Wednesday, 6 August 2014

Still Laffing After all These Years

Time for a bed-time story.  Is everybody sitting comfortably?  Good.

Before I begin, I have to warn you - tonight's story may frighten some of you.  It involves some pop economics, a bit of math (eek!), and maybe even a graph or two.  I would ask anyone who might get scared by any of these topics to get a glass of water and go off to bed.

(This is the moment in the "Hitler finds out that..." videos on YouTube where half the room walks into the corridor before the Fuehrer launches into a poorly-dubbed tirade.  Don't worry - this evening's story will not include a forced rant about some comical transgression about Stalin)

OK - let's begin.

In recent years, it has become almost accepted wisdom that the economies of most of the OECD countries are in a period of gradual to sharp decline for the common man.  Productivity has grown, but all the gains have gone to an increasingly small cadre of the well-connected.  In the US, this has coalesced around the famous "One Per Cent" meme that one can scarcely interact with media of any sort without seeing or hearing it, or its obverse "Ninety-Nine Per Cent" proxy for the guy on the street.

Always, the writer includes himself in the 99%, whether he is or he isn't. (Most famously, Hilary Clinton, eyeing another shot at becoming the US President, has gone on a bit of a pre-emptive tour describing how impoverished she and her husband, the former president Bill Clinton, were upon leaving the White House).  People with houses in Westchester County, NY and Georgetown are not 'middle class.'  

Few doubt that it's true that the middle-class in the US (and France, the UK, etc.) is facing unprecedented challenges.  Though official inflation is under control, things like housing costs, college tuition, and other talismans of the middle class lifestyle continue to grow.  A headline in the Sunday Times of London in fact indicated that, as house prices in London soar, it will be virtually impossible in a few years for anyone outside of the very wealthy to live in London (prices are up more than 10% over last year, and the average mortgage in the west of the city is now nearly $7500 per month).

The question of course, is not whether these trends exist, but rather, why they do.

The pat answer one gets from many is that the game is rigged by fat-cats and their puppets who set tax and corporate policies that tilt the field to their advantage.  And this may be.

But the ills and thus solutions from progressives are often exercises in through-the-looking-glass fantasies.  

It's All Ronald Reagan's Fault

Ronald Reagan for virtually all of his political life has been the Simon Bar Sinister of the left.  He emerged on the political scene as a vocal public supporter of Barry Goldwater (the godfather of the American conservative movement) in 1964, and later was the governor of California in the late 1960s and early 1970s.  That era was a turbulent time in California; the Watts riots shook Los Angeles - at the time the whitest large city in America - in 1965, and violent protests in Berkeley against, inter alia, the war in Vietnam, racialism, sexism, etc. helped shape the Golden State as it is now understood.  It's worth pointing out, for example, that in 1964, San Francisco had a Republican mayor, and the election that year of John Shelley was the first Democratic mayor of the city since 1910.  

It's virtually incomprehensible to imagine a Republican even pretending to the office these days.

As governor of California, Reagan put on a face of law-and-order leadership, at times being quite beligerent with the demonstrators in Berkeley.  At one point, tanks were actually deployed on Telegraph Avenue, making good on a promise he had made during the 1966 campaign to "clean up the mess in Berkeley."  Though Reagan was hardly a model of reactionary politics (he signed into law in 1967 one of the most liberal abortion laws in the country at the time), the left never really forgave him for his vocal dismissal of the protest movement, something that came to fruition many years later when they controlled the aparatus of the public media.

A common meme one sees today is that the decline in wages began in the 1980s "Decade of Greed."  But the truth is far more complex.

As this chart from economist Robert Murphy illustrates

real wages in fact peaked in 1973, and have been more or less flat since.  Murphy's plot shows inflation-adjusted wages versus productivity as measured in output per hour worked.  Wages rose in tandem with productivity until the early 1970s, were decoupled then, and have diverged sharply since.

The worst erosion of wages actually occurred in the late 1970s, under President Carter.  

The policies of Reagan in the 1980s came on to the scene well after the wages and productivity split, so as much as the left like to blame Reagan for everything wrong with the world that cannot otherwise be pinned on George W Bush, the data simply do not support the claim.

Tax Cuts Lead to Income Inequality by Impoverishing Government

This idea is more or less a corollary to the idea that the ills of the world are due to Ronald Reagan.  The so-called supply-side theory of economics is a frequent target, especially with respect to the enormous deficits that the US government runs.  One often reads or hears disparaging remarks about 'trickle down' economics - a term that, in point of fact, was never actually said by Reagan or any of his advisors.  It's become the left's equivalent of the "Al Gore invented the internet" apocrypha.

Simply put, the idea of supply-side economics is this: it's possible to cut taxes and at the same time increase government revenues if the tax cuts stimulate economic growth.  Reagan and his team sold his large tax cuts of the 1980s in part by offering that they would pay for themselves as productivity rises.  The basis of the idea came from a simple plot drawn by Arthur Laffer on a cocktail napkin, later known as the Laffer Curve.

It's a bit counter-intuitive, but only a bit. If one thinks more than two seconds, the principle makes perfect sense.  

