Global Economics and Management

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."

An Excellent Column

Over at Bloomberg, Matthew Yglesias makes the case for moderating the Biden Administration's policy ambitions. The column argues that many voters prefer stability to massive policy change, and that the Democrats now in power should focus on just a few priorities rather that try to change the whole economic system with very large outlays, backed by correspondingly large tax increases.

I don't wish to opine on the substance of the argument. I do think, however, that the premise is quite correct as a factual matter. Politicians are usually wrong to assume that voters will embrace radical change. In fact, in the recent past, even incremental change has been followed by defeat at the polls. I am thinking for instance of Obamacare, and the subsequent rout of the Democrats in the 2010 midterm elections. We live in a prosperous country, where things are basically fine. Sure, there are problems and challenges, but most voters are reluctant to embrace radical change for an uncertain payoff.

The founding fathers of the United States wrote in its Constitution many provisions that make it hard to effect change through the political system. Laws must pass both chambers of Congress, sometimes with a supermajority requirement, and be signed by the President. They are then subject to judicial review, where they could get overturned. Getting something radical done has always been hard. But it is even harder now. The reason is the growing heterogeneity of preferences and opinions that animates our very pluralistic population, and the fact that politicians now receive immediate feedback on these preferences and opinions. Want to enact policy A? Those who prefer policy B, or the status quo, will immediately make themselves heard. Want to enact policy B instead? The same thing will occur. Gridlock comes from two sources: the specific institutions of the US, and the set of preferences that feed into these institutions to determine policy. What comes out of this process at present is basically the status quo.

I have said it before, and will say it again: the Democrats' $3.5 trillion plan will not become law. The fact that a mainstream left-leaning columnist like Matt Yglesias calls for moderating it is revealing.

UPDATE: Speaker Pelosi seems to recognize this reality. The issue is whether the progressive wing of the Democratic Party will go along with these scaled-down ambitions. My hunch is that they won't, and this week's vote on the infrastructure package will be a clear test of this prediction.

The Facebook Files

In a remarkable investigative series, the Wall Street Journal covers the dark side of Facebook. This is Pulitzer-worthy reporting, in my opinion.

An associated podcast series is also worth listening to. The picture that emerges is one of an extremely corrosive, socially destructive platform. Personally, I quit Facebook years ago, and have no plans to go back.

A Pair of Articles on the State of American Education

1) Via the excellent Bari Weiss, an article from ProPublica and the New Yorker, on the devastating effects of COVID-related school closures on children, especially the poorest and most vulnerable of them. The effects on US inequality will be profound and will last for decades.

2) From the WSJ, it appears there is now a large gender gap in college-level education.(Hat tip: Ivo Welch; the article is also cited in Bari Weiss's Substack post, linked to above). The figures cited in the article are simply staggering. Combined with other diagnoses of the plight of young men (declining labor supply, increasing time spent playing video-games), the article makes for sobering reading.

Is the situation similar in other countries? I would guess the tendency is there, but less pronounced. China recently cracked down on gaming. Such a dramatic policy would not be feasible in Western democracies. In fact, it is not clear what policy intervention could address the issue effectively.

Various Relevant Articles

1) Is Australia still a democracy? Over at The Atlantic, Conor Friedersdorf is inclined to think not. The article is eye opening about the extent of the curtailment of human rights in Australia. To me this is one of the clearest examples of how COVID undermined democracy, one of the themes of my May 2020 lecture on the political economy effects of the pandemic.

2) What are the geopolitical consequences of America's withdrawal from Afghanistan? They may not be as obvious as one would think, argue Yaroslav Trofimov and Jeremy Page in a wide-ranging WSJ article.

3) Relatedly, Harvard's Joshua Kertzer penned an insightful article in Foreign Affairs, on the credibility and reputation costs of the Afghanistan withdrawal. I learned a lot from this article - in particular that credibility and reputation are not the same thing. Credibility is context-dependent so world powers should not interpret the US withdrawal from Afghanistan as necessarily representing a lack of commitment to pursuing other goals. In that sense, the US may not have necessarily lost credibility. Reputation is a more all-encompassing concept and Professor Kertzer argues that the US did indeed suffer a loss of reputation, especially in terms of perceptions of its competence. Just semantics? You be the judge.

