Proposals for city congestion charges continue to be put forward (even outside cities), both as a means to make the congestion disappear, reduce pollution, make city life more bearable and generate some revenue. The pioneer, London, has some mixed results according to a previous post, although I personally feel London is now much more bearable. In some cases, the benefits are much clearer, yet voters resist because of the unknown (other previous post).
Maria Börjesson, Jonas Eliasson, Muriel Hugosson and Karin Brundell-Freij update us on Stockholm, where people should be used to taxes and be easier to convince. Yet, it was not that easy to pass it by referendum, but the electorate warmed to the idea once it was in place. Also, it has reduced traffic and let to a significant (and visible, I must say) substitution to charge-exempt alternative-fuel vehicles. There seems to be a general agreement this is a success, and one needs to find a way to overcome initial resistance.
When is the US going to reach its fiscal limit?
Most western economies currently show large public deficits. Whether they are sustainable is subject to much debate, and if they are not there is also much debate when action should be taken, and how radical it should be. One important part of the debate is the measurement of public deficits and debt, which makes any discussion of possible scenarios difficult. And these scenarios have to make heroic assumptions about the future evolution of the economy, which may in fact be endogenous to policy. All this is very complicated, and pundits do not help at all in this.
Richard Evans, Laurence Kotlikoff and Kerk Phillips take a different approach. Take the current policies, assume they persist forever. Calculate the fiscal gap, that is, the tax rate required to balance the current debt plus the sum of discounted future non-interest liabilities less future taxes. Feed this into a DSGE model and see when it violates feasibility (when the current generation has incomes lower than the tax necessary to close the fiscal gap. In their simulations, it takes a century for the US economy to reach its fiscal limit, although there is a 35% chance this could happen within 30 years. This results fits well within Kotlikoff's decade-old message that every economy is on an unsustainable fiscal path, message he repeats on his platform as a candidate for the US presidency.
Getting back to the model at hand, I do not quite understand the result. To me, this implies that there is somewhere a dynamic inefficiency, or some transversality constraint is being violated. But I do not see where this would happen in the model economy. There is a lump sum transfer from the young to the old in each generation that corresponds to 32% of wage income. To it corresponds a promise for future transfers that may be more difficult to satisfy were the economy to be hit by adverse shocks. Thus, it seems difficulties arise accidentally when the economy is hit by a series of bad shocks and continues forging ahead without any adjustment. That seems unlikely to me.
Richard Evans, Laurence Kotlikoff and Kerk Phillips take a different approach. Take the current policies, assume they persist forever. Calculate the fiscal gap, that is, the tax rate required to balance the current debt plus the sum of discounted future non-interest liabilities less future taxes. Feed this into a DSGE model and see when it violates feasibility (when the current generation has incomes lower than the tax necessary to close the fiscal gap. In their simulations, it takes a century for the US economy to reach its fiscal limit, although there is a 35% chance this could happen within 30 years. This results fits well within Kotlikoff's decade-old message that every economy is on an unsustainable fiscal path, message he repeats on his platform as a candidate for the US presidency.
Getting back to the model at hand, I do not quite understand the result. To me, this implies that there is somewhere a dynamic inefficiency, or some transversality constraint is being violated. But I do not see where this would happen in the model economy. There is a lump sum transfer from the young to the old in each generation that corresponds to 32% of wage income. To it corresponds a promise for future transfers that may be more difficult to satisfy were the economy to be hit by adverse shocks. Thus, it seems difficulties arise accidentally when the economy is hit by a series of bad shocks and continues forging ahead without any adjustment. That seems unlikely to me.
Africa should finally industrialize
Africa is frustrating, as it seems to be regressing in many ways despite substantial development aid. Several have pointed out that the problem is with this aid, for example because it provides perverse incentives. But I think an important aspect is this obsession with improving agriculture on a continent where land is simply not good for agriculture. While the development stage in development in the rest of the world went first through a boost in agricultural productivity followed by industrialization, I see no reason why Africa cannot skip straight to industrialization. It has a lot of labor. There is the problem with poor transportation and low education, but they will improve if demand increases through industrialization, which little growth in agriculture cannot.
I am mentioning this after reading the report of John Page, who shows that, if anything, Africa is deindustrializing. While one can discuss whether the strategies he advocate can work, the fact is that the climate is not the best for investment into industry in almost all of Africa. Maybe charter cities could be the right trigger?
I am mentioning this after reading the report of John Page, who shows that, if anything, Africa is deindustrializing. While one can discuss whether the strategies he advocate can work, the fact is that the climate is not the best for investment into industry in almost all of Africa. Maybe charter cities could be the right trigger?
About taxing children for climate change
While some impact from global climate change can already be felt, it is believed the significant impact will be for future generations. As the current generation would only face a cost to alleviate what leads to this climate change, one can make the argument that the future generations should pay us. But they are not there yet to do so. However, their parents are and these care about their offspring. So parents should be taxed to take care of reducing pollution and redistributing funds to those hurt by reducing pollution from current levels. That is a rather twisted argument to argue for future generations to pay (homework: where is the error?).
A better argument can be made for parents to pay. It is by Henning Bohn and Charles Stuart, who observe that each additional person exerts a negative externality onto the others by generating more population, taking more spaces, etc. That externality is not internalized, thus it needs to be taxed. Thus, whatever the reasons are that we subsidize having children needs to be amended by this tax. And by the calculations of Bohn and Stuart, the child subsidy could very well turn into a child tax. Indeed, the child pollution tax is 21% of life-time parent income per child, which is needed to divide the population by four in the long-run. However, that tax can be reduced to 5% if there is a cap of pollution permits set at current levels.
