Economy – Donald Marron

Can Trump Make Mexico Pay for the Wall?

Mexico won’t willingly write the check for Donald Trump’s wall. So the president is hunting for a way to make Mexico pay.

That search isn’t going well.

Last week, press secretary Sean Spicer floated one idea: the destination-based cash flow tax. The DBCFT taxes imports and exempts exports. We import about $50 billion more from Mexico each year than we export. So the DBCFT could raise substantial revenue from trade with Mexico. Maybe Trump could earmark that money to pay for the wall?

Such earmarking sounds superficially plausible. But it has fundamental budget and logic flaws.

The budget problem is that Congress has other plans for that money. The DBCFT is the centerpiece of the House proposal for tax reform. House leaders insist reform will be revenue neutral. Any new money from the DBCFT will offset money lost from cutting business taxes. That leaves nothing for Trump’s wall.

Broader point: You can’t pay for anything with revenue-neutral tax reform (or, for that matter, with revenue-losing “tax relief”).

Trump may be more concerned with messaging than with these budget niceties. So he could still try to rhetorically link the DBCFT to paying for the wall.

But that leads to the logic problem. We run trade deficits with many countries. If the DBCFT makes Mexico pay for the wall, what does it make China pay for? Germany? Japan? Vietnam? And what about countries like Hong Kong, where America has a trade surplus? Are we paying them for something? And what happens when the wall has been paid for? Does Mexico become exempt from the DBCFT? Or does it start paying for something else?

These questions have no sensible answers. The DBCFT treats Mexico like every other nation, so it can’t make Mexico pay for the wall.

Some observers initially thought Spicer was suggesting a new tariff on Mexican imports. Most economists rightly hate that idea and fear it could spark retaliation against American products. And it seems clear that Spicer really meant the DBCFT. But let’s give that interpretation some credit. A tariff, unlike the DBCFT, could raise new revenue specifically from trade with Mexico.

But a tariff still faces a fundamental economics problem. A tariff doesn’t work like Las Vegas. Just because it targets Mexican products doesn’t mean the tax stays there. Instead, businesses will raise prices, passing some tax on to American customers. Consumers would pay more for cars, TVs, and avocados. Businesses would pay more for auto parts, trucks, and telecommunications equipment. Some burdens would decline over time as businesses shift to suppliers outside Mexico. But some shift of the burden to Americans is inevitable. A tariff would thus make American consumers and businesses, not just Mexicans, pay for Trump’s wall. And that’s without any retaliation.

If President Trump wants to target Mexico alone, he needs another strategy. Neither the DBCFT nor a tariff can make Mexico pay for the wall.

The Federal Reserve is Not Ending Its Stimulus

Yesterday, the Federal Reserve confirmed that it would end new purchases of Treasury bonds and mortgage-backed securities (MBS)—what’s known as quantitative easing—in October. In response, the media are heralding the end of the Fed’s stimulus:

“Fed Stimulus is Really Going to End and Nobody Cares,” says the Wall Street Journal.

“Federal Reserve Plans to End Stimulus in October,” reports the BBC.

This is utterly wrong.

What the Fed is about to do is stop increasing the amount of stimulus it provides. For the mathematically inclined, it’s the first derivative of stimulus that is going to zero, not stimulus itself. For the analogy-inclined, it’s as though the Fed had announced (in more normal times) that it would stop cutting interest rates. New stimulus is ending, not the stimulus that’s already in place.

The Federal Reserve has piled up more than $4 trillion in long-term Treasuries and MBS, thus forcing investors to move into other assets. There’s great debate about how much stimulus that provides. But whatever it is, it will persist after the Fed stops adding to its holdings.

P.S. I have just espoused what is known as the “stock” view of quantitative easing, i.e., that it’s the stock of assets owned by the Fed that matters. A competing “flow” view holds that it’s the pace of purchases that matters. If there’s any good evidence for the “flow” view, I’d love to see it. It may be that both matter. In that case, my point still stands: the Fed will still be providing stimulus through the stock effect.

P.P.S. I wrote about this last year during the tapering debate. In the lingo of that post, the Fed is moving from quantitative easing to quantitative accommodation. To actually eliminate the stimulus, the Fed would have to move on to quantitative tightening.

CEA’s New Weekly Economic Index

The Council of Economic Advisers just released an interesting paper examining the macroeconomic harm from the government shutdown and debt limit brinksmanship. To do so, they created a Weekly Economic Index from data that are released either daily or weekly (and weren’t delayed by the shutdown). These data include measures of consumer sentiment, unemployment claims, retail sales, steel production, and mortgage purchase applications.

The headline result: They estimate that the budget showdown cost about 120,000 jobs by October 12.

