Source: Office of Budget and Management (2010)
Showing posts with label U.S. Economy. Show all posts
Showing posts with label U.S. Economy. Show all posts
Sunday, May 02, 2010
Tuesday, April 20, 2010
INCOME INEQUALITY IN THE UNITED STATES
Sunday, April 11, 2010
VALUE-ADDED TAX FOR AMERICA?
Dan Mitchell wrote an interesting op-ed in NY Post (link) concerning the prospects of adopting a European-style value-added tax (VAT) in the United States.
Imposing a VAT would be detrimental to economic growth and productivity performance. If the U.S imposed the VAT, its spending levels would quickly approach the European spending levels. Indeed, the VAT is already used by OECD nations. In European Union, European Commission's Directive requires each country to harmonize value-added tax rate at the level of at least 15 percent. Federal spending in the U.S has already escalated. The consequence of $787 billion of stimulus measures is high public debt. Congressional Budget Office has forecasted the public debt to approach 70 percent of the GDP by 2012 and remain constant until 2020 (link). Rising costs of health care, entitlement spending and aging population have triggered government spending (link) and tax burden on the U.S firms and households. By 2020, health care spending is expected to reach 20 percent of the U.S GDP (link). Historical figures suggest a rather glimmering fiscal scenario for the United States in the next decade. In 1965, before the VAT spread across the European community, average tax burden of EU15 reached 27.7 percent of the GDP versus 24.7 percent in America. In 2006, the average tax burden for 15 developed European countries reached 39.8 percent. In United States, where VAT has not been introduced, average tax burden in 2006 remained close to the level of 1960s - at 28 percent of the GDP. The immediate consequence of VAT introduction in Europe was a surge in government spending. From 1965 to 2006, average government spending (as a share of the GDP) in the European Union increased by 17 percentage points while in America it increased by 7 percentage points. The total increase of spending growth in Europe and America is attributed to the widespread growth of the welfare state which includes entitlement spending and a growing cost of health care.
The economics of tax system is pretty straightforward. Alan Viard of the American Enterprise Institute (link) has outlined basic features of the VAT system. Contrary to the income tax system, VAT is a consumption tax. From the economic perspective, consumption tax is less distorting to economic behavior than the income tax. A pure VAT is tax at each stage of the supply chain. The taxation of individual income is a major distortion mostly because the source of direct taxation is labor supply. Introducing a tax on labor supply creates the so-called substitution effect where lower wage (w'=w(1-t)) is offset by a decrease in working hours and an increase in leisure hours either in pure leisure time or working more in household production or in the informal sector of the economy. Higher tax wedge in net wages has been the major factor behind fewer working hours in slow-growth European countries (Italy, France, Germany, Belgium etc.). The VAT is not as damaging as the income tax since the tax rate on individual consumption is applied when the income is already earned, so that income earning is not distorted. From a pure economic perspective, consumption taxation is more appropriate than income taxation mostly because the price elasticity of consumption goods is lower than price elasticity of labor supply. The consumption tax is based on the so-called Ramsey rule which states that the optimal tax rate is the inverse of the price elasticity of demand for a particular good ((t*=1/-dQ/dP*(P/Q)). It follows that on consumption goods with lower elasticity of demand, higher tax rate should be applied since the deadweight loss is smaller than in consumption goods with high price elasticity of demand. For example, price elasticity of demand is very low in goods such as gasoline since there's no close substitutes to gasoline. On the other hand, the elasticity of demand is pretty high in goods such as Big Mac or Coca Cola since there's a lot of substitutes for these goods (Subway snacks, Pepsi etc.) and a tax rate on Big Mac or Coca Cola can easily divert consumers to consume more Subway snacks, Pepsi or other goods.
While the introduction of a VAT is less income-distorting than a direct income tax, the imposition of both tax structures is a negative effect on economic growth, productivity and employment. Aside from the harmful taxation of income, the introduction of the VAT would further hamper individual consumption, raise consumer and producer prices and harm the manufacturing activity. One advantage of the VAT is a low cost and easy way of raising revenue. In economic theory, a uniform consumption tax is preferable to the income tax mostly due to fewer distortion in generating income which is the key feature of economic growth. A VAT also avoids imposing additional penalizing disincetives to labor supply and productivity.
Congressional Budget Office (link) has recently released Budget Outlook 2010, in which it laid out future perspectives of America's fiscal policy. Assuming an exerting pressure of tax burden in the coming years, the CBO has predicted the individual income taxes to grow from 6.4 percent in 2009 to 10.9 percent of the GDP by 2020. Imposing a VAT on top of the existing income tax would further reduce real disposable income and individual consumption. If a VAT were implemented on the federal or state level, there would be a significant and immediate increase in effective tax rates. The evolution of federal effective tax rates from 1970 to 2001 (link) shows a trend of decreasing effective tax rates and a growing after-tax income in all income quintiles.
The introduction of a VAT would dramatically change the US fiscal map. An article from OECD Observer (link) shows a comparative tax revenue distribution for the U.S, Europe and Japan. Back in 1999, the U.S was the only global economic giant with tax revenue from goods and service taxation of less than 30 percent of all tax revenues. The share remained steady until now. The non-existence of the VAT in America has contained the growth of overall tax burden. In 2004, total government revenues were 32 percent of the US GDP, far below the shares of high-tax countries. In Sweden, government revenue presented 59 percent of the GDP. While the U.S tax burden, measured as a share of government revenue in GDP, stayed below the level of France (50 percent), Germany (43 percent), Italy (45 percent), the introduction of a VAT may quickly turn America into a European-style country with high tax burden and benign economic growth. The international data (link) on total tax revenue in 2007 show that total tax revenue in the U.S presented 28.3 percent of the GDP. In 2007, taxes on goods and services presented about 4.7 percent of the US GDP; about three times less the level in Sweden (12.9 percent of the GDP) and four times less the level in Denmark (16.3 percent of the GDP). If a revenue from a VAT captured approximately 9.5 percent of the US GDP, America's tax revenue from a VAT would present about 14.2 percent of the GDP (9.5+4.7=14.2) comparable with high-tax countries such as Finland, Austria or Belgium and even more than in France.
