It's the Investment, Stupid

Steven Horwitz

Here is the most important blog post you will read all week, and it comes from the indispensible Bob Higgs.  Bob points out that all the talk about "stimulating consumption" is beside the point because consumption spending is not the problem!  Real personal consumption spending is now above its pre-recession peak.  And Lord knows government spending isn't the issue either.  Anyone who's taken intermediate macro knows what's coming next:  if GDP is lagging, and it's neither C nor G that's the problem, it's a pretty good bet that it's investment.  Consistent with the emphsasis on regime uncertainty that has become Bob's hallmark (and something I've tried to empahsize in other posts here), investment is indeed the problem (emphasis mine):

The economy remains moribund not because consumption spending has failed to recover and not because government spending has failed to increase, but because the true driver of economic growth—private investment—remains deeply depressed. Gross private domestic fixed investment fell steeply after the second quarter of 2007, and in the second quarter of 2011 it remained 19 percent below its pre-recession peak. This figure fails to show how bad the investment situation really is, however, because the bulk of the investment spending now taking place is for what the accountants call the ”capital consumption allowance,” the amount estimated as necessary to compensate for the wear and tear and obsolescence of the existing capital stock.

The key variable is net private domestic fixed investment—the investment that builds the productive private capital stock. Quarterly data through this year are not currently available at the BEA website, but the annual data show that an index of its real amount peaked in 2006, fell substantially in each of the following three years, and recovered only slightly in 2010, when the index showed net private domestic fixed investment was running about 78 percent below its level in 2005 and 2006. Here is the true reason for the recession’s persistence.

Private investors, despite the full recovery of real consumer spending and the increase of real government spending for final goods and services, remain apprehensive about the future of new investments, especially new long-term investments.

It really is that simple folks.  There's no better sign of the implicit acceptance of the Keynesian world view than the emphasis in the political realm and the popular press on the centrality of consumption (and jobs, for that matter) as a sign of economic health.  It's not.  From at least J. B. Say onward, we've known that production is the source of demand, and that you have to produce value before it can be consumed.  Austrians have long emphasized the importance of capital investment for economic growth.  In fact, the contrast between consumption and capital is a good proxy for the contrast between Keynesians and Austrians. Austrians have also pointed out that the necessary investment will only take place in an economy characterized by respect for private property, the rule of law, and sound money.  Right now, we don't seem to have any of those three in the sufficient amount, and the results are just what Bob argues in this post.

You want recovery?   Forget consumption.  Ask yourself what sorts of policy changes would make entrepreneurs and investors feel like they know what to expect over the medium and long run and convince them that they will be able to keep the fruits of their labor and investments.  Hint:  the president's jobs plan ain't it.

Comments

[Jerry O'Driscoll]

The regime uncertainty will end when the regime is changed.

[Cantillonblog]

Even the IMF study on fiscal policy responses to financial crises suggested that spending cuts (but not tax increases) led to a crowding-in of capex and swifter recovery.

It is interesting that despite unfavourable policy, and admittedly starting from a low-level, the rate of recovery in capex from the recession lows was the swiftest in post-war history.

Given unit labour costs in the US are extremely competitive, one should keep an eye on capex for signs of life. Policy may still be horrible, but the momentum in deterioration of the policy outlook has at least shifted.

[Mike]

Steve,

I thought keynesians believe investment demand is part of AD, right? And they claim recessions are primarily a problem of weak investment? If so, aren't the arguments against crude consumptionism misplaced?

Also, isn't regime uncertainty persistent in the last 100 years? If so, how can it explain this very abnormal recession?

[FC]

For one thing, both employers and employees are waiting for Justice Anthony Kennedy to flip a coin and say whether Obamacare will continue.

[Rob R.]

Its amazing that this data gets so little play in mainstream economic coverage, which just seems to assume weak consumer spending.

However I agree with FC that more sophisticated Keynesian would be comfortable using this data as evidence of low Marginal Efficiency of Capital and that, combined with their view that we are in a liquidity trap, would be used to back up their call for increased direct government investment.