Looking ahead, I wonder whether this index might prove useful in identifying future shocks to the economy, whether positive or negative. As the authors note:

In normal times estimating weekly changes in the economy is likely to detract from the focus on the more meaningful longer term trends in the economy which are best measured over a monthly, quarterly, or even yearly basis. But when there is a sharp shift in the economic environment, analyzing high-frequency changes with only a very short lag since they occurred can be very valuable.

P.S. I am pleased to see CEA come down on the right side of the “brinksmanship” vs. “brinkmanship” debate.

Uncle Sam Is Smaller (Relatively) Than We Thought

At 8:30 this morning, Uncle Sam suddenly shrunk.

Federal spending fell from 21.5 percent of gross domestic product to 20.8 percent, while taxes declined from 17.5 percent to 16.9 percent.

To be clear, the government is spending and collecting just as much as it did yesterday. But we now know that the U.S. economy is bigger than we thought. GDP totaled $16.2 trillion in 2012, for example, about $560 billion larger than the Bureau of Economic Analysis previously estimated. That 3.6 percent boost reflects the Bureau’s new accounting system, which now treats research and development and artistic creation as investments rather than immediate expenses.

In the days and months ahead, analysts will sort through these and other revisions (which stretch back to 1929) to see how they change our understanding of America’s economic history. But one effect is already clear: the federal budget is smaller, relative to the economy, than previously thought.

The public debt, for example, was on track to hit 75 percent of GDP at year’s end; that figure is now 72.5 percent. Taxes had averaged about 18 percent of GDP over the past four decades; now that figure is about 17.5 percent. Average spending similarly got marked down from 21 percent of GDP to about 20.5 percent.

These changes have no direct practical effect—federal programs and tax collections are percolating along just as before. But they will change how we talk about the federal budget.

Measured against an economy that is bigger than we thought, Uncle Sam now appears slightly smaller. Wonks need to update their budget talking points accordingly.

After 20 Years, Sweden’s Labor Market Still Hasn’t Recovered

By many accounts, Sweden did a great job managing its financial and fiscal crises in the early 1990s. But more than 20 years onward, its unemployment rate is still higher than before the crisis, as noted in a recent commentary by the Cleveland Fed’s O. Emre Ergungor (ht: Torsten Slok):

And its labor force participation rate is still lower:

Does Sweden’s experience portend similar problems for the United States? Ergungor thinks not. Instead, he attributes this shift to a structural change in Swedish policy that has no direct analog in the United States:

One study of public sector employment policies published in 2008 by Hans-Ulrich Derlien and Guy Peters indicates that for many years, the labor market had been kept artificially tight by government policies that replaced disappearing jobs in failing industries with jobs in the government. The financial crisis was the breaking point of an economic system that had grown increasingly more unstable over a long period of time. It was a watershed event that marked the end of an unsustainable structure and the beginning of a new one. Public sector employment declined from 423,000 in 1985 to 240,000 in 1996 mainly through the privatization of large employers—like the Swedish postal service, the Swedish Telecommunications Administration, and Vattenfall, the electricity enterprise—and it has remained almost flat since then.

With such a large structural change, what came before the crisis may no longer be a reference point for what will come after. Having corrected the root of the problem, the Swedish labor market is now operating at a new equilibrium.

That doesn’t mean smooth sailing for the United States, as he discusses. But it does leave hope that perhaps we do better than Sweden in creating jobs in the wake of a financial crisis.

How Creative Tax Policy Can Substitute for Devaluation

Taxes are the Swiss Army Knife of economic and social policy. With enough ingenuity, you can attempt almost any policy goal, from encouraging health insurance to discouraging pollution to stimulating the economy, to name just three. Over at Bloomberg Businessweek, Rina Chandran explains yet another use: helping a troubled economy achieve the moral and economic equivalent of a currency devaluation, without actually devaluing. That’s particularly intriguing for countries in the Euro zone:

The idea of fiscal devaluation originates with John Maynard Keynes. [Harvard Professor Gita] Gopinath’s insight was to advocate fiscal devaluation for Europe’s beleaguered currency union in a 2011 paper she co-authored with her colleague Emmanuel Farhi and former student Oleg Itskhoki, now an assistant professor at Princeton. …

The paper examines a “remarkably simple alternative” that doesn’t require countries to abandon the euro and devalue their currencies to revive growth through exports, Gopinath says. By increasing value-added taxes while cutting payroll taxes, a government can affect gross domestic product, consumption, employment, and inflation much as a currency devaluation would.

The higher VAT raises the price of imported goods as foreign companies pay the levy on the products and services they export to that country. The lower payroll tax helps offset the extra sales tax for domestic companies, reducing the need for them to raise prices. Since exports are VAT-exempt, the payroll cost saving allows producers to sell goods more cheaply overseas, simulating the effect of a weaker currency, according to the paper. The policy also can help on the fiscal front, as increased competitiveness can lead to higher tax revenue, Gopinath says.