Although the VAT is an easily applied method of taxing general consumption, imposing a VAT on the federal and state level would seriously harm America's future growth, investment, personal consumption, manufacturing activity and productivity. It would make America look like a typical slow-growth European welfare state for the first time.
Imposing a VAT would be detrimental to economic growth and productivity performance. If the U.S imposed the VAT, its spending levels would quickly approach the European spending levels. Indeed, the VAT is already used by OECD nations. In European Union, European Commission's Directive requires each country to harmonize value-added tax rate at the level of at least 15 percent. Federal spending in the U.S has already escalated. The consequence of $787 billion of stimulus measures is high public debt. Congressional Budget Office has forecasted the public debt to approach 70 percent of the GDP by 2012 and remain constant until 2020 (link). Rising costs of health care, entitlement spending and aging population have triggered government spending (link) and tax burden on the U.S firms and households. By 2020, health care spending is expected to reach 20 percent of the U.S GDP (link). Historical figures suggest a rather glimmering fiscal scenario for the United States in the next decade. In 1965, before the VAT spread across the European community, average tax burden of EU15 reached 27.7 percent of the GDP versus 24.7 percent in America. In 2006, the average tax burden for 15 developed European countries reached 39.8 percent. In United States, where VAT has not been introduced, average tax burden in 2006 remained close to the level of 1960s - at 28 percent of the GDP. The immediate consequence of VAT introduction in Europe was a surge in government spending. From 1965 to 2006, average government spending (as a share of the GDP) in the European Union increased by 17 percentage points while in America it increased by 7 percentage points. The total increase of spending growth in Europe and America is attributed to the widespread growth of the welfare state which includes entitlement spending and a growing cost of health care.
The economics of tax system is pretty straightforward. Alan Viard of the American Enterprise Institute (link) has outlined basic features of the VAT system. Contrary to the income tax system, VAT is a consumption tax. From the economic perspective, consumption tax is less distorting to economic behavior than the income tax. A pure VAT is tax at each stage of the supply chain. The taxation of individual income is a major distortion mostly because the source of direct taxation is labor supply. Introducing a tax on labor supply creates the so-called substitution effect where lower wage (w'=w(1-t)) is offset by a decrease in working hours and an increase in leisure hours either in pure leisure time or working more in household production or in the informal sector of the economy. Higher tax wedge in net wages has been the major factor behind fewer working hours in slow-growth European countries (Italy, France, Germany, Belgium etc.). The VAT is not as damaging as the income tax since the tax rate on individual consumption is applied when the income is already earned, so that income earning is not distorted. From a pure economic perspective, consumption taxation is more appropriate than income taxation mostly because the price elasticity of consumption goods is lower than price elasticity of labor supply. The consumption tax is based on the so-called Ramsey rule which states that the optimal tax rate is the inverse of the price elasticity of demand for a particular good ((t*=1/-dQ/dP*(P/Q)). It follows that on consumption goods with lower elasticity of demand, higher tax rate should be applied since the deadweight loss is smaller than in consumption goods with high price elasticity of demand. For example, price elasticity of demand is very low in goods such as gasoline since there's no close substitutes to gasoline. On the other hand, the elasticity of demand is pretty high in goods such as Big Mac or Coca Cola since there's a lot of substitutes for these goods (Subway snacks, Pepsi etc.) and a tax rate on Big Mac or Coca Cola can easily divert consumers to consume more Subway snacks, Pepsi or other goods.
While the introduction of a VAT is less income-distorting than a direct income tax, the imposition of both tax structures is a negative effect on economic growth, productivity and employment. Aside from the harmful taxation of income, the introduction of the VAT would further hamper individual consumption, raise consumer and producer prices and harm the manufacturing activity. One advantage of the VAT is a low cost and easy way of raising revenue. In economic theory, a uniform consumption tax is preferable to the income tax mostly due to fewer distortion in generating income which is the key feature of economic growth. A VAT also avoids imposing additional penalizing disincetives to labor supply and productivity.
Congressional Budget Office (link) has recently released Budget Outlook 2010, in which it laid out future perspectives of America's fiscal policy. Assuming an exerting pressure of tax burden in the coming years, the CBO has predicted the individual income taxes to grow from 6.4 percent in 2009 to 10.9 percent of the GDP by 2020. Imposing a VAT on top of the existing income tax would further reduce real disposable income and individual consumption. If a VAT were implemented on the federal or state level, there would be a significant and immediate increase in effective tax rates. The evolution of federal effective tax rates from 1970 to 2001 (link) shows a trend of decreasing effective tax rates and a growing after-tax income in all income quintiles.
The introduction of a VAT would dramatically change the US fiscal map. An article from OECD Observer (link) shows a comparative tax revenue distribution for the U.S, Europe and Japan. Back in 1999, the U.S was the only global economic giant with tax revenue from goods and service taxation of less than 30 percent of all tax revenues. The share remained steady until now. The non-existence of the VAT in America has contained the growth of overall tax burden. In 2004, total government revenues were 32 percent of the US GDP, far below the shares of high-tax countries. In Sweden, government revenue presented 59 percent of the GDP. While the U.S tax burden, measured as a share of government revenue in GDP, stayed below the level of France (50 percent), Germany (43 percent), Italy (45 percent), the introduction of a VAT may quickly turn America into a European-style country with high tax burden and benign economic growth. The international data (link) on total tax revenue in 2007 show that total tax revenue in the U.S presented 28.3 percent of the GDP. In 2007, taxes on goods and services presented about 4.7 percent of the US GDP; about three times less the level in Sweden (12.9 percent of the GDP) and four times less the level in Denmark (16.3 percent of the GDP). If a revenue from a VAT captured approximately 9.5 percent of the US GDP, America's tax revenue from a VAT would present about 14.2 percent of the GDP (9.5+4.7=14.2) comparable with high-tax countries such as Finland, Austria or Belgium and even more than in France.
