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December 2010
December 30, 2010
December 29, 2010
December 28, 2010
Three "Protestant Winds"
The Relief of Leyden, 1574:
Siege of Leiden - Wikipedia: [T]he dyke of Greenway halted the water, but this was seized and cut. But as the water spread over the countryside, it also grew shallower.... Soon, the water was so shallow that most of the Dutch ships ran aground. Meanwhile, in the city, the inhabitants clamoured for surrender when they saw that their countrymen had run aground. But Mayor van der Werff inspired his citizens to hold on by offering his arm as food. Thousands of inhabitants died of starvation. They held on because they knew that the Spanish would kill them all to set an example, as had happened in Naarden and Haarlem. Only on October 1[, 1574] did the wind, which previously blown from the east pushing the water out of the countryside, shift to the west which blew the sea water into the countryside. Then the rebel fleet was afloat again and they advanced.... [O]n the night of October 2/3, the Spanish retreated from their fort and lifted the siege....[T]he relieving rebels arrived at the city, feeding the citizens with herring and white bread. The people also feasted on 'Hutspot' (carrot and onion stew) in the evening. According to legend, a little orphan boy named Cornelis Joppenszoon found a cooking pot full with 'Hutspot' that the Spaniards had had to leave behind when they left their camp, the Lammenschans, in a hurry to escape from the rising waters...
The Defeat of the Spanish Armada, 1588:
Flavit Jehovah et Dissipati Sunt: Jehovah blew with His winds, and they were scattered is a famous phrase on the aftermath of the defeat of the Spanish Armada in 1588, when the Spanish fleet was broken up by a storm...
The "Glorious Revolution" Overthrow of King James II Stuart by William III Orange, 1688:
Glorious Revolution: [O]n 8 October... the expedition was... openly approved by the States of Holland; the same day James issued a proclamation to the English nation that it should prepare for a Dutch invasion to ward off conquest. On 30 September/10 October (Julian/Gregorian calendars) William issued the Declaration of The Hague.... William declared:
It is both certain and evident to all men, that the public peace and happiness of any state or kingdom cannot be preserved, where the Laws, Liberties, and Customs, established by the lawful authority in it, are openly transgressed and annulled; more especially where the alteration of Religion is endeavoured, and that a religion, which is contrary to law, is endeavoured to be introduced; upon which those who are most immediately concerned in it are indispensably bound to endeavour to preserve and maintain the established Laws, Liberties and customs, and, above all, the Religion and Worship of God, that is established among them; and to take such an effectual care, that the inhabitants of the said state or kingdom may neither be deprived of their Religion, nor of their Civil Rights.
William went on to condemn James's advisers for overturning the religion, laws, and liberties of England, Scotland, and Ireland by the use of the suspending and dispensing power; the establishment of the "manifestly illegal" commission for ecclesiastical causes; and its use to suspend the Bishop of London and to remove the Fellows of Magdalen College, Oxford.... James's attempt to pack Parliament was in danger of removing "the last and great remedy for all those evils". "Therefore", William continued, "we have thought fit to go over to England, and to carry over with us a force sufficient, by the blessing of God, to defend us from the violence of those evil Counsellors...this our Expedition is intended for no other design, but to have, a free and lawful Parliament assembled as soon as is possible."...
For three weeks the invasion fleet was prevented by adverse south-westerly gales from departing from the naval port of Hellevoetsluis, and Catholics all over the Netherlands and the British kingdoms held prayer sessions that this "popish wind" might endure. However, on 14/24 October it became the famous "Protestant Wind" by turning to the east...
Michael Froomkin Worries About His French...
I suspect Michael Froomkin's French sounds to les parisiens like the French from a movie made in the 1930s--emigrant language speakers do tend to freeze vocabulary, grammar, and slang, and transmit the frozen version to those who learn from them:
Attrapé: Yahoo Groupes (sic) is unhappy with me:
Votre navigateur n’accepte pas les cookies. Pour afficher cette page, vous devez modifier les préférences de votre navigateur pour qu’il accepte les cookies. (Code 0)
And it’s true too.
Somehow “Votre navigateur n’accepte pas les cookies” seems like amazing Franglais. This is why I wonder if I still speak French sometimes: The language has borrowed so much English that it has left me behind.
When I go to France, I sometimes wonder if people think I sound like someone speaking Edwardian English. If I could only convince myself the effect was Shakespearean...
My view is that all old languages sound Shakespearean. As xkcd says:
Which, of course, reminds me of the great http://xkcd.com/239/:
December 27, 2010
Yes, the Affordable Care Act Is a Sensible Centrist Policy
It is a fact that Nationwide RomneyCare is the kind of policy that hits the sweet spot as far as the center of the American electorate is concerned.
Matthew Yglesias:
Yglesias » The Median Voter Supports The Affordable Care Act: We’ve seen this before, but today CNN has another poll (PDF) confirming that the Affordable Care Act’s conservative critics are a minority.... I’m not 100 percent sure if “not liberal enough” is the way I would describe the law. But you make the ACA better by making it more aggressive. That’s a public option, but it’s also more forceful implementation of the Independent Medicare Advisory Panel concept and a more aggressive phase-out of the tax subsidy for employer-provided health insurance.
December 26, 2010
Econ 1: Fall 2010: U.C. Berkeley: September 29 Economic Growth Lecture
20100929: Econ 1: Fall 2010: U.C. Berkeley: September 29 Economic Growth Lecture:
Thank You For Taking the Midterm: Let me thank you all for taking next Monday's midterm. I know--it is way too early to be proper midterm. The problem is that I need it as an instructor reality-check device.
I stand up here and lecture at you. There are 620 of you. I cannot read your faces well enough to figure out what you are getting and what you are not. I have little clue right now whether my lectures are over most of your heads, or are mind-numbingly slow.
One reason that I lecture--even though I have little clue right now as to whether I am lecturing at the right pace--is that back in the Middle Ages a book cost the same share of average incomes as $50,000 is today. Look at a book. Think that if you were in the Middle Ages--well, you would probably be illiterate. If you were in the Middle Ages and were literate you would probably regard a book kind of like Southern Californians regard a BMW convertible. Students could not really afford books--at least, not many.
Suppose you were a student at the University of Naples in the 12th century. Suppose you owed student loans to the moneylender. Suppose you wanted to leave Naples--in order to go visit your parents in their manor near, say, Goslar. You could not--unless you first gave the moneylender your books to hold as a pledge. The idea was that your books were so valuable that you would repay your student loans if the moneylender had your books.
Come Gutenberg and the invention of printing books become cheap. The idea that teachers have to lecture because students cannot afford to buy all the books for the courses goes away. But still the very large lecture--a staple of education back in the days when the books were really, really expensive and what about the only way to get access to the book was for a group of you to get together and hear it read aloud--still continues. It continues for lots of reasons. But since it has lost its initial purpose as the only effective way that you can learn the words inside the textbook, it is important that our lectures be good. This means that I have to pitch them at the right level. This means that I have to figure out what you have learned. Hence this reality-check midterm, this early reality-check midterm. I really cannot stress enough that it is for my benefit, not yours. So I thank you all for taking it.
Before the Birth of Human Civilization: So, on to the economics of long-run growth.
When did we collectively invent agriculture? When was the Neolithic Revolution? When did we stop being very smart East African Plains Apes with stone tools and actually become civilized people--with fields and firms and domesticated animals and civilizations?
Figure that it happened soon after 10,000 BC.
Dating the invention of agriculture is important, because the invention in agriculture was one of the perhaps four major changes in human life worldwide, at least from an economic point of view. I claim that the first big change was when we learned how to make fire and stone tools. I claim the second was when we developed language: language allows for plannin,g and for collective action of scale much larger than otherwise possible. Otto von Bismarck said: "Fools learn from their own experience. I prefer to learn from other people's experience." Without language it is really difficult to learn from the experience of very many other people: you actually have to see Ogged poke a hornet's nest with a stick. With language it is easy: the cautionary tale of not to do what Ogged did to the hornet's nest can spread rapidly around the entire globe.
I claim that the third big change was the invention of agriculture.
What was human life like in the perhaps 50,000 years--perhaps more, but it is unlikely to be less--between the invention of language on the one hand and the discovery of agriculture? Those were the years when some of us decided to leave our original East African home and venture out across the Red Sea into Arabia, and then from there to pretty much everywhere else in the world (except for Antarctica) over the next 20,000 or 30,000 years?
For one thing, back before 10,000 BC we were pretty buff. Adult males were perhaps 5'8" on average. We were pretty strong too. We had high-exercise lifestyles. We were, however, short lived: life expectancy fracked. Infant mortality was high--babies are fragile things to drag around. And life was pretty dangerous: break a leg and your odds were not good at all; get an infected tusk gore and your odds were very bad.
Nevertheless, we rose in population numbers from perhaps 100,000 humans in 48,000 BC to perhaps 5,000,000 worldwide by 8000 BC. That is impressive: a population multiplication by a factor of 50,000 in what is on the evolutionary time scale a remarkably short time. Tell the biologists that a population multiplies 50-fold in 1600 generations and they will be impressed.
