What's wrong with Hong Kong? (Too much government)

From Scott Sumner of EconLog.

"You often read very thoughtful progressives explain why the government sector in the US is too small. You'd think 40% of GDP would be enough, but they insist we have "unmet needs" for a single-payer health care system (18% of GDP), universal preschool, etc. We should be spending something closer to 50% to 55%, like France or the Nordic countries.

If you ever find yourself starting to be persuaded I suggest you visit Hong Kong. I just got back from a trip to Hong Kong (previously I had visited in 1991 and 1999), and marveled at the world class infrastructure. Others seem to have been similarly impressed, as a recent study ranked Hong Kong's infrastructure number one in the world. This in an economy where government spending is 18.5% of GDP, vs. 41.6% in the US.

I don't know how good their schools and health care are, but their life expectancy is third highest in the world (trailing Japan and Singapore) despite bad air pollution. And they score very well on international education rankings.

Hong Kong does have its share of problems. I've mentioned air pollution--although in fairness a lot of that is beyond the government's control--drifting down from the heavily industrialized Pearl River Delta. They also have a lot of income inequality. I'd say that's partly offset by two factors. Many of the poor are immigrants from much poorer countries, who come to HK to do jobs like housekeeping. And all classes in Hong Kong are vastly better off than a few decades ago.

Hong Kong's per capita GDP (PPP) is now about the same as the US. The appearance of the city is a real hodgepodge, with older buildings in Kowloon looking awful, unless you have nostalgia for the HK of films like Chungking Express and In the Mood For Love. (And what movie buff doesn't?) But those old concrete tenements are rapidly being replaced by glitzy new buildings. There's a big hole in the ground where they're building a new high-speed rail station. Imagine getting on the train in tropical HK, and getting off the train in wintry Beijing, the very same day.

What impresses me the most is not so much the current position of Hong Kong, but rather it's trajectory. Unlike the US and Europe, it is still seeing rapid improvement. The fact that an economy can do so well with the government spending only 18.5% of GDP makes me even more skeptical of the progressives' call for a bigger welfare state in the US. If we are spending 41% of GDP, then the problems here are not due to any lack of resources for the government.

Now let's consider what is universally viewed as Hong Kong's greatest failing---housing. It's very expensive, and even middle class people live in very small apartments in high-rise towers. Now consider that real estate is the one sector where Hong Kong's government is heavily involved in the economy. They own most of the land, and sell only very limited amounts of land for new construction. Many people in otherwise laissez-faire Hong Kong live in public housing projects. So it appears that the biggest problem in relatively libertarian Hong Kong is too much government. More specifically, too much government involvement in housing. They should privatize both the land and the public housing projects. Here's an interesting article by Richard Wong of the University of Hong Kong:

The value of Hong Kong's housing capital last year was estimated at HK$6.8 trillion, or 320 per cent of gross domestic product. This is the net value of private residential housing at market prices, based on gross market value minus the value of outstanding mortgage loans. Total loans were a modest HK$900 billion - a mere 11.8 per cent of the gross market value. 

French economist Thomas Piketty, in his book Capital in the Twenty-First Century, obtained similar figures internationally. . . .

In Hong Kong, private residential housing only accommodates about half the population. The other half is in government-provided public rental housing and subsidised ownership homes, mainly tenant purchase scheme and homeownership scheme flats.

The market value of government-provided housing is very substantial, but because there are extremely severe restrictions limiting their use either as rental property or as assets for sale on the open market, their values are highly discounted. They simply provide shelter for the original occupants. As such, they are marginal to the market economy and measured GDP.
Privatisation of public rental units and deregulation of sale restrictions for ownership units, on the other hand, would substantially enhance the market value of government housing. What would be their market value if such steps were taken?

Based on the open market transaction prices of HOS and TPS flats, the gross market value of public rental housing units is estimated at HK$2.45 trillion, TPS homes at HK$410 billion, and HOS flats at HK$1.56 trillion. The total value of government subsidised housing is therefore HK$4.42 trillion, or 208 per cent of GDP.

What will be the economic gain to society from the privatising of public rental housing and waiving or substantially lowering of unpaid land premiums on all government-subsidised housing units? The value of private and public housing stock would easily amount to HK$11.24 trillion, or 528 per cent of GDP.

