Asymmetric Information

If the debt limit is not raised, and there's a government shutdown on steroids and amphetamines, and maybe a debt default after that, a big question is who the public will blame. The Republicans will have been the ones who voted against it, and who took America hostage to get what they wanted, but our press is so lacking, and asymmetric information is so bad, will most of the public understand that? especially with the Republican's billionaire backed propaganda machine.

The world is just so immensely advanced and complicated today, asymmetric information is just an enormous problem. It just really takes tremendous study to understand many issues in economics and government, and people have so little free time today.

One important solution is a better press, where the monumental positive externalities of serious analytic and investigative journalism are commensurately subsidized, but another huge one is try-and-see. We need to end the filibuster, for one, so we can have a lot more try-and-see to disintegrate Republican disinformation and really move us forward. Another thing is massive public campaign finance, and donation limits. With this kind of asymmetric information, we really need well informed and well intentioned representatives. Our legislators should be spending 80% of their time learning and studying to make good decisions, not 80% of their time raising money.

Automatic Registration and Permanent Mail Ballot with Tax Filing

The Democrats will be able to pass little or nothing over the next two years, so especially now it's best to focus largely on the long term and structural:

1) Make it far easier to vote – This is so crucial to Democratic success; you really wonder why they never pushed for it more. My specific idea is a law to make it so everyone, when they submit their income tax form, is automatically registered to vote – and put on the list to be permanently sent a mail ballot for every single election, no matter how small. And the same would be done when getting a drivers license, or with any filing with government. This would result in virtually 100% voter registration, and virtually 100% receipt of easy, convenient, no driving anywhere or waiting in any line, mail ballots, for every single election, no matter how small.

This would be an enormous boon to the Democrats, as Republicans vote disproportionately by a large margin – the older you are the more you vote, and seniors have all the time in the world to vote; moreover, the passionate, the whipped up by outrageous propaganda, (and the insane), are very motivated people; they'll make the time. It's far easier to vote if a ballot arrives in your mail, with a prepaid return envelope. And the ballot arriving in the mail makes it hard to forget an election. This could tremendously increase relative Democratic turnout. You can put a law like this on referendums all over the states, as well as trying to push it through nationally when you control congress.

2) Plan now for how and when you will end the filibuster, and build support for it behind the scenes now – try-and-see is far kinder to good ideas, ideas that are good for the vast majority, and far harsher to bad ones, thus try and see is a great ally of the Democrats and a great enemy of the Republicans and their best friends ignorance and deception – nothing decimates lies and misleading like try-and-see. And ending the filibuster tremendously increases the odds of try-and-see. If we had try-and-see we would have had, for example, Medicare-for-All and Cap-and-Trade permanently a long time ago. For more on this see here.

3) Push for the Presidential popular vote plan, where an electoral majority of states commits its electors to chose only the winner of the national popular vote. This would result in the winner of the national popular vote always winning, no matter what, unlike in 2000. So it would, for all practical purposes, end the Electoral College. Like suggestion1 above, millions of DNC money could greatly increase the odds of its success.

You wonder why the Democrats never put much effort or money into these things when they can do such great good long term. As an economist, it just doesn't seem very efficient or utility optimizing.

I should add that one good big thing that the Democrats might get by the Republicans, perhaps the only one, is free trade agreements. So now would be a good time for Obama to really push for them, and he seems to understand this. I would love to see a free trade agreement between NAFTA and the EU, a GFTA, which could later be joined by Japan, and with momentum, the vast majority of the world. But that's pretty ambitious for the next two years.

Do We Really Prefer Winner-Take-All Races?

In a recent post, Ezra Klein talks about the founding of Facebook and makes some important, relatively rarely considered, economics points. The following is a long drop quote, but please read it; the points are  important, and the ones I will make after depend on it:

At the same time, of course, Friendster, MySpace, Orkut, and a variety of other social networking platforms were swirling about. After all, technological advances had made these things simple enough that even college students could pull them together in a few weeks. If it hadn't been Zuckerberg, it would've been someone else. Maybe Goldberg.

