Edward Conard

Top Ten New York Times Bestselling Author

  • “…a fresh argument for the productive value of inequality.” - David Autor, Professor of Economics, Massachusetts Institute of Technology
  • “…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
  • “…a fresh argument for the productive value of inequality.” - David Autor, Professor of Economics, Massachusetts Institute of Technology
  • “Unintended Consequences is far smarter and more thought-provoking than most economics written for the general public” - Greg Mankiw, Harvard University, Former Chairman of the Council of Economic Advisors
  • “Unintended Consequences is full of substance, it is one of the must-read books of the year, and once I finish it I will be giving it a second read through right away.” - Tyler Cowen, Professor, George Mason University
  • “…a very valuable contribution.” - Larry Summers, former Secretary of the Treasury and director of the National Economic Council, president emeritus, Harvard University
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “…reminds us that inequality sends a signal of what society lacks most, in America’s case, entrepreneurship and risk taking.” - Lawrence Lindsey, CEO, The Lindsey Group, former Director of the National Economic Council
  • “…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
  • “Unintended Consequences offers deep and well-argued analyses on almost every issue.” - The New York Times
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
Upside of Inequality Oxford Unintended Consequences

Macro Roundup


Thursday, June 18, 2020

AI Summary. The US pandemic response may widen economic inequality, echoing the post-financial-crisis pattern in which the affluent saw income and wealth restored quickly while many Americans faced prolonged stagnation or permanent loss. One argument holds that low productivity growth is the central challenge, with wages growing more slowly than GDP leaving businesses little incentive to invest in productivity-enhancing technology.

James Politi and James Fontanella-Khan Financial Times
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The US pandemic response may exacerbate economic inequality, mirroring post-financial crisis trends where wealth recovery favored the affluent.

Does the US pandemic response widen economic inequality?

Core argument: The US pandemic response risks widening economic inequality by mirroring the post-financial-crisis recovery, in which the wealthy saw income and wealth quickly restored while many Americans faced prolonged stagnation or permanent loss.

The US pandemic response may exacerbate economic inequality, mirroring post-financial crisis trends where wealth recovery favored the affluent. While the wealthy saw rapid income and wealth restoration, many Americans experienced prolonged stagnation or permanent loss. Economist Michael Strain emphasizes that addressing low productivity growth is crucial, as it underpins broader economic challenges. With wages growing more slowly than GDP, businesses lack incentives to invest in productivity-enhancing technology, potentially stalling economic progress and widening the divide. This dynamic risks entrenching disparities, as those with capital benefit disproportionately from economic rebounds, leaving others behind.

Takeaways by Macro Roundup® AI

  1. The US pandemic response risks widening economic inequality by mirroring the post-financial-crisis recovery, in which the wealthy saw income and wealth quickly restored while many Americans faced prolonged stagnation or permanent loss.
  2. Economist Michael Strain argues that addressing low productivity growth is crucial because it underpins broader US economic challenges.
  3. With wages growing more slowly than GDP, businesses lack incentives to invest in productivity-enhancing technology, a dynamic that risks stalling economic progress while those with capital benefit disproportionately from rebounds.

“..“We are very much at risk of having this exacerbate inequality just like the financial crisis did,” says Heather Boushey, executive director of the Washington Center for Equitable Growth, a left-leaning think-tank. “In the US after the financial crisis, it was the wealthy who saw their incomes and wealth come back fairly quickly, in the first couple of years, while the rest of America had to wait, and for many, in fact, wealth never recovered.”…Michael Strain, an economist at the American Enterprise Institute, a conservative think-tank, says that focusing on limiting inequality should not be the immediate priority, arguing that other problems such as low productivity growth are more important to tackle….”

James Politi and James Fontanella-Khan, "Why The US Pandemic Response Risks Widening The Economic Divide,"Financial Times, June 18, 2020, https://www.ft.com/content/d211f044-ecf9-4531-91aa-b6f7815a98e3

