Global Economics and Management

Automation, Robotization, and Labor

I came across two items of note on the topic of automation, which will occupy a good portion of Part II of Global Trends, devoted to the rise of new technologies.

The first is a Forbes article by my fellow economist Effi Benmelech, from Kellogg. In this article Professor Benmelech takes a contrarian view on the rise of robots, arguing that expenditures on robots make up a tiny fraction of overall investment, and that these expenditures tend to be confined to the manufacturing sector (itself a modest share of GDP and overall employment). This leads him to conclude that the disruptive effects of automation might not be as severe as is often anticipated (displacement of labor, rising income inequality). However, as he recognizes at the end of the article, robotization is not the only manifestation of automation. And the other manifestations of automation (AI, cloud computing, etc.) may indeed have disruptive effects, replacing workers and leading to more inequality. Broadly speaking, I agree that robotization is unlikely to be the major issue. Automation more broadly, however, has the potential to really affect productivity (positively) and employment (negatively, at least for low-skilled labor). (For a full-blown academic study of this issue, I direct you to this link, where the ideas in the Forbes article are much more fleshed-out).

The second is an intriguing article from the Wall Street Journal on the growing use of automation and AI for job applicant screening and recruitment activities. Such technologies, in my view, have the potential to greatly improve the allocation of workers to jobs, resulting in efficiency gains. What gets programmed in the algorithms, however, raises very deep and interesting ethical questions, and it it not obvious that the resulting matching process will result in more equity and inclusion (a WSJ article from September 2021 goes into these issues in more detail). To be pondered...

Returns to Large Firms in India

In class today I mentioned that the rate of return to capital is higher in poor countries than in rich ones (based on my recent paper on this subject). I also said that India had experienced very healthy equity returns over the last couple of years. I mentioned that this is especially true of large cap companies. This was a subject of a GEM blog post from a few years ago. Here is the article from The Economist to which this blog post refers. The facts stated at these links remain by and large true today.

One of you also mentioned in class that India has 81 unicorns. Here is a source for this fact. Indeed the startup scene is vibrant in India, and I make a point of visiting startups and incubators when we visit India on the occasion of the immersion course that I teach.

Does Globalization Reduce Conflict?

One of the better established propositions in the field of international relations is known as "liberal peace theory". This theory holds that democracies tend not to go to war with each other, and that economic interdependence reduces the likelihood of conflict between states. Hence, in an open, liberal world, characterized by globalization and democracy, we should see fewer wars. The idea that globalization reduces conflict is pretty well documented in the literature (see the link above and also this very convincing study - there is a huge literature on this issue).

Why? In part because when countries are tightly linked by trade, going to war is more costly: these beneficial trade links have to be foregone. As a result, those who stand to lose from war will tend to resist. We see this all the time. Germany is reluctant to rattle things too much with Russia because it gets a lot of natural gas from Russia (and just got even more). One of the things keeping the US from an even more adversarial relationship with China is that many mutual trade links would be severed in a broader conflict. Of course, as the second link above points out, things can be more complicated when everyone is interconnected: if Germany were connected to an alternative source of natural gas imports (e.g. the US), then the existence of that trade link would reduce the cost of conflict with Russia. Similarly, as the US diversifies its supply chain away from a heavy reliance on China, conflict with China may become less costly.

Still, everything else equal, if you and I trade more, we are less likely to fight, because fighting would be more costly to both of us.

I mention this because the Wall Street Journal's Gerald Seib has a very thought-provoking piece in this morning's WSJ. The article argues that globalization has an asymmetric effect on autocracies and democracies. Seib's reasoning is along the lines above. Yet, I don't think his observation disprove liberal peace theory. On the contrary, the presence of trade links with Russia, in his reasoning, implies that Western powers will be reluctant to enter into a conflict with Russia. Instead, to the extent that Vladimir Putin seeks to attack Ukraine, he can do so largely unimpeded. Similarly, Seib's reasoning implies that China would face little resistance to reuniting with Taiwan because of the extensive trade links that exist with the US. To me, this is perfectly in line with the idea that globalization reduces conflict. We would get small scale regional conflicts (where the big players - Russia and China - would likely win easily) rather than a broader conflagration.

However, I am not so sure that the existing interdependencies are sufficient to prevent Western countries from getting involved in these conflicts. This uncertainty is probably what keeps Putin and Xi hesitant to precipitate things.

This subject is a nice point of connection between Module 2 of the class, which we will discuss today, and Module 7, where we will discuss new geopolitical risks.

Should We Fight Inflation with Price Controls?

Inflation is a huge issue of contemporary relevance, and the quest for policies to address the problem of rising prices occupies many minds right now. You can find some of my past musings on this issue here, here and here.