Although the VAT is an easily applied method of taxing general consumption, imposing a VAT on the federal and state level would seriously harm America's future growth, investment, personal consumption, manufacturing activity and productivity. It would make America look like a typical slow-growth European welfare state for the first time.
Sunday, March 21, 2010
TEXAS VS. CALIFORNIA
There's an interesting story from Washington Examiner (link) discussing the coming economic crisis in California (which has been notably called "The Greece of America") and the flourising economy in Texas which enjoyed a decade of robust growth, low taxes, favorable demographic outlook and superior public services. Not surprisingly, unions in free labor market in Texas did not allow public sector unions extracting $100 million from taxpayers for TV-adds in defence of the status quo for public employees:
"Californians have responded by leaving the state. From 2000 to 2009, the Census Bureau estimates, there has been a domestic outflow of 1,509,000 people from California -- almost as many as the number of immigrants coming in. Population growth has not been above the national average and, for the first time in history, it appears that California will gain no House seats or electoral votes from the reapportionment following the 2010 census... Texas is a different story. Texas has low taxes -- and no state income taxes -- and a much smaller government. Its legislature meets for only 90 days every two years, compared with California's year-round legislature. Its fiscal condition is sound. Public employee unions are weak or nonexistent."
Thursday, December 03, 2009
ECONOMIC GEOGRAPHY AND THE RECESSION
New York Times published an interesting geographic map of the recession in the U.S (link)
Saturday, November 21, 2009
FISCAL POLICY AND DEFICIT BOMB
Douglas Holtz-Eakin, former CBO director, discussed the negative effects of the new fiscal policy in the U.S (link).
Wednesday, November 11, 2009
U.S ECONOMIC RECOVERY AND MACROECONOMIC OUTLOOK IN 2009/2010
The latest macroeconomic data from major world economies suggested that the recessionary contraction is likely to be ended in the light of positive news on GDP growth and midterm macroeconomic outlook. However, the road of the economic recovery remains uncertain. The policymakers responded to the great contraction of 2008 by decreasing interest rates close to zero rate. Massive injections of monetary stimulus boosted liquidity and attempted to accelerate credit expansion. However, monetary stimulus such as TARP in the U.S encouraged excess reserves. Thus, the banking sector published significant quarterly results as the stimulus package covered the overall losses from the credit crunch and subprime mortgage crisis of the previous year. In this brief article, I outline the economic recovery in the U.S in the ongoing year.
In Q3, the U.S economy grew by 2.4 percent despite the negative unemployment figures. While the U.S productivity grew by 6.8 percent in Q2:09 and by 9.8 percent in Q3:09, the unemployment rate is expected to reach 10.5 percent in December. The $787 billion stimulus from Obama administration to the ailing industries did little to prevent the fallout of demand and the financial difficulties of many firms. In fact, most of the stimulus has not already been spent. In spite of enormous fiscal emergency aid, the Obama administration effectively nationalized the auto industry as Detroit's auto industry declared bankruptcy. The auto industry is likely to recover gradually. Eventually, the fall of Detroit's giants was more likely a consequence of auto industry's inability to cope with high labor cost and fringe health and pension benefits.
The underlying economic theory and evidence teach that massive government intervention in the economy is inefficient as if government bailout hadn't occured. In Q3:09, financial industry posted significant quarterly earnings. Monetary stimulus inflated another asset bubble which translated into highly prospective annual data and higher volatility. Morgan Stanley's annual stock return currently stands at 133.4 percent (link). On the other hand, stock markets rallied in the light of significant quarterly earnings of the banking and financial sector. In one year, Dow Jones Industrial Average grew by 18.27 percent (link), S&P 500 increased by 22.16 percent (link) while Nasdaq Composite's annual growth rate stands at 36.91 percent (link). Stock markets rallied in the light of favorable earnings projections and cost reductions.
On the macroeconomic level, the U.S economy is likely to face a long L-shaped recovery. The underlying conditions are extremely low interest rate, high unemployment rate and high quarterly productivity growth rate. Much of the confidence in fiscal stimulus and expansionary fiscal policy was based on the initial assumption that spending multipliers will exceed 1 and boost short-term output and investment to reduce the negative output gap. Nevertheless, fiscal policy outlook remains sluggish and the prevailing evidence suggests that spending multipliers are hardly positive, except for when the unemployment rate exceeds 12 percent, causing a major fallout of capacity utilization. Robert Barro and Charles Redlick recently estimated the cost of fiscal stimulus. The Obama administration has already expressed commitment to raising the marginal tax rates. Tax increases are the unfortunate midterm alternative because excessive borrowing and the estimated 9.9 percent of the GDP fiscal deficit in 2009 (link) has already downgraded sovereign U.S debt outlook. Redlick and Barro showed that one-period lagged increase in the average marginal tax rate reduces, GDP growth by 0.56 percentage point. The overall effect on consumption purchases is -0.29 and the overall effect on investment is -0.35, both statistically significant at 99 percent.
The U.S dollar further depreciated against the euro (link), increasing the U.S inflation rate above the expected target, partly as a result of the increase in short-term yield on Treasury bonds. Purchases of Treasury bonds effectively increased demand for U.S dollars and triggered short-term depreciation trend. An effective reduction of fiscal deficit in the coming years is a necessary condition for mitigating the negative effects of U.S current account deficit. As fiscal deficit raises demand for imports in the U.S, real depreciation of the real effective exchange rate raises relative prices in the tradable sector compared to non-tradable sector. The main highlights of U.S economy recovery will be focused on restrictive fiscal policy and policy interest rates. Zero interest ground is a real disadvantage in economic recovery, mainly because the negative output gap and the Fed is likely to face hard time trading-off between higher inflation if interest rates remains at historic lows while the real sector's credit demand could surge and potential output contraction in the coming quarterly periods if the Fed will raised targeted federal funds rates. In the latter scenario, the U.S economy could repeat the Japanese disease from the 1990s, being faced with long, sluggish and slow economic recovery that could last for several years.
