An interview with Dean Baker, György László-Oláh Dániel
Makronóm.Mandiner, September 10, 2017

In Hungarian

Current events and the big picture

 

Let’s begin with a current issue. A chemical plant exploded in the wake of Hurricane Harvey a few days ago. Texas Republicans helped the plant to lobby against safety rules. The textbook example of how big business influence policy to the detriment of people? What should we learn form this case?

Yes, it is remarkable how the debate over regulation gets turned on its head. In this case the issue was the safety precautions that a chemical plant had to take in order to prevent it from posing too large a hazard to people in the surrounding community. The factory lobbied successfully against stronger regulations. The flooding from Hurricane Harvey caused the plant’s cooling system to fail, which then led to the explosion and a release of dangerous chemicals in the air.

We can’t say for certain (or at least I can’t) whether the regulations would have prevented the explosion, but the point here is that regulations are not just about the government imposing costs on an industry, they are about preventing the industry from imposing costs on others. In this case the cost is being exposed to chemicals that cause immediate suffering, especially for people with respiratory conditions, and longer terms risks of cancer and other diseases.

This is hardly a question of free markets. No one argues that they have a right to throw their sewage on their neighbor’s lawn, but this is effectively the argument being pushed by the chemical plant in this situation. Because of their wealth and political ties, they were able to win the argument.

There are further cases: a Google-funded think tank terminated an entire team run by an anti-monopoly scholar who was critical of Google’s practices. And the new CEO of Uber is the board member of The New York Times. Corporations always try to influence ideas and policy, this is the message of the history of neoliberalism.

Major businesses have long used their wealth to promote their interests in public debates. Funding friendly scholars at think tanks and universities is a major channel for doing this. The specifics of the Google-New America Foundation firing are disputed, but there is little doubt that a Google-friendly think tank will have an easier time getting funded than one that highlights Google’s abusive practices. Usually, you would not have a firing, since a non-trusted scholar would not be hired in the first place.

The University of Utah gives a good example of a more typical situation. The University has had a very progressive economics department for close to forty years. To try to limit its influence and weaken its position in the University, the Koch brothers ( two very conservative multi-billionaires) are proposing to put up the funding to establish a more right-wing department in the business school. If they succeed, they will likely be able over time to get resources shifted from the current economics department to the right-wing one they will have established.

On Uber (somewhat separate issue) the question for me was what regulations should apply. The taxi industry has been heavily regulated by cities around the world for decades. Uber has come out and said that these regulations don’t apply to them because they are Uber. Undoubtedly many of the taxi regulations are outdated and should be altered or eliminated. Some are there to protect the industry against competition, ensuring high profits.

I have argued that we should be looking to modernize our regulations, but have them apply to everyone. There are reasons for wanting the government to ensure that both taxi and Uber drivers are competent drivers, that they don’t pose a threat to their passengers, that the cars are safe, that they will be insured if they hurt themselves in an accident, and that people in wheelchairs or suffering from various disabilities can count on taxi service. Uber has largely resisted any efforts at regulation, although this may change with its new leadership.

The mechanisms of upward redistribution

 

Do libertarians really want income to flow upwards? Why?

Libertarians are a very mixed bag, but some seem very committed to opposing interventions that have the effect of redistributing income downward, but are quite comfortable with ones that redistribute upward. As an example, there is no such thing as a neutral monetary policy. Looser monetary, that allows for higher rates of employment, will have the effect of benefitting workers, and especially less well-paid workers, at the expense of more highly paid workers and owners of capital.

A view that says central banks should run tight monetary policy and be vigilant in combatting inflation can’t be seen as less interventionist than a view that says central banks should try to let the economy grow as much as possible until there is clear evidence that inflation is becoming a problem. Yet, it is probably fair to say that most (not all) libertarians would fall in the former camp.

