Environmental Improvement

Jason D. Scorse recently posted some great thoughts for Grist Magazine. "My hope is that these four points will eventually seep into the minds of all environmentalists and the greater public. When this happens we can look forward to a much improved public discussion on environmental policy and greatly improve our chances of making substantial gains in environmental protection."

The Four E's of Environmental Improvement

1. Eliminate all natural resource subsidies

Subsidies to timber companies, fisherman, farmers, and the oil and gas industry are by far the most damaging environmental policies engaged in by governments around the world. Not only do these subsidies directly increase environmental degradation, but by artificially lowering the prices of natural resources they spur over-consumption, decrease conservation, and make it harder for substitute resources to compete. In addition, they cost taxpayers hundreds of billions of dollars a year; money that could be used instead for improving human welfare in myriad ways. (Many economists refer to these types of subsidies as “perverse subsidies” because they actually exacerbate bad behavior instead of encouraging good behavior).

2. Expand property rights in areas where they are weak or non-existent

The areas in the world where we witness the greatest levels of environmental degradation (the oceans, many large tropical forests, and the atmosphere) are those where property rights are absent, unclear, or poorly enforced. Without property rights resources are almost always treated as “open access”, which leads to a “tragedy of the commons”. While in many instances private property may be the best form of property rights from an environmental standpoint, property rights can also be held by the government (public property) or collectively by groups of individuals. They key is creating transparent and enforceable property rights for all of the world’s resources so that individuals, groups, governments, and corporations have the incentive to use the resources wisely and invest in their preservation.

3. Empower society with information

Basic environmental science is something that will be under-funded in a pure “free market” because it is rarely profitable, and therefore, governments should do more to support scientific research that helps us better understand the links between our actions and environmental outcomes. In addition, laws that mandate that companies disclose their pollution emissions and environmental impacts provide individuals, politicians, non-governmental organizations, and investors with information that can help gauge a company’s environmental performance and differentiate “green” companies from “brown” companies.

4. Enlarge green markets through government purchases

Since governments are some of the largest buyers of natural resources in the world (e.g. paper, power, food) their purchases have a huge impact on markets and the environment. If governments can increase their demand for “green” products (e.g. chlorine-free paper, power from renewable energy, pesticide-free food) they can push businesses towards much more environmentally-friendly practices at a greatly accelerated pace. In addition, governments can both save money and improve the environment by investing in state-of-the-art efficiency for all government buildings and infrastructure.

Globalization & Inequality

On July 17th 2006, Mark Thoma had some great thoughts on globalization and increased inequality.

What should we do about globalization and growing inequality? Making a comparison to the medical profession, it may be that while we can diagnose some conditions clearly, we have no effective cure for them (though there are economists hard at work daily hoping to change that, just as medical researchers are trying to find cures for their set of ills), it requires waiting for the system to "heal" itself over time.

Economists can suggest healthy diets (e.g. monetary and fiscal policy), but that is no guarantee that the economy will not get sick anyway and when it does, we don't always have the cure at hand, though I do think we have, for the most parts, prescriptions to help the economy heal faster. But people want instant cures, a pill to take that makes it better now, not a long difficult road to recovery.

Education, worker retraining, those sorts of things aren't cures, they simply (hopefully) speed the healing process along, and sometimes that can be a much longer process than any of us like.

I know a lot of you like to beat us up because we don't have the answers, and it's useful to motivate us to look all that much harder, but I'm not any more embarrassed for our profession because we can't solve every problem than doctors are who can't cure the common cold. And (this will make some of you mad) they, like us, have to listen to a lot of folk remedies that supposedly work, be told they are idiots, etc. And though every once in awhile the folk remedy is valid, generally the suggestions come from people who really don't understand all facets of the problem. You can't argue with them, they really believe their folk remedies work, so it's best to listen to them attentively, smile and nod, and not engage.

But that's pessimistic. My economics tells me that there will be winners and losers from things like free trade and that the winners will [generally] have enough to compensate the losers and still be better off themselves. So my solution would recognize this reality and, along with all the things we need to do to help the economy heal, it would also redistribute income in a way that produces far more winners and far fewer losers. But I don't think we have the political will to do that yet, the understanding that everyone will still be better off after the redistribution, though the the GOP's change of heart to allow consideration of a vote on the minimum wage is one sign that this is being recognized.