This is a rather common phenomenon: It's called "simultaneous invention," and it happens all the time: Technology advances to the point that the next step is obvious to multiple people, and so they all take the next step at approximately the same time. In the end, one of them gets the patent, or the market share, and so squeezes the other out and becomes synonymous with the invention. That's what happened with Alexander Graham Bell, who in all likelihood invented the telephone after Elisha Gray -- and both of them came after Antonio Meucci. Amusingly, the discovery of "simultaneous invention" was another case of simultaneous invention, with multiple thinkers and researchers publishing on the phenomenon all at once. "Unjust Deserts," by Gar Alperovitz and Lew Daly, has a good discussion of this.

What does this have to do with the movie? Not that much. Insofar as the film implies that only Zuckerberg could've invented Facebook, that's wrong. But since the movie is mainly a character study of Zuckerberg, it's a bit churlish to criticize it for focusing on his characteristics so intently. Alperovitz and Daly, however, would argue that it has a lot to do with how we should think about inequality. "Differences between individuals are almost negligible compared to the influence of the resources, infrastructure, and most important of all, the knowledge an individual has at his disposal," they write.

In other words, the difference between Mark Zuckerberg and Adam Goldberg was very small, while the difference between Mark Zuckerberg and the smartest college kid in 1999 was huge. It was the advancing storehouse of human knowledge, not the advancing capabilities of particular humans, that made up the difference. But humans tend to think about things in terms of other humans, and so we overestimate the impact of personalities (autistic genius) and underestimate the importance of technology (all sorts of people could suddenly build social networking platforms in under three months). That also makes it easier for us to believe people deserve* enormous, inconceivable monetary rewards for their inventions, as we tend to attribute the entire value of the product to them, as opposed to attributing the incremental difference between that product and whatever was right behind that product to them.

"There's a different argument that assuring people astronomical profits for creating useful things makes them more likely to create useful things. That argument makes more sense."

Ezra finishes up with this:

Note the word "deserve." There's a different argument that assuring people astronomical profits for creating useful things makes them more likely to create useful things. That argument makes more sense.

It does to some extent, but you can be way past the optimal point on that.

Consider this situation, which is analogous to the entrepreneurial, innovational example Ezra discusses:

You're in a race with 100 other people (or considering entering one). To have any chance of winning, you have to train for a year full time, so you can't work and make any other income besides what you may win in the race. Everyone has very close to the same odds of winning, about 1%. Even if you're most likely to win, your odds are still only 3% of winning and 97% of losing.

There are three ways the race's prizes can be structured that all cost the same to the races sponsors; let's call those sponsors society:

A) The Winner-Take-All Way – the winner of the race, first place, gets $100 million; everyone else gets zero.

B) The Very-Low-Taxation Way – the winner of the race gets $99.55 million. Second place gets $100,000. Third place gets $70,000, and the other 97 competitors get $20,000 – and this is for a year's work.

C) The Strongly-Progressive-Taxation Way – The winner of the race gets $30 million, and the other competitors divide up the other $70 million in a not extremely uneven way: Second place gets $2 million, third place $1 million, fourth place $700,000, and so on, so that even the 100th place competitor still gets $40,000, so he can at least afford to keep his family's health insurance and not lose their house.

Now really think about this:

1) Suppose you were able to enter this race, and chose either A, B, or C. Which would you prefer – even if you knew you were the most likely to win, even if you knew you had the 3% chance?

2) Do you really think you'd have that much less incentive to train hard for the race if the highest potential winnings were only $30 million, like in C, as opposed to $100 million, like in A (and keep in mind that in C you still have a strong incentive to train hard even if you think you have no chance of getting first, just because 90th pays a lot more than 100th)?

3) If the race were set up like A, would you even risk spending a year to train to enter? Would you even risk trying? And would you be (far) more likely to enter the race, to risk trying, if instead the race were structured like C?

So, the moral of the story is the vast majority of us are far better off, both ex-ante and ex-post, with highly progressive taxation in "winner-take-all" type situations, and such situations are common in the ultra high economies of scale, ideas/information based, modern high tech world. In addition, rather than decreasing the incentives to make an effort, take risks, and innovate, progressive taxation (if not taken to a ridiculous extreme; no one in power in the Democratic Party wants communism) increases incentives to make an effort, take risks, and innovate. And it funds the widespread education, public resources, and seed funding that makes widespread effort and high utilization of human productive potential possible.

