Mark Thoma discusses the remarkable economic cure-all.

From a full-page ad in the New York Times signed by more than 200 economists, including three Nobel laureates:

More government spending by Hoover and Roosevelt did not pull the United States economy out of the Great Depression in the 1930s. More government spending did not solve Japan’s “lost decade” in the 1990s. As such, it is a triumph of hope over experience to believe that more government spending will help the U.S. today.

If I observe that exercise didn’t by itself solve the weight problems of persons A and B, should I infer that it won’t help C?

Gary Becker poses an interesting question:

There appears to have been a huge conversion of economists toward Keynesian deficit spenders, but the evidence that produced such a “conversion” is not apparent (although maybe most economists were closet Keynesians all along). This is a serious recession, but Romer and Bernstein project a peak unemployment rate without the stimulus of about 9%. The 1981-82 recession had a peak unemployment rate of about 10.5%, but there was no apparent major “conversion” of economists at that time. What is so different about the present recession compared to that one, and to other recessions since then, that would greatly raise the estimated stimulating effects of government spending on various types of goods and services?

There are others better equipped than me to answer this question. But here’s my take:

1. Monetary policy isn’t enough this time.

Most Keynesians would still prefer monetary policy to be the first and main tool for stimulating demand in a recession. And no wonder; it did the trick in the recessions of the early 1980s, 1990s, and 2000s.

The 1981-82 downturn that Becker highlights differed from the ensuing ones, including the current one, in a key respect: the inflation rate in 1981 was 10%. The Fed Chair (Paul Volcker) and a growing number of economists viewed that as the central challenge initially, to be tackled via high interest rates. High unemployment was seen as a sacrifice necessary to wring inflation out of the system. Once that was achieved, monetary easing worked to end the recession.

But the Fed has now gone about as far as it can in lowering interest rates. As one of the apparent “converts,” Martin Feldstein, put it back in October, “With the Fed’s benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand. ” The rate has been reduced further since then, and is now lower than at any point in the three prior recessions.

Also, Japan’s experience in the 1990s offers an empirical instance of drastic reductions in interest rates failing to revive demand effectively.

2. Getting credit flowing again — that is, restoring the normal functioning of the financial system — is critical. But doing so has proved difficult, and it probably won’t suffice in any case.

Despite various efforts by the Treasury Department and the Fed to encourage lending, including infusions of cash to banks, credit remains tight. Scarred by their mistakes of recent years, lenders appear to be very cautious about extending credit. Moreover, the problem isn’t just lack of access to credit; it’s also inadequate demand. This takes us back to fiscal stimulus.

3. Because of the steep drop in household assets due to the collapse of stock and housing prices, the shortfall in demand is likely a good bit larger this time than in other recent recessions. As Joseph Stiglitz puts it, “Americans confronted with debt, shrinking retirement accounts, houses worth less than mortgages, and a tough credit environment will save more of their money than in the past.”

4. None of this, however, answers Becker’s specific question: Why is there enhanced belief that fiscal stimulus will be effective? As best I can tell, most who favor a Keynesian response in fact are uncertain about its impact. The justification is closer to “this is very likely a wise strategy” than to “this will work.”

On the first page of their memo estimating the impact of various stimulus packages, Christina Romer and Jared Bernstein caution that

It should be understood that all of the estimates presented in this memo are subject to significant margins of error. There is the obvious uncertainty that comes from modeling a hypothetical package rather than the final legislation passed by the Congress. But there is the more fundamental uncertainty that comes with any estimate of the effects of a program. Our estimates of economic relationships and rules of thumb are derived from historical experience and so will not apply exactly to any given episode. Furthermore, the uncertainty is surely higher than normal now because the current recession is unusual both in its fundamental causes and its severity.

Mark Thoma is a bit more blunt:

We have very little U.S. historical data for time periods when the economy is in a depression, so … I don’t think we know much at all from the econometric evidence about the success of fiscal policy in deep downturns. We’ll know more in the future because we’ll be able to look back at this one, but for now policymakers are flying pretty blind. What we can examine is the experience of the Great Depression, and when you do, the case for fiscal policy is strong.

Did it work in Japan? Here’s Paul Krugman in the new edition of The Return of Depression Economics:

Some readers may object that providing a fiscal stimulus through public works spending is what Japan did in the 1990s — and it is. Even in Japan, however, public spending probably prevented a weak economy from plunging into an actual depression. There are, moreover, reasons to believe that stimulus through public spending would work better in the United States, if done promptly, than it did in Japan. For one thing, we aren’t yet stuck in the trap of deflationary expectations that Japan fell into after years of insufficiently forceful policies. And Japan waited far too long to recapitalize its banking system, a mistake we hopefully won’t repeat.