Policies can protect people from losing jobs, but I think that's a recipe for stagnation in the long-run. Policy can help people get new jobs faster, that's where education, retraining, etc. come in, but that hasn't worked as well as we would like (but that's not an excuse to stop trying and my solution involves these things even though so many of you object to such policies). Policy can raise income for lower income groups, that's where minimum wages, negative income taxes, redistribution policy, etc. come in. These help ease the globalization transition by transferring income to affected groups and hence make it easier to accept politically, but it's not clear they make the transition occur any faster.

Finally, we can hope the electoral process results in a change in the use of political power to bring about transfers of income toward higher levels. We have enough trouble dealing with the economics driving such changes, we don't need legislation that makes it even worse.

I think part of the silence is that economists have no instant cure for problems that occur with globalization. We think it's necessary for our long-run health, and we can recommend policies that aid the recovery process, but perhaps our silence is because we've been waiting for some economist working hard to have a "Eureka" moment and announce to all of us a cure is at hand. Until that happens, we will be stuck with less satisfying rehabilitative solutions.

Economic Overview

This week, The Economist published an overview of the previous weeks economic headlines. Here is the article:

Economic and financial indicators
America's businesses, excluding farms, added 121,000 workers to their payrolls in June. The unemployment rate remained unchanged at 4.6%. America's trade deficit in goods and services reached $63.8 billion in May, thanks in part to higher oil prices. Its biggest bilateral deficit, with China, expanded to $17.71 billion from $17.03 billion in April.

Industrial production in Germany and France made big gains in May. Increases in manufacturing and construction raised German industrial output by 1.5% from the previous month and 6% from a year earlier. In France production rose by 2%, the biggest gain in six months, leaving it 2.7% higher than in May 2005.

In Japan core orders for machinery, which exclude those from ship builders and electricity companies, fell by less than expected in May. The 2.1% drop from the previous month was less than forecasts of over 5%, suggesting that investment spending may be stronger than expected. Meanwhile, producer prices in Japan rose by 3.3% in the year to June.

Average earnings in Britain increased faster than expected in the three months from March to May, at an annual pace of 4.1%. Pay was boosted by bonuses in financial services and the public sector. Unemployment hit a 5½-year high of 5.4%, largely because of a growing labour pool.

Emerging-market indicators
China chalked up a record trade surplus of $14.5 billion in June, compared with $13 billion in May. In the past 12 months it has accumulated a surplus of $123 billion. Russia's surplus for the year to May was even bigger, reaching $136 billion.

Brazil's consumer prices dropped by 0.2% in June, the biggest fall since 1998, because of cheaper ethanol and food. Consumer prices were still 4% higher than a year before.

Ambitious Economic Models

This week, The Economist published a very interesting special report entitled 'Economic models: Big questions and big numbers'. Here are some excerpts:

We cannot live without big and ambitious economic models. But neither can we entirely trust them.

Among the many gadgets, instruments and artefacts in its care, London's Science Museum holds a peculiar contraption that most resembles the work of a deranged plumber. Yellow tubes connect together a number of tanks and cisterns, around which coloured water can be pumped. Sluices and valves govern the flow of liquid and makeshift meters record the water-levels.

The “plumber” responsible for this device was William Phillips. Educated as an engineer, he later converted to economics. His machine, first built in 1949, is meant to demonstrate the circular flow of income in an economy. It shows how income is siphoned off by taxes, savings and imports, and how demand is re-injected via exports, public spending and investment. At seven feet (2.1 metres) high, it is perhaps the most ingenious and best-loved of economists' big models.

Economists today use computers and software not perspex and piping, but they share Phillips's itch to build models that faithfully mirror the real economy. For each of the big economic questions facing the world (What do we stand to gain from a global trade deal? By how much has expensive oil retarded growth? What might be the economic costs of an avian flu pandemic?) there is a model that will provide a big numerical answer ($520 billion, 1.5% of world GDP, and $4.4 trillion, respectively). Such figures are trotted out far and wide. But can we entirely trust them?

Economic models fall into two broad genres. Macroeconomic models, the distant descendants of Phillips's machine, belong mostly in central banks. They capture the economy's ups and downs, providing a compass for the folks with their hands on the monetary tiller. The second species, known as computable general equilibrium (CGE) models, largely ignore the vagaries of the business cycle. They concentrate instead on the underlying structure of production, shedding light on the long-term repercussions of such things as the Doha trade round, a big tax reform or climate change.
...

Short of good data, and stretched to their computational limits, the early modellers nonetheless had high ambitions. They aimed not merely to understand the economy, but to run it.
...