To put this percentage into perspective, consider Piketty's estimates of the value of all forms of capital (and not just housing capital) as a percentage of GDP. He found this to be 617 per cent in France, 543 per cent in Britain, 418 per cent in Germany, 417 per cent in Canada, and 456 per cent in the US.

Hong Kong could be a very capital-rich city if only government housing units were privatised and deregulated, which would put an additional HK$3.36 trillion housing value in the market.

First, half the population would be happier because the gap between the rich and the poor would be sharply reduced in one fell swoop.

Second, the pressure on government to finance rising health care costs, old-age social welfare payments, education spending, and even housing investment would be indirectly alleviated, as many underutilised public housing units would become unlocked and return to market circulation.

Third, new economic activity at the grass-roots level could be spawned. Mortgaging parents' homes is often a key way to raise capital among those without credit rating.

Fourth, mortgaging parents' homes would also provide an important source of upward intergenerational mobility, both in providing human capital investments to children and making down payments for their home purchases.

Fifth, these benefits would come at no one's expense. The government would not even need to raise taxes.

PS. Whenever I do these posts people complain that Hong Kong is not a typical country. It's a single city, with only 7.3 million people. That's true, but of course there are many European economies with similar populations, and in most modern economies only about 3% of the population is farmers. You could argue that at least in terms of demographics Hong Kong and Sweden are more alike than either place is like the US, which has a much larger and more ethnically diverse population. I don't claim that Hong Kong proves that small government can work everywhere, but it certainly demonstrates that it can work somewhere."

Uncle Sam’s ‘War on Poverty’: A Snapshot History

From Cafe Hayek.

"Look at the graph below (which I get from this Heritage Foundation page).  (To enlarge this graph, just click on it.)  You tell me if the revving-up of Uncle Sam’s welfare-state activities in the mid-1960s can be considered, by any scientific criterion, to have been clearly successful at reducing officially measured rates of poverty in the U.S."

Wages and the Free Market, Part 1: Dispelling labor market myths with theory and data

From economics professor SANDY IKEDA of Foundation for Economic Education.

"If you have a superficial understanding of modern economics, the following argument sounds plausible: In the free market, employers have an incentive to lower costs by driving wages down, which is bad for workers. Since driving down wages is what efficiency requires, it follows that efficiency is bad for workers.

The argument dates back at least to Karl Marx. It’s wrong but it continues to have appeal because, like many of Marx’s arguments, it contains a half truth: Given the choice between paying a worker $12 or $11 an hour, other things equal, an employer would usually rather pay $11. I think it’s a useful exercise to think through why it’s wrong.

Problem No. 1

One of the things the argument doesn’t address is why or even whether a person would accept $11 an hour to work. We need to ask what a worker would be giving up by accepting $11. If the something else is more valuable to her than $11 an hour, then she won’t accept that wage. What could that something else be?

Well, it could be that her leisure is worth more to her than $11. Or perhaps another employer is willing to pay her more than $11. Let’s focus on the latter.

Just as there is competition among sellers of a product—say, cellphones—to underbid one another and among buyers to outbid one another, there is competition in the labor market among workers (on the supply side) to underbid one another to be hired and among employers (on the demand side) to outbid one another to hire workers. And, as in the cellphone market, in the labor market sometimes it’s a buyer's (hirer's) market and sometimes it’s a seller's (worker's) market. So the question is whether there are forces in a free market that would persistently create a hirer's market in labor.

Here’s where the argument against free markets sometimes gets more sophisticated.

But isn’t efficiency still bad for workers?

That argument says that if efficiency enables firms to use less labor and other production inputs, workers let go by one firm because of increased efficiency must try to find employment elsewhere. But if all firms in the economy are becoming more efficient and letting workers go, where are those other jobs going to be? So because efficiency is always increasing the supply of labor, wages will just keep falling.

Let’s address this argument in two parts.

First, note that the competition in the cellphone market that is making firms more efficient is also making them lower the price of their cellphones ever closer to the lower costs of production. That means people who buy cellphones—including cellphone workers—don’t have to spend as much of their incomes to buy cellphones. It’s the same for the other things they want to buy. In other words, it’s important to distinguish wages denominated in terms of money (nominal wages) from the goods and services those wages will actually buy (real wages). Other things equal, lower prices for consumer goods will increase real wages.

