The Neoliberal Conspiracy

My name is Chris, and I’m a neoliberal. Well, at least I think I am. One can never be quite sure. The question of what defines a neoliberal and the significance of the term itself consistently drums up a somewhat bizarre debate with various points of view ranging from the idea that neoliberalism has dominated the world for the last 40 years (and literally the root of all our problems) to claims that neoliberalism is a completely meaningless term.

I don’t have any real stake in this debate – deciding what label should be used to describe people is almost always a fruitless exercise. It seems to me that neoliberal has been used primarily as an insult used by the Left to disparage people who think free markets are generally good, a point made in a recent article by Jonathan Chait. It is important to point out that neoliberal does not only refer to the hardcore libertarian end of the political spectrum. Clinton and Obama are lumped into the same label as Reagan and Bush. However, I think most people agree that the source of the so-called neoliberal movement comes from the strongest supporters of laissez-faire, market-oriented economics. Hayek, Friedman, and other big names in the libertarian community were the ones who set the neoliberal train in motion.

But as soon as they acknowledge the founding fathers of neoliberalism, many analyses of neoliberal thought tend to go off the rails. Perhaps the best example of the kind of thinking I am talking about is a 2014 article by Philip Mirowski entitled “The Political Movement that Dared not Speak its own Name: The Neoliberal Thought Collective Under Erasure.” Mirowski has dedicated much of his career to explaining the expansion of neoliberal thought. It is immediately clear that he opposes essentially all of its primary tenets, but of course anybody can be fascinated by a philosophy without agreeing with it. Unfortunately, Mirowski’s work paints (in my admittedly biased point of view) an incredibly misleading picture of not only what neoliberals believe, but also what their ultimate goals are.

Mirowski states his favored definition of neoliberal as “the dependence upon the strong state to pursue the disenchantment of politics by economics.” Hmm. Is that unintelligible to everybody or just me? Luckily, he also provides a longer list of principles he believes neoliberals adhere to (which he takes from Ben Fink):

(1) “Free” markets do not occur naturally. They must be actively constructed through political organizing. (2) “The market” is an information processor, and the most efficient one possible—more efficient than any government or any single human ever could be. (3) Market society is, and therefore should be, the natural and inexorable state of humankind. (4) The political goal of neoliberals is not to destroy the state, but to take control of it, and to redefine its structure and function, in order to create and maintain the market-friendly culture. (5) There is no contradiction between public/politics/citizenship and private/ market/entrepreneur-and- consumerism—because the latter does and should eclipse the former. (6) The most important virtue—more important than justice, or anything else—is freedom, defined “negatively” as “freedom to choose”, and most importantly, defined as the freedom of corporations to act as they please. (7) Capital has a natural right to flow freely across national boundaries—labor, not so much. (8) Inequality—of resources, income, wealth, and even political rights—is a good thing; it prompts productivity, because people envy the rich and emulate them; people who complain about inequality are either sore losers or old fogies, who need to get hip to the way things work nowadays. (9) Corporations can do no wrong—by definition. (10) The market, engineered and promoted by neoliberal experts, can always provide solutions to problems seemingly caused by the market in the first place: there’s always “an app for that.” (11) There is no difference between is and should be: “free” markets both should be (normatively) and are (positively) most the efficient economic system, and the most just way of doing politics, and the most empirically true description of human behavior, and the most ethical and moral way to live—which in turn explains, and justifies, why their versions of “free” markets should be, and as neoliberals build more and more power, increasingly are, universal.

So how many people would agree to all of the points above? I haven’t taken a survey, but if I did I can almost guarantee the result would be zero. The above description is not even a strawman of the philosophy of people like Friedman and Hayek (or me). On some points, it’s probably not too far off, but on others it’s either misleading or just blatantly false (I take particular issue with 1, 5, 7, 9, 10, and 11). Both the tone (of course all neoliberals regard people who complain about inequality as “sore losers or old fogies”) and the content are apparently designed to position neoliberalism as a front for the elites in society to retain their power. It is the unholy alliance of state and corporate power that drives the neoliberal doctrine.

Now, if you’ve ever read Friedman or Hayek (or my blog) and gotten a very different picture of what it means to be a neoliberal I don’t blame you at all (Note: I prefer to label myself libertarian, but again I’m not concerned about labels here – if Friedman and Hayek are neoliberal then so am I). While the state is certainly necessary to provide some of the features that neoliberals deem conducive to a prosperous society (property rights certainly seem to be a necessary condition), to claim that they “explicitly proposed policies to strengthen the state” is disingenuous. Mirowski gives two examples of such policies from Friedman: his plan to have the central bank grow the money supply at a constant rate and to replace public schools with vouchers. It’s certainly true that both of these policies require a state, but Mirowski chooses to avoid the fact that each requires significantly less state intervention than the current setup. Does he mean to argue that the state providing vouchers to attend private schools requires more state power than the government actually running the schools themselves? I can’t imagine.