On the other hand, we can calculate growth rates. Take the natural log of 50--that is four. Divide that by 1600 generations--that is a population growth rate of 0.25% per generation. That is a population growth rate of 0.01% per year. Look across the average century between 48,000 BC and 8,000 BC: in the average century, for every 100 humans who were alive at the century's beginning there were 101 alive at the century's end.
Contrast that growth rate of 0.01% per year with the current human population growth rate of about 1% per year today, or the growth rate of 3% per year from natural increase alone seen during much of the nineteenth-century temperate-settlement pioneer experience.
That slow population growth rate tells us something pretty important about material standards of living. Think of the British colonist landing on the coast of North America after the plagues, the epidemics, and the wars had decimated the Amerindian population. The rule of thumb is that a healthy settled human population with low female literacy, no effective means of artificial birth control, and ample food doubles every generation. Figure ten pregnancies per potential mother eight of which survive to term six of which survive infancy four of whom reach adulthood. Between 48000 BC and 8000 BC, it wasn't 4 children surviving to adulthood per potential mother but rather 2.005. 1.995 adult children per potential mother that we would expect to see in a settled population with ample food simply do not survive.
That much excess mortality tells us that life was not just short--life expectancy at birth of 25 or so--but brutish. You lived the healthy life. You got lots of exercise hunting and gathering. But you watched perhaps three-quarters of your children die. But you did have pretty much all your teeth--hunters and gatherers had a low-carbohydrate zero refined sugar diet. That is what life was like between 48,000 BC and 8000 BC. You were physically relatively fit. But populations grew at only the most glacial pace--which means that the odds were good that the jaguar got ya.
The Agrarian Age: Now let us move on to the world of agriculture that starts in 8000 BC or so: the agrarian society where people figure out:
- there are these grasses that have really big seeds
- if we plant all these grasses right next to each other in a place that has a lot of water, then
- if then we stick around for a while and drive off the birds before they eat the seeds
- we will be able to get a lot of our nutrition from these really huge grass seeds--they are quite nourishing
- and we won't have to rumble around our hundred square-mile foraging territory: we can just sit at home and each day gather some more grass seeds--especially if we figure out how to dry them so they will keep.
Nowadays we call these seeds by other names. We call them "wheat" "rice," "rye," "barley," "corn," and other things. They still contribute 75% of the calories that human beings eat--some of it in bizarrely-processed forms like the high-fructose corn syrup we drink. With the coming of agriculture your ability to get the calories to maintain your family goes way way up, and the necessity of roaming about the countryside looking for food goes the way way down. Thus you can start building permanent structures. You have much more time to start weaving plant fabrics together with turkey feathers and furs so you can have better clothes to wear.
Inventing agriculture seems like a no-brainer, right? You can build and live in a permanent house so you don’t get as wet. You can weave and stitch better clothes to wear so you don’t get as cold.
But when we dig up skeletons from 100 BC or so, we find that the adult males are not averaging 5'8" any more: they are averaging 5'2". Some people are taller--that Karl who was son of Pippin (called "the short") and of Bertha (called "greatfoot") appears to have been well over six feet tall. On the other hand, this was the guy whom Pope Leo III proclaimed Boss on Christmas Day of the year 800 AD:
Since the title of emperor had become extinct among the Greeks and a woman [Empress Irene] claimed the imperial authority [in the city of Constantinope]...
Pope Leo:
crowned [Karl] with a most precious crown. Then all the faithful Romans, seeing how [Karl] loved the holy Roman church and its vicar and how he defended them, cried out with one voice by the will of God and of St. Peter, the key-bearer of the Kingdom of Heaven, "To Karl, most pious Augustus, crowned by God, great and peace-loving emperor, life and victory." This was said three times before the sacred tomb of blessed Peter the Apostle, with the invocation of many saints, and he was instituted by all as emperor of the Romans. Thereupon, on that same day of the nativity of our Lord Jesus Christ, the most holy bishop and pontiff anointed his most excellent son Karl as king with holy oil...
You can bet that if there was food around, Karl got it--from infancy onward, and before that in utero, for you can bet that Bertha Greatfoot did not go hungry either. The lesson is that the upper classes were different--and with the coming of agriculture there are for the first time real upper classes. Most people after the invention of agriculture, look to have been quite short. Most people look to have been pretty much toothless and eating corn mash by the time they were 40--if they were alive. Everybody looks to have become a wonderful environment for human diseases: think of a bunch of people living together in a village, talking to each other, coughing at each other, drinking each other’s water--the bacteria love it and disease becomes a much bigger deal.
If your adult height is 5'2" for males or 4'11" for females, something has gone very wrong with respect to protein and calcium deprivation. If you were to feed your future children a diet that would make make the boys 5'2" at their adult height, California Child Protective Services would take your children away. But that appears to have been the kind of diet that most human beings seem to have had in the years between 8200 BC and, say, 1800 A.D.
There were, of course, exceptions. The biggest people that the anthropologists have are found so far are in fact the Sioux--the Lakota Indians of the American Great Plains. What is going on? By 1600 a bunch of tame horses imported into America by the Spanish Empire have escaped and run north. These are animals whose ancestors had been tamed and domesticated by humans for 3000. So the Souix can tame them. And all of a sudden the Sioux are no longer dragging their teepees and their other belongings behind them on human or dog-drawn travois as they follow the buffalo. They are riding horses--they can outrun the buffalo. It is, for them, a two-century paradise--until the railroads and the cavalry show up and want to replace the buffalos with cows behind barbed wire, and also want to mine the gold under the Black Hills. The Souix, not surprisingly object and make their objections strongly at places with names like "The Greasy Grass." But they are overwhelmingly outnumbered.
But the Sioux after the coming of the horse and before the coming of the railroad are exceptions. For most humans life is not only short and brutish, but nasty as well--protein and calcium deprivation and tooth decay and epidemic disease wreak their havoc.
Still, human populations grow. Maybe five million people in 8000 BC become 750 million people by 1800. A fifteen-fold multiplication in 10,000 years or 400 generations. That is a population growth rate of 1.25% per generation, or 0.05% per year--fully five times as fast as in the previous hunter-gatherer era. This is still a human population that is in toto close to the margin of "subsistence"--but not quite as close as in the hunter-gatherer age.
On the other hand, life appears to have been a lot less healthy in the biomedical sense. That calcium and protein deprivation hit your bones is obvious from the height of skeletons--and I shudder to think of what it did to your brains. Moreover, life is boring: you no longer have to roam around using your knowledge of plans--this is edible, this will this give me a rash, this will make me sick, this animal we might be able to catch, that animal is called a "grizzly bear" and it is time to run--but instead you do the same thing over and over again, ploughing, sowing, weeding, watering, harvesting, threshing, and so forth. Yesterday we transplanted rice seedlings all day. Today we are going to transplant rice seedlings. And tomorrow we get to transplant rice seedlings. The day after that we get to try to scare off the birds before they eat your rice. And because it is wet rice there are all these nice little worms that like to crawl up through your feet and then live inside you.
The stoop labor is not too good for your back either.
These are all things that lead UCLA professor Jared Diamond to say that the invention of agriculture was probably a mistake.
Yes we do have a lot more people in the world. The carrying capacity for the human race of a world with pre-industrial agriculture technology is about 750 million. That is a lot more than the five million carrying capacity of a world with hunter-gatherer technology. But for the overwhelming majority of the people you were illiterate peasants in the agrarian age, it was probably much more fun and much healthier being a hunter-gatherer back before 8000 BC than being protein-deprived, calcium-deprived, bored out of your skull, infested with hook worm, and suffering chronic plagues in the agrarian age.
The Population Explosion: Come 1500 or so there seems to be somewhat of a change. In the half-century starting in 1500 populations in America collapse: the Spanish land, bringing smallpox and a huge number of other diseases the Amerindians have never seen and have no immunity to with them. But everywhere else between 1500 and 1800 human populations appear to have grown by half--a population growth rate worldwide averaging 0.15% per year, three times as fast as in the previous agrarian age proper.
And since 1800 things have been very different indeed. From 1800 to 1900 our population grew at 0.7% per year. From 1900 to today our population grew at 1.5% per year. There are now nearly seven billion of us on the planet. At the moment we are hoping that the spread of birth control, female literacy, and wealth--together with the fact that while most literate women with opportunities to work outside the home want and are extremely happy to have one or two children, rather few want to have four or more--means that our global population will top out at a peak of ten billion come 2050. But if it does not--if human populations keep growing at 1.5% per year so that by 2100 we have 28 billion and by 2200 we have 127 billion people on the globe, our great-grand children's lives will become very interesting indeed, and not in a way that is likely to be good.
Making Sense of the Pattern: How do we read this broad pattern of human demography? Why were average standards of living so close to "subsistence" for so long? And why are they so different today?
