Comments on: A pointy-head post about issues

By: jet

jet — Tue, 22 Feb 2005 02:57:59 +0000

Ol’ Cleve, all over CrookedTimber with the jokes. Why doesn’t he take that fearsome step and actually engage on an issue? But if all the “most fertile young females” were reserved for the commie socialist, I’d convert tonight.

By: Cleve Blakemore

Cleve Blakemore — Mon, 21 Feb 2005 16:51:42 +0000

There is no point to doing thorough and comprehensive widescale experiments in social engineering through central control if we do not follow up the severe problems we create with even more stringent controls imposed on the already overcontrolled marketplace. The point of instituting central control in the first place is to cause enough sheer hell resulting to justify further controls. One of my primary beefs is that people should be willing to accept that if a management class is willing to accept the enormous burden of the greater good of mankind by drawing up virtually infinite lists of rules for others to follow, they have got to have legislative access to the best looking and most fertile young females during their off hours. That’s not me talking, that’s economics, damn it.

By: jet

jet — Sun, 20 Feb 2005 22:25:32 +0000

My head isn’t pointy enough for this discussion.

By: Kevin Donoghue

Kevin Donoghue — Sun, 20 Feb 2005 22:06:18 +0000

Jet (to Kevin Brennan): “Government bonds are just a substitute for increased taxes, while investments in the market do real work in that they create wealth.” The first part of this statement is true if taxpayers are very far-sighted. They treat a tax cut which is not matched by a spending cut as merely a postponement of the tax-bill (Ricardian equivalence). Hardly anyone believes this is empirically true. Still, there may be a good case for assuming something of the sort when it comes to a topic like SS. It helps to underline the principle that there is no such thing as a free lunch. The statement that investments in the market create wealth confuses two meanings of the word investment. Stockbrokers refer to the purchases of equities as investment. Economists do not. No wealth is created – all that happens is a transfer of title to existing assets.

By: jet

jet — Sun, 20 Feb 2005 18:58:20 +0000

Kevin, “EMH suggests that the current distribution is the correct one because the markets are the most efficient possible way of determining the correct values.” And that is because the market has so much control over tax rates and government spending? Maybe the current distribution post-government-tax-slurp is at its most efficient, but that isn’t really what we are discussing. I can’t believe this debate dropped so far down into the nuts and bolts of if government bonds perform the same as investing in the market. Government bonds are just a stubstitue for increased taxes, while investments in the market do real work in that they create wealth.

By: John Quiggin

John Quiggin — Thu, 17 Feb 2005 05:17:19 +0000

Nicholas, costless borrowing is part of the standard version of the EMH used implicitly all the time, particularly when generic assumptions about the virtues of free markets are used as a basis for policy analysis. If you don’t believe strong versions of EMH, you should be wary of all such analysis (of course, you can still go for second-best arguments). For a lot of purposes the costless borrowing assumption is not a bad approximation for financial markets, which is where most empirical application takes place. Most direct, large-scale participants in these markets can borrow at low cost (that is, low margin above the market interest rate) so arbitrage arguments and similar work well. On the other hand, as we’ve seen it works very badly in predicting the equity premium.

By: Nicholas Weininger

Nicholas Weininger — Thu, 17 Feb 2005 02:36:06 +0000

John: yes, I agree, any version of the EMH strong enough to imply such borrowing ability is ipso facto false. Indeed, I wonder if you can cite examples of people claiming to believe in such a strong version. Certainly you yourself have discussed much weaker and more defensible versions in previous posts, and this one begins to smell of straw.

By: BigMacAttack

BigMacAttack — Thu, 17 Feb 2005 01:50:34 +0000

Jack, I don’t believe in much of an EP. (Data I saw did not seem to take transaction costs into account) So for me all investors are credit constrained when taking advantage of a snall or non-existent EP. So I pretty much agree with you. The argument for privatization is based on secondary fators. Less government spending and other factors. (I am really not a fan of private accounts.) Which is maybe what John was saying? If you have an EM you cannot have an EP. It seems to me that is true by definition.