Of course, one can have endless arguments about the calibration used in the study. In this particular case, it is assumed that it costs 3% of output to reduce pollution by 25%. Also important is the output and time cost of children, as well as preference parameters. You may think of other parametrizations, but it remains that the child pollution tax makes sense. Only its amount it up to debate.
A better argument can be made for parents to pay. It is by Henning Bohn and Charles Stuart, who observe that each additional person exerts a negative externality onto the others by generating more population, taking more spaces, etc. That externality is not internalized, thus it needs to be taxed. Thus, whatever the reasons are that we subsidize having children needs to be amended by this tax. And by the calculations of Bohn and Stuart, the child subsidy could very well turn into a child tax. Indeed, the child pollution tax is 21% of life-time parent income per child, which is needed to divide the population by four in the long-run. However, that tax can be reduced to 5% if there is a cap of pollution permits set at current levels.
Of course, one can have endless arguments about the calibration used in the study. In this particular case, it is assumed that it costs 3% of output to reduce pollution by 25%. Also important is the output and time cost of children, as well as preference parameters. You may think of other parametrizations, but it remains that the child pollution tax makes sense. Only its amount it up to debate.
How to design public block and matching grants
In most countries, there are three levels of government: national, regional and local. In Europe, there is even a fourth one, the European Union. In many instances, higher level authorities provide funds to lower levels, either through block grants (allocations for a general purpose) or matching grants (allocations that requires matching funds from the grantee). How this should occur is not well studied, especially when one considers that these funds can be used to build local public capital.
Heng-Fu Zou makes an attempt at this, with a cascading Stackelberg structure from national to regional and local governments. I do not want to mention the conclusions, though, because I think the paper is fundamentally flawed. The most interesting aspects of the problem are bypassed here: first, there is a strong redistributive aspect to block grants, hence taxation need to be part of the model, but it is only modeled as a fix lump sum payment here. Second, the very reason why there are block grant for specific purposes instead on general grants is that lower governments may be tempted to put it all in public consumption. That variable is absent from the model, everything flows into public capital.
Third, the utility function is assumed to be log-linear in all public capital and expenditures individually. This implies that all of them are essential (a government can for example not take over responsibilities from another) and in particular that private consumption or investment is completely useless. As a consequence, it is always good to increases taxes, no matter their current level. Other results also derive directly from this assumption about the utility function. Fourth, the matching grant is so poorly set up that it allows the author to claim in all seriousness that capital can go instantly to infinity if the higher authority matches at 100% the local investment. Fifth, capital does not depreciate, which matters immensely when you write about the long run. Etc.
Interesting question, horrible execution.
Heng-Fu Zou makes an attempt at this, with a cascading Stackelberg structure from national to regional and local governments. I do not want to mention the conclusions, though, because I think the paper is fundamentally flawed. The most interesting aspects of the problem are bypassed here: first, there is a strong redistributive aspect to block grants, hence taxation need to be part of the model, but it is only modeled as a fix lump sum payment here. Second, the very reason why there are block grant for specific purposes instead on general grants is that lower governments may be tempted to put it all in public consumption. That variable is absent from the model, everything flows into public capital.
Third, the utility function is assumed to be log-linear in all public capital and expenditures individually. This implies that all of them are essential (a government can for example not take over responsibilities from another) and in particular that private consumption or investment is completely useless. As a consequence, it is always good to increases taxes, no matter their current level. Other results also derive directly from this assumption about the utility function. Fourth, the matching grant is so poorly set up that it allows the author to claim in all seriousness that capital can go instantly to infinity if the higher authority matches at 100% the local investment. Fifth, capital does not depreciate, which matters immensely when you write about the long run. Etc.
Interesting question, horrible execution.
An economist's foray into econophysics
I have described here some of the outlandish forays of physicists into Economics, where they try to use concepts from their discipline with disastrous results (last post here). But economists themselves may borrow concepts from physics. One that stuck was sunspots, from some chance correlation between sunspot activity and stock market performance, and made popular by David Cass and Karl Shell. But there were very little physics in this.
Martin Evans ventures deeper, using the concept of dark matter to understand exchange rate movements. It is well known that it is very difficult to understand what moves exchange rates. Dark matter is something that we cannot observe, but we see its impact. In this case, Evans builds a model where dark matter has an impact on nominal exchange rates, and then on other variables. This is based on the empirical observation that something like dark matter has an impact on expectations on long-run exchange rates, but not on recent and future interest rate differentials. This is achieved in the model by introducing shocks to household risk aversion. Why? Well, it is dark matter (or animal spirits). But all that matters is that it explains a large share of exchange rate fluctuations, in a rather consistent way for the other variables. Physicists would be happy with that. Economists would want to understand why.
Martin Evans ventures deeper, using the concept of dark matter to understand exchange rate movements. It is well known that it is very difficult to understand what moves exchange rates. Dark matter is something that we cannot observe, but we see its impact. In this case, Evans builds a model where dark matter has an impact on nominal exchange rates, and then on other variables. This is based on the empirical observation that something like dark matter has an impact on expectations on long-run exchange rates, but not on recent and future interest rate differentials. This is achieved in the model by introducing shocks to household risk aversion. Why? Well, it is dark matter (or animal spirits). But all that matters is that it explains a large share of exchange rate fluctuations, in a rather consistent way for the other variables. Physicists would be happy with that. Economists would want to understand why.
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