In Q3, the U.S economy grew by 2.4 percent despite the negative unemployment figures. While the U.S productivity grew by 6.8 percent in Q2:09 and by 9.8 percent in Q3:09, the unemployment rate is expected to reach 10.5 percent in December. The $787 billion stimulus from Obama administration to the ailing industries did little to prevent the fallout of demand and the financial difficulties of many firms. In fact, most of the stimulus has not already been spent. In spite of enormous fiscal emergency aid, the Obama administration effectively nationalized the auto industry as Detroit's auto industry declared bankruptcy. The auto industry is likely to recover gradually. Eventually, the fall of Detroit's giants was more likely a consequence of auto industry's inability to cope with high labor cost and fringe health and pension benefits.
The underlying economic theory and evidence teach that massive government intervention in the economy is inefficient as if government bailout hadn't occured. In Q3:09, financial industry posted significant quarterly earnings. Monetary stimulus inflated another asset bubble which translated into highly prospective annual data and higher volatility. Morgan Stanley's annual stock return currently stands at 133.4 percent (link). On the other hand, stock markets rallied in the light of significant quarterly earnings of the banking and financial sector. In one year, Dow Jones Industrial Average grew by 18.27 percent (link), S&P 500 increased by 22.16 percent (link) while Nasdaq Composite's annual growth rate stands at 36.91 percent (link). Stock markets rallied in the light of favorable earnings projections and cost reductions.
On the macroeconomic level, the U.S economy is likely to face a long L-shaped recovery. The underlying conditions are extremely low interest rate, high unemployment rate and high quarterly productivity growth rate. Much of the confidence in fiscal stimulus and expansionary fiscal policy was based on the initial assumption that spending multipliers will exceed 1 and boost short-term output and investment to reduce the negative output gap. Nevertheless, fiscal policy outlook remains sluggish and the prevailing evidence suggests that spending multipliers are hardly positive, except for when the unemployment rate exceeds 12 percent, causing a major fallout of capacity utilization. Robert Barro and Charles Redlick recently estimated the cost of fiscal stimulus. The Obama administration has already expressed commitment to raising the marginal tax rates. Tax increases are the unfortunate midterm alternative because excessive borrowing and the estimated 9.9 percent of the GDP fiscal deficit in 2009 (link) has already downgraded sovereign U.S debt outlook. Redlick and Barro showed that one-period lagged increase in the average marginal tax rate reduces, GDP growth by 0.56 percentage point. The overall effect on consumption purchases is -0.29 and the overall effect on investment is -0.35, both statistically significant at 99 percent.
The U.S dollar further depreciated against the euro (link), increasing the U.S inflation rate above the expected target, partly as a result of the increase in short-term yield on Treasury bonds. Purchases of Treasury bonds effectively increased demand for U.S dollars and triggered short-term depreciation trend. An effective reduction of fiscal deficit in the coming years is a necessary condition for mitigating the negative effects of U.S current account deficit. As fiscal deficit raises demand for imports in the U.S, real depreciation of the real effective exchange rate raises relative prices in the tradable sector compared to non-tradable sector. The main highlights of U.S economy recovery will be focused on restrictive fiscal policy and policy interest rates. Zero interest ground is a real disadvantage in economic recovery, mainly because the negative output gap and the Fed is likely to face hard time trading-off between higher inflation if interest rates remains at historic lows while the real sector's credit demand could surge and potential output contraction in the coming quarterly periods if the Fed will raised targeted federal funds rates. In the latter scenario, the U.S economy could repeat the Japanese disease from the 1990s, being faced with long, sluggish and slow economic recovery that could last for several years.
Saturday, September 26, 2009
HOW FISCAL AND MONETARY POLICY LED TO THE GREAT DEPRESSION
In the recent edition of WSJ, Arthur Laffer highlighted (link) how mismanaged fiscal policy during Hoover and Roosevelt administration led and prolonged the Great depression, and how contractionary monetary policy let it happen.
Thursday, August 06, 2009
ANTITRUST, MARKETS AND COMPETITION
Earlier today, I read Steve Forbes's discussion (link) of recent antitrust reaction to the announced Yahoo-Microsoft search-engine global partnership deal (here and here) by the Department of Justice. The merger of Yahoo and Microsoft is ought to create a new competitor to tackle Google's supposed 75 percent market share in search advertising. Back in 2008, Department of Justice swatted the aligned Google-Yahoo search-advertising partnership, saying that "it would have furthered Google's monopoly"(link). Google is currently also under investigation by Department of Justice which accusses Google of copyright infringement in company's book-scanning project (link). In addition, Christine Varney, Obama's antitrust appointee at the Department of Justice, targeted Google's dominance in search-ad market by blaming the company for "starting to colonize the emerging cloud-computing industry and amassing enormous market power" which customers would hardly escape.
The antitrust policy enhanced by Sherman Act, Clayton Act and Robinson-Patman Act prohibits the so-called "predatory behavior" that could restrain trade, induce monopolization efforts or impose unfair trade practices such as price discrimination. The antitrust targeting of Google has been inspired by the antitrust case from 1964 United States vs. Aluminium Company of America in which the court, headed by Judge Learned Hand, laid down a landmark decision that "under certain circumstances, a company may come to dominate its field through superior skill, foresight and industry." (here, here and here).
Donald Marron, former CEA economist, recently wrote a nice piece on how Google may defend itself against Department's potential antitrust investigation (link). First, Dept. of Justice will face a difficult task in defining Google's relevant market. Antitrust commentators often point out that Google possesses more than 70 percent of revenues in search-advertising market. However, Google's top antitrust attorney say that such definition of the relevant market is too narrow, arguing that the company actually receives less than 2 percent of revenues from search-ad market. The merger of Yahoo and Microsoft's internet search-engines could deteriorate Google's market share.
