The Oprah Winfrey Book Club Lottery:
“Suppose you and I are both accomplished writers of exactly the same age and reputation. We have both sold about the same number of books, yet we both only make $75,000 per year because we write “serious” books. Now, suppose a random event occurs: Oprah Winfrey opens up her book club. We both now face an equal chance that she might notice one of our next two books when they are published, read the book, and recommend it strongly to her audience. If I am the lucky one, then my income will soar from $75,000 to $5,000,000, and likewise for you if you are the lucky one.”
Well, let’s just do a deal. Let’s just enter into a contract whereby we agree to split the earnings 50/50, whoever gets the book deal. That way we both lock in a profit of $2,500,000. Pure free market economics right ?
At the end of this review, you can find how the author H. Woody Brock, (Harvard then Princeton PhD, uses this example to show us why progressive income taxes are
Elsewhere, the part I like most in this book is the analysis entitled “Must there be a Lost Decade ?”, largely I suppose because it is the part that has most relevance internationally in terms of ameliorating fiscal deficits. Brock demonstrates how we can have our cake and eat it, by increasing GDP growth and at the same time reduce long term fiscal deficits, hence preventing a Lost Decade 2010-2020. The answer lies in ensuring Government Spending is redirected towards “productive spending” on profitable investments (human capital and infrastructure). A new Marshall Plan.
Under conventional thinking it is most unlikely that these two goals can be achieved. First principles tell us:
Government Deficit = Net Private Savings + Net Foreign Capital Inflows.
Or, for the non-equation-minded, a government deficit must be funded either by (1) the domestic private sector, or (2) by foreign capital. That’s it. The late Wynne Godley of Cambridge University and the late Professor James Tobin of Yale were both proponents of this approach. So, if a government wants, say, to increase GDP growth by 2% (from the current 2% to 4%) and simultaneously reduce the government deficit by 7% (from an unsustainable 10% of GDP to a more sustainable 3%), then Net Private Savings must fall by 9%, as per the above equation. Simple.
Except that this is more or less impossible in current circumstances. Households are overly indebted, business investment confidence is low, and unemployment is rising, so the chances of a boom in overall investment spending from the private sector are...b**ger-all.
But, the insight from Brock is to focus on what we mean exactly by Government Deficit”. He engages in a Socratic Dialogue with President Obama, in order to propose a massive increase in Productive Spending.
So, out of a $4 trillion budget, $1 trillion should be invested in investments which generate positive returns, and the remaining $3 trillion (matched by tax receipts of $3 trillion) on “unproductive” spending (defence, interest payments, administrative costs, social and medical care etc).
Bond markets like this because this because the country is not running up
a structural deficit which must be serviced by future generations.
What does “productive”investment mean ? It means that an independent body would certify whether an investment is forecast to earn a positive return. It would take into account positive externalities, so that for example an interstate rail link would qualify because it generates employment opportunities in the areas which it services.
Brock draws the analogy with private accounting, where investment expenditure is not expensed, but is capitalised on the balance sheet and only the amortised portion is expensed.
There are a number of problems with Brock’s proposal. How you measure returns to take into account all those positive side effects ? Would, as proposed, international sovereign funds such as Norway or Abu Dhabi really come to the investment party, based on earning “social returns”? How do you prevent “Vested Interest Capture” of the Agency which is certifying new investments ?
And the potential for trampling over private property rights would be
But, overall the proposal deserves serious consideration, (a) because it is of global relevance for those G20 countries (most of them) running enormous deficits and (b) because the reality is that those governments are going to spend the money anyway.
Brock’s book addresses four other Big Challenges facing the USA. Two of them are very US-centric, and in my opinion not addressed rigorously enough. One is the Entitlements Crisis as exemplified by Medicare and Medicaid. Brock’s use of first principles is again to be admired, e.g. driving down the price of provision by shifting outwards the supply-curve of medical services (essentially, train more doctors and nurses). Practical ? Hmm. Of relevance to an international readership ? Limited. And even worse on China-bashing. Or, as Brock puts it: “The Need to Learn How to Bargain Effectively with Thugocracies”, in reference to China’s repeated outsmarting of the USA in
international policy matters. Yes, but China is on a much much longer time-cycle of strategic decision-making, with which 4-5 year Western electoral cycles can never hope to compete. Live with it. Democracy has some upsides too. And global geo-politics is a bit more complex than USA v China, I’m
afraid. I'd suggest non-Americans skip these chapters.
Another issue which Brock addresses is “The Risk of Future Financial Market Meltdowns”. On identifying the causes, his analysis is exceptional. Excess leverage in all sectors. An overreliance on classical economic theory over the last few decades had led decision-makers (public and private) to assume that there is no such thing as “excess” leverage, since investors will optimally leverage their positions in accordance with their own risk tolerances. Mordecai Kurz of Stanford University has developed a theory of “Endogenous Risk” which shows that when some members of society indulge in leverage over and above what is optimal, this increases the volatility of the business cycle for the entire economy, hence making everybody worse off in terms of increased risk, for little or no gain as to how much society as a whole ends up with. The policy prescriptions therefore, not surprisingly, reflect this.
A “Leverage Czar” would be appointed to monitor leverage in different asset markets, with strict penalties for contravention. I am very sceptical of the ability of a top-down agency to cope with this. And he should address the question of what the effects would be today of a one-off deleveraging within Eurozone banks in order to bring their equity into line with US banks. Brock is on surer ground in calling for bank break ups. In particular, the speculative parts of banks should not benefit from government guarantees. And I would have liked to see something on the merits of counter-cyclical fiscal policy, as sending a strong signal to the market.
Finally, Brock addresses notions of Distributive Justice. This is useful as it reminds us that the discipline of Economics is essentially driven by Politics, whether we like it or not. And whether you agree or not, Brock presents some compelling theory from the classical school (Leonid Hurwicz, Kenneth Arrow, Harvard) to demonstrate that redistribution through progressive taxes is indeed fair from a free-market perspective also. For the Economists, remember those theoretical “Arrow Securities” which allow you to hedge all risks in your life. Now, recall the Oprah Winfrey example at the beginning. Well, the insurance contract we entered into would be an example of an “Arrow Security”. But given that markets don’t operate fully efficiently to allow us to have enough information for these contracts, redistributive taxes do the job. They re-transfer wealth back to less wealthy individuals, and therefore play the role of the payout of the insurance contracts.
Overall I like this book, despite some flaws. The reason being that it is always clear and consistent, and is accessible to the layman, as the complicated theory is, rightly, shoved into appendices. And it is good at identifying much of what is wrong with today’s society.
The absence of Socratic dialogues (à la Plato) in which people debate logically in order reach mutually beneficial conclusions rather than bandying around soundbites and tweeting (“The Dialogue of the Deaf”). The overreliance on number crunching and data mining (“Students today believe that if they are equipped with a powerful database and the appropriate spreadsheet program, the truth will reveal itself”). And the mendacity of politicians (aided and abetted by a scandal-driven press) who are not subject to “irrationality scrutiny”when they introduce policies that are clearly against public benefit.
There is no Wikipedia link for this book. The facebook link is here.