Wednesday, April 27, 2011

Does the United States have a Revenue problem or a Spending Problem?

There is a debate about the causes of the record deficits in the United States. Republicans argue that we have a "spending problem", by which they mean spending is increasing too fast, while the left argues that we mainly have a "revenue problem", by which they mean taxes are too low.

The outcome of this debate will determine whether the most reasonable solution to the structural deficit will be tax increases or slowing the growth of spending. President Obama and liberals such as Paul Krugman like to give the public the impression that the deficit is entirely or to a large extent caused by Bush tax cuts for the wealthy (which is false, since Obama's proposed tax increase on the rich would only collect 0.3% of GDP). If that were the case, the most fair solution to the deficit would be - as the President put it - to raise "a little bit more" revenue from the rich.

It is easier to motivate tax hikes if you convince the public that the deficit was caused by tax cuts, rather than by an unparalleled expansion in spending.

When Republicans such as Paul Ryan say that the deficit is caused by a spending problem, they mean that once the recession is over, a federal tax revenue target of 19% of GDP (the historical average for the U.S) is sufficient to finance federal spending if spending is also kept at historical levels. Throughout, keep in mind that we are talking about Federal revenue and expenditure, the U.S public sector spends about 40% of national income if states and municipalities are included.

Slate columnist David Weigel attacks the Paul Ryan argument. His evidence is that revenue in 1981 was higher than later years of the Reagan presidency, which according to him proves that the Reagan tax cuts reduced revenue. Weigel is wrong. Revenue is highly volatile, because a lot of it depends on corporate profits, capital gains and other variables determined by the business cycle. Weigel is simply cherry-picking the year, 1981 was one of the highest revenue years in post-war history.

Similarly liberals like to pick the peak of the IT-boom at 2000 as the norm, where 20.6% of GDP was collected as revenue, even though it was the highest year in post-war history, and the second highest in American history overall. The highest year was 1944 during World War II, when Federal revenue briefly reached 20.9% of GDP.

In order to give a better picture, I have plotted the average revenue, deficit and spending as a share of GDP for all presidential terms in the post-war period.

First, this exercise shows us that Weigel is mistaken. Tax revenue during both Reagan terms was virtually identical with the Carter years, even though Reagan cut tax rates dramatically.

Second, revenues during the second Clinton term, the highest of the post-war periods, was 19.9%, only a little higher than the 19.0% level Paul Ryan has suggested (which liberals claim is far too little).

Lastly, President Obama has increased spending to levels never witnessed in American post-war history.

Let's move to President Obama's budget, as calculated by the esteemed Congressional Budget Office.

The President likes to give the impression that the deficit debate is about repealing the tax increases for the wealthy. But let us imagine what would happen if revenue during the coming years would be what is was during President Clinton's second term, long before the Bush tax cuts. During those years revenue was 19.9% of GDP.

The overwhelming majority of Presidents Obama's budgeted deficit would remain even if he collected Clinton-era record revenue. By the end of his term, when the recession is projected to be long over, 80% of the deficit caused by President Obama spending plan would remain even if we assume Clinton-era record revenue.

This is not strange, since during the second Clinton term, federal spending as a share of GDP was 18.8%. President Obama has already increased spending to levels unheard on in peacetime. Federal spending with Obama's budget will be 23.4% in 2016, when the recession is projected to be completely over. These numbers show us that President Obama and his defenders cannot use the recession as an excuse for their expansion of government and the immense deficits it is causing.

Clinton-era record revenue would be nowhere near enough to fund Obama-era record spending.

I want to illustrate a final point. Let's ignore the Obama years, and focus on the long run deficit. The figures for spending are from the Long Term Budget Outlook, again calculated by the Congressional Budget Office. These figures take into account the projected increase of Medicare, Medicaid and Social Security spending. This is primary spending, which means that interests on the debt is not included in spending, the numbers would look even worse if we included these.