[Daniel Kuehn]

Mike -
Right - for Keynesians investment is the primary problem in a recession. I'm not sure what Steve is getting at here.

This isn't something new that Higgs has turned up for this episode. This is always the case in every recession. That's why no existing business cycle theory suggests that problems with consumption drive the business cycle. None. It would not get any traction. You learn in freshman econ that investment fluctuations drive the business cycle.

[Daniel Kuehn]

Rob R. is right - this is someething to criticize confused journalists and politicians for. It's not really relevant to debates among economists.

[Bill Woolseu]

I think this is wrong.

Real consumption is nearly 12% below the growth path of the Great Moderation. Yes, it is nearly 1% higher than it was at its previous peak in 2007, and real output is still about 1/2 percent below its peak, that is hardly the "problem." Getting output back to where it was in 2007 is hardly enough.

The problem is that real output is 12.3% below its trend of the Great Moderation. If we can believe the CBO, part of this is due to reduced productive capacity, but by their estimate, it remains nearly 7% below that.

Does that mean that investment isn't a problem?

No, investment is 21% below its peak back in 2006 and 35% below its trend growth path of the Great Moderation.

In my view, both consumption and investment should be higher, along with output and employment.

If firms don't want to invest, for whatever reason, then consumption should rise.

Because, you know, the purpose of investment is production, but the purpose of production is consumption. So that makes the purpose investment, consumption.

Fortunately, there are market processes that do cause consumption to expand as needed. If necessary, real interest rates can turn negative, if nothing else by having the current price level fall below its long run expected value. And there is always the pigou effect which will generate sufficent "wealth" so that consumption rises to match production.

But...

If the CBO is right about potential output, then output is $977 billion below potential. Real investment is $986 billion below trend. So, if real investment increased back up to to its trend of the Great Moderation, this could fill the "output gap" and even allow a tiny decrease in real consumption.

Still...I can hardly imagine that all of those newly employed workers would consume nothing. Or, more exactly, that those areadly employed and earning income would reduce their consumption enough to offset the increased consumption of those employed.

[anon]

Higgs does not know how to read a balance sheet. His argument is that depreciation (capital consumption allowance) of the capital stock has declined by 78%. He is confounding flows with stocks.

Prima facie, the decline in the flow is true. However, almost 75% of that decline is residential structures. Since the 2009 recession trough, investment in equipment and software is outstanding. No regime uncertainty in that investment category.

If Higgs thinks that any more new residential structures (a signature of wealth not productive capacity) needs to be built in the short run, he is [fill in the blank].

It's Table 5.2.6 in the NIPA for the empiricists.

[Troy Camplin]

Direct government investments would cause misallocation of capital, resulting in, at best, a boom that would result in yet another recession. More of the problem that caused us to get into this situation isn't the solution. We need policies that allow people who have local knowledge, who are familiar with what real people in the real world want (and not mere political cronies), to invest and create things people want. That is how you get recovery. Period.

[J Oxman]

1) Keynesian language gets in the way of understanding. Can you really blame politicians and journalists for thinking it's a consumption issue when Keynesians talk in terms of "aggregate demand" all the time. If it's an investment problem, then say that. "Not enough investments!"

The next step is questioning why not enough investment.

"Not enough aggregate demand" comes the reply. Hey wait... I feel like I'm stuck in a loop.

2) Regime uncertainty is always present, but its marginal impact waxes and wanes as the government is more/less interventionist. Software investment is moving right along because the present discounted value of the net marginal benefit of software investment is obviously positive. Regime uncertainty increases won't bite everywhere, but is it unreasonable to think it has some effect? Especially for lower marginal productivity people?

3) Increased minimum wage and increased cost of employee benefits are basically certain. We might be looking at permanently higher unemployment rates.

4) EPA has increased its interference with business investment. If you want to run a pipeline, it's gonna take a few years to get approval. Software investment doesn't usually run through protected land.

5) Deleveraging takes a long time. Reinhart and Rogoff showed that a deleveraging recession will last longer than a simple productivity shock type recession.