This touches on a final point: Why do many who advocate fiscal stimulus favor one that is immediate and large? Our experience in the 1930s and Japan’s in the 1990s suggest that moderate and sporadic stimulus efforts are unlikely to be sufficient in the case of a deep downturn. The Depression and Japan’s “lost decade” also teach that if early stimulus efforts are too modest, they create a political trap: concern about the government debt produced by the earlier stimulus packages grows, which heightens opposition to further stimulus.

In the newly-revised edition of his book The Return of Depression Economics, Paul Krugman writes that

The quintessential economic sentence is supposed to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch … because there are unemployed resources that could be put to work.

Is there a Keynesian free lunch with respect to government revenues? The idea is that heavy government expenditures and/or large temporary tax cuts will increase demand and thereby invigorate the economy. This will produce larger tax revenues several years down the road than would otherwise have been the case, helping to offset the deficits incurred now.

This seems plausible. But it sounds suspiciously similar to the claim made by “supply-side economics” advocates: a reduction in tax rates will increase investment and hence growth and thus government revenues, offsetting the short-run loss in revenues due to the tax cut. If you don’t buy the supply-side free lunch claim, and relatively few serious analysts do these days, why should you believe its Keynesian counterpart?

One distinction lies in the hypothesized magnitude of the effect. The Keynesian version I’ve seen suggests that a large government deficit will be partially recouped by the resultant spur to economic growth, whereas the supply-side claim tended to be that the revenue loss from a tax cut would be fully or more-than-fully offset.

Another difference lies in attention to context. If the current tax rate is high enough that it really does impede investment, the supply-side free lunch exists: reducing the tax rate will yield little or no loss in government revenues. Put another way, the so-called “Laffer curve” is a reasonable depiction of reality. But its proper application requires asking where the current tax rate lies on the curve — whether, in other words, the current tax rate actually is impeding investment. Few supply-siders bothered to take this question seriously, and the notion became a blanket rationale for continued tax cuts. The experience of the past several decades has not been kind to the claim (see here and here).

As best I can tell, few contemporary believers in a Keynesian free lunch view it as context-independent. The hypothesis is that in conditions of a significant shortfall in demand and limited potential for further help from monetary policy, such as our present situation, an increase in the current government deficit is likely to stimulate enough growth to partly offset the cost.

The last sentence of this paragraph from Todd Moss’ book African Development caught me off guard.

Sometimes called “Africa’s World War,” the recent central African conflict has been fought mainly in the eastern parts of the Democratic Republic of Congo (DRC, formerly Zaire), but has directly involved at least seven countries and dozens of various militias. The war was initially sparked by civil war in Rwanda in 1994, when the Rwandan Patriotic Front (RPF) chased the genocidal Interahamwe militia into then Zaire. Once the RPF had regained control of Rwanda and Zaire’s Mobutu was seen as protecting the Interahamwe, Rwanda launched an invasion, backed by Uganda and various Congolese factions opposed to Mobutu. The longtime Zairian leader was weak and increasingly isolated, and the Rwandan-backed rebels marched all the way to Kinshasa, deposing him in May 1997. Rwanda then set up a buffer zone along the border and continued to pursue the Interahamwe. But Rwanda fell out with the new Congolese president, Laurent Kabila, and relaunched the war in 1998. This time, Kabila was able to get help as Angola, Namibia, and Zimbabwe sent troops and halted the Rwandan and rebel advance. A stalemate ensued with the country carved up among multiple foreign armies and factions. Meanwhile, Rwanda and Uganda began to attack each other inside DRC, presumably fighting over spoils. In 2002 a nominal peace process got under way, allowing gradual withdrawal of the foreign armies and attempting to build a sustainable political situation in DRC. Estimates of the overall death toll from this war are 3-4 million, mostly Congolese civilians.

I hadn’t realized the death toll was that high. Another estimate puts it at 5.4 million. The DRC’s population is a little over 60 million.

For some perspective, here is the number of American deaths (both combat and noncombat) in our country’s major wars:

Revolutionary War: 25,000

Civil War: 625,000

World War I: 117,000

World War II: 405,000

Korea: 37,000

Vietnam: 58,000

Iraq: 4,000

Total deaths in the two world wars are estimated at 15-20 million and 50-70 million, respectively.

A month ago it looked to me that Chelsea were the class of Europe, though I hadn’t (and still haven’t) seen Barcelona play.