Let us also be more generous to the left. Instead of assuming revenue for the highest presidential term, let's assume revenue for the record year. As pointed out previously this was the boom year 2000, where revenue was 20.6% thanks to unusually high capital gains and corporate profits.

This picture illustrates what would happen if Federal revenue as a share of GDP increased to the record high of the post-war period and remained there forever, and we continued at the currently projected levels of Federal expenditure.

Because of ever expanding government, the deficit would explode even when assuming record levels of revenue, with the debt growing to several hundred percent of GDP. Jon Stewart was therefore misleading his trusting and economically unsophisticated viewers when he showed them a graph where the deficit appears to vanish if only the Bush-tax cuts were repealed.

The only reasonable conclusion that the United States primarily has a spending problem, not a revenue problem. It is the expansion of the government - some already carried out by Obama, some projected to occur - that is causing the long term structural deficit to grow beyond control, not a reduction of revenue caused by lowering the taxes on the rich.

If liberals want to argue that government spending is too low, and that we should increase it for reasons of social policy and raise taxes to pay for it, they should feel free to do so. But please do not claim that the long term deficit is primarily caused by taxes being too low relative to historical levels, because that is simply not true.

Tuesday, April 19, 2011

The rich in Europe are poor.

Most of the focus of the policy discussion is the income of the poor and working class. As I have written previously, the American working and middle class is economically better off than their European counterpart. The poorest five percent have it better in Sweden compared to Swedish-Americans, whereas all other income groups earn more in the United States.

It is reasonable to focus on the well being of poor as a central measure of fairness and overall well being in a country. However, this focus can go to far, the poor are not the only group in society.

Today I want to discuss a different social group, the currently much maligned top ten percent of income earners. The group includes managers, successful business owners, professionals such as lawyers, doctors, consultants, civil engineers and also workers without a college degrees who are very good at what they do.

There are several reasons why we should care about the rich and upper middle classes.

The top percent of income is a non-negligible share of the population whose well being shouldn't be ignored just because they score low on the victimhood scale. Keep in mind that the share of the population who will be in the top ten percent at some point in their life-cycle is much higher than ten percent. The right over-exploits this argument (obviously not everyone has an equal chance of becoming rich, and many in society have close to zero opportunity). However the completely static view of the left is also an exaggeration.

More importantly, creating an environment where the most productive in society have incentives to acquire a lot of human capital, work hard, put their carrier ahead of leisure, work intensively and if necessary with unrewarding tasks, take risks and aim for the top is good also for everybody else.

* The more the high-skilled earn, the more we can tax them and fund welfare for the poor. According to the OECD, the top ten percent of American income earners pay 45% of taxes (this includes payroll taxes). In Sweden, the corresponding figure is only 27%, and in France 28% . Wouldn't ordinary Swedes be better off if our most talented worked more and paid more taxes?

* When you put a lot of skilled people together in knowledge industries and entice them to work hard, productivity appears to go up exponentially. This is what we observe in cities such as New York, and in elite organizations such as Mckinsey, Google or Harvard. These high-skilled individuals and organizations create a great deal of so-called innovation spillovers. The people who developed the microprocessor thus only captured a small fraction of the societal value created as private wealth. This is one reason I believe the standard estimates underestimate the negative effects of taxes on the economy, since they neither include innovation and knowledge spillovers or the effect skilled people have on the productivity of other skilled people.

* The high-skilled likely not only raise the productivity of each other, but also of the rest of society. When someone created a new venture he or she raises the productivity of the people hired. Similarly good managers are needed for companies to be productive.

* Lastly the high-income raise the wages of the poor by bidding up demand for their labor. Thus busboys in the U.S earn much more than busboys in El-Salvador, even if they perform the exact same task. The left tends to become angry whenever you point this out, although I have never seem them offer any arguments why this simple implication of economics doesn't hold.

Needless to say, raising the labor supply of the high-skilled generally does not imply theft from the poor. If a doctor or civil engineer postpones retirement for one year and earns more, that reflects more value created, not exploitation. There are examples when the high-skilled earn "rents" rather than create value (such as many lobbyist) or engage in zero-sum activity (some but far from all people in finance), but this is a minority of overall economic output of the professional classes.