Even Mirowski admits that the rhetoric of the neoliberal movement is aimed at promoting the freedom of the individual and limiting the power of the state. But here’s where it gets interesting. Instead of taking neoliberals at their word, Mirowski claims that all of this talk of liberty and freedom is really just a way to “postpone the truth as long as possible when it comes to the nature of the society they are dedicated to bring about.” All of those videos on Youtube of Milton Friedman exquisitely extolling the virtues of a free society? Yeah he doesn’t really believe any of that. The only reason you think he does is because you haven’t “devoted years of their lives to reading the neoliberals, as I [Mirowski] have.”

I think a more accurate statement might be that you haven’t spent years reading the neoliberals and doing everything in your power to find ways to make them look bad. As another person who has spent years reading the neoliberals, I’m almost sure that Milton Friedman believed every word of what he said in those Youtube videos. Mirowski continues in a footnote:

I am always shocked to find the infrastructure of the Neoliberal Thought Collective is always far more developed than any of my private paranoid fantasies. Not only is Free to Choose available on the ubiquitous YouTube, but there is also a slick dedicated website called FreetoChoose.tv, with extended unedited tape from the series…It also includes video lectures from many other neoliberal figures

This comment confuses me. The “infrastructure” of the neoliberal conspiracy is so highly developed that it even has videos on Youtube and *GASP* even a website?! There are two explanations. Either Mirowski has been so engulfed in his study of neoliberalism that he doesn’t realize we are in the 21st century, or he hasn’t had time to look at literally any other topic in the world. I don’t know what his “private paranoid fantasies” consist of, but if you can’t find a website dedicated to them, they must be pretty darn weird.

Jokes aside, Mirowski’s surprise at the lengths the neoliberal movement has gone to promote its message make more sense if we consider it in the context of his broad message. If the freedom rhetoric of the neoliberal movement is really just a front for its desire to strengthen the state and please the elites, his concern makes a lot more sense. For him, the tools of the “Neoliberal Thought Collective” are about as powerful and almost as terrifying as Nazi propaganda. Of course, there’s a far less pernicious reason why the reach of the free market movement extends so far: Its supporters truly care about its message and believe that it will lead to a better world.

And this point seems to be the one that those on the left have such a hard time grasping. They simply can’t believe that anybody honestly believes free markets would lead to a better society. The only explanation is that there is some grand neoliberal conspiracy driving it all. The elites (usually the Kochs take a starring role here) and their economist cronies put on a nice show. They bamboozle the public with nice words like freedom and liberty to draw support to their cause, but their real goal is to be the architects of the society they desire (and probably line their pockets while they’re at it).

Nancy Maclean’s recent book on James Buchanan is an excellent example of such a story. In her account, Buchanan carried out a “stealth plan” to destroy democracy and enact his own vision for the United States (which happened to include many racist policies). I haven’t read Maclean’s book, but I have read several interviews and I find her thesis very odd. Weren’t many of the civil rights victories only possible precisely because of limits on democracy? This post is already long and since I am not an expert on Buchanan and I haven’t read the book I don’t want to comment too much on Maclean’s point specifically (see here, here, and here for some reviews by people who do know what they’re talking about). But I think it does tie into exactly the same kind of thinking illustrated by Mirowski. Never is any probability given to the possibility that Buchanan actually just wanted to improve the system of government in the US. Since his methods were different than progressives, he must be racist and selfish. And since he can’t say those things outright, he had to hide them.

I can’t speak for Buchanan. I don’t know what was really going on in the brains of Friedman or Hayek. Maybe they are all just frauds. But I do know with certainty that there exists at least one person that supports free market policies because he actually thinks they are good (full disclosure: I have received Koch money to attend conferences at the Koch funded Institute for Humane Studies – but I got that money because I am libertarian, not the other way around). I’ve met many other people who are either great actors or are genuinely convinced that markets work well and are beneficial for the vast majority of society. They aren’t hiding those beliefs. They aren’t huddled behind closed doors trying to devise ways to lead everyone else into a trap. There is no hidden meaning behind their words. There is no neoliberal conspiracy.

One Year of the Pretense of Knowledge My favorite posts of the year

Exactly one year ago I published my first post on this blog. 64 posts later I’m very pleased that I have been able to keep it up this long and still have the motivation to write more. I have enjoyed having an outlet to express my ideas and I hope some of you have enjoyed reading them. In honor of the first anniversary, I thought I would highlight my top 5 favorite posts from the past year.


5. Why Do We Love Football?

The award for the most fun I’ve had writing a post on this blog probably goes to this post on football. Is there some hyperbole? Well, maybe just a bit, but I still stand by my comparison of Tom Brady and Mozart.