Now, not so much. This assessment seems about right.

Ruy Teixeira reports on a recent survey which finds majority support for cutting poverty in half, even if doing so requires higher taxes on the wealthy and new government spending.

In Outliers, Malcolm Gladwell relates a series of stories — about Canadian hockey players, Bill Gates, the Beatles, Jewish lawyers, Chinese schoolchildren, and others — which reveal that

It is not the brightest who succeed… Nor is success simply the sum of the decisions and efforts we make on our own behalf. It is, rather, a gift. Outliers are those who have been given opportunities — and who have had the strength and presence of mind to seize them. (p. 267)

It’s a good book. We should be wary of generalizing, as Gladwell does, from a small sample of cherry-picked cases. (Imagine the outcry from progressives at a book written by someone like Charles Murray that relied on this type of evidence.) Yet Gladwell’s stories are nevertheless compelling, and the details nicely illustrate what large, representative samples can’t.

My chief complaint about Outliers concerns Gladwell’s choice to frame his key causal factor as opportunity rather than luck. This leads to some odd interpretations and policy recommendations.

Consider Joe Flom, an attorney whose story is recounted in chapter 5. Because he is Jewish, Flom is denied jobs at the top corporate law firms in New York City in the 1940s, despite his top-flight educational credentials and evident ability. He joins a small start-up firm and focuses on hostile takeovers. At the time such takeovers were rare, so this wasn’t an especially lucrative line of business. But decades of practice puts Flom and his firm in perfect position to benefit when hostile takeovers become common in the 1980s, and he ends up rich and famous. Is it best to think of the discrimination Flom encountered as an “opportunity”? Or would we do better to label it (initially bad, then good) “luck”?

Gladwell’s main recommendation is that we as a society extend to everyone the thing that so benefited his success stories. He calls it opportunity. But he suggests that the key for Bill Gates was being at a junior high school that before almost any other had a computer terminal hooked up to a mainframe, living close to a university that provided him free access to a computer system, and having parents who allowed him (or didn’t notice) to sneak out in the middle of the night to use that university computer. For the Beatles it was getting invited, as teenagers, to play long sets for weeks at a stretch at a strip club in Germany. Can these types of “opportunities” be made widely available? Of course not. Their benefits couldn’t possibly be foreseen by a social planner, and in any event they aren’t replicable on a large scale.

At various points in the book Gladwell emphasizes the importance of parents’ traits, attitudes, and behaviors in contributing to success. This plays a central role in the story of Chris Langan, a genius who was raised in circumstances that stifled his capacity to later take advantage of his mental ability. How do we extend to more children the opportunity to experience good parenting? That’s a tall order in a society committed to limited interference in family affairs. As I see it, the only viable strategy here would be to take parenting out of the hands of parents to a greater extent. I don’t mean by force, of course. But if child care and preschool were available at sufficiently good quality and low cost, many less-than-stellar parents might be induced to utilize it. Interestingly, Denmark and Sweden have been engaged in an experiment along these lines since the 1970s, when their governments began providing extensive funding for early education. We have only limited study of the effects, though, and even in these circumstances parents’ impact is likely to be significant.

I’m fully in favor of expanding opportunity. But the real message of Gladwell’s book is that individual success tends to be heavily influenced by luck. That, in my view, should encourage us to think not only about how to increase opportunity, but also about whether a bit more redistribution from the lucky to the less fortunate would be just.

My two favorite dailies, the New York Times and the Financial Times, offer divergent takes today on prospects for the Obama administration’s proposed economic stimulus package.

According to the NYT,

To a degree that would have been unimaginable two years ago, economists and politicians from across the political spectrum have put aside calls for fiscal restraint and decided that Congress should spend whatever it takes to rescue the economy.

But with the Congressional Budget Office projecting a federal budget deficit of 8% of GDP in 2009, the FT suggests

The president-elect … will now find it harder to achieve broad bipartisan support for the package. In addition to rising Republican concerns about the size of the stimulus, which has not been factored into the CBO’s 2009 fiscal deficit projection, fiscally conservative “blue dog Democrats” are now more likely to drag their feet on the measure.

In an earlier post I showed a chart that attempted to convey the limited progressivity of the American tax system when not only federal taxes but also state and local ones are taken into account. Here are two additional charts. They’re based on my calculations from data for 2004 in a Tax Foundation report (tables 3 and 4 and figure 1) by Andrew Chamberlain and Gerald Prante.

