Monthly Archives: January 2007

Not so fast…

Menzie Chinn (of Econbrowser) and his co-authors find:

We evaluate whether the Renminbi (RMB) is misaligned, relying upon conventional statistical methods of inference. A framework built around the relationship between relative price and relative output levels is used. We find that, once sampling uncertainty and serial correlation are accounted for, there is little statistical evidence that the RMB is undervalued. The result is robust to various choices of country samples and sample periods, as well as to the inclusion of control variables.

GDP Growth reports:

The economy snapped out of a sluggish spell and grew at a faster-than- expected 3.5 percent pace in the final quarter of last year as consumers ratcheted up spending despite a painful housing slump.
The fresh snapshot of business activity, released by the Commerce Department Wednesday, underscored the resilience of the economy; it has managed to keep on moving despite the ill effects of the residential real-estate bust.

The economy’s performance in the October-to-December quarter, which followed two quarters of rather listless activity, exceeded analysts’ forecasts for a 3 percent growth rate.

The economy opened 2006 on a strong note, growing at a 5.6 percent pace, the fastest spurt in 2 1/2 years. But it lost steam during the spring and late summer. It grew at a 2.6 percent pace in the second quarter and then a weaker 2 percent pace in the third quarter. The fourth-quarter’s rebound ended the year on a positive note.

For all of 2006, the gross domestic product (GDP) increased by 3.4 percent, an improvement from a 3.2 percent showing in 2005.

Quote of the Day

“Some people might describe my view of politics as ‘cynical.’ I reject the charge. I describe my view of politics as realistic.”

Don Boudreaux

Enough is Enough, part 2

In my previous post on Pigouvian taxes, I made the claim that the tax penalizes individuals who live in the furthest proximity to their job. I have received quite a bit of hate mail exclaiming that I am stating the obvious. Therefore, I would like to explain myself further.

The proximity of one’s dwelling to their place of employment is the result of many factors. Individuals choose the location of their home not only on the distance to their place of employment, but also to that of their spouse. In addition, many people choose to live in the same metropolitan area as their relatives (if possible). Further, neighborhoods are also chosen based on safety and the public school district.

Surely there are other factors that play a role as well. Essentially, the point that I am making is that individuals make decisions about where to live based on a variety of factors.

Most of those who work here in Detroit, do not live within the city limits. In fact, people have been fleeing Detroit at an rather quick rate. The reasons are quite clear. The neighborhoods in suburban Detroit are safer and the schools are better. Others have further personal reasons for choosing the suburbs — and specific suburbs for that matter.

Pigouvians claim that if the gas tax is raised, individuals will reduce gasoline consumption by using alternative methods of transportation, purchasing new vehicles, and moving closer to work. In reality, this is not the case. An increase in gas prices in not likely to cause anyone in suburban Detroit to migrate within the city limits. Doing so would require individuals to live in neighborhoods that are less safe, send their children to poorly performing schools, and pay unusually high property taxes. This is hardly a worthy trade-off.


More hate mail has arrived criticizing me of opposing this idea for ideological reasons. Sure I have ideological reasons for stating my case. Allow me to explain.

Choosing a car is similar to choosing the proximity of housing to one’s workplace. There are a variety of decisions involved. Different families and individuals have different tastes and necessities. Cars are chosen based on family size, the desired use of the vehicle, the vehicle’s style, and a variety of other factors. Gas mileage is just one of those factors.

Thus, changing to more fuel efficient vehicles is also not without a major trade-off. (I wonder how the Toyota Prius managed in the three plus inches of snow that graced the Motor City this morning?) For years, individuals have chosen to purchase trucks and SUVs voluntarily. Therefore, it must be the case that the cars provide something that individuals want. Perhaps it is the four-wheel-drive or the safety and security or even the ability to seat six. For whatever reason, Americans have by and large chosen to drive the vehicle that best fits their needs.

In essence, the Pigouvian tax on gasoline says to Americans that they are unable to make decisions on their own and seeks to forcibly change their behavior through government coercion.