4. Kevin Malone Economics

My most read post of the last year thanks to retweets by Noah Smith and Steve Keen. Roger Farmer wasn’t too pleased with it, but Steve Keen seemed to like it. I think it provides a pretty good argument for why DSGE models should not be the only option for macroeconomic research.

3. About that Productivity Gap

A relatively short post, but I think it’s also one of the most interesting. If you’ve seen graphs showing a growing gap between worker compensation and productivity, please read this post before you start coming up with crazy stories about exploitation of workers.

2. It’s Not Your Fault

This post on why I don’t believe in free will was one of my first, but I still think it is one of my best written.

1. Why I’m a Libertarian

Libertarians perhaps unfairly often get lumped in with a republican party that is an absolute mess right now. A recent book alleges libertarians are just conspirators trying to overthrow democracy for the benefit of the wealthy elite. I think it’s fair to say that the reputation of libertarians is not exactly at a high point. Hopefully this post shows that that characterization is misplaced. Libertarians have many of the same goals as progressives and conservatives. We all want the world to be a better place, we just have very different ideas on how to get there.

Bonus: What’s Wrong With Modern Macro?

You’d have to be a bit of a masochist to make it through this riveting 15 part series on the problems with modern macro, but I can’t finish this post without at least mentioning it.


I expect my pace of blogging will be a bit slower in year 2 as I need to ramp up my actual research efforts (which I may also tie in to some future posts), but I definitely plan to continue writing as much as I can. Thanks to anybody who has read and commented so far. I hope you’ll stick around for another year.

Don’t Be Afraid of Trade

One of the economic concepts that is most frequently misunderstood by non-economists (and probably by economists too) is the trade deficit. First, a definition. The trade deficit refers to the difference between the amount of goods a country imports and the amount it exports. As the graph below shows, the US has had a large trade deficit for the past several decades. It has been importing goods at a much higher rate than it has been exporting them. Nobody disagrees with that definition or that fact. The debate comes in when people start to decide whether this situation is actually a problem.

Part of the problem is simply an incorrect interpretation of what the trade deficit measures. It is common for non-economists to confuse this trade deficit with the equally frequently maligned budget deficit, which measures the difference between how much the government spends and how much it takes in as revenue. Unfortunately, our own president is among those who have made this mistake. According to Trump:

“The United States has trade deficits with many, many countries, and we cannot allow that to continue … with South Korea right now, but we cannot allow that to continue. This is really a statement that I make about all trade: For many, many years the United States has suffered through massive trade deficits; that’s why we have $20 trillion in debt.”

This statement is complete nonsense. The trade deficit with South Korea or any other country has absolutely nothing to do with the US government’s $20 trillion debt. The debt is the consequence of perennial budget deficits that derive from the US spending a ton of money on military, social welfare, and other government programs.

The trade deficit isn’t really a debt at all. It simply represents the fact that the US buys more goods from foreign countries than they buy from us. In the short run, a trade deficit is almost certainly beneficial for the US. As Milton Friedman eloquently explains in a video I posted a while ago, what a trade deficit really means is that foreigners are giving us real goods and services in exchange for pieces of paper. We get TVs from Japan. All they get are US dollars.

However, a more careful criticism of trade deficits recognizes that trade deficits can be good for the country in the short run, but represent a cost in the long run. Noah Smith articulates such a point in this post, where he argues that the trade deficit is a “loan of real goods and services.” He gives the example of somebody in the US buying a car from Germany. If the US citizen pays in dollars, he calls this an IOU to Germany. At some point, a German will use the dollars to buy goods and services from the US. Even if the dollars were used to buy an asset like a stock, eventually that stock will be sold and the dollars from the sale will be used to buy goods and services. His logic makes sense. Every dollar must eventually come back to the US in some form or another at some point.

But thinking of the trade deficit as a debt seems to me to be either misleading or completely wrong. One confusing point here is that the trade deficit is a flow, while debts are stocks. What is the value of the debt the US has to repay? The stock of all goods and services ever imported minus all goods ever exported? The current stock of foreign dollar holdings? I’m not sure there is any consistent definition of what this debt is that we are supposed to repay. Even if there were, I don’t think the idea of the trade deficit as a debt is meaningful.

Let’s flip Noah’s story. Assume a Chinese citizen really wants to buy Apple stock since they think it will increase in value. They need dollars to buy Apple stock so they exchange some Yuan for dollars and buy stock. At the same time, Apple needs to buy parts from China to make iPhones, so it imports them, trading dollars for Yuan in the process. For simplicity, assume these two transactions exactly cancel out. Where are the IOUs here? Does either country owe a debt to the other? It certainly doesn’t seem like it to me. The stock of dollars and Yuan in either country is exactly the same as it was before the transaction.

