In response to the Athens riots

Unrestrained idealism, explosive temperament and no much to lose will get you that way. I don’t know if its better but its definitely sexier than polite complaints uttered quietly about the state of things. - Srta. Batsouli

Shut-up, NYT: Mankiw Will Work Less if Taxed More (see also: Laffer curve)

The bright and extremely personable professor of economics at Harvard University, Greg Mankiw, writes in the NYT about how higher taxes mean he'll end up working less.

HERE’S the bottom line: Without any taxes, accepting that editor’s assignment would have yielded my children an extra $10,000. With taxes, it yields only $1,000. In effect, once the entire tax system is taken into account, my family’s marginal tax rate is about 90 percent. Is it any wonder that I turn down most of the money-making opportunities I am offered?

I'd like to personally thank Greg for this eloquent explanation of the Laffer curve. I'm sure it's included in once of his excellent textbooks, although this article was certainly more memorable. My issue is with his last thought, though:

Now you might not care if I supply less of my services to the marketplace — although, because you are reading this article, you are one of my customers. But I bet there are some high-income taxpayers whose services you enjoy.

Maybe you are looking forward to a particular actor’s next movie or a particular novelist’s next book. Perhaps you wish that your favorite singer would have a concert near where you live. Or, someday, you may need treatment from a highly trained surgeon, or your child may need braces from the local orthodontist. Like me, these individuals respond to incentives. (Indeed, some studies report that high-income taxpayers are particularly responsive to taxes.) As they face higher tax rates, their services will be in shorter supply.

Yes, maybe. But Greg is making the assumption that if he doesn't provide his services, someone else wouldn't step-in to fill in the gaps. I'd see this argument being valid when we are close to full employment levels, but the unemployment rate amongst individuals, even if lower than the less educated, is still elevated.

Image source: Calculated Risk

I'm sure that there is plenty of unemployed or underemployed economists who would be happy to take that work Greg doesn't really want, many of which are probably adequately qualified, even if they lack his reputation.  To Greg's possible substitutes that fall under a lesser marginal tax-rate, this same work would yield more savings, meaning they'd be more willing to take on that extra work even if their supply curves are identical. Those who are less financially comfortable and are more willing to sell their labor may be willing to provide the same services for the lesser compensation they might be offered as a result of lacking Greg's name-recognition. So my final comment to Greg is that it may be worth considering that maybe this is not so much about "how much the government should redistribute income" but about how much government should redistribute the opportunity to work. And right now, Greg, there is plenty of us that would be perfectly willing to provide our services for both income, and the opportunity to create a name for ourselves so that one day we too can turn down jobs because, after taxes, they don't pay that much.

As a final nitpick, that 90% estimate is kind-of a worst-case scenario. If Greg's concern is really how much taxes are going to reduce what he finally leaves his children and grandchildren, he should look into estate-planning and all of the opportunities there is to distribute accumulated wealth to heirs over time to reduce the tax-impact, whether it is tax-exempt gift allowances, 529 Plans, or other of the products that are available for these purposes. If you are interested in any of those services, Greg, please feel free to leave a comment and I will make sure to put you in touch with some financial professionals that are both highly-qualified and very much willing to work.

Wikipedia, Khan Academy and The Price of Knowledge in the Digital Age

Being twenty-six years old and having been heavily-involved in technology since my early teen, I've had a chance to witness a lot of big things from the beginning. I remember when Audioscrobbler (the thing that drives Last.fm) was still a grad-school project.  I remember when OpenID was just a post on Brad Fitz' LiveJournal. I remember when Wikipedia got it's 1000th article. My first contribution as a registered user dates to September 2002. Back then Wikipedia was a sort of wild-west and I didn't even know what "peer-review" meant. I've been programming for the better part of the last 12 years and and remember making contributions to the software that runs Wikipedia before it even had a name. I remember the site being down for hours and hours--sometimes even days--when the servers were overloaded or a hard drive failed.