Such ambitions now seem quaint. In countries not cursed by socialism or war, the market is left to decide what to produce and in what proportions. But the state remains responsible for keeping the overall macroeconomy ticking over. Policymakers are largely indifferent to what is in demand, so long as the tank of demand remains full.
...

These measurements were fed into their models, which in turn guided their policy advice.

In 1958, for example, Phillips showed that for long stretches of British history, high unemployment coincided with low wage inflation, and vice versa. Many macroeconomic models therefore featured a trade-off between the two: doves could choose low unemployment at the expense of high inflation; hawks the opposite.

But in the 1970s these trusted relationships broke down. And in 1976 Robert Lucas, of the University of Chicago, explained why. Such trade-offs, he argued, existed only if no one expected policymakers to exploit them. Unanticipated inflation would erode the real value of wages, making workers cheaper to hire. But if central bankers tried to engineer such a result, by systematically loosening monetary policy, then forward-looking workers would pre-empt them, raising their wage claims in anticipation of higher inflation to come. Cheap money would result in higher prices, leaving unemployment unchanged.

In short, one could not judge how the macroeconomy would respond to a new policy based on its behaviour under the old regime. The “Lucas critique”, as it was called, brought its author fame and a Nobel prize. But it dealt a big blow to the confidence of model-makers. As Christopher Sims of Princeton University has put it, “Use of quantitative models as a guide to real-time policy advice was cast into such deep disrepute that academic research on the topic nearly completely ceased.”
...

In the past decade, a number of central banks—and even the International Monetary Fund (IMF)—have reared a new generation of practical macroeconomic models, all of them sporting microfoundations. First-born was Canada's Quarterly Projection Model in the mid-1990s; its close siblings include the Bank of England Quarterly Model (BEQM) introduced in 2004; the SIGMA model groomed by the Federal Reserve's International Finance Department; and the IMF's new Global Economic Model (GEM). Old hands doubt whether the new microfoundations are quite as secure as they seem—the macroeconomy is surely rather more than the sum of its parts—but no self-respecting theorist can now be seen in public without them.

Stabilising the macroeconomy is only one of the responsibilities of governments in a market economy. They must also raise taxes and most feel the need to impose tariffs, both of which put rocks in the stream of economic life. When they contemplate big changes to these policies, most governments cannot resist turning to CGE models to forewarn them of the consequences.
...

Trade's virtuous effects are of two distinct kinds. First, trade helps countries make the most of what they already have. It frees countries to allocate their resources—whether they be cheap labour, fertile land or educated minds—as efficiently as possible. But, secondly, trade can also allow countries to accumulate resources more quickly. Indeed, the biggest prizes lie in faster growth, not heightened efficiency; in accumulation and innovation, not allocation.

By their nature, CGE models are better suited to capturing the first effect than the second. They provide “before and after” snapshots of the economy at two points in time. They are therefore good at capturing the one-off gains that might arrive from a redeployment of the economy's resources. They are much less good at capturing the continuing gains that result from a faster accumulation of capital, or a quickened pace of productivity growth. Most trade models, indeed, hold productivity fixed.
...

Most empirical exercises confront theory with numbers—they test theories against the data; sometimes they even reject them. CGE models, by contrast, put numbers to theory. If the modeller believes that trade raises productivity and growth, for example, then the model's results will mechanically confirm this. They cannot do otherwise. In another context, Robert Solow, a Nobel prize-winner, has noted the tendency of economists to congratulate themselves for retrieving juicy plums that they themselves planted in the pudding.
...

To be fair, most modellers are quite open about the theoretical principles that underlie their simulations. But to compute an economic model, this theory has to be given concrete form, spelt out in definite algebraic terms. Alfred Marshall, one of the fathers of neo-classical economics, distrusted mathematics for this very reason. To be expressed in mathematical form, he complained, many important economic considerations had to be “clipped and pruned till they resembled the conventional birds and animals of decorative art.” Economic theory gives only the roughest guide to this pruning. It points out, for example, that supply rises when prices increase. But does it rise in a straight line or curve upwards? Perhaps, as prices rise, supply traces out an inverted U-shape or an S-shape?
...

Phillips's pump-action model was, he wrote, meant for “exposition rather than accurate calculation.” But all models should ultimately be seen as pedagogical devices, their calculations a means to the end of helping policymakers think through their decisions. Unfortunately, Phillips's model was rather better at this than many of its more sophisticated successors. It was transparent: you could see through its casing, trace the flow of expenditures through its pipes and watch wealth accumulating in its tanks. Get things wrong and prosperity drained away in front of your eyes. The model was also easy to tinker with: valves could be loosened, sluices opened and taps tightened. It was clear what was governing its results.