The way to think about humanity once people get the bright idea of agriculture and settlement--and so for the first time it becomes really easy not to forget technologies when the people who invented them die--is more or less like this:
Once we have agriculture and settlement, it becomes rare that human knowledge is lost. You have to look hard for cases--the Dorian Dark Age after the Trojan War in the Aegean, the fall of the Roman Empire in the west--to find them. And human knowledge does improve. Sometimes the improvements are remarkable and marvelous. Between the Tang and the Sung dynasties humans develop via selective breeding strains of rice that allow for double- and then triple-cropping each year. Before 800 AD or so Southern China and Southeast Asia were not very advantageous places to live. It was hard to grow enough food to support a substantial population. But with the coming of multiple-crop wet-rice strains, things change. And so people move from the largely wheat-growing Yellow River valley south, to where a family with a relatively small wet-rice farm can eat their fill. By 1200 there are 50 million people living in and south of the Yangtze in the rice bowl that is southern China.
That is why the history of China before 1000 is a history of northern dynasties and populations--Chin, Han, Tang--while the history of China after 1000 is primarily a history of southern populations--and the capital stays in the north, when it does, to keep an eye on the Mongols.
It is a wonderful thing to develop triple-crop strains of rice. It is a significant technological improvement. It all by itself allows the world population to grow by ten percent or so in the years before 1500--and still feed the 10% higher population at the same standard of living that the lower population had had in 1000.
But such impressive inventions and innovations really are a once-in-two-hundred-years thing. And because such innovations come only once every two centuries, the fact that better-fed people with stronger immune systems have more children meant that human populations expanded and so living standards fell back to "subsistence" rather than having improvements in living standards cumulate. Before 1500 human technological inventiveness tended to produce not better-fed people or richer people, but (save for the upper class) only more people. Figure 0.01% per year as a rough yardstick measure of the pace at which human technological capacity grew.
Since the Industrial Revolution: Today things are very different. Right now the worldwide rate of growth of human technological capabilities looks to be not 0.01% per year but rather 2% per year. This iPad could not have existed ten years ago. It cost something like $500 last April. It will cost $250 next April--when its successor is released. These days we get as much technological progress in a single year as our agrarian society ancestors would get in two centuries. Then it would be a really big deal when you finally figured out a way to attach a horse to a cart in such a way that the weight of the cart was on its shoulders rather than on its neck. It took until 750 AD before people out a plough that was actually any good for ploughing Northern European soils.
Back in the agrarian age each year saw on average one-two thousandth more stuff produced than the previous year. In the 1500-1800 commercial revolution early modern period each year saw on average one-two hundredth more stuff produced than the previous year. The first century of the industrial revolution era--1800-1900--saw perhaps one-seventieth more stuff produced each year than the previous year. But today world global GDP is growing by about one-thirtieth every year. What we humans produce is right now doubling every generation, and has reached a level of about $7000 per person per year.
Now this $7000 bucks per person per year of stuff is not distributed evenly. We have say greater than san Francisco--in which the average material standard of living is close to $50,000 bucks per person per year.We have Somalia where, in a good year, the standard of living is $500 per person per year.
We had in 1968 the most unequal world that humanity had ever seen--or at least humanity had ever seen when some groups of Eastern Africa Plains Apes had developed language and others had not. But there are very good reasons to hope that the world will draw closer together in the future as it has during the past generation and a half. And I think that in the long perspective the most extraordinary thing our great grandchildren will remember about the two past centuries will not be the fact the world has become so unequal but rather that it has become so remarkably rich relative to our past.
Think of it: we had nearly 10,000 years during which humanity was closed to a subsistence agriculture standard of living--a bowl of millet and a bowl of rice every day, maybe a chicken egg once a week, maybe a chicken once a month, and whatever greens you can gather.That was how most people lived most of the time between the invention of agriculture and the industrial revolution.
Our Wealth: Alexander the Great, King of Macedon, conqueror of the Persian Empire, Lord of Asia--the guy who led his soldiers all the way from Greece to Punjab. (At Punjab he turned back because his veteran soldiers started asking him: "just why the frack are we still doing this? I understand revenging the defeats suffered by our ancestors. I understand that Babylon would be a nice push place to live. But here we are by the Jhelum River. Do you really want us to go further? Why?)
Alexander the Great owned two books--the Iliad and the Odyssey. Alexander the Great carried them with him in a gold chest. The books were worth more than the chest.
I, by comparison, have here in this iPad 20000 books instantly accessible for the price of ten steak dinners. And when Google Books becomes properly online I will have access to millions of books. Alexander the Great thought his books were among the most precious things he owned. In book-wealth, I outstrip him by a factor of ten thousand--and will soon outstrip him by a factor of millions.
Back, say, 500 years before Alexander the Great, suppose you wanted a high-status career path. If you were athletic and noble-born you could be a king--even king of a small territory would do because it would give you some armed retainers at your back to help you sack cities. Think Agamemnon son of Atreos, or Akhilleus son of Peleos, or Odysseus son of Laertes. But suppose you weren't a king. Then the best upwardly-mobile career path available to you would probably be to learn how to chant the Odyssey. That would make you a good person to have around in the cold winter nights, and on the warm summer nights too. It could get you a place at the table and a warm place to sleep. Telling the story of the adventures and the homecoming of Odysseus was an economically-valuable service that you could perform:
"What ails you, Polyphemus," said they, '"that you make such a noise,
breaking the stillness of the night, and preventing us from being
able to sleep? Surely no man is carrying off your sheep? Surely no
man is trying to kill you either by fraud or by force?But Polyphemus shouted to them from inside the cave,
"Noman is killing me by fraud! Noman is killing me by force!""Then," said they, "if no man is attacking you, you must be ill;
when Jove makes people ill, there is no help for it, and you had better
pray to your father Neptune."Then they went away, and I laughed inwardly at the success of my clever stratagem...
But if someone comes up to you today and says: "I know how to chant the Odyssey--and I am going to use this skill to get a high-paying job," we try to let them down gently. We point out that people can buy the audiobook of Ian McKellen chanting the Odyssey for $26.37. We point out that people can buy the Kindle version of Robert Fagles's translation for $12.99--and can download Alexander Pope's translation for free.
Things that would have been regarded in the recent past as valuable and important skills--well, today we are so rich we really don’t notice them at all. That is the change that the industrial revolution. has made.
Why the Industrial Revolution?: Thus the big historical question is: what happened after 1800, and even more so after 1900, that made what we call the industrial revolution? It is the fourth of the big changes in how humanity has lived--along with the invention of agriculture, the development of language, and the invention of stone tools and of fire.
The answer to "what happened" is not "the market economy happened.: Ancient Greece had the market economy. Sung China had the market economy. Neither had the explosion of the economic growth we have seen.
The answer might be "limited government." After 1500, for the first time ever, we have governments that are able to promise that they won’t steal your stuff when they feel like it and to actually carry through on those promises. Before 1500 if had stuff and if you wanted to keep it, the only way to be sure you could do so was to rapidly become part of the government and focus all your attention on keeping yourself part of the government. Government is, as the great Arab historian Ibn Khaldun liked to say, an organization that prevents all injustice except for that it commits itself. A limited government is a government that binds itself not to commit (much) injustice. Under such a government people can turn their attention to other things. For example, Steve Jobs in Cupertino can turn his attention away from lobbying the government and doing favors to politicians so that they don't steal his stuff, and instead turn his attention to terrorizing the engineers of Apple Computer and otherwise motivating them to produce the best possible successor device next April to this iPad I hold before you.
Some of the answer might be "the Columbian exchange." Starting in 1500 all of a sudden humans start moving all kinds of useful plants across the world--transfer the rubber plant from Brazil to Malaysia, transplant the coffee plant from Ethiopia to Java and from Java to Brazil, transplant the hot Mexican pepper to Sichuan, transplant the Peruvian potato pretty much everywhere. That may have given humans enough of an edge above subsistence to allow them to turn more attention to invention and innovation rather than just trying to keep their heads above water.
It is interesting. We look across the dividing lines of 1500 or 1800 in practically every field of human excellence, and our predecessors speak to us. We still listen to the music of Pachelbel. We still study the orations or some of us study the orations of Cicero. We still examine the campaigns and battles of Julius Caesar and Alexander the Great. We still admire the statues of Michelangelo. Poets, generals, politicians, musicians, sculptors, playwrights, artists--we don’t seem to have much more on the ball than they did, even though there are a lot more of us today and you would expect the law of large numbers to produce more excellence today than in the past.
But the economy is different. Wherever we turn in the economy, we find that the organizations we have have literally nothing to learn from anybody in the past.
So what happened to produce this divide is the big historical question. Because this is a principles of economics class and not an economic history class we are not going to answer them. I recommend that you take a global economic history or a sociology of modernity class. But I don't have time here to cover these issues. Thus next time we are going to talk about not why the industrial revolution occurred, but rather how economies have grown since the industrial revolution.