We should be honest and admit that skilled professionals contribute more to society than the bottom ten percent. However I also believe that those at the top tend to have had a more privileged life and hence should feel a stronger social obligation.

In would guess that the behavior of the top ten percent is one of the most important reasons for the success of the U.S economy compared to that of Europe. Highly skilled Americans work crazy hours, are professional and motivated, and tend to be quite good at what they do. Probably mainly due to lower taxes and a better business climate, the top ten percent earn far more in the United States than in Europe.

An exciting new database by economists Facundo Alvaredo, Tony Atkinson, Thomas Piketty and Emmanuel Saez amongst others has data on the income level of the tenth percentile for several countries. This measure, P90, is the level of income that would make someone richer than exactly 90% of the population.

I have adjusted the figures for inflation and PPP based on OECD data. For a couple of countries the data was a few years prior to 2005, so I assumed their income share remained constant and their income increased with GDP.

These are not perfect estimates, because the data comes from different sources, have different units and different standards, you should just view them as illustrative. These are pre-tax income. Payroll taxes are not included, nor is employer funded benefits such as health insurance and pensions. These are mainly based on the statistics gathered by the tax-agency, so unreported income will not be included.

In 2005 the P90 threshold in the United States was $105.000, which means that ten percent of Americans had income at or above that level.

The same year the P90 threshold in Sweden was $43.000 (37700 kr), so if you earned this paltry sum you were among the top ten percent highest earners. In fact, less than 1 percent of Swedes earn more than $100.000 per year, about 880.000 kronor per year purchasing power adjusted.

This is confirmed by the Swedish Statistical Agency, which reports that in 2005 there were 61.000 Swedes who earned more than 800.000 kronor per year, or merely 0.8% of the adult population. 10.2% earned more than 360.000 kr, which again indicates that the figures are almost identical to the Top Income Database.

No doubt, those at the bottom are better off in Sweden than in the United States. However the middle class in Sweden is still somewhat poorer than the middle class in the United States, while high-skilled Swedes are far poorer than high-skilled Americans.

I don't think having few poor people requires us to keep the rich down. The left considers the relative poverty of the top earners in Sweden a good thing for Sweden, while I believe it is a problem. The comparative poverty of the rich is problematic both from the perspective of those hired by entrepreneurs, those who benefit from new technologies and products developed by skilled workers, those who sell their goods and services to the rich and not the least from the perspective of tax collection and the welfare state.

Friday, April 15, 2011

Open borders and the Welfare State

Today I write an article about classical liberal theory and compleatly free immigration in Svensk Tidskrift, a journal tied closely to the center-right Swedish Moderate Party. The text is in Swedish. It is pushing the boundaries of what is permitted to say in Sweden and may get me into trouble, but I made the choice to take the hit, hoping for intellectual honesty from those who disagree with me.

My hope is that as someone who grew up for ten years on welfare, who lived close to two years in refuge camps and the rest of his childhood in so called "Millionprogram" housing, in foster-care and "ungdomshem", who in school was physically assaulted several times by skinheads and Neo-Nazis, who had Neo-Nazis come to his home and yell "sieg heil" in the buzzer, who lived in 99% immigrant Ronna while he commuted an hour and a half each way to Handelshögskolan, I can get away with a tiny bit more on this contentious topic than a blond bourgeoisie Swede would.

I argue against open borders in a modern welfare state based on classical liberal principles.

First I demonstrate that unskilled immigration to current welfare states has led to sizable transfers of wealth from and reduction of freedom of the current owners of the state. These owners are of course citizens, needless to say regardless of race or ethnic origin.

Libertarian theory which is used to derive the principle of completely free immigration tends to make the unrealistic assumption that the welfare state and voting rights over the properties of others do not exist. Libertarians sometimes acknowledge the problem of combining a welfare state and open borders, but proceed to declare that they support open borders and no welfare state.