As the world becomes more and more "winner-take-all" with ever greater increases in economies of scale, technology, and importance of zero marginal cost ideas/information, greater progressivity of taxation will become more and more important to maximizing growth and total societal utility.

The Optimal Level of Governemnt Investment in the High-Tech World of 2010, not 1810

In response to Stephen Williamson's opus magnum last week, I left a series of comments that actually exceeded his word count. I encourage you to read them and the whole discussion. I think there are a lot of important points and insights. But I especially think the following part is important, and so I have reprinted it here, with modifications and expansions.

David Andolfatto asked:

    Richard,

    Would you mind elaborating on this:

    Due to externalities, especially positional/context/prestige and carbon, asymmetric information, the zero marginal cost of idea/information use, high transactions costs, great economies of scale and the problems of monopoly power, inability to price discriminate well leading to inefficient provision, and much more, the current level of government spending, insurance, and especially investment is far below the optimal level.

    Do you have any way of quantifying the importance of these "externalities" you highlight above? And what is the "optimal" level of government spending, investment, taxation, etc.?

Here is my reply (again, modified and expanded from the original comment):

David (and Stephen),

This is a very big question. A good complete answer can be book length (or books length). It's far from a few simple statistics and p-values. And I'm especially short of time right now, but I think I can give you some big important indicators that I hope will encourage you to really think about this – logically utilizing all of the evidence you've seen in your lifetime, not just the fraction that's considered "formal". As the great growth economist and perennial Nobel shortlister Paul Romer of Stanford said:

In evaluating different models of growth, I have found Lucas's (1988) observation, that people with human capital migrate from places where it is scarce to places where it is abundant, is as powerful a piece of evidence as all the cross-country growth regressions combined. But this kind of fact, like the fact about intra-industry trade or the fact that people make discoveries, does not come with an attached t-statistic. As a result, these kinds of facts tend to be neglected in discussions that focus too narrowly on testing and rejecting models.

Economists often complain that we do not have enough data to differentiate between the available theories, but what constitutes relevant data is itself endogenous. If we set our standards for what constitutes relevant evidence too high and pose our tests too narrowly, we will indeed end up with too little data...

My greatest regret is the shift I made while working on these external effects models...I suspect I made this shift toward capital and away from knowledge partly in an attempt to conform to the norms of what constituted convincing empirical work in macroeconomics. No international agency publishes data series on the local production of knowledge and inward flows of knowledge. If you want to run regressions, investment in physical capital is a variable that you can use, so use it I did. I wish I had stuck to my guns about the importance of evidence like that contained in facts 1 through 5.

– Journal of Economic Perspectives, Volume 8, Number 1, Winter 1994, Page 20.

That said, let's lay out some big chunks of evidence:

Stephen, regarding asymmetric information, you talk about contracts and credit markets, but asymmetric information (or just lack of information – or, as is often forgotten by economists, the lack of expertise to evaluate it well in a very advance complicated world, expertise that can take years or decades of full time study to obtain) is far more extensive than just this kind of thing.

Here is a a 2009 Eureka Alert. It notes a large scale survey which found 97% of climatologists who are active in research think that human activity is a significant contributing factor in global warming, but only 58% of the public thinks this.

And there's this AP poll from July which found that 59% of Americans would oppose any climate bill if it would cause their electricity bill to rise by even $10 a month.

Now that's what I call asymmetric information!

But this is asymmetric information that, David, will lead to massive government underinvesting in basic scientific research related to alternative energy, as well as related infrastructure, and as well as undertaxation of carbon (either direct or indirect).

But there's more than this; how many people understand the underlying economics, that the free market alone isn't the most efficient at all for providing many things (especially after the constant and massive disinformation efforts of the Republicans)? How many people understand the list of potential market problems referred to in the beginning of this comment? And how many people can you expect to have the time or willingness to learn this much economics, when the vast majority have careers that are in very different areas, and they have historically little free time?