Gapminder.com: Let me close by cutting and pasting from the gapminder.com website which has a bunch of very nicely represented data series on levels of prosperity and standards of living in different countries since 1800 along the horizontal axis and life expectancy at birth along the vertical axis. It shows us how the world was in the 1800, when the great mass of human standard of living is something between $200 and $1000 per capita per year (with China being the big red ball in the middle, and with the United States and the United Kingdom the industrializing societies out there on the prosperous edge).
Fast forward to 1968. A whole bunch of countries, mostly in Africa, look very much like they looked back in 1800 with respect to income--but everybody looks much better with respect to public health and life expectancy.
Since 1968 the world has continued to grow and has become a much, much more equal place. The reduction in inequality stems from the fact the big red ball (China) and the big blue ball (India) have joined the upward merge of prosperity bigtime. It is not so much that the universe of countries have been doing different since 1968. It is that two countries have been doing different since 1968: together they are a third of the human race.
Economics 1: U.C. Berkeley: Fall 2010: September 27 Government Deficits and Debts Lecture
Economics 1: U.C. Berkeley: Fall 2010: September 27 Government Deficits and Debts Lecture
The Dynamics of the Debt-to-GDP Ratio: Last time we talked about fiscal stability and about the danger that the government's promises would unravel completely--that you would wind up in some "Mad Max Beyond Thunderdome" scenario in which nobody trusts the government and its monetary system. We saw that happen in the past decade in Zimbabwe.
Last week, however, I skipped over one part of the analysis of the sustainability of government deficits: the debt equation, the equation for how to calculate what's happening to a country's debt-to-GDP ratio, the ratio of government debt D to annual GDP Y.
(D/Y)t = (1 + (r-g))(D/Y)t-1 + d
Here is how you think about it: You take the previous year's debt-to-GDP ratio; (D/Y)t-1. Start by noting that if nothing changes the debt the next year will be the same as the debt this year--that is the "1" in the debt equation. Plus you have got to pay this year's interest on last year's debt. That is the "r" in the debt equation. But even if the debt is growing the debt-to-GDP ratio will be shrinking if the economy is growing faster than the debt, so you have to include a term for the percentage rate of growth of GDP: that is the "g" in the debt equation. Even a rapidly-growing debt is perfectly consistent with a stable debt-to-GDP ratio if the economy is growing rapidly too. For it is not what is happening to the debt but rather what is happening to the debt-to-GDP ratio that determines whether a government's promises to pay back its debt are going to be credible or not. Last you have to add in this year's primary deficit: the excess of spending on programs over revenues. That is the lower-case "d" in the debt equation.
The deficit reported in newspaper headlines around the country is not the primary but the total deficit. Why do I focus, instead, on the primary deficit? Two reasons. First, the primary deficit is what the arithmetic wants: it is the primary deficit that shows up in the debt equation. Second, the government controls the primary deficit. It does not get to choose what the interest rate on government debt is: the market gets to choose that. The primary deficit is the quantity that government policy controls.
Now let us ask our debt equation a question: what must be the case for the debt-to-GDP ratio to be stable? What must be happening if this year's debt-to-GDP ratio is the same as last year's? To see the answer, we expand our equation out:
(D/Y)t = (D/Y)t-1 + r(D/Y)t-1 -g(D/Y)t-1 + d
We set (D/Y)t equal to (D/Y)t-1 and cancel terms:
0 = r(D/Y)t-1 -g(D/Y)t-1 + d
We move the lower-case "d" to the left-hand side:
-d = r(D/Y)t-1 -g(D/Y)t-1
And we divide through:
-d/(r - g) = (D/Y)t-1
And let us denote this stable value of the debt-to-GDP ratio by a star:
-d/(r - g) = (D/Y)*
This is our answer: You take that level of the primary deficit. You attach a minus sign to it. You then divide it by the difference between the interest rate on government debt and the growth rate of the economy. That tells you where the debt-to-GDP ratio can balance.
The first lesson to get from this final equation is that if g > r you do not have a problem: if g > r your debt-to-GDP ratio is heading for zero if you are running a primary surplus--if d is less than zero--and is headed for some well-defined and stable number if you are running a primary deficit.
But what if--as is more likely--r is greater than g? The a stable long-run debt-to-GDP ratio requires that you run a steady primary surplus. And if your primary surplus gets too small---if when divided by r - g it is less than your current debt-to-GDP ratio, you are in big trouble: your debt-to-GDP ratio is then primed to grow without bound. If you don’t want to want primary surpluses or run a large enough primary surplus--well, either people believe that policies are about to change and you are about to start running a large-enough primary surplus, or you are headed for the Mad Max scenario.
At the moment in the U.S. r is less than g. This debt equation thus tells that there is not any big problem now. The government can run a primary deficit and then over time the economy will grow faster than the interest rate and so even a big deficit now will gradually shrink over time as a share of GDP so that in the long run will be able to pay it off without much trouble.
Does that mean we should not worry about the government deficits the United States is now running? No. r is less than g now, but it would be very foolish to believe that r will be less than g over the long run.
This ends the piece of last week's lecture that I did not have time for.
The Government Budget and "Depression Economics": Now let us move on to the government budget in the less-than-long run. We already covered situations of "depression economics." In situations of "depression economics," boosting government spending puts cyclically-unemployed people to work directly and also increases the supply of safe savings vehicles that people can hold. Thus it has a direct and may have an indirect stimulative effect--if the cause of the downturn is not a shortage of money per se but rather a shortage of bonds or a shortage of safe assets. There is a presumption in situations of "depression economics" that the government should spend more and tax less in the short term.
The Government Budget at Other Times": Suppose, however, that we are not in a situation of "depression economics." And suppose that there are no worries that the government will not pay back its debts in the long run. We still have an unanalyzed question: what happens in the medium run if the government runs a larger or a smaller deficit?
We are going to assume the level of production and employment in the economy is pretty much equal to the economy's productive capacity, that real GDP Y is equal to potential output Y*. Remember that back in our income-and-spending framework we had GDP Y divided into four components: consumption spending by households C, plus investment spending by businesses I, plus government purchases G, plus the balancing net exports term.
Y = C + I + G + NX
And remember our consumption function: a part of consumption that depended on the confidence consumers had about the future and a part that depended on their incomes today:
C = c(0) + c(y)Y.
We can substitute our little consumption function in for C in our income-and-spending equation and we can replace the level of GDP Y by potential output Y* to get:
Y* = c(0) + c(y)Y* + I + G + NX
We can move all terms with Y* to the left and group them:
(1 - c(y))Y* = c(0) + I + G + NX
The potential output of the economy multiplied by the marginal propensity to save, by the difference between one and the marginal propensity to save--that is going to be equal to investment spending, plus government purchases, plus next exports plus that part of consumption spending that depends on household confidence.
The reason to do this algebra is that when we look at this equation, we notice that--unless we are in a "depression economics" situation--the left-hand side is going to be very close to a fixed number. The level of potential output Y* is not going to change quickly by much. Neither is the marginal propensity to consume.
This tells us that if government purchases go up and G rises--or if tax cuts make consumers feel flush and boost c(0)--then investment spending I or net exports NX or both are going to go down.
Do we like having investment spending and net exports go down? Investment spending is one of our major sources of economic growth, and we like economic growth. Diminish the amount that the economy is devoting to adding to its capital stock and you're going to diminish its rate of economic growth and make the future poorer. We probably do not want to do that. If net exports go down--if they turn large and negative--then we owe a bunch of money to people in foreign countries. When we pay that money back it will diminish our wealth. Large external foreign debts have been a common source of financial crises and episodes of depression economics over the past two centuries. Moreover, we do think that it is important for economic growth to maintain a certain productive capabilities inside the United States. We like having Applied Materials located in Silicon Valley: it is a major source of technological innovation, and if you have technological innovation in one place that tends to make for a whole bunch more technological innovation around that and makes everyone in the whole region if not the country richer. There are powerful external benefits from being at the forefront of technological progress
Crowding Out: Our conclusion that government spending crowds out investment and net exports, however, is just math. The math tells us that if government purchases go up and if we are not in a depression economics situation then you can bet that net exports and investment spending have to go down.
But that math does not really tell us why this happens. That is the problem with mathematical arguments in economics. They get you to a place. Often they get you to the right place. But you do not understand how or why you got there, or what it means.
So how is it that when government purchases rise--and when we are not in a depression economics situation--investment spending or net exports or both fall?
Government purchases rise. The government is thus running a larger budget deficit. The government must issue more bonds in order to raise the financing to pay for its extra spending. And as the government issues more bonds, bond prices fall: it is supply and demand.
When bond prices go down, interest rates go up. That is accounting. That is what a high interest rate means: that you can purchase a bond cheaply and thus get a lot of interest payments in return for your initial outlay.
When interest rates go up, foreigners take a look at the potential profits from investing in the United States. More foreigners who had just sold us imports decide that they don’t want to buy American exports but instead they want to buy United States bonds to get the high interest rates those bonds pay. Thus their spending on U.S. exports drops, and net exports falls.