The Pigouvian Subsidy

Those who have purchased a hybrid in the past year are eligible for a tax credit. This subsidy was created to encourage individuals to purchase a more fuel efficient vehicle. Further, it leaves the decision up to each individual without doing so forcibly. In my opinion, this is a much better way to encourage individuals to purchase more fuel efficient vehicles than the Pigouvian tax.

Critics argue that the subsidy results in deficit spending. Further, with the coming fiscal crisis of Social Security and Medicare, the United States can ill afford this type of spending. However, this is a red herring. If the problem is with Social Security and Medicare, not the subsidy.

Further, if the government is so focused trying to change behavior, why shouldn’t they spend money to try and solve the problem rather than soaking individuals with a regressive tax on gasoline?

Something can be done to help the environment. I remain unconvinced that the Pigouvian tax on gasoline is the way to do so.

Becker on Health Care Reform

Gary Becker has written an excellent post on health care reform:

Health care reform in the United States is receiving lots of attention recently from politicians and the media, and major changes in federal as well as state health law are likely. In thinking about reforms it is crucial to recognize that the American system has many strong features that should be preserved, such as the predominant role of private physicians, private hospitals, and private HMO’s that compete against each other for patients and health care dollars.

Pepper . . . and Salt

The Battle Has Begun

The Pigou Club dismisses my argument by falsely assuming that their are no transaction or transition costs. My short rebuttal is in the comments.

Enough is Enough

Our friend Greg Mankiw has been promoting his Pigou Club for some time. And while I may be willing to sign up for Pigouvian taxes for producers that emit a large amount of greenhouse gases, I am not sold on higher gasoline taxes for individuals.

Mankiw’s hypothesis is that if we institute a Pigouvian tax on gasoline, it will lead to lower gasoline consumption. Perhaps this is possible in aggregate, but I am not sure that it would be the panacea that Mankiw makes it out to be.

Individuals respond to incentives. So, if a tax is placed on a good, individuals will be inclined to change their behavior. Pigouvian taxes work especially well on things like cigarettes and alcohol. The increased taxes cause many to cut down on their unhealthly habits; or even quit. However, there is something quite different between tobacco use and automobile use.

Most people use their cars to drive to work, the store, and to see friends and family. If the tax on gasoline was raised, Mankiw argues, individuals would consume less. However, individuals would still have to go to work, pick up the groceries, and presumably visit with family. Thus there would be little wiggle room for reducing consumption.

In addition, substitutes are in short supply. Those who live in cities like New York and Chicago may be able to take some sort of public transportation, but what about those who live in the suburbs? Suburbanites, in general, would be disproportionately hit with the tax. In effect, the tax would penalize individuals based on their proximity to work.

Carpooling is a possible option, but for many workers. There are unseen costs associated with carpooling; the passenger is at the mercy of the driver and his schedule. In addition, carpooling is not an option for many in large metropolitan areas where co-workers are relatively spread out.

Further, many drivers are locked into contracts — whether it be through a lease or some sort of financing. Therefore there would be a high cost for individuals to switch to a more fuel efficient vehicles. In the short run, we would see very little shifting to more fuel efficient vehicles and those who are locked into the contracts would begin paying a high price immediately.

In addition, transportation companies would see the costs of operation skyrocket. This cost would not simply be absorbed. Instead, the cost would be past along to wholesalers and retailers and thus to consumers.

Mankiw has also dabbled in philosophical fallacy:

Some of my libertarian friends aren’t members of the Pigou Club because they view gasoline taxes as a case of excessively intrusive government. But if this tangle of regulation is the alternative, isn’t it time for them to reconsider?

Mankiw’s false dilemma assumes that there are only two solutions: regulation or pigouvian taxes. Regulation is bad and thus his idea is good.

The Pigou Club purports to solve our energy problems by taxing fuel consumption. However, driving is not simply a bad habit like smoking a cigarette. Many would be unable to reduce their gas consumption by a significant amount. The tax would be especially hard on the transportation sector and thus would carry over into many consumer goods.

Pigouvian taxes are designed to correct for externalities. A pigouvian tax on gasoline, however, would be riddled with its own negative consequences. The tax assumes that individuals have a greater ability to reduce consumption than is actually the case.