Or foreign policy: How many people really understand the extent of the effect a declining price of oil has on positive change for some of the worst authoritarian and terrorist sponsoring regimes in the world (including the old Soviet Union in the 80s), where terrorism costs us trillions per decade in increased security costs, let alone the loss of life.

How many understand that that $10/month, or $100/month, on average, progressively applied, will essentially not make their monthly budgets any tighter after a period of adjustment (see here).

So this should give you an idea of the true extent of asymmetric information, and the magnitude of a large source of government underinvestment.

But now let's look at another huge one.

Cornell economist Robert Frank in 1999 wrote:

A cautious reading of the evidence suggests that we could spend roughly one-third less on consumption--roughly $2 trillion per year--and suffer no significant reduction in satisfaction. Savings of that magnitude could help pay for restoring our infrastructure, for cleaner air and water, and a variety of other things.

Now let's think about this.

I'm 47. I spied on David's vita and found he finished his undergrad degree in 1985, so he's probably around 47, and Stephen has admitted to 55. So all of us should remember 1978 very well.

Disco was sweeping the country and real per capita GDP was $25,503 (from the BEA, in 2005 dollars). In 2009 it's up to $41,890, for a difference of $16,387. Multiplied by the current population of 308 million, that's $5.05 trillion per year (and keep in mind here the yearly GDP figures are adjusted very little for increases in quality, like increased effectiveness of medical treatments).

Now, let's compare how people lived in 1978, their happiness, their utility, to how people live today. Have we added that $5.05 trillion per year efficiently from the standpoint of optimizing total societal utils? (and I care even less about the Pareto definition of optimality or efficiency than Stephen. What's Pareto optimal can have tragically comically small total societal utility).

In 1978, I lived like a pretty typical member of the middle class, in a three bedroom suburban house in Oak Park Michigan. Our floors were all carpet except for the kitchen and bathrooms which had nice linoleum. Our kitchen countertops were linoleum too. It was carpet and linoleum, not wood, stone tile, and granite. But for all that our home was much smaller and less expensive than a comparable one today, from my human experiences, our family (like those of our peers) found it just as beautiful and just as high quality as a comparable one with comparably middle class families today.

Now, there's no t-statistic here, but I can take assumptions just as mild as those on which t-statistics typically are based, or milder, and construct a logic chain showing that it's extremely unlikely that my experiences throughout 47 years in many cities and neighborhoods, with many people, were completely unrepresentative of the population as a whole – and that's what they would have to be to not conclude that a huge amount of that $5.05 trillion was positional/context/prestige utility, of zero sum game at the societal level. This is as opposed to intrinsic utility like increased incidence of air conditioning since 1978, or improved medical effectiveness – which is a quality increase little included in that GDP statistic.

As Paul Romer said, things that don't come with a t-statistic can be a lot more valuable pieces of evidence. And I'd add that their logic chains can be just as rock solid and anchored to assumptions as mild – or far milder – than those behind the t-stat, or other formal empirical evidence.

Now, today total government spending on basic scientific and medical research is approximately $34 billion per year. That includes all of the government spending on basic scientific and medical research on curing cancer, arthritis, backaches, headaches, obesity, robots building robots, solar power, everything. [Calculation: National Science Foundation data, table 2, 2007, the sum of columns E,H,N,O, and W, 2000 dollars adjusted to 2009 via GDP deflator]. And these are things well known to be usually provided more efficiently by the government, either directly, or largely indirectly, say through sponsorship, or purchase from the private sector – Paul Romer quote time:

As just one example, recall that the increasing returns to scale that is implied by nonrivalry leads to the failure of Adam Smith’s famous invisible hand result. The institutions of complete property rights and perfect competition that work so well in a world consisting solely of rival goods no longer deliver the optimal allocation of resources in a world containing ideas.

– Forthcoming American Economic Journal paper, page 8.

and

Think about the basic science that led to the discovery of the structure of DNA. There are some kinds of ideas where, once those ideas are uncovered, you'd like to make them as broadly available as possible, so everybody in the world can put them to good use. There we find it efficient to give those ideas away for free and encourage everybody to use them. If you're going to be giving things away for free, you're going to have to find some system to finance them, and that's where government support typically comes in...Because everybody can use the idea at the same time, there's no tragedy of the commons in the intellectual sphere. There's no problem of overuse or overgrazing or overfishing an idea. If you give an idea away for free, you don't get any of the problems when you try and give objects away for free. So the efficient thing for society is to offer really big rewards for some scientist who discovers an oral rehydration therapy. But then as soon as we discover it, we give the idea away for free to everybody throughout the world

– 2001 interview with Reason magazine.