Alternatively, businesses thinking of issuing their own bonds to finance investment projects take a look at the low prices they would have to accept to sell their bonds given the low prices of Treasury bonds--a substitute investment. They decide that given the high interest payments they would have to incur, it is not worth undertaking their investment projects, and so investment spending falls.
So the conclusion; if we don’t want investment spending or net exports to fall when government purchases rise--in this scenario in which there is no depression economics and in which there is no fear of lack of credibility in the government's promises, at least--we would need to do something to consumer confidence. We need to do something to c(0) so that its decline would offset the expansion of government purchases G.
How do you diminish The parameter c zero? You need to make households feel poor and so want to spend less. What measures can the government take to make households feel poor and want to spend less? Increasing taxes. Increase taxes and, yes. indeed people have less money because their paycheck goes down. This tends to disturb them: they tend to feel poor. Congratulations! you have raised government purchases without diminishing investments spending or net exports. That is a big win on the macroeconomic balance sheet.
However, it is also likely to be a big loss on the political balance sheet if you are a politician. Voters do not like governments that make them feel poor. Hence politicians really do not love to increase taxes.
Nevertheless, if we want to stay far away from Mad Max-like scenarios--and we do--we do have to do the tax increases. As Milton Friedman liked to say: "to spend is to tax." Once you have decided to spend you have also then decided to tax. You can then tax stupidly or you can tax smartly, but to complain about the taxes once you have done the spending--well that is just stupid. And if you tax smartly, and balance your spending increases with tax increases, you can avoid the falls in investment and net exports that slow economic growth that happen if you tax stupidly.
Dysfunctional America: Alas! America today seems prone to tax stupidly. You can postpone taxes until later. Postpone them until the next presidential administration, or until you have retired from Congress or become a lobbyist and are happily riding around in your limousine. Then it is your successor sitting in the seat who has to take the blame.
And indeed there can be good reasons to postpone tax increases: remember our discussion of depression economics that a cyclical deficit is a good thing to have when unemployment is high.
But if we're not in depression economics, postponing our tax increases is likely to be a bad idea.
Five Rules for Public Finance: And so now we have arrived at five rules for public finance:
(1) The government must do whatever is necessary in order to make sure that people have confidence it will pay back its debts.
(2) You really ought to have budget balance over the business cycle. It is fine to run cyclical deficits in times of high unemployment, but you really should balance them with surpluses when the economy is in a boom.
(3) That implies Milton Friedman's Pay-as-You-Go principle that he set out in his late 1940s framework for fiscal and monetary stability: whenever the government takes on a mission to do some long term spending program, it also needs to match that by imposing some tax large enough to fund the spending. Changes in government spending plans over time should be accompanied by changes in taxes so that when politicians make decisions and when voters evaluate politicians there is no gaming the system.
(4) You need to keep plenty of headroom in your debt capacity in normal times. In normal times you should aim to keep your debt-to-GDP ratio fairly low. There will come emergencies and opportunities during which you will want to increase your debt-to-GDP ratio. Remember 1803: Thomas Jefferson was president and Napoleon I was about to become Emperor and was willing to sell French "rights" to the entire Louisiana territory. The United States had plenty of debt capacity and could easily afford to borrow--and Jefferson did. Thus we have a United States that doesn’t end at the Mississippi river but instead continues all the way on from the Atlantic to the Pacific Coast. The War of 1812, Civil War, World War I, World War II--in all of them we were very grateful that we started with a low national debt-to-GDP ratio. The government wanted to fight these wars for reasons that it thought were sufficient. It was able to borrow in order to build the armies and navies and air forces to fight them, It could not have done that if the debt to GDP ratio was really high. The Great Depression and the current Great Recession--we want to respond to them by deficit spending as well.
And then there are the other foreign policy missions: after World War II--even though we'd already run up a large debt during World War II--we decided it was to the world's advantage to undertake a remarkably large aid program to Western Europe to help rebuild it under the three headings of the UNRRP, the United Nations Relief and Rehabilitation Program; the MSA, Mutual Security Assistance, and the ERP, the European Recovery Program better known as the Marshall Plan. (Who, you ask, was Marshall? Wasn't Truman the president? Yes, the president was Truman. George Marshall was the ex-general who was the Secretary of State. Truman decided to call it the Marshall Plan: "Can you imagine how low its chances of passage would be in an election year with a Republican majority Congress would be if we called it th Truman plan?" he said. Smart man, President Truman.)
One more digression. Most of you were... barely born when the Cold War came to an end at the start of the 1990s. I remember a whole bunch of us economists--besides me I remember Barry Eichengreen, Rudy Dornbusch from MIT, Larry Summers then at the World Bank, Joe Stiglitz, a whole bunch of people--saying this: We had just spent what would be $8 trillion at today's prices over the previous generation preparing to resist the military threat of the Soviet Union. Shouldn’t we be willing to spend an eighth of that--$1 trillion--on a Marshall Plan for Eastern Europe and the former Soviet Union to help shape their transitions away from really-existing communism to a more normal political system? We made the argument. We were shot down because the debt-to-GDP ratio was then on rising trajectory because of Ronald Reagan's budget deficits. The view of the politicians then was the U.S. government could not take on another large additional commitment given the instability of its long run finances.
I think we would be living in a better world now if we had found the extra trillion to disburse to countries that elected leaders friendly to democracy to move Eastern Europe and the Soviet Union in the direction of a normal political-economic configuration. The current state of Russia--where it settled without that large push from us--disturbs me greatly. But we could not find the resources to do it.
The fact that you are going to face emergencies and opportunities that involve large-scale government spending programs is a powerful argument for keeping your debt-to-GDP ratio low in normal times.
(5) But that does not mean that countries should not borrow except in emergencies. It is perfectly okay for a government to borrow and run up its debt when it is undertaking projects that are going to primarily benefit future generations.Taxing the citizens of the East Bay and San Francisco right now to pay for the entire reconstruction of the Bay Bridge seems unfair--the new Bay Bridge will still be there and be earthquake-safe 50 years from now. People who are going to move into the San Francisco area 40 years from now will benefit from the bridge. They should pay some part of the cost. Thus you should finance infrastructure projects that build up productive capacity through borrowing and debt.
You should also finance current spending through borrowing and debt if you think the future is going to be a lot richer than the present. If everyone in 2070 is going to have five personal robots capable of taking care of their every need, while we each have zero, perhaps we should run up the debt-to-GDP ratio and spend some of what their robots are going to produce on ourselves--for it will be little skin off their nose if they were taxed extra so that they had to divert the production of one of their robots to debt service and only had four personal robots capable of taking care of their every need.
If I had here a wormhole time machine with the other end in 2070, the people in 2070 might respond to that by sending us one of their killer robots to say:
Aren’t you already doing this? Aren't you imposing huge costs on us in your future by changing the climate with your carbon emissions? Right now you are melting the north polar ice cap as on hors d'oeuvre. You have no idea what you are ordering for an entree--but we are going to have to deal with all the floods and typhoons your actions are bringing to the people of the Genghis Delta in what is your future but our present.
If you weren't selfish dorks, you would right now be reducing your debt-to-GDP ratio now because we're going to need all the resources we can find to deal with global warming.
That's an argument.
That's the kind of argument you have to think about in thinking about what your plicy for the debt-to-GDP ratio should be. Which arguments should you find most convincing? I think you should pay very close attention to arguments made by people who can deploy wormhole time machines and killer robots..
So here we have our five rules for public finance.
A Right-Wing Conclusion: I want to close this lecture by making a right wing argument that these five rules are inconsistent and we have to drop one of them.
This right-wing argument is one that back when I was your age I pooh-poohed as nonsensical and simply silly. But it is 30 years later. I at least feel a little bit wiser. It's not that I believe this right-wing argument completely. But it has much more force with me than it did 30 years ago.
The argument comes from Nobel Prize-winning James Buchanan. He pointed out two generations ago that he didn’t think that these rules were politically sustainable. If you try to enunciate the principal that cyclical deficits in downturns are good and permanent structural deficits are bad--that is just too complicated for the political system to process.If you tolerate and approve of cyclical deficits to fight downturns, Jim Buchanan argued, then you're setting the political stage for permanent structural deficits because politicians will be eager to grab the argument that the deficits that they want to run are actually good for the economy.
Allow cyclical deficits, and you make permanent large structural deficits likely. They will slow growth by crowding out investment. They might eventually lead to an erosion of confidence in the government's ability to pay back its promises--and so lead you down the road to Mad Max.
Thus, Buchanan argued, the risks run by undertaking deficit spending in a downturn are too great. The only prudent course is to enunciate the principle: "always balance the budget, no matter what." 30 years ago I thought this was of course complete nonsense: to say that counter-cyclical deficits are good and structural deficits are bad did not seem to be an argument that was too complicated for the American political system to understand.
Today? Today I have to say that I just don’t have that confidence any more.
How many people have read George Orwell's Animal Farm? Oh, excellent--it is part of our common culture!