I argue that this is a logically flawed proposal.

Immigrants from third world countries tend to earn less than for example native Swedes or Americans, and furthermore tend to come from countries with no tradition of classical liberalism.

Hence 77% of non-European immigrants voted for the left in the 2010 election, a year when only 43% of native born Swedes voted for the combined left. In the United States whereas only 35% of whites prefer raising taxes and expanding government, the figure is 65% for Hispanic immigrants and 66% for second-generation Hispanics.

These patterns are completely rational, immigrants earn less and unlike Anglo-Saxons have no traditional preference for limited government.

The way immigrants vote and their political preferences cannot simply be assumed away in any serious ideological discussion.

Open borders in a affluent welfare state leads to unskilled immigrants soon becoming the majority of the voters. Since unskilled immigrants in the reality we live in generally do not support libertarian style limited government, the Sanandaji Principe states that you can only pick 2 out of 3 of:

1. Limited Government
2. Open Borders
3. Democracy

Even if Swedes and Americans abolished the welfare state tomorrow (something which I would oppose), with open borders the welfare state would reemerge as soon as the immigrants became the majority of voters. Ignoring the voting patterns of immigrants when you propose abolishing the welfare state and fully opening borders is subsequently a violation of the Lucas Critique. Open borders and an abolished welfare state can only be combined in a nightmare society where immigrants and their children are never allowed to vote.

For me the choice is simple, I prefer Democracy to Open Borders. If a country decides to take immigrants, they have to be included 100% with full rights, and not permanent second-class citizens.

The three most important Libertarian intellectuals of the last century who thought deeply about the subject all concluded that open borders in our societies with welfare states was a bad idea.

Friedrich Hayek thus wrote ”a recognition of collective ownership of the resources of the country which is not compatible with the idea of an open society”. The minimum standard of living that Hayek believed the state should guarantee even its poorest citizens ”necessitates certain limitations on the free movement across frontiers”.

Milton Friedman also recognized this, and stated ”You cannot simultaneously have free immigration and a welfare state”.

Late in his life, Robert Nozick become skeptical about open borders, saying (in an interview with a libertarian Swedish journal no less!): ”Why do we not have completely free immigration everywhere? One reason is the welfare state".

Swedish Libertarians such as Johan Norberg, Mattias Svenssson and Henrik Alexandersson by contrast support open borders combined with keeping or if need be expanding the welfare state. Thus Norberg, Svensson, Alexandersson and others in the "Frihetsfronten" who for decades fought to abolish tax financed health care and schools for Swedish citizens supported the recent decision to grant the same services to illegal immigrants. Mattias Svensson's comment on this historic expansion of the Swedish welfare state in scope to potentially the entire planet was "This is what solidarity is about". Johan Norberg similarly gave the decision a thumbs up in his column.

Remember, a simple libertarian solution would have been to allow illegal immigrants to pay for health care and education services out of their own pockets, just as Frihetsfronten wants Swedes to do. But being pro-immigration has become so important for Swedish libertarian identity that they are cheering expanded welfare state services for illegal immigrants. If you wanted to be unkind, a suitable name for this novel ideology would be Libertarian-Socialism.

Limits on free migration is not just an arbitrary state construct, it is necessary to uphold ownership rights imposed by owners (citizens), just as a fence is necessary to uphold private property. Organizations such as condo-associations who produce social externalities for their members and make decisions about collective matters always limit membership. Since we have chosen to organize ourselves in a nation-state and grant some rights over our lives to fellow citizens, we need to restrict who has coercive power over us. Borders are limits on expanding the necessary-evil which coercion through voting represents.

Voting rights of citizens over common decisions and collective assets should therefore best be viewed in this context as form of property. If you accept this premise, abolishing borders in a modern welfare state is a form of socialism, just as abolishing fences would be. Note that both private property and citizenship rights evolved gradually through the spontaneous order and were not "created", that both serve to increase societal efficiency, and that both are common to all modern societies. Libertarians should remember that that private property also limits free mobility. This theoretical view confirms with reality, where the consequence of unskilled immigration to the welfare states such as Sweden have been an expansion of government and a reduction of the freedom of the existing citizens.

