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Reminder of Speech in Richmond Indiana Today, by David Henderson

Wed, 18 Apr 2018 12:46:04 -0500

Today, I'll be giving a talk at Indiana University East in Richmond, Indiana.

Title: How Economists Helped End the Draft
Time: April 18 at 4:00 p.m.
Location: Tom Raper Hall 124

If you're an EconLog reader and you live nearby, please come. If you do, come up and say hi before or after.


An Economist Deals With a Cancelled Flight, by David Henderson

Tue, 17 Apr 2018 21:58:06 -0500

Today, I flew from Monterey to LAX on United, then on to Washington Dulles, with a connection planned to Dayton, Ohio. My plan was to rent a car in Dayton and drive to my hotel in Richmond, Indiana, and then go to a late dinner with some of the faculty at Indiana University East. I speak tomorrow afternoon at Indiana University East.

One problem: when I got to Dulles, I found out that my flight to Dayton had been cancelled. There wasn't another flight to Dayton until the morning and this involved a connection in Newark.

I asked the customer service rep if she could get me on another airline. My little upset: I'm pretty sure that if I hadn't asked her, she wouldn't have mentioned it. But she worked the problem and came up with an alternate: take a Super Shuttle to Washington Reagan airport (DCA) and take American Airlines late this evening to Dayton. Done. So I'm sitting here in Washington Reagan waiting until I get hungry for a Five Guys hamburger.

There are two economic components to this experience.

1. Sunk costs.

I could have got all pissy and woe-is-me about the cancelled flight, but what's the point? Then I would have paid for it twice: by missing a meal I had been looking forward to with some faculty and by having a fit. The loss due to the cancelled flight is a sunk cost.

When I have taught sunk cost in the past, I would sometimes remind my students of the expression "Don't Cry Over Spilt Milk." Then I would say that that wasn't quite the right expression. Maybe you need to cry, but recognize that it's spilt and that you can't get it back.

Now I think it's an apt expression. The crying over the missed flight would, as noted above, have added to the cost.

2. Compensating Differentials

Because the flight was cancelled due to a mechanical problem, United was responsible for making amends. The customer service rep gave me a $29 voucher to cover the Super Shuttle to Reagan, a $10 voucher for a meal either at Dulles or Reagan, and a ticket on American to Dayton.

It occurred to me that some people might scoff at the $10 voucher. But not me. I'm an economist. I recognize that $10 doesn't cover a really nice meal. But think through what would happen if United's policy changed to where they give you a $20 voucher. That extra money has to come from somewhere. Where does it come from?

Here's where compensating differentials enter. The new equilibrium would be for United to charge a very slight amount more for tickets. I would rather pay slightly less each for a whole bunch of tickets and face the small probability that sometimes it means that instead of having a nice dinner with a glass of wine, get a Five Guys burger. (Truth be told, I'm actually looking forward to a Five Guys burger.)


