Tuesday, October 25, 2005

Economic Statistics and Political Goals

Bush nominated Ben Bernanke to replace Greenspan as head of the Federal Reserve in January. On CSPAN last night, they showed a clip of a meeting in which Bernanke was discussing his budget philosophy with some House committee. In that discussion, I heard Bernanke and several Senators express a line of thought that concerned me.

Leanings

For the most part, I am an economic conservative. My beliefs are grounded on the idea that if Person A spends Person A's money, he will spend it in ways that benefit Person A; while, if Person B spends Person A's money, he will spend it in ways that benefit Person B.

If Person B is a Senator or Representative, the money will still tend to be earmarked towards whatever fulfills his or her interests, and not necessarily the interests of those who are providing the money – the taxpayers.

In short, the political system is inherently corrupt. I am not talking about the type of corruption where sinister people in powerful positions with a knowing disregard for right and wrong advance their interests at the expense of others. I am talking about the tremendously underrated power of self-deception; believing something merely because one wants it to be true (e.g., that there are weapons of mass destruction in Iraq.)

I am talking about a case where somebody running for public office gets introduced to somebody who has control of money and the capacity to influence a large number of voters. This stranger comes with a passion for an idea. If the politician likes the idea and embraces it, he will get this stranger’s support – as well as the contributors and voters that this man can influence. So, he wants to believe that the idea has merit, and gives it the benefit of all doubt.

Of course, this is not to deny that there are individuals who knowingly cook studies and promote fallacious reasoning because it profits them to do so.

In fact, the plan has been built on faulty research, logical fallacies, and wishful thinking. However, neither the stranger proposing the plan nor the politician wants to see this. As a result, this, and a lot of other very poor ideas, make it through the legislative process and become law, to the detriment of all tax payers.

Illustrating Flaws in Reasoning

The arguments that disturbed me most in the hearing I saw yesterday were arguments of this type that Republicans, and Bernanke himself, seemed to accept. During the session, they focused most of their attention on gross economic figures -- total economic growth, unemployment, and overall inflation rates. As I see it, these figures tell me nothing about whether a particular policy is a good idea.

I would like to illustrate the problems that I have with this line of reasoning with a hypothetical example. In using this example, I am not saying that this is what is happening under our current policies. My claim is that the arguments that these people are using do not rule out this possibility and do not show any concern for it. Because of this, I cannot tell it the statistics being cited are giving me good reasons to support the policy, or good reasons to be concerned about the policy.

So, let's take a hypothetical society in which there are ten people each making ten dollars per year. We institute a tax cut. As a result, the income distribution changes. One person is now making $100 per year, while the remaining nine are now making $9 per year.

As a result of our tax cut, we have grown the overall economy by $81 dollars -- nearly doubling its size. However, nine out of ten people are actually worse off. Most people (almost all of them) are living a worse life than they would have had under the original system, and only one person is experiencing a better life.

Those who endorse this line of reasoning, however, speak about how great this tax cut was, since it did such a good job promoting economic growth. They also claim that government now has more money, because there is more wealth in the economy and more taxes are being paid. Because of the success of this program, they argue for another round of tax cuts.

While the public debates this argument, it is useful to note that in this example one person now controls over half of the economy. He has $100 in income, while the remaining nine combine assets; the remaining nine combined control $81. In a “one dollar – one vote” private economy, this one person gets to cast over half the votes, and dominates the economy. Anybody who does not please him suffers; those who please him are rewarded.

This one individual also has the capacity to buy up the radio stations and the television stations. Everywhere a citizen turns, he hears about the benefits of these tax cuts – how they increased economic growth and government revenue. Nobody can afford to say anything else because they do not have the money, and they fear the wrath of alienating those who have the money.

So, our hypothetical economy gets another round of tax cuts. This one person’s income goes up to $200 per year, while the other nine people drop to $8 per year. This time, we have grown our economy by $91. Average income is now up above $27 per person, and the government is now bringing in even more money.

However, it still makes sense to ask where this economy is heading. If this keeps up, we will end up with an economy where one person makes $1000 per year, and the rest are his slaves. Yet, the economic measures being used in arguing for this economy says that average income has now reached an all-time high of $100 per person. Those numbers suggest that the economy is 10 times better than it was before these tax cuts were enacted.

There is something wrong with using these types of numbers to measure economic success.

Now, I want to repeat that I am not saying that this is what is happening as a result of these policies. I can make another hypothetical argument in the other direction. Assume a country in which one person makes $1000 and nine people make $10. We start a wealth-redistribution program that damages the economy so that 1 person makes $100, eight people make $8, and 1 person ends up unemployed. Wealth redistribution is not necessarily a good thing, and I have not proved the case one way or the other.

My point is not to say that one program works and the other doesn’t. My point is to identify the types of measures we should look at in determining what works, and to warn against measures that work like bait in a trap, drawing in voters by their sweet smell until they have no opportunity for economic escape.

A Statistic Worth Using

Here is a statistics that actually have some merit in determining if policies work.

Median Household Income

Median Household Income is the amount of money made by the person in the middle of the income spectrum. If a household is at the median household income, then half of the households make more than they do, and the other half makes less. This is different from the “average” household income e. The first hypothetical example above shows average household income going up to $18 on the first round of tax cuts, while the median household income drops to $9.

In both of the hypothetical examples given above – the ‘tax cut’ and ‘income distribution’ examples -- median income dropped. What we need are policies that allow median income to go up.

In the real economy, real median household income (adjusted for inflation) has increased from $35,000 per year to over $44,000 – a 33 percent increase.

This statistic still has some weaknesses. How much of the median income is going to health care? If the household income is going up, but employers used to pay for health insurance and pensions that employees now need to cover out of their wages, then an increase in median household income does not mean much.

This measure also still assumes (incorrectly) that money is everything. If we could eliminate certain health risks, but doing so would reduce our median household income by $1 per year, it may be worth it. Thus, a higher median household income is not the only thing that matters.

Conclusion

The main point is to pay attention to numbers and indicators that actually say something about whether the country is heading in a direction that we would want it to go. Anybody who talks about economic growth or average income or even government receipts is not giving us useful data. Either he does not know how useless this data is, or he knows and is hoping that we do not.

3 comments:

Anonymous said...

Such a clear, informative explanation... enjoyed reading it, and thinking it through.

progressiveethics said...

Great argument and I suspose you read Paul Krugman in nyt? hc

Blue Cross of California said...

Great blog I hope we can work to build a better health care system. Health insurance is a major aspect to many.