These charts show effective tax rates for each of the five quintiles of households. The effective tax rate is calculated as taxes paid divided by income. For instance, to get the effective rate for the bottom quintile, I divide the average amount paid in taxes by households in that quintile by the average income of those households.

It turns out that whether taxes are progressive depends on how income is defined.

As the first chart shows, if income is measured as market income — income from employment, investments, and a few other sources, but not including government transfers — the tax system is essentially flat. The effective tax rate is approximately 30% for households throughout the income distribution. This may hide some progressivity, since the effective rate may be higher in the top portion of the top quintile, but we can’t be sure because the Tax Foundation data don’t separate out the top 1% or 0.1% of households.

Adding government transfers (as the Congressional Budget Office does in its calculations of federal tax progressivity) increases the average income in each quintile, but much more for the bottom than for the middle or top. This reduces the effective tax rate more in the lower part of the distribution than the upper, resulting in a progressive structure.

What should we conclude? I think the first chart here better reflects the impact of the U.S. tax system. It does very little to alter the market distribution of income. Redistribution is achieved mainly by government transfers rather than by taxes. We aren’t unusual in this respect, though; it’s the case in most if not all rich countries.

President-elect Obama reportedly has decided to wait on raising the federal income tax rate for the highest-income Americans. The Bush tax cuts are scheduled to expire two years from now, at the end of 2010, at which time the top marginal rate will shift from its current level of 35% back to its pre-Bush level of 39.6%. Rather than raise the top rate immediately, the Obama administration plans to allow the tax change to occur as currently scheduled.

I’m puzzled by this choice.

Public sentiment surely is not an obstacle to increasing the top rate right away. And economic considerations favor doing so. It’s unlikely to delay economic recovery by reducing consumer spending, since most of those affected will still have sufficient income to be able to spend as much as they desire. The tax-rate increase is small enough that it should have little or no adverse impact on investment; when the rate was 39.6% in the late 1990s, investment didn’t suffer. And the added tax revenues could be used either to boost the size of the stimulus package or to reduce its impact on the federal deficit.

My guess is that political considerations have won out. The calculation must be that this compromise will improve the odds of Obama’s stimulus package getting through Congress quickly. If this calculation is correct, I would go along. The stimulus is surely needed to help get the economy moving again, and the health of the economy is likely to have a bigger impact on the living standards of ordinary Americans over the next few years than anything else. The stimulus package also includes some tax changes that will directly benefit low- and middle-income households.

Yet it seems to me it would have been more useful to hold onto the timing of the top-end tax rate increase as something to compromise on if necessary, rather than give it up at the outset.

Stephen Dubner has a post on the “Freakonomics” blog titled “The next time someone tells you that taxes are not progressive…” He relays information from a new Congressional Budget Office (CBO) report, via Greg Mankiw, which lists effective federal tax rates for households at various points in the income distribution. The rates are higher for those with larger incomes. The implication is that our tax system is quite progressive.

But it doesn’t make much sense to look only at federal taxes. State and local taxes account for about a third of total tax revenues, and they tend to be less progressive than federal taxes.

If we take into account all taxes — federal, state, and local — the effective tax rate for the well-to-do is only a bit higher than for the poor. Here is one way to see this, based on data from the CBO and the Tax Foundation.

Robert H. Frank says no. A wiser approach, he suggests, is to raise tax rates on the highest earners.

I agree. The motivation for limiting executive compensation is understandable. But the logistics of a true cap are problematic, and the merit of singling out executives as opposed to entertainers, athletes, and non-executive financial high-rollers is questionable.

“I acknowledge the electoral commissioner’s declaration and congratulate Professor Mills.” These words are from Nana Akufo-Addo, who, according to the New York Times, has lost a run-off election for the presidency of Ghana by a very narrow margin. His acceptance of defeat may help Ghana avoid the type of violence produced by disputed election results in Zimbabwe, Kenya, and a variety of other countries in recent years.

There are, of course, circumstances in which the declared result is not fair and protest is justified. But nothing is more important to democracy than the normalization of peaceful transfer of power (Akufo-Addo’s party has held the presidency the past eight years). Here’s hoping this type of statement will be uttered many more times this year and into the future.

Update: Similar sentiment from Chris Blattman and Todd Moss.

In a 1980 article, Adam Przeworski tried to estimate the likely costs to workers in rich capitalist nations of a transition to socialism. He concluded that they were sizable enough to be a serious deterrent to socialist preferences.

History turned in the opposite direction: less than a decade later eastern Europe began its transition to capitalism. In The Economist‘s 2008 year-end special issue, Laza Kekic offers a two-decades-on estimate of the costs of that transition.