I have also emphasized in the context of the United States economy, a peculiar asymmetry in trade agreements. Our trade deals have been very much focused on opening our markets to manufactured goods from all over the world, which has the predicted and actual effect of putting downward pressure on the pay of manufacturing workers and less-educated workers more generally. At the same time, these deals have done very little to reduce the professional barriers that protect our doctors, lawyers, and other highly paid professionals. The result is that our professionals, and doctors and dentists in particular, are paid twice as much as their counterparts in Canada, Germany, and other wealthy countries.

Many free traders will scream bloody murder about even the smallest protectionist barriers put in place to help manufacturing workers. For example, there was a “buy America” provision for some of the infrastructure spending in the stimulus, but they manage to completely ignore the protectionist measures that benefit the most highly paid workers in the economy.

It is also worth noting that we have structured our financial system to allow the industry to make enormous profits at the expense of the rest of the economy. For example, most workers now have individual retirement pensions (in addition to their government Social Security), which are run by the financial industry. The industry typically charges fees of around 1.0 percent a year of the holdings in these accounts. This is in addition to the fees charged for actually managing the funds in which these accounts are invested. The actual cost is near zero, which we know because a huge non-profit fund (Vanguard) charges its customers nothing apart from a small amount that it extracts from the individual investment funds.

Self-proclaimed supporters of the free market are largely content to leave undisturbed these and other inefficient arrangements that transfer large amounts of income upward. It is only when the interventions have the effect of benefitting those at the middle and bottom that they seem to tout the virtues of the market.

So is your conclusion that the current economic structure is strongly protectionist?

Patents and copyrights are by definition forms of protection. They are government-granted monopolies. The government will arrest individuals who try to sell items that are in competition with a legal patent or copyright. In this sense, they are undoubtedly forms of protectionism.

They also have the effect of redistributing income upward from everyone else to the small group of people who are in a position to benefit from rents from patents and copyrights. Bill Gates is a great example of this. He is the richest person in the world with a fortune that is estimated at more than $90 billion. It’s clear that he would not have anywhere near this much money if he didn’t have patent and copyright protection on Windows and various other software produced by Microsoft. In that situation, it would be meaningless to “own” Windows or any other software. Once it was developed anyone who wanted to could freely make as many copies as they wanted without even sending Bill Gates a thank you note.

I don’t actually argue for getting rid of these forms of protectionism, which at the least would be difficult to do legally as a result of a wide variety of treaty obligations made over the last three decades. I instead argued for alternative mechanisms for supporting innovation and creative work.

I think the case for an alternative is clearest in the case of prescription drugs. In the United States we are on a course to spend over $450 billion (2.3 percent of GDP) in 2017 for drugs that would likely cost less than $80 billion in a free market. Patent protection in this area in effect means that we want people to pay for the research at a point when they are suffering from a life-threatening disease. In the case of many of the new cancer treatments, the price in the United States is more than $100,000 a year. This is in a context where the cost of the generic version would almost always be well under $1,000.

This approach makes zero sense, especially since the patient is most often not the payer in any case, rather it is an insurer or the government, so we can’t even try to tell a story about consumer preferences. And, the massive gap between the price and production costs leads to all sorts of rent-seeking behavior, just as economic theory predicts. Drug companies mislead the public about the safety and effectiveness of their drugs, they try to entice doctors into prescribing their drug even if it may not be the most effective treatment, and they lobby the government to pay for it.

The secrecy surrounding patents also distorts the research process itself. Rather than widely sharing findings, drug companies only disclose the information that is necessary to get a patent. They also are only interesting in pursuing research that leads to a patentable product. This means, for example, that they have little interest in pursuing or sharing information that may suggest a condition is caused by dietary or environmental factors.

My proposal is to have public funding of research, which could be contracted with private drug companies. This would not be a huge departure for the United States, since we already spend more than $30 billion a year on biomedical research through our National Institutes of Health. However the current spending mostly goes to basic research which is then turned over to the pharmaceutical industry at little or no cost. Under the system I am proposing the funding would be used to also develop drugs and bring them through the clinical testing and government approval process.

