Sunday, September 27, 2020

Reinventing the Bazaar a book by John McMillan

John was a Kiwi economist (22 Jan 1951 - 13 Mar 2007)

I recommend McMillan's book. I read this book a very long time ago. Today, the book is even more relevant than it was in 2002. It is a lucid, full of meaningful stories, and an overall enjoyable read. It could help many young people, especially economists, think about the role of the government? Should the government intervene in the economy? How much? How? When? 

McMillan had an interesting view about the market and the role of the government. He did not advocate more government intervention, socialism, or liberalism. He was neither for a free market nor for social policies. He wrote, "the market system is not an end in itself but an imperfect means to raise living standards. Markets are not magic, nor are they immoral. They have impressive achievements; they can also work badly." He thought that the "design of the market" matters the most. He believed that the evidence is that economic growth is good  for everyone, including the poor, but he also believed that equity matters too. He cited evidence that countries with more equal income distributions grow faster.  

I am not totally sure about that kind of thinking because McMillan must have had an implicit assumption that there is "a government" out there, a "designer" that can actually make a better market via rules and regulations. Where do we find such a government, I wonder? 

In my view, the government may, and can, intervene in the market, but that intervention depends on the size and the scope of market failure. There must be robust, careful, and verifiable evidence of free market failure before the government is allowed to step in.

Here are some excerpts that I found interesting.

Chapter one, "On November 9, 1989, the people of Berlin joyously tore down the wall that for thirty years had divided their city. As the wall fell, so did communism and planned economy. On April 30, 1995, the U.S. government ceased controlling the internet. As entrepreneurs devised procedures for online buying and selling, electronic commerce burgeoned. These two dates denote the beginning of what has become, for good or for ill, the age of the market."  

I think that the internet market could have been an amazing free market experiment. Unfortunately, we are getting more and more government interventions by the day. Be careful please when you blame the free market. We do not have a  free market anywhere in this world. In fact we had more free markets in the past centuries than today. Is it funny (or not) that a Republican like Trump is against free market and a Chinese communist like Xi Jinping is for free trade?

Chapter Twelve, How did so many countries come to be centrally planned? [after WWII] . You might find this paragraph interesting. He writes,"Albert Einstein wrote an article in 1949 called "Why Socialism?" His answer: "the market economy brings crisis, instability, and impoverishment. The economic anarchy of capitalist society as it exists today is, in my opinion, the real source of evil." The only way to eliminate this evil, he concluded, was by establishing socialism, with the means of production "owned by society itself." He advocated a planned economy, which adjusts production to the needs of the community, would distribute the work to be done among all those able to work and would guarantee a livelihood to every man, woman, and child." 

There are more stories like those in the book. 

Einstein's view was shaped by the horrors of the Great Depression, no doubt. I cannot blame him. I hope that he lived to see the whole socialist tragedy. Socialism collapsed spectacularly in 1990 for good reasons. Does the free market make people poor? How do we answer this question?  McMillan says, no it does not. We do not even have a free market experiment anywhere to examine. Instead, we have crony capitalism, nepotism, racial and social discrimination, subsidies, bailouts, tariffs and trade restrictive laws and regulations, etc.

PP. 25, John writes, "Rembrandt was an innovator not only in painting but also in commerce. He helped establish a full-fledged art market in the seventeenth-century Amsterdam." "Composers in Germany or so later switched from being long-term employees of aristocrats to producing for the open market. Handel and Telemann were vocal in their dislike of being subject to their employer's whims, and they paved the way for Mozart and subsequent composers to work freelance. In a 1781 letter to his father, Mozart said, doubtless exaggerating somewhat, believe me, my sole purpose is to make as much money as possible; for after good health it is the best thing to have."...Mozart saw the market as offering him creative freedom." 

There will always be business cycles and depressions in the future just like in the past. Although many economists believe that government intervention gets us out of prolonged recessions. I highly doubt that we have evidence to support such an assertion. To the contrary, we have examples of policy error. These errors are persistent. They are costly to undo. There are many examples, but most known is that the Great Depression was a monetary policy error, Friedman and Schwartz wrote extensively on this. 

McMillan tells some interesting stories about New Zealand's reforms in chapter 15. Imagine that the NZ government made rules and regulations for every bit in the economy including the color of Margarine, which had to be white not yellow so it couldn't compete with Butter!