The tax is a bad idea. Enough is enough.


Russ Roberts weighs in on much more philosophical grounds:

Shouldn’t we support having government encourage (not force) people to make better decisions if without that encouragement people will make bad decisions? My answer is no. I don’t expect pigs to fly. Why should I expect government to be good at helping people make good decisions?


It would be naive to argue that we shouldn’t worry about pollution because people will feel guilty polluting and that will discourage pollution. Similarly, it strikes me as naive to encourage government to solve the pollution problem via a gasoline tax if you know that the level of the tax will be set wrong and that the money will be badly spent.


But advocating a gas tax simply because driving produces externalities is a move in the wrong direction.

Another Minimum Wage Update

Gary Becker and Richard Posner write in The Wall Street Journal:

The strong bipartisan support for increasing the federal minimum wage to $7.25 an hour from the current $5.15 — a 40% increase — is a sad example of how interest-group politics and the public’s ignorance of economics can combine to give us laws that manage to be both inefficient and inegalitarian.

An increase in the minimum wage raises the costs of fast foods and other goods produced with large inputs of unskilled labor. Producers adjust both by substituting capital inputs and/or high-skilled labor for minimum-wage workers and, because the substitutes are more costly (otherwise the substitutions would have been made already), by raising prices. The higher prices reduce the producers’ output and thus their demand for labor. The adjustments to the hike in the minimum wage are inefficient because they are motivated not by a higher real cost of low-skilled labor but by a government-mandated increase in the price of that labor. That increase has the same misallocative effect as monopoly pricing.

Although some workers benefit — those who were paid the old minimum wage but are worth the new, higher one to the employers — others are pushed into unemployment, the underground economy or crime. The losers are therefore likely to lose more than the gainers gain; they are also likely to be poorer people. And poor families are disproportionately hurt by the rise in the price of fast foods and other goods produced with low-skilled labor because these families spend a relatively large fraction of their incomes on such goods. And many, maybe most, of the gainers from a higher minimum wage are not poor. Most minimum-wage workers are part time, and for the majority their minimum-wage income supplements an income derived from other sources. Examples are retirees living on Social Security or private pensions who want to get out of the house part of the day and earn pin money, stay-at-home spouses who want to supplement their spouse’s earnings, and teenagers working after school. An increase in the minimum wage will thus provide a windfall to many workers who are not poor.

Some economists deny that a minimum wage reduces employment, though most disagree. And because most increases in the minimum wage have been slight, their effects are difficult to disentangle from other factors that affect employment. But a 40% increase would be too large to have no employment effect; about a tenth of the work force makes less than $7.25 an hour. Even defenders of minimum-wage laws must believe that beyond some point a higher minimum would cause unemployment. Otherwise why don’t they propose $10, or $15, or an even higher figure?

A number of countries, including France, have conducted such experiments; the ratio of the minimum wage to the average wage is much higher in these countries than in the U.S. Economists Guy Laroque and Bernard Salanie find that the high minimum wage in France explains a significant part of the low employment rate of married women. Mr. Salanie has argued that the minimum wage also contributes to the dismal employment prospects of young persons in France, including Muslim youths, an estimated 40% of whom are unemployed.

As a means of raising people from poverty or near poverty, the minimum wage is inferior to the Earned Income Tax Credit, which compensates for low wages without interfering with the labor market or conferring windfalls on the nonpoor. EITC is not completely devoid of effects on efficient resource allocation, because like any other government spending it is defrayed out of taxes, and it has been abused by underreporting of income and overreporting of dependents. But it is a more efficient tax than the minimum wage as well as being more effective in redistributing income to the poor.

Read the whole thing.

Challenge Accepted

Paul Krugman opines:

The tax code, [Bush] said, “unwisely encourages workers to choose overly expensive, gold-plated plans. The result is that insurance premiums rise, and many Americans cannot afford the coverage they need.”

Again, wow. No economic analysis I’m aware of says that when Peter chooses a good health plan, he raises Paul’s premiums.

Alex Tabarrok offers a simple graphical rebuttal.