Default or High Inflation?, by David Henderson

Mon, 16 Apr 2018 16:44:49 -0500

I was on a discussion on Facebook yesterday with an economist about default and high inflation. This economist and I agree that the U.S. federal government has an enormous deficit and debt problem in its future. What we disagreed about is whether there's much difference between the feds defaulting on their debt or creating high inflation. He saw not much difference. I see a lot. That motivated me to go back to an article that San Jose State University economist Jeff Hummel and I had published in Independent Review back in 2014 that, for some reason, I don't seem to have posted about here. It's titled "The Inevitability of a U.S. Government Default." In it, we argue that the feds are likely to default, that money creation as an alternative is not likely to get them out of their fiscal fix, and that default is actually better economically than massively high inflation. I recommend that you read the whole article if you want both to comment and to maximize the probability that I will pay attention to your comment. Some highlights: The problem is this. Three components of the federal government budget--Social Security, Medicare, and Medicaid--are highly likely to take an increasing share of gross domestic product (GDP). Overall federal government spending, including interest on the debt, could exceed 40 percent of GDP by 2050. For more than sixty years, overall federal revenues as a percentage of GDP have almost always been within a narrow range. They have never gone over 21 percent of GDP and have almost never gone below 17 percent. Even during the crisis years of World War II, they never exceeded 22 percent of GDP (White House 2013).1 The result, if the government does not change policy, will be annual deficits of approximately 20 percent of GDP. This is unsustainable. The question then becomes: What will change? This is difficult to predict. But we give the following predictions in decreasing order of certainty. First, federal government revenues are unlikely to be more than 22 percent of GDP for more than a few years. Second, well before spending reaches 30 percent of GDP, the federal gov- ernment will face a renewed, more serious fiscal crisis. Third, likely cuts in the growth of Medicare and Medicaid spending would at best delay, but not prevent, this crisis. Fourth, the probability is therefore fairly high that the federal government will be forced to default on some or all of its debt. Fifth, outright default on the federal debt will occur despite any increasing inflation. Why Seigniorage Won't Do It Assuming that revenues from explicit taxes remain capped at 20 percent of GDP, whether for structural or political reasons, and that politicians will have little incentive to cut spending, seigniorage would have to come up with the difference. Given that 10 percent inflation during the 1970s generated revenue amounting to 0.5 percent of GDP in the United States, a straight-line extrapolation suggests that covering the growing fiscal shortfall would require more than a tripling of the price level year after year after year. Within three years, the dollar would be worth only about 2.5 percent of its value just three years earlier. Such continual triple-digit inflation would be unprecedented, the highest the United States has ever experienced outside of its two hyperinflations. Moreover, seigniorage itself faces its own Laffer Curve (known as the Bailey Curve, after economist Martin Bailey). In order to avoid higher taxes on their real-cash balances, people spend money faster as inflation rises, thereby exacerbating the price increases. Higher rates of inflation thus generate proportionally ever-smaller revenue increases. Once we also acknowl- edge that the CBO's projections are probably too optimistic, we can see why our estimate that financing the explosion in Social Security, Medicare, and Medicaid payments will necessitate a 246 percent annual inflation is probably too low. How likely is it that governments in any developed country will be willing or even able t[...]

Why I Find It Easy to Admit Mistakes, by David Henderson

Sun, 15 Apr 2018 16:14:23 -0500

My main frustration in debates about politics and economics is the difficulty many of those I argue with have in admitting my points. Often on Facebook, for example, I will make a point, someone will respond critically, and I'll respond to that point. If I'm persuaded, my response is something like "Touche." (I learned that line from Leland Yeager when he taught a course at UCLA in 1975. Leland was, and probably still is, great at admitting it when you had a good argument against him.) And then I move on. If I'm not persuaded but I think I'm right and I seem to have answered the other person's point, a response from that person is often--nothing. No admission of a mistake on his part. I've been thinking lately about why it's so easy for me to admit mistakes and why it's so hard for many others to do so. I don't have a good answer for the latter, but I do have a good answer for the former. I think back to two things in my childhood: (1) my learning style, and (2) a painful apology I made when I was about 12. My Learning Style I was interested in many issues in government policy from a very early age, starting at about age 7 or so. We didn't have a good library in my small town, so most of what I knew was from reading the Winnipeg Free Press and talking to adults around me. (I didn't learn anything from TV because my family didn't get TV until January 1961, when I was 10 years old.) I think we are hard-wired to have opinions on things. We hear a few facts and we come up with hypotheses or theories to connect them. Based on the few facts we have, the odds that we get it right are fairly low. I learned this at an early age. So what I did was come up with my loosely held hypothesis and then test it by asking adults around me what they thought, listening to their responses, and evaluating, changing my view if I heard good enough responses. I guess you could said I was an early Bayesian. Given that I came up with this learning style in my home town of Boissevain, you could call me a Boissevain Bayesian. That style worked pretty well. I'm not saying that I usually came out with the right answer, but that style helped me readily admit mistakes. I remember one incident when I was about 11, living in Carman, Manitoba, where my family had moved when I was 9. The janitor at my church, an older man, had taken a liking to me, and vice versa. One Sunday, he invited me to come over to visit him and his wife in the afternoon. My parents approved and so I went. Somehow we got talking about politics. The New Democratic Party (NDP) had formed the previous year as a merger of the old Cooperative Commonwealth Federation and the Canadian Labour Congress. My friend, the janitor, dismissed them as Communists. That didn't ring true with what I had read in the Winnipeg Free Press and so I challenged him on it. He dug in his heels. I had always trusted my mother to be good on facts when she was pretty sure of the facts and so I told him I was going to call my Mom (in Canada, we said "Mum") and ask her. So I did. My mum said that that was false. I thanked her and hung up and told him that was false. I don't remember whether he admitted that he had badly exaggerated. I'm telling the story mainly to say that this was how I fact checked and learned. It has served me well. It is so easy to check facts now and so there is even less excuse for getting them wrong. But the point is that I don't have a lot of emotional energy tied up in holding to my position. I do have a lot of emotional energy tied up in being right, but that's what makes it easier to admit mistakes. If I see that I've made a mistake, I change my view--precisely because I want to be right. The Apology Our family moved to Carman, Manitoba in July 1960. Within a few months, my mum formed a close friendship with a very outspoken younger woman in our town. Her name was June Staite. The Staites lived only about half a block away in a town of about 1,800 people. June was a pistol. She was full of energy a[...]