Anyway, one of my favorite memories is showing my father Wikipedia and him laughing. He attempted to explain the concepts of authorship and authority, why he was skeptical about the quality of the site, and how the concept of it all was a radically different from the status-quo--naturally, I had no interest. As time went on, he increasingly became a believer too. We were seeing this massive revolution happen before our eyes, in the shadows of the .com crash, when nobody gave a flying fuck about tech anymore. I didn't realize what it all meant then, but I remember my father talking to his friends about it and heated debate happening; they were all genuinely interested and excited about what it meant. In the true, original spirit of the internet, Wikipedia was democratizing access to knowledge, leveled the playing field like few things before, and it was all capital "F" Free. The price to access it was $0.00 and the value of it was increasing exponentially as the network of information nodes became increasingly interconnected and of increasingly better quality. The most relevant comparison in my mind is probably the Gutenberg press.

Recently, I had a feeling of deja-vu as I signed-on to the Khan Academy. I first learned about the Khan Academy a little over a year ago. I was having a little bit of trouble remembering some mathematics concept and someone suggested I look for it on Youtube, as there was this "Sal dude" posting instructional videos. I searched, found, learned, and didn't really give it much thought again. Since then, Sal Khan was gotten a ton of press, and so recently, idle from my lack of employment, I logged on to the Khan Academy. I was totally shocked by what I found. Not only is the library of lessons huge but I finally used the problem-generating component, and I was totally floored by what I found. Sal created a "Knowledge map" (accessible once you sign-in with a Google account) wherein as you complete certain lessons and the set of problems satisfactorily, new areas are suggested.

The system is basically a tree of nodes that correspond to a specific lesson, each of which has an instructional video. Each node has zero or more parents, with the root node being "Addition 1". As nodes are completed, new ones are recommended, organically building upon the previous ones. Completing "Addition 1," recommends "Addition 2" and "Subtraction 1". As nodes are completed,  the student can continue to explore each branch of the tree independently. Likewise, someone who is interested in learning, for example, linear algebra, could look at the map and follow it back until he or she found the first familiar subject and then beginning with the next lesson.

The videos--mostly math-related at present time--are both focused and engaging. Khan is a gifted teacher, able to distill lessons to their core and present everything you need to know about one thing in a few minutes.  With 20-30 minutes a day, one could easily follow the knowledge map and become proficient in most any mathematics subject in a couple of weeks or months. Any motivated learner has the ability to learn whatever they want, at whatever speed they want, at no cost at all. For parents who lack the knowledge to coach their children or are unable to afford tutors; adults that need additional education but lack the economic means or time to do it at a traditional venue; and students wishing to place higher in college math-placement exams in order to save themselves an unnecessary and expensive introductory or remedial course, the implications are huge. Khan has singlehandedly, in a remarkably short time, changed the landscape for mathematics education.

To test it all out, I decided to "attend" the Khan Academy. I started with lesson 1, "Addition 1." and worked myself up to calculus over a couple of days. I didn't watch the videos for the simpler subjects like addition and subtraction, but I did start skimming through once I got to Algebra II and started really watching in the later parts of Trigonometry. I was amazed of how fast time went, and how rewarding it was to complete the subject examinations--you must get 10 consecutive questions right in order to advance. Both the videos and problem-sets were generally completed before my attention span was exhausted, which means 10-15 min. As I completed problem sets and worked my way up the map, I started feeling like I was opening new levels on a video game or something, it was really strange.

The process is not limited to individuals working on their own. Pupils are able to enter a "coach ID" and be linked to a "class". The interactive problem sets generate data that the coach can use to identify students that are stuck on a certain type of problem or are working at below/above average speeds. Because the students can work independently of one another, no one student is held-back or left-behind. Someone having trouble with, for example, variable substitution can simply re-watch the short lecture, rewinding or fast-forwarding as needed to focus on the points he or she doesn't grasp.