Now, can you imagine how much faster, over the long run, science and medicine would advance if we increased this ten fold? One could easily see it advancing multiples as fast over the long run. At the end of this commentary, I'll leave references to some formal studies that do some quantifying, but for now I'll just leave this from the abstract of a 1998 Quarterly Journal of Economics paper by economists Charles I. Jones of Stanford and John C. Williams of the San Francisco Fed:

Is there too much or too little research and development (R&D) [This is all R&D combined together, not just basic scientific and medical research. It includes basic scientific and medical research, plus applied research, plus product development (even if it's for products of little or no intrinsic utility, but high positional/context/prestige externality, like "silky smooth transmission" or geo gravitational adjustment for a $100,000 mechanical watch for 0.1 seconds per month better accuracy, but still less accuracy than a $30 atomic clock radio-controlled watch) The estimated total for all of this is $308 billion per year from all sources combined, government, business, and non-profit, NSF data, table 1, column C, adjusted by the GDP deflator]? In this paper we bridge the gap between the recent growth literature and the empirical productivity literature. We derive in a growth model the relationship between the social rate of return to R&D and the coefficient estimates of the empirical literature and show that these estimates represent a lower bound. Furthermore, our analytic framework provides a direct mapping from the rate of return to the degree of underinvestment in research. Conservative estimates suggest that optimal R&D investment is at least two to four times actual investment [emphasis added].

– Vol. 113, No. 4 (Nov., 1998), pp. 1119-1135

A ten fold increase in government research spending is about an extra $304 billion per year, about 1/17th of our $5.05 trillion increase from 1978. Now you don't think if we channeled 1/17th of the increase since 1978 into this we'd produce much higher total societal utility over the long run? We went 1/17th of the way back, less giant wheels on cars, but they seem just as high quality and prestigious because everyone's wheels are smaller, do you really think an average person with a new 1978 Cadillac, with the crushed velvet and pile carpeting, got much less pleasure (or any less) out of it than their counterpart with a 2010 Mercedes of equal societal rarity and affordability? And technological advancement is very little in the GDP, so you can also compare such a Mercedes to the pleasure you'd get from one 2.1% less expensive ($304 billion divided by the current GDP of about $14.6 trillion), but it was just as rare and prestigious and high quality seeming because everyone else's car cost 2.1% less too? And remember, in return you get a ten fold increase in government basic scientific and medical research, and since 54% of basic scientific and medical research is government [same NSF data as before], that means an over five fold increase in total basic scientific and medical research from any source.

Think about it.

Or look at it this way: According to Berkeley economist Emmanuel Saez's data, the top 1/10th of 1% of earners in the United States in 2008 got 5.37% of all income including capital gains. U.S. GDP in 2008 was $14.6 trillion (2008 dollars), so depending on Saez's definitions and calculations, that 5.37% is in the neighborhood of $800 billion. And given that very few people are in the top 1/10th of 1%, his data estimates that that group makes a minimum – minimum – of $9.1 million per year. Now, suppose we take our $304 billion to increase government basic scientific and medical research ten fold and total basic scientific and medical research from all sources, government, business, and non-profit, five fold, from their $800 billion, so they all have about 3/8ths less, so they earn a minimum – minimum – of about $5.6 million per year.

But they all maintain their same relative position, same relative prestige, same relative feel of quality for what they have. Instead of making $9.1 million per year, it's $5.6 million per year. Instead of $91 million per year, it's $56 million per year. Instead of $910 million per year, $560 million per year. Do you really think there will be much of a loss of utils for these individuals, especially given that they will have the exact same level of prestige because all of their counterparts lose an equal proportion of income, the exact same feeling of quality for what they have?