How many people remember the one-sentence slogan that is the basic principle of animalism? It is:
Four legs good, two legs bad.
That is the basic principle of animalism: four legs good, two legs bad.
(Note, by the way, that a wing is properly classified as an organ of locomotion. The wing properly understood is a leg and not an arm--and it is certainly not a hand. So even though chickens and geese have only two legs, they are not properly classified as Enemies of the Animals.)
The pigs and chickens and dogs and horses of Animal Farm can understand: "four legs good, two legs bad." Why can’t the senators at Congressmen of Washington understand the principle: "counter-cyclical deficit good, structural deficit bad"?
I have a much harder time believing in the rationality and the intelligence and the honesty of the politicians we tend to elect than I had thirty years ago. Right now we have a Republican party that's just set out its platform for the fall 2010 election. As best as I can see, the one sentence summary of its platform is: deficits are bad, so let's take steps to cut taxes and make them bigger.
Since 1980 I have seen all kinds of people--most of them but not always Republicans--attempt to permanently unbalance the U.S. federal government budget over the long run with all kinds of truly astonishing and falacious arguments. I have seen economists I had a lot of respect for--the likes of Eddie Lazear, Marty Feldstein, Glenn Hubbard, and Greg Mankiw--fall in line at the dictates of their political masters and argue for budget policies that they know are long-run economic disasters. So I would like to inoculate you against some of these fallacious ideas.
On the Laffer Curve: The idea you will hear more often is the idea of the Laffer Curve--the claim that cutting taxes is actually increasing taxes because if you cut tax rates you will increase tax revenues. Why? Because the cut in tax rates will produce such a huge outburst of extra economic activity and prosperity.
To immunize you against this I want to say that this Laffer Curve argument really does work in three but in only three situations.
The Laffer Curve argument can work in "depression economics" situations. Because business investment depends on how large business profits are, a cut in taxes that boosts consumption spending can also boost business sales by enough to raise profits enough that investment grows enough that the government-deficit multiplier is large enough your cut in tax rates while unemployment is high actually improves government finances and lowers the debt-to-GDP ratio. In times of very high unemployment you should at least think about whether cutting taxes and raising spending might put the government finances on a sounder basis. I think that that is definitely the case for Ireland today. Ireland embarked upon a policy of fiscal austerity, of cutting back spending and increasing taxes in order to reduce its deficit and restore confidence in the government. What did they find happened? They just pushed one of their biggest banks over the edge into bankruptcy. The cost of keeping it from bringing down the entire Irish financial system into a complete crash will be in the order of five times as large as the improvement in the deficit they got by increasing taxes and cutting spending.
The Laffer Curve generally works with tariffs--taxes on imports, on international trade. Taxes on trade are extremely damaging in the sense that you raise remarkably little money for the economic activity you discourage. Indeed, one of my jobs when I worked for the Clinton administration was to make Laffer Curve arguments about how tariff cuts were in fact likely to produce much more benefits in terms of expanded economic growth by letting people who would make things more cheaply in different parts of the world make them. And I still stand behind those arguments.
The Laffer Curve works when tax rates are nearly 100%--whether through the tender mercies of the likes of Kim Jong-un or Fidel Castro or just through complete corruption. Under those situations cutting "tax rates" on enterprise is something you surely want to do.
But if you have the relatively honest governments of the North Atlantic with their effective tax systems, and if you have our remarkably well-functioning Internal Revenue Service successfully making people pay what taxes they owe by threatening them with random terror if they underreport their incomes--then your Laffer coefficient is one-tenth rather than one. You should think that if you cut tax rates, then you will find that you have induced some people to shift some of their income into taxable forms and you won't lose all of the tax revenue that you had initally calculated you would lose--but you will lose 90% of it.
December 24, 2010
December 23, 2010
Econ 1: U.C. Berkeley: Fall 2010: Transcript of J. Bradford DeLong September 22 "Inflation Economics" Lecture
Is something like this useful? Or is it just too rough and too situation-dependent to be of interest or use to anybody who was not there? (Or, indeed, to any of the people who were there..)
Logistics: We on the teaching staff do realize that in today's Age of the Internet we can very easily throw more material at you than you can possibly absorb.
But you are 21st century Americans. You are used to swimming in a deep sea of information.
And you are students at U.C. Berkeley: you are among those whom by genetic endowment and luck and hard work are best-prepared to absorb whatever we throw at you to build your human capital.
And you are not paying for a good chunk of your education. The good citizens of Paso Robles and San Dimas are, even though you are highly likely to be richer over your lives than they are. They are paying for a good chunk of your education because they believe that money spent educating a technocratic elite is money well spent because you will use the knowledge you build here to go do great things to better California and the world. It is our job up here not to make sure that you have fun but to teach you as much as possible so that the chance that the good citizens of Paso Robles and San Dimas get good value for their subsidy to the University of California is as high as possible.
Thus whenever we prepare or run across anything that we think might be useful to some of you, our natural inclination is to throw it up on the web so that you can take a look and judge whether it is of significant use--to you.
So as you start to prepare for the midterm, do take a look at the files we have thrown up. Be sure to do problem set three. And I highly recommend that you do the practice midterm--it should be easy because you can use the time you would otherwise you to do problem set 4, which we are postponing until after the midterm.
Inflation Economics: One final note about "inflation economics." At this moment, out of the seven seats on the Federal Reserve board three are vacant. The Obama administration has--after long and unconscionable delays--nominated MIT economist Peter Diamond, San Francisco Federal Reserve Bank President Janet Yellen, and my wife’s college classmate Sarah Bloom Raskin. The Republicans in the Senate have blocked their confirmation. It is not clear why--as I understand it, no Republican senator admits to blocking their confirmation, but one of them is and the rest are standing behind him.
The Chair of the Federal Reserve Board can be an overwhelming and dominant voice. But this Federal Reserve Chair, Ben Bernanke, is not: he sees his role as that of expressing the consensus of the Board and of the other committee he chairs, the Open Market Committee. That means that right now the voting members of the FOMC excluding the chair consist of one Democratic nominee, Daniel Tarullo; two Republican nominees of whom, in the words of one of my colleagues, "one of them is pretty good"; and four Federal Reserve Bank presidents who have been largely chosen by their local bankers.
By this time you should be scratching your head: Why hasn't a new president made it a point--in what is now 20 months in office-- of getting his people confirmed to the board that performs the important task of making monetary policy? Why is such an important public and governmental function as the making of stabilizing monetary policy made primarily by guys chosen by bankers? Back when the Federal Reserve was established there was a worry that bankers had too great an influence--and the solution enacted during the Great Depression was to make sure that a majority of voting members would be presidential nominees coming from the government--people who had been appointed by the president who had been elected by the people--and that only a minority would be chosen by the bankers on the grounds that while you wanted their expertise you did not want them to dominate the discussion.
But that solution does not work if the president does not nominate and the senate does not confirm.
Government Budget Economics: With that commercial for Federal Reserve reform--and senate reform--we leave inflation economics and turn to the long-run government budget. I have here in my hand a piece of currency, a dollar bill. It is from Zimbabwe. It is for $100,000,000,000,000 Zimbabwean dollars.
How does a government get into a situation in which it is printing bank notes like this? How does a government make sure that its successors will never get into a situation in which they are printing bank notes like this?
A government that finds itself printing hundred trillion dollar bills is a government that is doing very badly indeed. It is destroying its system of monetary exchange. It is deranging its economic division of labor. It is severely crippling if not eliminating altogether the ability of people to make and trade things on markets for predictable prices--which is one of the things that makes us all so rich. It is returning the economy to barter and to the autarchy of unspecialized production for yourself. It is throwing away what we have learned through 6000 years of progressing civilization about how to organize economies.
The answer is that governments find themselves resorting to printing things like these Zimbabwean hundred trillion dollar bills when they have proven permanently unable to balance their budgets.
When government spending has outrun taxation, and when their spending has outrun taxation so long and so far that nobody is willing to lend the government money because nobody thinks that they are ever going to get whatever they lent back--that is when a government finds itself printing hundred trillion dollar bills. The questions of how governments get into such situations, and of whether the US government now is close or getting closer to such a situation--those are the key questions of government budget economics.
The U.S. Debt-to-GDP Ratio Over Time: Look at this graph of the United States national debt truly held by the public divided by the annual GDP of the United States. Take the total amount of money the government has promised to pay its bondholders, divide that amount by annual GDP, and you have a measure of the potential burden of the debt on the U.S. economy. Here we have this measure back to the early 1790s.
Alexander Hamilton and the Origins of the National Debt: Back in the early 1790s, the national debt was close to 40% of annual GDP. It was close to 40% because the first Treasury Secretary, Alexander Hamilton, thought it was a good idea to make it close to 40%. He convinced congress to let him go to the states and say:
You know all that money you spent winning us our independence from Britain by raising armies during the Revolutionary War? The federal government is going to pay you back for all of that. We in the federal government are going to assume your Revolutionary War debts, and pay off all the bonds you issued at full face value.
