"Misapplying the theory I mislearned in college."

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Economism and Health Care

Fri, 01/20/2017 - 11:49

By James Kwak

A core feature of competitive markets, according to the basic model, is that they allocate goods to the people or companies that are willing to pay the most for them. In theory, and in many situations, this is a good thing: If I am willing to pay $1,000 for a custom portrait of my (daughter’s) dog, and you are only willing to pay $1 for it, then aggregate satisfaction is likely to be higher if I get the portrait. But not always: If I am willing to pay $10 for a turkey sandwich, but you are only willing to pay $1 because you only have $1, and have no borrowing capacity, then society may very well be better off if you get the sandwich. Yet in an ordinary, healthy market, I get the sandwich.

This problem is acutely apparent when it comes to health care. People place a high value on not dying, but when it comes to the allocation of medical treatment, they can’t bid more than their income allows. The obvious result is that markets deliver unnecessary procedures to rich people while denying essential care to poor people—because that’s what markets do. Obamacare attempted (with mixed success) to mitigate this problem. The Trump administration is rhetorically committed to deregulating health insurance; the question is whether they are willing to accept the political consequences of pricing millions of people out of not dying.

This is the topic of my new guest post, “Health Care and John D. Rockefeller’s Dog,” on Econbrowser (a fabulous economics blog, by the way, written by Menzie Chinn and James Hamilton). For more, head on over there.

Conflicts and Corruption

Thu, 01/12/2017 - 11:28

By James Kwak

To be clear, the idea that Donald Trump will be president while he or his children effectively own a company that does business all over the world is preposterous. (Quick primer on trust law: A trust is managed its trustees for the benefit of its beneficiaries. In this case, we know the trustees include two of Trump’s children, and the beneficiary is likely to be either Trump or his children.) If people, companies, and foreign governments want to pay bribes to the president of the United States, they need only give favorable deals to the Trump Organization. An in any of his official actions, the president will have the temptation to do what’s right for his company, not for the country.

The point I wanted to make in my Atlantic column today, however, is that this is just the most obvious and egregious example of the larger problem of corruption: government officials acting in the interests of themselves, their family and friends, or their business associates. The example I focus on is estate tax repeal, because that one thing alone would be worth more than $1 billion to the Trump family. It’s a classic example of a president doing what’s in his own personal interests and the interests of his core constituency of gazillionaires, while pretending it’s for the good of the country.

Betsy DeVos is another great example, perfectly illustrated by this graphic from the AFL-CIO:

The way American politics works is that people and organizations with money—today, largely billionaire families—invest in politicians and demand policies that favor their private interests. Donald Trump just eliminated the middlemen—not only winning the presidency, but also inviting fellow billionaires like DeVos into his cabinet. This is why, beyond the ongoing catastrophe that is the Trump presidency (which technically hasn’t even started yet), we still need to fix our democracy, so everyone has an equal say in our government.

For more, see the full article in The Atlantic.

Economism Typo Contest

Tue, 01/10/2017 - 07:56

By James Kwak

Today, you may be getting your copy of Economism: Bad Economics and the Rise of Inequality in the mail. Or you may even be able to buy it in a bookstore. But before you crack it open, I want to tell you something.

I hate typos.

I try to read each of my book manuscripts carefully before submitting them. I hire my own line editor to go through my writing for grammatical and stylistic errors. The publisher then does a copy edit. When I get the “galleys” back from the publisher, I hire my own proofreaders to scour them again for mistakes. But inevitably typos sneak into the published books. Here’s one from 13 Bankers:

(That should be “economic policy,” in case you’re wondering.)

Furthermore, I am almost incapable of reading anything that I’ve written before. It’s just too boring when you already know what the next sentence is going to say; at best I can skim. So it’s very hard for me to catch mistakes in anything that I’ve published. Out of sympathy to my fellow writers, I often circle typos when I find them in books that I am reading. Sometimes I even email the author out of the blue with a list of mistakes, if there is still time to fix them in the paperback version.

So, before you start reading, I’d like you to know about the Economism Typo Contest. If you are the first person to find and tell me about a mistake, I will send you a limited edition, spiral-bound, 5×8 notebook with the jacket cover of Economism on the front (signed on the inside if you like). Or, if you prefer, I will pay you ten dollars in cash money.

The detailed rules and instructions for submitting mistakes are over at the version of this post over at Medium.

Thanks for your help.

Economism and the Future of the Democratic Party

Mon, 01/09/2017 - 17:33

By James Kwak

I haven’t written much about the election itself (except to point out that the same data can be interpreted in diametrically opposing ways). That’s because the election was so close that the fact that Clinton lost can be explained by any number of but-for causes, and much of the Democratic Internet has been a cacophony of people insisting that their preferred cause (Comey, Russian hacking, not enough attention to African-Americans, too much attention to minorities, not enough attention to the white working class, too much emphasis on Trump’s personality, etc.) was the One True Cause.

I do think, however, that if Democrats (a group in which include myself) want to return to power and change the overall political dynamics of this country, one thing we need to recognize is that Republicans have been crushing us on the economic messaging front for decades. We have adapted by becoming Republicans Lite—no longer the party of jobs and the working person, but now the party of minimally intrusive market regulation, technocratic expertise, and free trade agreements.

This is the subject of my article in Literary Hub today, “The Failure of Democratic Storytelling.” Now that Democrats are out of power virtually across the board, we have the opportunity to develop a new vision, without having to compromise with Joe Manchin, Arlen Spector, and Susan Collins to squeak legislation through Congress. The question is what we make of that opportunity.

A Change Is in the Air

Fri, 12/30/2016 - 15:35

By James Kwak

There was one moment, when I was finishing up the manuscript of Economism, that I thought someone had already said what I was trying to say in the book. This is what I read:

“The beauty and the simplicity of such a theory are so great that it is easy to forget that it follows not from the actual facts, but from an incomplete hypothesis introduced for the sake of simplicity. … The conclusion that individuals acting independently for their own advantage will produce the greatest aggregate of wealth, depends on a variety of unreal assumptions …

“Individualism and laissez-faire could not, in spite of their deep roots in the political and moral philosophies of the late eighteenth and early nineteenth centuries, have secured their lasting hold over the conduct of public affairs, if it had not been for their conformity with the needs and wishes of the business world of the day. …

“These many elements have contributed to the current intellectual bias, the mental make-up, the orthodoxy of the day.”

That’s from the third section of “The End of Laissez-Faire,” the published version of a lecture delivered by John Maynard Keynes in 1924 and 1926.

Photo from Wikimedia Commons (CC BY-SA 3.0)

Keynes’s argument goes something like this:

  • Beginning in the late eighteenth century, economic theory extended the political philosophy of democratic individualism (epitomized by John Locke), providing a supposedly scientific basis for “the idea of a divine harmony between private advantage and the public good.”
  • That idea in its simple form, however, was not a correct statement of what leading economists actually believed. Instead, it was the work of “the popularisers and the vulgarisers”: “the dogma had got hold of the educational machine; it had become a copybook maxim.”
  • Economists themselves understand that the world is considerably more complicated. However, “many of those who recognise that the simplified hypothesis does not accurately correspond to fact conclude nevertheless that it does represent what is ‘natural’ and therefore ideal.”
  • The ubiquity of laissez-faire ideas is ultimately due to the interests that it serves: the business world. “To suggest social action for the public good to the City of London is like discussing the Origin of Species with a Bishop sixty years ago. The first reaction is not intellectual, but moral. An orthodoxy is in question, and the more persuasive the arguments the graver the offence.”

Although Keynes was writing in the 1920s, this also describes of the state of the intellectual and political world over the past few decades. The idea that market forces necessarily produce optimal outcomes, and that government should generally stay out of the way, has dominated public policy discourse since the late 1970s. This is obvious for Republicans, but consider also the deregulatory policies of Jimmy Carter, Bill Clinton proclaiming that “the era of big government is over,” the end to “welfare as we know it,” bipartisan financial deregulation, and Obamacare’s reliance on markets—indeed, the current Democratic orthodoxy that government should simply identify and correct for discrete market failures.

It is also widely claimed that the universal superiority of competitive markets is some fundamental law of economics—that the minimum wage necessarily increases unemployment (because it is a price floor), or that taxes on investment income necessarily reduce savings and investment (because they reduce the returns to saving). Yet, just as in the 1920s, few economists actually believe in such immutable laws, although some do think of them as some Platonic ideal for how the economy should behave. What happened is that a handful of simple economic concepts was picked up, vulgarized, and popularized by a network of foundations, think tanks, and media outlets. A few prominent economists played important roles in this process—notably Friedrich Hayek in The Road to Serfdom and Milton Friedman in Capitalism and Freedom and Free to Choose—but their ultimate influence depended on the reach of organizations such as the American Enterprise Institute, Heritage, and the op-ed page of The Wall Street Journal.