Second, note that the argument assumes that the demand for labor is not rising. But if the demand for labor is rising while the supply is also rising, nominal wages won’t be affected as strongly. In fact, if the demand for labor rises faster than the supply, real wages will actually rise even if the average prices of consumer goods stay the same. And if average consumer goods prices are actually falling, so that you can buy more with a dollar than before, then real wages would rise even faster.

Why would the demand for labor rise?

There are different reasons why the demand for labor would rise, but for now I’ll focus on gains in productivity. By productivity I mean how much the output of a business will increase when you add another worker to it. Say I’m currently hiring 20 people in my carwash who can together wash 400 cars a day. If by hiring one more person I can increase that output by 20 cars to 420 cars a day, and if I can charge $10 per wash, then that worker would bring in an additional $200 a day (20 x $10). While I might gladly pay that person nothing for working in my carwash, competition from other potential employers for her labor could push me to pay her as much as $200 a day, which is the revenue her labor brings to my business.

Now, I might invest in some new capital equipment at a cost of $1,000 a day, but only if the dollar increase in my workers’ productivity were greater than the cost. Suppose the new equipment increases the output of my original 20 workers from 400 to 600 cars a day, an increase of 200 cars. Let’s say I lower my price to $8 to bring in more cars. So at $8 per wash, my revenues would rise by $1,600 a day (200 x $8). That increase would certainly justify my investment in new capital. But I’ve also increased the average productivity of my workers by 50 percent, from 20 to 30 cars a day.

It’s certainly possible that instead of 200 more I might only be able to sell 140 more carwashes a day, even after lowering my price to $8. In that case, it’s still worthwhile to invest in new capital although I might indeed have to lay off two people. But note that I’m buying more equipment for my carwash. That increased production in the capital market means more money available for hiring those people I laid off, along with others who may have been laid off owing to efficiency gains elsewhere.

Overall, if the productivity and thus the average real wage of people in the rest of the economy is also increasing, via investment in capital, then workers in other markets, such as cellphones, can now afford more carwashes than before because nominal prices for carwashes (and cellphones, houses, education, and so on) are falling.

What the data show

The historical trend in per-capita real income since the year 1800 has been unambiguous. Per-capita real income around the world has been rising at an accelerating rate, which coincides with the spread of and respect for free-market ideas and practices. Deirdre McCloskey refers to this phenomenon as the “hockey stick” of economic growth.

Imagine a hockey stick lying on its side. For millennia, per-capita real income had been low and stagnant, about $1 to $3 a day for the vast majority of people everywhere. That’s the long handle of the stick. Suddenly, around the year 1800, there was an unprecedented increase in growth—up to a factor of 50 in some parts of the world—with no decrease, “except in places with the misfortune of tyrants on the model of Robert Mugabe in Zimbabwe, or entirely uncontrolled robbers or pirates as in Somalia.”

Now, some economists have argued that “conventional methods of analysis” show that real wages in developed countries such as the United States have been stagnant or falling since the 1970s, even as productivity has increased. The process is known as “decoupling.”

But economists Donald Boudreaux and Liya Palagashvili counter that “conventional methods” tend to exclude substantial fringe benefits and use inconsistent methods of accounting for inflation, both of which understate the growth of real wages. They also point out that conventional studies overlook the deadening effects of government policies and regulations on economic development.

So we’ve seen that lower prices of cellphones and carwashes will tend to increase sales of those products and increase real wages, and that rising demand for capital equipment can productively employ more people in those markets. So the question remains: What happens to those who are laid off and still can’t find a job?

The answer relates to something even more important than efficiency: Innovation. It’s the topic of my next column."

Fixing Climate Change Will Never Be Free

From Megan McArdle.

"Is fixing climate change free? That’s the suggestion of an international blue-ribbon panel in a new report, which has been enthusiastically embraced by people who would like to fix climate change. “This may sound too good to be true, but it isn’t," Paul Krugman says. "These are serious, careful analyses.”

I hate to be the person to pour cold water on this, but I happen to have this bucket right here …

The details are a bit fuzzy so far (the report promises more in a forthcoming technical appendix). But most of the benefit seems to come from reducing respiratory diseases in the developing world and ending fossil-fuel subsidies, which are, no matter what you may have heard on the Internet, also concentrated in the developing world, not the U.S. tax code.

