British Contractions

'Tis perhaps premature, for one quarter does not a trend make, but the contraction of British economy by 0.5% is hardly a startling vindication of the "cut and grow" line of economic thought. To paraphrase Paul Krugman, contractionary measures, it turns out, are in fact contractionary.

Now, to be fair, we shouldn't attribute much to the direct effects of the austerity politics in this number. The bulk of the cuts (and tax hikes) will really start to bite this year. But if the theory was: Step 1 - shrink the government and reduce deficits, Step 2: business confidence returns, Step 3 - watch the economy grow, then Step 2 should be occurring already and slowly percolating down into Step 3. This isn't happening.

But let me put my pseudo-Austrian hat on for a bit and try to find some nugget of gold in this puddle of extrement. While I'm no fan of drawing arbitrary lines in the sand, the size of the British public sector relative to the overall economy did seem a wee bit large there, in excess of 50%. Some shrinkage is perhaps in order. The shrinkage is currently mis-timed, because unless Christ brings some fishes to the hungry people, it will presently only cause more suffering and, very likely a double-dip. But that will boot the Tory-LibDem coalition out of office in no time, and maybe Labor will be swept into majority on a new platform of increased public investmment in infrastructure, clean energy and secondary education - which are all things that, I hear, Britain needs almost as much as America.

Accounting Identities, Republican-style

The other day's widely circulated Greg Mankew and  this from Krauthammer today

Suppose someone - say, the president of United States - proposed the following: We are drowning in debt. More than $14 trillion right now. I've got a great idea for deficit reduction. It will yield a savings of $230 billion over the next 10 years: We increase spending by $540 billion while we increase taxes by $770 billion.

He'd be laughed out of town.

... makes me think not so much that Republicans have forgotten arithmetic, but that they have never learned basic accounting identities. You see, the thought espoused by Mankew (who is an economist, for chrissakes!) and Krauthammer originates in the confusion between the pocketbook of the citizenry and the pocketbook of the government. They think that the two move in tandem, where, in fact, it's exactly the opposite. They think that lowering taxes helps the people save money (true!) and therefore also helps the government save money (absurdly false!). And they think that goverment spending increases government borrowing (true!) and therefore also increases the debt of each citizen (also false!). 

It's easy to see how you make the leap - after all, aren't the debts of the government our collective debts? That's intuitive but also completely wrong. The Govenment is the ultimate accounting counterparty to each of us individually, rather than a contiguous entity whose assets and liabilities can be meaningfully consolidated with each of us. Government debts are assets of those who own them - i.e., the people* (*ignoring foreign governments and corporations for the time being).  Money is, fundamentally, a demand promissory note of the government (or an ultra-short-term government debt).  So when the people try to save (increase their assets) the government has to borrow (increase its liabilities).  And vice versa.

They took our 'jerbs'.

I like the theme of this post by Karl Smith. But it got me thinking on a different topic altogether - tax policy. We've got to seriously start thinking about how to preserve basic human welfare in a world where human labor becomes gets increasingly substituted by cheaper and better machine labor, and progressively wider swaths of the population become unnecessary for employers. How exactly do humans survive under these conditions? Where is the money going to come from?

At the outset, let's dismiss (1) the idea that every human is going to own a robot who will go to work for some company in lieu of his human owner (who'll presumably be sitting on the couch watching TV) and bring home the cash, or, for that matter, (2) the idea that every human will own enough robot servants to take care of all of his/her needs. Long before anything like that becomes possible, a 20%+ unemployment rate will be a grim reality that we will need to deal with. In addition, if history is any guide, machines tend to be owned by fairly large businesses more so than individuals, becuase (A) large businesses can afford a large capital outlay in exchange for years of improved productivity and (B) machines we make tend to be specialist and not generalists - subsituting humans at a given task or two, rather than replacing the whole package (like in iRobot books) - and this is likely to continue becuase that's how you get maximum marginal product for the lowest cost.

I see two possible models of society that could cope with the problem:

1. A universal ownership society - in which virtually every human owns either a part of a large business or a natural resourse that generates sufficient income to survive. Robots/machines do all the work, while humans reap the benefits of ownership - sounds nice, but also rather utopian given where things stand now.  It's just hard to see how you can get those currently destitute (of which there are plenty) to "wealthy" without some steps in between.   A small-business idealist might propose to somehow dramatically improve the odds of starting your own shop that does something, but I've yet to see an idea that would offer a dramatic improvement over the status quo. More fundamentally, small business as a concept is going to get exponentially more difficult as production of any kind becomes more capital intensive and less and less labor intensive. In other words, when Starbucks replaces even barristas with machines that operate at a fraction of the marginal cost, but cost a lot to buy up front, it will be even tougher for a coffee-shop startup and its owner to compete with Starbucks and survive.

2. A welfare state, that takes care of the unemployed and the destitute with tax revenues. This finally brings me to the core of the argument: where are sufficint tax revenues going to come from, if employment income of human beings is constantly falling? We can't continue taxing income and hope for solvency. We need a re-think and start increasinly relying on tax revenues from large enterprise, because that's where the money is going to be. So rather than lower corporate income taxes, we need to at least keep them where they are, but maybe think about lowering payroll taxes to lower marginal cost of employing humans (though this would only delay the reckoning) and make evasion exceedingly diffucult. A VAT would perhaps be even better, becuase this tax does not care about whether value was added by a human or a machine. U.S. needs a VAT, the sooner the better.