To take one example of how this works, consider the tens of millions of dollars that large company CEOs make, or the hundreds of millions of dollars that hedge fund and private equity fund managers take home. According to a simple Economics 101 model of the labor market, everyone’s compensation is exactly equal to her marginal product—the value of the work she does for her employer—and therefore those huge pay packages are both fair and necessary (or otherwise business superstars would choose to do something else with their time). Yet, as the Economist reminds us, academic economists have known for nearly half a century that information asymmetries undermine the textbook functioning of labor markets. (For a longer discussion of this topic, see chapter 4 of Economism).

The idea that pay equals marginal product is not economic truth, but ideology. Like any powerful ideology, it makes the interests of a class seem conterminous with the interests of society as a whole. As Marx wrote in The German Ideology, each ruling class “has to give its ideas the form of universality, and represent them as the only rational, universally valid ones.”

So when Ray Dalio says, “Society rewards those who give it what it wants. That is why how much people have earned is a rough measure of how much they gave society what it wanted,” he’s not speaking as someone who knows anything about economics. He’s speaking as a member of the ruling class—a billionaire hedge fund manager (and now Donald Trump cheerleader). If you’re a billionaire, it’s nice to think that your wealth simply reflects your contributions to society. It’s also useful for other people to think so, so they don’t raise your taxes. But that doesn’t make it true.

In the 1920s, Keynes thought the dominance of the laissez-faire ideology was coming to an end. “We do not even dance yet to a new tune,” he wrote. “But a change is in the air.” He was right. Increasing dissatisfaction with the unregulated capitalist system helped produce fascism in Germany and Italy and a much greater degree of government intervention in the United States, the United Kingdom, and France.

Could the same be true today? It is undeniable that the rapidly widening gap between the very rich and the middle class has undermined popular support for the economic status quo. Throughout the advanced, post-industrial democracies, there seems to be a brewing revolt against technocratic elites who appear insensitive to the plight of ordinary working people. In the United States, the Bernie Sanders insurgency demonstrated the tenuous hold of the Clinton-Obama-Hamilton Project-Center for American Progress coalition over the Democratic Party, while Donald Trump overthrew the Republican establishment.

While Trump has his own fascist, racist, and sexist tendencies, however, most of his actual policy proposals come straight out of the conservative playbook. This is not surprising, given that he is (probably) a billionaire, his most important backers are billionaires, and he shows few signs of intellectual curiosity, originality, or honesty. So in the short term, we are going to see four more years of economism triumphant—less regulation of businesses, particularly banks; lower taxes for corporations and the very rich; and a return of the bad old pre-Obamacare days, when people without employer health plans had to fend for themselves in an unregulated individual market. One thing we can be sure of is that a Trump presidency will do nothing to solve the economic problems facing the poor and the middle class, or narrow the widening gap between them and the 1%.

At the end of his essay, Keynes wrote:

“For the most part, I think that Capitalism, wisely managed, can probably be made more efficient for attaining economic ends than any alternative system yet in sight, but that in itself it is in many ways extremely objectionable. Our problem is to work out a social organisation which shall be as efficient as possible without offending our notions of a satisfactory way of life.”

That remains our challenge today. If we cannot solve it, the election of 2016 may turn out to be a harbinger of worse things to come.

The Curse of Credentialism

Mon, 12/26/2016 - 07:30

By James Kwak

I just finished reading J. D. Vance’s memoir, Hillbilly Elegy. I don’t feel like adding to the torrent of instanalysis of the “white working class,” however, so I’ll just comment on the description of Yale Law School—which, in the book, serves the dramatic function of introducing the author to the Elite.

Photo by Shmitra at the English language Wikipedia (CC BY-SA 3.0)

There are a few details that seem unfamiliar to me—I can’t recall attending a single one of the “cocktail receptions and banquets” that Vance describes as the school’s social rituals—but then again I was thirty-nine and married with a child when I started law school. But there is one thing that Vance nails: the culture of credentialism.

Yale Law School is undeniably an elite institution, the undisputed number one school in a field that is intensely (and toxically) hierarchical. Also, because it is a law school—as opposed to other elite institutions such as West Point or the UConn women’s basketball team—it is filled with people who have never had any idea of what they wanted to do other than be successful and gain access to the best opportunities out there.

One of the curious things about Yale is that it is impossible to compete over grades; the first semester is pass/fail, and for reasons not worth going into the grading scheme is essentially meaningless after that point. I thought this was wonderful, but I’m sure at least some of my classmates experienced it as a disappointment. So what do you do if you’ve spent your life trying to prove that you’re smarter than other people? Some people use their newfound freedom to do truly great things: the Iraqi Refugee Assistance Project (now International Refugee Assistance Project), for example, was founded by a few students in the class before me. Many others pour themselves into clinics that make a huge difference in people’s lives. (The challenge to the Connecticut public school system that recently won in the trial court began in a Yale clinic.) I wrote a book.

But a common reaction is to find other things compete over. And, as Vance describes, the two primary candidates are membership of the Yale Law Journal and post-graduation federal court clerkships (which is a competition that goes on and on, because it takes at least a second, and often a third year of clerking to make it to the Supreme Court). The institutional culture communicates that the most prestigious distinctions are Journal membership and federal clerkships (I’m simplifying slightly, but that’s pretty close). As Vance writes:

“No one seemed to know what value the credential actually held. We were told that the Journal was a huge career boost but that it wasn’t that important, that we shouldn’t stress about it but that it was a prerequisite for certain types of jobs.”

This is like a mind-altering drug for those twenty-somethings whose modus operandi is to accumulate badges of excellence that will open as many doors as possible. Most students come to law school with little interest in 35,000-word legal theory articles (and no interest in editing and cite-checking those articles, which is mainly what law review editors do), yet come springtime they become intensely interested in the pathologically stupid citation formatting, or “Bluebooking” test (what Vance calls “the  most important test of our first year”) that represents the first step toward Journal membership.

The same goes for clerkships. I should point out that my friends who did clerkships—doing research and writing for a judge—generally thought they were a good experience (as opposed to the Journal). But that’s not why most Yale law students want them, at least not at first. It’s because they are the closest thing to graduating with honors, given that Yale doesn’t give honors at graduation. And because there are hierarchies among clerkships—appellate courts beat district courts, and within each level famous judges beat less-famous judges—a clerkship is the closest thing you can get to class rank at a school that has no class rank (or GPA, for that matter). Vance admits trying to get a clerkship with a “high-powered federal judge with deep connections to multiple Supreme Court justices” until his primary recommender—you have to have one of these to get a top-shelf clerkship, so the intermediate thing people compete for is relationships with well-connected professors—pointed out that he was doing it solely for the credential. He pulled out and got a less-prestigious clerkship where he could be close to his girlfriend. Good for him.

As you may have guessed, I didn’t apply to the Journal or to any judges. But that was because I had a family, and I didn’t want to spend any more evenings away from them to do cite checking. I also had a career and enough accomplishments behind me that I was emotionally secure enough not to pursue credentials for their own sake. But if I had been single and in my twenties, I’m sure I would have played the game. That’s what our educational system teaches smart young people: that there are universal, objective markers of achievement and ability, and that’s what you’re supposed to get.

At the end of my first year, I wrote an email to the school’s mailing list proposing that the Journal simply be opened to everyone. My basic point was that the Journal competition was an unnecessary zero-sum contest that existed solely for the purpose of having a something to compete over. If I recall correctly, the public email responses were in favor by a large margin. But the Journal gets to make its own rules, so nothing changed.

As things go, whether Yale Law School 1Ls waste dozens of hours immersing themselves in the stupidest citation system known to man  (“the acme of absurdity in legal expression,” says Judge Richard Posner in Divergent Paths*) is decidedly trivial. But the broader problem of credentialism is real. For one thing, the pursuit of brass rings because they are shiny creates unnecessary stress and unhappiness. More generally, when you give out prizes based on idiosyncratic criteria, ambitious people adjust their behavior to excel at those criteria—which may not be particularly valuable in the real world.

Then there’s the cost to society. A world in which success means Rhodes/Teach for America/Goldman/McKinsey followed by Yale Law School/Harvard Business School followed by Blackstone/Bridgewater/Facebook is one in which too many talented, well-intentioned people follow the same path and end up doing the same few things. (Since I graduated from college a quarter-century ago, the only real additions to the hierarchy have been TFA and the technology behemoths.) In their famous paper, Kevin Murphy, Andrei Shleifer, and Robert Vishny found that countries with more engineering majors tend to grow faster and those with more law students tend to grow slower. A society in which smart, hard-working young people with generic ambitions tend to become hedge fund and private equity fund managers, management consultants, corporate lawyers, and strategists for technology monopolies is probably not one that is allocating talent effectively.

The reasons for credentialism go beyond any easy cure. One is the innate (personal) conservatism of people who play by the rules and excel at school. One is the high degree of inequality in contemporary society, which inflates the costs of not landing at the top end of the income distribution. One is the homogenization of culture, which means that most smart young people in the United States grow up in the same informational environment, evaluating the same set of options. Finally, for the most part, credentialism is individually rational: it’s “work for Goldman now, save the world later.” But after too many years in that environment, people come to believe that working for Goldman is saving the world (I believe the phrase is “doing God’s work“). And that’s where credentialism can lead you.