It is even clearer that the trade deficit is not a debt if we consider what happens if Apple suddenly goes out of business. The value of their stock goes to zero and their imports also go to zero. The trade deficit that was created by Apple is gone and no US goods were ever given to China. I imagine Noah considers that analogous to defaulting on a debt, but I don’t buy that analogy at all. Does he think Apple owes a debt to all of its shareholders or just its foreign ones? Isn’t the risk of Apple’s stock price falling inherent in its purchase? If you still aren’t convinced, Daniel Ikenson also has an excellent rebuttal to Noah’s article.

The other important point to keep in mind that is implicit in the example above is that foreign countries don’t just buy goods and services from the US. They also buy assets (stocks, bonds, etc.) or invest directly by building their own factories and capital equipment here. The current account (goods and services) and the capital account (assets) are always in balance by definition. A current account deficit is always offset by a capital account surplus.

This fact means that there are two ways we can frame the US’s large trade deficit. It could be that Trump is correct and we are really just falling behind in competitiveness. Nobody wants US goods anymore so they don’t buy our exports while we eat up their imports (which again is not necessarily bad – we get goods and they get paper). Or it could be that the US is home to many of the safest and best performing assets in the world. Other countries are dying to invest in US companies (and treasury bonds) and the result is a huge capital account surplus. One statistic won’t tell us which story is more accurate, but I think it’s pretty safe to say that we don’t have to be too worried (either now or in the future) about the trade deficit.

Let the Facts Decide on Minimum Wage

Basic economic theory has very clear predictions on what should happen to a labor market with a minimum wage. If we assume an upward sloping labor supply curve and a downward sloping labor demand curve, a minimum wage will cause demand for workers to fall while supply increases. The result: an excess supply of workers, also known as unemployment.

The real world is obviously much more complicated than the standard Econ 101 textbook story. Perhaps the most important difference is that there is not just one equilibrium wage. No two jobs are exactly the same. Workers with different skill levels will face different labor markets. Location matters. The list of reasons why the real world doesn’t conform to the simplifying assumptions of economic theory is potentially endless.

However, those caveats do not necessarily invalidate the intuition of basic economics. I don’t think it’s a controversial statement that firms will attempt to substitute away from an input when its cost increases. In this case, that input is low skilled workers. As minimum wage increases, so does the necessary productivity of a worker who wants to be hired. A worker who only produces $10/hr of value for an employer will never be paid $15/hr regardless of the level of the minimum wage. Their choice is not between 10 and 15, but between 10 and 0 (unemployment).

But can we be sure that workers are actually paid based on their productivity? Couldn’t it be that they are simply being exploited, with firms pocketing the additional profits they generate? Under this scenario, an increase in the minimum wage could increase wages without hurting employment.

Here we see the limits of theory. Under some assumptions a minimum wage is good and under others it is bad. The clear next step is to look at the facts. Do minimum wage laws hurt or help low wage workers in the real world? Luckily, due to recent experiments with a $15/hr minimum wage in some cities, we have plenty of data to work with.

Supporters of minimum wage laws will be happy to find out that cutting edge research shows we have nothing to worry about (here’s the link to the full study). The increase in Seattle minimum wage to $13 (15 is being phased in over time) hasn’t had severe disemployment effects. There was a minimal decrease in employment, but overall, “results show that wages in food services did increase — indicating the policy achieved its goal.” So take that Econ 101. Minimum wage is great. Case closed.

Well, not quite. Because this morning, just 6 days after the study above came out, we have a new study looking at the exact same natural experiment (although with a different data set). The results are not so nice. They find that “the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016.”

Now what? Theory gives us conflicting results and so does data. How can an unbiased observer make a decision about the truth? Well, to be sure of the results of the studies above, they would need to sift through around 100 pages of dense statistical analysis. But of course, anybody untrained in statistics would first have to take a few classes to have any idea what they were talking about. And even with that training, they’d need to take a close look at the datasets used, weigh the pros and cons of each methodology, decide whether the results can generalize to other places, etc. Maybe after about two years of hard work they’d be able to have a qualified opinion on the two studies (never mind the dozens of other studies that have been done on the topic).

What is actually more likely to happen? Everyone who supported the minimum wage will cite the first study and look for flaws in the second (I would bet anything that Arin Dube – one of the biggest minimum wage scholars to support an increase – is scouring it right now looking for something to criticize). Everyone against minimum wage will do the opposite. Both will pretend they are letting the facts decide.

Who Says No? A Climate Change Compromise

Many on the left are up in arms over Trump backing out of the Paris agreement. Ignoring the fact that the agreement says that countries are free to set their own targets and their own policies and is largely symbolic anyway, let’s work under the assumption that liberals actually believe that this policy is disastrous for the earth’s future. In fact, let’s start from the (perhaps ridiculous) assumption that everybody in this debate is being intellectually honest.

Then Republicans have a great opportunity. Offer Democrats a compromise. The United States will re-enter the Paris agreement. And they’ll go even further. Democrats will be given full control over all matters of the environment. Carbon taxes, cap and trade, clean energy subsidies, whatever they want. Completely blank check.

