Friday, April 19, 2013

When it comes to justifying economic development initiatives and incentives, public officials and those seeking favorable treatment from state and local government generally find it easy. And the most common drumbeat is “Jobs! Jobs! Jobs!” But I’ve noticed a trend where it seems the economic profession’s criticisms are affecting a positive change. Alas, I believe the change is chimerical.

We now hear the champions of economic development talking the talk that “not all economic development is created equal” and “there are some developments that are just not worth the price”. But I think this is a sales pitch to quiet the dissent without actually making a change. The mantra is still JOBS!, but now we hear of “primary” or more desirable jobs versus “secondary” or less desirable jobs. The definition of these two alleged distinct types of jobs shows some fundamental misunderstandings of economic analysis.

Here is the idea. Suppose you are an economic planner representing a regionally large, nationally small but important city. Oklahoma City is a good example. Two prospective firms are each considering a new location in one of a few cities, and Oklahoma City has made the short list for both firms. You know what each wants, say it is a ten-year tax break that amounts to $5,000,000, but the problem is because your city operates under strict balanced budget accounting, you are only authorized to give up to $5,000,000 in tax incentives away. That amount may go up or down in a year, but for now that is all you can agree to. Both firms want it, and you know with high certainty that either firm will take it and choose your city but without it the firms will go elsewhere. You want the jobs (because, after all, it is JOBS!); so you must decide to which firm to extend the incentive.

  • Firm A is a call center that will have 100 employees who will take calls from around the world to solve computer technology problems for a fee.
  • Firm B is a high-end automotive mechanic service employing 100 who will compete with local dealerships to offer high quality auto repair. The customers base is expected to be nearly 100% local.

The average wage and distribution of wages is the same between the two firms.

To the economic planner Firm A is offering “primary” jobs while Firm B is offering “secondary” jobs. Never mind the fact that jobs are not a good but a cost—there is a reason people aspire to retirement and Garfield hates Mondays. Firm A is “bringing in wealth” by exporting the service calls and importing the customers’ payment for service. Firm B is “moving around wealth” by selling auto repair for payment all within the locality. The preference is intuitive since in Firm A’s case revenue is flowing into the city rather than just revolving around the city as with Firm B. But the intuition here is a deeply flawed economic analysis. It stems from fundamentally misunderstanding the economics of exchange.

When a firm adds value to society, it does so by using less resources than it provides. The measure of this is profit. But profit in the case of both firms flows to the owners who may or may not reside in your community. Because you as economic developer are trying to grow quality jobs, you must consider which jobs are more desirable--remember, you only can give the incentive to one firm. Firm A gives up call center services exporting them outside of the community in exchange for money from outside the community which is partially used to pay the 100 employees' wages. Firm B gives up auto repair services for money all of which remains in the community. Firm B is retaining all of the benefit within the community while Firm A is sending away half of the benefit.

To make this clearer we should remove the monetary component, which serves to muddy the analysis. Ultimately, money is a proxy for what it can buy. At its essence exchange is still a bartering process; it's just that half of the barter is anything you want it to be (anything money can buy--so not love, Dr. McDreamy). Let's replace money with food. Perhaps now we can see it clearly: Firm A is sending computer services out of the community in exchange for food while Firm B is facilitating people within the community exchanging auto services for food. Both exchanges are mutually beneficial to the parties involved. But if you are going to prefer the local society over the society at large since you're the local economic developer, then you should prefer Firm B because that firm is retaining all the benefits (goods and services along with gains from trade) within the community.

Thursday, April 18, 2013

Greed versus Envy

The White House put out a budget just a couple months late of when it is supposed to, which is a rather good record in comparison to the Senate who hasn't passed a budget in four years. Contained within it was an interesting proposal--capping the amount a person can save for retirement through tax-deferred accounts such as traditional IRAs where taxes are paid only once distributions begin, which is usually during retirement.

The maximum a person could set aside in an IRA would be $3 million--an amount Obama feels is plenty enough. Just when you thought we were doing all we could to punish saving and reward consumption, we get this to up the ante. Here is a voice of concern about the implications for tax-deferred savings accounts in general. Here is another. Seems there might be unintended consequences from the government deciding for us how much deferred consumption is enough.

But you see, deferred consumption amounts to deferred taxation. And that is where the greed angle comes in. Obama would have us believe that greed is good in this case--the greed the government has for tax revenue now rather than later. Yet there are two facts that make me doubt that greed is the true motive here:

  1. The proposal is estimated to generate a negligible amount of $9 billion in tax revenue over the next decade--about 3% of 1% of what the federal government plans to spend over that time. 
  2. If this were really about accelerating tax payments from the future to the present, then part of the proposal would include allowing unlimited Roth IRA contributions where taxes are paid up front. 
The absence of the second component in the budget makes me think this is more about envy than greed.

