JustOneMinute

Taking The Icy Plunge

The NY Times delivers a comedy classic as it attempts to explain to its readers that a prominent CNN executive has resigned under fire:

Eason Jordan, a senior executive at CNN who was responsible for coordinating the cable network's Iraq coverage, resigned abruptly last night, citing a journalistic tempest he touched off during a panel discussion at the World Economic Forum in Davos, Switzerland, late last month in which he appeared to suggest that United States troops had deliberately aimed at journalists, killing some.

A "journalistic tempest"?  This is the first story to appear in the Times!  Geez, fashionably late to a party is one thing, but fashionably late to a journalistic tempest?

Though no transcript of Mr. Jordan's remarks at Davos on Jan. 27 has been released,

Love the passive voice.  Did the Times attempt to obtain a transcript?  Would they care to tell us what obstacles prevented them from getting a transcript?  Did they ask Mr. Jordan whether he could help them get a transcript?  Mightn't they mention that Mr. Jordan is not exactly pushing to have a transcript prepared from the existing video?

Or perhaps these investigative aces simply walked outside and looked up, hoping that Davos transcripts were falling from the winter sky like snowflakes.  Then, disappointed, they resumed their effort.

...Mr. Jordan was then challenged by  Representative Barney Frank of Massachusetts, who was in the audience.

"In the audience", on the panel, whatever.  Sen. Dodd was in the audience, but he won't be in this story.

In accepting Mr. Jordan's resignation, CNN appeared intent on putting the episode behind it as quickly as possible, perhaps in an effort to avoid repeating the drawn-out tensions last fall between CBS News and the Bush administration, as well as its conservative supporters.

Perhaps Sen. Dodd and Rep. Barney Frank were part of this sinister Bush conspiracy as well?  Oops, we aren't mentioning that.  John McCain plus fifty Senate Democrats is "bi-partisan".  I guess Dodd doesn't count.

...After broadcasting a report in early September that was critical of President Bush's Vietnam-era National Guard service, CBS defended the report, in the face of criticism on Web logs, for more than a week before announcing that it could not substantiate it.

Odd that the Times would overstate the power of the blogs - although bloggers were instrumental in breaking and developing the story, ABC News, the Washington Post, and the Dallas Morning News did lots of legwork and found plenty of key witnesses.  Oh, but mentioning other news services might be a bit of a reminder that other papers like the Washington Post have covered this current "tempest".  Well, sort of covered it.

Asked last night if CNN had had any contact with the Bush administration over the fallout from Mr. Jordan's remarks, a network spokeswoman, Christa Robinson, said, "Not that I'm aware of."

Such fun!  We have exerted our Dark Powers to obtain this not-to-be-believed transcript of the phone conversation between the Times Aces and the CNN spokeswoman:

The Aces:  Is there any reason to report that the dark shadow of McCarthyism is spreading, and that another honest voice of journalistic dissent has been stifled by the machinations of that evil, all-controlling White House machine?

CNN Spokeschick:  McCartney?  He was great at the Super Bowl, loved him!

Aces:  Not McCartney, McCarthy!  The falling night, the spreading shadow!  Suppression of dissent!  Is the White House behind this Eason resignation?

CNN:  Sorry, I thought you were joking.  No, not that I am aware of, although Senator Dodd and Barney Frank have been chewing on us.

Not to worry.  The Left will live, while they have the NY Times to promote their fantasies on slim evidence.

MORE:  Kurtz of the WaPo reports this as a bipartisan uprising.

Now Why Did They Listen To The Daily Kos?

The NY Times, a couple of Congressional Democrats, and Josh Marshall are all relying for the inside skinny on "Jeff Gannon" as presented by the Daily Kos.

There is just the smallest of small problems - on the most incendiary tidbit, The Lost Kos folks have precious little evidence.  ["Gannon" Speaks!  See UPDATE].  Which means that the Times has fallen overboard. 

Let's start with the Times:

Two Democrats in Congress are pressing for investigations into how a Washington reporter who used a pseudonym managed to gain access to the White House and had access to classified documents that named Valerie Plame as a C.I.A. operative.

The Democrats, Representatives John Conyers Jr. of Michigan and Louise M. Slaughter from Rochester, wrote yesterday to Patrick Fitzgerald, the independent prosecutor appointed in the Plame case, seeking an investigation into how the reporter, James D. Guckert, who used the name Jeff Gannon, had access to classified documents that revealed the identity of Ms. Plame.

Well.  The Plame connection is quite exciting.  No "alleged", no "reportedly", no hedging at all - "Gannon" had access to classified documents, in two separate paragraphs.  Let's see how Josh Marshall described it:

Of particular interest, to me at least, is just how 'Gannon' managed to have access to classified documents relating to the Plame matter. It's not uncommon for journalists to get hold of classified materials. But given the dynamics of that story and how much the White House was gunning for Wilson, it's awfully odd that he would have had this stuff come into his hands for what could at all be called journalistic reasons.

Hmm, Josh loved the Kos input on Feb 9.  Now, let's see if we can establish another Kos Connection - gee, was it only last week I noted a bit of confusion over there?

The emerging theme, as tracked by the hard-working SusanG, was that:

White House-credentialed fake news reporter "Jeff Gannon" from fake news agency "Talon News" was cited by the Washington Post as having the only access to an internal CIA memo that named Joseph Wilson's wife, Valerie Plame, as a covert CIA agent. Gannon, in a question posed to Wilson in an October 2003 interview, referred to the memo (to which no other news outlet had access, according to the Post). Gannon subsequently has been subpoenaed by the federal grand jury looking into the Plame outing.

My goodness!  I tried to tell them (and even had a pleasant back-and-forth with a Kossite last night) - you have almost no evidence of anything at all!  The Washington Post did not say that Jeff Gannon had "exclusive" access to the memos; in fact, the entire memo was described, in detail, in the Wall Street Journal several weeks before Gannon demonstrated any knowledge of it.

Let's cover what they do have - "Jeff Gannon" really was subpoenaed by the Special Counsel investigating the Plame affair [Now I am as bad as the Times - "Gannon" was reported to have been subpoenaed, but he denies it - see UPDATE], along with a number of other reporters who had been involved in the early stages of the breaking story.

But did he have an "exclusive" look at some secret memo, as alleged by SusanG last week?  Well, the Kos crowd did pay me a bit of heed, and their press release backs up quite a bit:

According to the Washington Post, Guckert may have had access to a leaked internal CIA memo which revealed the identity of Ambassador Joe Wilson's wife, then an undercover CIA operative.  In fact, because of his possible tie to the leak, Guckert was one of a small number to be subpoenaed to testify in the federal grand jury investigation into the matter.

Getting warmer!  Gannon "may have had" access to a leaked document; he had a "possible" tie to the leak.  Their late-breaking nuance was missed by both the Times, Josh Marshall, and the Kos himself, who tells us that "[Gannon] was receiving classified CIA documents".  (Uhh, that would be INR documents, but whatever...).  [The letter from Rep. Louise Slaughter must have been written by someone high on Kos Kool-Aid]

As to what really happened?  Hey, maybe they are right, but hold on to those hedges and qualifiers a bit longer.

Here is a quick sequence - on Oct 17, the WSJ reported at length on the memo:

An internal government memo addresses some of the mysteries at the center of the White House leak investigation and could help investigators in the search for who disclosed the identity of a Central Intelligence Agency operative, according to two people familiar with the memo.

The memo, prepared by U.S. intelligence personnel, details a meeting in early 2002 where CIA officer Valerie Plame and other intelligence officials gathered to brainstorm about how to verify reports that Iraq had sought uranium yellowcake from Niger.

Ms. Plame, a member of the agency's clandestine service working on Iraqi weapons issues, suggested at the meeting that her husband, Africa expert and former U.S. diplomat Joseph Wilson, could be sent to Niger to investigate the reports, according to current and former government officials familiar with the meeting at the CIA's Virginia headquarters. Soon after, midlevel CIA officials decided to send him, say intelligence officials.

Now, drawing on the fine work of the Kos group, we learn that Jeff Gannon interviewed Amb. Joseph Wilson following the Journal story:

At some point during the week leading up to October 28th, Gannon interviews Wilson by phone. The contents of that interview are astonishing.

TN [Talon News]: An internal government memo prepared by U.S. intelligence personnel details a meeting in early 2002 where your wife, a member of the agency for clandestine service working on Iraqi weapons issues, suggested that you could be sent to investigate the reports. Do you dispute that?