Essentially, if developing countries stop selling artificially cheap gas, replace their coal plants with a combination of nuclear, solar and wind power, and get people to use gas or electricity for cooking and heating instead of wood, dung or coal, we can go a long way toward reducing total greenhouse-gas emissions. Further benefits come from building more compact cities (they’re looking at you, America) and better conservation of rural land.

These things may be splendid ideas. But as the New York Times suggests, it may be a bit optimistic to think that they will actually leave us with more cash in our hands. And getting the developing world to go along may be a bit tricky.

For example, I am sure that China would be a much healthier nation if it used more clean renewable energy instead of dirty coal plants. I can even believe that switching to clean renewable energy would generate enough savings in the future to cover the cost of the fix. Still, I have some questions.

The first, most obvious question: How much money would the Chinese would save on medical bills by switching to renewable power, compared with, say, installing stack scrubbers and other fixes to clean up particulate emissions from the plants they have? The second, perhaps less obvious, question: How far in the future will those benefits arrive -- in five years? Or are we saying that China should stop building coal plants now, build more expensive nuclear plants while hoping that solar and wind come to cost parity, and thus deliver to their grandchildren a cleaner country and a better budget picture?

Intertemporal comparisons of this sort get really tricky in a developing country. Poverty has an urgency that overrides other considerations, which is why so many people have migrated from pristine countryside to squalid city. This sort of cost benefit is relatively easy in America -- but it’s also not money-saving, because we already made war on our particulate emissions.

There are also political considerations. It’s easy to say that poor countries should get rid of their fuel subsidies -- I mean, there, I just said it, and it’s absolutely true, they should! On the other hand, I am not attempting to hold onto power in a country that has built all of its economic activity around absurdly cheap oil.¹ The transition costs away from fuel subsidies are high, and they are difficult to make in an economy where lots of people are subsisting close to the poverty line.

Noneconomic costs are always hard to factor into these sorts of calculations. But they need to be brought up, because they will factor heavily in any analysis of the political feasibility of your proposal. For example, they point out that Atlantans could save a lot of money on transportation if their city had the petite footprint of Barcelona. But said Atlantans would have to live in tiny apartments rather than large single-family homes with yards. They might not like that. Especially because the mini-Atlanta would have much less charm than Barcelona, its residents having lacked the foresight to build their city on a lovely beach in a long-declining European power.

This is not to say that the report is wrong. But many of the people who read it seem to have come away saying, “OK, great, it’s free, why can’t we do it?” Even if this is a free lunch over the long term, it is not a free lunch right now to the people who would need to make major changes in their lives. No matter how long you point to the equations, they will resist.

I’m a pessimist on the prospect of collective action on climate change, but I’m a mild optimist on the technological frontier, because human beings are endlessly creative, and so far, they’ve ultimately done what they needed to, though they might kick and scream along the way. I think that some combination of nuclear, solar and wind, plus adaptation and maybe geoengineering, are going to keep climate change from being catastrophic. But I doubt it will be free, and I’m quite sure it won’t feel that way to many of the people who are affected by whatever changes we do end up making.

¹ I know you think that America’s price is absurdly low, because negative externalities. But we’re not in the same class as Venezuela, which has long kept gasoline practically free."

Is Every 18 Year Old High School Graduate Worth $30,000 A Year?

If we made the minimum wage $15 per hour, that works out to about $30,000 a year. Is every 18 year old high school graduate capable of generating $15 per hour in revenue on any job they might get? My guess is that many of them are not and will not get a job when they graduate. So when will they get a job? Who knows. Maybe they will never get their first job and will never enter the world of work.

In fact, the WSJ recently reported that many college graduates barely make what a high school graduate makes:

"The median wage of an American with a bachelor's degree was $48,000 last year, far higher than the $25,052 earned by those with only a high-school diploma. But the lowest-earning quarter of college graduates make $27,000 or less."

So if many college grads cannot make $30,000 per year, how is it possible that each and every high school grad will? They probably can't

Ending slavery made America richer

From Scot Sumner of EconLog.