6) Hiring people to get them paid so they can buy stuff is nonsense and ignores the basic point of labor: you hire a person who will add value to the enterprise. I avoid hiring people who like not add value. This is a price of labor issue as well.

Unemployment is not an across-all-sectors problem. It is concentrated in construction and manufacturing. It's completely plausible that people are (a) stuck in a mortgage and (b) stuck in a location where alternative employment opportunities are scarce. That makes employment matching very difficult. People aren't as mobile and capital, and policies that try to keep them in their houses (or put them in houses they can't afford) just hurt.

7) The NIPA tables only contain flows. How is Higgs confounding flow and stock? New investment has to at least keep up with depreciation in order to not shrink the productive part of the economy.

The really interesting table is here: http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1

Not just residentials are down. Physical productive capacity is in general not being built.

8)Economists have no better idea what the "structure of production" should look like than any politician or journalist does. What we do know, as economists, is that interference with the market mechanisms will lead to an unsustainable structure of production.

9)Dodd-Frank must also be considered here. Dodd-Frank's effects, and the Basel 3 effects, are largely unknown at this point. We do know that there will be much more discretion by regulators, and a much heavier regulatory burden on businesses that need external capital. Is it such a surprise that they would want to build up internal capital as much as possible now to fund future investment?

That's all I got for now, except for this. Businesses always face uncertainty in terms of future sales, future costs, future competition, etc. The survivors are experts at forecasting. Saying that they always deal with uncertainty is stating the obvious and is, as such, unhelpful. The question is: are they dealing with unfamiliar problems? Is marginal uncertainty up? The answer is obviously yes.

[anon]

Oxman. Table 5.2.6 is flow. Table 5.9 is stock. I'll reiterate. Higgs can't read either an income statement or a balance sheet.

On the balance sheet, nominal 2010 produced assets are greater than nominal 2007 produced assets. That was a helleva a 2009 downward revaluation (line 37) though.

If you could read the 5.2.6 income statement you would know that nominal gross private investment exceeded nominal capital consumption allowance in any year that Higgs references.

[J Oxman]

Anon,

I don't really understand your point. Higgs isn't saying investment is below depreciation. Just that it's exceedingly low. And it's not just low for residential structure.

According to your favorite table, net fixed investment in equipment and software was the worst one. It was the only negative one in 2009.

Again- please tell me exactly your point, because I'm not getting it.

[Jerry O'Driscoll]

When you study microeconomics, you learn that savings funds investment; investment is the source of production, employment, and income growth. That funds consumption.

When you study macroeconomics, you learn the opposite is the truth. Consumption drives growth. Only one of these theories can be correct.

Like Hayek (and Alchian), I opt for microeconomics. There is no such thing as macroeconomic theory. There are macro (aggregate) consequences of microeconomic forces. There is, however, no valid aggregate economic theory of aggregate consequences.

As an aside, Allan Meltzer, who authored a challenging account of Keynes' ideas, said that Keynes never favored stimulating consumption. He only favored stimulating investment. But modern KEYNESIANS are obsessed with consumption.

So, Steve's post is on point.

Bill Woolsey, whom I respect and do hope will correct the spelling of his name in his comments, appparently believes macroeconomic outcomes can be determiend by pulling the appropriate policy lever.

Consequently, I find Bill's comments the most discoordant of anyone's on this site. He is the most purely technocratic commenter (much more so than Daniel, who is thoutful on Keynes). And I simply can't follow his reasoning. I offer this as feedback and not a jibe. He is welcome to ignore it.

[Bill Woolsey]

I don't think microeconomics shows that investment drives growth.

I don't think that macroeconomics shows that consumption drives growth.

My own view is that technological innovation primarily drives growth, along with increases in the labor force and investment.

These things are what determine the productive capacity of the economy.

However, for that productivite capacity to be used, real expenditure must match it.

In the absence of monetary disequilibrium, real income generates matching real expenditures. And there are market processes that will correct monetary disequilibrium.

My own special area of interest is what sort of monetary institutions will smooth that process.