* Posner is just getting started: “The law review editors who enforce its mindless dictates are pod people. Its relentless growth threatens to lobotomize the legal profession.”

Larry Kudlow and Economics in the Trump Administration

Fri, 12/23/2016 - 11:19

By James Kwak

Noah Smith (along with a fair section of the Internet) has some concerns about Larry Kudlow as chair of the Council of Economic Advisers: he’s overconfident, too much of a partisan, and fixated on nonexistent problems (e.g., inflation). I’m not so worried that he’s on Team Republican; after all, Donald Trump gets to pick the advisers he wants, and they shouldn’t be rejected solely because they take political sides. But I am worried about what Kudlow’s appointment means for the relationship between economics and policy.

The world is a complicated place. Anyone who studies society in depth should learn to have respect for that fact. At any given moment, we have only a hazy understanding of what combinations of transitory phenomena and underlying structural factors produce what outcomes. (For Exhibit A, see the election that took place on November 8.) This tweet at the beginning of Game 7 of the Cubs-Indians World Series, channeling the great French historian Fernand Braudel, is one of my all-time favorites:

Buck: Will we see history tonight?
Smoltz: Yes!
Braudel: No man can see history. This is the foam. The current of history is beyond our ken.

— Old Hoss Radbourn (@OldHossRadbourn) November 3, 2016

Contemporary research economists have become incredibly sensitive to the difficulties of explanation. The papers that get the most attention—like Chetty et al. on intergenerational mobility, or Autor-Dorn-Hanson on the impact of Chinese imports on labor markets—are no longer purely theoretical. Instead, they analyze large datasets, often compiled with tremendous amounts of effort, to try to tease out the relationships between different variables. Any empirical paper in a good journal will discuss which way the causal arrows points and include multiple robustness checks to try to ensure that the results are not the product of outlier observations or an idiosyncratic specification. Good economists know that the answer to most questions is: It depends.

This is one of the important contributions that economics can make to public policy: the understanding that the world is complicated, and the dedication to uncovering rather than masking that complexity. In a presidential administration, you would expect this perspective to come from the Council of Economic Advisers. The treasury secretary is a public spokesperson, a diplomat, and the manager of a huge organization; the director of the National Economic Council is a policymaking coordinator; and the director of OMB is a budget planner.

I don’t particularly care that Larry Kudlow doesn’t have a Ph.D. in economics. Paul Volcker didn’t have one either (as far as I can tell), and few Democrats would have seriously objected to him as chair of the CEA. What concerns me is that he has been working as an economist for decades—that is, he makes money by thinking and talking about economic issues—yet his conception of the discipline seems limited to the simple, theoretical relationships of Economics 101.

Most of Kudlow’s thinking about economic issues appears to boil down to three ideas. The first is that tax cuts increase economic growth—a mantra that conservatives have repeated for decades, yet is not supported by reviews of existing research. The second is that expanding the money supply will necessarily generate high inflation, on which basis Kudlow predicted a “major inflationary plunge” just as the Great Recession was beginning. The third is that an expensive currency—what politicians call a “strong dollar,” but Kudlow calls “King Dollar” (with the capitals)—is good for the economy.

The first two ideas are things you would expect to hear from a first-semester college freshman (like Jeb Hensarling in his Texas A&M days). They make sense on a two-dimensional diagram, but they are at best distant approximations of how the world works. The third—King Dollar—is just weird. The value of a currency is the outcome of various factors, such as interest rates, and it doesn’t make sense to think of that outcome in isolation from the things you would need to do to produce that outcome.

Studying economics is a process of indoctrination and then de-indoctrination. First you learn that competitive markets produce optimal outcomes; then you learn that this is only true in rare circumstances, that real markets are imperfect in a myriad of ways, and that in any case perfect market outcomes are not necessarily optimal in any meaningful sense. Larry Kudlow, whether naively or disingenuously, still seems to be stuck on Economics 101. That’s the essence of what I call economism, the subject of my new book: a worldview that assumes that society operates according to a small set of fundamental principles, and that public policy can be shaped on that assumption.

With Kudlow as chair of the CEA, Donald Trump is giving up even the pretense of trying to understand economic reality, instead doubling down on a handful of abstract slogans that have little to do with our current challenges. That’s hardly surprising, given that Trump is basically just an extreme caricature of contemporary conservatism, but that doesn’t make it any less concerning.

How Not to Invest

Wed, 12/21/2016 - 07:30

By James Kwak

Forty years after John Bogle launched the Vanguard 500 Index Fund, passive investment funds now account for about one-third of the mutual fund and ETF market. You would think this would pose a threat to traditional asset managers that charge hefty fees for actively managed mutual funds, and this is true in part. On average, index funds charge 73 basis points less than active funds, and the average expense ratios for actively managed funds have fallen from 106 bp to 84 bp over the past fifteen years (Investment Company Institute, 2016 Investment Company Fact Book, Figure 5.6).

The asset management industry, however, has been quite adept at defending its traditional share of investors’ assets. One response has simply been to go along with the index-fund wave—without lowering fees to reflect the considerably lower expenses of using simple algorithms instead of humans.

In the Wall Street Journal, Micah Hauptman summarized a recent paper by Michael Cooper, Michael Halling, and Wenhao Yang on mutual fund fees. They find, as did previous research, tremendous differences in prices for S&P 500 index funds. The variation between the fees charged for these virtually identical products has actually increased since it was first measured in 2004; in recent years, the difference between the 10th percentile and 90th percentile S&P index funds (by expense ratio) has been a staggering 116 basis points. That means there are people paying well over one percentage point of assets per year for a product that only costs 16 bp at Vanguard (5 bp for a minimum investment of just $10,000). Furthermore, Cooper, Halling, and Yang analyze variation in prices across all U.S. stock mutual funds, in part by identifying funds with similar holdings. Again, they find large price discrepancies that cannot be explained by fundamental fund characteristics.

For an investor, the lesson is very simple: If you are paying more than 16 bp for an S&P index fund (5 bp if you have more than $10,000 in the fund), you should get out and buy a cheaper one instead, unless you’re locked in because of large, unrealized capital gains.

For society as a whole, however, there is a more interesting takeaway. According to very basic economic theory—the kind you get early in your first year—this type of price dispersion cannot occur. It’s as if oil were selling for $16 per barrel in one place and $132 per barrel in another place. Now, that can happen with oil if, say, there’s an embargo or a blockade going on. But the market for U.S. stock mutual funds and ETFs is supposed to be highly transparent and liquid; it usually only takes few minutes and a computer to sell one and buy another. Wide variation among prices for identical products with minimal search and transaction costs is proof that the simple story taught in Economics 101—prices for identical products must converge because buyers will only buy the cheap ones—is sorely incomplete. Something else is going on, and therefore we cannot count on markets to protect investors. (For example, one thing that could be going on is retirement plan administrators only offering expensive index funds to captive plan participants.)

Yet that faith in markets is endemic in large parts of our political and legal systems. For example, Judge Frank Easterbrook of the 7th Circuit dismissed evidence of excessive mutual fund fees in 2008 as follows:

It won’t do to reply that most investors are unsophisticated and don’t compare prices. The sophisticated investors who do shop create a competitive pressure that protects the rest.

As evidence, he cited a purely theoretical law review article written twenty-five years earlier—even though the evidence about index fund price dispersion was already out there for everyone to see. This absolute conviction that the world must operate the way it does in theory is another example of economism in its purest form. (Easterbrook was overruled by the Supreme Court, but on other grounds.)

The asset management industry’s other brilliant revenue-maintaining innovation was the target date fund. The theory behind these funds is plausible, although not entirely compelling. The idea is that you pick the date when you expect to retire, and the funds reallocate your holdings from an aggressive mix (more stocks) when you’re young to a conservative mix (more bonds) when you’re old. I say this isn’t entirely compelling because there is no particularly convincing theory of what your asset allocation should be (well, there’s the CAPM, but that doesn’t hold up in practice), let alone what it should be at any given age. For example, it makes no sense that a very rich person and a middle-income person should have the same allocation just because they are the same age.

That said, target date funds could be a solution for an investor who (a) follows the conventional wisdom that you should shift from stocks to bonds as you age and (b) doesn’t want to have to rebalance manually every few years. But in practice, they are just a clever marketing vehicle for complexity and high fees. I was looking at Fidelity target date funds for a friend (who is locked into Fidelity by her retirement plan, which is not too unusual). Here’s the Fidelity Freedom 2040 fund:

Thirteen U.S. stock funds? Remember, the whole point of a mutual fund is each one is already diversified; if you buy thirteen funds within the same market, you’re just getting lots of overlap in unknown quantities. The sole purpose here is to provide a veneer of sophistication (Wow, I can get twenty-five different investments with just one fund!) to justify a fee of 77 basis points. Vanguard, by contrast, puts your money in four index funds covering the global equity and bond markets, and charges just 16 bp.