Alexander Hamilton did this for three reasons. One was he had a bunch of friends who were financiers in New York. Once they got wind of how he was thinking they had the opportunity to buy up pieces of the debt from the merchants, the soldiers, and the others to whom the government owed money--to say:
You don't think New Jersey will ever pay off that piece of paper, do you? I'm willing to gamble that they will eventually pay something--how about you trade it to me for 40 cents? You get the cash, I take the risk, it is a good deal for both of us.
Then Alexander Hamilton announces his debt assumption plan. New York financiers who understand how Hamilton thinks make an awful lot of money. And they are grateful.
That, however, was only a minor reason.
One major reason was that Alexander Hamilton saw that the United States was then a relatively small country in a world dominated by two super powers, Britain and France. Both Britain and France had ocean-spanning ambitions and blue water navies. Hamilton thought it likely that we would at some time in the future get into a big war with either Britain or France. And he wanted to make sure that if we did get into a big war that the federal government would be able to borrow money in order to fight it effectively. Moreover, even if we did not get into a big war a U.S. federal government that could not borrow--that had no debt capacity--would be weak. Both France and Britain would both notice that we were weak, and they would steal our stuff, press our sailors and make them man their navies, et cetera et cetera. Thus Hamilton thought it was important for the federal government to start its existence by building up its debt capacity. And what better way to convince investors that the federal government would pay off its debts in the future than for it to pay off the debts of the United States incurred during the Revolutionary War--even or perhaps especially if those debts had not been incurred by the current federal government?
The most important reason, however, was that Alexander Hamilton was Secretary of the Treasury in a country where the rich were at best uneasy about the revolution and independence. Of America's upper class as it stood in 1775, full half of them were gone: had fled to Britain or Canada during the Revolutionary War. Those who remained remembered that back before 1775 the British monarch had protected property, that the British army and navy had protected them against deprivations of all kinds, that it was quite clear who the police worked for. Now you have a republic with a much broader electorate. Might politicians run on a platform of soaking the rich and redistributing wealth to the poor? Thus the rich people were nervous--and at least thinking about how maybe it would be good if the British came back and ruled again.
This was where Alexander Hamilton had his good idea. Suppose, he thought, he could set things up so that the rich owned a lot of U.S. government bonds. Then if the British returned--well, the British were not going to pay off the Revolutionary War debt of the United States of America under any circumstances. Having a national debt was a way to bind the United States rich to the country--giving them a stake in the new republic's survival. And by large it worked: the national debt was a national blessing.
Standard Debt Dynamics: In this figure from 1790 to 1980 we see what became the standard dynamics of the United States national debt. During big wars--the Civil War, World War I, World War II, and to a lesser degree the War of 1812--the United States borrows big time to fight. And so the debt-to-GDP ratio rises. When the United States goes into a significant economic depression--either the Great Depression or our current Great Depression--it also borrows frantically, sometimes enthusiastically and sometimes reluctantly, to avoid massive cuts to government spending programs and to try to keep the economy moving again.
In other non-war non-deep depression times between 1790 and 1980 the budget was always more-or-less balanced. There might be a small deficit. But because the economy was growing through immigration, through capital accumulation, and through the progress of knowledge about technologies and organizations that increases productivity, GDP was growing much more rapidly than the debt, and so the debt-to-GDP ratio was falling. Raise the debt-to-GDP ratio in wars and depressions. Watch it fall at other times. Those were the standard dynamics of the U.S. national debt.
The Reagan Revolution: That works until the 1980s. What happens to change it? In 1980 we elect Ronald Reagan, the first of the huge peacetime deficit presidents.
When Reagan was governor of California from 1966 to 1974, he was very much a balanced budget governor: he thought it important that the government not overspend, that it not run big deficits. He believed in investment in the future, yes--funding the University of California and building infrastructure--but not in large-scale deficit spending.
As soon, however, as Reagan gets elected president he pushes for massive peacetime deficits, and the debt-to-GDP ratio rises quite rapidly during his terms and during his successor George H.W. Bush's term. Then Bill Clinton gets elected in 1992. Clinton reverses course: he raises taxes and puts ceilings on spending growth. The debt-to-GDP ratio resumes its normal peacetime downward trajectory.
Then we elect--well, Justices Scalia, Rehnquist, Thomas, O'Conner, and Kennedy elect--George W. Bush. His vice president Richard Cheney believes that "Ronald Reagan showed that deficits don’t matter." Lo and behold, the deficits starts up again and the debt-to-GDP ration rises. Then the financial crisis hits. We react as we usually do in a big downturn: spending money--albeit not enough money--to to and keep the economy on an even keel.
Now the Obama administration is in a puzzling situation. How fast should it cut the deficit? When are we going to get out of our "depression economics" situation in which a deficit is a positive good as a demand stimulus? When will we start having normal times again in which the debt-to-GDP ratio should be on a downward trajectory? And how are we then going to put the debt-to-GDP ratio on its normal peacetime non-depression downward trajectory?
The scary thing is that as I look at the complexion of politics in Washington, putting the debt-to-GDP ratio on its normal downward trajectory appears a very difficult task. Things have definitely changed.
There are two theories to why things appear to have changed around 1980--why our political system no longer generates the small government deficits and the downward debt-to-GDP trajectory that it used to.
The first theory is ideological: that something has gone very wrong with the minds of the Republican Party's officeholders, apparatchiks, and their tame intellectuals. From the end of the Civil War all the way up to 1980 the Republican Party tended to be a small-government balanced-budget party: its consensus was that the first priority was to balance the budget, and that if the budget was balanced the next priority was to cut spending. Since 1980 the Republican Party has been a large-government unbalanced-budget party: its first priority is to cut taxes, its second priority is to raise spending on national defense and spending and tax expenditures on programs of interest to lobbyists who fund Republican campaigns, and balancing the budget is a distant third priority--if it is there at all.
The second theory is structural: that we have changed the character of government spending. It used to be that most of U.S. federal government spending was done through the appropriations process--spending that had to be decided upon and revoted year after year. The U.S. federal government spent on defense, on national parks, on building dams and ports, on building interstate highways, building canals. But that is not what the U.S. government spends on today: today the U.S. government spends on Medicare, Medicaid, and Social Security. Spending on those programs as a share of GDP goes up automatically as the population ages and as doctors and pharmacists become more inventive about how to treat people with diseases.
Health Care Spending and the Long-Term Budget Outlook: This particular chart here is by the Congressional Budget Office, an organization headed by my friend Douglas Elmendorf. This is his take on the long-term outlook for the U.S. federal government's spending and revenue--his "alternative fiscal scenario," which is his guess of what will happen if the budget votes that congress typically takes keep on going the way they have been typically going.
The big black line at the top is total primary spending--spending excluding interest on the national debt. The rule of thumb is that in normal times the debt-to-GDP ratio will be constant if primary spending is equal to revenue, that the debt-to-GDP ratio will rise if primary spending exceeds revenue, and that the debt-to-GDP ratio will fall if primary spending is less than revenue.
Spending on government programs--primary spending--consists of mandatory or entitlement spending and discretionary spending. Mandatory spending makes up the bottom two layers of this cake. Discretionary or appropriated spending makes up the top, light blue layer: national defense plus everything that the civilian government used to do.
At the bottom are the big entitlement programs. The United States has promised it will pay Social Security benefits. We know that under current law Social Security spending is projected to rise from about 4% of Gross Domestic Product today up to 6% by 2035.
On top of that are the federal health spending programs: Medicare, Medicaid, the Children’s Health Insurance Program, and the "exchange subsidies" that are part of our brand-new newly-enacted but not yet implemented RomneyCare system by which people are required to buy health insurance on the yet-to-be-started health insurance exchanges, but this requirement is eased by providing poor people with subsidies to make buying private insurance affordable.
The amount of money that these health care programs will cost is, if things continue as they have been, scheduled to grow from a total of 5.5% of GDP today to something like 9% of GDP in 2035. And these spending programs are automatic. The United States government has promised that it will pay for them. For spending to grow less rapidly would require that congress vote and the president sign big changes in what categories of health spending the federal government will pay for. At the moment the federal government will pay for what your doctors and nurses say is medically appropriate. And Doug Elmendorf says that if he has learned anything from being a health economist over the past 30 years, it is that doctors are very good at figuring out new and expensive things to do that are medically appropriate.
Many of things are medically appropriate. Our revolutions in medicine and public health have doubled lifespan over the life of this country. But many of these things are expensive. And neither political party wants to make controlling the rate of growth of healthcare spending--changing the law so that Medicare will no longer pay for a kidney transplant for your grandma--its signature issue. The big Republican talking point this fall is that the Democratic Party's promises to streamline Medicare to make it more efficient are really plans for huge Medicare cuts that mean that someday your grandma or you will have to go in front of a government "death panel" that will turn their thumbs down. We, the Republicans are saying, are going to repeal all of the Medicare cuts and the tax increases in the recently-passed Affordable Care Act--but we are going to keep all of the parts of the ACA that actually cost money.