The price that coordinates saving and investment is the interest rate. An increase in saving (in the absence of monetary disequlibrium, results in a lower interest rate and a shift in the composition of real expenditure away from consumption towards investment. This does increase future real output, real income, and real expenditure (in the absense of monetary disequilibrium in the future.)

It is likely that an excess demand for money will reduce real consumption and real investment. And correcting that disequilibrium will result in additional real consumption and real investment.

To some degree, I think what you are calling "microeconomics" involves the allocation of resources assuming no monetary disequilibrium.

What I call macroeconomics is certainly about the implications of monetary disequilibrium.

In my view, you (O'Driscoll) have gotten hung up on the paradox of thrift. Somehow, when it involves debt repayment, you fail to see it for what it is.

[Daniel Kuehn]

I agree with Bill's first four lines especially. There is a big difference between conceptions of growth and conceptions of fluctuations in economic activity. It's not clear to me why anyone would expect the determinants of long-term growth to be the same as the determinants of recovery from a recession. It's true that "growth" is going on in both cases, but aside from that superficial point they seem quite different. In one instance we're dealing with the addition of new productive capacity, and in the other we're dealing with the utilization of existing productive capacity because nobody seems to like the level at which its currently being utilized.

[John P. Cochran]

While Allan Meltzer may be correct on consumption versus investment relative to Keynes’s technical writings, Keynes in a radio broadcast January 1931 (Essays in Persuasion, p. 152) clearly calls for increased consumption spending. Echoing the kid in the poem “I want to be a consumer”, he advises, “Therefore, oh patriotic housewives, sally out to-morrow early into the streets and go to the wonderful sales, which are everywhere advertised. You will do yourselves good- for never were things so cheap, cheap beyond your dreams. … And have the added joy that you are increasing employment, adding to the wealth of the country because you are setting on foot useful activities, bringing a chance and hope to Lancashire, Yorkshire, and Belfast.”

[Eric Hosemann]

"My own view is that technological innovation primarily drives growth, along with increases in the labor force and investment."

How does innovation drive growth without investment?

Innovation requires capital; it consumes capital, in the form of lab space and equipment and the innovator's time, and it is performed on capital.

The Neolithic entrepreneurs had to set aside time to hone their spearheads.

[Steve Horwitz]

"Rob R. is right - this is someething to criticize confused journalists and politicians for. It's not really relevant to debates among economists." - DK

Horwitz: "There's no better sign of the implicit acceptance of the Keynesian world view than the emphasis in the political realm and the popular press on the centrality of consumption (and jobs, for that matter) as a sign of economic health."

Do people not read the words on the page? I named where the problem was pretty clearly there.

And yes, I'll defend the phrase "Keynesian world view" with its reliance on C+I+G etc.

But seriously, do people not read posts before they comment on them?

[J Oxman]

"But seriously, do people not read posts before they comment on them?"

Often, no. Moreover, if you link to a piece in your post, most people will comment on what you linked to without ever reading it.

[Jerry O'Driscoll]

Further to John Cochran's comment, Keynes also co-signed the famous 1932 letter to the Times in which the signatories argued it was the "patriotic duty" of Britons to consume, to spend on anything. It was answered by a letter co-signed by Hayek in which the signatories make much the same point that Steve Horwitz makes in his post: private investment is the driver of economic growth. (I discuss the exchange in a forthcoming paper in the Journal of Private Enterprise.)

The ideas of propping up consumption and "pump-priming" is pre-Keynesian. It was, as Steve has argued in prior posts, the policy of the Hoover administration. Hoover was much criticized, even derided, for his policies. I believe Steve has a paper forthcoming on Hoover.

[Daniel Kuehn]

Steve I read the words you wrote. I'm criticizing what you just said you defend - that this is an "implicit acceptence of the Keynesian world view".

If I thought you were failing to criticize journalists or politicians I would have said you were failing to criticize journalists or politicians. What I've consistently criticized you for is extending the argument beyond journalists and politicians.

The reason to comment here is that your posts are worth reading. It would defeat the purpose of being here if I didn't read them!