Classical Liberals should take after Hayek, Friedman and Nozick and think deeply about these issues. The discussion should take real world empirical patterns into account and use a richer model than the simple neoclassical model with assumes away voting, the public sector and social externalities. We have to first have a theory of what a nation-state is, what citizenship is and what voting rights are, before we propose to abolishing these rights through open borders.


I had to cut parts of my article [In Swedish] due to space limitations, so I will put it here:

"Ett något tyngre vägande argument än det ekonomiska är att invandring gjort Sverige kulturellt rikare. Men även det påståendet brister. Visst har Sverige berikats enormt mycket av globaliseringen. Men dessa extremt viktiga influenser utifrån har till överväldigande del inte kommit genom invandring, utan genom utbyte av information (och i mindre utsträckning genom handel). Steve Jobs och Jerry Seinfeld var inte tvungna att flytta till Sverige för att vi skulle kunna påverkas av dem.

Det land som Sverige utan jämförelse har tagit mest kulturella influenser ifrån under efterkrigstiden är USA, ett land som vi har få invandrare från i Sverige. I jämförelse är de kulturella influenserna på vanliga svenskar från t.ex. Afghanistan, Irak, och Somalia i det närmaste noll. Sverige har visserligen fått matinfluenser från Mellanöstern, men vi har också fått ännu större matinfluenser från Frankrike, Japan, Thailand och Indien, utan att ha någon omfattande invandring från dessa länder.

Med tanke på att matkultur består av information och råvaror är detta egentligen självklart, på grund av frihandel och informationsrevolutionen behövs det ytterst få individer för att sprida matkultur. Italiensk och fransk matkultur har i och med globaliseringen erövrat hela världen, utan någon storskalig utvandring. Johan Norberg påstod nyligen att Sverige inte skulle ha haft olivolja eller espresso i affärerna utan invandringen. Detta är fel – trots allt finns olivolja i t.ex. finska mataffärer, trots att Finland haft avsevärt lägre invandring än Sverige.

Om invandring inte stärker Sveriges ekonomi, är det åtminstone inte det bästa sättet att hjälpa andra till ett bättre liv? Svaret är tyvärr troligtvis nej. För det första är tredje världens problem för stora för att lösas av invandring, invandringen till väst är en droppe i havet satt i relation till totalbefolkningen i dessa länder. Inget land har i modern tid blivit rikt på att dess invånare flyttat utomlands. Kina och Indien började i slutändan inte utvecklas genom extern utvandring, utan genom interna liberala reformer (precis som i Sverige på 1800-talet, all romantik kring utvandringen till trots). Inte heller är invandring effektiv biståndspolitik. Sverige skulle kunna rädda miljoner liv med mat och medicin för de stora summor invandringen kostar.

Det går inte att täcka in alla aspekter av ett så brett fenomen som invandring i en artikel. Jag är kanske något mer ensidigt pessimistisk än jag borde vara. Å andra sidan är det ytterst sällan sakliga negativa argument lyfts fram på ett samlat sätt. Invandringspolitikens inverkan på samhället börjar nu bli så pass påtaglig att det inte längre räcker med att konstatera att ”som liberal är jag givetvis för en generös invandrings- och flyktingpolitik”."

Wednesday, April 13, 2011

Doing the math: President Obama's plan to tax the rich will hardly make a dent in the deficit

The President will give a speech tonight on how he plans to solve America's deficit problem by taxing the rich.

From a distributional point of view, I have nothing against taxing the rich. Further, while it true fact that taxes tend to shrink the tax base (the only question is how much), let's ignore the Laffer-curve controversy. Let us instead accept the left's own calculations about tax revenue.

The centerpiece of President Obama's plan is to raise taxes on the rich (households making $250.000 or more). There is no doubt that the rich have become richer over the last few decades, and hence could afford this tax increase. If taxing them would solve the deficit crisis, I would support it in a heartbeat.