4) A recent randomized controlled trial (RCT) in Bangladesh is the most convincing evidence that I have seen that masks reduce the spread of COVID. Other evidence cited in favor of mask mandates until now relied on observational studies, from which causal inference is dubious. And existing RCT studies on the effectiveness of masks in preventing the transmission of respiratory diseases tended to find weak effects, though most of these studies were not about COVID per se. Note however that the Bangladesh study finds considerable heterogeneity in the effectiveness of masks, especially across age groups and mask types. And it is not clear that the findings apply to the Delta variant, as the intervention occurred from November 2020 to January 2021. Details of the study can be found here. 

5) Senator Manchin (D-WV) on why he won't support the $3.5 trillion reconciliation package now being crafted in Congress. In this summer's offering of Global Trends I predicted that this package would not pass (a recording exists!). I hold to that prediction. Moreover, let me specify things more precisely: I did not predict: "this specific package will not pass, but some watered-down version will pass". I predicted that nothing would pass. The infrastructure package that already passed the Senate is another matter, but if I had to bet I would wager that this one won't become law either. I think it will die in the House, from lack of support from the progressive wing of the Democratic Party. But I am much more confident of the first prediction.

Edward Luce on the US Pullout from Afghanistan

The FT''s Edward Luce has written one of the best articles I have read about the recent and ongoing pullout of the US from Afghanistan. The opening paragraphs focus on short-term political consequences for the Biden administration, and they may or may not be of much relevance for us given how fast things change in politics. But the balance of the article focuses on the long-term strategic consequences, and is very relevant from our perspective in Global Trends, especially for Module 7.

My view is that if the world is going to move in a multipolar direction, as it clearly is, then events like the Afghanistan pullout (and the associated chaos and humiliation) are going to become more frequent. I don't mean to be callous with regards to the plight of the United States, as a proud American myself. I am just trying to stare at reality in its face. If the US electorate is going to go in the direction of withdrawal from involvement in world affairs and if, at the same time, countries like China, Russia, India, Pakistan, etc., are going to be rising both economically and strategically, then scenes like the ones that are occurring in Kabul right now are going to be on our screens more frequently. It is one implication of the rise of new powers, and the corresponding decline of old ones.

Vaccines, Masks, and Social Antagonism

In Module 8 of our class, we discuss the rise of new interests. In a recent paper, written jointly with Klaus Desmet and just published in The Economic Journal, we make the case that the United States is experiencing an increase in cultural disagreement: over the last 30 years or so, people on average have tended to give more diverging answers to big societal questions. It is hard to look around and not see that fact manifest itself in everyday life. The range of opinions, views and beliefs that one sees espoused on social media, for instance, is simply staggering - and it seems that whenever a person proffers an opinion on something, someone will be there to take the other side of the issue.

This is true too when it comes to COVID policies - in particular on vaccines and mask mandates. My personal view is that the case in favor of COVID vaccination is a slam dunk (the case for mask mandates seems less clear-cut). Billions of shots have been given, so if there were serious and widespread side effects, we would know it by now. And the evidence suggests that COVID vaccines are highly effective at preventing infection and, barring that, at preventing serious illness and hospitalization. However, every society seems to be witnessing serious disagreements about vaccines. The Wall Street Journal recently took an in-depth look at the social divisions that result from disagreements over vaccinations. The article provides a perfect illustration of the themes of Module 8: growing social antagonism and polarization. Despite COVID being an ordeal common to all in our society, this common threat does not seem to have brought us closer together - quite the opposite: it created the opportunity for yet more social disagreement.

I am sure we will have a chance to discuss the reasons for these growing social divisions. Klaus and I argue in our paper that they are due to the rise of new forms of information and interactions. Instead of a common set of news (the evening news on ABC, NBC and CBS) that the previous generations watched, we now have access to much more tailored sources of information, on talk radio, cable TV, and the internet. Instead of interacting mostly with neighbors, members of local clubs, churches and associations, or family members, we now have social media, allowing far-flung connections with people or groups with a wide range of beliefs. What does Joe care if he doesn't share the beliefs of most of his neighbors? He can find 100,000 people online who believe the same conspiracy theory as he does. There is much less broad-based conformism, imposed by common news or social influence from those around us. So we can develop and sustain widely divergent belief systems - some of them possibly quite at odds with reason.