In return, Republicans get everything else. They can pass whatever tax code they want, any deregulation they want. Democrats will have no say in healthcare, no control over education, no input at all over any issue except climate.

So my question is: who says no? Republicans (and Trump) have to go back on one of their key issues and allow the Democrats free reign. But for sucking up their pride on one thing they get everything they’ve ever wanted for a whole range of others. And what about the Democrats? Sure they’d be sacrificing a lot. In their view, we’d be significantly worse off in the short run. But isn’t that worth saving the world? If the results of climate change are truly catastrophic, isn’t it worth some people in the richest country in the world not having health insurance? Isn’t it worth middle class Americans being required to take out student loans to attend college?

Now maybe there are some issues that are as important as climate. If you think Republican control of the military would lead to nuclear war, then of course that can’t be part of the deal. Fine, keep that one. I’ll even throw in gun control, another issue that seems to be of vital importance for the left.  You can come up with your own list of some other issues you would never want to compromise on to save the world. But that list should be very small.

So who says no? I can’t imagine any Republican ever denying the above compromise. But I also doubt a single Democrat would take it. If that prediction is right, we are left with three possible conclusions. The first, which I think we can rule out, is that Democrats believe giving Republicans complete control over anything would be worse than the end of the world. The second, which could be true, is that they believe they can convince Republicans of the correctness of their view without conceding too much. Considering their lack of success to this point, and the apparent urgency with which they believe something needs to be done, this also seems unlikely. So we are left with the third, and in my opinion most likely, option: Despite their rhetoric, Democrats are simply not that concerned about climate change.

Outrage on Net Neutrality

In a previous post I agreed with Bret Stephens that complete certainty about an issue doesn’t help convince anybody that your view is correct and may in fact work against the argument. I extended his point by arguing that not only do people express complete certainty that their ideas are right, but they also tend to find the idea that anybody could think differently completely outrageous. However, I don’t think climate change was the best example to prove that point. If you truly believe that climate change will cause catastrophic changes, you might have a right to be outraged. There is a much better example: net neutrality.

Senator Al Franken recently claimed that the FCC’s plan to roll back some of the regulations on net neutrality would be a “major step to destroying the internet as we know it.” Other reports in the media have had a similar tone: there go those idiot Republicans again trying to convince people that we don’t need the government involved in every aspect of our lives. Perhaps the worst offender is Gizmodo, who I follow for tech news, not to see articles like this one. Now, I suppose it’s possible that a writer for Gizmodo knows enough to have a strong, well qualified opinion on a topic like internet regulation, but I expect their knowledge on the topic is pretty close to mine. And I will freely admit my own ignorance on the topic. I have no idea whether net neutrality is a good idea.

To be clear, just as Bret Stephen’s article was not about the correctness of climate change, this post is not about whether net neutrality is a good idea. Instead, it is about the complete certainty with which its proponents appear to believe it’s a good idea. If you are well read on net neutrality, I’d be happy to hear a more qualified opinion on why this issue is so clear cut. From my perspective, however, the issue is not an obvious one at all and the goal of this post is to sow the seeds of uncertainty for those who haven’t tried to think through the issue in at least a small amount of detail.

I do think I understand the basic argument for net neutrality. Without net neutrality, its supporters argue, internet providers will be free to offer different prices to access different websites on the internet. Right now you pay a fixed price to your internet service provider for access to any website on the internet. ISPs are not allowed to treat bandwidth from one website different from any other. Without this guarantee, it is possible that internet providers could charge more for people who want to access popular websites. You pay $30 per month for internet, but if you want Facebook access too that’s gonna be another $5. Want Netflix too? Well maybe you can get the entertainment package for an extra $15. Even worse, if Comcast wanted to push its own video service, it could completely shutdown Netflix for its customers, leading to higher prices and lower quality service. Special treatment could also go the other way. Large companies could pay to receive faster access to their websites while small startups struggle to survive.

One of the most common ways to summarize the changes is to say that it would make the internet look more like cable TV (see this article for example). Expensive bundles, premium content, bad service. Who wants that? And that does sound bad. But hold on a second. Why do we hate cable TV service? Isn’t the main complaint that you have to buy a bunch of channels you don’t want? If I only want to watch ESPN I can’t buy just that, I have to buy the whole sports bundle. Now, it’s true that net neutrality makes these kind of bundles illegal, but it also makes selling access to individual websites illegal. With internet you only have one choice: buy everything or nothing. Perhaps this method makes more sense for internet than it would for TV, but it’s not immediately obvious that it’s better. It could be that net neutrality leads to inconvenience, higher prices, and worse service. It could also be that it leads to heavy internet users paying more than light users. That doesn’t seem so bad to me.