Here is another story, he says, "The bizarre nature of the old New Zealand economy is illustrated by an anecdote from the industrialist Alan Gibbs. For the sake of employment, the government required television sets be assembled locally. When Gibbs went to Japan to negotiate a price for the components, he was greeted with disbelief. Because of the way the production lines were set up, the Japanese television makers could supply the separate components by placing workers at the end of the assembly line to take apart the completed televisions. Gibbs firm has to pay 5 percent more for the pieces..."     

 Many young Kiwis do not even know what New Zealand looked like before 1984.

Monday, August 17, 2020

Income inequality, politics, and economics

Many people, including a number of economists, are concerned with income inequality. They are concerned that a small number of people have more money, wealth... than the vast majority of citizens have. The precise measurement of such inequality is tricky.

To reduce or eliminate income inequality, many politicians and economists advocate taxing the wealthy people hard, e.g., a 70 percent tax was suggested by the American congresswoman Alexandria Ocasio-Cortez. The famous French economist Thomas Piketty suggested something like 90 percent tax on wealth. Tax the rich is a 2020 election policy for the Greens in New Zealand. 

There is an ideological aspect to this issue, but I am not concerned with it. 

However, I want to show you some data, which reveal that some countries have relatively low-income inequality and at the same time they are richer in terms of income per person, have low public spending, and low taxes. The data suggest that income inequality could be reduced without spending more, taxing more, or reducing anyone income. Instead of reducing somebody's income simply try to increase everybody's income.   

To think in terms of economic theory, we should think about Pareto improvement, which is an efficiency condition whereby at least one person can be made better off without making anyone worse off.  

Measurement is tricky as I said, however, for comparison, I use the UN measure of income inequality, which is the ratio of average income of the richest 10% of the population / the average income of the poorest 10%...Here is the table. I list the English-Speaking nations first, followed by the Europeans, the Scandinavians, and finally the Asians countries.

Australia, NZ, and the U.K. have the same level of income inequality. The U.S. has the highest level of income inequality in OECD. Canada is more comparable to the Europeans with medium level inequality. The Scandinavians have the lowest income inequality in the West, but the Asian countries have low-income inequality too. Japan's is the lowest in the world perhaps, followed by South Korea. Singapore and Hong Kong have lower income inequality than the U.S.  

Given these figures, one might think that the Asian countries, Japan and South Korea in particular, must have high public spending on social welfare programs, high taxes to finance such programs, and an income per capita growth similar to the Scandinavians!  

No, they don't.

In the Asians countries, particularly in Korea, however, public spending and taxes are significantly lower than the rest of OECD, and income per person growth is significantly higher than all other OECD countries. 

This figure plots real income per person growth rate (data source:IMF-WEO) and government spending to GDP ratio. The Asian countries spend less as a percent of GDP and have higher income per person growth than the rest of the OECD. The English-speaking countries spend less and have higher income per person than the Europeans' have, and the Scandinavians have more spending the least income per person growth. Japan is somewhere in the middle. Still, Japan public spending is much lower than the Europeans' are.

This figure plots the real income per person and the tax-GDP ratio (OECD data). The Asian countries tax their people less because they spend less on social welfare programs, and have higher income per person than the rest. 


The correlation between government spending - GDP, tax-GDP ratio and income per person growth is strongly negative across the OECD. 

These significant differences in objectives and policies across OECD countries reflect the voters' demands for social welfare programs and the politicians' competition for votes.

Korea achieved a better income inequality outcome than the European countries and comparable to the Scandinavian countries, and much lower than Australia and New Zealand with less public spending, and a higher income per person growth rate. Similarly, Singapore and Hong Kong have much better outcomes than the U.S. Even Japan, which has the lowest income inequality in the world, has less public spending and lower taxes than all European and Scandinavian countries. So why can't we do that? 

Nevertheless, I think that as long as the voters continue to demand forceful government actions against wealth accumulation, politicians will compete for votes and promise more. This pattern will not change soon.

Monday, June 1, 2020

Financing the Budget Deficit and the Wealth Effect

People are already thinking about the bill of COVID-19, and how would it be paid. Just look up the Google mail and see the flood of articles. The New Zealand Minister said that the government will borrow to finance the deficit, but it is not as simple as this. At some point in time, a government, which may not be this government would have to raise taxes. The borrowing matters whether the public holds an interest-bearing government bonds or non-interest bearing bonds. The latter type is like the US Treasury Bills. They are non-interest bearing bonds or zero-coupons, which are bought at a discount price of their face value i.e., they pay no interest, but eventually sell at the par value, therefore, they bring about a positive yield to holders.  

