Why Educational Reform in The US Never Works

Politicians from both political parties spend a lot of time talking about how to improve education.  It makes sense to propose plans for improving education because the great majority of parents care about the quality of education. However, most of the policy changes that have managed to get through the political maze, have been shortsighted and unproductive.  This is the best article that I have read about public education because it offers no simple solution to a complex problem.  One of the simple solutions, that is always on the political agenda, is to improve teacher effectiveness.  The problem with that solution is that teacher effectiveness cannot be separated from school effectiveness.  A simple thought experiment illustrates the connection between school effectiveness and teacher effectiveness.

Suppose we recruited teachers from Finland, which has a well earned reputation for turning out effective teachers, and did a teacher exchange program between the state of Indiana and Finland.  What results might we expect from that exchange? The most likely outcome after five years would be that the teachers from Finland would have decided to seek an alternative career in the US, and that the US teachers would be very successful and committed to a career in teaching.  It is easier to be an effective teacher in an effective school and it is very difficult to succeed in ineffective schools.

Our little thought experiment shifted our attention from teacher effectiveness to school effectiveness.  That is much more complex problem that goes well beyond the simple problem of teacher effectiveness. This article describes some of the factors that contribute to effective schools, and it explains why it easy to recruit good teachers in Finland and provide them with an opportunity to be successful teachers.  Political leaders in Finland are not any smarter than politicians in the US who care more about winning elections than they do about improving the education system.  Wasting human resources in the US is very expensive in the long run.  We are paying for it in many ways.

The Return Of The Laffer Curve And Dynamic Scoring

The Washington Post published an op-ed, posted below, which celebrates the 40th birthday of the Laffer curve and the restoration of the Reagan Administration myth that his tax cuts increased tax revenues.  I was wondering why the Post bothered to publish the Laffer celebration until I was reminded by this article that the GOP wants to force the Congressional Budget Office to use dynamic scoring.  Paul Ryan was unable to get the CBO to use dynamic scoring, but now that his party controls Congress it intends to find a CBO Director who will use the magic wand of dynamic scoring to show that tax cuts for the wealthy, and for corporations,  will actually increase federal tax revenues.  Dynamic scoring assumes that tax cuts will stimulate economic growth enough to pay for the tax cuts.  

Do Tax Cuts Really Increase Tax Collections?

Stephen Moore is the Chief Economist for the Heritage Foundation which receives its funding from folks who hate to pay taxes and only like government when it does good things for them.  The Washington Post provided Moore with an opportunity to broadcast the Heritage message.  Apparently, it did so without the benefit of editing or fact checking.  There are so many things wrong with this article that it is hard to know where to start.  One would expect, however, that Moore should not contradict himself in his article.  I will simply point out the contradiction and let Paul Krugman and some of the commentators in response to his article address some of the other problems with Moore's article.

Ostensibly, the article is about the durability of the Laffer curve which holds that tax revenues will increase as the tax rate rises up to a maximum point;  they will then begin to fall as the tax rate increases further.  Nobody would argue against that point.  On the other hand, there is a lot of disagreement about the inflection point.  That is, at what tax rate do we see a decline in tax revenue? Ronald Reagan cut the top income tax rate from around 70% to around 28%.  Tax revenues increased during the Reagan administration, and we also had a period of economic growth.  The Heritage Foundation and other think tanks, funded by the same folks who fund Heritage, have been claiming that our experience during the Reagan Administration proved that the Reagan Tax cuts validated the Laffer curve, and more importantly, the superiority of supply side economics to demand side economics which have been destructive of our economy under President Obama.

Moore knows that the Laffer curve has often been called the Laugher curve by economists because the inflection point is undetermined.  He acknowledges that point in his article.  He points out, however, that liberals want to increase taxes on carbon emissions because they understand that you get less of something when you tax it. They seem to agree with Laffer that high tax rates will cause people to work less and also decrease business investment.  Laffer claims that most economists agree that you get less of something when you tax it.  That is often true, but his curve also shows that you get more tax revenue from higher tax rates up to the inflection point.  The Laffer curve does not tell us that lowering the tax rate will always increase tax revenue.  Higher tax rates increase tax revenue until we get to the indeterminate inflection point.

Moore also fails to tell us that Reagan increased taxes during his administration.  He substantially increased the regressive Social Security tax rate which helped to pay for the huge reduction in the top marginal income tax rate.  This shifted the tax burden from the highly paid to lower income citizens because there is a cap on the Social Security tax. The Social Security tax rate falls as one's income increases. Even worse, Moore includes Social Security tax revenues along with income tax revenues when he reports the increase in tax revenues under Reagan.  Federal tax revenues, excluding Social Security taxes, increased by only 20.8% under Reagan.

We expect economists who decide to make a career at think tanks like Heritage to support the mission of their employer.  Its unfortunate, however, that one of our most widely read newspapers would provide an unfiltered platform for Heritage to spread its message to the public without a more critical review by its editors.

A View Of The Second Economy From Silicon Valley

The Harvard Business Review published an article by a Silicon Valley venture capitalist and a journalist who has covered this high tech Mecca for many years.  The article raises a serious question about the second economy that is already under development.  The second economy will take advantage of Moore's Law which has established the rate of speed by which computer chips process and store information, as well as the advances in artificial intelligence which leads to the development of much smarter machines.  As the intelligence of these machines increases, the types of jobs that they will be able to perform will also increase.  Today they are being used to perform routine tasks that are being done by low paid workers.  As the cost of the machines continue to fall even low paid workers in China will be replaced by robots.  As the machines become more intelligent, and achieve an IQ of around 120, they will provide a low cost substitute for highly skilled and high paid labor.  In a sense, the wage rate will be set by increasingly intelligent robots.

