Is Investment Depressed by an “Anti-Business” Climate?

The National Journal asks for reactions to a recent blog post by Greg Mankiw regarding the reasons why US investment has fallen sharply.

I agree with Greg that the dominant empirical fact about investment is its procyclical volatility (the main reason investment has been depressed for the last two years is that the economy has been depressed), and also that the recent credit crunch made it worse. But I don’t agree with a third item on his list: “the policy environment seems adverse to business.” As in many areas, it is when we get to the politics that I disagree.

Greg cites trade policy, fiscal imbalances, and energy costs, in support of his proposition that the current policy environment is anti-business. Let’s consider each of the three.

Trade. I wasn’t happy in September when the White House put tariffs on imports of Chinese tires. But President Obama, despite the pressures of the most severe recession since the 1930s, has yet to succumb to any protectionist measures as big or as blatantly in violation of international trade agreements as were Ronald Reagan’s quotas on Japanese auto imports or George W. Bush’s tariffs on steel imports. (Greg, of course, was the Chair of Bush’s Council of Economic Advisers.)

Budget. Most of us think that the $787 billion fiscal stimulus and the distasteful banking rescues were minimal necessary responses to the recession. But let’s address the serious question of the bleak longer term fiscal outlook. It is known to those who look carefully at the budget numbers that Obama’s recent actions are a distant 5th on the list of contributors. #1 in the long term (by far) are the future costs of Social Security and Medicare. #2 are the long term effects of Bush’s tax cuts. A close #3 are the effects of Bush’s spending increases (including the wars in Iraq and Iran and the expansion of Medicare benefits, among other things). #4 is the loss of tax revenues from the recession that began December 2007. A distant #5, as I say, is the recent fiscal stimulus. (The banking layouts are being repaid, usually with a high return for the Treasury – as the Administration had predicted, to critics’ ridicule.) I believe that as the recovery becomes better established Obama will, as he says, take much more serious steps than his predecessor in the direction of long-run fiscal consolidation. But only time will tell.

Energy costs. Greg Mankiw in fact believes that a system of energy taxes or cap-and-trade would increase the efficiency of the economy, even though it would raise the relative price of energy. (This is all the more true if the comparison is to past policies of subsidizing oil and other fossil fuels.) Greg founded the Pigou Club on this principle, and I heartily congratulate him for it.

I am skeptical that investment is currently depressed by perceptions of an anti-business climate. But if the average businessperson does in fact have the perception that recent Democratic administrations have been worse for business than Republican administrations, I suggest setting aside campaign rhetoric and looking at actual history. Start with the fact that, in the graph in Greg’s blog post, investment growth was substantially higher during the Clinton Administration than during the Reagan or Bush Administrations. Investment will recover when the economy does.

I Hope We All Agree Now: Central Bankers Should Pay Attention to Asset Prices

“Should Central Banks Target Asset Prices?” That is the question addressed by the current symposium in The International Economy (2009, no.4).

My answer:

Alan Greenspan was right to raise the question “How do we know when ‘irrational exuberance’ has unduly escalated stock prices?”, which is what he actually said in 1996. But he was wrong to conclude subsequently that monetary policy should ignore asset prices (or even that it should take asset prices into account only to the extent that they contain information about future inflation, as the Inflation Targeters would have it). More specifically,
(1) Identifying in real time that we were in a stock market bubble by 2000 and a real estate bubble by 2006 was not in fact harder than the Fed’s usual job, forecasting inflation 18 months ahead;
(2) Central bankers do have tools that can often prick bubbles; and
(3) The “Greenspan put” policy of mopping up the damage only after run-ups abruptly end probably contributed to the magnitude of the bubbles, while yet being insufficient to head off the worst recession since the 1930s. All three points run contrary to what was conventional wisdom among monetary economists and central bankers a mere two years ago.

As Claudio Borio and Bill White at the BIS pointed out before the financial crisis, many of the worst economic collapses of the last 100 years have occurred after excessively easy monetary policy had shown up in asset prices but not in inflation: US 1929, Japan1990, East Asia 1997, and now the US 2007.

A final point: “Targeting asset prices” is the wrong phrase. The word “target” (for example, with respect to the money supply, exchange rate, or inflation) implies a number, or at least a numerical range. I don’t know anyone who thinks that the central bank should contemplate setting a numerical range for the stock market. Rather, the claim, which I think the evidence now supports, is that central bankers would be well advised to monitor prices of equities and real estate and to speak out, and eventually to act, on those rare occasions when asset prices get very far out of line.

Border Measures Could Make Climate Policy Better or, More Likely, Worse

At Climate Talks, Danger to Free Trade Mounts,” reports the international press.

The Copenhagen negotiations have essentially failed to include among the many topics covered the question of import tariffs or other trade penalties that individual countries apply against the products of other countries that they deem too carbon-intensive. Such border measures are already in EU and US legislation (the bill not yet passed by the Senate). Properly designed, they could turn out to be the missing instrument needed to get each country to cut emissions without fear of others taking unfair advantage, via leakage. More likely, national politics will turn them into protectionist barriers.

Actions taken multilaterally would probably make the difference as to whether border measures are used for good or ill. Here is my personal ranking of five possible scenarios.

  1. Best choice — a system of multilateral sanctions as part of a new “Copenhagen Protocol” or other treaty.
  2. Next-best choice — national import penalties adopted under multilateral guidelines:
  • (i) Measures can only be applied by participants in good standing.
  • (ii) Judgments to be made by technical experts, not politicians.
  • (iii) Interventions in only a ½ dozen of the most relevant sectors.
  1. Third-best choice — no border measures at all.
  2. Fourth choice — each country chooses trade barriers as it sees fit.
  3. Worst choice: national measures are subsidies to adversely affected firms, even if they take the form of free emission permits (as is contemplated in EU provisions). These do nothing to limit carbon leakage. They function simply as bribes to those industries lucky enough to receive them, in return for political support.