One of the worst ideas ever devised to fight inflation, however, is also making the rounds: price controls. Price controls are a terrible idea in a market economy (in any economy, in fact), because they interfere with the information discovery process that prices embody (when price go up, it signals an increase in relative scarcity, incentivizing consumers to curtail demand and producers to expand supply). Price controls lead to shortages, and rationing. Their design is very difficult to get right, as price control boards are made up of humans (or even worse, economists!), who do not have the knowledge required to get prices right like a decentralized system of competitive markets does. In almost all cases (including during the last bout with inflation experienced by the US in the 1970s), they were an unmitigated disaster. So why The Guardian would agree to publish this utter nonsense is beyond my understanding... 

Some Articles of Note

Here are a few articles that caught my eye and provide useful recent information that will affect our discussions in class:

1) The great Paul Krugman on how to think about inflation in a world of zero nominal interest rates. The article is complete with an erudite reference to Richard Strauss (can you spot it?). Krugman is at his best when he brings his vast knowledge and understanding of economics to bear on the great issues of our times. 

2) One likely effect of the COVID pandemic will be to accelerate automation. From The Guardian, here is a fascinating article on efforts to reduce inter-personal contacts in South Korea, using automation - to build a so-called "untact" society.

3) Sent to me by my former student James Y. Kim (FEMBA 2023), a superb article from Foreign Affairs, authored by two political science professors, on the current state of liberal democracy. The article covers many themes of the Global Trends class, and as such would make excellent introductory reading for the course. Thank you, James!

4) One the biggest environmental issues facing India is the annual burning of crop waste ("stubble burning") in the region near New Delhi. This results in off-the-charts urban air pollution in winter months, with enormous health consequences. Now, it appears that a clever technological solution may help limit the problem. Bloomberg Green has the details. As I strive to cover more environmental issues in Global Trends, this article and the good news that it contains could not come at a better time.

Is the US Vulnerable to Military Conquest?

As I gear up to teach the next iteration of Global Trends, I am on the lookout for news items that could be relevant to the class. Yesterday I came across a striking article by Hal Brands over at Bloomberg News. In this article Professor Brands argues that the US is more vulnerable to a conflict on its own soil than is generally acknowledged. Of course, the relative geographic isolation and military might of the US means that it has (mostly) managed to avoid conflicts on its own territory until now. But the growing military clout of Russia, China and other players, coupled with new technologies to project force across vast distances (missiles, of course, but also cyberattacks) may mean that the next major conflagration may not be fought "over there" but "right here". Definitely worth pondering.

Inflation Acceleration

The inflation numbers that came out of the BLS this morning should be a source of grave concern to all. Inflation seems to be accelerating, which is a clear sign that a wage-price spiral may have begun. Once that cat is out of the bag, it can be extremely costly to put it back in. We had better hope that the FED has the fortitude to do what is needed (i.e. slam on the brakes). Given the erosion of its independence in recent years, and the ongoing debates on who should occupy the senior FED posts that are vacant or soon to be vacated, one is allowed to have doubts. If the FED does not act decisively to curb inflation, we will live with dire consequences in the years ahead. And politicians will have to deal with irate voters who will surely punish the incumbents at the polls. Such an environment would create conditions for a return to power of the populists, and that will not make the situation any better.

A lot of people have egg on their face for not seeing this coming, including many of my fellow economists. This inflationary explosion should have been apparent to all who observed economic data closely. One does not inject trillions of dollars of liquidity into the economy, coupled with an unprecedented fiscal expansion, without creating inflationary pressures. This was clear to me, as I noted on several occasions (1, 2, 3). It was also very clear to one of my favorite economists, Larry Summers. He took a lot of flak for it when he warned about inflation, but as Politico notes he has been vindicated. That's because Summers is unusual among economists in that he generally does not let his political priors get the best of his professional judgment. In contrast, most other mainstream economists wanted so badly for the government to spend trillions of dollars on redistributive transfers that they minimized the likely negative consequences of these policies.

Another institution that will suffer a loss of credibility is the FED itself. Back in August of 2020 they announced that rates would be kept at zero for five years. There is no way now that this will be the case. The FED will therefore have announced a policy that they must renege on. Should we believe any pronouncement they will now make?

One last point. The last two major shocks to the US economy were the mortgage crisis of 2008 and the COVID crisis of 2020. Policies to address these two shocks involved giving good stuff to voters - liquidity and government transfers. In contrast, addressing the inflationary shock of 2021 will entail taking good stuff away from voters - liquidity, and government transfers - in order to tamp down demand. Not only is the shock itself likely to anger voters, who dislike variable and increasing prices, but the policy solution also is likely to invite more voter dissatisfaction.