All the patents stemming from this research would be in the public domain subject to copyleft conditions.[1] In addition, as a condition of getting the money all research findings would be published on the web as soon as practical so that all researchers would be able to benefit from them. In this situation, all the new drugs developed through this system would be available to be produced as generics from the day they were approved.

This would not prevent a drug company from staying outside of this system and trying to finance its operations with patent monopolies. The problem they would face is that they would risk a new drug being available at generic prices that was as good or better than the one they had spent years developing. My guess is that few companies would choose to take this risk.

I also propose a system of shorter patents (3-5 years) and more direct funding in other areas. Here also the condition of being able to use the material supported through publicly funded research would depend on accepting a shorter patent for any innovations.

As an alternative to copyright I propose an expansion of a system already in place whereby people get a tax deduction for charitable contributions. This includes contributions to non-profit orchestras, museums, and theater groups. For wealthy individuals this effectively means the government covers 40 percent of the cost of their contribution.

I propose a system of small tax credits (e.g. $100 per person) which everyone would have at their disposal to support the creative worker(s) of their choice or any organization that supports creative workers. This would mean that a person could give their credit to musician or singer their like or an organization that supports a particular type of music, writing, or visual art. The condition of getting the money is that person would ineligible for copyright protection for a period of time (e.g. 5 years) after getting the money. (This prevents someone from establishing a reputation under the publicly funded system and then flipping over making a fortune through the copyright system.)

I would expect that the vast majority of creative workers would enter this system and presumably stay there, since they could not guarantee that their fame would survive a 5-year period out of the public limelight. Furthermore, with a vast amount of material available over the web at no cost, my guess is that it would be difficult to get people to pay any substantial amount of money for material subject to copyright protection. So I would leave people with copyrights (again treaty obligations would require this), but the protection is just not likely to be worth very much.

Global macroeconomics

 

Your ideas often contradict to the mainstream. You think that there is no relationship between profits and investment. Is it not advisable to decrease corporate taxes? Even if it is not, what can a small country do to avoid the race to the bottom?

I guess I would say there is a weak relationship between profits and investment. Other things equal, I’m sure that more profits mean more investment. However, I showed in the aggregate data for the United States, that if anything, there is inverse correlation. Investment peaked as a share of GDP in the late 1970s and early 1980s when profits were at their low point. Conversely, as profit shares are now near post-World War II highs, investment is at roughly normal levels.

I think part of the story here is that the U.S. is still a relatively closed economy and the upward redistribution that has gone alongside the shift from wages to profits (most of it actually has been within the wage distribution) has weakened demand in the economy and therefore given firms less reason to invest. This story will be less the case for a small country like Hungary where many firms will be looking to other countries for their markets.

Firms will try to play off countries against each other for lower taxes. This is a real problem. One offset is giving companies other things that attract them, like a highly skilled workforce and cutting edge infrastructure. These factors are more important at the end of the day than tax rates. Congo could make its tax rate zero and it will still not see a flood of investment from abroad.

It is also worth trying to make whatever taxes are imposed as simple as possible. I have proposed replacing the corporate income tax in the U.S. with a system where companies to turn over a number of share of non-voting stock that is intended to be roughly equal to the targeted tax rate (e.g. if the targeted tax rate is 25 percent, then the non-voting shares should be equal to 25 percent of total shares).

The non-voting shares will get the same dividends and be subject to the same buyback rules as voting shares. This means if the company pays a $2 dividend on its voting shares, the government gets $2 on each of its shares. If the company buys back 10 percent of its shares at $100 each, then the government sells back 10 percent of its shares for $100 each. This has the advantage that there is no way to cheat the government out of its tax revenue unless the company is also cheating its stockholders. It also should mean that companies save money on their accounting since they don’t actually have to keep careful tax records and file forms. They just pay the government whatever they pay their shareholders. It’s a safe bet that corporations will still not like paying taxes, but this minimizes the burden associated with whatever amount the government actually collects.

What is the tax avoidance industry, how it works, and what are the welfare effects?

The tax avoidance industry is a pure waste from an economic standpoint. It creates nothing productive; it simply reduces the amount of money paid to the government in taxes. We should want a tax code that creates as few possibilities as possible for people to make money on tax avoidance schemes.