[Daniel Kuehn]

To be honest, after Don Boudreaux had a few "Keynesianism as consumptionism" posts it was refreshing to read your first four paragraphs which were quite good criticisms of underconsumptionsm and the journalists who promote underconsumptionism.

I refrained from groaning until I got to your fifth paragraph and saw a link to an article titled "consumerism is Keynesianism" and your talk of an "implicit acceptance of the Keynesian world view". Before that point you had been making an argument I agreed with entirely.

[Allan Walstad]

1. Austrian business cycle theory is criticized on the grounds that entrepreneurs should come to recognize when interest rates are artificially and temporarily low and not take the bait. Well, perhaps the current situation indicates that they are indeed learning.

2. Purposely increase consumption in the face of lower production? Sounds like eating one's seed corn.

3. @Daniel Kuehn: "In one instance we're dealing with the addition of new productive capacity, and in the other we're dealing with the utilization of existing productive capacity because nobody seems to like the level at which its currently being utilized."

What happens if policy designed to correct the latter interferes with the former? Indeed, what happens if it interferes with merely working out the distortions induced in the current structure of production by earlier misguided policies? The housing situation (and, with it, the situation in construction) is a very clear example. Houses are a capital investment for individuals and families, as well as for speculators and remodeling house-flippers. Artificially low interest rates facilitated unsustainable capital projects in the form of housing. And now politicians are doing everything they can to prevent the necessary liquidations and restructuring.

[Daniel Kuehn]

Allan -
re: "What happens if policy designed to correct the latter interferes with the former?"

It doesn't seem to me that this always has to be a tradeoff - but obviously it sometimes is. We can also think of it the other way around (good long-term policies like a carbon tax might not be wise to implement in 2011... but maybe 2014 might be a smart time to start talking seriously about it).

Anyway - if it's a tradeoff then obviously that's unfortunate, but we have to weigh the tradeoff. Life is tough like that.

[Bill Woolsey]

I think innovation and investment are conceptually separate. It is possible to improve technology without making production more round about. The replacement of existing capital goods with ones that produce more or better goods can occur with no net investment. It is even possible to have net disinvestment while replacing existing capital goods with ones that produce more or better goods.

Suppose people chose to dissave and reduce net worth? That wouldn't prevent technological innovation from tending to raise real income at the same time that the capital consumption tended to reduce it.

Also, identifying innovation with lab science is a big mistake, though that is part of it. At least, I don't see the sort of innovation done by entrepreurs to be working in a laboratory.

All that said, innovation is enhanced by all the things Horwitz and Higgs described as desirable for investment. I favor all all the standard libertarian reforms.

I also think that improvement along those lines will tend to raise investment demand. That will tend to raise the natural interest rate (as would a decrease in the supply of saving and increase in consumption demand.) Given reasonable ceterus paribus assumptions, these would tend to relieve monetary disequilibrium, raise nominal expenditure, and increase actual production towards potential.

I think the orthodox view of these things is correct--if firms were motivated to invest more, this would result in increased output, income, and consumption. Not due to the long run effect of more productive capacity, but rather more utilitzation of existing capacity. (Of course, the enhanced investment will have the long run effect of increasing productive capacity, real income, and future consumption. Good.)

But I also believe that additional consumption and higher current sales for firms producing consumer goods would motivate those firms to invest more. What is important, of course, is anticpated sales in the future, rather than sales now, but it seems like many firms do project the recent past into the future.

One of the many things of I have learned from Sumner is the importance of future monetary equilibrium. If firms and households expect monetary equilibrium in the future--particularly slow, steady growth in money expenditures, the need to prove to households and firms that recovery is occuring would be less of a problem.

In my view, a Fed wedded to periodic adjustments in short and safe interest rates in order to keep the expected price level rising at 2% does not provide a reason to believe that real expenditure will rise to match capacity. Further, clever intervenetions in financial markets so that the natural interest rate on short and safe assets rises to a level the Fed likes market interest rate always seemed implausible. Existing Fed policy has failed.

Anyway, aside from just explaining what I consider basic free market economics, my original point was that just because real consumtpion has barely passed the previous peak does not mean that it is now "high enough." I think consumption should be higher, and investment higher still.