The enforcement of antitrust policy in preserving competitive market structures has resulted in complete failures several times. Recently, the European Commission imposed € 1.06 billion fine on Intel Corporation for exercising illegal practices such as giving loyalty discounts and implicit rebates to computer manufacturers and major retailer under the condition that Intel's chips are integrated into CPUs. The Commission argued that such "illegal practices" prevented customers from choosing alternative products (link) and thus, Intel supposedly abused the dominant position. That is against the provisions of EC Treaty.
The enactment of antitrust policy relies on the idea of competitive market structures. Microeconomic theory teaches that a monopoly leads to a deadweight loss and, thus, its relative efficiency is inferior to competitive market structure which operate under zero-profit assumption. However, the classic microeconomic theory neglects economies of scale in industries with significant fixed costs and entry costs such as high tech, health-care and airline.
However, antitrust policy embodied in Clayton Act, Sherman Act and other legislative acts, often leads to protectionist pressures from interest groups since the enforcement of antitrust is driven by the political process. Thomas DiLorenzo, famous Austrian economist, showed how interest group use lobbying pressures to exercise antitrust policy in favor of protecting competitors rather than competition (link).
In recent years Google acquired several smaller companies. The Federal Trade Commission and Dept. of Justice, for instance, put the acquisition of DoubleClick in 2008 under investigation. However, acquisitions in tech industry could produce significant efficiencies in distribution and consumer prices (link).
The notion of Sherman Act is that practices that restrain trade are illegal and doomed to be prosecuted. However, antitrust enforcers should recognized that high fixed costs and entry costs are not the result of market action or conspiracy but natural obstacle. Thus, industrial organization in technology, retail, health care and airline industries, enables significant economies of scale through lower average costs of production. This requires high levels of innovation including merging resources and joint cooperation. By the token of perfect competition for instance, Wal-Mart should be broken (link). If federal antitrust enforces forced Wal-Mart to split into more parts, gains in distribution which enable low prices and various discounts, would diminish considerably.
Thus, the real aim of antitrust enforcement should not be to prosecute successful firms and deprive them of productive gains, but to prevent alledged conspiracy that inhibits market entry and harms the consumers. In a free market, natural monopolies are short-lived and challenged by either new entrants or international competition.
The antitrust policy enhanced by Sherman Act, Clayton Act and Robinson-Patman Act prohibits the so-called "predatory behavior" that could restrain trade, induce monopolization efforts or impose unfair trade practices such as price discrimination. The antitrust targeting of Google has been inspired by the antitrust case from 1964 United States vs. Aluminium Company of America in which the court, headed by Judge Learned Hand, laid down a landmark decision that "under certain circumstances, a company may come to dominate its field through superior skill, foresight and industry." (here, here and here).
Donald Marron, former CEA economist, recently wrote a nice piece on how Google may defend itself against Department's potential antitrust investigation (link). First, Dept. of Justice will face a difficult task in defining Google's relevant market. Antitrust commentators often point out that Google possesses more than 70 percent of revenues in search-advertising market. However, Google's top antitrust attorney say that such definition of the relevant market is too narrow, arguing that the company actually receives less than 2 percent of revenues from search-ad market. The merger of Yahoo and Microsoft's internet search-engines could deteriorate Google's market share.
The enforcement of antitrust policy in preserving competitive market structures has resulted in complete failures several times. Recently, the European Commission imposed € 1.06 billion fine on Intel Corporation for exercising illegal practices such as giving loyalty discounts and implicit rebates to computer manufacturers and major retailer under the condition that Intel's chips are integrated into CPUs. The Commission argued that such "illegal practices" prevented customers from choosing alternative products (link) and thus, Intel supposedly abused the dominant position. That is against the provisions of EC Treaty.
The enactment of antitrust policy relies on the idea of competitive market structures. Microeconomic theory teaches that a monopoly leads to a deadweight loss and, thus, its relative efficiency is inferior to competitive market structure which operate under zero-profit assumption. However, the classic microeconomic theory neglects economies of scale in industries with significant fixed costs and entry costs such as high tech, health-care and airline.
However, antitrust policy embodied in Clayton Act, Sherman Act and other legislative acts, often leads to protectionist pressures from interest groups since the enforcement of antitrust is driven by the political process. Thomas DiLorenzo, famous Austrian economist, showed how interest group use lobbying pressures to exercise antitrust policy in favor of protecting competitors rather than competition (link).
In recent years Google acquired several smaller companies. The Federal Trade Commission and Dept. of Justice, for instance, put the acquisition of DoubleClick in 2008 under investigation. However, acquisitions in tech industry could produce significant efficiencies in distribution and consumer prices (link).
The notion of Sherman Act is that practices that restrain trade are illegal and doomed to be prosecuted. However, antitrust enforcers should recognized that high fixed costs and entry costs are not the result of market action or conspiracy but natural obstacle. Thus, industrial organization in technology, retail, health care and airline industries, enables significant economies of scale through lower average costs of production. This requires high levels of innovation including merging resources and joint cooperation. By the token of perfect competition for instance, Wal-Mart should be broken (link). If federal antitrust enforces forced Wal-Mart to split into more parts, gains in distribution which enable low prices and various discounts, would diminish considerably.
Thus, the real aim of antitrust enforcement should not be to prosecute successful firms and deprive them of productive gains, but to prevent alledged conspiracy that inhibits market entry and harms the consumers. In a free market, natural monopolies are short-lived and challenged by either new entrants or international competition.