Since 2006, the share of 401(k) plan participants holding target date funds has more than doubled, from 19% to 48% (ICI 2016 Investment Company Factbook, Figure 7.14). Because retirement plan administrators typically only offer one series of target date funds (rather than a passive option and an active option), by getting participants to focus on the benefits of target date funds, they can take the passive investing option off the table and quietly funnel everyone into actively managed funds.

Again, the lesson for the individual investor is this: If you are investing in a target date fund, figure out what’s in it, and figure out if you can make essentially the same investments more cheaply. And the lesson for society is this: Even when the products are basically pretty simple (U.S. stock funds), companies will manufacture complexity and barriers to entry in an effort to boost prices well above marginal cost. That’s how the economy works—not the way you learn on the Economics 101 blackboard.

Jeb Hensarling and the Allure of Economism

Tue, 12/20/2016 - 13:07

By James Kwak

The Wall Street Journal has a profile up on Mike Crapo and Jeb Hensarling, the key committee chairs (likely in Crapo’s case) who will repeal or rewrite the Dodd-Frank Wall Street Reform and Consumer Protection Act. It’s clear that both are planning to roll back or dilute many of the provisions of Dodd-Frank, particularly those that protect consumers from toxic financial products and those that impose restrictions on banks (which, together, make up most of the act).

Hensarling is about as clear a proponent of economism—the belief that the world operates exactly as described in Economics 101 models—as you’re likely to find. He majored in economics at Texas A&M, where one of his professors was none other than Phil Gramm. Hensarling described his college exposure to economics this way:

“Even though I had grown up as a Republican, I didn’t know why I was a Republican until I studied economics. I suddenly saw how free-market economics provided the maximum good to the maximum number, and I became convinced that if I had an opportunity, I’d like to serve in public office and further the cause of the free market.”

This is not a unique story. Robert Bork, who took economics at the University of Chicago Law School, recalled the experience as a “religious conversion” that “changed our view of the whole world” (quoted in Sidney Blumenthal, The Rise of the Counter-establishment, p. 303).

Introductory economics, and particularly the competitive market model, can be seductive that way. The models are so simple, logical, and compelling that they seem to unlock a whole new way of seeing the world. And, arguably, they do: there are real insights you can gain from a working understanding of supply and demand curves.

The problem, however, is that the people who are most captivated by the first theorem of welfare economics (the one that says that competitive markets produce optimal outcomes) are often the least good at remembering the assumptions that don’t apply and the caveats that do apply in the real world. They forget that the power of a theory in the abstract bears no relationship to its accuracy in practice.* As Paul Samuelson said in one of my two favorite passages of the original edition of his textbook (p. 36):

“Even [Adam Smith] was so thrilled by the recognition of an order in the economic system that he proclaimed the mystical principle of the ‘invisible hand’: that each individual in pursuing only his own selfish good was led, as if by an invisible hand, to achieve the best good of all, so that any interference with free competition by government was almost certain to be injurious. This unguarded conclusion has done almost as much harm as good in the past century and a half, especially since too often it is all that some of our leading citizens remember, 30 years later, of their college course in economics.”

Hensarling, who likes to quote market principles in the abstract, doesn’t appear to have moved on much from Economics 101. The Dodd-Frank Act, he has said, “is gradually turning America’s largest financial institutions into functional utilities and taking the power to allocate capital—the lifeblood of the U.S. economy—away from the free market and delivering it to political actors in Washington.” The alternative he proposes is to “restore market discipline, end taxpayer bailouts and protect consumers with innovative, competitive markets policed for fraud and deception.” This ritual invocation of markets ignores the fact that there is no way to design a contemporary financial system that even remotely resembles the textbook competitive market: perfect information, no barriers to entry, a large number of suppliers such that no supplier can affect the market price, etc.

As Samuelson continued, our economy “is neither black nor white, but gray and polka-dotted.” Regulatory policy that presumes well-functioning markets that don’t exist is unlikely to work well in the real world. Actually, Bill Clinton and George W. Bush tried that already, and we got the financial crisis. But to people who believe in economism, theory can never be disproved by experience. Hensarling is “always willing to compromise policies to advance principles,” he actually said to the Journal. That’s a useful trait in an ideologue. It’s frightening in the man who will write the rules for our financial system.

* Actually, one could argue that, because of competition among theories, those that are more powerful in the abstract are less likely to be accurate in practice.

Economism: Special Holiday Offer

Mon, 12/05/2016 - 17:34

By James Kwak

As you may have noticed by now, I have a new book coming out. It could be a perfect holiday gift for, well, maybe a handful of people out there—the father-in-law who wonders why our country’s economic policies are so screwed up, or the annoying libertarian niece who insists that we should get rid of public schools and privatize the police force, or the progressive friend who studied anthropology and is unnecessarily intimidated by economics. But even if you pre-order it, you won’t get it until around January 10.

So, here’s the offer: If you pre-order a copy of Economism as a gift for someone, I will mail you a signed card with the image of the book jacket on the front and, on the inside, an explanation of what the recipient is getting (i.e., a book that will arrive in January). That way you can give the person the card instead of the book. If you want a card, send me an email at james.kwak@uconn.edu with your name and address and the name of the person I should inscribe it to. I am planning to mail the cards out by first class mail on Saturday, December 17 (from Massachusetts), which will give them a full week to get to you before Christmas. If you need one sooner for a different holiday, let me know and I’ll do what I can.

If you send me an email by Sunday (December 11), I expect to be able to send you a card. After that point I can probably do it, but I can’t guarantee it because it depends on how many extras I order in advance.

Have a happy holiday season.

More on the Deduction Fairy

Fri, 12/02/2016 - 14:50

By James Kwak

[Updated with Mnuchin’s position on charitable contribution deduction.]

I wrote two days ago about the fairy tale that you can lower tax rates for the very rich yet avoid lowering their actual taxes by eliminating those mythical beasts, loopholes and deductions. The basic problem with this story is that, at the very high end of the distribution, deductions and exclusions (with the possible exception of the deduction for charitable contributions) just don’t amount to very much as a percentage of income. Therefore, eliminating those deductions may increase rich people’s taxes by tens of thousands of dollars, but that is only a tiny proportion of their overall tax burden, and not enough to offset any significant rate decrease.

Unlike me, Daniel Hemel and Kyle Rozema are actual tax scholars (Hemel has a blog on Medium), and their detailed research largely tells the same story. They have a forthcoming paper that analyzes the mortgage interest deduction (MID) and shows that, while it is worth more dollars to rich people than poor people (for all the well-known reasons—bigger houses, higher marginal rates, itemizing), the MID causes people in the top 1% to pay a larger share of the overall tax burden. Therefore, eliminating the MID and using the increased tax revenue to reduce tax rates for everyone (what Mnuchin proposed in concept) would be a large windfall for the top 0.1% and a small windfall for the rest of the 1%.

The numbers are in the last column of this table:

The Proportionate column shows the distributional effects of repealing the MID and using the money to reduce everyone’s taxes in equal proportion, which are even worse. (The only good outcome is the Per Household column, which uses the revenue from eliminating the MID to give every household a flat $558 tax rebate, but no one is talking about that.)

Hemel and Rozema do a similar analysis of the deduction for state and local taxes, which I didn’t mention in my post (and which many rich families can’t take because of the AMT). The basic story is the same: repealing the deduction to lower rates is, again, a windfall for very rich families.

The only deduction that turns out to increase inequality under this approach is the one for charitable contributions, because there is no practical limit to the possible size of such donations. (And guess what? Mnuchin doesn’t want to touch this one!) Eliminating this deduction could cause the rich to pay more in taxes, but they could easily maintain the same level of disposable income simply by donating less to charity. In other words, tax revenues would go up, but the money would effectively be coming from charities, not from rich people.

So, there is no deduction fairy. You can’t cut tax rates in anything like the way the Trump administration proposes without vastly increasing inequality. Once again, it’s a conceptually plausible idea that is providing air cover for a massive raid on government services to benefit the very rich.


Economics 101, Economism, and Our New Gilded Age

Fri, 12/02/2016 - 09:40

By James Kwak

My new book—Economism: Bad Economics and the Rise of Inequality—is coming out on January 10 (although, of course, you can pre-order it from your local monopoly now). If you’d like more information about the book, the book website is now up at economism.net. (I used Medium instead of WordPress.com this time.) The post below, which is also the top story on the book website, summarizes the main themes of the book.

Income inequality is at levels not seen for a century. Many working families are struggling to get by, only kept afloat by Medicaid and food stamps. The federal minimum wage is just $7.25 per hour—below the poverty line even for a family of two. The bright outlook for corporate profits has driven the S&P 500 to record levels. Surely it makes sense to raise the minimum wage, forcing companies to dip into those profits to pay their workers a bit more.