And don't tell me the pie will shrink because they'll work less. They’ll only make $5,000 per hour after taxes instead of $8,000, so that's not enough incentive? Anyway, we all know the income and substitution effects. Stephen in his post just assumed a tax increase would get people to work more hours due to the income effect. In fact, tax rates in anything but a very extreme range have little effect over the long run on work hours, especially if they are constructed smartly to allay psychological effects (like a VAT with progressivity from using the proceeds progressively like for free universal pre-school and bachelors degree). From an expert well versed in this literature, MIT economist Jonathan Gruber:

Changes in tax rates appear to have relatively modest effects on total gross income; the total amount of income actually generated through work or savings does not respond in a sizable way to taxation.

–  "Public Finance and Public Policy", 2nd edition, 2007, page 734

I even got Scott Sumner to admit this! (see the comments of this post)

So again, I ask you, do you really think there will be much loss of utils for these super wealthy individuals with this 3/8ths diversion to basic scientific and medical research?

And you have to decide one way or another here. However happy you are with your data and evidence, not making a choice, or the status quo, is a choice. And one that must be justified with the data and evidence you have – not fancy non-existent data and evidence that you'd like to have – because the theory is not determinate due to all of the market imperfections of the invisible hand that are well acknowledged in economics, that are referred to at the start of this comment.

Do you really think that this little intrinsic utility loss per person – over this tiny an amount of people – would outweigh, over the long run, the utility gained from a ten fold increase in government basic science and medicine, which is a five fold increase in basic science and medicine from all sources, government, business, and non-profit combined?

Again, you have to choose a level of government investment too, based on the same data and evidence that I do. The data and evidence is no more formal and fancy for you (although I'll give some additional strong formal data and evidence at the end). You have to rely on the same data and evidence that I do to justify your decision if you say we should keep the level of government investment the same, if you say we should cut it, or if you say we should cut it by 99%. The theory is not specific. It's clear due to externalities etc. that government investment shouldn't be zero and it's clear that it shouldn't be 100%. To find out what it should be in between you have to use the data and evidence you have, and it's well established in statistics that it's inefficient to throw away data and evidence. Now, I hope to illustrate this with a little parable:

A snobby empirical economist is hiking with a friend who eats a berry off a bush and immediately keels over and dies. The snobby economist thinks to himself, well it's just a sample of one berry; you can't draw any conclusions from a sample of one. It's just anecdotal evidence. And being hungry himself, he eats a handful, keels over, and dies.

Moral of the story: It's very inefficient, and perhaps very dangerous, to ignore abundant a priori information at your disposal, even if that information is not formal, but still logical – the logic chains are completely solid – and based on relatively realistic assumptions. You just currently don't have a formal version of it.

It wasn't hard at all to put together a completely solid logic chain showing those berries were poisonous using common, but informal, a priori knowledge about biology, human physiology, evolution, similarity across humans, and extremely realistic assumptions.

Now, I think I could put together a similar case here with regard to the magnitude of positional/context/prestige externalities, the magnitude of the effect of the zero marginal cost of idea/information usage, etc., etc.

In any case, this is plenty for now. As I said at the start of this, a good complete answer can be book length (or books length), and I can't write that here, but I hope what I have written gets you to really think about this.

Before leaving you with a sample of strong formal evidence, I'll tie this post to it's title with this comment I recently left on the blog of Richard Green:

I think a big point is that as a country advances more technologically, high return government investment of the kind the free market will grossly or inefficiently underprovide (due to long established in economics market problems like externalities, etc.) becomes more and more important.

In 1810, there was little need for education. The vast majority just did low tech farming and there was not much to learn in school. Medical costs were tiny because there wasn't much for a doctor to learn and there wasn't much he could do.

As a country advances the need for these social investments increases and we've fallen far behind this increase over the last generation in California and in the country as a whole.

Now, I'll leave you with that sample of strong formal evidence:

Robert Barro and Jong-Wha Lee, "Educational attainment in the world, 1950–2010", Vox, http://www.voxeu.org/index.php?q=node/5058

Charles I. Jones, "Sources of U.S. Economic Growth in a World of Ideas", The American Economic Review, Vol. 92, No. 1 (Mar., 2002), pp. 220-239

Charles I. Jones and John C. Williams, "Measuring the Social Return to R & D", The Quarterly Journal of Economics, Vol. 113, No. 4 (Nov., 1998), pp. 1119-1135

Zvi Griliches, "Productivity, R and D, and Basic Research at the Firm Level in the 1970's", The American Economic Review, Vol. 76, No. 1 (Mar., 1986), pp. 141-154.