In my view, our rent seeking society makes investment problematic. I don't think that the Obama administration generated some kind of sea change in that environment. I don't think it has been anything like FDR.

But if politicians get significantly worse about these things, I still think monetary institutions providing for slow steady growth in nominal GDP would be possible. And they would be the least bad option, even if the result was increases in consumption matched by dissaving and disinvestment. To me, it is a no brainer. I don't see how monetary disequilibrium helps.

[Bill Woolsey]

Walstad:

1. Entrepreneurs who aren't "fooled" don't take existing short term rates to persist. The lower short term rates make short term investment projects more profitable, and make long term projects slightly more profitable. The problem occurs when investment is undertaken on the assumption that interest rates will remain low.

Anyway, you are assuming that the economy is starting at equilibirum, with the market rate equal to the natural interest rate, saving equal investment, and quantity of money equal to the demand to hold money. If an increase in the quantity of money leads to an excess supply of money and an excess supply of credit, the market interest rate will be pushed below the natural interets rate. While entrepreneurs make long term investment plans based on this interest rate?

If, on the other hand, the market rate is above the natural interest rate, saving is greater than investment, and the demand to hold money is greater than the existing quantity of money, then an increase in the quantity of money and a reduction in the market interest rate are equilibrating.

2. Increased consumption out of reduced production isn't consuming seed corn when there is an excess demand for money. You are assuming output is equal to capacity.

An excess demand for money will usually decrease consumption and investment and result in output below productive capacity. Consumption can increase, and when any seed corn is needed, it can be produced too.

[Eric Hosemann]

@Bill:
"Also, identifying innovation with lab science is a big mistake, though that is part of it. At least, I don't see the sort of innovation done by entrepreneurs to be working in a laboratory."

I think it is a big mistake to conceptually separate innovation inside and outside of laboratories. The laboratory is simply a complex web or shell of capital secluding the innovator. Hence my mention of Neolithic man. Remove the money illusion and there is little difference between altering the composition of a semiconductor or light bulb filament and adding another production line in a factory. The understanding behind these acts is essentially the same: to increase production.

[Martin]

"Bob points out that all the talk about "stimulating consumption" is beside the point because consumption spending is not the problem! Real personal consumption spending is now above its pre-recession peak."

Honest question, but why does it matter that it is above the pre-recession peak? It's also above 1996 and it's also above 1896.

I don't see what the significance is of the pre-recession peak. Isn't the trend far more important as the trend tells you what people were expecting?

[Jerry O'Driscoll]

Exceeding a pre-recession peak defines "recovery." It's a term of art.

[Amin]

"From at least J. B. Say onward, we've known that production is the source of demand, and that you have to produce value before it can be consumed. "

Exactly. The idea that consumption drives economic growth is a seductive 'easy answer'.

[Richard Schulman]

Daniel Kuehn writes:

"...good long-term policies like a carbon tax might not be wise to implement in 2011... but maybe 2014 might be a smart time to start talking seriously about it..."

Why would it be a good idea in 2014? The climate science on which the idea of a carbon tax is based is controversial and indeed probably wrong. (Cf. the recent cloud chamber experiment at CERN, which provided further plausibility for Henrik Svensmark's cosmic ray theory as the principal driver of earthly climate variability, not anthropogenic global warming.) Nor, even if the anthropogenic global warming hypothesis had been correct, the huge expense of the measures proposed and the ridiculously small temperature reduction predicted to be achieved meant that the proposal didn't pass the minimum semblance of cost-benefit rationality.

Why have Keynesians like yourself, Daniel, along with Romney's two top economics advisors, Hubbard and Mankiw, been so eager to jump on this discredited bandwagon? I would suggest it is because of Keynesians' genetic fondness for solving problems -- real or imagined -- with more government by experts paid by other people's taxes.

[Daniel Kuehn]

Richard Schulman -
Certainly it's controversial, but don't you think controversial things are precisely what we should "seriously talk about"??

re: "I would suggest it is because of Keynesians' genetic fondness for solving problems -- real or imagined -- with more government by experts paid by other people's taxes."