The good news is we don’t have to guess what the internet would look like without net neutrality. If you don’t know already, take a guess when you think the rules that currently uphold net neutrality were put into place. If you’ve heard any of the horror stories I imagine you would think that the internet has always had these kinds of regulations. You probably don’t remember the internet being a price gouging wasteland in all the time you’ve been using it so the rules must have gone into place in the 80s or 90s at the latest. There’s no way that net neutrality regulations were passed within the last 3 years right? Well…

So we pretty much know exactly what would happen if we get rid of net neutrality. We would destroy the internet as we know it and replace it with the internet of 2015. Why is that a big deal again?

Of course, as I’ve already admitted, I have no idea what I’m talking about on this issue. I think I am barely qualified to talk about macroeconomics, which I study many hours per day. So let’s defer to the experts. Maybe this article about how the effects of net neutrality are minimal. Or this one that shows that there is insufficient evidence to make a strong case that net neutrality rules are needed. The supporters of net neutrality aren’t the only ones making unsubstantiated claims. The claim that net neutrality reduces investment is probably overblown.

I’m sure you can find other articles to support either side. That’s not the point. The point is that net neutrality is not climate change. There is no 97% consensus here. And even if there was, even in the worst possible case, we end up not with the world ending, but with a slightly more expensive internet. The outrage remains regardless. In today’s political climate, every issue has to become a battleground and the urgency of the arguments appears to bear little correlation to either the size of the issue (because everything is a catastrophe) or the probability a person has the correct view (because obviously you are right about everything).

Welfare for the Rich? Are Tax Deductions the Same as Welfare Payments?

Imagine three friends (let’s call them Rich, Poor, and Average) share an apartment and have a strange deal for paying the rent each month. Average pays all the rent, but he collects money from his friends Rich and Poor. However, since Rich makes so much money, they agree that he will pay most of the rent. Each month, rent costs $1000. At first, Rich pays $700, Poor pays $100, and Average pays the remaining $200. One day, Poor loses his job and can no longer pay the rent. Average asks Rich to chip in a larger amount to cover the missing $100, but he also realizes that Poor won’t be able to buy food either. So he asks for $200 extra and gives $100 to Poor each month. Now the rental payments look like this: Average pays $200, Poor pays -$100, and Rich pays $900. Rich isn’t too happy with the arrangement, but he agrees since the other friends will kick him out if he doesn’t.

One day, the three friends notice that they need to buy some new furniture. A couch costs $300. Average tells Rich that if he buys the couch, he will deduct the $300 for his rent payments for the month. So for the month, the payments now look like: Average pays $500, Poor pays -$100, Rich pays $600 (plus $300 for the couch).

But then Poor comes to Average and starts complaining. “Rich already makes the most money, and now you’re giving him even more. I only got $100 from you this month and you gave him $300. How is that fair? And look, now you have to pay $500 rather than $200. If you just hadn’t let him deduct the couch, you could have given me an extra $100 and kept $200 for yourself.”

If this argument seems ridiculous read this article that claims rich people get government handouts just like the poor. Notice something strange about this list? Not a single one is actually a government handout. Instead, each is a tax deduction. I only linked to one article, but google “welfare for the rich” and you’ll find many similar ones. But just like in the example above, “welfare for the rich” in all of these cases is simply allowing people who already pay a large share to keep a little bit more of their money. Calling that welfare is deceptive at best. It assumes that the government already has a right to your money. Anything they allow you to keep should be considered a favor.

Let’s put it another way. Imagine there is no government. Everybody keeps everything they earn. Now a single welfare program is put into place where the top income earner pays $1,000,000 to the lowest income earner. However, mortgage interest is allowed to be deducted so the effective payment only ends up being $500,000. Soon, the richest guy starts to complain that the system is unfair and that the poorest guy gets $500,000 without doing anything. The Washington Post writes an article berating the rich guy for complaining. After all, he also receives $500,000 in handouts from the government in the form of a mortgage interest deduction. Essentially, this situation is exactly what we are dealing with here. If you really think “welfare” for the rich and poor is at all the same there is an easy test: get rid of all government welfare and reduce taxes on everybody uniformly to keep revenue the same (assuming taxes can’t go below zero). Who complains the most?

There are certainly good arguments for why we wouldn’t want to offer tax deductions. They are the same arguments for why we wouldn’t want to tax specific goods. By offering a tax deduction, we distort relative prices as these goods become artificially cheap relative to other goods. If you believe the government can do a good job figuring out which kinds of goods are beneficial for society, these kinds of policies could effectively nudge society towards a social optimum. If, on the other hand, you think government is more likely to make terrible decisions based more on special interests than economic welfare, we’re probably better off keeping deductions to a minimum.

So by all means fight against tax deductions. But stop pretending they are welfare for the rich.

What’s Wrong With Modern Macro?

After 15 posts, 17,795 words, and about 9 months, my series of posts on the problems with modern macro is finally complete. If anyone cares, here is the list of all the posts in order.