Was it cautious or "cautious"?

You often read that Obama was too cautious in the size of his stimulus, making it too small (for example here). But really in this context the word cautious should be in quotation marks.

Having a smaller stimulus may have been what seemed cautious to many, or what was considered cautious by Washington conventional wisdom, but it was actually much riskier politically for Obama and the Democrats – and for the country.

The truly cautious thing was actually doing the opposite -- erring on the side of making the stimulus too big (assuming you could pass a bigger one).

Making the stimulus substantially bigger than the estimated expected amount needed was the cautious thing. Making it much smaller was the "cautious" thing.

Positional/Context/Prestige Externalities

In an open letter to his students at Berkeley, that I encourage everyone to read, Michael O'Hare wrote last week:

The budget deficit that’s paralyzing Sacramento is about $500 per person; add another $500 to get back to a public sector we don’t have to be ashamed of, and our average income is almost forty times that.

Here's something extremely important - and neglected:

Many middle class people (and poor) will say, hey, an extra $1,000/year will bankrupt me, or will be very hard. I'm barely paying my mortgage, and day care, and student loans,...now.

First off, the tax increase should be highly progressive, so the wealthy pay, say, $4,000, and the very wealthy and super wealthy $10,000, or much more. The solidly middle class might pay $500 (about $40/month), others less, or a lot less.

But what they, and too many economists, really don't realize is this:

It's not that you just pay $500 and that's it; $500 is gone and nothing changes in return. Your student loans would have been lower with this kind of – progressive – tax raise used for smart investment, and your children will require less money from you to go to college. You may get universal pre-school, saving a great deal in pre-school/day care cost, free, or inexpensive, high quality public recreation, and so on.

But here's a huge thing that is tragically neglected in economics, and public discourse in general, positional/context/prestige externalities. If you have $500 less to spend on your house, so do your peers, so housing prices, and your mortgage payment, drop accordingly – maybe the house has more carpet instead of stone or wood floors, but if your neighbors' houses have the same decrease, then there's no feeling like your house is cheap and unprestigious, or low quality, and the intrinsic utility difference is tiny and perhaps negative (I think intrinsically carpet is more comfortable, versatile, and better. I think it provides higher utility when there's not a positional/context/prestige externality).

If you have $500 less to spend on your car, then so do your peers, so you feel you should spend  less on your car, and your car cost drops accordingly – maybe it has a few less horse power, less "silky-smoothness" to its transmission, or less giant wheels, but if your neighbors' cars have the same decrease then there's no feeling like your car is cheap and unprestigious, or low quality (think of how high quality and prestigious the solidly middle class thought their cars were in the 1960s with not even power windows, inexpensive hubcaps, and plastic and fabric, not wood and leather), and the intrinsic difference is tiny, and in some cases, for some, it's negative (I find leather in a family car less comfortable, and it's hot in the summer and cold in the winter. I find this super rigid expensive suspension so you can take a sharp turn at 50 miles per hour with little lean – but you never will do anything like that – less comfortable for the driving most people actually do in a family car, even though it's more costly, thus making it more rare, and gets the car magazines to say the car is prestigious.)

The upshot of this is that people will find if everyone, not just them, has $500 less, then their finances don't really get much tighter – or any tighter – after a period of adjustment. This is why families of a generation or two ago with incomes the same or a lot lower felt a lot more financially comfortable and prosperous, and had much less financial distress. Their homes had carpet and linoleum, not wood and granite, but they felt just as beautiful and prestigious because that's what their neighbors had too – and they had a lot more free time to enjoy those homes – and their families.

What's left, after all of this, is that now you have a massive increase in the quality of your state – in education, infrastructure, parks and recreation, quality of life, as well as higher growth due to greater university investment in science, a more educated populace, and more productive infrastructure – and your finances, your family budget, is the same, or more secure, because your expenses dropped along with the tax increase because of a commensurate drop in the costs of positional/context/prestige externalities.

