Signals v Causes: Rome

This gave me a chuckle, from this week’s EconTalk with Charles Marhon about what makes a strong town:

I like to point out that Rome didn’t get the Colosseum and then build Rome. The Colosseum was the byproduct of centuries of success. And you know, you can look and say Rome was successful because they had a Colosseum. And go out and build a Colosseum and then say, why isn’t Rome appearing here?

I recommend the podcast. Marohn makes a lot points that I am sympathetic to.

He thinks we’ve gone overboard on infrastructure due to the belief that more is always better for growth.

Because of that thinking (similar to thinking on housing and education) and distorted incentives (we don’t directly pay for all that infrastructure) we’ve pushed into the diminishing returns part of the curve and cities that have built infrastructure to try to stimulate growth (rather than build to keep up with growth) are getting to the point where they may not be able to pay their bills.

Good links

A short, but insightful graduation speech.

A longer and insightful discussion of wealth and how different views of where it comes from can affect the words we use.

From the first:

4. Everyone responds to incentives, including people you want to help. That is why social safety nets don’t always end up working as intended.

From the second:

Europeans and Americans “claimed” a higher portion of global output only because they produced a higher portion of global output!  What these Europeans and Americans “claimed” simply would not have existed had they not produced it.

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Whose wealth is it?

The author of a Letter to the Editor in the local paper is tired of hearing about how the richest country in world is broke.

The author makes a common mistake of confusing someone’s wealth for the country’s, or our, wealth.

Should we raise the tax rate on wealthy people?

Here’s my attempt at using the Costco Connection format to look at this question from both sides.

Yes

What the experts say: Economists tell us that wealthier folks have lower utility for each marginal dollar than less wealthy folks, because they have more than met their basic needs.

Or, as most people believe, the wealthy can afford to pay more than the less wealthy.

The wealthy benefit more from government, so should pay more to support it.

Tax rates can help us remedy unfair income distributions.

No

The wealthy already pay more than the less wealthy.

It’s presumptuous of us to feel we have the right to demand more from the wealthy than we are willing to give ourselves.

Even if it’s true that the wealthy have less utility for each additional dollar than the less wealthy, that’s not the right comparison. Wealthy people have higher utility for each additional dollar than government bureaucrats have with other people’s money.

Diminishing marginal utility is not a good argument for taking stuff from people. If I stole all the stuff in your attic, would you accept my argument that what I did was right because you weren’t using it?

Everyone benefits from government and it’s fair to expect everyone to pay something for it.   In any situation where a minority pays for the majority of something that everyone benefits from (or thinks they benefit from), the tendency is for the majority to demand more and more, because it costs them nothing to do so.

Tax rates do not remedy envy. Higher tax rates on the wealthy can contribute to perceived income inequality, as wealthy folks respond to the incentives of their after-tax pay, not their before-tax income, while inequality is often based on gross income. In other words, if you raise taxes on the wealthy, they’ll seek to make even more income to make up for those higher taxes.

Higher tax rates also encourage the wealthy to make adjustments in their lives to avoid paying those taxes. Wealthy folks moved from England and France after those countries passed higher tax rates on the wealthy, for example.

My opinions

I think we spend too much time talking about tax rates and not nearly enough time talking about government spending.

I think everyone, no matter how rich or poor, should pay something.

I don’t begrudge the wealthy of their wealth, especially the wealth of those who have earned it fair and square. That means they’ve added value to society, something we fail to consider as we salivate over ways to take it from them.

Even with 20/20 hindsight, I’m appalled at how we fail to see that earned wealth often carried with it gut-wrenching risks, previous failures and an extraordinary amount of persistence against the odds. We act as if it was a given.

I don’t accept that wealthy people have less marginal utility for an additional dollar than the less wealthy. If that were true, I would expect to see more evidence of that in the financial behavior of less wealth people.

“My wealth does not create your poverty.”

In Russ Roberts’ take on Occupy Wall Street he points us to P.J. O’Rourke characterization of wealth:

But as the writer P.J. O’Rourke has said, wealth is not a pizza. If we’re sharing a pie, and you get a bigger piece, that does not mean that I have less to eat. It depends on what happens to the size of the pizza. Ten percent of an enormous pizza is more filling than all of a tiny one.

For those who think of wealth as a fixed pie, I don’t think the ‘pizza-size’ analogy helps them see what’s really happening with wealth, because they still view it as one pizza to be divvied up somehow.

What P.J. O’Rourke actually said (btw, I recommend his book On The Wealth of Nations) is better than the ‘pizza-size’ analogy (emphasis and numbers added):

Wealth is not a pizza where, if I have too many slices, you have to eat the Dominos box. [1] My wealth does not create your poverty. Your wealth does not create my poverty. They’re separate questions. [2] And we can generate more wealth.

O’Rourke makes two excellent points, as numbered.

Point 1:  Your wealth does not mean I have less wealth.  This is the point that the ‘pizza-size’ analogy misses.

Point 2:  We can create more wealth, which is the ‘pizza-size’ analogy again.  But, it’s helpful to understand point 1 before thinking about point 2. Instead of thinking about the size of the pizza, though, maybe we should just say that we can make more pizzas.

Unfortunately, both points are counter intuitive and that’s why we have such debate on the issue of wealth.

When you hear someone say things like ‘wealth is concentrated’ or ‘1% controls some large percent of wealth’, ask yourself where did that wealth come from?