Part 1: Before Modern Macro – Keynesian Economics

Part 2: The Death of Keynesian Economics: The Lucas Critique, Microfoundations, and Rational Expectations

Part 3: Real Business Cycle and the Birth of DSGE Models

Part 4: How Did a “Measure of our Ignorance” Become the Cause of Business Cycles?

Part 5: Filtering Away All Our Problems

Part 6: The Illusion of Microfoundations I: The Aggregate Production Function

Part 7: The Illusion of Microfoundations II: The Representative Agent

Part 8: Rational Expectations Aren’t so Rational

Part 9: Carrying on the Torch of the Market Socialists

Part 10: All Models are Wrong, Except When We Pretend They Are Right

Part 11: Building on a Broken Foundation

Part 12: Models and Theories

Part 13: No Other Game in Town

Part 14: A Pretense of Knowledge in Macroeconomics

Part 15: Where Do We Go From Here?

If you made it through all of them I’m not sure if I should congratulate you or feel sorry for you, but either way thanks for reading.

What’s Wrong With Modern Macro? Part 15 Where Do We Go From Here?

I’ve spent 14 posts telling you what’s wrong with modern macro. It’s about time for something positive. Here I hope to give a brief outline of what my ideal future of macro would look like. I will look at four current areas of research in macroeconomics outside the mainstream (some more developed than others) that I think offer a better way to do research than currently accepted methods. I will expand upon each of these in later posts.


Learning and Heterogeneous Expectations

Let’s start with the smallest deviation from current research. In Part 8 I argued that assuming rational expectations, which means that agents in the model form expectations based on a correct understanding of the environment they live in, is far too strong an assumption. To deal with that criticism, we don’t even need to leave the world of DSGE. A number of macroeconomists have explored models where agents are required to learn about how important macroeconomic variables move over time.

These kinds of models generally come in two flavors. First, the econometric learning models summarized in Evans and Honkapohja’s 2001 book, Learning and Expectations in Macroeconomics, which assume that agents in the model are no smarter than the economists that create them. They must therefore use the same econometric techniques to estimate parameters that economists do. Another approach assumes even less about the intelligence of agents by only allowing them to use simple heuristics for prediction. Based on the framework of Brock and Hommes (1997), these heuristic switching models allow agents to hold heterogeneous expectations in equilibrium, an outcome that is difficult to achieve with rational expectations, but prevalent in reality. A longer post will look at these types of models in more detail soon.

Experiments

Most macroeconomic research is based on the same set of historical economic variables. There are probably more papers about the history of US macroeconomics than there are data points. Even if we include all of the countries that provide reliable economic data, that doesn’t leave us with a lot of variation to exploit. In physics or chemistry, an experiment can be run hundreds or thousands of times. In economics, we can only observe one run.

One possible solution is to design controlled experiments aimed to answer macroeconomic questions. The obvious objection to such an idea is that a lab with a few dozen people interacting can never hope to capture the complexities of a real economy. That criticism makes sense until you consider that many accepted models only have one agent. Realism has never been the strong point of macroeconomics. Experiments of course won’t be perfect, but are they worse than what we have now? John Duffy gives a nice survey of some of the recent advances in experimental macroeconomics here, which I will discuss in a future post as well.

Agent Based Models

Perhaps the most promising alternative to DSGE macro models, an agent based model (ABM) attempts to simulate an economy from the ground up inside a computer. In particular, an ABM begins with a group of agents that generally follow a set of simple rules. The computer then simulates the economy by letting these agents interact according to the provided rules. Macroeconomic results are obtained by simply adding the outcomes of individuals.

I will give examples of more ABMs in future posts, but one I really like is a 2000 paper by Peter Howitt and Robert Clower. In their paper they begin with a decentralized economy that consists of shops that only trade two commodities each. Under a wide range of assumptions, they show that in most simulations of an economy, one of the commodities will become traded at nearly every shop. In other words, one commodity become money. Even more interesting, agents in the model coordinate to exploit gains from trade without needing the assumption of a Walrasian Auctioneer to clear the market. Their simple framework has since been expanded to a full fledged model of the economy.

Empirical Macroeconomics

If you are familiar with macroeconomic research, it might seem odd that I put empirical macroeconomics as an alternative path forward. It is almost essential for every macroeconomic paper today to have some kind of empirical component. However, the kind of empirical exercises performed in most macroeconomic papers don’t seem very useful to me. They focus on estimating parameters in order to force models that look nothing like reality to nevertheless match key moments in real data. In part 10 I explained why that approach doesn’t make sense to me.

In 1991, Larry Summers wrote a paper called “The Scientific Illusion in Empirical Macroeconomics” where he distinguishes between formal econometric testing of models and more practical econometric work. He argues that economic work like Friedman and Schwartz’s A Monetary History of the United States, despite eschewing formal modeling and using a narrative approach, contributed much more to our understanding of the effects of monetary policy than any theoretical study. Again, I will save a longer discussion for a future post, but I agree that macroeconomic research should embrace practical empirical work rather than its current focus on theory.


