Friday, November 11, 2005

Joe Stiglitz, Ig-Nobelist

Economist Joseph Stiglitz (a.k.a. Paul Krugman plus Nobel prize) recently reviewed Benjamin Friedman's The Moral Consequences of Economic Growth. Stiglitz delivers many outrageous ideas, not the least outrageous of which is this:
Inequality did seem to fall in the United States after the Great Depression, but in the last 30 years it has increased enormously.
Inequality seems to go with economic growth -- as Stiglitz admits. But he prefers equality and lower incomes for all to inequality and higher incomes for all. He has no regard for those whose talents and entrepreneurship fuel growth and help to make everyone better off. That's probably why he's an academic.

Then there is this:
The question should be, are there policies that can promote what might be called moral growth -- growth that is sustainable, that increases living standards not just today but for future generations as well, and that leads to a more tolerant, open society? Also, what can be done to ensure that the benefits of growth are shared equitably, creating a society with more social justice and solidarity rather than one with deep rifts and cleavages of the kind that became so apparent in New Orleans in the aftermath of Hurricane Katrina?
This is absurd talk coming from a so-called economist. He must have learned his economics at the knee of Karl Marx. Aside from enforcing laws against force and fraud, government should simply get out of the way. Markets thrive without government intervention. Markets are the essence of cooperation. Markets are inherently "tolerant" and "open" because the pursuit of self-interest (profit) requires service to the interests of others. Markets ensure equitable sharing of the benefits of growth by incentivizing and rewarding contributions to growth. A society of free markets and limited government would not have fostered the conditions that led to New Orleans's poverty and rank dependence on incompetent government.

But Stiglitz continues undaunted by the ghost of Adam Smith:
As the income distribution becomes increasingly skewed, with an increasing share of the wealth and income in the hands of those at the top, the median falls further and further below the mean. That is why, even as per capita GDP has been increasing in the United States, U.S. median household income has actually been falling.
Left-wingers like to talk about the "skewed" distribution of income, but they don't like to talk about the fact that there is considerable mobility across that distribution. As I wrote here, for example,
at the end of the 20th century, only about 15 percent of the households (3 million of 21 million) then in the bottom quintile had been there for a generation.
(See also this post and this one.) Moreover, Stiglitz views household income selectively. Instead of looking at the long-term trend, which clearly is upward, he focuses on recent, recession-related data. Here is the big picture:

Source: Census Bureau. See Figure 5, at this link.

Stiglitz, of course, likes to invoke the usual Left-wing bugbears, as if the bottom line (rising real income) were irrelevant. Thus he alludes to the poverty rate, which in fact is in long-term decline; job security, a nebulous scare-term that somehow cancels out rising real income and the 20-year decline in the unemployment rate, which is now well below the average for 1948-2004; the percentage of persons without health insurance, which has risen somewhat since 1987, probably due to immigration and government mandates that have raised the cost of health insurance; and so on.

Now Stiglitz mounts a direct assault on Adam Smith:
In a market economy with imperfect and asymmetric information and incomplete markets -- which is to say, every market economy -- the reason that Adam Smith's invisible hand is invisible is that it does not exist. Economies are not efficient on their own. This recognition inevitably leads to the conclusion that there is a potentially significant role for government.
Of course nothing is perfect, except in the mind of a delusional economist or engineer. The price of perfection is too high: perfection is inefficient and stagnant. But Stiglitz doesn't want to talk about that; he wants to talk about how the visible, heavy hand of government can do to us what we refuse to do to ourselves. He doesn't want to talk about the very high cost of government intervention in markets, which I have documented here. That high cost includes the direct cost of government -- which, including welfare programs, now amounts to 40-50 percent of GDP -- and the incentive-dampening costs of taxation and regulation -- which, over the past 100 years, have slashed GDP to about 60 percent of its potential level.

Finally, Stiglitz offers this bit of "evidence" for the superior wisdom of government:
There is, for instance, a greater role for government in promoting science and technology than Friedman seems to suggest. A report by the Council of Economic Advisers (conducted when I was its chair) found that the returns on public investment in science and technology were far higher than for private investment in these areas and than for conventional investment in plant and equipment.
I wonder how it was that Stiglitz, as chairman of the Council, was able to sponsor a report that came to such pro-government conclusions? (Just asking.) Actually, Stiglitz misrepresents the findings of the study to which he refers. The study (as cited here) actually found
the private rate of return of R&D to be between 10 and 40 percent, while the social rate of return ranged from about 20 to 140 percent.
(An analysis with similar results can be found here. The following critique applies to all such studies.)

What we have here are apples and cucumbers. The private rate of return to R&D is the additional profit that results from additional investments in R&D. The social rate of return to R&D is the gain in consumption (GDP) that results from additional government investments in R&D. Thus, according to Stiglitz's study, if a corporation invests a dollar in R&D, it can expect that dollar to return a profit of between 10 and 40 cents a year, whereas a dollar of government R&D enables an future increase in consumption (additional GDP) of between 20 cents and $1.40 per year. However, a corporation's profit is net of something, namely its sales. If a corporate investment of $1 is to yield a profit of 10 to 40 cents a year, it must generate additional sales (additional GDP) of considerably more than 10 to 40 cents a year.

To convert the apple of private R&D to the cucumber of government R&D we must convert after-tax profits to the equivalent amount of GDP required to generate those profits. Drawing on National Income and Product Accounts Table 1.15 (Price, Costs, and Profit Per Unit of Real Gross Value Added of Nonfinancial Domestic Corporate Business) for 1929-2004, I find the mean and median after-tax profit of nonfinancial corporations to be have been 7.7 percent of value-added for that period.* Thus, over the long haul, every dollar of profit represents about $13 in additional GDP. Applying that ratio, we get a valid comparison of the returns to private and government R&D:
  • The private rate of return to R&D, in terms of additional GDP, is between 130 and 520 percent.
  • The so-called social rate of return (i.e. return to government R&D, in terms of additional GDP) ranged from about 20 to 140 percent.
The true private rate of return to R&D is about 4 to 6 times that of the government rate of return. What else would one expect, knowing that the private sector responds to the signals sent by consumers while government just makes it up as it goes along?

I hereby nominate Joe Stiglitz for the Perpetual Ig-Nobel Prize in Left-Wing Economics.
* The profit rate for 1999-2003 dropped below the long-term mean and median. That wouldn't bother Stiglitz, of course. He seems to believe that government, not business, is mainly responsible for economic growth, and that corporate poverty is somehow good for people, when just the opposite is true.