But that’s not what you learn in Economics 101. The impact of a minimum wage is blissfully easy to model using the supply-and-demand diagram that dominates first-year economics courses.

A price floor in the labor market—that’s what a minimum wage is—causes demand to exceed supply. The difference is unemployment, and the reduction in the employment level represents value lost by society. People who want the minimum wage are well-meaning but muddle-headed do-gooders who don’t understand economics. As Milton Friedman wrote in Capitalism and Freedom, “minimum wage laws are about as clear a case as one can find of a measure the effects of which are precisely the opposite of those intended by the men of good will who support it.”

That’s what Economics 101 teaches you—but it’s not what many economists actually think.

Economists polled by the Chicago Booth School of Business are evenly split on whether an increase in the minimum wage to $9—or even $15—would significantly increase unemployment. Professional opinion is divided exists because detailed empirical research is inconclusive, with several recent studies (e.g., Dube, Lester, and Reich 2010 and 2014) and meta-studies (Doucouliagos and Stanley, Belman and Wolfson) showing no significant impact on employment.

In policy debates and public relations campaigns, however, what you are more likely to hear is that a minimum wage must increase unemployment—because that’s what the model says. This conviction that the world must behave the way it does on the blackboard is what I call economism. This style of thinking is influential because it is clear and logical, reducing complex issues to simple, pseudo-mathematical axioms. But it is not simply an innocent mistake made by inattentive undergraduates. Economism is Economics 101 transformed into an ideology—an ideology that is particularly persuasive because it poses as a neutral means of understanding the world.

In the case of low-skilled labor, it’s clear who benefits from a low minimum wage: the restaurant and hotel industries. In their PR campaigns, however, these corporations can hardly come out and say they like their labor as cheap as possible. Instead, armed with the logic of supply and demand, they argue that raising the minimum wage will only increase unemployment and poverty. Similarly, megabanks argue that regulating derivatives will starve the real economy of capital; multinational manufacturing companies argue that new trade agreements will benefit everyone; and the wealthy argue that lower taxes will increase savings and investment, unleashing economic growth.

In each case, economism allows a private interest to pretend that its preferred policies will really benefit society as a whole. The usual result is to increase inequality or to legitimize the widening gulf between rich and poor in contemporary society.

I became aware of the subtle power of economism during the 2009–2010 financial reform debate, when bank lobbyists invoked economic logic to protect their clients’ profits from new regulations. As far as I can recall, I first wrote about it in a 2011 blog post titled “The Smugness of Unintended Consequences.” My new book, Economism: Bad Economics and the Rise of Inequality, offers an intellectual history of the rise of economism in the late twentieth century, case studies of its impact in several different policy domains, and—I hope—the tools to enable readers to understand both the merits and the limitations of arguments based on Economics 101. Because the first step in overcoming an ideology is understanding how it works.

The Deduction Fairy

Wed, 11/30/2016 - 16:18

By James Kwak

Incoming Treasury Secretary Steven Mnuchin promised a big tax cut for corporations and the “middle class,” but not for the rich. “Any tax cuts for the upper class will be offset by less deductions that pay for it,” he said on CNBC.

This is impossible.

The tax cutting mantra comes in two forms. The more extreme one claims that reducing the overall tax burden on the rich will turbocharge the economy because they will save more, increasing investment, and will also work more, starting companies and doing all those other wonderful things that rich people do. The less extreme version is that we should lower tax rates to reduce distortions in the tax code, but we can maintain the current level of taxes paid by the rich by eliminating those famous “loopholes and deductions.” Donald Trump the candidate stuck with the former: his tax proposal, as scored by the Tax Policy Center, gave 47% of its total tax cuts to the top 1%, who also enjoyed by far the largest reduction in their average tax rate.

Mnuchin’s comment implies that he favors the latter version: lowering rates but making it up by “broadening the base.” This math might work for the merely rich—say, families making $200,000–400,000 per year. Take away the mortgage interest tax deduction, the deduction for retirement plan contributions, and the exclusion for employer-provided health care—which together can easily shield $50–75,000 in income—and you could probably fund several percentage points of rate decreases. (Of course, it would be politically impossible to completely eliminate those tax breaks, but that’s another story.)

When it comes to the truly rich, however, there just aren’t enough deductions out there to eliminate. You can only deduct interest on a mortgage up to $1 million. The fanciest employer-provided family health plan isn’t worth more than $30,000 or so. The aggregate limit for employer retirement plan contributions is around $50,000. At the top end of the wealth hierarchy, where people make millions or tens of millions of dollars per year, these are rounding errors; eliminating these deductions wouldn’t even make up for a reduction in tax rates of a single percentage point.

There are some tax breaks that matter for very rich families. Only one is technically a deduction: the deduction for charitable contributions. But obviously that only affects (to a significant degree) a small number of wealthy people in any given year, and those people can work around any limits in this deduction by simply cutting back on donations. (By contrast, if you get rid of the exclusion for employer-provided health care, employees won’t respond by foregoing health care altogether.)

The biggest tax breaks for the very rich (as I’ve written about before) are the preferential tax rate for capital gains, the deferral of taxes on those gains until you sell the assets, and the step-up in basis at death (which means that, if you pass on assets to your children, no one ever pays tax on the appreciation during your lifetime). Given that Republicans have been trying to reduce capital gains tax rates for decades (with Paul Ryan occasionally saying they should be zero), we can be sure that preferential rates aren’t going away. Taxing gains in assets when accrued is also certain not to happen. Trump has in the past supported a version of eliminating step-up in basis at death, but that was along with slashing tax rates and getting rid of the estate tax, which would be a net win for the wealthy.

In short, the idea that you can reduce tax rates without reducing the tax burden at the top end of the income distribution is a fantasy on par with the idea that you can increase tax revenue by raising rates—plausible in theory but impossible given current reality. That Mnuchin is taking this line is simply evidence that the Trump administration will try to reconcile a massive tax cut for the rich with their fake-populist rhetoric for as long as possible. In the end, we know which one will win out.

What You Can Do

Thu, 11/17/2016 - 08:00

By James Kwak

Several of my friends, some of whom I haven’t spoken with in a long time, have reached out to me over the past week to discuss what to make of last week’s election. I imagine this is happening with a lot of people.

Although I don’t have any simple answers, I do have some thoughts on what we can do in response to the prospect of Donald Trump and the Republicans controlling the entire federal government, as well as a large majority of states. But first, we need a short detour—for a bit of perspective.

Maurice Walker is a fifty-five-year-old man with schizophrenia whose only income is $530 per month in Social Security disability payments. On September 3, 2015, he was arrested by police in Calhoun, Georgia for being a “pedestrian under the influence”—something many of us have been guilty of at one time or another. If Walker had been able to come up with $160 (something most people reading this blog could do in seconds), he would have walked free. Instead, he was locked up in jail, without his medication.

The City of Calhoun has a fixed bail schedule, in which the amount of bail is set for each offense, without regard for ability to pay. People arrested for misdemeanors cannot see a judge until the next Monday court session (which would have been eleven days for Walker, because the next Monday was Labor Day). This means that, among those arrested on the same charges, poor people are locked up for several days while rich people walk out of jail. This violates the Constitution. In Tate v. Short, 401 U.S. 395 (1971), and Bearden v. Georgia, 461 U.S. 660 (1983), the Supreme Court has held that the Constitution prohibits policies that systematically result in the incarceration of indigent defendants while allowing those with money to go free.

And yet it happens. Of the more than 600,000 people in jail in this country (not counting those in state or federal prison), 70% have not been convicted of anything and hence are legally innocent. Many of them are behind bars solely because they cannot afford to buy their pretrial release.

Being locked up before trial doesn’t just mean you lose a few days of freedom. Will Dobbie, Jacob Goldin, and Crystal Yang are studying the impact of pretrial incarceration on trial results and long-term economic outcomes. They find that people who are released are 27% less likely to be convicted and 28% less likely to plead guilty than people who stay in jail—which makes perfect sense, since you are more likely to plead if it’s your only way to go home and see your family. These effects are even larger for defendants charged with misdemeanors and those with no prior offenses in the previous year. In the long term, pretrial release increases by 27% the likelihood that people will be working three to four years later, with a larger effect for those who were working at the time of arrest. Again, this is obvious: If you miss work because you’re in jail, you could lose your job; and if you plead guilty to get out of jail, the conviction makes it harder for you to find work.

(For those worried about sample selection issues—that is, people who make bail are different from those who don’t—this study takes advantage of the fact that bail judges are quasi-randomly assigned in Philadelphia and Miami. The relative harshness of the judge is the instrument for pre-trial release.)

Maurice Walker was lucky. He got a lawyer. In fact, he got some of the best: Sarah Geraghty and Ryan Primerano of the Southern Center for Human Rights, and Alec Karakatsanis of Equal Justice Under Law. Walker was arrested on a Thursday evening. The next Tuesday, his lawyers filed a class action lawsuit against the City of Calhoun; Walker was released the next day. On January 28, 2016, a federal judge sided with Walker:

Any bail or bond scheme that mandates payment of pre-fixed amounts for different offenses to obtain pretrial release, without any consideration of indigence or other factors, violates the Equal Protection Clause. . . .