That is astonishing.  Read the Journal story, and the Gannon question, and you can almost hear his copy of the Journal rustling.  Do I need to highlight the matching phrases?

Now, for a bit of bonus hilarity, Intrepid Reporter Jeff Gannon also asked Amb. Wilson about a Nick Kristof column written on Oct. 11; this appears in the Kos timeline at Nov. 3, 2003.

So, the Alternative Explanation - Jeff Gannon reads the papers!  That might explain why he has not been wacked with a contempt citation.  It might also explain why he said this:

"I will tell you that the information did not come from inside the administration," Gannon told Talon News. "For something that is supposed to be classified, it seems that this document is easily accessible."

Media Matters adds this:

"I don't know why I'm on the list of journalists being called before the Grand Jury," Gannon said. "I have been an outspoken critic of the leak probe and an aggressive questioner of the motives behind it. That seems to have drawn the attention of someone with the authority to issue subpoenas."

Well, in other forums Gannon has said other things.  And why does he not just admit that he got his news from the Journal?  Well, why should he admit it - the Special Counsel is ignoring him (we wonder why...), and pretending to be a Bold Reporter who is Bravely Protecting Sources may have a certain glam appeal.  (I would fold up like a cheap suitcase in front of the Grand Jury myself, but I would never admit to that later.  Well, unless you asked.)

Or maybe Gannon, the Journal, and others got this memo - that would be consistent with the WaPo account.  Two WSJ reporters (Gigot and Hitt) were also subpoenaed - what is their status?

My guess - there is much less here than even the newer, calmer Kos Crew supposes.  Maybe Gannon got the memo when some other folks did; I'll bet he reads the news.  Time will tell.

MORE:  Since we hold our journalists to a high standard of accuracy, is it fair to zip off an e-mail to the Times inquiring as to the evidence backing their lead sentence?  What is their source for the news that Gannon "had access to classified documents that named Valerie Plame as a C.I.A. operative." 

Perhaps the official position of the Times is that, since he was subpoenaed, he must have done something?  Odd; one might expect them to be a bit more protective of journalists.

Or perhaps they have more evidence?  One wonders what it might be.

Daniel Okrent will be delighted to ignore you: [email protected]

UPDATE:  "Gannon" / Guckert is interviewed by Editor and Publisher; keep those grains of salt handy, and here we go:

NEW YORK In a lengthy, wide-ranging interview with E&P today, former White House reporter Jeff Gannon, whose real name is James D. Guckert, revealed that, contrary to many media reports, he has not been subpoenaed in the Valerie Plame/CIA case.

He also threw into question media accounts suggesting that he had seen a classified CIA document critical to the Plame case, saying he had made references to the “internal memo,” but adding, “I never said I had it or had seen it.” But when asked if he had in fact seen it, he declined to say.

...Guckert said that contrary to many press reports, he was never subpoenaed by the special prosecutor and has never testified before a grand jury in the case. But he said he was interviewed by two FBI agents in his home for about 90 minutes last year.

"I answered their questions truthfully and honestly, but I would prefer not to say more,” he said. “I assume the information was routed back and that is why I was not called to testify."

Although he hinted that he had not seen a classified CIA document after all, he added, "I am not going to speak to that. It goes to something of a nature I do not want to discuss."

*IF* that is true, it is easy enough to imagine what he told the FBI.  *IF*.  (He might not be credible, right, Kos people?)

LATE UPDATE:  Howard Kurtz of the WaPo wraps up the Eason Jordan and "Jeff Gannon" stories, but skips right past the Plame connection.  Sort of odd, since the Times led with it, and two Dem congressfolks played it up.  Not newsworthy, Howard?  Or put another way, how can Kurtz and the Times both be right about what is newsworthy here?

One More:  Great lefty perspective from William Rivers Pitt:

    And therein lies the rub. If "Gannon" were getting zapped for simply being a conservative reporter who filed boilerplate GOP talking points as news, one could possibly have some sympathy for him even if you find his views repugnant and his hypocrisy intolerable. Yet the real issue at hand here has to do with the name Blitzer failed to bring into the conversation: Valerie Plame.

His personal blog is also quite helpful, and yes, he says it was the Kos Connection that linked Plame to "Gannon".  Well, Mr. Pitt will enjoy the Kos press release.

Does Your Model Have HAIR?

We have been following the intellectual struggle between Paul Krugman and the Council of Economic Advisors.  The basic question - can the US stock market continue to produce high returns even in a (projected) period of reduced growth?  The CEA says yes; Krugman says no.

I have spent too much of my time and my reader's patience explaining how the seeming conflict between "return on capital" and growth" can be modeled in the macroeconomic framework employed by the Social Security Trustees.

However, thanks to a very illuminating comment from one of my readers, and drawing on inspiration from Andrew Samwick, I can now resolve the puzzle in a more traditional framework of dividend yield and P/E ratios.

Let's set the stage - folks have been saying, in effect, the following: historically, the US GDP has grown at 3.5% per year, and stocks have had a dividend yield of 3% per year;
profits (net of depreciation) have grown with the economy (and kept a relatively stable share thereof), so, on balance, stocks have produced a real return of 6.5%, composed of 3% dividend yield, and 3.5% capital appreciation, also known as capital gains.

However, folks go on to say, the current yield is (roughly) 1.5%; future growth is forecast to be 2.0%; therefore, we have a problem - if the return on capital is 6.5%, and 1.5% is paid out in dividends, that leaves 5% to be reinvested.  Let's allow 1% for stock buybacks, and we are down to reinvesting 4%.  But if we reinvest (i.e., expand the capital base) at 4%, then profits will grow at 4% while GDP only grows at 2%, and the profit share of US corporations will become an absurdly high proportion of the US economy.  (Here, "absurd" is based on historical evidence, or common sense - over 75 years, a 2% growth differential results in a profit share rising from, let's say, 10% of GDP, up to 44% of GDP.  This is grand news for Bill Gates's heirs, but a bit rough on the rest of us.)

So, folks conclude, since that future world is not plausible, the starting assumptions must be wrong.  But where?  The growth forecast is pretty reliable (based on things like a demographic projection of the workforce), and the dividend yield has an eighty year history behind it.  Aha!  It is the rate of return number that must be suspect.  The world has changed, these people say, and the future rate of return must change with it.  Lower growth, lower returns, night follows day, autumn follows summer, this is the way of the world, and the sun is setting on the US equity market.

Or, somewhat more gloomily, we could have a stock market crash, stocks could start over at greatly reduced prices, and we could march forward with high returns from the new, lower starting point.  But from where stocks are priced now, hopeless!

That, anyway, is the theory as I understand it; if someone would care to guide me to a concise description of such a view, we live to learn.

And we beg to differ.  Let me start with a question - does your model have HAIR?  That would be a Hidden Assumption of Impossible Reinvestment - maybe, in your model, you are simply putting your capital in the wrong place.

Let's switch gears for a moment.  Imagine BigCo has capital equal to 1% of GDP, and provides a 20% return on capital (this must be a huge private equity deal, or folks would bid the price up and the yield down instantly).  My question - can BigCo produce this 20% Return on Capital for the next 30 years?

Some quick noodling tells you that if BigCo grows at 20% while GDP grows at 2% for thirty years, BigCo will grow by a factor of 237 while the economy increases by a factor of 1.8; from its humble origins, BigCo will swamp the US economy.

You, a skeptic, tell me it is impossible.  I salute your facility with exponents.  But you failed - BigCo may well be able to deliver a 30% Return on Capital for thirty years, or forever (absent competitive forces, but don't let's get distracted).

Why?  Your model has HAIR - you made a hidden assumption that BigCo would reinvest all of its Profits (i.e., return on capital) back into the capital base.  As the capital base grew, the profit target grew, and thirty years later, both the profit and capital figures were absurdly high as proportions of GDP.

But why did you assume that?  Suppose BigCo pays out *all* of its profits as dividends.  Then the capital base does not grow, the annual profits do not grow, and BigCo is actually on its way to becoming SmallCo -as GDP grows, BigCo becomes a *declining* share of the US economy.

Hmm.  A 20% return on capital for thirty years with no growth, and it does not swamp the US economy.  Well, if you allow BigCo to pay out dividends, this will work fine.