What's the difference between these bonds and what is the effect on the economy?

On this issue, I remember a paper that I read when I was a graduate student preparing for my PhD exams, Robert Barro (1974) wrote in the Journal of Political Economy "Are Government Bonds Net Wealth?" This issue is pertinent to the situation we and others are facing.

Barro argued that government debt, which is held by the public could increase or decrease in real terms when the price level changes. So if the price level falls for whatever reason (the situation now with a near zero interest rate means that people are indifferent between holding money or bonds), the real value of government debt increases, and economy's level of wealth increases too. However, if the government finances the budget deficit with interest-bearing bonds, and people anticipate an increase in future taxes to finance the deficit, an increase in the real value of government debt outstanding will also imply an increase in the present value of future tax liabilities. Therefore, government debt cannot be considered a net wealth increase for New Zealanders.This bond buying business may not stimulate the economy as much as the government thinks. 

The NZ government bonds are low interest bearing bonds as shown in the this statement, but not a zero-coupon. Therefore, holding these bonds cannot be net wealth.

Financing the budget deficit with a non-interest bearing bonds (zero coupon bonds), on the other hand, could be a net wealth to New Zealanders. The reason is that the increase in the real value of the debt outstanding is not associated with an expected increase in tax liabilities. 

I seems like a great idea to buy government bonds while working and cash them to finance retirement, if they were zero-coupon type of bonds. In this case government debt is net wealth to Kiwis, and the government can finance its deficit and lower income tax on people's labor income. One can see how such fiscal policy can increase labor productivity. 



Friday, May 22, 2020

What Have I Learned from COVID-19 Data So Far...

Everyone knows that there is an argument about the data of the number of confirmed cases. Many papers were written about understating the number of infections. The typical story is that, with the absence of reliable and timely tests, we may have understated the infections by a factor of 10. Because the US government pays hospitals for treating infected patients, and also pay them more if the patients need to be on ventilators, some hospitals were overstating the number of COVID-19 deaths related cases. Minnesota was one state circulating in the news. So, if the numbers of confirmed cases, which we are using from Oxford University, the Johns Hopkins, or else in our research, are understated, researchers must deal with these measurement errors. Ordinary Least Squared regressions estimates are biased and inconsistent. IV estimators should be used. Testing for COVID 19 matters for reducing the number of deaths even though millions remained untested. See my paper

The second thing I learned from COVID-19 data is that the modelling of the infection using the Gompertz (1825) function overestimates the peak infection. Usually, we try to model the data as they arrive. The data have a steep upward slope. The Gompertz function is a very suitable model for this kind of events. However, it is a statistical function, which has a couple of fixed parameters. It does not account for policy. So if we have data from time t to t+k and we fit the function up to time t+k+1 without having accounted for policy, we will overestimate the peak infection. Policy (stringent) reduces the number of infections, but the Gompertz function does not take this into account.

Figure (1) plots my estimates of the New Zealand curve, see my paper ...The data that I used in this paper were from Feb 28 to Mar 27. Figure (2) use the same graph but add the actual data up to Apr 23. As you can see in figure (1), I predicted the peak infection to be 2630 cases on April 3. Then we learned when the actual data arrived that the number of infections on April 3 was 772, see figure (2). The peak, probably did not occur until April 22...and much lower than my estimate.

Figure (1)
Figure (2)

I also learned that policy responds to the number of infections positively, and the latter responds to the former negatively. Policy response, however, is endogenous and country-specific. New Zealand and Australia responded quite differently to the infection, but the outcomes of the two countries are pretty much similar. I also learned that if country A adopts country B policy response, country A cannot achieve the same outcomes of country B. I tested whether, or not, the New Zealand policy response, which achieved zero infections, could reduce infection to zero if it is adopted by Denmark, Sweden, and the USA.I found that it is effective in reducing the infections significantly, but not to zero as it did in New Zealand. There are omitted factors that need to be taken into account in such analysis. Culture might be an important missing variable. Although the Swedes and the Danes are seemingly Scandinavians, they followed different polices and the people have been reacting differently. The outcomes are very different. See my paper.     