The only problem with this "solution" is that it is dishonest. President Obama likes to give the impression that his plan to tax the rich can significantly reduce the deficit, a claim which is false and which Obama knows is false.

Everybody knows that the rich have a lot of money, so it may appear reasonable to non-economists that taking some this wealth can fill the hole in the budget. What the public doesn't know, and what President Obama will not tell them, is that there are just too few rich people in America for this plan to work.

According to the Congressional Budget Office, over the next 10 years the Obama budget will produce a deficit of $10.900 billion, or 5.3% of GDP on average.

According to the left's own calculations and as reported by the New York Times, Obama's plan to raise taxes on the rich will generate $700 billion in additional revenue over the next decade, or just a pathetic 0.3% of GDP.

In other words, the plan to raise taxes on the rich will only cover one out of fifteen dollars of deficit spending. Where is President Obama going to get the other fourteen out of fifteen?

To the $10.9 trillion in deficits we need to add the unfunded liabilities of Medicare and Social Security. According to the Trustees of these programs, the unfounded liabilities are a staggering $52 trillion.

Again, any honest economist who knows the facts can tell you that a measly 70 billion in revenue per year from the rich will not come close to cover Americas fiscal hole of at least 63000 billion dollars.

Sometimes you hear from the left that repealing the Bush tax cuts will raise 3.7 trillion over the next 10 years. That certainly sounds better! What is the difference between this figure and the 0.7 trillion figure I reported for the rich?

The answer is that the 3.7 trillion figure includes the Bush tax cuts for the middle class, which amount to 3 trillion over the next decade. The key to remember is that the Bush tax cuts mainly went to households making less than $250.000. Obama has no plan to repeal that part of the Bush tax cuts. The Democrats and their allies in the media who cite the 3.7 trillion figure are playing bait and switch and trying to confuse the public. I saw this trick used recently by John Stewart to deceive his economically unsophisticated audience.

A graph with the next ten years of deficits with and without the tax hike for the rich:

But what if we taxed the rich even more? Didn't Warren Buffett promise taxing the wealth of billionaire's like him could solve the problem or something?

Forbes Magazine lists all American billionaires. Going by their 2010 numbers, American billionaires have around 800 billion in net worth.

Even if we could take confiscate all their assets without any risk to the economy, this one-time solution would just pay for around six months of the 2011 deficit Obama is running.

By opposing the tax increase for the rich based on the argument that it would hurt growth instead of pointing out how little revenue it generates, the Republican party has given President Obama a gift. The Democrats give voters the impression that the only obstacle in the way of fiscal balance are the Republican's, their rich friends and their supply-side ideology. This strategy works, because the public is as economists say "fiscally ignorant". Ordinary people simply don't know the relative magnitudes of the deficit, they only know the rich have lots of money.

The media meanwhile has only a selective interests in educating the American public. When miss-perceptions help the left the media suddenly loses interest in their duty to inform the policy debate.

Friday, April 8, 2011

Red State Rising

Richard Florida is a urban theorist, famous for his book "The Rise of the Creative Class". The book argues that since liberal cities with a large concentration of high-tech industries such as San Francisco and Boston have plenty of street musicians and gay bars, street musicians and gay bars must be causing the high-tech sector.

Because of its politically correct message, the book is popular among politicians and in the media. But due to the unsubstantiated claims of causality and shaky statistical evidence, it is not very well respected among economists. Harvard professor Edward Glaser reviewed Florida's statistical analysis, and found that Florida's correlations vanish or even reverse signs once you simply take the level of education in a city into account.

Richard Florida is back with an attack on conservative America in The Atlantic. He writes:

"Conservatism, more and more, is the ideology of the economically left behind. The current economic crisis only appears to have deepened conservatism’s hold on America’s states."..." American politics is increasingly disconnected from its economic engine [liberal states]. And this deepening political divide has become perhaps the biggest bottleneck on the road to long-run prosperity."

