Don’t Forget Rent Seeking

Greg Mankiw looks at an article by Paul Krugman on the current economic problems.

The essence of Paul’s argument is that the economy of the Great Depression was in a liquidity trap, which implies that the AD curve is vertical, which in turn implies that policies that adversely shift the AS curve do not affect equilibrium output in the short run. Thus, a policy that under normal circumstances would be bad, such as cartelizing the supply of labor, is not bad under the extraordinary circumstances of the 1930s. (See Gauti Eggertsson for a more sophisticated version of this line of argument.)

[…]

Even staying within the AD-AS model, it seems possible to argue the opposite point of view. Imagine you are a manager of a firm considering a long-term investment project. The President has just announced a policy to encourage your workers to form a cartel. How does that influence your decision to proceed with the project? Very likely, it deters you. Investment spending, however, is part of aggregate demand (in fact, one of the most volatile components). Thus, the policy could shift the AD curve, as well as the AS curve, in a contractionary direction.

As a general matter, the state of aggregate demand depends on an amorphous variable called confidence. Anything that threatens to screw up AS in the long run most likely reduces confidence and AD in the short run. The textbook separation of AD and AS is useful for focusing discussion in the undergraduate classroom, but events in the real world are rarely so clean.

And all of this discussion ignores the issue of rent seeking. Once you tell labor organizations that they can act as a cartel and charge what are, in effect, monopoly prices and possibly even enforce such an edict with the full coercive power of the government how do you take back such a nice juicy bit of pork? The labor organization is going to love such a move and will lobby to protect such rents. At the same time corporations will lobby to remove such rents. All that lobbying is not going to help produce goods and services.

And lets keep in mind, when a cartel charges a higher price it does so by restricting output which in this case would be the number of people working. Driving up wages might be a good thing in the current economy, but you also have to think beyond the current situation and the problems you are creating for yourself down the road. Think of it like medicine to some extent. Yeah the patient in pain and needs surgery. But at the same time if you aren’t careful with the pain medication you use you could create and addict who ultimately destroys himself. And government programs, laws, and regulations have a tendency to stay around well past their desired expiration date.

And lets look at another post on Prof. Mankiw’s website,

Economists Mark Bils of the University of Rochester and Pete Klenow of Stanford say we should cut the payroll tax to stimulate the economy. They email me their rationale:

As part of a temporary fiscal stimulus, we would argue for subsidizing the payroll tax (employer and employee portions) out of general revenue over some sustained period, say calendar year 2009. It has some distinct advantages:

(1) Like previous stimulus efforts, it has the standard demand side impact (same as cutting checks). But it also stimulates employment directly by reducing the tax penalties for working and for hiring workers. Related, it works under all business cycle models (even including those obeying Ricardian Equivalence).

(2) It targets domestic production better than sending out checks (or a sales tax cut).

(3) It targets lower income households, due to the cap on social security taxes. These households may respond more in both their consumption and employment decisions.

Now, it does not target the unemployed. But, in combination with extension of unemployment benefits, those with labor force attachment are still covered. In fact, it helps limit the damaging effects of extending the duration of unemployment benefits in terms of distorting reentry and job creation decisions.

Basically this would raise the after tax wage, which is precisely what Krugman is arguing for when he talks about creating a labor cartel, but this one probably wouldn’t face the same rent seeking problems as creating a labor cartel. Why? Voters are a diverse disorganized group, whereas a labor cartel and corporations are not, as we can see when we look at how taxes.

FILED UNDER: Economics and Business, Government, , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Drew says:

    Steve –

    I do not understand the assertion: “It targets domestic production better than sending out checks (or a sales tax cut).”

    Are they saying that a producer will be induced to employ because of lower employment costs in the absence of consumer demand?

  2. DL says:

    What happens if there is a job cartel? Isn’t that what occurs on those scare hot dog stand corners?

  3. Steve Verdon says:

    I do not understand the assertion: “It targets domestic production better than sending out checks (or a sales tax cut).”

    It would work on both the employer and employee side. That is my guess as to what they are talking about.

    Are they saying that a producer will be induced to employ because of lower employment costs in the absence of consumer demand?

    Yes, that would be my guess. It is more direct in that it lowers the costs associated with hiring an employee attributable to payroll taxes.

  4. odograph says:

    Yesterday’s “planet money” had a economist on who really came clean about how little the discipline can do, and how they’ll just disagree about what happened after.

    That’s what I’m talkin’ about. I caught that vibe here, trying to goad Steve into a proof for his position. Obviously it’s not just Steve. The economists don’t know what the f_ck they’re doing.

    After years of them telling us they now know exactly how to turn back out of a Great Depression style scenario, we find out they can’t.

    (They can argue around the edges about rent seeking of course … to which I wish I could say “just fix it!”)