It is also an important source of inequality since the payoff is quite large to many tax avoidance schemes. The private equity industry in the United States relies to a large extent on tax avoidance. This industry has produced many of the richest people in the country.

According to your view, the financial sector is a source of inequality.

This is the same story as the tax avoidance industry. We obviously need a well-working financing system to facilitate the allocation of capital to firms that need to borrow and also to households to finance house purchases and other large expenses. However the financial industry has grown much larger than is necessary to serve this purpose in the United States, as well as in many other countries. This extra size is effectively pure waste from an economic standpoint, but it can make people enormously rich.

Someone who develops an algorithm that allows them to anticipate large market movements can become very rich by trading a fraction of a second ahead of the market. However this adds zero economic value. It just allows this person to effectively appropriate gains that would have otherwise gone to longer term investors. If we can foreclose opportunities to profit like this, we will have made the financial sector more efficient and also reduced inequality.

The Hungarian government implemented both a transaction tax and special sectoral taxes on financial and oligopolistic sectors after the crisis to an extent of 2 percent of the GDP. Commentators were arguing that these steps do wrong to market confidence and the economy in the long-term. In spite of this, Hungarian economy could avoid a collapse and managed to increase wage shares.

What is the reason for the fall in labor income shares: is it the story of productivity, technology, bargaining power, or something else?

I don’t know that much about the details of the Hungarian government’s actions, but both measures can in principle be defended as moves to both increase efficiency and reduce inequality. A tax on financial transactions will discourage short-term trading that is likely to be of little or no economic value. The reduction in trading costs will be a gain to the economy. Since most research indicates that trading volume is elastic, it means the volume of trading will fall by a larger percentage than the increase in trading costs due to the tax. This means that the financial sector will effectively bear the full burden of the tax in the form of reduced trading revenue, even if it is successful in fully passing on the cost of the tax in individual transactions.

A tax on monopoly profits can also be justified if it is well implemented. The point is that there are sectors in which corporations have excessive market power that allows them to charge prices far above what are consistent with a normal rate of profit. This is an inefficient outcome that can be addressed in three different ways.

The first way is to regulate the monopoly so that its profits are more in line with what it would earn in a competitive industry. This is what the U.S. did for decades with the telephone industry and still does in most states with the power industry. The second route is to break up the monopoly. This may not be feasible if the monopoly is associated with real economies of scale. The third route is to tax away the excess profits. This is apparently the route the Hungarian government has chosen.

This can be a reasonable course, but it does require that the government continually reassess the extent of the excess profits and adjust the tax accordingly. (To be clear, it doesn’t have to get it exactly right – nothing is ever exactly right – it is just important it not be hugely wrong.) There is always a risk that political considerations may affect the tax rate, but this problem arises with the other two routes as well. Anyhow, it is important to be aware of the political risk, but there is no simple remedy.

In terms of the drop in labor shares, I think higher unemployment and the resulting weakening of bargaining power has been a big factor in most countries. Most central banks have made low inflation their main or only focus in the last three decades. This has meant much higher unemployment rates on average than what we saw in the prior three decades. High unemployment reduces workers’ bargaining power.

There is a similar story with labor unions. There has been a deliberate policy in most countries (certainly in the United States) to lessen the power of unions. This has led to drops in unionization rates pretty much everywhere and for declines in labor’s power.

The way globalization was pursued has also been a factor, as it has put downward pressure on the wages of manufacturing workers, by design. This is most true in the United States, but it has been a factor everywhere. There is also the obvious feedback that competition with low-paid workers in the developing world weakens the power of labor unions.

The argument that the downward pressure on wages has been due to technology misses a step. If technology was partly responsible for the upward redistribution of income then it is due to our rules on intellectual property (IP). People would not be earning money from software, biotech, and other areas, if we did not grant them patents and copyrights and other forms of protection. If the argument is that this has led to an increase in inequality that is undesirable then we should have been debating whether the gains from additional productivity growth from stronger IP were worth the resulting increases in inequality.