Bernie Sanders is Right

Senator Sanders came out very strongly today against a proposed reinstatement of the SALT deduction for five years, to be part of the proposed reconciliation package. He is right to oppose the SALT deduction. It is a provision that has no redeeming features. As a reminder, the SALT deduction allows taxpayers to deduct their state and local taxes from their taxable income. The 2017 Paul Ryan tax reform capped the deduction at $10,000 per taxpayer. Some Democrats in Congress now want to restore the full deduction for five years.

The reason the deduction has no redeeming features is that: 1) It is distortive: it implies a federal subsidy for state and local tax increases - voters don't pay the full cost of tax increases, so politicians face incentives to raise them beyond what would otherwise be the case. The distortion extends to the type of taxes that policymakers might adopt: the deduction encourages income taxes rather than sales taxes, i.e. it encourages taxes that distort work and innovation incentives, to the detriment of taxes that encourage thrift and capital accumulation (as is the case with consumption taxes). 2) It is regressive. Those who benefit the most from the SALT deduction are taxpayers who own a lot of property (local taxes) or who earn a lot of income (state income taxes). Essentially, under the SALT deduction, the poor have to pay more taxes to finance a tax cut for rich people. Indeed, according to the bipartisan Committee for a Responsible Federal Budget, about 80% of the tax cut would go to the top 5% of taxpayers. It would also be the biggest line item in the Build Back Better plan.

The proposal to restore the SALT deduction is symptomatic of the newfound tendency of center-left parties in advanced industrial democracies to cater to moneyed interests. This tendency was recently documented in admirable detail by Thomas Piketty and his coauthors. The populist right understands this and has made huge inroads with the working class.

Not only should Congress not restore the full deduction, they should also reduce or eliminate the partial deduction that now exists. While they are at it, they should also completely get rid of the mortgage interest deduction, which is similarly distortive and regressive.

The Proposed Tax on Unrealized Gains

The Democratic majority in Congress seems to be inching toward proposing a tax on unrealized capital gains, to be applied to billionaires. Bloomberg provides some details, and the proposal is being discussed quite widely in the press. Unfortunately, there is very little academic analysis of the likely effects of such a tax. One possible exception is an old paper by Alan Auerbach, from 1991, but this paper studies a scheme that would levy interest on taxes due on past accruals, to be paid at the time the gains are realized. This is not the current proposal, where accruals themselves would be taxed every year as they occur, even when not realized. Another assessment (not particularly kind to the proposal) comes from a finance professor at NYU, but it does not take the form of an academic paper, i.e. it lacks the rigor that peer-review imposes. Still, the effects that this blog post describes seem plausible. Billionaires will have to sell a portion of their holdings every year, meaning they will have less skin in the game (and this will have consequences for overall asset prices); they will face incentives to purchase hard-to value, easy-to-hide assets like art and expensive wines, they will face incentives to engage in more conspicuous consumption (yachts, airplanes, which depreciate over time), and to take their firms private (if there is a carve-out for privately held businesses - as there should be since these are often impossible to value). I also shudder to think of the litigation that will come out of this: billionaire by definition have plentiful resources, and it would make sense for them to devote even a small fraction of these resources to contesting the taxman's valuations. Lawyers and tax accountants will surely rejoice. Finally, as Elon Musk aptly reminded us today, taxes aimed at a very small group usually get extended down the income and wealth distribution eventually, as was the case with the Alternative Minimum Tax. The list of unintended consequences is long. I think implementing this untested idea would be reckless.

I also wonder why the proposal is limited to monetary capital. Why not extend it to human capital? The highly educated have invested resources to accumulating knowledge and skills in expectation of future gains. These gains are quite sizable, as David Autor's work on the college wage premium has shown. For example, I calculate the average lifetime monetary gain from obtaining a UCLA Anderson MBA degree to be in the vicinity of $2 million, in present value terms, compared to earnings that flow from the good undergraduate degrees that our students typically possess. This number is actually easier to calculate than the value of a billionaire's asset holdings! Should we tax that now, too, or wait until these gains are realized? Unrealized gains are notional gains. They are not income until the gains are realized, i.e. the asset is sold. If we are open to taxing unrealized income, the possibilities are endless: anything that could conceivably produce income in the future becomes taxable.

This discussion, of course, may be moot, since the whole package will most likely never become law [I hold to my prediction that nothing will pass].

Australia

Australia's descent into tyranny continues. Chilling.

What is striking about images like these is how much they reveal about underlying autocratic instincts in human nature: men are prone to arbitrarily abuse their power when given the least excuse to do so. COVID gave closet autocrats around us the very excuse they needed to succumb to their worst instincts. Australia is a case in point, as I discussed before.

I hope Australian voters will severely punish their leaders at the next election, but I am not so sure they will. As Senator Amidala famously said, "this is how liberty dies...with thunderous applause."