  5. odograph says:

    BTW, they CAN of course provide their patented sneering condescension WHILE they don’t fix it.

  6. Steve Verdon says:

    Odograph,

    You are a fool. The problem here is that the best solution is not a viable solution politically. For example, the policy I’ve noted above would meet many of the standards for fiscal stimulus. Further, it fits with some empirical research and it would appear to result in the same effects under different models of the economy–i.e. it is a robust policy.

    However, do you really think that it will be put in place? No. Why not? Because it is just to damn banal for a politician. Politicians want to be seen as the savior so that they can take credit for it. Cutting payroll taxes and,

    1. Putting more money in the paychecks of everyone who earns under $90,000 (approx.).
    2. Reduces employment costs.

    [Aside: Both of those effects will, all else being equal, increase employment and consumption. We need both right now.]

    But its just too…simple…too blah. Creating a new agency, talking about how it is going to spend billions and hire thousands maybe millions to do “public works”. Now that…that’s sexy. And it makes people feel good becuase it is something that sounds good…sounds powerfull. Its hands on while cutting payroll taxes is too hands off. Republicans will blather on about capital gains tax cuts and regulations. Which isn’t probably going to do a whole lot right now either.

    You think these decisions are made in a vacuum when it comes to ideology? Do you? It sure seems that way.

    Oh and rent seeking is one of the reasons we are in this mess. And the only sure fire way to fix that is to get goverment out. You think that is going to happen.

    Stop acting like a complete idiot.

  7. odograph says:

    Steve, way to open with sneering condescension!

    Putting the problem off as political is absolute b_ullshit. Why? Because if your “science” could put together an answer, the politicians would take.

    Instead Mankiw points one way, Krugman the other.

    The same thing happens that always happens. 100 economist offer 100 plans and the politicians choose 1. It works or not, but regardless the 99 rejected economists get to write books about how their answer was better.

    Contrast this to real science and engineering where practitioners can at least agree on a framework to test their ideas. They may not agree on which bridge design is best, but they can agree on physical models.

    Economics has none of this. The why’s of the Great Depression are friggin’ debated now as we should know what the lesson was and how it applies.

  8. odograph says:

    Oh and rent seeking is one of the reasons we are in this mess. And the only sure fire way to fix that is to get goverment out. You think that is going to happen.

    OF COURSE economics can provide a narrative, it just can’t tell you which factor in the narrative is really the driver to world events.

    Talk about pretentious losers.

  9. Steve Verdon says:

    Steve, way to open with sneering condescension!

    You get treated that way because my reply to you has basically the same message I’ve had in several posts now. The government isn’t about to implement the best solution for the crisis. The government isn’t interested in doing that.

    Putting the problem off as political is absolute b_ullshit. Why? Because if your “science” could put together an answer, the politicians would take.

    Oh right. Politicians are not going to consider the political ramifications of a proposed solution. Nope, they will sacrifice their power, if need be, so that others can have better lives. Right.

    Instead Mankiw points one way, Krugman the other.

    No. No. No. If you read Mankiw’s post he points out that it is probably a good idea to use a policy that would show similar results under a variety of models/assumptions about the economy.

    This is the second time I’ve written that and you obstinately refuse to incorporate that in your response. In the original post I noted that it results in the same effect Krugman is tyrig to obtain with his model: raising the after tax wage rate. And you wonder why I think so poorly of you.

    Contrast this to real science and engineering where practitioners can at least agree on a framework to test their ideas. They may not agree on which bridge design is best, but they can agree on physical models.

    Economics is not engineering or physics. I can’t belive I had to actually point that out. When you build a bridge the laws of physics don’t suddenly change as a response.

    Oh, and if everyone agrees on a given model and it is incorrect….what then oh brilliant one?

    Economics has none of this. The why’s of the Great Depression are friggin’ debated now as we should know what the lesson was and how it applies.

    Look at how stupid you are. On the one hand you complain that economists haven’t figured out how an economy made of millions of individuals respond to not only government policy, but other endogenous and exogenous factors, and at the same time think we should have already figured it out. You are contradicting yourself.

    OF COURSE economics can provide a narrative, it just can’t tell you which factor in the narrative is really the driver to world events.

    And yet you manage to out do your previous stupidity.

    Here is an idea: perhaps there is no single driver.

  10. odograph says:

    Simple question:

    Do economists agree on a single best solution to the crisis?

    Where do we look it up?

  11. odograph says:

    To help you get started, I said:

    Instead Mankiw points one way, Krugman the other.

    On October 17, Paul Krugman wrote Let’s Get Fiscal, in which he wrote:

    On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

    And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case. The usual argument against public works as economic stimulus is that they take too long: by the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn’t needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil. So let’s get those projects rolling.

    Do you think Mankiw buys into that? Do you?