Good News on Tuition from the Conversable Economist, by David Henderson

Fri, 13 Apr 2018 12:34:36 -0500


One of my favorite blogs, both for its balance and for its focus on important facts and issues, is that of the Conversable Economist, written by Timothy Taylor, the managing editor of the Journal of Economic Perspectives.

I would have written my note below as a comment on his recent post on spending on higher ed, but his post does not accept comments.

Tim starts by writing:

"Everyone" knows that the future of the US economy depends on a well-educated workforce, and on a growing share of students achieving higher levels of education.

I know Timothy a little, mainly through email and partly by having attended a 3-day conference in Montana with him in 1985. In other words, I don't know him well enough to understand the reason he put "Everyone" in quotation marks. Is it irony, because he has my co-blogger Bryan Caplan's dissent in mind? Is it because he knows that when people say "everyone knows something," that's not really true but it's almost true because everyone who counts knows that thing? I don't know.

But what's striking is that in a well-researched piece on higher education (all Tim''s posts are well-researched), he doesn't even mention Bryan's book. It's a pity. Tim brings thoughtfulness to every issue he tackles, but he takes it as given that of course the government needs to spend more on higher ed.

Even, by the way, if one rejects Bryan's view that higher ed is 80% signaling and 20% learning, and holds to the view of my Hoover colleague Eric Hanushek that the numbers are reversed, one would still have to justify having government spend more on higher ed. Most of the gains from higher ed, whether they are from signaling or from learning, are captured by the person received the education. So it's hard to justify handing taxpayer money to people most of whom will, because of that expenditure, be in the top third of the income distribution.

In any case, although Tim sees the news on government expenditures and tuition as bad, from Bryan's and my viewpoint, it's good. Here's his key paragraph summarizing the point:

This figure clarifies a pattern that is apparent from the green bars in the above figure [DRH note: the figure with green bars is a figure he posts on his site--it is not the one above]: the share of spending on public higher education that comes from tuition has been rising. It was around 29-31% of total spending in the 1990s, up to about 35-36% in the middle of the first decade of the 2000s, and in recent years has been pushing 46-47%. That's a big shift in a couple of decades.


Adam Smith on the Glory of War, by David Henderson

Thu, 12 Apr 2018 15:11:45 -0500


Yesterday I posted two quotes from Adam Smith's The Theory of Moral Sentiments to back up a Glenn Greenwald claim. Based on that, it seemed that Glenn had given a very rough precis.

Well, it turns out that Glenn's summary of Smith's point was actually dead on. Because it turns out that the relevant Smith quote is from The Wealth of Nations. Here it is:

In great empires the people who live in the capital, and in the provinces remote from the scene of action, feel, many of them scarce any inconveniency from the war; but enjoy, at their ease, the amusement of reading in the newspapers the exploits of their own fleets and armies. To them this amusement compensates the small difference between the taxes which they pay on account of the war, and those which they had been accustomed to pay in time of peace. They are commonly dissatisfied with the return of peace, which puts an end to their amusement, and to a thousand visionary hopes of conquest and national glory, from a longer continuance of the war.

HT2 Liberty Fund and Andrew G. Humphries.