Tuesday, August 04, 2009
THE IMPACT OF RECESSION: GERMANY vs. AMERICA
Douglas J. Elliott of the Brookings Institution compares the impact of this year's recession in the U.S and Germany (link):
"Equally importantly, Germany is justifiably proud of its prowess in exports, particularly industrial machinery and automobiles. Somewhere between 40% and 50% of Germany’s GDP comes from exports, depending on when and how you measure it. This is more than three times that of the U.S., although it is important to note that Germany is a considerably smaller country and is closely integrated with its European neighbors, who are the largest importers of German products. (If the U.S. counted sales from the Northeast to California as exports, our figure would be sharply higher than it is.) Germans view their trade surplus as a sign of virtue and the source of overseas investments that will carry the country through a future in which their aging population cuts back on output and necessarily lives more on the fruits of past labor."
"Equally importantly, Germany is justifiably proud of its prowess in exports, particularly industrial machinery and automobiles. Somewhere between 40% and 50% of Germany’s GDP comes from exports, depending on when and how you measure it. This is more than three times that of the U.S., although it is important to note that Germany is a considerably smaller country and is closely integrated with its European neighbors, who are the largest importers of German products. (If the U.S. counted sales from the Northeast to California as exports, our figure would be sharply higher than it is.) Germans view their trade surplus as a sign of virtue and the source of overseas investments that will carry the country through a future in which their aging population cuts back on output and necessarily lives more on the fruits of past labor."
Monday, July 06, 2009
CALIFORNIA'S DISMAL FISCAL LEGACY
At Bloomberg, Kevin Hassett wrote an article (link), discussing the shortcomings of California's fiscal crisis. According to the official estimates, California's annual budget deficit is likely to hit $26 billion. Dan Mitchell recently debated California's spending disease on CNBC (link). In addition, high government spending has deteriorated California's economic growth prospects. California has become a textbook case of gradual economic stagnation. Back in 1960, California's GDP per capita stood 24.5 percent above the U.S average. In 2008, it stood 7.4 percent above the U.S average. In recent decade, California has pursued an economic policy based largely on government's meddling into economic affairs.
The data from California's Department of Finance (link) reveal the outcome of economic mismanagement. In California, minimum wage has been growing steadily with a fascinating rate. In 1957, the minimum wage rate stood at $1.0 per hour. In 2008, the minimum wage rate was $8.0 per hour. That is 800 percent increase. In 2008, the minimum wage rate in California was 10.35 percent above the U.S average. The economics of minimum wage is simple: as unions set the minimum wage above the non-union rate, the employment drops and union members enjoy a wage premium and more employment protection. Larry Summers, the chairman of National Economic Council, nicely summarized how minimum wages, welfare payments and unemployment insurance spur long-term unemployment (link).
The macroeconomic outlook of California is not favorable. Seasonally-adjusted unemployment rate in May 2009 stood at 11.5 percent compared to 9.4 percent of the U.S average. Second, California's record-breaking budget deficit is largely a result of high tax burden and high government spending. In 2009, California's government spending is projected to reach $417.3 billion or almost 25 percent of California's gross state product (GSP). The share of government spending in the GSP is likely to climb higher when the 2009 GDP data will be released. Time-series data on fiscal policy (link) show that California's gross public debt in 2009 is set to hit $367.7 billion or 21.63 percent of state's gross product. A study conducted by Arthur Laffer & Moore Econometrics (link) showed that California's 10.3 percent top personal income tax rate is the second highest in the U.S, just behind the state of New York.
Not surprisingly, the overall employment grew only by 1.4 percent. In Texas, one of the most vibrant and highest-growing economies in the U.S, the overall employment grew by 2.9 percent. That is 107 percent difference. California's tax policy has also taxed dividends and capital gains by 10.3 percent tax rate, thus discouraging capital formation.
If California were an independent state, it would be the 8th largest economy in the world. However, tax and spending fine-tuning left a disastrous fiscal legacy of high public debt, deep budget deficits and stagnation of employment, productivity and income growth. To stabilize California's public finance and boost state's economic growth, the remedy of fiscal policy would include a drastic reduction of government spending, the ending of budget deficit and the creation of surplus. In addition, tax rates that penalize savings, work and investment should be slashed radically. It should not be neglected that entitlement spending is a hampering burden to the economy and is ought to be anchored by an official fiscal target. If California's public finances and fiscal policy continue the status quo, then, in a couple of years, California's economy will resemble France more closely than ever before.
The data from California's Department of Finance (link) reveal the outcome of economic mismanagement. In California, minimum wage has been growing steadily with a fascinating rate. In 1957, the minimum wage rate stood at $1.0 per hour. In 2008, the minimum wage rate was $8.0 per hour. That is 800 percent increase. In 2008, the minimum wage rate in California was 10.35 percent above the U.S average. The economics of minimum wage is simple: as unions set the minimum wage above the non-union rate, the employment drops and union members enjoy a wage premium and more employment protection. Larry Summers, the chairman of National Economic Council, nicely summarized how minimum wages, welfare payments and unemployment insurance spur long-term unemployment (link).
The macroeconomic outlook of California is not favorable. Seasonally-adjusted unemployment rate in May 2009 stood at 11.5 percent compared to 9.4 percent of the U.S average. Second, California's record-breaking budget deficit is largely a result of high tax burden and high government spending. In 2009, California's government spending is projected to reach $417.3 billion or almost 25 percent of California's gross state product (GSP). The share of government spending in the GSP is likely to climb higher when the 2009 GDP data will be released. Time-series data on fiscal policy (link) show that California's gross public debt in 2009 is set to hit $367.7 billion or 21.63 percent of state's gross product. A study conducted by Arthur Laffer & Moore Econometrics (link) showed that California's 10.3 percent top personal income tax rate is the second highest in the U.S, just behind the state of New York.
Not surprisingly, the overall employment grew only by 1.4 percent. In Texas, one of the most vibrant and highest-growing economies in the U.S, the overall employment grew by 2.9 percent. That is 107 percent difference. California's tax policy has also taxed dividends and capital gains by 10.3 percent tax rate, thus discouraging capital formation.