Tuesday, April 16, 2013

The Midas Touch

What a difference a few days make. I planned on making this post last Thursday after a client meeting where the discussion included the pros and cons of an investment allocation to gold. My basic premise is no truer today than it was before gold's plunge in price Monday, but it would have given me a few bonus points to state my thesis on gold before the dramatic sell off.

The case for gold in a portfolio like the case for any precious metal is difficult to make. The theoretical support would be that it is a good inflation hedge, an historical store of value across societies and time, and uncorrelated with most other investments. But that is where the difficulty begins because those beliefs are not as ironclad as goldbugs would have you believe. In fact the most important theoretical support for gold, inflation hedging, seems to be the weakest case of the three. We'll get to that in a second, but first let's consider what gold lacks.

Gold lacks industrial use. It is not a capital good. It is a consumer good. So is bread, Travertine tile, and 55"-LED LCD TVs. Unlike bread, it won't go bad, but also unlike bread, it won't do you a bit of good if you eat it. It is durable like Travertine tile, but a lot more expensive--so much so that someone might try to steal it, which makes it expensive just to protect. One ounce of gold will buy you a pretty good TV. At the margin, I'd rather have the TV. Already there is something funny about using this soft, yellow metal as an investment asset.

Here are two of the top seven Warren Buffett quotes on gold as told by Minyanville:
3. "Gold is a way of going long on fear, and it has been a pretty good way of going long on fear from time to time. But you really have to hope people become more afraid in a year or two years than they are now. And if they become more afraid you make money, if they become less afraid you lose money, but the gold itself doesn't produce anything."
4. "I will say this about gold. If you took all the gold in the world, it would roughly make a cube 67 feet on a side…Now for that same cube of gold, it would be worth at today’s market prices about $7 trillion – that’s probably about a third of the value of all the stocks in the United States…For $7 trillion…you could have all the farmland in the United States, you could have about seven Exxon Mobils (NYSE:XOM) and you could have a trillion dollars of walking-around money…And if you offered me the choice of looking at some 67 foot cube of gold and looking at it all day, and you know me touching it and fondling it occasionally…Call me crazy, but I’ll take the farmland and the Exxon Mobils." [Note: The price of gold has changed since this quote was made. The gold would buy much less today.]
The first quote alludes to a chief problem many including myself have with gold as an investment--it has no cash flow. Aside from a potential positive roll yield when the futures market is in backwardation, a gold allocation generates no gains but does have substantial costs to maintain (transactions, storage, and carrying).  And realize that not having a cash flow of any kind (direct to the investor like a dividend or interest payment or indirect to the firm like a profit stream) means we can only value it based on the amorphous idea that someone does and will want it at a future date at a price attractive for us to sell.

Let's now turn to the historical record. To be a good inflation hedge, an asset should have a high correlation to inflation along with relative outperformance of inflation--when inflation is high, the asset is high or higher and when inflation is low, the asset is low or not as low. The first part is crucial. We want our inflation hedge to come through in the clutch. The U.S. left the gold standard in April of 1968 allowing gold to freely float when priced in dollars. It is at this point that it became investable as a theoretical hedge against dollar inflation.

Well, for the period April 1968 through April 2013 gold has only about a 13% correlation to CPI, which is to say they have basically been uncorrelated over this time span. The correlation doesn't improve much in the high inflation days of the late 70s and early 80s. The S&P 500 was even more uncorrelated with CPI at about -10%. But for what it gave up in correlation, it more than overcame in return. [UPDATE: the correlation between gold and CPI for the 1973 - 1985 period is only about 14%.]

Looking at the total return from owning gold to owning the S&P 500 with dividends reinvested over this time span, the comparison is not close. The S&P 500 returned over 6,850% while gold returned over 3,560% (see chart below). [Note: The source for these calculations is the St. Louis Fed's FRED. When using Bloomberg, I get somewhat different results for gold, about 4,400%. I will try to get clarification on this calculation to verify why there is a discrepancy. UPDATE: Looking further into the Bloomberg data it seems that the historical gold price is a composite and that the TR calculation is much closer to the FRED data, about 3,843%.]

This return difference is impressive. While gold was in the lead for two decades, the S&P 500 made a strong comeback to take over. Only the recent run up in gold has helped the yellow metal gain some but not all ground. And notice the long lulls for gold. This is another knock against it. For someone retiring in 1984, it would not have been a very good store of retirement value.

Over the full span the S&P 500 is over 50% higher in value. To understand how big that is think about everything you own and then imagine not having half of it.

Gold beckons you to enter, but there is no disguising what I fear.
To love the gold investment, the golden words poured into my ear,
there must be another whose heart is cold
He loves only gold.