So much of what we spend on today is what Cornell economist Robert Frank calls conspicuous consumption, things of relatively low intrinsic utility and relatively high positional/context/prestige externality utility. This is as opposed to inconspicuous consumption, such as scientific and medical research to, say, cure cancer, back pain, headaches, or my favorite, so we can eat as much as we want without gaining weight, spending more time with our families, having a cleaner environment without monumental risk of global warming, and a safer one, so children can play freely outside the way they used to, and having better social insurance for the hard working, so they and their families aren't nonetheless financially ruined by a job loss.

One of the most tragic flaws of economics today is the neglect of positional/context/prestige externalities.

Why Libertarianism Doesn’t Work, Part N+a

But first – Why Regulation can Work, Part M+b (Part M+a is here):

Nobel Prize winning economist Paul Krugman just had a post, "Why Does Regulation Work?".  In reply, a commenter wrote, "Oil is washing up on Louisiana's beaches, yet Paul Krugman declares that 'regulation works'."

O.k., let's talk about this.

First I would note that if there were no regulation at all it would be far worse. These disasters would be far more frequent and severe. Fly-by-Night drillers would be setting up everywhere, and good luck suing them; they wouldn't have nearly enough assets to pay for their massive damage.

But a huge point is not that regulation always works well (overall), but that we have the option of it working well (overall). This is an option voters have, and it's very important that voters know their options. If they don't want regulation to work well, if they want it to work horribly, and be dismantled, then vote for the party that wants it, and government in general, to work horribly and be dismantled, the Republicans. They'll appoint Brownies, political hacks, cronies, and others who will make the regulation as ineffective as they can get away with. And, at the same time, they'll pass laws to just dismantle the regulation directly.

But, we do also have the option to vote for the other major party. And if we do, then there's a long history of strong regulation being highly successful, and implemented in a competent, objective, professional way.

There are myriad examples from the New Deal until the start of the modern Republican era in 1980. Perhaps most notable is the strong regulation of finance that led to the great moderation, and an era of unprecedentedly high evenly spread growth that created the great middle class.

Another example is one Krugman brought up:

Well, here’s the thing: regulation demonstrably does work where tort law doesn’t. Consider the environmental issue: in reality, the perpetrators of oil spills never pay most of the cost; but in reality, environmental regulation has led to much cleaner air and water. (Look up the history of Los Angeles smog or the fate of Lake Erie if you don’t believe me.)

So, we can have regulation that works; it's our choice; the option does exist; all it takes is voting Democrats into power. When we choose to vote Republican, regulation (and government in general) works far worse; it's severely degraded. When we vote Democrat it works, overall, well, or very well. And history shows this.

Now to Why Libertarianism Doesn’t Work, Part N+a (which is related to the above):

In Part N+1, Krugman wrote, "A few days ago I put up a post about how libertarians say we don’t need government regulation, because tort law will do the trick..." He then pointed out, "in practice, politicians will find ways to shield the powerful, as illustrated by the $75 million cap on damage payments from oil spills."

I'd like to really get into the meat of this with another example: vaccines.

The no regulation / just litigation, libertarian approach says, don't force people to get polio vaccinations, or subsidize them, just sue the person who gave you polio.

Ok, first it's almost surely impossible, or nearly impossible, to prove in court someone gave you polio. And, it also may be incredibly costly to prove this in court even if you could. There are lawyer costs, investigator costs, your time costs, and all of the court costs; judges, jurors, facilities, security, enforcement of rulings, etc.

And, as if that's not enough, second, the person who gave you polio probably doesn't have anywhere near enough money to fully compensate you for the costs and misery of a lifetime of polio.

By contrast, requiring that all children have polio vaccinations before they can attend school, and/or the government paying the cost of the vaccination, is very easy and inexpensive.

Remember the old saying, an ounce of prevention is equal to a pound of cure? The libertarians essentially want no prevention (regulation, subsidization, etc.) and only cure (litigation), even for things that are impossible to cure, or incredibly expensive to cure, but relatively cheap to prevent.