So, where is the HAIR in our earlier model, with 2% GDP growth, a 2.5% dividend yield, and a 6.5% return on capital?  Well, remember we agreed that the problem with the model was that profits grew to become an unrealistically large number?  We solved that by lowering the rate of return, but we might just as well have raised the dividend yield.

Suppose we had.  Let's picture MyCo with a starting capital of $100, and a return on capital of 6.5%.  First year profits are $6.5; since the economy will only grow at 2%, let's reinvest 2%, or $2, to expand the capital base at that rate.  The rest, $4.5, is paid out as dividends.

Next year, the GDP will be 2% larger; since my capital base is 2% larger, my profits will also be 2% larger, but they will be the same proportion of GDP as previously.  If we continue to pay out a (slightly higher) dividend, and grow the capital base by 2%, we can keep this up forever.  The return on capital will always be 6.5%; the profit as a percent of GDP will not change; and no one will have a problem.

Well, yes, some will have a problem - "isn't that dividend yield awfully high by historical standards"?, someone will ask.  Well, yes.  But I have a quip, and a serious answer.  Quip first?  Dividend policy, like the Constitution, is not a suicide pact.  If companies really don't have any suitable investments available in a low growth economy, it is a bit odd to assume they will invest anyway.  The historic dividend yields reflected a certain historic growth pattern; let the new yields reflect the future!

In a closed system, I think that answer would be compelling.  However, Jim Glass has his hand up, so let me address his point.  This will also reassure those who are desperate to maintain a low dividend yield.

Why did we feel obliged to increase dividends?  Because we wanted to grow the company's capital base (and profits) in line with the growth of the US economy.  But isn't it a big world out there?  Is there some reason that the company can't invest its capital abroad?

Suppose it does.  Imagine that MyCo has $100 of capital, initially all in the US.  It earns $6.5 as before, reinvests $2 in the US as before, but only pays out $1.5 as dividends, for a 1.5% yield.  This leaves $3.  In our original "implausible breakdown" model, this went back into the US, resulting in an implausible level of capital and profits.  But let's invest overseas.

So, year 2:  MyCo has *US* earnings and capital in line with *US* GDP.  No problems - US capital and profits are growing at 2%, in tandem with the economy.

However, a tiny new item appears on the MyCo report - foreign profits of (6.5% x $3) or $0.20.

And from tiny acorns, mighty oaks grow - depending on what one assumes about the reinvestment of foreign and domestic earnings, the foreign side of MyCo will become quite large - in my quick spreadsheet, with dividends paid on both US and foreign capital, reinvestment in the US to keep pace with GDP, and all "excess cash" available after dividends to be reinvested abroad, in 20 years the US capital of MyCo is $148.59, while the foreign capital is $116.74.  (The $148.59 simply reflects 2% growth, obviously).

Now, does this approach lead to a train wreck of implausible proportions?  Not if the world economy grows by 4.5%.  And if it does not, then we fall back to increasing the dividend yield.  Although the total profits of MyCo grow relative to US GDP, the US share reported in GDP accounts does not.  This should be a stable, plausible scenario.

Now, obvious caveats - these numbers and examples do not, and can not, *prove* that the US stock market is correctly valued, or that the dividend yield must remain at 1.5%, or that foreign investment by US corporations *must* grow to some number by some date.

However, what these numbers *do* prove is that a perfectly coherent, mathematically consistent explanation of current share prices, earnings yields, and dividends yields is available.  Toss in foreign investment, and we offer this in refutation of the various "HAIRy" models that attempt to "prove" that stocks must fall.

Folks who would care to vex me are encouraged to bring over some gloom and doom proofs of impending economic calamity, and we will see if we can spot the HAIR on them.

Thanks very much.  I promise my (few remaining) regular readers - we are almost off of this, and we look forward to resuming our regular ranting.

And yes, I still want the Dean Baker "No Economist's Left Behind" Cup.  You haven't seen the end of me!

Now It Is Krugman Versus The Council Of Economic Advisors

We have been arguing for a week that Paul Krugman made a common laymen's mistake in when he confused "growth" with "return on capital" in his column titled "Many Unhappy Returns".  Now it is the Council of Economic Advisors that says Paul Krugman is all wet, in a press release dated Feb. 4.

First, the good news - most lefties can stop thinking right now: if Paul Krugman says one thing, and the White House CEA says another, then Paul Krugman must be right.  Thanks for stopping by.

Now, for those of you who would like to reflect upon the issues, we will present a bit more.  And we may even present our list of "Frequently Unanswered Questions", so that you can seek clarity from a lefty economist you can trust.  (Even mathematics has gone partisan, I have learned.)

Righties may enjoy seeing the CEA wack Krugman, and we can all wait for his climbdown.  Here we go, Krugman first:

Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting.

Emphasis added, but his meaning seems to be clear enough.  Now, let's see what the CEA had to say:

II. Are projections of future stock returns realistic given the outlook for long-term economic growth? Yes. The Social Security Actuaries assume that stocks will provide an average real return of 6.5% per year over the next 75 years. Some argue that this is unreasonably high if, as the Social Security Trustees predict, economic growth will average only 1.9% per year in the future. This argument is incorrect; the stock return and economic growth assumptions are not inconsistent.

...The Trustees predict that economic growth will slow primarily because of slower population growth. Slower population growth need not imply lower stock returns.

• The Social Security Trustees project that economic growth will slow in the future, primarily because of slower population and labor force growth. Some observers believe that this growth slowdown will reduce future stock returns.

• Although short-run movements in growth can affect stock market returns, there is no necessary connection between stock returns and economic growth in the long run. Long-run economic growth is determined by productivity growth and labor force growth here in the United States, while stock market returns are determined by the overall cost of capital in the global economy and by the return investors require to bear the risk that comes with equity ownership. There is no reason to believe that slowing population growth in the United States would significantly lower the cost of capital, as set by increasingly globalized capital markets, or the premium required by stock investors.

Could the difference be more stark?  On Feb. 3, I offered a post attempting to explain that "growth" and "return on capital" are different things; on Feb. 5, I presented a post attempting to explain that adding growth to Paul Krugman's low return forecast would surely not raise the return on capital if the growth came in the form of new workers ( I hedged on productivity, an issue the CEA ducks).  At the end of this "Who Wants To Bet On Paul Krugman" post, I even included some tedious math, which, for those so inclined, is reposted here.

Finally, on Feb. 9, I claimed the Dean Baker "No Economist's Left Behind" Cup with this post, illustrating how a plausible economic forecast could combine low growth with a high return on capital.

My gist - Return on Capital is simply (Profits/Capital); is there any quick reason to think that profits ought to grow more quickly than capital?  None comes to mind, which suggests that "growth" might be a dead end.

So, re-express Return on Capital as [(Profits/GDP / (Capital/GDP)].  Now, is there any reason to think that the ratio of Capital to Output is poised for a long term decline as we grow ever more prosperous?  Currently, the wealthier countries have relatively more capital, not less.  However, Paul Krugman may have differing views about our future.

Finally, we come to (Profits/GDP).  Can we imagine a world in which the corporate share of the GDP pie grows a bit?  Paul Krugman could, in Dec 2003; the Economic Policy Institute could in Feb 2004; John Kerry could during the Presidential campaign.

Say it with me - Benedict Arnold CEOs threaten workers, whose job protections have been gutted by Republicans since Reagan, with outsourcing.  This holds down the ability of workers to get productivity based wages and leads to, together, "stagnant real wages".  And even a short period of stagnant real wages lets the GDP pie be re-sliced sufficiently in favor of the corporate sector to make this work - one year of stagnant wages ought to do it.

Meanwhile, Republicans protect their corporate cronies from paying their fair share of taxes.

In short, privatizers don't need growth to make their schemes work - they just need a greedy corporate sector enabled by tax-cutting, labor-bashing Republicans.

And could Paul Krugman get behind this forecast?  Politically, it spins just fine for him.  Sure, he would have to admit to a bit of a *cough* mistake *cough*, but these things happen.

Currently, on my side I have the CEA, Nobel Laureate Franco Modigliani, a slightly younger Paul Krugman, and the Economic Policy Institute.  And among the cards in my hand is the argument about foreign profits, elucidated here by Jim Glass. 

What I haven't seen is a rebuttal.

And at some point, my lefty readers might wonder just where their normal sources for economic guidance stand on this puzzle.  Ignore me for a moment (or forever - does forever work for you?) - the CEA says one thing, Krugman says another, who is right?  Let me know what you find out.