Monday, April 15, 2013

Taxes are the price we pay to live in an insane society

It's that time of year again. Time for all Americans to take Uncle Sam's annual insanity quiz: if you can get through the tax forms and still think it all makes sense, congratulations, you're nuts! Notice that I'm not even criticizing tax rates or tax burdens for being too high. At this point I'm only complaining that the process is bat guano crazy.

There are lots of ways to raise as much revenue as we raise today while being immensely more efficient not to mention being fairer. We don't even have to give up all those wonderful special interest giveaways. There are plenty of ways to subsidize them and incentivize behavior otherwise to support all the various things without which society would break down--like jobs for tax preparers, mortgage interest rebates, 366-day stock holdings, and trains running to nowhere. Or would straightforward, simple subsidies be too obviously indefensible?

Regardless, here are my top alternatives to our current tax nightmare (each would be a wholesale replacement of all that befuddles us today):
  • A value-added tax (VAT) applicable to all goods and services--no exceptions.
  • A final goods and services sales tax as described here.
  • A total compensation payroll tax (this means all wages and benefits including education/training, equity including stock options, and health insurance, et al. would be taxable benefits).
The whole mess reminds me of this:

Today also marks the infamous 2-year anniversary of Black Friday as it is known in the poker community. That is the day that a US Attorney unsealed an indictment against Internet poker companies sloppily labeling online poker a crime, a baseless charge that was later dropped, and shutting down effectively all online poker in the United States. As the cases against those charged with money laundering and bank fraud continue to play out and millions of dollars in player funds sit in limbo, it is not at all surprising that a government-created, quasi-black market attracted shady characters and suboptimal market outcomes. The Poker Players Alliance continues the fight for freedom.

Thursday, April 11, 2013

If Marie Antoinette lived in a glass house, would her pot and kettle be black?

So I'm mixing methaphors . . . and stealing one in this case. Bob Stoops, the University of Oklahoma's rather well-paid football coach, made some comments the other day to the Sporting News regarding college football players' "pay". Having read the article, I'm not nearly as worked up as I was when the comments were related to me--so much for the reliability of hearsay.

The part where I'm stealing a metaphor comes from The Oklahoman's columnist, Berry Tramel's, article. I think he gets it basically right: message wasn't so bad, but delivery including the messenger is a problem.

Stoops' message is an argument worth having: that college football players do get paid in the form of scholarships, tutoring, athletic training, etc. Of course at some point the NCAA's basic message would be in conflict with Stoops' in that all the TV ads the cartel runs keep telling us that college athletes are almost always "going pro in something other than their sport". So much for the value of the training.

I read that Stoops says he is all for stipends. So maybe we are just arguing about the form and structure of how college football players, et al. should be paid. But if he wants to argue that a scholarship is of high value to an athlete, and let's remember that value is subjective (i.e., wage value is in the eye of the laborer), then there is a simple test we can conduct. Let athletes choose between full scholarships and the comparable amount in after-tax income. Stop making them attend classes unless they choose to attend and pay for college. If Stoops is right, then not much should change in the college football landscape.

PS. To those who would invoke the silly argument that college football players would make a foolish choice taking the money instead of the education, I'd say be careful the point you raise. Are you sure you know better how adults (nearly all college football players are adults) should live their lives than they do? If college football players are so foolish or short sighted or subject to bad decision making perhaps due to adverse influences in their lives, then are we sure no one other than the people profiting off of their labor should be making these choices for them? Are you sure college is as valuable as you think? Have you read Charles Murray? Are you sure all universities are created (and continue) equal? Does the fact that 115,000 janitors hold bachelor's degrees give you pause? How would you characterize "The Great Gatsby"? Was he . . . uh  . . . great!?

Wednesday, April 10, 2013

Marriage: a matter of equality before the law

Here comes another post where I relate an on-going discussion I've been having with a friend. The friend is a self-described conservatarian (part conservative and part libertarian). He struggles with some issues of libertarian ideology such as full drug legalization and same-sex marriage. He is thoughtful in his disagreement, when he has disagreement with my strict-liberty philosophy, and this extends to a careful treatment of the same-sex marriage issues. While he is not yet a supporter of same-sex marriage, he is very tolerant of those who are homosexual, and he is questioning his position on the marriage issues. He is willing to learn.