The future of macro should be grounded in diversity. DSGE has had a good run. It has captivated a generation of economists with its simple but flexible setup and ability to provide answers to a great variety of economic questions. Perhaps it should remain a prominent pillar in the foundation of macroeconomic research. But it shouldn’t be the only pillar. Questioning the assumptions that lie at the heart of current models – rational expectations, TFP shocks, Walrasian general equilibrium – should be encouraged. Alternative modeling techniques like agent based modeling should not be pushed to the fringes, but welcomed to the forefront of the research frontier.

Macroeconomics is too important to ignore. What causes business cycles? How can we sustain strong economic growth? Why do we see periods of persistent unemployment, or high inflation? Which government or central bank policies will lead to optimal outcomes? I study macroeconomics because I want to help answer these questions. Much of modern macroeconomics seems to find its motivation instead in writing fancy mathematical models. There are other approaches – let’s set them free.

Some Thoughts on Universal Basic Income

People who oppose redistribution from the rich to the poor generally give two types of arguments against it. Perhaps the more obvious argument comes from a natural rights perspective – the person who created the wealth has a right to do whatever they want with it. However, if you don’t believe in free will (as I don’t), then this reasoning doesn’t make much sense. If you weren’t truly responsible for the circumstances that led you to create the wealth in the first place, why should you get to keep all of it? Shouldn’t some of it go to all of the people that had any influence on getting you to that position?

The stronger argument derives from incentives. Taking from the productive to give to the unproductive makes being unproductive far more attractive and we end up with a society where perfectly capable people choose not to work because they expect others to support them. Any attempt to solve poverty needs to deal with this issue, which makes designing anti-poverty measures difficult.

Our current welfare system has some checks in place that attempt to circumvent incentive problems, but it doesn’t solve them completely. Many of our current welfare programs involve cutoff levels where benefits begin to be reduced and eventually disappear altogether. This type of program introduces an implicit marginal tax on low income earners. Not only do they have to pay a higher official tax rate as their income rises, but they also lose some of the benefits they received at a lower income.

A simple way around this problem is to never phase out those benefits – to give them to everyone. This idea forms the backbone of the Universal Basic Income (UBI). One of the most complete proposals for a UBI comes from Charles Murray (yes, the same Charles Murray who gets kicked off college campuses because of his dangerous right wing ideas). In his version (laid out in his book In Our Hands), each American over the age of 21 would receive $13,000 per year in benefits unconditionally. Of this money, $3,000 has to be spent on health insurance, but the rest comes with no strings attached.

Of course, such a plan would be incredibly expensive. However, as Murray points out, our current system is already expensive. According to his calculations, if we eliminated our entire welfare system (including Social Security and Medicare), we could more than pay for the UBI. Getting rid of these programs would be difficult politically, but Murray offers several reasons why doing so would be desirable for almost everyone. Most notably, he estimates that poverty would be all but eliminated under his program vs the approximately 15% that remains under our own system.

Murray’s justification for some level of redistribution is similar to my own:

Inequality of wealth grounded in unequal abilities is different. For most of us, the luck of the draw cuts several ways: one person is not handsome, but is smart; another is not as smart, but is industrious; and still another is not as industrious, but is charming. This kind of inequality of human capital is enriching, making life more interesting for everyone. But some portion of the population gets the short end of the stick on several dimensions. As the number of dimensions grows, so does the punishment for being unlucky. When a society tries to redistribute the goods of life to compensate the most unlucky, its heart is in the right place, however badly the thing has worked out in practice
Charles Murray (2016) – In Our Hands

If we accept that some redistribution is desirable, a UBI seems like a more efficient way to carry it out than our current welfare setup. One common argument against the UBI is that it doesn’t make sense to waste resources on the rich. Bryan Caplan has given some arguments along these lines and argues that phasing benefits out gradually would avoid the implicit marginal tax rate problems without needing to give benefits to everyone. And it makes sense. If our goal is to eliminate poverty why not focus our efforts there?

But I don’t think that argument really works when you consider that a UBI is inextricably linked to the tax system. A UBI doesn’t look so universal after you consider that the rich are going to be paying for almost all of it. Everyone might get a check for $13,000, but top income earners pay far more than that in taxes. Their net benefit from government programs would still be strongly negative even after receiving the UBI. Depending on your perspective towards redistribution, this feature could actually be a negative, but given that redistribution is going to happen anyway, the UBI seems like a more efficient way of actually doing it.

It’s obviously not without fault, but I do think a UBI would be an improvement over our current system and I definitely recommend reading Murray’s book (it’s not that long) to anyone who wants to help the poor but believes we can do better than we do now.