MORE:  "But growth and high returns have gone hand in hand forever - surely, what you are saying flies in the face of all history!"

I hear you, and don't call me Shirley.  Thoughts on growth and return on capital below.

We Move Towards The "Hummina Hummina" Moment

Max Sawicky, who has gone to the mattresses in opposition to Bush's Social security reform, continues to dredge up problems with the Notional Offset account.

But who are these erstwhile righties aiding and abetting him?  I can't tell whether it is Jim Glass or Victor of the Parrots that dislikes these Notional Offsets more.  [Full Disclosure: I am an Early Disliker as well.]

Let me join in.  What Max has is a lot of questions; what the Administration spokespeople have are very few answers.  This sort of mismatch leads to what is often described as the "hummina hummina" moment, which is normaly a reliable precursor to the "oh, forget about it" moment.

Well, I have questions, too.  Apparently, we are meant to buy annuities so that our total guaranteed benefit will be enough to keep us above the poverty line (the Times reported this last week, but I can't find where I linked to it).  Dean Baker wonders whether this will pretty much exhaust the Personal Account for a low income worker.  But I have other wonders:

- who issues these annuities, under what rules?  Is it insurance companies under various state regs, the Federal Government under the aegis of Social Security, or what?

- do the annuities discriminate by age/gender/race/health?  Suppose John, a 65 year old man, is retiring with heart disease.  Ginny, an active 62 year old, is retiring so she can spend more quality time with her parents (gotta like her longevity genes!).

Do Ginny and John get annuitized at the same rate?  C'mon, Ginny is going to be here another thirty years, and John could drop tomorrow!  You have to charge different rates.

But hold on!  Under the current Soc Sec rules, Ginny (and women generally) get a subsidy paid by (shorter-lived) men.  Are we going to scrap that?  Is the privatization plan anti-woman?

And I am afraid to ask about gay folks with HIV, or racial discrimination based on seemingly different longevity among different ethnic groups - where do folks think that is headed?  Should we pretend everybody has "average" longevity, knowing that certain easily identifed groups may harmed by that decision?

And on a related front, Jim Glass (linked above) is worried about the loan rate charged on the Notional Offset, and thinks a fair rate would be lower.

Well, yes, but... who holds the Notional Offset loan?  Is it an asset of the US Treasury, or of the Social Security Trust Fund (watch eyes glaze over as Admin spokespeople try to answer that one).  If we lower the rate on the Notional Offset loan, doesn't that mean someone is subsidizing the Personal Accounts at the expense of the folks who did not participate (or at the expense of the general taxpayer)?  Or is the new, lower rate, not a subsidy, but a "fair" rate?  Then why did the Administration think a higher rate was fair a week ago?

I would encourage my fellow privatization advocates to rally up some answers to these questions; they are going to be asked eventually.  (I mean, I am delighted to ignore Max, but he does seem to find outlets).  This issue is easy to demagogue and obfuscate, and the Administration is making it easier with this "there is no plan, there is a legislative process" approach.

My current position is that the whole Notional Offset idea looks like an idea dreamed up buy some economists with no guidance from the political pros (and it came from the Bush Commission led by Moynihan - go figure).  The result is an answer that is actually highly defensible intellectually, but which looks terrible.

Put another way, in several months of disliking the Notional Offset, a better way has not jumped out at me - introducing private accounts to a pension system already under way, and which carries a huge accumulated deficit, is not easy.  As we are seeing.

Sen. Dodd On Imus: "Davos Ought To Release The Tapes"

Se. Chris Dodd appeared on the Imus in the Morning show and was asked about the Eason Jordan/Davos controversy.

Sen. Dodd said that "Davos ought to release the tapes".  He then went on to say that Eason Jordan himself ought to support the release of the tapes in order to defend himself, speculating that Eason Jordan's job was, or might be, "on the line".

Sen. Dodd broadly confirmed the version of events that seems to have emerged (at least as I understand it):  Jordan made some "outrageous" remarks about the Pentagon targeting reporters, Barney Franks called him on it, and Jordan backpedaled for the next fifteen minutes.

Sen. Dodd thought the tapes would clear up the extent to which Jordan backpedaled, and give a sense of just how successful that backpedaling effort was.

[A brief note: I heard this on the radio while driving; folks who TiVo'ed the MSNBC broadcast will have a more complete version.  That said, the phrases in quotes are verbatim].

Now, a quick quip - as to the question of why, if the "targeting reporters" allegation is true, CNN has not done a story on it, surely the answer is obvious - they are still reporting under Baghdad Rules.

MORE:  Gotta love "Spellcheck", which clamors for "Sen. Dodd" to be "Sen. Dodo".  We long ago saluted the programmer who thought that "Krugman" should be "Ragman".

UPDATE:  Excerpts at Sisyphean Musings:

Sen. Dodd: "... In fairness, Davos ought to release the tape because you're getting a lot of speculation. Eason Jordan's claiming he said one thing and those of us in the audience thought we heard something else. So in fairness to him Davos ought to get the tape out and he ought to ask for it so that there's no equivocation trying to read into people's interpretations of what he said."

...Imus: "Well who's it up to ..."

Sen. Dodd: "Davos. The people at Davos. They have tapes of all of these panels. Usually they don't like to that that, but I think when you got a controversy like this, and I presume Eason Jordan's job may be on the line over this, then it seems to me that he ought to be the first one to say, 'Look get the tape out', so we can put an end to these rumors if in fact his interpretation of what he was trying to say is accurate and those of us who heard it is a bit different. Then the best answer for him is to get that information out so you, and others, can watch it and draw your own conclusions about it."

A BIT LATER:  Eason Jordan to resign.  Whoa.  We are going to be insufferable now, baby.  (Weren't we?)

In Which I Claim The Dean Baker "No Economist's Left Behind" Cup

A bit like Arthur with the stone, I am feeling sufficiently cheeky to claim the Dean Baker "No Economist's Left Behind" Cup.  Let's quickly recap the challenge, as posed a week ago by Paul Krugman:

...Which brings us to the privatizers' Catch-22.

They can rescue their happy vision for stock returns by claiming that the Social Security actuaries are vastly underestimating future economic growth. But in that case, we don't need to worry about Social Security's future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come.

Alternatively, privatizers can unhappily admit that future stock returns will be much lower than they have been claiming. But without those high returns, the arithmetic of their schemes collapses.

It really is that stark: any growth projection that would permit the stock returns the privatizers need to make their schemes work would put Social Security solidly in the black.

And I suspect that at least some privatizers know that. Mr. Baker has devised a test he calls "no economist left behind": he challenges economists to make a projection of economic growth, dividends and capital gains that will yield a 6.5 percent rate of return over 75 years. Not one economist who supports privatization has been willing to take the test.

But the offer still stands. Ladies and gentlemen, would you care to explain your position?

I would be delighted to explain.  Let's get some starting numbers.  In the column we are given an initial P/E ratio of 20, for an earnings yield, and implied return on capital, of 5%.  Our target, also per the column, is a return on capital of 6.5%, which is 30% higher.  Prof. Krugman implies that we need to grow our way there.

But hold on.  Return on Capital is simply [Income / Capital].  To grow this ratio, I must somehow grow Income faster than Capital; any equal growth rate will simply preserve the ratio.  Bit of an impasse.

Let's try a different perspective, and express both Income and Capital as a percent of Gross Domestic Product.  Here we go:

[ (Income/GDP) / (Capital/GDP) ] = 5%; we want to grow this to 6.5%.

Well.  Suppose we hold the ratio of Income to GDP (which we can call the profit share of corporations) constant.  Then to increase the Return on Capital by 30% (6.5/5, from before), we need to somehow shrink the Capital as a percent of GDP by 30%, in a prosperous, growing economy.

Intuition fails me here - when I look around, it strikes me that the wealthier countries also have the higher ratios of Capital to GDP.  Is Prof. Krugman looking for a forecast that has the relative role of capital in the economy falling dramatically over time as we all get richer?  Cool, and excellent news for Africa, since they already have a ghastly ratio of capital to output.  Capital starvation as the path to economic salvation!  Sort of an Atkins Diet for economists.