Progress on Global Warming Is Not Yet in Evidence in Copenhagen

I am writing from Copenhagen, the site of the 15th Conference of Parties to the UN Framework Convention on Climate Change. If one were to judge by outward appearances, the prospects look dim for a meaningful global agreement by the end of the week.

First, most conference participants have been put through an experience that seems designed to convince them that global warming may not be such a bad idea after all: a registration system that requires waiting in long lines in temperatures near freezing. (Reported wait times vary from one hour for China’s chief negotiator to 8 hours for other participants, such as prominent NGO leaders. Even 9 hours.)

Second, there has been little convergence of positions. The views expressed here cover the same fantastically and unbridgeably wide range as they did at the time of the Kyoto meeting 12 years ago. At one end of the spectrum, developing countries are still asking for reparations — African delegations boycotted Monday’s meetings; and demonstrators are still very confused about who they should be trying to persuade and how. At the other end of the spectrum, the climate change deniers are also represented here, at least outside the meeting hall. Recent opinion polls show that the percentage of skeptics among the fickle American public has risen very recently, even though the scientific evidence for anthropogenic warming continues to mount. (For some reason, many find it easier to deny science than to make any of the less indefensible arguments available to critics: that global warming wouldn’t be all bad, or that cutting emissions enough to prevent it would be too expensive, or that the U.N. is not an effective instrument, or that geo-engineering would be a cheaper approach.)

Most importantly, the impasse between the rich countries, notably the United States, and the poor countries, notably China, remains. That, of course, is why world leaders acknowledged some months ago they would not be able to agree in Copenhagen on a successor treaty to the Kyoto Protocol.

Many here, however, take hope from the idea that President Obama would not have committed to come to Copenhagen at the end of this week if the White House did not have reason to expect to be able to achieve at a higher level an interim understanding that goes beyond the positions that the negotiators until now have been instructed to take.

My own plan for how to break the impasse has been detailed in this blog before. (The paper is now published, in a book co-edited by Joe Aldy and Rob Stavins). The proposal can be boiled down to a couple of bare essentials:

Stage 1:

  • Annex I countries commit to the post-2012 targets that their leaders have already announced.
  • Others commit immediately not to exceed BAU, thus precluding leakage.

Stage 2:

  • When the time comes for developing country cuts, targets are determined by a formula designed so each is asked only to take actions analogous to those already taken by others before them. Developing countries could agree now to the principle, without yet agreeing to specific parameters.

Ten Ways to Move the Budget Back Toward a Sustainable Path

The National Journal asks “President Obama and his team said recently that the fiscal 2011 budget will represent a credible effort to reduce budget deficits and put the federal government on a path toward ‘sustainable’ deficits… How would you alter taxes and spending to achieve (or at least pursue) that goal?”

Here are my ten proposals to move the budget back to a sustainable path (like the one it was on until January 2001):

First, auction off most greenhouse gas emission permits, rather than giving them away to firms (which would confer windfall profits). This is what President Obama originally proposed last February, but it is not in the congressional legislation.

Second, raise the gas tax. Among the benefits, besides raising revenue, would be reducing traffic congestion, accidents, pollution, dependence on Mideastern oil, and the trade deficit.

Third, cut agricultural subsidies to rich farmers and agribusiness, saving money and improving economic efficiency. This is another measure that Obama proposed when he first took office, but that was voted down.

Fourth, continue to cut expensive weapons systems that the military doesn’t want, but are kept only because the suppliers are in the districts of influential congressmen. President Obama and Secretary Gates amazingly managed to do this with the F22 (the first administration to succeed at such a thing, or even to try, so far as I know).

Fifth, end manned space exploration. We don’t need it. Spend half the money on useful science instead, including research on energy and medicine (and unmanned space exploration).

Sixth, let the George W. Bush tax cuts for the rich expire as under current law. Of course the Bush plan to eliminate the estate tax completely in 2010 and have it bounce back to its 2001 level thereafter is nonsense. Level the taxable threshold out at some reasonable estate size, a few million dollars, something high enough to de-legitimize the hysterical stories about inheritors supposedly being forced to sell their small farms or small businesses to pay the tax. (Use some of the revenue in these proposals to fix the AMT once and for all. And, in the meantime, continue Obama’s return to honesty in budget accounting regarding the costs of AMT, wars in Iraq and Afghanistan, tax cuts, etc. Bush’s habitual trick of purposely understating such costs in future budgets allowed him to pretend that we could afford his profligate fiscal policies, which in turn added far more to the national debt than the current recession measures are adding .)

Seventh, encourage hospitals to standardize around national best-practice medicine – to avoiding unnecessary tests and procedures – using levers such as making Medicare payments conditional on best practices. This is another part of the Obama plan. (Don’t follow the logic of radio show propaganda that labels even modest government involvement in health care “socialism,” because that would certainly require dismantling veteran’s hospitals, which provide good medical care relatively efficiently, even before it would require dismantling Medicare.)

Eighth, limit or eliminate the tax-exemption for employer-paid health insurance (proposed by Senator McCain), at least the cadillac plans which are very expensive but don’t even pay off in health results (proposed by Senator Kerry).

Ninth, ideally, eliminate the tax deductibility of mortgage interest too. But proposing this would be political suicide. Congress and the public are still virtually unanimous in wanting to tilt the playing field in favor of owner-occupied housing and against rental housing and the rest of the capital stock, notwithstanding that such policies contributed to the housing bubble and crash.

Tenth, to save Social Security, raise the retirement age (just a little), tax higher incomes (just a little), and progressively index benefits for future retirees to price inflation, rather than to wage inflation (just a little).