Enlightening Aggregation

I typically think that looking at things like the economy in terms of aggregates is not helpful.  GDP, for example, is an economic aggregate, or a sum of several different categories of spending that is used as a gauge on the health of the economy.

GDP can be useful for visualization, comparison and analysis.  For example, it’s fair to use GDP per capita to compare the relative living conditions of the U.S. and Zimbabwe, or folks living today and folks living in the U.S. fifty years ago.

The danger comes when those in power believe it is something they need to micro manage.

The following passage provides an example of an author who used aggregation to create an effective visual.  I read it years ago, and every now and then it bubbles back to the surface.  I think it may be especially timely now with the debt limit debate in DC (emphasis added).

Wm. Rickenbacker editor of the Rickenbacker report and author of a recently published “Savings & Investment Guide” has pointed out that 28.6 mil.  Americans depend on gov’t retirement and disability programs.  Then you add in recipients of survivor programs — almost 9 mil, unemp. benefits to 6 mil., Military 3-1/2 mil., civilian emps. & dependents and you come up with a total of 81.3 mil. people dependent on tax dollars for their year round living.

All of those tax dollars must come from 70.2 million Americans working & earning in the private sector.  Ah! but you say govt. workers pay taxes too. And so they do. But all their inc. & therefore the portion they pay in taxes comes originally from tax dollars so they are just returning to gov’t. tax money already pd. by the worker in the pvt. sector.

The 70.2 mil. private sector workers have 62.1 mil. personal dependents, so we’re talking about a private sector of 132.3 mil. sharing their income with an additional 81.3 mil.

To sum it up roughly 70 million Americans provide a living for themselves and 143.4 [million] additional people.

Now, don’t take this as meaning there should be no recipients of tax dollars or that all who work in gov’t are parasites.  Obviously, we want to provide for the needy & disabled.   Just as obviously we must have & are happy to have in the military those who provide for our security.  This goes also for policemen and firemen & all those who provide services we want & need.

The point I’m making is that somewhere there must be a figure beyond which we can’t go in the growth of gov’t without wimping out those in the private sector who pick up the tab.

The plain truth is every effort to slow gov’t growth or reduce gov’t costs has failed.  In the last 20 yrs. corp. profits have risen 105%–wages have gone up 213%–govt. costs have risen 340%.  There is one sensible, long overdue answer; fix in the constitution a limit on the share of earnings govt. can take without becoming a drag on the economy.

These words are from the book Reagan: In His Own Hand.   They were written as a manuscript for a Paul Harvey-esque radio spot that Reagan gave in those days.  This one aired on radio on November 16, 1976.

I thought this was an interesting way of looking at the economy.  Wealth must first be created in the private sector before it can be used by government.  Government doesn’t divine wealth out of thin air.  It lives off the wealth created in the private sector.  And the ratio of folks living of that wealth is high.  Someday I might try to update these numbers to see if the ratio has changed.

The reason we transitioned from hunter-gatherers — folks who spent most of their time providing the essentials — to where we are now is through private sector trading that allowed us to free up time amongst ourselves and others.  That freeing up of time allows us to use some of our produce to fund things like government.  It allows some people to not produce much at all and do things like occupy government positions.

While people have many different ideas about what wealth is, wealth derives from this savings of time.  How much time does it take to feed ourselves compared to our hunter-gatherer ancestors?  Much less.  If it didn’t, we couldn’t afford government.

I think it’s good to keep that in mind as some of those in government seem awfully preoccupied with biting the very hand that feeds them.

Tick, tick, tick, tick

Ricky Gervais, creator of the television show The Office, and Andy Rooney both lamented about how much money they have on this evening’s 60 Minutes.  Ricky said that he doesn’t work harder than a lot of other folks, but earns many multiples of their income.  He said that a large part of his success was due to luck.

I agree.  Nassim Taleb, author of the Black Swan and Fooled by Randomness, educated me on how much luck plays in the success of successful people.  As Taleb says, we always hear about the successful people but never about the just as talented people who aren’t as successful because they just haven’t had their lucky break.  Sometimes it’s as simple as meeting the right person at a party.

But, I will give Ricky something, he does have talent.  He makes me laugh.  I enjoy his humor, acting and writing.  Not to say that others aren’t as deserving, but any dollars Ricky has of mine in his pocket were well earned.

Rooney seemed bothered by having more than his share, but comforted by the fact that he doesn’t have as much as others.  He referenced the Forbes 400 list of the richest 400 people as proof.

What bothered me: C’mon guys.  Rather than feel down about being wealthy, celebrate it.  Encourage others.  Tell us how awesome it is that we live in a world where you can follow your dreams, work hard and be rewarded.  Acknowledge, as Ricky did, that there is some luck to it, but one thing is for certain – they wouldn’t have been successful if they hadn’t tried.

And, if you don’t have a dream but can still live a decent, comfortable life as a nurse, engineer, electrician or some other chosen profession, that’s awesome too.  Compared to how people lived a century ago or how people live in other parts of the world (some within a day’s drive for most of us) – we are all rock stars.  That something that we should feel good about it.

We should be asking ourselves why that is.  What are the root causes that allow each of us live better than royalty in the past in exchange for an honest day’s work?  We should want more of that.

They showed an 80s video of Ricky taking a stab at the music business.  Apparently it didn’t work out.  He wasn’t bothered by it.  He seemed to recognize that all things don’t work out, but trying matters.