Living With Strong Russia

This week, The Economist published an article entitled 'Living with a strong Russia'. Here are some excerpts:

Forget the formal agenda at this weekend's G8 summit, given over to energy security, infectious diseases and education. The really awkward issue for the leaders of the seven rich democracies gathering in St Petersburg concerns their host: how to live with a strong, but increasingly undemocratic, Russia.

Since Vladimir Putin became president in 2000, Russia has in many ways been a remarkable success. Thanks largely to high oil prices, its economy has grown by an average of 6.5% a year. Living standards have improved and a sizeable middle class has emerged. The stockmarket has boomed. Russia is running a huge current-account surplus, it is paying off the last of its debt and the rouble has just been made fully convertible. At the summit Russia also hopes to surmount the last hurdles to its joining the World Trade Organisation.
...

Yet as well as these steps forward Russia has taken steps backwards. In Mr Putin's early years optimists hoped that stability and prosperity would not come at the expense of liberty and democracy. Western leaders gave him the benefit of their doubts over such matters as the war in Chechnya or curbs on the media. But it has become ever clearer that Russia is moving in the wrong direction. Greater state control of the economy, especially in the energy industry, has bred corruption and inefficiency. Any serious political opposition has been crushed. The broadcast media have been shut down or taken over by the government and its allies. Regional governors have been squashed—one of the last elected governors was arrested recently—and parliament has been emasculated, continuing the Kremlin's drive not merely to centralise, but to monopolise, political power.
...

So what can the West do? The short answer is, not a lot. In the 1990s an economically enfeebled Russia needed help from abroad. Unless the oil price unexpectedly collapses, no such leverage will be available in the near future. Politically, too, pressure from outside is likely to rebound. With the Kremlin once again firmly in control, Russia will almost certainly change only from within—or not at all.
...

They (western leaders) should speak out against Mr Putin's moves away from democracy, against his policy in Chechnya, or against Russian use of energy to bully its neighbours (many west European countries have been too timid in their criticism). They should continue to help NGOs and others who are trying to establish a civil society that may, one day, provide an alternative to the dead weight of the Kremlin. As the next presidential election of March 2008 nears, they should insist that any move to amend the constitution so that Mr Putin can run again is unacceptable—and would result in Russia's expulsion from the G8. They should do what they can to press for free and fair elections, even if the Kremlin's chosen candidate seems sure to win.

There are things they should not do, as well. Russia's membership of the G8 may be an embarrassment, since it is supposedly a club of democracies. But to throw it out now would only push Russia farther out of the West's orbit, and risk making it even less helpful over such issues as curbing Iran's nuclear ambitions. Equally, Americans and Europeans are right to assist countries in Russia's near-abroad that want to escape its baleful influence. But to push for Ukraine or Georgia, say, to join NATO before they are ready would serve no good purpose. Above all, Western leaders should avoid giving the impression that what they really object to is not an illiberal and undemocratic Russia but a strong and rich one—a paranoia that even Russia's few remaining liberals all too often share.

Sixty years ago a wise American diplomat, George Kennan, proposed that the right policy of the West towards an expansionary Soviet Union under Joseph Stalin should be “containment”. Russia today is clearly no such threat. But it still matters, and the West should care about where it is going. The best policy now is no longer containment but “wary engagement”.

The Value of Remittance

The Los Angeles Times recently published an interesting four-part special entitled 'The New Foreign Aid'. Here are some excerpts discussing the value of remittance:

Migrants have been sending money home, in one form or another, for centuries. But only recently have economists recognized its significance. Today, remittances are the largest, fastest-growing and most reliable source of income for developing countries. Poor nations reported $167 billion in receipts from overseas workers last year, according to the World Bank, more than all foreign aid. Including unrecorded transactions, the bank estimates that the total exceeded $250 billion.
...

Mexico's annual remittance inflow has doubled since 2002 and reached $20 billion last year, second only to petroleum as a generator of wealth for the country.

Other developing nations also depend heavily on their migrants' money. Brazilian laborers in Japan send home more than $2 billion a year, out-earning their country's coffee exports. Remittances bring in more than tea exports do in Sri Lanka and tourism does in Morocco. In Jordan, Lesotho, Nicaragua, Tonga and Tajikistan, they provide more than a quarter of the gross national product.