The bail policy under which Plaintiff was arrested clearly is unconstitutional.

The city is appealing the case to the Eleventh Circuit Court of Appeals; the Department of Justice, the American Bar Association, and the Cato Institute have all weighed in on Walker’s side.

What does Maurice Walker have to do with last week’s election?

The sad truth is that many people in the United States already had very tough lives before November 8. Besides Walker and the thousands of people in jail because they are poor, they include Cleopatra Harrison, a domestic violence victim who was threatened with jail because she could not pay a $150 “victim assessment fee” assessed by a court; A.J. and hundreds of other children who face criminal charges in juvenile court without being represented by a lawyer, in violation of the right to counsel; Aron TuffWilmart Martin, Andre Mims, Jeremiah Johnson, and other people sentenced in Georgia to life in prison without the possibility of parole for nonviolent drug offenses (all of whom are African-American); and Tim Foster, who was sentenced to death by an all-white jury after the prosecutor struck every African-American from the jury pool.

There is an ocean of injustice out there. Many of the people harmed by it are poor, minorities, immigrants, or some combination of the above. I only know about the examples above because I’m on the board of the Southern Center for Human Rights, which took all of those cases and was able to help all of those clients. There is no doubt much, much more injustice of which I am unaware.

The perspective is this: Things didn’t suddenly go from wonderful to awful on Tuesday night last week. For many people, they were already pretty bad. A Trump presidency will no doubt make things worse. There will be more hate crime; more deportations of people whose only crime is wanting to work hard and make a better life for their children; more and higher hurdles for women who want an abortion; more people without health insurance; more gun violence; and more hungry children unable to rely on food stamps.

These are all problems that our country had on the morning of November 8, and there are already organizations dedicated to helping the people who face them. As I said, I’m on the board of the Southern Center for Human Rights. We had a board meeting and benefit dinner in Washington last week. And while no one was happy about the national election, it didn’t change what the organization does; it just meant that the struggle will be that much harder for the next four years.

So if you want to “do something” about President Trump, the first thing you can do is donate money to some of the organizations that actively protect people’s civil and human rights. If you’re inspired to give money to the Southern Center, I can assure you that it won’t be wasted; we have some of the best lawyers anywhere, working as hard as they can for remarkably little money. (Today, November 17 is Georgia Gives Day, too, if you prefer to give that way.) But there are many other worthwhile groups out there: the NAACP Legal Defense Fund, the ACLU (perhaps particularly important given Trump’s attempts to intimidate the media), Planned Parenthood, or your local food bank, soup kitchen, or homeless shelter, among many others. At the end of the day, ordinary people will be the victims of the Trump administration, and they will need your help.

That’s the point I wanted to make today, but I imagine that’s not where you expected this post to end. So I’ll add a few words about the other thing that we need to do: take back at least partial control of our government(s). That is a much more difficult issue. You might say that Hillary Clinton lost by only 107,000 votes; by that measure, we only need a slightly better candidate, a slightly better message, or slightly better luck to win in 2020.

More realistically, however, with the small-state bias of the Senate (and the forbidding 2018 electoral map), gerrymandering in the House, and overwhelming Republican dominance of state governments, Clinton’s loss reveals how weak the Democrats already were. This is what I wrote back in June:

Republicans are apoplectic at the idea that Hillary Clinton could appoint the deciding justice to the Supreme Court, but the smart ones realize that she will be able to accomplish little else; even if by some miracle Democrats retake the House, Republican unity will suffice to block anything in the Senate. Democrats, by contrast, are terrified because a Republican president means that they will get virtually everything . . . : not just the Supreme Court, but a flat tax, new abortion restrictions, Medicaid block grants, repeal of Dodd-Frank, repeal of Obamacare, Medicare vouchers, and who knows what else.

The Republicans are dominant not just because of Trump, but because of the decades of work that preceded him: promoting the ideology, cultivating the funders, motivating the base, building the media empire, stocking the judiciary, weakening unions, undermining campaign finance rules, buying state elections, redrawing districts, and suppressing the vote. Yes, Trump was an unlikely leader to take them over the top. (And yes, he is popular among white supremacists.) But even if he hadn’t, the GOP would still be just one election away from a sweep of the White House and Congress.

There is a raging debate right now over the identity of the Democratic Party. I don’t to argue the specifics of that debate right now. But if we want to compete, we need more than a new, focus-grouped brand that can win 51% of the popular vote in a general election. We need an ideology that can mobilize millions of new voters and motivate thousands of people to run in races for school board, town council, state assembly, and state senate, all over the country. We need a long-term political movement, not a quadrennial scramble to demonize the other guy just enough so voters pick our guy.

I don’t know how to create that movement. So all I can recommend, on a personal level, is that you find people whom you believe in—on all levels of politics—give them money or volunteer for their campaigns, and throw your little bit of weight into pushing the party in what you think is the right direction. (Or, if you’re up for it, run for office yourself.) It’s not a great answer, but there is no magic bullet.



Thu, 11/10/2016 - 08:56

By James Kwak

[Updated to add another headline leading with “white voters.”]

Two days later, some of the world’s leading newspapers—or their headline-writers, at least—are saying it was all or largely about race:

The respective roles of race and class in this year’s election are a highly contentious issue. I’d like to add to that contentiousness as little as possible while pointing out that this race-based framing isn’t really supported by exit poll data. I want to get ahead of the vitriol by stipulating that the exit polls don’t provide conclusive evidence for either side.

OK, here’s the data:


Those are vote shares in the presidential election by racial or ethnic group. The numbers at the right show you the shift from the previous election.* In this case, the Democratic-Republican gap among white voters shifted by 8 points toward the Republican. That’s evidence that the election was about white voters, right?

Except those are the 2012 exit polls. The 8-point shift is relative to the 2008 exit polls.

Here’s the equivalent chart for 2016:

As you can see from the right-hand column, Trump did better than Romney among every racial or ethnic group. In fact, if you subtract off how he did among all voters (2 points better than Romney), his performance among whites relative to his overall performance was 1 point worse than Romney’s.

What about income? This is 2016:

There are two factual statements you can make about this picture. One is that Trump lost the “working class” (under $50,000) vote. You will hear a lot of people make that statement. The other is that he did much, much better among the working class than Romney: about 11 points better (the <$30K and $30–50K groups are roughly equal in size). The Democrat always does better among poor people, in part because Democratic policies are always better for poor people, at least as a first-order matter. (The Republican theory is that their tax cuts for the rich eventually help everyone, and I don’t want to argue about that here.) But in 2016, relative to 2012, the Republican did much better among the poor and much worse among the rich.** His gains among the poor outweighed his losses among the rich by just enough to swing the election.

Looking at these pictures alone, at first glance, the story seems to be more about class than race. In politics, change happens at the margin. Trump is still not the candidate of the working class—Clinton is—but he was able to appeal to them much more successfully than Romney or McCain. As for whites, they have voted for the Republican in every election since at least 1968, and Trump didn’t expand that advantage significantly over where it stood in 2012.

But as I said earlier, I don’t think you can necessarily infer from the exit polls that class was the dominant factor and race was less significant. The problem is that we know a larger proportion of working class people voted for Trump than for Romney, but we don’t know why they voted for Trump, at least not from the data we have. We can make some guesses, but again the exit polls provide support for both stories:

(How each of these two questions provides support for a different story is left as an exercise for the reader.)

At the end of the day, we know that the “white working class” supported Trump much more strongly than it supported Romney, but we can’t tell from polling data if that was because of their judgments about Trump’s policies, their feelings about race, or their feelings about their economic status. In practice, different people in the same demographic group make political choices based on different combinations of those (and other) factors.

I think it’s important to try to understand the relative importance and the interactions of these different motivations, and how those have shifted over time. But if there’s one thing I want you take away, it’s that you can’t answer these questions by looking at aggregate polling data—even though many people will try to do exactly that in the next few days.

* Thanks to the Times for this presentation, and for the ability to switch easily from election to election. When anyone cites a poll number, your first question should be: “Relative to what?” In this case, I think the previous election is the most obvious baseline for interpretive purposes, although it certainly isn’t perfect.

** In 2012, Romney won the >$200K group by 10 points, while Trump won it by 1–2 points; you don’t see that shift in the picture because the 2012 data don’t have a break at $250K.

The Biggest Voter Suppression Campaign of All

Tue, 11/08/2016 - 07:00

By James Kwak

This election day, spare a thought for the largest group of citizens who aren’t eligible to vote: children.

My four-year old just learned that he doesn't get to vote tomorrow and he burst into tears and I feel for him.

— Justin Wolfers (@JustinWolfers) November 8, 2016

When I was in high school, I believed strongly that there should be no voting age whatsoever. Anyone should be able to vote, no matter her age. Well, I still feel that way, particularly after watching my ten-year-old daughter knocking on doors and explaining to adults why she doesn’t want her school to be grade-reconfigured. And I feel that way even though I also have a four-year-old son whose vote could be bought for a lollipop. (Whether he would stay bought is another question.)