Is conservatism the ideology of losers? Is the Republican Party the party of those who cannot make it on their own in the marketplace, and are hence bitter? Are liberal states the "economic engine" of America?

Well, let us start with the fact that a "state" doesn't take an ideological position, individuals do. Although rich states tend to vote Democrat, within states the richer you the more likely you are to vote Republican. So while Mississippi is poor, the poorest groups in Mississippi are Democrats. This is true for whites as well as minorities. This paradox been established by Columbia University's Andrew Gelman (whom Florida cites, so he can't be unaware of it).

Overall, the within state tendency of the economically successful to vote Republican is far stronger than the between state tendency of rich states to vote Democrat. In the United States, it is still true that the economically successful are more likely to vote for free-enterprise Republican and the unsuccessful to vote for welfare-state Democrats.

In 2008 in Georgia 70% of the voters who earned less than $30.000 voted for Obama, whereas only 40% of Georgia voters who earn more than $100.000 voted for Obama. The affluent in Georgia are Republican, whilst Democrat voters are those who are dragging down the state average. In Mississippi 66% voters who earned less than $30.000 voted for Obama, compared to only 23% of high income voters.

In poor white West Virginia, Obama got 62% of those making less than $30.000 but just 39% of those making more than $100.000. In other words, those WV Appalachian "Rednecks" that the media loves to demonize and portray as Republicans on closer observation turn out to vote Democrat. I could go on, the pattern is the same across all Red Stats.

This paradox that poor states vote Republican while poor Americans vote Democrat may be too subtle to understand for journalists, foreigners and causal observers of politics. We should however expect a professor writing in the Atlantic to make the effort. But of course we know why he didn't. The liberal audience of the Atlantic likes to be told that they belong to the party of wealth and success, while Republican voters are losers. Why spoil a good story with facts?

Let's go from states to the national averages. This is how individuals voted in 2010.

Of American voters who earn less than $30.000 per year 40% voted Republican, and the rest for Democrats.

Of Americans voters who earn more than $200.000 per year 64% voted Republican!

Does the Atlantic seriously want to claim that people who makes more than 200k per year are "economically left behind"?

None of this is really new, although Professor Florida apparently needs the reminder. Let's more forward to Florida's claim that liberal areas are the "economic engine" of America.

Red States, by which are mean states that voted for Bush in 2004, are on average poorer than Blue states, mainly due to having more poor Democrats.

However, during the last few decades the less regulated and taxed Red States have had faster growth than Blue states. According to the Bureau of Economic Analyses Regional Economic Accounts Between 1970 and 2010, real output increased by an average of 3.4% per year in Red States compared to 2.6% per year in Blue States. The real per capita growth rate of personal income in the Red States was 2.0% per year, compared to 1.8% per year in Blue States.

The graph below shows the convergence of per capita income. Note that this does not adjust for the cost of living, which is lower in Red States. One reason Red States have been growing faster is that they started at lower levels and are converging. Another likely explanation is pro-growth economic policies.

Job numbers in Republican states are even more impressive. Red States have been creating far more new jobs than Blue States. Part of this is that Red States have had enjoyed a better economic climate and consequently have been attracting more people over this period. Americans are voting with their feat, leaving Blue States for Red States.

The most striking number is that between 1990 and 2009 the Red half of America created 24 million new jobs, compared to only 12 million new jobs in Blue States. This means that Red States created two thirds of all new jobs in the United States between 1990 and 2009. These are the very states which Richard Florida claimed were increasingly falling behind. The Blue States, which Florida calls the "economic engine" of the United States, not only had lower income growth, but only added half as many new jobs as Red States.

Richard Florida's claims in the Atlantic may confirm liberal stereotypes, but have little support in economic data.

Friday, April 1, 2011

David Brooks and Malcolm Gladwell wrong about I.Q, Income and Wealth

In his book "The Social Animal", reviewed here, David brooks writes:

"Once you get past some pretty obvious correlations (smart people make better mathematicians), there is a very loose relationship between IQ and life outcomes."