Unpredictable Tax Revenues

On July 16th 2006, The New York Times published an article by Edmund L. Andrews entitled 'Those Wild Budget Swings'. Here is the article:

It was enough to make a supply-side, tax-cutting Republican beam with pride. Striding into the East Room on Tuesday morning, President Bush announced that tax revenues had been pouring in so fast this year that the federal deficit was likely to shrink for the second year in a row — even though spending continued to balloon. Tax revenue hasn’t climbed this quickly since President Bill Clinton was in office. After plunging throughout Mr. Bush’s first term, tax receipts are running 27 percent higher this year than in 2004 — an added $500 billion. The White House now predicts that the budget deficit this year will be $296 billion, down from $318 billion in 2005 and $412 billion two years ago.

But the real news is not that tax revenues are particularly high; they are not. The big change is that tax revenues have become more of a crapshoot — more volatile, more unpredictable and more buffeted by swings in the stock market than they were 10 years ago.

Why? Because tax revenues are increasingly dependent on the fortunes of the very rich. And it turns out that the rich are different from most other taxpayers. Much more of their income is tied, not to wages and salaries, but to the stock market and to executive bonuses, which can swing widely from year to year. Relying on these gyrating tax revenues makes it harder to gauge the government’s true fiscal health. Mistakes are easier to make, and long-term problems can be glossed over.

At first blush, the recent jump in tax revenue would seem to validate Mr. Bush and those who believe that tax cuts ultimately generate higher tax revenues because they prompt people to work harder, invest more and take more entrepreneurial risk. The White House, in a news release last week, boasted that tax revenues have climbed 34 percent since Congress passed Mr. Bush’s second big tax cut — which included a major reduction in taxes on stock dividends and capital gains.

But revenues are only up in comparison with how low they had plunged in recent years. Individual income taxes, the biggest component of federal revenue, are barely back to the level that was reached in 2000, $1 trillion. Adjusting for inflation, income tax revenue is still lower than six years ago. “The idea that tax cuts have led to higher revenues is pernicious,” said Robert L. Bixby, executive director of the Concord Coalition, a bipartisan research group that lobbies for fiscal discipline. “Tax revenues may be higher, but they are not higher than they would have been if the tax cuts hadn’t occurred.”

But beyond the perennial debate about whether “fiscal discipline” means raising taxes or cutting spending, there is also an issue about the increasingly erratic pattern of the tax revenue itself. The top 1 percent of taxpayers — those who earn more than $300,000 a year — provide about 30 percent of the federal government’s individual income tax revenues. The top 10 percent of taxpayers — those with incomes above $100,000 — provide about two-thirds of income tax revenue. The lopsided burden is partly a result of progressive taxation, and partly a result of widening income disparities between people at the top and bottom of the economic ladder.

It’s hard to imagine what the federal government could do to reduce instability. Because about 40 million people do not owe any federal income taxes, almost any attempt to broaden the tax base would shift more of the tax burden from the wealthy to middle-income households. Yet the more the rich bear the burden, the more they will seek to escape it.

The unpredictable tax revenues first surfaced almost 10 years ago, as booming economic growth and the dot-com frenzy propelled the stock market to spectacular highs. The result was a tidal wave of tax revenue that far eclipsed projections by both the White House and the Congressional Budget Office. As if by magic, budget deficits disappeared and turned into surpluses. For the most part, the Congressional forecasts missed the mark by less than 4 percent from 1982 until 1995. But starting in 1996, when the dot-com frenzy erupted in earnest, the agency began undershooting by as much as 9.5 percent. In 1996, tax revenues came in $93 billion higher than expected; in 1997, they were $163 billion higher; in 1999, they were $152 billion higher. When the dot-com bubble popped in 2001, and the economy slid into a brief recession, tax revenues plunged $308 billion below what the Congressional Budget Office had predicted and remained depressed for the next three years.

NOW the pendulum is swinging once again. Corporate tax payments, which plunged more than $70 billion from 2000 to 2003, could hit a new record of $332 billion this year. Capital gains taxes could climb back from a low of $50 billion in 2003 to $75 billion this year. Few budget analysts would say the jump in revenues is bad news. But if the last decade is any indication, it would be foolish to count on more of the same.

The Bush administration has quietly acknowledged the point. Its latest estimate anticipates that tax revenues will be almost flat in 2007 and that the deficit will widen to $339 billion. But only if things turn out as expected.