I understand that this is not the first experiment of it's kind, I'm familiar with Open Course Ware and I've used iTunes U, but this is definitely different. The casual approach, accessible language, narrow focus, instant availability, lack of requirements and flexible structure all combine to create something orders of magnitude more accessible to the casual user. Not everybody knows how to use a podcast, but everyone knows how to work Youtube. Just click "play," and look at your screen, it's that simple. Have a question? Under each video is a list of previously-asked questions and responses, and if yours is not on there, you can add it instantly and someone is likely to respond promptly. I'm not saying this approach will work for every subject, but I have no doubts it could work for at least undergrad-level physics, chemistry and finance. As someone who barely passed high-school chemistry, something like this would have saved me a lot of angst as I tried to cover a month's worth of skipped classes the Thursday night before the test.

With the recent press the Khan Academy has been receiving, including public accolades from Bill Gates and sizable donations, the project has been able to pay Sal a salary and will be able to fund it's continuing existence. As momentum builds, it is not unreasonable to expect the number of contributing teachers to increase--some volunteers are already helping translate and close-caption the videos. Because the subjects covered don't change, there is no reason why these videos couldn't be used for generations to come--although, admittedly, some of the earlier ones could use a quality upgrade. The value produced by the Khan Academy is accumulative and increases with each additional topic and translation--I can't even imagine what a textbook company would be willing to pay for it--yet the price to access it, like Wikipedia, is zero. Of course, the free ability of content online is not enough, you have to give people access to the internet first, but with the ubiquity of mobile-phone service, rapidly-falling prices of computers and initiatives like OLPC, it isn't hard to imagine a world ten years from now where 80% of school-age children have access to the internet, even if it is from a shared device. When I first understood what Wikipedia was about, nine years ago, all I could think about was "Wow, this is going to change everything." Mark my words, this will change everything, too.

Must read from Interfluidity

 Even in a depression, cutting expenditures to entrenched interests that make poor use of real resources can be beneficial. Even in a boom, high value public goods can be worth their cost in whatever private activity is crowded out to purchase them. Rather than focusing on “how much to spend”, we should be thinking about “what to do”. ... If we do smart things, we will do well. If we do stupid things, or if we hope for markets to figure things out while nothing much gets done, the world will unravel beneath us. We have intellectual work to do that goes beyond choosing a deficit level. The austerity/stimulus debate is make-work for the chattering classes. It’s conspicuous cogitation that avoids the hard, simple questions. What, precisely, should we do that we are not yet doing? What are the things we do now that we should stop doing? And how can we make those changes without undermining the deep social infrastructure of our society, resources like legitimacy, fairness, and trust?

Ummm, yeah, what he said. I've been trying to make that point for six months now, but Stever just blew me away with how well he presented the argument.

Previously:
"My biggest criticism is the assumption that the fiscal stimulus will be spent in value-creating projects / activities--I simply don't think politicians can be trusted to do this." -- From my review of The Holy Grail of Macroeconomics

"Sometimes I really wonder if policymakers understand that the best and most sustainable path to increasing your wealth is not to take someone else's, it's to create your own." -- China, bubbles trade-wars and balance of payments

"For example, if RMB 100 is borrowed to build a railroad, the debt is sustainable if the railroad creates net economic value to China of RMB 100 or more. If it doesn’t, the difference must be considered net debt that one way or another must be paid for by Chinese households." -- Pettis on debt-fueled stimulus

China: Exchange rates, productivity and inflation

Pettis writes today:

China is faced with a difficult policy choice. It can maintain an undervalued exchange rate, it can run the risk of inflation, or it can increase the domestic costs of financial repression. How Beijing balances these separate forces will determine the pace and form of its necessary rebalancing.

Which is much along the lines of what I wrote a couple of weeks ago. As always, I highly recommend reading all of Pettis' blog, which is very informative. What I found most interesting this time around was his discussion in inflation. In a closed economy, a rise in productivity increases the amount of goods provided, leading to price decreases as the number of good rises and the amount of money stays the same. In this scenario productivity increases and money supply growth can coexist and maintain price levels stable, even if a small amount of money is being printed.