Government by experts is a proven failure. Any solution needs to recognize that no central authority can make decisions for people on how to use resources. That's why - if there is a blindspot in the market like any sort of pollution - any solution is going to have to be cognizant of the dispersed information that people have on what they value and the tradeoffs they want to make. That's the whole reason why pro-market economists are backing a carbon tax - because it allows market forces to weigh the tradeoffs associated with a cost that was previously being involuntarily imposed on people. Overall, you don't seem to have a very firm grasp on the way Keynesians think. Of course, this particular policy has nothing to do with Keynesianism - so the fact that you cite Keynesians here is a little odd to begin with.

[J Oxman]

Daniel,

Pollution isn't a 'blind spot in the market' as you say. Pollution would be priced in the market if property rights were properly recognized and enforced. Because the property rights are not recognized and enforced, pollution appears to be an externality, but that is due to state failure, not market failure.

[Martin]

@Jerry

"Exceeding a pre-recession peak defines "recovery." It's a term of art."

Fair enough, but how does it follow then that consumption is not the problem?

Higgs argues that it is not a problem because it is above peak, others will argue that it is a problem because it is below trend.

Higgs argues that it therefore must be uncertainty keeping investment down and others will that consumption is the reason why investment is down and both will be right based on their own assumptions.

How do I know which assumption is the more plausible one?

[Daniel Kuehn]

re: "Pollution would be priced in the market if property rights were properly recognized and enforced."

I agree 100% J Oxman. You let me know when we've institutionally figured out how to operationalize property rights for future generations to global temperatures such that we can work this out in the market. I would be fully on board.

Until then, let's rely on market based solutions rather than wishful thinking about a property rights regime that seems to have no chance of working out in practice. And let's proceed cautiously and emphasize innovation for the reasons that Lomborg and others have laid out.

re: "Because the property rights are not recognized and enforced, pollution appears to be an externality, but that is due to state failure, not market failure."

What do you mean "appears to be"? That's what an externality is. That's the definition of an externality. I don't care whether we call it "market failure" or "government failure" and I prefer we call it neither. It's not a market failure because the whole problem is there is no market allocation. That's a weird thing to blame the market for! It's not a government failure because while the state has a role in property rights, we know that property rights don't come from the state any more than any other right. It's an externality - not a "market failure" or a "government failure". It's unfortunate the term "market failure" is even used as a synonym for "externality", in my opinion.

[McKinney]

Of course Keynes wanted to stimulate investment, but how did he propose to do it? He proposed exorcising businessmen of their animal spirits by confronting them with greater consumption. Otherwise, why would Keynes prescribe increased government spending? Why did he not instead demand that the state give money directly to businesses with the provision that they use it to invest and hire?

Keynes regularly changed his mind and he told his audiences what he thought they wanted to hear. If you try to distill Keynesian economics from the writings of Keynes you will become very confused.

There is no doubt that the current Congress has ratcheted up political uncertainty to FDR levels. However, the auto and housing industries have been hit hardest. Their size in terms of employment make it nearly impossible for other industries to take up the slack any time soon. Auto sales are almost one half their previous high.

Here is a great chart depicting changes in employment by sector:
http://macroblog.typepad.com/macroblog/2011/09/another-cut-at-the-postrecession-job-picture.html

Employment will not recover significantly until housing and auto sales pick up. Housing sales won’t pick up until house prices quit falling. I fail to see how boosting consumer spending will increase auto and house sales. Increasing the money supply will boost the stock and bond markets, and gold, but will do nothing for housing because no one wants to invest in housing right now.

And an increase in the money supply will cause inflation that impoverishes the middle class and makes them less inclined to buy cars, and it impoverishes banks and makes them less inclined to loan

[J Oxman]

Daniel,

Actually, this issue was "figured out" in the 19th century. Institutionally, what happened was government interfered with property rights to the benefit of industry and the detriment of households.

Increasing the state's power will take us farther away from a market-based solution, not closer to one. Unfortunately, the current climate favors more regulation, not less. A tax is not a market-based solution, do you see that? And the cap-and-trade in Europe, which is arguably more market-based, is a fiasco.