Feckless Congress: That is what drives the increase in expected federal government spending as a share of GDP over the next 25 years in Doug Elmendorf's Alternative Fiscal Scenario: that whenever it gets the chance congress will shy at the jump and push all steps to reduce the rate of growth of government health-care spending programs off for an extra year or two--as it has done with the Medicare Sustainable Growth Rate formula for a decade now--and keep pushing them off. That is the thing that makes the long-term budget outlook look extremely dicey. These increases in spending happen without a single congressional vote: they are build into the structure of Medicare and Medicaid, of SCHIP and of the exchange subsidies. If we simply have congressional gridlock as usual, spending goes up as a share of GDP. And if we simply have congressional gridlock as usual, taxes don't go up as a share of GDP.
Now, you can hear people say--you can sometimes hear me say--that the current law baseline is close to balanced: our primary fiscal gap is only 1.2% of GDP over the next twenty-five years. That assumes that congress will not do what it usually does--which is to change laws so as to reduce revenue and increase spending whenever the date for scheduled tax increases and spending cuts approaches. I believe that we will see this again at the end of this year, when the 2001 and 2003 tax-law provisions expire. While congress let them expire, or will it find some excuse to extend them?
Doug Elmendorf says: don’t bet on congress letting these tax increases take effect. When he looks at the congress and he counts the vote, he cannot see congress restraining itself. He believes that the United States is not on the current-law baseline path, but rather on the Alternative Fiscal Scenario path along which healthcare spending program growth drives an ever-increasing gap between what we are spending and what our revenues are. A
Confident Investors: At the moment, it appears that investors all over the world do not agree with Doug. At the moment, it appears that investors think that the United States government is a sound operation--that in the long run we will balance our budget and that we will raise taxes in order to pay for our spending and also pay off our national debt. That is the reason that U.S. Treasury bond prices right now are so high and U.S. Treasury interest rates right now are so low.
Nevertheless, when you read Doug Elmendorf's Long-Term Fiscal Outlook document and when you look at this picture, it is hard to understand why investors are so confident. What is supposed to change about U.S. politics that will make a congress that has been unwilling to let the AMT fix or or the R&D credit expire actuallay let the expire? Where is a congressional majority supposed to suddenly grab the courage to allow the "middle class tax cuts" to expire, or to allow the special cost on high cost health plans to go into effect, or to let the Independent Payment Authorization Board to do its thing--when these involve big negatibve hits to the incomes of politically powerful groups like doctors, insurance companies, unions, Silicon Valley, doctors again, relatively rich people living in California and New York who own big houses, the rich who are about to die, the rich who give campaign contributions?
The answer is that the world's bondholding investors believe in us. They believe that we will in the end elect representatives and senators who understand that winding up as Zimbabwe is not what you want to do.
A problem is that even before you get anywhere near Zimbabwe--even when people just begin to fear that perhaps there is some chance the government might become one that resorts to hyperinflation--even the fear that there might someday be an unsound government with no plans to balance its budget can itself produce big financial crises and substantial episodes of depression economics. We saw this in Mexico 1995, in East Asia in 1997, in Argentina in 2001, and in Greece in 2010.
What happens when investors stop thinking that your government is certain to be a safe and sound place to put their money? Then the government has a choice between finding some other government to bail it out on the one hand, starting the money printing process on the other hand, and "austerity" on the... I guess on the prehensile tail. If a government reduces government spending to match the limited amount of taxes that it is able to collect--well, this is where Greece is now. It makes people unhappy: they burn police cars in the streets of Athens. So far we haven’t seen situations like this in Iceland or Ireland or Spain or Portugal or Southern Italy yet. But there is a substantial chance that those times are coming to them as well.
Are we close to the edge in which investors appear to be losing confidence in the long term soundness of the U.S. government? Well, no we are not. Will we be there someday? Perhaps. When will we be there? We don’t know.
The long-run U.S. government budget situation is right now what we economist call "unsustainable." My old teacher the late Rudiger Dornbusch used to say two things about unsustainable economic situations: first, they last for longer than economists believe is possible; second, when they end they end very, very quickly. Nobody eighteen months ago saw Greece as prone to capital flight and to a major government financial crisis. Now everybody does.
What happened to make things different after 1980? This is a question to which the right answer differs depending on whether you are a Democrat or a Republican. If you are a Republican, you say that the big problem was the Democratic Party had ruled from 1932 to 1980 by promising that the government would spend more money and pay for it by taxing the rich. Because the rich are a relatively small part of the voters, such promises lead people to elect you and you continue to rule even though your policies are bad for the country in the long run because too-high taxes on the rich do harm investment, enterprise and innovation, and do slow the rate of economic growth and in the end make everyone worse off.
If you are a Republican, you say that the Republican Party had to find a way to compete with the Democratic Party's "spend money on programs you like and pay for them by taxing the rich" meme. How to compete? The only way was to adopt the "spend money on programs you like and pay for them by cutting everybody's taxes" meme. "But that makes no sense!" the Democrats say. "But it is your fault that we are saying this," the Republicans say: "If you Democrats had not been waging this class war since 1932 we Republicans would not have been forced to resort to unbalancing federal government finances in order to have a chance of winning congressional majorities."
If you are a Democrat, you simply say that around 1980 the Republican Party candidates, legislators, apparatchiks, and tame intellectuals simply abandoned what remained of their scruples and ethics.
Since I am a Democrat, the correct answer on the problem is (D). If I were a Republican, the correct answer on the problem would be (E).
Conclusion: What is the most likely outcome for the U.S. government budget come 2060? We have our politics. We have a medical system in which we very much want to have medical care allocated to people who need it as opposed to allocated on your by basis of your wallet. We are unwilling to say: "a coronary bypass would do you good but if you’re not rich enough to pay for it yourself we are just going to let you have your heart attack." So as doctors and pharmacists and nurses and technologists keep on inventing new things to do the list of medically appropriate procedures keeps on growing. Certainly by the time you are 80 there will be a doctor who will say that it is medically appropriate for you to have a cloned heart in the basement of Alta Bates Hospital just in case you suddenly need a hot heart-swap. That is the territory that allocating health care spending according to what is "medically appropriate" tends to push you toward.
We have health-care technologists who are very good at finding new things to spend money on. We have a political-ethical belief that healthcare should be allocated according to what you need rather than how rich you are. We have a government that has agreed to take on a huge load of healthcare spending. We have two political parties, one of which says that the middle class is taxed too high and should get tax cuts (but the rich could easily pay more) and the other of which says that everybody is taxed too much and should get tax cuts. And both parties say that we should not enact major cutbacks to the rate of growth of any forms of federal spending except those that are "waste, fraud, and abuse." And those parts of federal spending that are actually waste, fraud, and abuse--ethanol anyone?--have very powerful political protectors, and are untouchable.
What do people think is the most likely outcome from this situation?
- Come 2060 will we have raised taxes by a lot? We could double income taxes between now and 2060 and barely pay for extra government health spending.
- Will we have cut doctors’ wages and enslaved them by drafting them into a socialist national health service?
- Will we have abandoned our egalitarian healthcare beliefs?
- Will the healthcare efficiency cost-effectiveness fairy have come and rescued us?
- Or will the federal government as we know it will have collapsed and those of us who are still alive be involuntarily starring in a remake of Mad Max: Beyond Thunderdome?
What do people think?
I am glad to see so many clicking on answer (1). It shows that we have a bunch of optimists--a bunch of people who believe that we will have raised taxes to pay for government spending, and that the United States will become more like a western European country with higher share of government spending in GDP than we have, a mixed economy with more of the government in the mix.
Answer (2) is what Ronald Reagan was worried about in 1961 when he first opposed Medicare. He began cutting records. They would then be distributed around the cities of California. People would come to grassroots meetings. They would play Reagan's records. He would talk about how Medicare was the first stage on the road to full communism and slavery. Because after all, if the government was going to promise that it was going to pay for healthcare it had to raise the resources somehow? What is the easiest way to raise resources? Draft doctors and send them where the government wants and pay them what the government wants. Nobody, Reagan thought, would speak up when the secret police came for the doctors. And he thought that once one group of people loses their freedom then eventually everyone is going to lose their freedom--that in order to keep liberty in America we had to stop Medicare now.
I think that was substantially overwrought. We have now had Medicare for 45 years and we have managed to avoid enslaving our doctors yet. But it is possible.
Answer (3), abandoning our commitment to providing state-of-the-art healthcare to the sick and not just the wealthy. That’s definitely a possibility--especially if health care becomes more and more expensive.
Answer (4) is that the healthcare cost-effectiveness fairy will save us: we will figure out ways to treat people that do not become more expensive over time but instead less. I do not see what those ways would be.
Then there is answer (5), the real dystopian scenario. I don’t think we’re going there. All of the other solutions provide easier safety valves. Even enslaving doctors does not involve a complete collapse of the social contract.
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