On Koo: Using Stimulus to Avoid Deflation

I recently finished reading The Holy Grail of Macroeconomicsby Richard C. Koo, and incredibly well-thought out, if slightly repetitive, account on what he calls Balance Sheet Recessions. You might recognize his name since he's been in the news recently. I loved the book, even though I am sure he could have written it in half the pages. I've been waiting to write about this topic until I have the time to write a book review about Holy Grail, but I can't let Perfect be the enemy of Good here. Basically, Koo explains that after an asset-bubble implosion, the private sector is stuck holding assets which are worth less than the debt used to buy them, like the "under water homeowners." When this is the case, Koo argues, businesses will focus on paying down debt as fast as possible at the cost of profit maximization because they are technically (close to) insolvent, that meaning liabilities outweigh assets. During these times of no credit demand, monetary policy becomes impotent and businesses will refuse to borrow, no matter how long the interest rate, leading to a shrinking money supply, or deflation. I am not going to argue about whether deflation is a good or bad thing, but Koo explains that if a government wants to avoid deflation, it should become the borrower of last resort and borrow excess funds from the private sector to use as fiscal stimulus, therefore staving off deflation.

His thesis is well documented, to the point where you want to scream, "OK! I GET IT! JUST PLEEEEASSEEE MOVE ON!" It is hard to argue against it, since it does make sense. The problem with it is that Koo--wrongly, in my opinion--assumes that the Government will adequately allocate that capital. According to Koo, the excess savings from the private sector deleveraging, combined with accommodating monetary policy from a central bank, will keep borrowing costs low until the private sector recovers and starts borrowing again, at which time the government should start to scale back stimulus letting the private sector take over. Koo argues that the growth in the debt have little effect because borrowings will be financed at low rates and, as the economy recovers, tax-receipts will organically increase, leading to deleveraging in the public balance sheet as the private one releverages.

While Koo's is an elegant model, I have some bones to pick. First of all, Koo is proposing a solution to a problem--he's giving us insecticides to kill our pests. While I welcome his contribution, it doesn't mean that we shouldn't still focus on reducing or avoiding asset-price bubbles. As Pettis so eloquently wrote:

By net contingent liabilities I mean the excess of debt over the value of the investment it supports. For example, if RMB 100 is borrowed to build a railroad, the debt is sustainable if the railroad creates net economic value to China of RMB 100 or more. If it doesn’t, the difference must be considered net debt that one way or another must be paid for by Chinese households. This will of course reduce their future consumption along with the economic growth associated with satisfying that consumption.

Pettis may be talking about China, but the issue of mal-investment still applies. The federal government can borrow as much as it wants to stimulate the economy, guarantee Build America bonds, back-stop bank losses and fight tooth-and-nail to fight deflation, but if the capital is poorly allocated, it may be creating a bigger problem than it started. Fighting asset-price bubbles starts with making sure interest rates are not negative. Greenspan enacted used monetary policy to stimulate the economy after the .com bubble and, as Koo explains Chapter 7, started inflating " the housing market, the most interest-rate-sensitive sector of the economy." Well, look how that turned out.

I am not saying that deflation is a good thing, but I am saying that if the stimulus is applied incorrectly, it could just make problems worse down the road because, while stimulus may make everything rosy in the GDP = C + I + G +NX model, it doesn't take into account value. That is, it uses the GDP as a proxy for value created, which may or may not be right. In the end, all these stimulus funds will do is fund projects that will transfer wealth to the private sector by borrowing from the public's future wealth, keeping momentum going. A problem, however, surfaces when the projects undertaken do not create wealth equal to the present value of the debt. You can keep an economy going by paying people to shovel sand from one pile to another but, if we do that, once the stimulus runs dry all we are left with is a couple of piles of sand. I'm not saying the government wants us to shovel sand--they could be building the next Eisenhower Highway System for all I know--I'm just not comfortable leaving that decision up to the guys that decided to try to reflate the bubble by pulling-forward demand, subsidizing toy arrows and foreign liquor and build useless airports. Just sayin.