Ed Comment:Oy! High-skill productivity is growing faster than GDP because the investment opportunities (e.g., IT) exceed the supply of properly trained talent. Algebraically, if something grows faster than average, then something else must grow slower than average, namely low-skilled productivity. An unconstrained supply of low-skilled labor from low-skilled immigration, trade with low-wage economies, and automation exacerbates the problem. Growth will increase wages if the supply of labor is constrained, or employment if it’s not. US employment has grown twice as fast as Europe (and still America’s middle-class incomes are 30 to 70% higher). Were the supply of low-skilled workers constrained, high-skilled productivity growth would get transmitted to low-skilled productivity growth in the following way: Increasing demand for a limited supply of low-skilled labor would raise wages, which would prune off the least valuable work (e.g., landscaping), which would increase the marginal product of labor, which would raise wages. An unconstrained supply of low-skilled labor causes its productivity to grow slowly. Strain doesn’t see the above linkage to supply. (more below on that.) he thinks of productivity growth as an independent variable. Probably, in large part, because he sees it only linked to capital investment, like Pettis. Pettis uses a two factor model, instead of 3 factors—labor and capital, without talent. And weirdly he doesn’t start with causality. So business doesn’t invest if low-skill productivity is growing slower than GDP. And productivity doesn’t grow faster without investment. Unlike me, he never explains why productivity is growing slower than GDP. It just is. It’s empirically true. But he provides nothing more than a circular reason.I’m always surprised how much difficulty economists have following all the macro links around. In part, I think most economists lack the training, knowledge, brain power, and determination to think through all the linkages carefully. The also have a certain determination not to admit to themselves that certain truths are true—in this case, that low-skilled immigration increase the supply of labor, which reduces the marginal product of labor and wages. (in Glenn’s case, that the multiplier probably does justify his proposed investments and therefore they must be justified for humanitarian reasons.) The purpose of thinking is to stop thinking. In the case of low-skilled immigration, they are too quick to justify their wishful thinking (to support low-skilled immigration because it’s virtuously humanitarian) with “supply creates it’s own demand.” Yes, it does; but what at what marginal product of labor? Aside from the supply of labor (and capital per worker), the primary thing driving up the marginal product of low-skilled labor from “waiters waiting on waiters”, is the supply of high-skilled relative to the supply of low-skilled. Only I see that.

Michael Pettis Comment:According to this important article, “an economist at the American Enterprise Institute, a conservative think-tank, says that focusing on limiting inequality should not be the immediate priority, arguing that other problems are more important to tackle, such as the ‘slow rate of productivity growth’”. But what if the two problems are related? As long as wages grow more slowly than GDP, why would businesses invest in productivity-enhancing technology?With wages so low there is little pressure to do so (unlike in the 19th and early 20th centuries, when US wages were the highest in the world and rising rapidly). In fact it is more profitable for companies individually to force down wages, and with wages continuing to grow slowly, businesses collectively don’t face the demand for their products that justifies large increases in productivity-enhancing investment. This is a self-reinforcing process, and it is probably not a coincidence at all that the slowdown in American productivity growth overlaps with the rise in American income inequality. This by the way is also what happened in Germany after the 2003-04 labor reforms.

AI Summary. A global savings glut has not produced a corresponding investment boom; higher net saving in surplus economies has coincided with lower domestic saving and higher consumption in deficit economies rather than more investment. Proposed explanations include weak demand, capital inflows shifting production toward less investment-intensive non-traded activities, and market concentration weakening investment incentives.

Martin Sandbu Financial Times
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Global savings glut has not led to a corresponding investment boom, raising questions about why surplus economies’ exported capital is consumed rather than invested by deficit economies.

Why has a global savings glut not produced more investment?

Core argument: The global savings glut has not produced a corresponding investment boom: increased net saving exported by surplus economies has shown up in deficit economies as lower domestic saving and higher consumption rather than higher investment.

Despite a global savings glut, there has not been a corresponding investment boom, raising questions about why surplus economies' exported capital is consumed rather than invested by deficit economies. On a global level, saving and investment must balance, yet increased net saving from surplus economies has not led to higher investment in deficit economies but rather to lower domestic saving and higher consumption. Weak demand can hold back investment when macroeconomic policy fails to shift pessimistic expectations. Additionally, net capital inflows into technologically advanced economies like the US may shift productive structures towards non-traded activities, which are less investment-intensive. Furthermore, increased market concentration, potentially encouraged by low interest rates, weakens investment incentives. These factors contribute to the disconnect between savings and investment, highlighting complex macroeconomic dynamics.

Takeaways by Macro Roundup® AI

  1. The global savings glut has not produced a corresponding investment boom: increased net saving exported by surplus economies has shown up in deficit economies as lower domestic saving and higher consumption rather than higher investment.
  2. Weak demand can hold back investment when macroeconomic policy fails to shift pessimistic expectations.
  3. Net capital inflows into technologically advanced economies such as the US may shift productive structures toward less investment-intensive non-traded activities, while greater market concentration, potentially encouraged by low interest rates, weakens investment incentives.