By: Jack

Jack — Thu, 17 Feb 2005 00:38:40 +0000

bigmac, the difference it makes is that poor constrained investors might not be able to take appropriate advantage of equity investment if their social security contributions are paid into forward earnings linked annuities. Equities are expected to earn extra to compensate for their risk but that is not what is being left on the table. Historically equities have earned even more than supposedly necessary to compensate for the risk. This is the equity premium puzzle of Prescott and Mehra. In fact there are all sorts of complications with the theory—different people have different risk aversions, different liabilities and different fixed investments like house. The point is that there is no argument for private accounts that is compelling in the first order. No direct increase in investment, no obvious free uplift in investment results, nor even any major help on solvency as far as I can work out. Any such arrangement is likely to be very expensive too, perhaps as much as 100 times, certainly an order of magnitude. What there is in the proposal is mostly bizarrely political. Will social security funds become available to creditors? Will unused funds be heritable? Will the poor reveal hitherto invisible Randian heroism when deprived of a safety net for their old age? How much would go on fund management? $5bn a year? $10bn?

By: BIgMacAttack

BIgMacAttack — Wed, 16 Feb 2005 22:52:32 +0000

John Quiggin, ‘“But of course in any remotely realistic world A can’t do that [borrow at the real bond rate to finance her desired equity position]” which is why EMH is false and you need to look at the credit-constrained case.’ What difference does it make if they can or cannot? Even at a 1 – 3 % interest rate the return is significantly reduced? I mean how large an EP is being claimed? Presumablely stocks must pay some premium for the risk?

By: John Quiggin

John Quiggin — Wed, 16 Feb 2005 21:18:14 +0000

“But of course in any remotely realistic world A can’t do that [borrow at the real bond rate to finance her desired equity position]” which is why EMH is false and you need to look at the credit-constrained case.

By: Kevin Donoghue

Kevin Donoghue — Wed, 16 Feb 2005 18:59:39 +0000

Nicholas: cuts are a different kettle of fish. Abolishing both payroll taxes and payments to retirees increases the incentive to work, both for those currently employed and for the luckless retirees. We don’t need the EMH to tell us that. It is a much different proposition from swapping debt for equity, which is just shuffling paper claims. As for SS creating uncertainty, that’s true of any government policy and it is a useful argument against too-big government. It is also an argument against too-small government; there is a lot of uncertainty in failed states. The debate about the right size for government will never end. It seems to me there is a good case for some form of safety-net but there is a trade-off between generosity and preserving incentives.

By: Nicholas Weininger

Nicholas Weininger — Wed, 16 Feb 2005 18:02:40 +0000

Kevin D.: indeed, the existing system is in the hands of knaves and fools, and so is the reform process. Don’t mistake me for a supporter of the Bush plan. I favor straight-out cuts in SS over private accounts, in large part because I don’t think the government can be trusted to set up private accounts in a transparent or efficient way. But the validity or invalidity of John’s points doesn’t essentially change, I think, if you substitute cuts for accounts.

By: Nicholas Weininger

Nicholas Weininger — Wed, 16 Feb 2005 17:50:03 +0000

On reflection, my Investor A example concedes both too little and too much. In a narrow sense, John and Kevin D. are right: if the EMH is correct and this implies people can borrow costlessly and SS really just forced A to invest 12% of her income in Treasury bonds paying a market rate of interest, she could borrow 4% of her income at that same market rate, use her forced bonds to pay the interest, put the principal in equities and be no worse off. But of course in any remotely realistic world A can’t do that, and the reason is not just that real markets have borrowing costs, it’s because of the nature of SS itself. Both John’s footnote and my parenthetical “(effectively)” ignore too much. In fact SS is not the same as people being forced to put 12% of their income into government bonds, not even close. One reason is of course that SS has a large redistributionist component. But even ignoring that, there’s still the fact that SS benefits are set by the grace of Congress and can be changed arbitrarily at any time. When you buy a Treasury bond you’re buying a contractual promise from the government to pay you, the bondholder, a specific rate of return over a specific term. Paying SS taxes gets you no such promise. Now SS defenders will respond that simply abolishing SS tomorrow is politically unfeasible, perhaps almost as unfeasible as defaulting on the debt. But significant changes in SS benefits and/or taxes, and thus changes to the “effective rate of return” to SS taxpayers, are not only feasible but, as John’s footnote notes, almost certain to occur. And the likelihood of these changes means that SS itself creates uncertainty that raises the cost of getting one’s optimal debt-equity mix.

By: Kevin Donoghue

Kevin Donoghue — Wed, 16 Feb 2005 17:32:54 +0000

Nicolas Weininger, Certainly if the choice is between allocation of resources by an inefficient market, or by a corrupt and/or incompetent government, then many of us would sooner take our chances with the market. However the arguments for SS privatisation which I have seen do not include the assertion that the existing system is in the hands of knaves or fools. If it is then reform of the system is in those same grubby hands, so we should be highly suspicious. Actually, if the debate were about designing a system which minimises the government’s power to do harm, it would be a much healthier debate. But right now that is OT.