I want market based solutions. The only way to do that is through property rights, not dictates from the EPA.

Btw, last I checked, an externality is an example of market failure. But I'll let Mas-Colell catch you up on that.

[Troy Camplin]

The government solutions to global warming cost 40x more than the economic disruptions global warming is supposed to cause (and for which there is less than zero evidence -- from an economic standpoint, there is pretty good evidence that it will open up far more land to farm; from an ecological standpoint, there is good evidence that the earth's natural feedback system will adjust the earth's climate and cool it off if it gets too hot, as it has in the past). As usual, the government solution is anything but. Everyone loves to talk about negative externalities as they relate to the economy, but nobody wants to talk about the overwhelmingly large and numerous government externalities.

[McKinney]

Good points, Troy and JOxman! In addition, don't forget about positive externalities.

Those who have a fetish about negative externalities never talk about positive ones. But a free market creates enormous positive externalities that government action kills.

As always, we need a cost benefit analysis, not just a single minded fixation on negative externalities.

[J Oxman]

McKinney,

Thanks. But I especially appreciate the link you provide in your 1047 posting. I didn't even know the Atlanta Fed maintained a blog! It's excellent.

[Martin]

"The government solutions to global warming cost 40x more than the economic disruptions global warming is supposed to cause (and for which there is less than zero evidence -- from an economic standpoint, there is pretty good evidence that it will open up far more land to farm; from an ecological standpoint, there is good evidence that the earth's natural feedback system will adjust the earth's climate and cool it off if it gets too hot, as it has in the past)."

@Troy

1. The whole reason that you can observe that it happened in the past is that we're here. If it hadn't happened in the past, chances are we would not be here.

2. You're assuming a tendency for the earth's eco-system to settle in a new equilibrium. Fine, but does that equilibrium include us?

3. 40x? What's the price of a blue whale? Aren't prices supposed to be subjective? How do you know what the value of a blue whale is to future generations?

Instead of engaging in a possible destruction of capital on a gargantuan scale, let's step back and see what the alternatives are. One alternative would be replacing income taxation for carbon based taxation. Or are you telling me that carbon based taxation would be more distortionary than income based taxation? Surely not I hope.

[McKinney]

Martin, you forget the medieval warming period when it was as hot as now.

[J Oxman]

Martin also may be interested in David Friedman's excellent post here: http://daviddfriedman.blogspot.com/2011/09/what-is-wrong-with-global-warming.html

[Martin]

@McKinney, what about it?

@J Oxman, thanks. I've read similar arguments before from Lomborg and the like and I am not entirely unsympathetic.

What I do not understand is why we simply do not switch from inefficient taxation of income to carbon taxation (and perhaps later to taxation based on energy consumption)? It can be more inefficient than an income tax. It bears similarity to a consumption tax and the effects of AGW - good or bad - will be diminished.

Also as Friedman said, the earth was not designed for our convenience. We however know that the current environment suits our needs, we do not know about the environment changed due to AGW.

I don't see why we should increase our risk to maintain an inefficient form of taxation, because that's precisely what we're doing.

[McKinney]

Martin, you wrote: "If it hadn't happened in the past, chances are we would not be here."

It has happened in the past and we're still here.

[Troy Camplin]

The calculations are 40x GDP.

Anyone who values blue whales (and I'm fond of them myself) could certainly try to figure out a way to own them, thus solving many of the problems in question. Then the person/people could monitor the whales, determine what is affecting their reproduction, sue people for damages, including damages caused by whaling, etc.

Humans have lived through ice ages and hotter times than this. I'm not worried about us. And last I heard the very definition of evolution was creative destruction. 99.99% of all life that has ever existed on earth is extinct. Things change. Humans are unique in our desire and ability to stop or reverse extinction. We are far less ruthless than the rest of nature.

The earth is not and has never been and will never be in equilibrium. Ever. It's a less valid concept in ecology than it is in economics.

[J Oxman]

Martin,

If your goal is taxation reform, I'm all for it. End income tax!