There are two main arguments against a voting age. The first is that any plausible justification for a minimum voting age could be better served by some other test—which would be illegal. Many people think it is obvious that children shouldn’t be allowed to vote because they are uninformed, irresponsible, lack the necessary cognitive skills, are easily swayed by their parents, or something along those lines. (Note that similar arguments were made about all the other groups that used to be unable to vote.) But if the point of a voting age is to ensure that the electorate is properly informed about the issues and the stakes, we could administer a test, which would do a better job than an arbitrary age cutoff. (Who is the vice president? Which house of Congress approves judicial nominations? Etc.) That test would violate the Voting Rights Act, just like literacy tests.

If the point is to ensure that the electorate has the ability to process information and make rational decisions, again we could come up with a test for that—which would also probably violate the Voting Rights Act. And if we think that children are too easily swayed by their parents, what do we think about the undecided voters who are swayed by the types of television ads that every politician is running right now?

In short, the minimum voting age is supposedly intended to ensure certain characteristics in the voting population. Screening for those characteristics directly would be illegal. So why is OK to use a poor proxy for them?

The second, and more fundamental, argument against a voting age is that it undermines the whole point of our system of government. The reason we have a democracy isn’t that we think everyone is equally capable of making good decisions about who our leaders should be. It’s that we want our leaders to be accountable to ordinary people. This is called government by the consent of the governed. We want our representatives to take their constituents’ interests into account when making decisions; and if they don’t, we want to be able to vote them out of office. Because we want our government to be accountable to everyone, we don’t restrict the suffrage to certain classes of people; we don’t want some types of people to have more political power than others, simply by virtue of who they are.

Except that we do restrict the suffrage. Young people bear the costs of public policy as much as anyone (and arguably more so, since they will be alive for longer), but politicians can safely ignore them because they can’t vote. (Saying their parents will represent their interests is just silly; by that logic, we could simply have one vote per family.) Children live under our government; therefore they should be able to vote. It’s as simple as that.

Politically speaking, a lower voting age would probably help Democrats, since young people tend to be more liberal than old people. (It would probably also eliminate any suspense in the Clinton-Trump contest.) But that’s not the point, just like making election day a holiday isn’t about helping Democrats or increasing turnout. It’s about making sure that everyone has an equal opportunity to hold her representatives accountable.

So I think that if you have the ability to express a preference, you should be able to vote. I recognize that most people won’t agree with that rule. But there’s no reason that states can’t start by reduce the voting age to sixteen. (I’m not a constitutional law scholar, but Nathan Persily is, and he agrees that this is possible.) And do you know what? The world won’t end. And our democracy will be just a little bit stronger.

Models of Economic Policymaking

Sun, 10/30/2016 - 09:00

By James Kwak

The evening that he won the Iowa caucus in January 2008, Barack Obama said this:

Hope is the bedrock of this nation. The belief that our destiny will not be written for us, but by us, by all those men and women who are not content to settle for the world as it is, who have the courage to remake the world as it should be… . [the belief that] brick by brick, block by block, callused hand by callused hand, … ordinary people can do extraordinary things.

That speech is at the opening of K. Sabeel Rahman’s new book, Democracy Against Domination. It invoked one of the central mobilizing themes of Obama’s 2008 campaign, which set him clearly apart from Hillary Clinton: the idea that the senator from Illinois would usher in a new kind of politics, a more democratic, more inclusive approach to government as opposed to business as usual inside the Beltway.

Well, that didn’t happen. Whatever you think of President Obama’s policy goals and accomplishments, he had little impact on how our political system works. Plenty of blame for that goes to the Republicans, who set out from Inauguration Day focused exclusively on making him a one-term president. But it’s also true that the new president did not make political reform a priority during those first two years when he had majorities in both houses of Congress.

It can be argued that Obama had other important priorities: stabilizing the financial system, the 2009 stimulus, Obamacare, and the Dodd-Frank Act. But one of the central arguments of Democracy Against Domination is that the president made a conscious choice. When it came to financial regulation, for example, “Obama’s response to the financial crisis evinced a deep-seated … faith in professional, technocratic expertise to solve social problems and transcend the controversies and messiness of ordinary democratic politics” (p. 6).

Let’s step back for a minute. Rahman’s book, on one level, is about how we regulate our economy. Throughout the twentieth century, there were two dominant models of economic policymaking. One, which characterized the New Deal, is technocratic managerialism: the idea that economic regulation is too complex to be left to democratic processes, and therefore must be entrusted to experts who are insulated from day-to-day politics. The other, which became more and more influential as the century wore on, is the ideology of free markets, which dictates that the economy should simply be left to regulate itself.

We all (should) know by now that market self-regulation can lead to catastrophic consequences, such as the financial crisis and Great Recession. But, as Rahman points out, the free marketers developed a pretty powerful critique of technocratic managerialism: the public choice approach to politics and the theory of regulatory capture. So we are left with two main factions—conservatives who want to deregulate everything and moderate Democrats who want to give more authority to to apolitical technocrats (consider the Dodd-Frank Act)—who agree that economic policy has to be insulated from politics. Then we have (some) progressives who think unregulated free markets will produce bad outcomes, but also think that technocracy, at least in areas such as financial regulation, will simply be captured by industry. Simon and I in 13 Bankers fall into that last group.

The question is, if you don’t trust markets and you don’t trust the revolving door, how can you make economic policy? Rahman’s answer is simple, although it raises plenty of other questions: you trust democracy. On a theoretical level, the argument is that if you want economic policies that are responsive to the needs of ordinary people, that will not be captured by elite interest groups, and that are perceived as legitimate, you need to involve ordinary people in the policymaking process.

In the book, Rahman talks about various ways in which democratic participation could be incorporated into the administrative state, such as citizen budgeting or community groups more aggressively engaging with regulators. (Jared Bernstein in The Reconnection Agenda also cites the work of the Center for Popular Democracy, which is trying to encourage Federal Reserve banks to pay more attention to the concerns of the working class.) At present, I would say still there needs to be a fair amount of practice to substantiate the theory. I don’t yet see a way to have non-specialists make substantive contributions to the hundreds of pages of the Volcker Rule. Of course, Paul Volcker himself said the rule should be four pages long, so maybe that’s part of the point. (That was one reason Simon and I argued for simple size caps in 13 Bankers, and why Anat Admati and Martin Hellwig argued for simple capital requirements in The Bankers’ New Clothes.)

At this point, we’re off into questions of democratic theory and political institutional design, in which I am far from an expert. But Rahman’s idea could represent a promising way forward, particularly for people who believe both that the economic playing field is tilted against ordinary people, and that our political system is increasingly deaf to their concerns.

The Last Chapter Problem

Sat, 10/29/2016 - 11:08

By James Kwak

Like many analytically minded liberals, I’m good at identifying problems and less good at coming up with solutions—a common disease sometimes called the “last chapter problem.” I recently finished reading The Reconnection Agenda by Jared Bernstein (which you can even download from his blog), which takes the opposite approach.

The problem he addresses is one that we all know about—inequality, stagnant real wages, the divergence between productivity gains and living standards, etc. Bernstein recalls a meeting with a group of insiders in 2014, when a pollster interrupted a discussion of the post-Great Recession economic recovery to say:

If you mention the word “recovery” to people, they don’t know what you’re talking about. And they conclude you don’t know what they’re talking about. It’s not just that they feel disconnected from an economy that’s supposedly growing. It’s that they don’t think anyone understands or knows what to do about their situation.

And he aptly summarizes the state of inside-the-Beltway economic policy debate between “you’re-on-your-own” Republicans and Democrats:

The YOYOs run around arguing, unconvincingly to most, that government is the problem, while most Democrats nibble at the edges with YOYO-light, maybe sprinkling in a minimum wage increase. Everyone treats the private market economy like a delicate vase that mustn’t be bumped.

(That near-consensus on the magic of market forces is also the subject of my new book.)

But Bernstein, to his credit, gets the description of the problem out of the way in the first two chapters. He devotes the rest of the book to solutions: policy tools that can not only increase growth but, just as importantly, ensure that the benefits of growth are widely shared throughout the income distribution. Some are relatively standard Democratic fare, like expanding automatic stabilizers, spending more on infrastructure, universal pre-school, and maintaining a symmetric monetary policy—that is, not pretending you have an inflation target when what you really have is an inflation ceiling.

More generally, however, Bernstein focuses on the importance of using economic policy to change the pre-tax distribution of income—bolstering the bargaining power of workers so they can demand a larger share of the gains from increases in their own productivity. Among other things, that means making it easier for workers to form unions, subsidized jobs and apprenticeship programs to help people gain skills, and ban-the-box rules that help people with “criminal records” (which can mean just an arrest with no conviction) compete fairly for jobs. These are not policies that all Democrats support. But, as Bernstein writes, turnout by Democratic constituencies “may well hinge on whether they believe a candidate will try to implement a set of policies that convincingly relinks growth and their living standards.”