The second economy will much different from the industrial revolution which replaced human muscle with mechanical power.  It will replace human intelligence with machine intelligence at a much faster rate than mechanical power replaced human power.  This may seem like science fiction to many of us but it is very real to many in Silicon Valley. 

The good news is that the second economy will be very productive.  New and better products and services will available at lower cost.  The bad news is that we will be able to produce the output with fewer workers.  That will solve the problem of scarcity, which has plagued humankind for centuries, but we will need to figure out how to deal with a world that requires less human labor.  The easy answer to that question has usually made reference to the Luddites who opposed the industrial revolution.  Machines replaced the labor of textile workers and there was a 50 year lag between the advent of the industrial revolution and a better life for the Luddites.  Anyone who raises questions about the implications of technological advancement is reminded of the Luddites who would have blocked the industrial revolution and the advances that followed.  The second economy is rolling out at a faster pace than the industrial revolution which replaced human power with machine power.  It raises a question about the ability of our political leadership, which seems to be stuck in low gear, to manage the rapid changes that are brewing in Silicon Valley.

How To Fight Deflation In The Eurozone

It is likely that the EZ will report in January that prices changes were negative in the EZ.  The ECB has a mandate to maintain price stability, therefore, it must do something about price deflation.  The US Federal Reserve used quantitative easing to stabilize prices in the US but it would not work as well in the EZ for many of the reasons presented in this article.  An alternative to QE is proposed for the ECB in this article along with some of the possible objections which are refuted.

Adair Turner Provides His Big Picture Of The Economy

This video of Adair Turner's speech in London pulls several strands of the economy together into a comprehensible mosaic.  He links rising income and wealth inequality to some of its more obvious causes such as globalization and immigration which expands the labor supply and fosters wage competition, but he also shows how our new economy decreases demand for labor and physical capital.  That contributes in income and wealth inequality and it also contributes to slower economic growth.  Its easy to see that effect when one compares Facebook with the Ford Motor Company.  A relatively small number of software engineers and physical capital was required to bring Facebook public at a value of $170 billion.  Facebook can also add new customers at almost zero marginal cost.  It also becomes more valuable through network effects.  The more customers it attracts, the more valuable it is to every customer and to advertisers.  Henry Ford needed a large labor supply and a huge investment in physical capital to bring his cars to market.  We also had to build the roads and the infrastructure necessary to support auto transport.  A large sales and service network was also required.  Business investment spending and consumer spending expanded as the auto industry developed.  Facebook made a small number of people very rich but it does relatively little to increase business investment and consumer spending.

Turner also destroys some of the myths about our banking system that taught in econ 101.  Banks do act as intermediators between savers and businesses that require those savings for investment.  Only 15% of bank assets are loans to businesses.  65% of the savings are used to fund mortgages,  and a large share of real estate transactions are for the purchase of existing properties.  25% of bank lending is used to support household consumption. 

Given the large amount of savings that are used to fund mortgages it is not surprising to learn that most of our wealth is held in real estate.  Moreover, most of the asset appreciation is in the price of the land.  There is a fixed supply of highly desired real estate locations and a high elasticity of demand for those locations.  Investors have responded by purchasing choice locations to capture the asset appreciation.  Most of that appreciation will go to investors who have surplus income.  That contributes to wealth inequality and it does little to expand aggregate demand.

Turner argues that income inequality has led to the expansion of credit to support aggregate demand.  There has been almost no real wage growth for the bottom 75% of the income distribution in the US.  Consequently,  private credit has been used to fill the income gap. That is what the sub prime mortgage system was all about. The idea was to expand credit to households that would not otherwise have access to credit.  That is unsustainable over the long run.  Consumption spending slows down, the economy contracts, and government debt increases in response to declining tax revenue and increased spending on public welfare programs.  The rise in public debt leads to fiscal austerity, and a reliance on monetary policy to support fiscal austerity programs.

Turner is not a fan of quantitative easing.  He argues that low interest rates have driven up asset prices but they have done little to increase aggregate demand.  He favors policies that put more money into the hands of households that will spend it.  Progressive tax policies would be part of his agenda.

Turner does not have much regard for economists who claim that our basic problem is a skill gap.  It doesn't take much to destroy that argument.  A quick look at job growth projections by the US Bureau of Labor shows that there is very weak demand for computer and network technologists.  Moreover, wage growth in those areas has also been weak.  Most of the job growth is in the service sectors and many of those jobs do not require advanced training.

The History Of The 2% Inflation Rate Target

Most of the world's central banks have a target inflation rate of 2%.  This article provides an overview of the history of that target which may have been set 25 years ago by the central bank of New Zealand, and ultimately became a common central bank target.  More importantly, it discusses the strengths and weaknesses of that common target.  A higher target would provide greater flexibility during serious recessions because central banks would be less likely to hit the zero lower bound when they cut interest rates to stimulate the economy.  If the target rate were 4% they would have more freedom than they do at 2%.  There are also advantages that derive from the lower target because it is easier to make economic plans when the purchasing power of money is more constant.