subject: Information Asymmetries 2 [print this page] By Leslie Pratch By Leslie Pratch
August 29, 2009
By Leslie Pratch
To continue my previous post on information asymmetries and economic stimulus, Milton Friedman said if you want to stimulate the economy, just give the poor money. That was how the negative income tax was born. I believe in protecting those at the bottom end of the income distribution in times of depression by giving them money to bring them up to the 5th or 8th percentile. But I don"t know how to do that. I don"t think we can rely on philanthropy. Sometimes the government has to intervene.
I would like to bridge those on the left to those on the right. Those on the left tend to be more in favor of social policies; those on the right say those social policies interfere with legitimate freedoms. The government, for example, shouldn"t give out smallpox vaccines. The negative income tax was Friedman"s idea of a permanent arrangement to help the poor not be poor targeted at recessions.
Most economists at the University of Chicago do not think government action is prudent because the stimulus is too small and it takes too long to work its way into the system; Joseph Stiglitz and Paul Krugman have made these same points. Investors in the private sector are skilled at making investments and even they make mistakes. Government officials are neither skilled in that activity nor do they make decisions to maximize output; Ted Steven"s bridge to nowhere is an example.
Krugman has said for months we ought to substitute government spending for shortfalls in private spending; essentially, government should substitute spending to fill in the gap in spending not filled by the private sector. That seems reasonable but do we have the right incentives in place? Government officials haven"t been trained in managing investment projects, and they are motivated by political considerations. That"s a recipe for wasting money. The government allocation of spending is subject to political forces in the government which means a lot of it is going to be wasted than if it were done in the private sector.
Sam Pelzman, an industrial economist trained at Chicago (I believe he got his Ph.D. in 1960 or 1961) said this past December that only one policy works: a payroll tax holiday. What this means is that instead of holding wages for social security you let the employee have it. The payroll tax is 7.65%. If you make $40,000 a year, $333/month is taken out for payroll taxes. Pelzman"s idea is just don"t withhold that money. Total consumer spending will go up by 10%. That is a powerful engine. With 120 million workers times one thousand times four is half a trillion dollars and that amounts to 3-4% of GDP which, if put in consumers" hands, they will spend.
Milton Friedman put forth the idea that people spend what they perceive their permanent income to be. When you have a transitory component of income, you view it as transitory. Friedman"s hypothesis is that consumers will invest the transitory component in a durable good such as a car. The essence is that consumers take the transitory income to pay down debt which is like investing in durable goods and the payroll tax holiday would go on for a couple of years.
I believe there are ordinary and natural forces in the economy that produce a correction. I think we are already seeing it. The stock market has been really strong since March 9, 2009, which I believe was the bottom; the Dow is trading above 9,000 and so it"s up 2500 points on a 6500 point base. That"s a 40% increase in the stock market; each stock market point is worth $15 billion; so we are up 2500 points. That"s $15 billion times 2500 "" in other words, $4 trillion of added wealth through stock market moves alone. I think the stock market itself will stimulate spending. The economic climate should be good in a year and unemployment by then might be down to 9%. It takes time for labor unemployment to go down, but there is now a lot of slack capacity and eventually that slack capacity will be priced appropriately and then, finally, consumers will spend.