As I’ve written about previously, this presidential election has become a referendum on Donald Trump. But for Democrats to have any chance of maintaining our congressional gains in 2018, we have slightly less than two years to convince the public that we care about something more than fiscal responsibility and overall economic growth.

Time to Vote; No on 5

Mon, 10/24/2016 - 10:24

By James Kwak

If you live in Massachusetts, early voting has begun. You can ask for an early ballot by mail, or just find a polling place here. This is what my town hall looks like today:

Not surprisingly, I voted for Hillary Clinton (more about why here). If you don’t live in Amherst, Massachusetts, you may want to stop reading. If you do live in Amherst, I’d like you to consider voting no on Question 5.

Technically speaking, Question 5 allows the town to override Proposition 2-1/2, which ordinarily limits property tax increases, in order to issue bonds to build a new school for all Amherst children in grades 2–6. (The bonds would be issued now, but presumably property tax increases will be necessary to back them.) I ordinarily vote for overrides as a matter of course, but this time I voted no.

The original motivation for this project was that two of our three neighborhood elementary schools for grades K–6, Wildwood and Fort River, are in poor physical condition. To make a long story short, the school district successfully applied for money from the Massachusetts School Building Authority, but that money can only be used at one physical site—hence the plan to build one large school complex instead of building two smaller schools (or renovating both Wildwood and Fort River). According to current estimates, the MSBA will contribute about $33,700,000 to the project, and the town’s share will be $32,700,000.

At the same time, the plan is to completely reconfigure elementary education in the town. The third current school, Crocker Farm, will become a K–1 school. (Crocker also has a small, not-universal pre-K program, which will remain.) The new, $66 million school complex will serve all students in grades 2–6. It will be organized as two separate “schools” with various shared facilities. This is what I am opposed to.

I am opposed for two types of reasons. First, there are several obvious problems with this plan. It significantly increases time on the school bus for both grade K–1 children in North Amherst and grade 2–6 children in South Amherst. Amherst is a tall and skinny town, and it takes a long time to get from one end to the other—considerably longer on a school bus. Our children would be better off if we were to invest the extra ten minutes in the morning and ten minutes in the afternoon in classroom time rather than bus trips.

In addition, the reconfiguration creates an extra school transition for seven-year-old kids, just two years after the wrenching transition of starting kindergarten. It also increases grade cohorts by 200% (or 50% in grades 2–6, to the extent that the two “schools” at the new site will be kept distinct).

Second, and more fundamentally—and this is what I said in last year’s survey of parents—reengineering the entire grade configuration is a solution in search of a problem. The clear problem is that Wildwood and Fort River are in bad physical shape and need to be renovated or replaced. We should solve that problem. But a school is more than a building. We have three of them. And nowhere in all the documents that I saw last year did I even see an argument for why we need to blow them up and start over from a theoretical blueprint.

I saw some claims for why consolidating entire grades in one place would be a good thing, along the lines of greater efficiency using shared resources. (For example, instead of three small libraries, you can have one big one.) I used to be a management consultant. I can make that argument, too.

But there’s a more important principle: Don’t tear apart things that work well just because, in theory, you can put them back together in an even better way. Running any kind of organization is hard enough as it is without creating complications trying to solve problems that don’t exist. There’s a reason why most school districts in the country don’t make all children switch schools between first and second grade. What research and debate there are center around when to switch from elementary to middle school—not whether to split elementary school at age seven. Are we really confident that we—including a superintendent who just resigned—know better than anyone else how to organize a school system?

My daughter goes to Crocker Farm. We think it’s a good school. We have friends who sent their kids to Wildwood. They think it’s a good school—in a bad building. I don’t want to blow up Crocker Farm (the school, not the building), and I don’t see why anyone would want to blow up Wildwood (the school, not the building). I would gladly vote for an override to fix Wildwood and Fort River, or build new buildings for them, or—if necessary—build new buildings for them right next to each other.* But I don’t think it’s right to inflict a vast, unnecessary grade configuration experiment on our children.

* Lest anyone think this is about my property taxes: If anyone can tell me what the actual increase in my property taxes would be under Question 5, and if Question 5 is defeated, I will donate that amount to the schools.

Ideas, Interests, and the Challenge for Progressives

Fri, 10/21/2016 - 12:28

By James Kwak

Updated based on feedback from Matt Stoller. See bottom.

Mike Konczal wrote an article a few days back arguing that various progressive policies aimed at helping poor people would not be able to pry the “white working class” away from Donald Trump and Trumpism. I think the article was insightful and intelligently argued. This was my quick response:

@rortybomb It took 35 years to create the economy we have. It will take 35 years to fix it and create broadly shared prosperity.

— James Kwak (@jamesykwak) October 19, 2016

In other words, it’s the long term that matters. We need policies that create broadly shared prosperity not because they will peel away Trump supporters in the short term, but because they are the right thing to do. And in the long term, if progressives prove that they can deliver the goods—a society with less inequality and less economic insecurity—that will change the political landscape.

Dani Rodrik wrote a longer, better response to Konczal. Rodrik’s perspective, which he’s presented in greater depth in the Journal of Economic Perspectives and a recent paper with Sharun Mukand, is that political outcomes result from the interaction of interests and ideas. As he writes in his recent post, “The politics of ideas is about activating identities that may otherwise remain silent, altering perceptions about how the world works, and enlarging the space of what is politically feasible.” Politicians appeal in part to voters’ interests, but also attempt to make salient identities that they share (or pretend to share) with particular segments of the electorate.

In this framework, Konczal may be correct—progressive economic policies may not appeal to white, working class Trump voters—but that’s because progressives lost the battle of ideas long ago. The implication is that progressives need better ideas, not just more effective policies. In his post, Rodrik cites Konczal’s example of people who “view the federal government as something that is helping people ‘cut in line,'” and continues:

In other words, people dislike and distrust the government. And yes of course, conditional on that belief, the progressives’ agenda of enhanced environmental regulation will not draw the support of the people it tries to help. Same with dealing with the banks, creating more jobs, or progressive taxation.

Clearly, the progressives have lost the war of ideas here – on government as a force for good. Equally clearly, they will not win it by offering detailed policy proposals on each one of these areas.

We progressives tend to be rather smug about the belief that our policies (infrastructure spending, social insurance, expanded family leave, universal pre-K, etc.) will do a better job helping poor people than typical conservative policies (cut taxes and regulations and let the invisible hand do its magic). Where we have generally failed is in convincing ordinary people, not policy wonks, that our vision will create a better society for them and their families—or perhaps that we have a vision at all.

This is hard to do, and I don’t have a simple answer for how to do it. But it is something that the right did extraordinarily well during their decades in the wilderness after World War II. It was an article of faith among Hayek, Friedman, Buckley, and the old conservative warriors that ideas mattered—that they could only gain political power by undermining the intellectual and political near-consensus around the New Deal. Part of their success lay in transforming their economic policy program—small government, low taxes, union-busting—into a powerful ideology that could appeal to people in all classes. Ronald Reagan’s message that government was the problem, and that the solution lay in unleashing the energy of the free American people, was and remains compelling even to people who have been the victims of Reaganite policies. More generally, the idea that markets are the best way to solve all problems has become so completely baked into contemporary discourse that it is no longer seen as an ideology. (This is roughly what I call “economism” in my new book.)

In the battle of ideas, progressives have been on the back foot ever since Reagan, which is probably one reason why we like to retreat to the realm of policy detail, where we can revel in our technocratic superiority. But somehow, as Rodrik points out, “they need to convince the electorate that it is their interests they have at heart – not those of bankers or of large corporations.” That could also take thirty-five years. But we have to begin somewhere.

Update: Matt Stoller responded with several tweets on Twitter. I think this one encapsulates his criticism:

@jamesykwak @ddayen You're castigating the issue as the failure to convince, not that the actual implementation had impacts.

— Matt Stoller (@matthewstoller) October 22, 2016

Stoller is rightly pointing out that you could read my post to say that the only fault of progressives has been failing to make a better case for their policies—when, in fact, Democratic administrations have inflicted plenty of lousy policies on the poor and the middle class (welfare reform, 1997 capital gains tax cut, financial deregulation, HAMP, looking the other way on foreclosures, etc.).

Now, I don’t consider either Bill Clinton or Barack Obama a progressive, but there is disagreement about what that term means. So let’s just say this: One reason Democrats have failed to win the hearts and minds of large segments of the working class is that our actual policies, when we have been in power, have not served them that well. Yes, our policies were generally better than what Republicans would have done; and yes, there were some that helped the poor, such as Medicaid expansion and the Obamacare subsidies. But on balance, the Democrats have done little to reverse the tide of the Reagan Revolution. In the future, if we want to win back the whole working class, we’ll need both better policies and a better vision than “we’re not as bad as the Republicans.”