The sceptic’s guide to ignoring popular economics commentary

1. Monetary policy is never “neutral” or “doing nothing”. Like temperature, it is a general background condition – of liquidity in the economy. “There is no temperature right now” makes no sense.

2.(a) Money can’t “leave the country” in any meaningful sense. If you buy imports (goods that foreigners are really good at making) and hand people green pieces of paper in exchange, they can burn them or hide them under their mattress, which basically means you got your imports for free, or they can take them and buy things in your country with them. If they buystuff that they can take home with them it’s an export. If they buy stuff that stays in your country (bonds, factories, stocks), it is like a loan to you and is called a capital inflow. So the “trade surplus/deficit” just indicates what share of the stuff they buy the foreigners take home after they are done shopping, with the strange corollary that politicians think your country will be better off if the foreigners take their purchases with them (exports!) than if they leave them behind for you to play with (capital inflows).

2.(b) You can’t hoard money. Yeah, that’s right. Both Marxist economic theory and modern “mean corporation” rhetoric think that there is a way that capitalists/companies can “hoard” money and keep it from productive uses in the economy. This is called the “Junker problem” by Tyler Cowen here, allegedly because 19th century German “Junker” (large landholders) were believed to be stifling growth by buying land instead of machines with money. The issue is that money is not the same as real resources. Consider this: Imagine you are able to somehow get hold of half of all the dollar bills in the country and burn them. Does this mean that any resources are kept from the economy? Well, this is equivalent to a reduction in the money supply, so the central bank could simply reprint all the dollar bills you stole and there are no effects on the real economy, or nominal prices will fall until the real prices are the same as before – nothing changes. What’s more likely though in real-world examples is that “hoarding” happens by putting your income into a bank account  – from which the bank can simply lend it out to other people – or investing in safe treasury bills, which means handing your money to the government and telling it to have a good time with it until you want it back. I suppose a libertarian might say with a wink that funding government spending through bonds is the same as keeping it from productive uses, but that is clearly not what all sorts of pundits seem to be criticizing when they take about the “hoarding” going on.

3. The impact of changes in GDP on living standards depends on what part of GDP is produced in a market-priced environment and what part is produced in a government-priced environment. That is, if I have a dollar, I can buy whatever I want with it, for example chocolate ice cream. But if the government takes that dollar through taxes and decides that it should buy me a vanilla ice cream, I am made worse off, because if I wanted vanilla, I could have bought itin the alternative scenario, but I didn’t. Thus, the “one dollar of GDP” increases my living standards by less if I am not free to decide how to spend it. On the other hand, the more likely scenario is that the government takes my dollar, debates for 8 months what to do with it, decides to buy vanilla ice cream, bribes a congressman, who obstructs the legislation, with a quarter ice cream in earmarks, sends the remaining money through several bureaucracies, which have to be paid with another quarter ice cream, only to finally buy me half a vanilla ice cream a year after they took the dollar, even though I was going to buy a whole chocolate ice cream with it. The important thing is that all of this activity will still be considered to have created “one dollar of GDP”, but because I don’t value the wasteful political process on which part of it was spent, the increase in living standards is smaller than before.

4. When most people say that “Globalization”, “Free Markets” have done something terrible to poor people, they usually point to examples where neither one of these things have ever been tried and enumerate problems that are best addressed by increasing globalization and free markets. Examples include: African development, global income inequality, increasing food prices, decreasing food prices, high profits for multinational corporation, Greece’s current misery, Spain’s economic malaise…

5. “Income” is not a very meaningful concept in public policy terms. Although everyone loves to cite all sorts of facts about income levels, growth, distributions etc., this category usually lumps together labor (wages) and capital income (interest and capital gains from investments) although these two should be considered separately from a moral and economic standpoint. The latter kind of “income” is just the result of taking (already taxed) labor income and deciding to consume it at a later point in life. For that purpose it is put into some kind of savings device, that is, invested as “capital”, where an interest rate or appreciation compensates you for the purchasing power loss that you would otherwise incur from consuming your income in a later year. Counting and taxing that compensation again, as “capital income”, once you decide to consume it later, is double-counting and -taxation. There is no reason to treat capital gains as “income” at all, as it is simply the compensatory nominal increase in value of your investment that ensures that present consumption is equal to future consumption in present value terms (discounted for the fact that we like money in the future less than money today). If properly accounted for, having capital income is simply a result of choosing a different point in time for consumption of previous labor income, but does not change lifetime consumption at all.

This may sound quite technical and strange, so let me try to illustrate:
Imagine you and another person both earn ice cubes of equal size (their labor income) in the first period. Ice cubes are really tasty and people like eating them. There is a sweating guy in the area (an investment opportunity) who would like to borrow as many cubes as he can. As your original cube will melt partly before he gives it back to you (it is “discounted”/you have a present bias), he promises to give you some smaller bits of ice (capital income) with it when he returns it to you to make sure you are not worse off by lending it to him. Before your earned cubes are handed to the two of you in the beginning, the government chops off an equal share from each one to keep as payroll tax. Then, you are free to invest it or consume it. The other guy immediately consumes his ice cube. You decide to lend it to the sweating guy under the assumption that he’ll make it up to you by giving you some ice bits with it when he returns it. When, in the next period, the sweating guy returns your partly molten ice cube and wants to hand you the corresponding ice bits, the government suddenly jumps out from its hiding place and says to you: “Oh, you had more income, I see! That’s not fair to the other guy who ate all his ice already! You are having an ice cube AND ice bits! I will take part of your ice bits away (capital income tax)!” This seems wrong, doesn’t it? After all, both you and the other guy had the choice of saving some of your ice cube for later in exchange for ice bits, so why should the government take an additional chunk away from you just because you chose to consume your ice in the next period? This illustrates that capital income is basically just labor income whose consumption was delayed and should therefore not be taxed again.

  So if someone says “Income has…” in an article, the immediate question should always be: Labor or capital income? Why do we care about “income”, rather than consumption/wealth? For the best reference for these thoughts and an explanation for why inheritance tax should be negative read Scott Sumner.

To be continued…

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