He brought today a new argument that he had heard recently. For background, this relates to an earlier segment of this debate we've been having where I invoked Mike Munger's rather good argument (I believe it is a very good argument) that the issue is not about some slippery slope to three-way marriage, etc. Today the argument brought was something along the lines of the following (I am paraphrasing and probably butchering as well):
The state should be blind in many respects in the marriage contract: Blind to race, blind to national origin, blind to religion, and blind to sexual preference. But the evolutionarily natural and by far historically predominant state of marriage has been between a man and a woman. If the state begins sanctioning the marriage contract between man and man or woman and woman, then the state is no longer blind to sexual preference. The state is making a judgment about conditions within marriage that it was previously blind to. Therefore, the state should not disrupt the natural and common understanding of marriage (man and woman). Otherwise, why not man-woman-woman? Why not spinster sisters who want to avoid inheritance tax? Etc.
The argument itself is a non sequitur and the additional worry at the end is a red herring. It is a strange twist to say that the state is treating people equally by not allowing some people major advantages it offers others because some don't meet a rather arbitrary condition: heterosexual union. 

As we discussed it further, we seemed to get bogged down in the slippery-slope part where if the state says that being a man and a woman are not essential conditions for marriage, then, according to the argument presented, there is no logical way to draw the line limiting it to two people, etc. The idea is in part an attempt to "corner a libertarian" by making me take a difficult position through reductio ad absurdum. If so, he was barking up the wrong tree. My argument was as follows: 
There may be a logical straight line (pun intended) as well as a liberty-principled reason to support marriage contracts among more than two people, but that is a battle for another day. It is not the current debate, and it doesn't shed light on how we should settle the current debate over same-sex marriage. What's more, many of these hypothetical marriages do not follow logically from allowing same-sex marriage. We can draw lines about what will and what will not be considered a legitimate marriage contract. 
I was searching for an analogy in the law to help make this concrete. At first I thought of liable and how it is different in different jurisdictions and somewhat arbitrary, but with liable we essentially get to a point where a balance is struck. Then I thought patent law might be a better analogy as it is a creation of the state as is the marriage contract (in case it isn't obvious, this entire discussion has nothing to do with how a particular religion defines marriage--it is only about state-recognized contract). But then the best analogy came to mind, and I sent the following email:
Forget the liable analogy. This one is much better, I think, to express my argument against the logic you were laying out this morning: The minimum age we allow people to get married.
This is something that has varied arbitrarily throughout history and varies today across societies. In the US it is usually 18 with the exceptions of Nebraska (19) and Mississippi (21). Most states allow minors to get married with parental or judicial consent generally limiting this group to 16 and 17 year olds. There are also pregnancy exceptions for females below 18 along with some other exceptions in various states.
I would equate same-sex marriage prohibitions with age prohibitions for those 18 or above. So Nebraska and Mississippi become the problem cases. Nebraska and Mississippi might argue that if they are forced to move their restriction down to 18, then why not 17? Why not 14? Etc. That isn't the issue. The issue is if legal, consenting adults can marry. Arguments could be made that those below the arbitrarily-set age of majority, 18, should still be allowed to marry, but that is not the issue at hand. Changing the definition of state-sanctioned marriage to include same-sex couples may weaken the case against three-person or more marriage, but that is not the issue being addressed. The issue is whether the state-sanctioned marriage contract can be rightfully limited to couples that are comprised of one male and one female.
My first-best solution is that the state should have no role in marriage--there shouldn't be a marriage penalty or benefit in tax policy, exchange of assets, etc. My second-best solution is that the state should not discriminate when sanctioning a marriage by considering the genders of the marriage participants. We've come a long way since the Army recruiter's standard question for Winger and Ziskey: "Are either of you homosexuals?" We still have a ways to go.

Saturday, April 6, 2013

Highly linkable

I'm back from my unintentional hiatus. Now that my bracket is busted and other things have been put to bed, at least for a while, I can get busy with a lot of blogging that has been on my mind. To begin, let's get some good links in.

Megan McArdle takes just six minutes in this Cato Daily Podcast to very effectively explain what insurance is and what it is not and why Health and Human Services Secretary Kathleen Sebelius is in the camp of confusion. The all-too conventional wisdom is that insurance is about a transfer of expense, but this should obviously be nonsense. How could a redistribution scheme be a profitable endeavor? Insurance is rather a transfer of risk.

While we enjoy the excitement of March Madness, let us not forget the madness that is the non-free market of college athletics. Dave Berri has a column on Freakonomics asking simply, "How about a free market for college athletes?"

Speaking of Freakonomics, if you'd like a scary example of how quickly a consortium of "experts" can slip into technocratic thinking and tyrannical behavior, listen to this Freakonomics podcast on fighting obesity. There was a strong vein of Kling's oppressor-oppressed narrative running through these progressives.

John Cochrane explains why boogeyman-like fears of genetically modified organisms (plants, foods, etc.) is not only misplaced, anti-science, and anachronistic, but it is also very bad for the poorest among us. GMO just ain't the big, bad wolf.

Finally, Stephen Landsburg makes a point in principaled agreement with me by showing in two videos how magnificently wealthy we are.