If California were an independent state, it would be the 8th largest economy in the world. However, tax and spending fine-tuning left a disastrous fiscal legacy of high public debt, deep budget deficits and stagnation of employment, productivity and income growth. To stabilize California's public finance and boost state's economic growth, the remedy of fiscal policy would include a drastic reduction of government spending, the ending of budget deficit and the creation of surplus. In addition, tax rates that penalize savings, work and investment should be slashed radically. It should not be neglected that entitlement spending is a hampering burden to the economy and is ought to be anchored by an official fiscal target. If California's public finances and fiscal policy continue the status quo, then, in a couple of years, California's economy will resemble France more closely than ever before.
Wednesday, June 10, 2009
THE COST OF FISCAL STIMULUS
The Economist observes that a growing public debt and exploding fiscal deficit is the foremost macroeconomic enemy of the U.S economy (link). Interestingly, Douglas W. Elmendorf, the head of CBO delivered a brilliant testimony (link) on the state of the economy, emphasizing the interest rate spread, the macroeconomic effects of financial crisis and the deflationary outlook for 2010. Below is a time series and the long-term projection of the U.S public debt in the percentage share of the GDP under three scenarios.
Source: Congressional Budget Office (link)
Source: Congressional Budget Office (link)
U.S TRADE DEFICIT AND CHINA
Today, Bloomberg reported (link) that April's trade deficit in the U.S increased by 2.2 percent. The recession in major trading partner sharply reduced external demand for U.S exports. As trade deficit has continued to grow, the U.S experienced significant investment inflows due to Fed's and external demand for Treasury bonds by which Chinese central bank accumulated massive foreign currency reserves. Consequently, the U.S dollar depreciated against the yuan, pushing up trade deficit. In the last three months, the yuan appreciated by 0.3 percent. In spite of the recession, the Chinese economy is set to expand by 7.5 percent annually in 2009. Thus, it is hard to understand why some U.S politicians repeatedly say that the yuan is overvalued.
Tuesday, March 10, 2009
LESSONS FROM THE GREAT DEPRESSION
Here is a link to Christina Romer's speech about the lessons from the Great Depression and the economic recovery of 2009, presented yesterday at the Brookings Institution.
Thursday, February 19, 2009
THE CURSE OF PUBLIC DEBT
John Steele Gordon wrote an article (link) about the history of U.S. national debt in the twilight of CBO's estimate of $1.2 trillion federal deficit before the stimulus package.
Monday, January 05, 2009
THE MOST EDUCATED TOWNS IN THE U.S
Here (link) is an interesting research conducted by Forbes. It is the list and specific charateristics of the most educated towns in the U.S.
Thursday, September 25, 2008
COMPETITION, MARKETS AND DISCRIMINATION
Professors' Gary S. Becker and Richard Posner articles on the economics of discrimination (here and here) gave me an interesting motivation to discuss some economic aspects of discrimination which is a popular question into the economic analysis.
The Framework of Labor Market
Discrimination is a relatively young and still fresh theme in economic analysis. It has been pioneered by professor Becker's The Economics of Discrimination (link). The analytical foundations of the economic analysis of discrimination can be found in the attempt to measure discrimination in the labor market and elsewhere by the empirical analysis. In a simple, two-variable model of labor market determined by wage and quantity of labor, there is not a unique equilibrium of demand and supply in the labor market. The demand for labor is downward sloping, reflecting the fact that lower wage (the price of labor) tends to induce the demand for labor. For example, if the wage for software engineer drops from 8 EUR per hour to 6,5 EUR per hour, then Google, for example, will certainly not feel reluctant to hire more skilled software engineers. It should be noted that the slope of labor demand curve is much flatter than demand curves in partial equlibrium models usually behave. The reason is that firms hire labor supply in order to maximize profits and firm's utility function. However, there is no simple marginal rate of substitution between labor and other means of production and that labor suppliers' knowledge, skills and profession determine the result of firm's production function. Also, there is not a unique picture of labor supply, since workers possess different preferences regarding the allocation of time between leisure and consumption. For example, productivity gains by Google engineers may induce them either to increase the amount of leisure time they consume or to allocate even more time to research and product development. In economics, to sketch a brief picture of labor market, we use regression analysis to depict labor demand and supply curve where the wage as an endogenous variable is determined by the inclination of demand curve and the quantity of labor as an exogenous variable. Since a decreasing wage rate induces the demand for labor, demand curve is, expectedly, downward sloping. On the other hand, labor supply is upward-sloping since employees are not reluctant to supply more free time when the rate of real wages is increasing. Even though labor market is a partial equilibrium model of employer-employee preferences, discrimination has often resulted in a two-sector labor market where skills and knowledge are traded in separate markets as shown by the picture.
The Framework of Labor Market
Discrimination is a relatively young and still fresh theme in economic analysis. It has been pioneered by professor Becker's The Economics of Discrimination (link). The analytical foundations of the economic analysis of discrimination can be found in the attempt to measure discrimination in the labor market and elsewhere by the empirical analysis. In a simple, two-variable model of labor market determined by wage and quantity of labor, there is not a unique equilibrium of demand and supply in the labor market. The demand for labor is downward sloping, reflecting the fact that lower wage (the price of labor) tends to induce the demand for labor. For example, if the wage for software engineer drops from 8 EUR per hour to 6,5 EUR per hour, then Google, for example, will certainly not feel reluctant to hire more skilled software engineers. It should be noted that the slope of labor demand curve is much flatter than demand curves in partial equlibrium models usually behave. The reason is that firms hire labor supply in order to maximize profits and firm's utility function. However, there is no simple marginal rate of substitution between labor and other means of production and that labor suppliers' knowledge, skills and profession determine the result of firm's production function. Also, there is not a unique picture of labor supply, since workers possess different preferences regarding the allocation of time between leisure and consumption. For example, productivity gains by Google engineers may induce them either to increase the amount of leisure time they consume or to allocate even more time to research and product development. In economics, to sketch a brief picture of labor market, we use regression analysis to depict labor demand and supply curve where the wage as an endogenous variable is determined by the inclination of demand curve and the quantity of labor as an exogenous variable. Since a decreasing wage rate induces the demand for labor, demand curve is, expectedly, downward sloping. On the other hand, labor supply is upward-sloping since employees are not reluctant to supply more free time when the rate of real wages is increasing. Even though labor market is a partial equilibrium model of employer-employee preferences, discrimination has often resulted in a two-sector labor market where skills and knowledge are traded in separate markets as shown by the picture.