Brooks further cites a study claiming that there is "no correlation between accumulating large wealth and high IQ."

Both claims are wrong. The result Brooks cites is after "controlling" for education and income. But education and income are themselves functions of I.Q, so you shouldn't control for them if the question you want to answer is how I.Q effects life outcomes.

I have not seen this graphed online, so let's visualize the relationship between an estimate of I.Q and income and wealth so you can see for yourself. The source is NLYS79, a dataset which tracks a representative sample of the U.S population. Intelligence is approximated by the military when the individuals in the sample were mostly teenagers, while income and wealth data is for the same guys in their 40s. The sample is restricted to non-Hispanic white men.

For this group the lowest decile is people with I.Q below 84, and the highest decile above 116, which is not a very high cutoff. So keep in mind that we are not talking about only super-geniuses, in which case the results would be even stronger. Also remember that the middle of the distribution have very similar I.Q scores, the 5th decile is around 101-104, and the 6th decile around 104-108.

As you can see Americans men lucky enough to be born either with genes or a home environment that facilitates high I.Q earn more and accumulate more wealth.

The strong link between I.Q and earnings is well known by labor economists, but perhaps not by the affluent and high-I.Q readers of the New York Times. Obviously most of it goes through education. As technological development makes I.Q more valuable and unskilled labor less valuable, this disparity is increasing.

Another common claim of Brooks and of Malcolm Gladwell is that I.Q may matter, but only until around 130, after which it becomes meaningless. This is also wrong. Many previous samples have had too few observations to make reliable inference about the effect of I.Q above 130. Of course not having sufficient data hardly justifies Gladwell confidently claiming that I.Q above 130 is irrelevant even for scientists in technical fields (which I and others who are not smart enough to handle advanced mathematics could have told you from personal experience was a bizarre theory). After all, 130 is not that high, around the mean for a Harvard or SSE student.

This recent paper by Heckman, Gensowski and Savelyev studies the life outcomes of the Terman sample, which entirely consists of American men and women with I.Q above 135 (in some cases far above 135). They find that I.Q has a significant effects on earnings and educational outcomes, also for those above the 135 I.Q threshold. Another Malcolm Gladwell myth busted.

There are some policy implications from this realization. One is that smart and successful people shouldn't congratulate themselves so much. They didn't so much "earn" their talent than were lucky in the gene/environment lottery. If you are born healthy, with high I.Q genes and with educated parents and a good home environment you are expected to earn more than a more disadvantaged child who exerts the exact amount of effort through life.

Unlike libertarians, Conservatives believe that those who were the recipients of good fortunate have a moral obligations towards the rest of society, in particular to the people who do their best but just have less marketable skills.

Another is that the left is wrong about the market allocating income mainly based on chance, connections or "power". In fact, earnings are strongly linked to intelligence, which indicates that they are linked to productivity, just as economic theory predicts. Poor people are on average less productive than rich people, a claim which may sound obvious (almost tautological) to an economist but which outrages a lot of people on the left.

Denying the link between productivity and earnings is very important for the modern left, as their entire source of outrage is based on the view that the capitalist system "exploits" the poor. More likely, because of the modern welfare state and because of the growing importance of human capital, more resources are transferred from the productive rich to the poor than vice-versa. There is so little demand in the labor market for unskilled people that the poor in industrialized countries increasingly don't even work full time.

The fact that the rich don't exploit the poor doesn't mean the rich shouldn't help the poor. But it's one thing to claim you are rich because you are stealing from poor people, and another to believe you have an obligation to help all members of society due to randomly having being granted more valued skills. Fairness perceptions are not only a function of the type of distribution we desire, but to an even greater extent a function of the process we believe creates inequality.

I suppose David Brooks and Gladwell give an inaccurate impression about I.Q and income/wealth in order to make their readers feel warm and fuzzy. But that is not an accurate depiction of the world we live in, we live in a much harsher and more unfair reality.
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