Why Many Economists Favor Immigration

In today’s New York Times, Greg Mankiw offers a nice explanation for why many economists favor immigration:

First, many economists, especially conservative ones, have a libertarian streak. Ever since Adam Smith taught us about the wonders of free markets and the magic of the invisible hand, we have been loath to prohibit mutually advantageous trades between consenting adults. If an American farmer wants to hire a worker to pick fruits and vegetables, the fact that the worker happens to have been born in Mexico does not seem a compelling reason to stop the transaction.

Second, many economists, especially liberal ones, have an egalitarian streak. They follow the philosopher John Rawls’s theory of justice in believing that policy should be particularly attuned to its impact on the least fortunate. When thinking about immigration, there is little doubt that the least fortunate, and the ones with the most at stake in the outcome, are the poor workers who yearn to come to the United States to make a better life for themselves and their families.

Third, economists of all stripes recognize that our own profession has benefited greatly from an influx of talent from abroad.

I’d add a fourth item to Greg’s list: Many economists, both liberal and conservative, have a cosmopolitan streak. They thus place great weight on the wellbeing of foreigners, not just native Americans. From the libertarian side, that means caring about the liberty of the Mexican worker, not just the American farmer. And from the egalitarian side, that means caring about the poor immigrant worker seeking a better life, not just the person who employs them or the resident worker competing for similar work.

Such cosmopolitanism isn’t universal, of course. For example, some economists oppose greater immigration on the egalitarian, but non-cosmopolitan, concern that it would drive down wages for existing U.S. workers. On average, though, that perspective seems less common among economists than among non-economists.

Why Is the Economic Recovery So Slow?

The U.S. economy has recovered slowly since the official end of the Great Recession in 2009. Mark Lasky and Charles Whalen of the Congressional Budget Office just released a study asking why. Their answer: two-thirds of the slowness (relative to past recoveries) reflects weak growth in the economy’s potential. The potential labor force, capital stock, and productivity are all growing less rapidly than they did following past recessions. The other third reflects cyclical weakness, particularly in government, housing, and consumer spending.

CBO’s Maureen Costantino and Jonathan Schwabish turned those results into a nifty infographic (click to make larger):

When Economists Run for President

In real life, economists never get elected president (sorry Larry Kotlikoff), probably with good reason.

In fiction, though, our odds are better. Jed Barlett is one of the most popular presidents ever, and a Nobel Laurate to boot.

And now the Planet Money team is offering up a new, faux candidate for 2012. His six-point plan for getting America going again — built on the suggestions of a diverse group of well-known economists — is five parts tax reform (repeal the mortgage interest deduction, repeal the tax benefit for employer-provided health insurance, eliminate the corporate income tax, institute a carbon tax, tax consumption not saving) and one part marijuana legalization.

Here’s his first campaign ad:

I don’t think President Obama, Governor Romney, or even Governor Johnson have much to fear.

Swedish Lessons for EU Bank Owners

Sweden is rightly admired for the way it handled its banking crisis in the early 1990s (and its ensuing fiscal challenges).

In yesterday’s Financial Times, Dag Detter looks back for some lessons for Europe as it struggles to resolve its current banking crisis:

When the Swedish banking system crashed in 1992, the government faced an identical problem. Yet in the end, Sweden’s taxpayers came very well out of their experience of bank ownership. How was this achieved, and what lessons can be learnt for Madrid and the EU’s new bank resolution policy?

First, move fast. Spain and bankers have been in denial about the scale of bad lending for too long. The Rajoy government rightly came to office this year on a promise to force banks to write down bad loans. The situation has predictably turned out to be much worse than assumed, but their policy is the right one. Painful as it is, transparency on the scale of bad debt is vital for the market to be confident that it understands risk and uncertainty in Spain and can therefore price it properly.

Catharsis can come only with a purge of bad assets. Banks should present plans to handle problem assets, strengthen controls and improve efficiency. This might require government or even supranational assistance in the orderly closure of moribund institutions. In addition, “bad” bank parts must be demerged from the “healthy” to facilitate recapitalisation. The state should never be left holding the junk while the healthy part of a bank wriggles free.

Second, maintain commercial principles. In Sweden, each state bank investment was made on what would have been commercial terms in a normal market, always with the aim of maintaining competitive neutrality. The terms of the investment must be structured in a way that gives the bank and its owners no grounds to request more state funding than is necessary, combined with the incentives to facilitate a swift exit. Yet it must be sufficient to ensure that the bank can return to profitability without additional government assistance.

The whole piece is worth a read.