Martin Sandbu, "Savings Gluts And Investment Droughts,"Financial Times, June 18, 2020, https://www.ft.com/content/6360c193-2fa8-488a-b8d3-f2fec3f203a2

“..economists have picked up on one of the key puzzles thrown up by Klein and Pettis’s argument: if there is a global savings glut, how come there has not been a global investment boom to absorb the greater desire for saving?... On a global level saving and investment must balance. So it cannot be that the world as a whole invests less than it saves. To be precise, then, the question is why an increase in net saving exported as capital from surplus economies has not been matched by higher investment in deficit economies but instead by lower domestic saving and higher consumption. To simplify, why has the exported capital from “savings glut” countries been consumed rather than invested by the importers? (This way of stating the problem, by the way, suggests it is too one-sided to condemn surplus countries exclusively. When economies run up current account deficits while their rates of public and private investment drop, this must also reflect their own internal dynamics. I also disagree that capital exports from surplus economies have falling employment in deficit countries as the “inevitable consequence”, as Klein and Pettis suggest. The only advanced economy that saw consistently falling employment — outside of recessions — in the period in which global macroeconomic asymmetries grew was the US, and that had much to do with its own specific pathologies.)… a number of possible mechanisms to explain the failure of investment to respond to increased savings. One is that weak demand can hold back investment when macroeconomic policy fails to unlodge pessimistic expectations. (We need not accept that central banks are unable to do this to believe in this mechanism, just that they are unwilling to stimulate enough.)Another is a “financial resource curse” through which net capital inflows into technologically leading economies such as the US shift their productive structure towards non-traded activities that may be less investment-intensive. This would be a specific case of the broader problem that beyond a certain point, financial deepening is bad for growth because it allocates capital to less productive uses. The third possible mechanism is that investment incentives are weakened by more market concentration which, in turn, may have been encouraged by low interest rates….”

Sandbu on the key question arising from Pettis’ new book

Ed Comment:Oy! Sandbu (and his new book) is a particularly virulent stain of the misguided macro economists I was describing in the last email. The last Rognlie paper confirmed a large piece of the puzzle (which I have known for years). Neither savers nor investor are very sensitive to interest rates—the price that equilibrates savings. In large part, that’s because the marginal cost of capital is (constrained) equity not (unconstrained) debt. If not interest rates, then what constrains investment? Risk and expected return, especially since non-financial investors are overwhelmingly undiversified. What is needed to assess and manage risk? Properly trained talent. Good ideas can and do become money-losing ideas if you lack the talent to design, implement, and supervise them. So why don’t investors just increase the capital per worker in underdeveloped countries?Because countries are underdeveloped BECAUSE they lack the talent needed to make those investments work. Or said differently the talent is working on projects with higher returns, often project that don’t require much debt (e.g., IT).A guy like Sandbu doesn’t want to see that, so he can’t see it. And again, he only sees an out-of-date 2-factor model—labor and capital without talent.

AI Summary. Americans in metropolitan areas with populations above 1m are over 50% more productive than those in smaller cities, even after controlling for education, experience, industry, and measured cognitive ability. Adding test-score controls reduces the urban wage premium by only 1.15%, suggesting observable ability differences explain little of the gap.

Edward Glaeser and David Mare National Bureau of Economic Research
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Americans residing in metropolitan areas with populations exceeding 1m are over 50% more productive than those in smaller cities, even when accounting for education, experience, industry, and IQ.

Does measured ability explain the wage premium in large cities?

Core argument: Americans in metropolitan areas with populations above 1m are over 50% more productive than those in smaller cities, even after controlling for education, experience, industry, and IQ.

Americans residing in metropolitan areas with populations exceeding 1m are over 50% more productive than those in smaller cities, even when accounting for education, experience, industry, and IQ. This productivity advantage persists despite controlling for AFQT scores, a measure of cognitive ability, which only reduces the urban wage premium by 1.15%. The data suggests that observable ability factors have minimal impact on the urban wage premium, indicating that unobservable factors are not the primary drivers of this productivity differential. This underscores the significant economic benefits of urban living, highlighting the role of cities in enhancing productivity and economic output.

Takeaways by Macro Roundup® AI

  1. Americans in metropolitan areas with populations above 1m are over 50% more productive than those in smaller cities, even after controlling for education, experience, industry, and IQ.
  2. Controlling for AFQT scores, a measure of cognitive ability, reduces the urban wage premium by only 1.15%, indicating that observable ability factors have minimal impact on the premium.
  3. The minimal effect of observable ability controls suggests that unobservable worker characteristics are not the primary drivers of the urban productivity differential.

Glaeser inTriumph of the City"...."Americans who lives in metropolitan areas with more than a million residents are, on average, more than 50 percent more productive than Americans who lives in smaller metropolitan areas. These relationships are the same even when we take into account the education, experience, and industry of workers. They're even the same if we take individuals workers' IQ into account"..."