I am sure that we will learn more from doing more research.

Friday, May 8, 2020

Future Prices and inflation

What happens to the future prices and inflation as a result of the expansionary polices in response to the pandemic? 

As a result of the increases in the money supply and government spending in response to the pandemic, future prices of goods, services, and assets will increase for sure...not necessarily the inflation rate. 

Under a system of inflation targeting, bygones are treated as bygones. It means that the increase in prices is not a concern, but the rate of growth of prices, i.e., inflation, is kept constant. 

The plot shows that currency per unit of real output and the CPI are positively correlated, thus in the short run the increase in the money supply increases prices under inflation targeting (it increases real output sooner, in the short run).

The second plot shows that there is no correlation between the growth rate of money per unit of real output and the expected inflation rate in the long run (6 quarter moving average) under inflation targeting. 

These are New Zealand data, but it is true in all inflation targeting countries.

That said, the pandemic might be an adverse supply shock. It knocks output production and increases the price.

Sunday, April 26, 2020

New Zealand's Coronavirus Policies

The government's Coronavirus policy is driven by many factors, but R0 number (the reproduction rate) seems to be the PM (Jacinda Ardern) preferred indicator. The reproduction rate depends on total infections. There are more papers posted now arguing that total infections are understated especially when "testing" is lacking. So R0 is understated too. The official R0 is less than 0.5, maybe it is more than 1 or even higher. 

Conversely, the good news is that the death rate would be smaller than what we have, which is already relatively small. (death rate is number of deaths / infections). Should death rate be the guide for successful policy? I think so.

But what about those asymptomatic people who are infected? If indeed we have more infected people than we can tell, and we relax the lockdown to level 3 or 2, we could have a spike of infections and deaths next month.  I think that effective testing can resolve the problem. Those who test positive get quarantined and treated and those who test negative go back to work. The question is about testing every person, and quickly. Testing, however, requires money and resources.

It was reported that the government is looking into the proposal of the Chief Economist of the Kiwibank Mr. Kerr to give people cash, maybe 6 billion dollars. Cash gift is an ineffective stimulus. The theory of consumption predicts that people do not spend windfalls. A few desperate people might, but there will be no significant increase in consumption. Deposits in Kiwibank might go up a little :) A better way to spend the money, in my view, is that the PM Jacinda Ardern spends it on testing. Test every person, and do it before the end of the year. Hopefully a vaccine will be available early next year.

Tuesday, April 14, 2020

Does Testing for Coronaviris Reduce Death?

The Nobel Laureate Paul Romer explained his plan to restart the U.S. economy. He argues that conducting 30 million tests a day and allowing those who test negative to resume working would restart the economy sooner. Certainly, this is a smart idea that I have not heard anyone in this entirely infected world think about. Although they have been thinking about it for sure, so far, no government has provided any plan on how to restart the economy. Trump in fact said that he might stop testing altogether! 

Germans, on the other hand, have been testing people more efficiently. Say that there are five people in your bubble. They do a combined test for all five at once. If the result is negative then all five people are safe. If positive, they redo the test to each one in the bubble. So Germany could easily follow Romer's plan to restart the economy.

The population is very small in NZ so we have a very good chance that we can restart the economy in a week if the government follows these strategies. 

Ten days ago I began working on examining the effect of testing for Coronavirus on death. Ten days ago I found two data sets. The first one is published by the  EU (here) and the other is by Oxford University (here). The EU data set is large and reports data for deaths and infections by more than 200 countries and territories. Oxford University data set is smaller and reports data on testing for Coronavirus. The data are daily. Some countries report fewer data than other, different dates, and many have missing data. I combined both data sets to arrive at a balanced panel of 8 countries only that have continuous data from March 1 to March 31 for all three variables, tests, death, and infections.

I found that, on average, a one percent increase in daily testing for the Coronavirus reduces death by about 4 a day. When I allowed the coefficients to vary across countries, I found that the U.S. and Italy could reduce death by about 13 and 68 respectively. At a lower significance level, the Belgium and the U.K. could reduce death by about 2 and 32 respectively. Japan could reduce death by 25. So there is reasonable evidence in this small panel that testing for the virus reduces death. You can read the paper on Massey University Website in a couple of days (here).