I eagerly await more information about this "declining capital" theory.  I have some tedious math at the end of this post explaining how high productivity makes such an outcome vaguely possible, but I would be more comfortable hearing an eminent economist like Paul Krugman explain the declining role of capital in our ever more-productive world.  Otherwise, I think you will laugh (I plan to listen respectfully for as long as possible).

Well, we are balked on the capital side, so let's look at the top of the ratio, where we see Income/GDP.  This simply represents the slice of the GDP pie taken by corporations.  Hmm, if we can increase that by 30%, we are done.  And how might the corporate sector claim a bit more of the pie?

My goodness, haven't you been listening?  The threat of outsourcing and the gutting of labor protections begun by Ronald Reagan have left workers with little bargaining clout against Benedict Arnold CEOs who can move a factory to Manila quicker than a sneeze.

And on the tax side, Republican enablers refuse to make their corporate cronies pay their fair share.

Net result - workers lose a bit of the pie to corporations; the government gives up a bit of what might have been its tax slice; and corporate profitability rises enough to reach our target return on capital.

Don't tell me that scenario is implausible - tell Paul Krugman, circa December 2003; tell the Economic Policy Institute, which currently holds the number one slot on Google for "stagnant real wages" with their Feb 2004 paper.

OK, talk is cheap - would those sorts of changes actually get you there without blowing past the bounds of historic observations?  Can we have some numbers, please?

Formatting may pose a puzzle here, sorry:

                                1945-75    1974-2003    Full Period   Current

Corporate Profitability               
(Percent of GDP)

        Before Tax           9.8        7.2            8.5%             7.7%   
        Taxes                 4.5        2.8             3.6                2.1%
        AfterTax              5.4        4.4              4.9              5.6%

Compensation               56.2      58.2            57.2             57.3%

OK, I need to increase my 5.6% of the GDP pie (That is the Current Corporate after-tax income as a percent of GDP) by 30%, which will be 0.3 x 5.6, or 1.7%

Let's take 1.1% from labor.  Hah!  Moving them from 57.3% to 56.2% puts them down at the levels they enjoyed during Paul Krugman's Golden Era of Income Equality.  Enjoy yourselves!

And we still need another 0.6% of GDP.  No worries - corporate taxes fell from an average of 4.5% of GDP in the first thirty year period to an average of 2.8% in the last thirty years, and they will keep falling to 1.5%, passing an additional 0.6% of GDP to corporations.

Net result - in the ratio of [(Income/GDP) / (Capital/GDP)], the Income to GDP has risen by 30%; consequently, the return on capital has risen by 30% as well.

All well within historical boundaries and trends, and backed by the sort of grim story of rapacious corporations and the tax-cutting Republican who enable them that any proper Democrat could embrace.  Have embraced, I should say.

So, do I collect the "No Economist's Left Behind" Cup?  I hear rumblings - didn't Dean ask for something about dividend yields, capital gains, and economic growth?

For heaven's sake - when I was a kid, my uncle would tell me that my shoe was untied; when I looked down, he would pull a quarter out of my ear.  Years later, I don't automatically look where people tell me too.  Pending a description of the "Declining Capital" theory, growth is a distraction to a return on capital discussion.

And Nobel Laureate Franco Modigliani realized that dividends are a distraction, too - they reflect a financing decision of the firm, but don't mean anything in terms of value.

Return on Capital is Income/Capital - focus  on that.

Now, a bit of assistance for my friends on the left - this new forecast spins just fine. Instead of  saying that privatizers are lying about the growth prospects of the US economy, just switch gears and say that they are  relying on corporate greed, worker fear, and Republican tax cuts for their corporate cronies.  You won't miss a beat.

Its a bit of a problem for the Paul Krugman column, however - does anyone want to actually defend that?  Let's set the bar with a quick excerpt, shall we:

Schemes for Social Security privatization... invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting.

Hmm.  Emphasis added, of course.  Who would care to rise and defend the proposition that "mathematically impossible" means "not possible unless what Democrats have been saying about corporate greed and taxes comes true"?  I am not putting my forecast forward as a most likely case; are Krugman's defenders going to argue it has a zero probability of actually coming to fruition?  Please.  Higher corporate profitability sustained for 75 years?  I give this a 10% chance, minimum.  Mathematically possible, and then some.  The economy may develop along any number of paths - one plausible path, outlined here, is a combination of low growth and higher corporate profitability.

And who can help with the unanswered puzzle from a bit earlier - how can the [(Income/GDP)/(Capital/GDP)] ratio be increased if we rely exclusively on faster growth?  What odd Capital/GDP assumption is Krugman relying on there?  Or, if he is not relying on one, why does he allow the (Income/GDP) ratio to rise in high growth scenarios, but not low ones?  Perhaps a flood of immigrants holds down wages in a way that the threat of outsourcing does not?  In the new era of mobile capital, it is more profitable to bring the workers to the capital then bring the capital overseas to the workers?  Whew, you are straining my credulity.  Perhaps there is some other explanation.

Pending one, here is my guess as to what happened.  Dean Baker had a low growth / low return on capital scenario in which Social Security had early financial distress.  Higher growth deferred the date of trust fund exhaustion.  Eureka!  But did anyone check to see whether the return on capital had gone up in the new forecast?  I doubt it, and I still don't see how it could have.

Well, people make mistakes.  Will someone tell me whether Krugman made one here?

UPDATE:  I extend my greetings to the cavalry.  From a Feb 4 press release prepared by the Council of Economic Advisors:

The Trustees predict that economic growth will slow primarily because of slower
population growth. Slower population growth need not imply lower stock returns.

• The Social Security Trustees project that economic growth will slow in the future,
primarily because of slower population and labor force growth. Some observers believe
that this growth slowdown will reduce future stock returns.

Although short-run movements in growth can affect stock market returns, there is no
necessary connection between stock returns and economic growth in the long run. Long-run economic growth is determined by productivity growth and labor force growth here in the United States, while stock market returns are determined by the overall cost of capital in the global economy and by the return investors require to bear the risk that
comes with equity ownership. There is no reason to believe that slowing population
growth in the United States would significantly lower the cost of capital, as set by
increasingly globalized capital markets, or the premium required by stock investors.

Feb, 4, huh?  Well, I started yammering about foreign markets and globalization in this Feb 2 post; on Feb 3, I went on about the confusion between "growth" and "return on capital"; for some reason I skipped a day, then on Feb 5 I applied those thoughts to the forecast being made by Krugman, offering (again) the argument essentially being supported by the CEA.

Where is my "No Economist's Left Behind" Cup?  You haven't seen the end of me!

Christmas Shopping At The Mall

We are going to take a break from Paul Krugman, and send you out to become a security guard at a mall out in the heartland, sometime before Christmas.  It's a busy Saturday afternoon, and you are glancing over the monitors in the security office - hey, here's nothing, two guys got out of a van in the indoor parking lot.  They are kind of bulky, but with obesity in America, and their winter jackets, you think nothing of it.

You glance back a moment later.  That's odd, these guys are moving bags *out* of the van, and into shopping carts.  Huh?  More dissatisfied customers, maybe, returning something?

Well, you had better get some folks down there ASAP - if you look away, or forget it for a moment, the scenario picked up by the Chicago Boyz, as described by former National Security Advisor Richard Clarke, will unfold.

But Richard Clarke is a wimp - my terrorists are wearing body armor, like these robbers in LA, because my terrorists read the most busted source in news.

And my terrorists have shopping carts filled with guns, ammo, and a few jerry-cans of gasoline to help keep the party going.

C'mon - I love my fellow right wing-nutters dearly, but a few civilians with hand guns won't change what happens next.  I'm not even sure that if the security guard who spots these guys in the parking lot sends a car over, the story changes.

And I don't mean to sound hopelessly close-minded, but please, the odds of my changing my mind on this are slim.  And as much as I enjoy debating the issues with gun right's enthusiasts (and I am broadly sympathetic), my brother-in-law fills that space in my life quite nicely.  (No, Joe, the other brother-in-law).

 

No Takers? No Support For Paul Krugman?

I have a long post describing three bets I am prepared to entertain with Krugman's supporters.  Despite his popularity in the blogosphere, I have yet to find a taker.

Fortunately, we have time.  And let's just recap the propositions - Krugman says that only higher growth can improve the return on capital of American business, thereby helping the stock market.  However, he goes on, since higher growth also improves the financial outlook for Social Security, personal accounts only make sense when we don't really need them.