A tiny thought-exercise.  If tax rates are set at 0%, the governemnt necessarily will collect no revenue.  This is a guaranteed outcome of the model.  If tax rates are set at 100%, one would expect the government to collect, if not nothing, very low tax revenues, as few people will be willing to work when they keep none of the fruits of their labour.  It won't be zero, of course, as even slaves - which is ostensibly what a person who is forced to turn over all of his wages to the government becomes - produce something.  But it won't be much.

So if one anchors at $0 (or near to it) government revnues at tax rates of 0 and 100 per cent, logic impels that there be a curve between the two that must rise, must flatten, and must fall.  With some empiric data and basic calculus one might ascertain approximately where on the curve the point of maximal revenue is, and there is plenty of room for argument that that number might be 20%, 50%, 75%.  But the basic idea of Laffer is water-tight.

If one looks at the data, Reagan (and Laffer) was right.  In real dollars, federal tax receipts rose from $1.37 trillion in FY 1981 (the final budget for which President Carter was responsible), to $1.64 trillion in FY 1990 (the final Reagan budget). In Truth, government revenues increased  Liberal economist Paul Krugman points out that, despite his reputation as a tax cutter, Reagan raised taxes as often as he cut them.  

Looking at another metric of same - tax revenues as a portion of the GDP - tax receipts were remarkably stable during Reagan's eight years in office, as indeed they have been in the post-war period, ranging between 16.9% (1984) and 18.6% (1982).

High Taxes Lead to Prosperity

Another saw one hears is a sort of weird (for progressives) nostalgia for the post-war period 1950-1980.  It was a time of high taxes (one frequently reads about how the top marginal rates of 90% co-incided with high wage expansion in the 1950s and 1960s, and arguments for Keynesians that high taxes and spending lead to growth.  The following table demonstrates top marginal rates in the US following World War I.

Looking at the data, it's true that once, top marginal rates were 90% during and following World War II through the Kennedy administration (JFK is consider by some the father of supply-side economic practice).  

Aside from the caveat that correlation is not causation, one does ask - IF taxes were high, just who was paying them?  As mentioned before, in FY 1951 (top rate 90%), tax receipts were 15.7% of GDP.  In 1959 (top marginal rate 70%), they were 16.4%.  Between 1953 and 1968, tax receipts were 18.2, 18.0, 16.1, 17.0, 17.2, 16.8, 15.7, 17.3, 17.2, 17.0, 17.2, 17.0, 16.4, 16.7, 17.8, and 17.0 per cent of GDP - a relatively stable range around 17%.

Simply put, the relative amount of real dollars being collected over the period, with tax rates ranging at four different levels, remained remarkably stable.  Spending (ranging in the 16-19% of GDP range) remained similarly stable.  It's not immediately obvious then, other than an implicit correlation argument, how higher marginal tax rates were influencing government tax collection or spending.

One simply must, then, accept that top marginal rates must have some sort of intrinsic, quasi-talismanic effect on inequality.  I'm not one given over to magical thinking, and long ago stopped believing in unicorns or the power of horseshoes, and thus am inclined to see this argument as little more than class envy, thinly disguised with a whiff of statistical seasoning.

Misplaced Nostalgia

The next frequent talking point one hears is about union power - i.e., the 1950s were a golden age of union organising, where management and workers had an implicit shared community bond.  If we could only get away from the current era where monocle and top hat wearing plutocrats snicker in an evil way as they stuff money into a burlap sack with a cartoonishly-large dollar sign on the outside run the world and back to the era where union good guys held sit-down strikes or Norma Raes led heroic fights to keep the boss in line, the US could go back to the way things were in 1955.

Simply put, such a simplistic world view ignores some basic realities.

The first problem is, the world economy is not a simple, univariate system.  Yes - incomes were growing more strongly and broadly in 1954 than they are in 2014; but beyond the simplistic analysis of tax rates and unions, there are myriad other variables at play.  Europe and Japan were rebuilding from the devastation of the war.  China was an isolationist, third-world country with no export economy.  US industry was largely unchallenged - all of that has changed under globalisation.  Strengthening unions will not undo the establishment of Japan and South Korea as serious competitors, nor will it roll back the growth of China.

Another problem is the rise of automation.  We are far (IMHO) from true artificial intelligence, but a machine capable of simulating actions will be good enough.  It's a new take on the old joke about not having to out-run a bear; machines just have to out-run you.  Or, to do it well enough that it becomes cost-effective for it to complete your job in your place.

As professional pessimist John Derbyshire wrote:

The assumption here is that like the buggy-whip makers you hear about -  like dirt farmers migrating to factory jobs, like the middle-class engineer of 1960 - the cube people of today will go do something else, creating a new middle class from some heretofore-despised category of drudges.
But… what? Which category of despised drudges will be the middle class of tomorrow? Do you have any ideas? I don’t. What comes after office work? What are we all going to do?
What is the next term in the series: farm, factory, office…? There isn`t one. 
The evolution of work has come to an end point, and the human race knows this in its bones. Actually in its reproductive organs: the farmer of 1800 had six or seven kids, the factory worker of 1900 three or four, the cube jockey of 2000 one or two. The superfluous humans of 2100, if there are any, will hold at zero. What would be the point of doing otherwise?
The djinn is out of the bottle with respect to machines; no amount of union-era nostalgia will stop that.