To my knowledge this debate has not taken place anywhere. On its face, it would look like a hard argument. Productivity growth has not been very strong in most wealthy countries, especially in the last decade, so the benefits from strong IP rules are not obvious. Furthermore, even if strong IP rules did produce substantial growth dividends we should still ask whether there were ways to produce comparable gains that did not involve as much inequality, as I argued earlier, but we have not seen even this first step.

One way to increase labor share is through the minimum wage. Hungary is increasing the minimum wage by 15 percent in 2017 and a further 8 percent in 2018. Unemployment rate is at 4,2 percent, even lower than the US rate, and the economy needs a boost in productivity. Is it a great period to transform an economy to higher productivity by increasing minimum wages? If inefficient companies go bankrupt it will not be a social problem nowadays?

It is good to press the minimum wage until the point where there is a substantial impact on employment. I don’t know enough about Hungary’s economy to know where that point is. In the United States we have gone almost a decade without increasing the minimum wage, which means that it has fallen by more than 15 percent in inflation-adjusted terms and close to 30 percent adjusting for inflation and productivity growth. This implies substantial room for an increase just to get back to 2009 levels. And, since we probably could have supported a higher minimum wage even then, it should be possible to raise the minimum wage in the U.S. 30 percent or more in real terms from its current level.

It is important to be cautious in minimum wage hikes. They should be phased in gradually to allow businesses time to adjust and also to make sure they don’t go too far. There is a serious point raised by opponents, that if a too high minimum wage does lead to large amounts of unemployment, the people who suffer most will be the most disadvantaged segments of the workforce.

It is however important to realize that any reduction in employment due to a higher minimum wage does not condemn a worker to permanent unemployment. Minimum wage jobs tend to have high turnover, especially in the United States. This means that the loss of jobs will generally mean that it takes people longer to find a job when they leave a previous job or just enter the labor market. That is unfortunate, but the reduction in working time has to be measured against the increase in the wage. If a higher minimum wage means that workers will be able to on average work 5 percent less, but get 20 percent more per hour on average when they do work, it would be difficult not to view this as a gain for low-paid workers.

However the issue that some businesses will not be able to support a higher minimum wage should not be a serious concern, as long as overall employment remains high. This is how a market economy is supposed to work. Workers leave lower paying less productive jobs and go to higher paying more productive jobs. This is why we are not all still working in agriculture, workers moved into better paying jobs in manufacturing, but many farms went out of business. This process is how economies increase productivity through time.

Wage shares are 10 percentage points lower in Central Eastern Europe compared to the Western part on average. What may be the explanation for this? A general argument points to the mistaken transition process marked by the Washington Consensus.

There is a genuine tradeoff here. Businesses took advantage of cheaper labor in Central and Eastern Europe and therefore invested heavily in the region. If they had to pay higher wages, they would have invested less. It is possible to envision alternative strategies of integration where the EU offered more assistance to allow the former Soviet bloc countries to raise their living standards more quickly, but since this wasn’t on the table, it is not obvious that the low wage strategy was a mistake. In other words, given the choices Hungary and the other countries of Eastern and Central Europe faced, it is not clear they could have avoided this wage route.

What is the most important economic problem today and the best economic school of thought to explain it?

I think the biggest single problem remain underemployment. Much of the world still has some way to go before full recovering from the 2008-09 recession. The concern for deficits and debt has paralyzed most governments, forcing countries to rely on central banks for demand stimulus. This is better than nothing, but nearly as effective as direct government spending in boosting demand. The failure to take stronger steps to boost economies following the recession has resulted in tens of trillions of dollars in lost output worldwide. This output could have done an enormous amount to reduce world poverty, combat global warming, and achieve other important goals.

Keynes wrote about this more than 80 years ago. Unfortunately the economics profession has largely forgotten or chosen to ignore his lessons.


[1] This means that anyone else could freely use the patent as long as any patents they claims were also subject to copyleft conditions.