Edward Glaeser and David Mare, “Cities and Skills,” National Bureau Of Economic Research, May 1994, https://www.nber.org/papers/w4728

“…Regression (10) includes the AFQT variable from the NLSY. This variable is an ability test given to the members of this sample and is one possible measure of omitted ability that is not captured by the standard individual characteristics. In fact, this variable is higher in SMSAs than in the hinterland so it does make it possible that part of the urban wage premium is omitted ability bias. Controlling for AFQT scores causes only a 1.15 % fall in the urban wage premium. As we argued above, since observable ability factors make only small differences in the urban wage premium we find it difficult to believe that unobservable ability factors are driving the ability bias that remains….”

Specifically looks like the support is Table 5, Regression 3 which is showing the AFQT (so ~ an IQ test) the data we looked at trying to crack the code on this earlier this year for race.

The relationship btw relative productivity and IQ is from Glaeser’s 1994 paper “Cities and Skill”

Edward Glaeser, Triumph Of The City: How Our Greatest Invention Makes Us Richer, Smarter, Greener, Healthier and Happier.” New York Penguin Press, 2011.

Friday, June 19, 2020

AI Summary. US trade deficits are driven in part by push factors, as economies with structural savings surpluses export excess capital to avoid domestic recessions, often by maintaining depreciated exchange rates and purchasing foreign assets. The author argues these actions are misread as currency manipulation rather than as mechanisms savings-glut countries use to sustain growth.

Kenneth Austin Real World Economic Review
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US trade deficits driven by push factors like surplus savings from other countries, which drive capital into the US. @KennethAustin, Real World Economic Review.

Are US trade deficits driven by other countries' excess savings?

Core argument: US trade deficits are influenced in part by push factors, as economies with structural savings surpluses, such as Germany, seek to export excess capital to avoid domestic recessions.

The US trade deficits are influenced by push factors such as surplus savings from other countries, which drive capital into the US. Economies with structural savings surpluses, like Germany, often seek to export excess capital to avoid domestic recessions. This capital inflow is facilitated by maintaining depreciated exchange rates, creating trade surpluses and foreign exchange inflows. Central banks may purchase foreign assets to sustain these surpluses, even at the risk of capital losses. Such actions are often misunderstood as currency manipulation but are crucial for countries with savings gluts to maintain growth. Additionally, precautionary reserve purchases and financial outflows from stable economies further contribute to these imbalances. Understanding these dynamics is essential, as misinterpreting them can lead to deflationary policies globally.

Takeaways by Macro Roundup® AI

  1. US trade deficits are influenced in part by push factors, as economies with structural savings surpluses, such as Germany, seek to export excess capital to avoid domestic recessions.
  2. Countries with savings gluts sustain trade surpluses and foreign exchange inflows by maintaining depreciated exchange rates, with central banks purchasing foreign assets even at the risk of capital losses.
  3. Interpreting savings-glut-driven capital exports as currency manipulation misreads their role in sustaining growth in surplus economies and can lead to deflationary policies globally.

Kenneth Austin, "American Trade Deficits And The Unidirectionality Error,"Real World Economic Review, 2019, http://www.paecon.net/PAEReview/issue90/AustinK90.pdf