The Questions Not Answered

What remains virtually un-asked, of course, is, what has been the impact of the tectonic shifts that have occurred since 1970 in the economics of the West?  One almost never hears analysis of two quite central changes that have occurred in the West.

The first is, the emergence of women as significant elements of the permanent work-force.  It's a widely-held truism that feminism, flourishing in the 1960s and 1970s, allowed for the movement of women into paid work.  It's a virtually unchallenged belief that this has been an net, if not absolute, good for all.

Setting to the side arguments about the benefit and justice of women being 'free' to opt for careers that are fulfilling, I've long thought it was a reasonable question to ask about the impact of a rapid, massive increase in the population of eligible workers is on wages.  Basic economic theory is that, absent any other changes, if the supply of something is doubled, the price will be reduced.

Looking at the data for the rise of women in the workforce in the OECD world 

between 1900 and 1970, the participation of women in the workplace was relatively stable, but gradually increasing.  There was an inflection point at that time, when their participation went from roughly one in four to about one in two.  This correlates closely with the point at which over-all wages stopped increasing.

This of course proves nothing - correlation and causation existing in their uncomfortable if familiar dance - but it's worth asking, I think, if there is not a relationship between the two.  Add to the mix the now quite familiar data that women earn about 70 to 80 cents on the dollar of what a man earns, and one returns quickly to the basic facts of supply and demand.  IF suddenly there are millions more potential workers, and IF those workers largely are willing to work for lower wages, is it not reasonable then to expect that real wages will at least be flat?

A second conjecture revolves around the decision, in 1965, to pass the Immigration Reform Act.  Prior to 1965, immigration to the US was highly restricted, and tied to quotas relating to the population of the country as it existed in the early part of the 20th century.  

A bit of history is in order:  immigration restriction in the 1920s (the Johnson Act of 1924) was a reaction to high levels of immigration to the US in the late 19th and early 20th century and a severe recession following World War I.  It's worth pointing out as well, the undeniably xenophobic nature of the act (it's hard to call it "racist", as the primary targets were southern and eastern Europeans), and that the Act was championed by, among others, big labour, who argued that immigrants undermined the wages of American citizens.  None other than Samuel Gompers - the founder of the AFL - who wrote in a letter to congress expressing his support warning of "corporation employers who desire to employ physical strength (broad backs) at the lowest possible wage and who prefer a rapidly revolving labor supply at low wages to a regular supply of American wage earners at fair wages."

The 1965 Immigration Act removed restrictions, and the result has been nothing short of a sea change in the US population.  There are millions of those who come with high levels of education and achievment, and they have been vanguards of the new economy.  The founders of Google, for example.  

It's not much of a stretch to argue that Silicon Valley simply would not exist without the large numbers of Chinese and Indian immigrants who have been instrumental in its creation.

But there are also tens of millions of immigrants - legal and illegal - who have come with no skills and less than a high-school education.  Many cannot read or write even in their own native languages.  It's difficult to see how that could possibly be a plus in terms of wages on the lower end of the wage scale.

In this post three years ago, I looked at the nature of the US population in the coming years. A stark graphic was available:

At the time, I wrote on the fundamental changes likely to coincide:

It's useless to pretend it won't happen, so let's get realistic in assessing what the outcome in a more or less sanguine way when it does.   
Some changes will be good (think of all the new dining options we will have access to).  Some less so.  But it seems almost axiomatic that the very nature of what it means to be "American" will be different if these data and models are true.
Immigrants and their descendats will represent roughly 75% of the population growth in the US by mid-century.  A large number of them will be semi- and un-skilled workers.  This growth almost perfectly co-incides with the Immigration Reform of 1965.

Is it not reasonable to ask if, in an era when jobs at the lower end of the skills spectrum are becoming scarcer due to foreign competition and automation, is it smart to add millions more to the pool of people looking for such work? Is that likely to increase or to decrease wages?  To make inequality better or more extreme?

Samuel Gompers and labour leaders seemed to see things more clearly in 1920 - without the benefit of big data or massive computing power - than current leaders do.


I haven't of course gotten into the question of whether the truisms are, in fact, true about the erosion of the middle class.  But if one assumes that it is getting tougher - and virtually everyone, left, right, and centre - seems to think it is.  So starting from that point, the causes we hear seem to focus on false fetishes and wilful ignorance about potential, measurable factors.


And the nostalgia the progressives have for the 1950s is truly baffling.  Conservatives are often accused of wanting to build a bridge to the past, but on this front, it's the left who seem blissfully ignorant - wilfully ignorant - about just how things actually were in their golden age.

Yes, taxes were high in 1950.  And unions were strong.

But guess what?

In the golden age of blue collar prosperity, Europeans were rebuilding rubble, Asians were seen as starving, inscrutables who at best made cheap toys, women stayed home.  And white people were 90% of the population.

Does anyone seriously advocate going back to that?


Since I don't see any hands up, it's time to turn off the lights and go to bed, children.


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