Nonsense, say I - basic finance says that if you want to increase the return on capital, you need to either increase the income being earned by the capital, or decrease the amount of capital employed.  Growth is a secondary consideration - in fact, growing the profits of a low return-on-capital enterprise simply results in a larger enterprise with a low return on capital.

My answer - increase the income share going to capital in the Social Security forecasts.  With a starting cost of capital in the forecasts of 5%, a 30% increase in the income share will increase the return on capital by 30% to 6.5%, which is the target offered by Krugman.

Does that seem like a lot?  If the income share rise from 8% to 10.4% of GDP, that is a 30% increase.  And how might this happen?  Well, productivity growth is forecast at about 1.7% per year.  If we have two years of stagnant real wages, with workers unable to benefit from higher productivity, then "capital" captures two years of productivity related growth.  This will raise the income share going to capital by (roughly) 3.4% (e.g., from 8% to 11.4%), which is well above the 2.4% increase we are looking for.

Now, in his column Krugman implicitly says that such a result is "mathematically impossible" without much higher long term growth.  But surely the spectre of workers threatened by outsourcing and rendered helpless as the Bush Administration guts labor protections is a staple of Democratic politics. In fact, let's see what Krugman wrote just a bit more than a year ago:

Commerce Department figures reveal a startling disconnect between overall economic growth, which has been impressive since last spring, and the incomes of a great majority of Americans. In the third quarter of 2003, as everyone knows, real G.D.P. rose at an annual rate of 8.2 percent. But wage and salary income, adjusted for inflation, rose at an annual rate of only 0.8 percent. More recent data don't change the picture: in the six months that ended in November, income from wages rose only 0.65 percent after inflation.

Why aren't workers sharing in the so-called boom? Start with jobs.

...But if the number of jobs isn't rising much, aren't workers at least earning more? You may have thought so. After all, companies have been able to increase output without hiring more workers, thanks to the rapidly rising output per worker. (Yes, that's a tautology.) Historically, higher productivity has translated into rising wages. But not this time: thanks to a weak labor market, employers have felt no pressure to share productivity gains. Calculations by the Economic Policy Institute show real wages for most workers flat or falling even as the economy expands.

So if jobs are scarce and wages are flat, who's benefiting from the economy's expansion? The direct gains are going largely to corporate profits, which rose at an annual rate of more than 40 percent in the third quarter. Indirectly, that means that gains are going to stockholders, who are the ultimate owners of corporate profits. (That is, if the gains don't go to self-dealing executives, but let's save that topic for another day.)

My impression of this debate is that sometime soon, Krugman's supporters (if they can be coaxed forward - they stood up and cheered when he wrote this) will explain to me that "mathematically impossible" means "Not, in Krugman's opinion, very likely".  C'mon - even on sports talk radio, no one says that it is mathematically impossible for the Orioles to win the pennant.

MORE:  Well, well.  Here is a CBO forecast covering 2003 (Historical) to 2014.  Although it may not be directly comparable to the Soc Sec forecast, the CBO has corporate profits moving from 7.9% of GDP in 2003 up to 11.7% in 2005, and then settling down at 9.1%.  Yet I am being implicitly informed that an increase from 8% to 10.4% is "mathematically impossible".  In fact, it would simply require the profit share to *fall* by a bit less than the CBO expects.

Fine, it may not be directly comparable, and we have different starting points, yada, yada.  But the profit share I need to make my forecast work is not science fiction, even by CBO standards.

UPDATE:  Incredibly, folks are not rushing up from the left to bash Krugman, although I have even helped them with the spin - since my revised low growth/high return forecast relies on higher corporate profitability, the new sound bite will be (once they have digested this) that "OF COURSE raising profitabilty raises the retrun on capital, anyone knows that, it was too obvious for Krugman even to risk insulting his readers by mentioning it.

And the reality is (they will go on), privatizers did not lie about the economy's growth prospects; they lied about just how greedy and rapacious corporations would have to be to make this work.

It still spins, just a bit differently.

Why Krugman missed a chance to bash greedy corporations and the Republicans who enable them will remain as one unanswered question; another will be, how does raising the growth of a low return on capital scenario improve the return on capital?  (There is a productivity angle that makes this possible but implausible; see the tedious math at the end of this post).

We hope to have a list of Frequently Unanswered Question for Paul Krugman soon enough.

Tips For Powerful Writing

Very funny.  And the first comment nearly tops it.

Dissension At The AARP

We have (scorching) e-mail, from a chap who is fed up with the AARP opposition to Bush's effort to reform Social Security:

Mr. William Novelli
President
AARP
601 E. Street, NW
Washington, D.C. 20049

Dear Mr. Novelli:

I have operated a public relations firm for the last 26 years and, so, I write this letter both as a former industry colleague from your career at Porter Novelli and as one of your members.

Put simply, I am incensed that my dues are being used to fund AARP’s opposition to the President’s efforts to reform the Social Security System. Moreover, I was left dumbfounded by your explanation of that opposition during your interview with Ron Insana this afternoon on CNBC.

The Bush proposal, while still open to improvement, is an important attempt to modernize a system that grows increasingly irrelevant to the American workers who will be called on to bear the financial burden for its support in the years ahead. Their motivation is paramount to the ongoing solvency of the system and to our competitiveness as a nation. Private accounts strike me as a progressive attempt to preserve the incentive of younger Americans to support Social Security and encourage their productivity. Even at the age of 52, I would still expect to benefit from the change and would welcome the opportunity to pass my private account on to my heirs.

Which brings me to your CNBC appearance. You seemed confused by the President’s proposal, especially with regard to private accounts. While you said that you do not oppose them as “add-ons” to the present system, you neglected to mention that we already have such accounts: IRAs and 401ks. Your suggestion is clearly beside the point. Further, you evinced no understanding of the estate-planning benefits of these accounts. The ability to pass such accounts to future generations gives one and all a real stake in the Social Security System and in its health. Instead, you seem to focus reflexively on criticisms of the proposal that cast your lot – and that of us whose interests you claim to represent – with others who look back to the New Deal instead of to the future. I am dismayed that instead of crediting the President for putting forward the subject of reform, you are doing your best to thwart the dialogue.

Enclosed please find my AARP membership card. Please remove me from your membership rolls; I no longer wish you to represent my interests in this important matter, sir.

    Sincerely,

    Michael Weiser
    Chairman

    The Weiser Group

An Eerie Silence

Mary Eileen, who has a fine blog but no last name, is rumored to be dating Phillip Michael Thomas of the old Miami Vice show.  And what will they call the kids? 

NO, I made that up!  Mary Eileen has been noticing the odd "abortions rose under Bush" meme, and sends us to Michelle Malkin, who is also becoming irked.  As am I.

Is there any stopping it?  Shall we wait for some Braveheart from the "Reality Based Community" to examine this?  My letter to the NY Times met with the usual response.  Perhaps we can single out Matt Yglesias, who echoed it in his endorsement of John Kerry last fall.  Kevin Drum picked it up from Matt; perhaps he can help us understand his reality.

Lots of links to relevant material at this old post.  As per the usual disclaimer, maybe these guys are looking at something other than the absurd Stassen "study" that Hillary appeared to be citing.

But hey, they are busy guys, and I am not running an assignment desk here.  Our breath is bated, but not held.

Soc Sec - A Risk For Republicans

Ron Brownstein of the LA Times counts votes on Social Security reform, and doesn't find many.

He also highlights a subtle risk to tax-cutting Reps that may arise from this debate:

A more promising alternative might be to establish investment accounts as an add-on to Social Security, funded by a new source of revenue (like a small consumption tax), not the payroll tax.

Washington could subsidize contributions workers make to their accounts with tax credits, creating in effect a universal 401(k) plan. With those funds available to future retirees, both parties might agree to modestly reduce guaranteed Social Security benefits, and increase payroll tax revenue, to close the program's long-term financing shortfall.

Initially, Bush and most conservatives would probably resist add-on accounts — an idea President Clinton favored — as a costly new entitlement. But such accounts could offer Bush his best chance of promoting more ownership — and winning spending cuts that help stabilize Social Security's finances. If he wants a bipartisan Social Security deal — and not just a fight to organize around politically — they might offer his only chance.

Dems have not had much success promoting tax increases to "reduce the deficit" - my theory is that for the broad public, "the deficit" is someone else's problem, the pain is uncertain and diffuse, and tax hikes are real and immediate.