"... Safe Haven: Safe haven flows may originate in countries with surplus savings or where savings are scarce. Investors may be protecting money from their home government... Savings Glut: The “push” comes from economies with structural savings surpluses. In closed economies, these savings might cause recessions. In an open economy, the surplus savings can be lent abroad and finance net exports, avoiding a recession, high levels of debt-financed private and government consumption, or secular stagnation depending on the particular circumstances. This is the motive for many governments to try to achieve export surpluses: producing more than they consume. In some cases, the savings are mobilized by the state or central bank and used to directly finance the trade surpluses. In other cases, the private sector demands “safe” foreign assets in the absence of attractive returns or even in spite of poor returns abroad or concern about eventual depreciation. This can represent some form of market failure. Often, these private flows are aggravated by macroeconomic policies intended to increase savings in the country of origin, even though the savings may eventually become a drag on aggregate demand..... Reserve accumulation is the simplest push-factor mechanism…. A country with weak aggregate demand can expel surplus capital by setting a depreciated exchange rate. That rate fixes a low relative price of the country’s goods on world markets and creates a trade surplus and an inflow of foreign exchange (generally dollars) in the hands of exporters. If that inflow is simply sold locally, it depresses the local price of foreign currency and cause a corresponding appreciation of the local currency. That would reduce the trade surplus. To maintain the fixed exchange rate and the trade surplus, the surplus must be financed by the purchase of foreign assets. If the private sector cannot, or will not, purchase sufficient foreign assets, the central bank has to purchase the balance at the official rate. The central bank must buy this foreign exchange surplus and purchase reserves without regard to the needs of the reserve issuer or market conditions. Its demand for reserves is determined solely by the chosen exchange rate and the resulting private sector net sales of foreign exchange. The return on reserve assets is, at best, a secondary consideration. Prasad (2014, p. xiv) notes that emerging markets ultimately expect to experience capital losses on dollar reserves. The role of exchange rates in causing global imbalances is often misunderstood. Demanding that a country stop “manipulating” its currency is equivalent to asking that country to stop buying central-bank reserves. An exchange rate alone cannot cause and sustain a trade imbalance without a counterpart flow of savings to finance it. Such currency manipulation would be an obviously bad policy and a drag on growth for a capital-scarce economy. But for a country with a savings glut depressing aggregate demand, this would help maintain growth. Thus, maintaining a depreciated exchange rate and large surpluses is a strong indication of a savings glut... Precautionary Reserve Purchases: A common argument used to explain trade imbalances is that some countries need to acquire precautionary reserves as self-insurance against a sudden stop or reversal of capital flows. The precautionary motive may be real, but this is a weak explanation of trade imbalances. A central bank can sterilize the private inflows and purchase reserves to give it one-for-one insurance against sudden stops or reversals of capital flows without financing a trade surplus (but would probably pay a negative spread). The large reserve build ups after the East Asian financial crisis may have been an overreaction, or they could have just vented surplus savings (export-led growth). Even genuine precautionary reserve purchases, from the perspective of the reserve issuer, are pushed capital inflows.... Flows at the zero lower bound among advanced countries are puzzling. The large financial outflows from stable and conservative Germany do not have an obvious, return-maximizing mechanism driving them. One can easily understand how German funds flowed to the peripheral states of the EMU and Eastern Europe prior to the 2011 financial crisis. After that, it became harder. Even as the current accounts of the crisis countries swung to surpluses, German surpluses grew again; German investors acquired even more foreign assets elsewhere, including a significant amount of interbank lending. But the precise mechanism pushing German outflows is not clear, even if its effects are evident. But Germany is a clear case of an economy that benefits from capital outflows at the expense of its neighbors….”

His Five Factors:

“…This article labels assertions of one-sided causality “the Unidirectionality Error.” This error rules out by assumption the question, “Does the United States borrow because it needs to borrow or because other countries need to lend?” The flip side of efforts to increase trade surpluses is an effort to export or expel unwanted capital. This contradicts standard economic assumptions that capital is always scarce and economies benefit from more and cheaper capital. Capital outflows may be advantageous for one economy, but harmful to the receiving economy. When the drivers of capital flows are misunderstood, the resulting policy prescriptions can be globally deflationary….”

Kenneth Austin from Treasury has a list of Push factors driving money to US that might be useful at some point:

Ed Comment:100%. Especially the line: Demanding that a country stop “manipulating” its currency is equivalent to asking that country to stop buying central-bank reserves. It's too bad I don't get credit for being at the vanguard of this and that risk-averse capital is not constrained. Except for me, economists still don't understand risk. It's like the duality of particles and waves and the juxtaposition of quantum mechanics. They get particles/savings/capital but they just can't bend their minds around waves/risk. Saving have two dimensions not one. And it's a 3 factor economy not 2. So it's 6 factors in total 1) low-skilled labor, 2) properly trained talent, 3) risk-averse savings, 4) willingness and 5) capacity to bear risk, and 6) exposure to the technological frontier, where low-skilled labor and risk-averse capital are unconstrained. Successful risk-taking builds institutions that are capable of mining the frontier. Exposure of properly trained talent to the frontier gives us more valuable ideas. Good ideas increase our willingness to take risk. But it takes more than willingness. We need the capacity to underwrite risk/ie someone needs to suffer the inevitable losses. Guys like Pettis walk around with a ridiculous 2 factor model of labor and capital and most of them (not Pettis) think both/all aspects of both are constrained. It is laughable misguided. How did Germany do it inside the EU? Very cleverly. They loaned to solvent French banks who's deposits were guaranteed by the French government. Those banks loaned to the Italian, Greek, and Spanish governments, with practically zero reserve requirements because the loans were government guaranteed (even though the governments had no way to pay back the loans). Those governments ran large fiscal deficits (and corresponding trade deficits) to finance redistribution/consumption/unnecessarily large government employment and BS well-intended white elephant infrastructure projects. The EU, that had rules about not running large fiscal deficits whined but never did anything. That channel was closed after the financial crisis. Covid now facilitates increased fiscal deficits.