of recessions and of the Great Depression, posted by Greg Mankiw on his blog (September 9).

Apparently I was right to claim almost from the start, and on this blog (“Raison garder”, November 28, 2008), that the magnitude of the current crisis was not, in any way, comparable to that the Great Depression.

Tens of Thousands Rally Against Big Government in Washington D.C.

They oppose taxes, spending and health care plans (which mean more spending and more taxes in the future) of the federal government, the Washington Post reports (Saturday, September 12).

But what’s surprising in fact is that such a protest comes so late, while governments have kept growing, in the US as elsewhere, in an era of general downsizing of all hierarchical organizations (and the state is a country’s largest one usually), against the “natural” trend deriving from the information and communication revolution.The massive transfers operated during the financial crisis may have triggered a new awareness of the contradiction, while inducing the Obama administration to (wrongly) believe that the New Deal interventionist era was back for good.

Economic Revolutions and General Purpose Technologies

Commenting on Gegory Clark’s work on the impact of innovations on aggregate growth during the industrial revolution (“The Secret History of the Industrial Revolution”, Working Paper, University of California at Davis, October 2001) in which he shows that it crucially depends on such accidental factors such as the size of the sector affected and the price elasticity of demand, Brad de Long points to the fact that “even extraordinary rates of invention and innovation in any one sector have a limited impact on overall economic growth. (…) in a sector with a healthy 10% expenditure share, not subject to satiation, (…) a thousand-fold multiplication of productivity in the sector leads to a mere doubling of aggregate wealth.

To truly modern economic growth – not just one doubling of wealth but repeated, ongoing doubling – no narrowly-focused set of inventions will suffice. You need broad-based economic growth produced by constantly revolutionizing technologies in most of not all of the economy.” (“Leading Sector Technology and Aggregate Economic Growth: A Finger Exercice”, De Long’s blog, September 7, 2009).

It means, I would like to add, that only “General Purpose Technologies” (GPT) can bring about an economic revolution. It was the case of electricity and of gas powered engines in the 1920s, and it is of course the case of IT today.

Do Central Banks and Independent Economists Mix?

“How the Federal Reserve Bought the Economic Profession” is an honest and precise analysis of how the Federal Reserve dominates the field of economics and stifles real criticism, in The Huffington Report here .

Things are even worse on this side of the Atlantic since criticisms of the European Central Bank (other than on technical niceties) amount to zilch, and the bank controls the profession through employment of economists, research grants, and gate keeping of journals and publications by affiliates, helped in this task by national central banks (Yes, they still exist despite monetary integration!). Hence the dominance of monetary macroeconomics, and the overall approval of the euro by European economists, even when they voice some superficial doubts, only to better refute real and fundamental criticism.

But it would be fair to add that central banks, in turn, are extremely dependent on financial big businesses.

Inflation or Deflation?

While Paul Krugman says that large resource gaps have made him worried about deflation, Allan Meltzer says that massive growth in the monetary base has made him worried about inflation.

Charles L. Evans, President and Chief Executive Officer, Federal Reserve Bank of Chicago, thinks “neither a harmful deflationary episode nor a repetition of the Great Inflation (1965-1982) is very likely” and develops an interesting argument leading to that conclusion.

A link to his paper: here .

American Capitalism and the Corporatist Trap

At last a serious analysis of the current crisis and its origin in the development of the corporatist, crony capitalism. Luigi Zingales, Professor of Entrepreneurship and Finance at the University of Chicago, and co-author with Raghuram Rajan of Saving Capitalism from the Capitalists (a great book by the way) urges the government to support genuine pro-market reforms by appealing to the best of the populist tradition, and to limit the banks' and large firms' political connections that undermine the traditional American understanding of the difference between free markets and big business.

“This would mean abandoning the notion that any firm is too big to fail, and putting rules in place that keep large financial firms from manipulating government connections to the detriment of markets. It would mean adopting a pro-market, rather than pro-business, approach to the economy.
The alternative path is to soothe the popular rage with measures like the limits on the executive bonuses while shoring up the position of the largest financial players, making them dependent on government and making the larger economy dependent on them. Such measures play to the crowd in the moment, but threaten the financial system and the public standing of American capitalism: a path that blurs the distinction between pro-market and pro-business policies, and so imperils the unique faith the American people have long displayed in the legitimacy of democratic capitalism.”

Bravo. Unfortunately, the European governments have precisely chosen this "alternative path" and it is no happenstance. Readers of this blog will make the parallel with my denunciation of “patronalisme” (systematic pro-business and anti-growth policies) which, I claim, explain in large part the dismal performance of the corporatist European economies (September 8, 2008, “L’erreur historique de Jean Peyrelevade”, also published in Commentaire, n° 124, Hiver 2008-2009, and see also my "La crise des capitalismes hiérarchiques" in Commentaire, also downloadable on my website).

For a first step in the direction of a return to a competitive (and ethical) capitalism, it is essential to make completely clear that a pro-market (or competition-enhancing) policy is quite a different thing from a pro-business one. A distinction that Europeans, raised in and accustomed to heavily corporatist and collusive economies, fail to understand. As a consequence they dub their collusive systems of big state and big business “ultra-libéralisme”, a characterization that is the exact opposite of the truth.

The Zingales paper is thus a must read here.

And I can only warn my American friends: do not follow the European way.

(Hat tip to Greg Mankiw for signaling the paper).

Economics Still Useful … and Fun

William Easterly on the current cheap anti-economic rhetoric and the amazing predominance of pretty Eastern European women in pro tennis here .

Color Photos of Tsarist Russia, 1907-1915

They really give another view of a beautiful country, not unlike contemporary underdeveloped ones. Courtesy Newsweek here , via Tyler Cowen.






http://www.newsweek.com/id/214585http://www.newsweek.com/id/214585

In Search of the Next Information Revolution

Can scientists go on increasing the availability of cheap information in the coming years? The now “traditional” transistor is reaching its limits and researchers push to create the next generation of switching devices smaller, faster and more powerful than today’s ones.

Read today’s New York Times article here .

Given the huge impact of the quantity (and cost) of information on organizational structures, further progress in that direction would comfort the decentralizing and democratizing trends initiated in the 1970s.