As a final clarification, this is not an attack on Koo, not even close. I just think we should question whether we can trust the political class to Do The (Economically) Right Thing for all of us, not just their campaign donors.

Previously, in Angry Rants:

If we ever hope to get back to growth and increasing standards of living we can't all just sit around trading shit back and forth, we need to reduce our speculative activities and get back to funding and working on value creating processes.

More on the Chinese real estate "bubble"

While reading the comments to M Pettis' excellent latest entry I spotted this:

The loan to value ratio has been between 10-20% from 2005 to 2008, it had increased to 46% in 2009 and further surged to 76% in 1Q10. (I used the incremental increase in mortgage loans from PBoC report and value of commercial residential transacted data from NBS ... I suspect the surge in loan in April further increases this leverage ratio.

I attribute this surge in leverage to two main reasons, 1) speculators have finally realized they can make a lot more $$ if they lever up and the common belief in China is that property prices will keep on going up ... Real demand is forced to lever to buy. To me, this is a sign of the upper bound of the affordibility. (sic)

Ding! ding! ding! If this man is really correct, those are some bubblicious circumstances. And if the LTVs are really as high as the upper 70s, well, 3 words: Balance-sheet recession. This should be really interesting. Outside of that whole thing, Pettis makes some excellent arguments and manages to concisely verbalize thoughts that I could spend hours rambling about and never really get across, so I'll just quote him:

For example, if RMB 100 is borrowed to build a railroad, the debt is sustainable if the railroad creates net economic value to China of RMB 100 or more.  If it doesn’t, the difference must be considered net debt that one way or another must be paid for by Chinese households.  This will of course reduce their future consumption along with the economic growth associated with satisfying that consumption.

Note that net economic value does not mean the total profits of the railroad generated by ticket revenues less operating costs.  We could begin with that number, but the value of the railroad would be increased by associated externalities – i.e. building the railroad might lower transportation costs for a number of businesses, allowing them to grow and to add economic value indirectly.  It would be reduced by certain opportunity costs, for example the alternative use of the land if it had a better use, or the negative impact it might have on the existing highway and airline infrastructure.

But most importantly it would be reduced by distortions in the financing cost.  For example, if the railroad were to be fully financed by 10-year bonds with interest rates 3 percentage points below the “natural” borrowing cost (a very low estimate), the economic value of the railroad would have to be reduced by RMB 19.

This amount is simply equal to the net present value of the hidden transfer from the lender to the borrower.  The fact that the borrower can obtain subsidized funds at an artificially low cost must represent a transfer of wealth from the providers of the funding, and this subsidy is a loss for the rest of the economy equal to the additional value for the entity being subsidized (another way of saying that there is no free lunch*).  By the way if the cost of funding is repressed by 6 percentage points, a perfectly plausible number, the net present value of the hidden subsidy is RMB 34.  These are not small numbers.

 I know that's long, but compared to how much he says, it's not a lot of words. This is the best summary of the problems of cheap credit I have EVER seen. And it's not only applicable to China, it applies to us too! Think about all  the artificially suppressed mortgage rates, the Fed and FDIC backing/guarantee programs, the whole issue of ZIRP etc. There's a ton of liquidity out there and it needs to go *somewhere*. If you lower rates enough, people will start investing in projects with negative NPVs. I know that doesn't make sense, but if you calculate the NPV as the present-value of the probability-adjusted payouts, one might go into a project with the odds against him because you can finance it with a loan, and if it goes bust you can just default. Which is really the problem with ZIRP, that it we end up investing in what essentially is a debt-financed call-option.

This kind of casino capitalism isn't going to get us anywhere. If we ever hope to get back to growth and increasing standards of living we can't all just sit around trading shit back and forth, we need to reduce our speculative activities and get back to funding and working on value creating processes.


PS: I find it fitting that Abnormal Returns (no link for them) linked to this same article when talking about the SSE performance. Way to miss the whole point, assholes. It's fitting that it's part of the "twit" network.