However, the Social Security debate allows Dems to suggest, in effect, tax hikes with personally-dedicated revenue.  "We aren't raising taxes to cut the deficit - this is YOUR RETIREMENT FUND!"

Folks might well say, "Hmm."  Rather than seeing the tax hike as representing their money pitched into a rat-hole, folks might well believe that they will get those taxes back - here is the tax bill, there is the personal account, very simple.

Eventually, because they are not terminally daft, Dems will suggest other taxes on "bad things", and dedicate the revenues to the Soc Sec fund.  Since everyone figures that Soc Sec will otherwise go bust, this will personalize the benefit of the higher taxes.  Well, that will be the sales pitch.

Irwin Stelzer suggested something like this in the Weekly Standard.

A truly radical reformer would consider alternatives to the job-destroying payroll tax system. After all, why tax a good thing, like jobs, rather than the many bad things that currently go untaxed? Two leap to mind: pollution and imported oil. Surely a reduction in the payroll tax, funded by a tax on either of those two items, would do more to stimulate economic growth, and to reduce the regressive character of the Social Security finance system, than would any of the reforms now being considered.

Well, the slippery slope is open - tax hikes, here we come.

(Not that that is a bad thing...)

Who Would Like To Bet On Paul Krugman?

[LATE UPDATE:  I claim the Dean Baker "No Economist's Left behind" Cup here.]

How one could make money from writing a blog has vexed greater minds than mine.  And how one might make money by *reading* them has been truly puzzling. 

Until now.

I have a longish, confusing-ish post making a point about Social Security, economic growth, and returns on capital that, when understood, is so obvious folks will wonder what the discussion was about.

However, my point stands in direct contradiction of a column written by Paul Krugman, and (so far) has not found support anywhere in the blogosphere.

So, my proposition - I will pick out a couple of key phrases that summarize the Krugman argument, and put my money where my mouth is.  If a consensus emerges that I am correct, you pay; if, OTOH, I am wrong, I pay.  The technical term for this is "wager".  (Let's just add, VOID where PROHIBITED!  And for those who prefer, settlement can occur in the form of a donation to a charity of the winner's choice, subject only to a "nothing embarrassing, no hideous mailing list" type of restriction.)

Now, frankly, I ought to be the underdog here - we are talking about macroeconomic forecasts, and Paul Krugman is who he is (I am who I am, too, but what is that?)

And, as regular readers know, there is a certain "stopped clock" quality to my criticism of Paul Krugman.  Oh, I may think I score the odd success, but frankly, if Krugman said "Good morning", I would probably put up a post saying it's nighttime in Tokyo, and wondering how a guy with a reputation as an international economist could possibly overlook that trivial and obvious fact.

Well.  The wagers.  Despite my heavy underdog status, I will put these up at even money.  $100 on this one:

...the numbers the privatizers use just don't add up.

Let me inflict some of those numbers on you. Sorry, but this is important.

Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting.

Emphasis added.  In my post I demonstrate that higher growth at a low return on capital does not increase the return on capital (no, seriously - Krugman really is on the other side of that proposition, although he probably does not realize it).

SO, the bet - I win your money if: 

(1) some credible economists emerge to endorse the notion that the return on capital question is separate from the economic growth question (i.e, taking the low growth/low return scenario and increasing growth does not automatically turn it into a high return on capital scenario, but rather, can simply turn it into a high growth/low return on capital scenario); that the projected return on capital depends a lot on how you forecast returns on capital (I'm really on a limb with that one); and, here we go, that there are mathematically possible and economically plausible scenarios where we have low labor force growth and low (1.7%) productivity growth, but high stock market returns.  I am not even holding out for more foreign income on this point, although I suppose I could.

Just to handicap this a bit, I will even tell you the winning argument: the return on capital is determined by the income flowing to capital (the income share of capital) and the level of capital employed.  In the high growth scenarios, we need to model levels of investment (replacement plus new investment), a capital/labor ratio (those new workers need capital to be productive), and an income share to capital.

What folks will realize, upon reflection, is that the return on capital will only go up if the relative capital deployed falls, or the income share of capital rises.  The notion that either of these ratios must be directly dependent on labor force growth or productivity growth will not be sustained - in fact, their behavior is a result of modeling choices.  In short, higher growth does not automatically increase the return on capital.

Having settled that, folks will ask what might increase the return on capital.  Increasing the income share is an obvious way. 

So, in a low growth environment, suppose that productivity growth is 1.7% per year, but for two years, real wages are *flat*, so that the increased income from the increased productivity goes to capital.  The income share of capital will rise from roughly 8 to 11%, which will take the return on capital from 5% to 6.5%.  Bingo.

Is that laughably implausible?  These folks are worried about *falling* real wages (here, too, but  not at Heritage!) - for my forecast to work, all I need are two years of stagnant real wages.

So, a fine bet, yes?  Takers are invited to enlist in the comments section.  Should be an easy $100.  Krugman versus The Minuteman!  Help me out, help yourself out, win my money!

You want more?

In the long run, profits grow at the same rate as the economy. So to get that 6.5 percent rate of return, stock prices would have to keep rising faster than profits, decade after decade.

That may or may not be true as an historical fact, and who cares?  Shall we wager on this:

(2) profit growth is not the same as return on capital; a firm, or an economy, can have high profit growth with a low return on capital, or low profit growth with a high return on capital.  (HINT: Don't forget dividends!)

Go ahead - if we find a consensus that my statement is false, you win.  Make it another $100.  Now, does my statement directly contradict Krugman's?  It certainly runs counter to the spirit of his statement, I think.

Let's have one more.  This is excerpting Krugman:

They can rescue their happy vision for stock returns by claiming that the Social Security actuaries are vastly underestimating future economic growth. But in that case, we don't need to worry about Social Security's future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come.

Alternatively, privatizers can unhappily admit that future stock returns will be much lower than they have been claiming. But without those high returns, the arithmetic of their schemes collapses.

(3) For $100 - the preceding from Krugman is false.

In fact, low-growth scenarios with high stock market returns and an early distress for Social Security (Trust fund exhaustion by 2042 or sooner) are easily developed; high growth scenarios with low stock market returns and deferred trust fund exhaustion are also easily developed.  In fact, although growth is an issue for Social Security (since the number of retirees doesn't grow, at least right away), it need not be for stock market returns.

Let's do (3) for $100, even though it is very close to (2).  And I am not going to get all quibbly about folks whining "no fair, an income share of 11% is too high, Krugman didn't mean that, and it's not reasonable".  He didn't say "reasonable"; he said it can't be done with low growth, and that only high growth led to salvation. 

He also says that high growth scenarios improve capital returns, but that will only be the case if the income share to capital rises, or the relative level of capital deployed falls. And that is surely not what he said in the excerpt, where he talks only about growth.  If Krugman will allow (by implication) a higher income share to capital in high growth scenarios in order to make his statement about higher returns true, then he must be willing to contemplate a higher income share to capital in a low growth scenario.  Fair's fair.  Let's play (3) for another $100.

OK, as I said, this is a fine chance for someone to commercialize their blogging, or blog-reading.

I would love to take people's $300.  Dare I say, Bring it on!

MORE: Even though no one asked: I believe that growth is good, and that it is certainly easier to project high returns on capital in a higher growth environment; I suspect that the 6.5% real return folks talk about for equities is high; I believe that Dean Baker's fundamental point, that the Soc Sec Trustees ought to either explicitly forecast a return on capital, or back out the return on capital implied by their forecast, is excellent; I believe Oswald acted alone; and I believe that the Soc Sec Trustees have an institutional bias towards low-ball forecasts.

UNRELENTING:  Dare we do equations?  The formatting will be brutal, but why not?  See the continuation.

UPDATE:  No takers?  I should track down some of the folks who cheered Krugman last week.  Here is Ian Walsh; and here is Kevin Drum's take:

Typically, they assume long-term returns of 6.5-7%, but returns like that are only feasible if long-term economic growth is also very strong. The problem is that if long-term growth is strong, Social Security isn't in trouble in the first place:

...Privatizers assume that stock market returns for the next 75 years will be as high as they have been for the previous 75 years. For that to happen, economic growth for the next 75 years also needs to be roughly as high as it has been for the past 75 years.

Well, well, well.

Kerry On Imus

John Kerry appeared on the Don Imus radio show this morning.  Elements of it were poignant and charming (Hmm, does this mean I will start getting Google hits for "John Kerry poignant charming"?  I have a reputation to consider...).