How Discrimination is Motivated?
There are two types of discrimination in the labor market. First, employers discriminate when they hire labor supply with higher wage rate, even though other labor supplier are cheaper relative to their productivity than labor suppliers hired by the employer. In this case, discrimination is motivated by employer preference of future employees by race, religion, sex or other human charateristics. An employer who discriminates has a comparative disadvantage compared to employers who do not discriminate since first employer's profits are lower due to the fact that first employer's competitor scores better on productivity performance and profit while his relative market-clearing price of labor is lower. Employer discrimination can be enforced with strong cultural and institutional background. In former socialist economies, such as Slovenia, regulated and rigid labor market protected the premium of insiders while it, at the same time, increased entry and career barriers to future employees. Thus, with the lack of productivity convergence and high tax burden, employers in Slovenia are reluctant to hire high-skilled labor supply because of (1) high bargaining power of trade unions and because (2) age-determined income distribution favors older workers compared to younger workers even though older workers in infant industries do not posses high human capital skills as college graduates do. Consequently, human capital premium has been replaced by age premium. In job advertisment, employers often put experience ahead of knowledge and ideas, thus restricting job and career prospects to labor market entrants. On the other hand, employee discrimination occurs when employees, for example, refuse to work with minority workers, demanding real compensation. Regulated labor market structure is, most notably, a cause of employee discrimination since workers possessing more bargaining power tend to discriminate workers with weaker concentration of bargaining power, thus requesting higher premium enabled by the formal (trade union) or informal (intra-market nets) monopoly of existing labor supply. Nonetheless, the attempt to exterminate labor market discrimination by the exercising regulation results in information asymmetry, giving privilege to inside workers' privileges such as seniority and their bargaining power over the medium term (see: Lindbeck, Snower 2002).
Competitive Markets, Economic Freedom and Flexibility
For example, in the old American south, African Americans were often discriminated by local employers (link). Thus, the old South was put in a comparative disadvantage in comparison with Northern and Western states which faced higher productivity growth rates and profits. The situation led to a gap between northern-western and southern states; the latter having lower living standards because of the productivity lag as a partial result of labor market discrimination. The deregulation of labor market is essential to less discrimination since economic freedom such as freedom of trade, enterprise and labor, leads employers to relatively less beneficial discriminatory hiring preferences unless employers prefer lower profit. In Europe, where labor markets are more regulated than in countries such as the United States, Singapore, Denmark and Australia, regulated labor markets lead to lower productivity performance, except that age and experience-based discrimination substituted racial or sexual discrimation at the workplace. Consequently, the standard of living in European welfare states is significantly lower than in the United States. For example, cost decreases in child care, as a result of competition, put more mothers into the labor market in the United States and Canada (link) while the percentage of mothers in the labor market, while having child-care liabilities, is significantly lower in Europe, reflecting regulated and rigid labor market designed by the intervention of trade unions. In freer labor markets where employers have fewer discrimination preferences, firms score higher on productivity, human capital and profits, advantaging employers with non-discriminatory hiring practices while putting employers with discriminatory hiring (related to race, skin color, religion, sex or any other characteristic) in a serious relative disadvantage.
Saturday, September 13, 2008
WHY HUMAN CAPITAL MATTERS
Professor Glaeser of Harvard University wrote an interesting article, addressing the issue of importance of human capital for economic growth, income and welfare (here):
"Also since the mid-1970s, America has become much more unequal. Not all inequality is bad. I wouldn't mind if the guys who gave us Google earned even more, given their contributions to society. I do, however, care deeply that millions of Americans seem to have reaped, at best, modest benefits from the past 30 years of technological change... By contrast, investing in human capital offers the potential for permanent increases in earnings that encourage work. Education increases the ability to deal with innovation, so that investing in skills today will make Americans better able to weather the storms of future technological changes."
"Also since the mid-1970s, America has become much more unequal. Not all inequality is bad. I wouldn't mind if the guys who gave us Google earned even more, given their contributions to society. I do, however, care deeply that millions of Americans seem to have reaped, at best, modest benefits from the past 30 years of technological change... By contrast, investing in human capital offers the potential for permanent increases in earnings that encourage work. Education increases the ability to deal with innovation, so that investing in skills today will make Americans better able to weather the storms of future technological changes."
Sunday, September 07, 2008
THE POTENTIAL OUTCOME OF OBAMANOMICS
Tom Wilson, a British speechwriter, wrote an opinion (link) in Wall Street Journal, showing incredibly similar parallels between Obama's economic agenda and the economic agenda of Britain's Labour party in Pre-Thatcher years, that turned British economy into the sick man of European economy.
Thursday, July 17, 2008
FED INTERVENTION
Allan H. Meltzer explains why Fed should be taken away from investment banks (link):
"So what can taxpayers expect from an increase in the Fed's discretionary authority over investment banks? The likely answer is rescues, delays and lax supervision – followed by taxpayer-financed bailouts. Throughout its postwar history, the Fed has responded to the interests of large banks and Congress, not the public. Investment banks don't need the Fed to regulate them. Some clear rules on capitalization would suffice."
"So what can taxpayers expect from an increase in the Fed's discretionary authority over investment banks? The likely answer is rescues, delays and lax supervision – followed by taxpayer-financed bailouts. Throughout its postwar history, the Fed has responded to the interests of large banks and Congress, not the public. Investment banks don't need the Fed to regulate them. Some clear rules on capitalization would suffice."
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