Anyway, Kerry was an effective straight man, and played along with good grace when Imus teased him about his windy and/or evasive answers.

But enough of that!  Although I missed it, he reaffirmed his pledge to sign the Form 180 (Imus was one of the few media biggies to hammer this during the campaign).

My teeth-grating moment came when Kerry said (and this is verbatim from memory, if that makes sense) that Bush's Social Security proposal would "cut benefits for seniors".

Maybe Kerry missed that bit of Bush's speech, but the news that nothing changes for folks over 55 has been widely reported.

On the other hand, Kerry has had a hard time grasping this point for a while.

Let's Help Paul Krugman With An Economic Forecast

Paul Krugman misinterpreted some economic forecasts, and consequently falsely besmirched the reputations of the advocates of Social Security privatization (Is it an odd-numbered day?  I am one!).  On behalf of both Truth and the Besmirched, I stand ready to provide a bit of assistance with some economic modeling.

First, the False Accusation:

...the numbers the privatizers use just don't add up.

Let me inflict some of those numbers on you. Sorry, but this is important.

Schemes for Social Security privatization, like the one described in the 2004 Economic Report of the President, invariably assume that investing in stocks will yield a high annual rate of return, 6.5 or 7 percent after inflation, for at least the next 75 years. Without that assumption, these schemes can't deliver on their promises. Yet a rate of return that high is mathematically impossible unless the economy grows much faster than anyone is now expecting.

...Which brings us to the privatizers' Catch-22.

They can rescue their happy vision for stock returns by claiming that the Social Security actuaries are vastly underestimating future economic growth. But in that case, we don't need to worry about Social Security's future: if the economy grows fast enough to generate a rate of return that makes privatization work, it will also yield a bonanza of payroll tax revenue that will keep the current system sound for generations to come.

Alternatively, privatizers can unhappily admit that future stock returns will be much lower than they have been claiming. But without those high returns, the arithmetic of their schemes collapses.

Is that clear - according to Prof. Krugman, we need high growth to get a high return on capital, and good stock market performance.

This notion certainly has strong intuitive appeal.  Most folks who think about the stock market have learned that low growth is bad for profits and sales, and high growth is good; extending that intuition over the next 75 years seems to produce the obvious result described by Prof. Krugman.

However, intuition is not analysis.  What went wrong here?  For most people, "low growth" mentally translates into "growth below expectations"; high growth becomes "growth above expectations".  But there is no reason that a stable, no-growth economy can not have a stable, positive, attractive rate of return, as we illustrate at painful length here.  Folks who like to think in terms of financial instruments will remember that a Treasury bond provides no growth at all, but a very stable return.

So what happened with the forecasts used by the Social Security trustees?  Well, folks who reflect upon economic forecasts will agree that the return on capital projected by an economic forecast is highly sensitive to the method used to forecast the return on capital.  Hmm, does that strike you as painfully obvious?  Let me elaborate.

It turns out that growth is not the issue Prof. Krugman think it is.  I will grant that the low growth scenario presented by the Social Security Trustees may imply a low return on capital.  However, using the modeling method assumed by Dean Baker, economic growth is not a solution. 

Economic growth comes from growth in either the size of the labor force, or an increase in the productivity of each worker.  Each worker requires new capital, at the same level as current workers.  (Beyond that, higher productivity requires capital "deepening", which amounts to more capital per worker - this adjustment makes the Krugman error even more glaring, however).

So, we can get more growth out of economy by bringing in more workers.  If, for example, the labor force grows by an additional 1% per year, GDP will also grow by an additional 1% per year.  The payroll tax base will rise, and Social Security will be "saved".  High growth is good!

But wait - does that new high growth forecast actually imply a higher return on capital?  Not as Dean Baker modeled it; new workers require new capital, and the return on capital remained the same as in the original low-growth forecast.  This, by the way, is a common-sense result - if a factory with 100 workers manning 100 drill presses sells 100 units and produces a 5% return on capital, then 200 workers manning 200 drill presses should produce 200 units for sale, but the return on capital will still be 5%.  Lots of growth, but the return on capital does not change.

Well.  Prof, Krugman said "growth" - maybe he meant "productivity growth"?

Maybe he did, but that does not help, as modeled by the Soc Sec trustees and interpreted by Dean Baker.  Higher productivity means that there is more output per worker.  However, the question instantly arises, who captures the benefit of that increased return?  A very common assumption in economics is that workers capture most of that benefit - skilled workers get raises.  Higher productivity results in higher growth, but the return on capital does not change; instead, real wages rise.

This outcome can "save" Social Security - the higher wages result in higher payroll tax receipts today (and higher benefits indexed to the wages down the road, but we are moving quickly over a lot of ground here.  No, really, this IS quick.)  However, even though Social Security is "saved", returns on capital continue to be dismal, as per the original assumptions.

In my factory example above, the 100 workers have a productivity surge and produce 105 units.  In the short run, the owner may benefit by pocketing the profit on the additional 5 units.  Eventually, however, competitive forces will prompt him to offer the workers raises, or see them leave.  That, at least, is the gist of how it has been modeled here.

So, you may be thinking, if the high growth forecasts that "save" Social security don't also "save" the stock market by implying higher returns on capital, why did Prof. Krugman say they did, and is it hopeless for stocks?

As to how Prof. Krugman made an error he would not tolerate from one of his grad students, I have no idea.  But the stock market question is easily answered - now that we know that growth, per se, is not the issue, we know where to look - if you want to forecast higher capital market returns, you need to figure out what, in the model, is guiding capital returns.  Tweak that, contemplate the implications, and there you are.

Eventually, the analysis will come back to the income share earned by capital.  The Social Security trustees assumed it would remain constant; Dean Baker's astute observation [Link, please!] was that, given the current earnings yield and the requirement for new capital, the assumption that the income share to capital was constant led to some fairly gloomy implications for share prices.

Problem solved - we need to raise the return on capital by projecting that capital will earn more.  Can we do that in a low growth scenario?  Sure.

Suppose the work force grows even more slowly than the low growth scenario because a (daft) Congress cracks down on immigration.  Fewer workers, less growth, less payroll taxes, and an earlier problem date for Social Security.

Meanwhile, Benedict Arnold CEOs use the threat of outsourcing to hold down wage increases.  Is that implausible?  It sounds like the Kerry campaign (feel free to tell me he was implausible).  And no, I don't think it would represent a long run equilibrium for the US economy.  But during a transition period, the income share of capital could be modeled to rise from, e.g., 8% to 10%.  Throw in some foreign profits from the newly outsourced jobs, and equity returns can look pretty good.

Net result - low growth, a quick financial challenge for Social Security (we don't say "bankrupt"), and great stock market returns.

Let's be clear - I am identifying, not advocating.  Prof. Krugman insisted, in his column, that growth and capital returns went hand in hand, and implied that privatizers were playing a bit of a shell game with the public.  In fact, he was wrong, and there are plausible low-growth scenarios that hammer Social Security but are good for stocks.

I hope that sets the record straight (what are the odds?).  There are still plenty of other reasons to support or oppose Social Security privatization (and Republicans are not touting the stock market anyway.

I would like to thank Dean Baker, whose underlying idea was quite insightful.  He has been a good sport and provided some useful guidance in an earlier comments thread.  I should also find a more useful link, but, incredibly, other duties call.

 

Sometimes A Great Notion

Maybe you hated the Notional Offset Account that is currently the Banquo's ghost of the Bush Social Security reform concept.  But there is no way you hate it as much as Victor of the Mostly Dead Is Partly Alive Parrots.  And for those of you who have misplaced your scorecards, Victor is broadly sympathetic to the privatization concept.

I'll offer a Not So Bold Prediction - this concept get scrapped.  That will not chase away the underlying reality - different choices will lead to different outcomes, and after the fact, it will be possible to identify winners and losers, and bemoan the poor decisions made by some.

However, this Notional Offset puts the consequences of the decisions so squarely in people's faces that it won't fly.

Let's put it this way - suppose Washington passed a regulation requiring every brokerage statement to include a calculation of (a) the money market alternative, and (b) the S&P 500 Index Fund alternative, where the hypothetical value of the account would be tracked assuming every deposit and withdrawal went into either (a) or (b). 

This disclosure might provide useful information, but Wall Street would never agree to it - people just don't want to know.