"Matt Yglesias has a good post that goes right at the "smiley-face" view of early US history--that we were a great country save for the regrettable aberration of slavery. He doesn't pull any punches:

Specifically, white Americans conquered a vast new empire (Alabama, Mississippi, Florida, Arkansas, Louisiana, Missouri, and Texas), populated it with millions of slaves forcibly transported from the Atlantic coast, and developed innovative new torture-based management techniques to enhance the productivity of this coerced labor.

Thus I regret to say that the title of the post sends the wrong message:

American prosperity was built on slavery and torture

In fact, countries with free labor tend to be more prosperous. Indeed Yglesias's post contains a graph (from Thomas Piketty's book) that undercuts the message in the title:

 

At first glance it doesn't look like there was much change in the capital stock between 1850 and 1880. But that's very deceptive, as Piketty classifies (or should I say mis-classifies) slaves as "capital." It's true that they were legally considered capital, but in a functional sense they were obviously labor. Slaves don't stop being people just because the government treats them like animals.

Between 1850 and 1880 the market value of slaves falls by just over 100% of GDP. And that decrease is almost precisely offset by a slightly more than 100% increase in capital (industrial and housing.) The total capital stock declines slightly in the Piketty graph, but that's only because of a fall in the value of agricultural land, not capital.

Now here's where mislabeling slaves as capital comes into the equation. At first glance it looks like America's capital stock was unaffected by the abolition of slavery. But the actual capital stock rose by over 100% of GDP---an industrial revolution. If you insist on treating slaves as "capital" it doesn't change the basic story. Because in that case a separate ledger of "labor resources" would have soared after 1865. Former slaves would now be classified as "labor," and hence the labor stock would rise dramatically, even on a per capita basis. Either way, abolishing slavery made America a much more productive, and hence richer country.

Now let me anticipate the "yes buts." Some Americans were made worse off. Obviously slave-owners, and less obviously those who were closely connected to the slave economy (bankers who financed them, cotton mills, etc.) But as Fogel showed (in a study of railroads), when thinking about any economy we tend to mentally overrate the importance of any one sector, especially big sectors. So despite the very real losses to a sizable group of Americans, the economy overall did much better as a result of the abolition of slavery.

Do we know that this was because of the abolition of slavery? There are very few certainties in economics, but consider:

1. Brazil didn't abolish slavery until the 1880s, and did worse than America. It also did worse than countries to the south of Brazil.
2. When the American South abolished Jim Crow, incomes in that region began to converge on those in the North. Indeed even southern whites began to catch up, especially when adjusting for cost of living differences. Freedom increases productivity.
3. Most of the rich countries around the world were places with free labor in the 19th century. Places that had slavery tend to be much poorer.
4. Superficially the South seemed "richer," but only if you don't count slaves. But why not count them? The North was far more dynamic, industrializing rapidly and drawing more immigrants from Europe. Why didn't more whites from Europe move to the South?
5. Countries are richer when workers have more rights---compare North and South Korea.
America still has a long way to go. Blacks (and whites) are legally barred from many professions by occupational licensing laws. It's also worth pointing out that Yglesias is one of the few progressives that frequently criticizes those laws.

America is much freer than it used to be, but there is more work to be done."

Robert Reich makes 36% more than average CEO and gets $40k for a one-hour talk vs. average worker pay of $46k/year

From Mark Perry.

"

Former Labor Secretary Robert Reich is currently a professor of public policy at the University of California-Berkeley and he was paid $242,613 in 2013 according to this University of California database. According to this link provided in an article by the Daily Caller, Professor Reich is scheduled to teach only one undergraduate class this fall semester – Public Policy 260 – that meets only one day a week (Monday) for two hours (12 – 2 p.m.). That works out to about $2,500 for each hour of lecture time that Professor Reich will spend with UC-Berkeley students this semester, or about the same amount as the average adjunct college professor gets paid for teaching an entire one-semester 15-week class ($2,700 according to this AAUP report)!

As the Daily Caller reported yesterday, Professor Reich took time off from his hectic one-course, two-hour a week teaching schedule to berate and excoriate American CEOs and Harvard Business School in a post on the Harvard Business Review blog for allowing “a pay gap between CEOs and ordinary workers that’s gone from 20-to-1 fifty years ago to almost 300-to-1 today.”

As I reported earlier this year on CD in a post about the never-ending claims of “excessive CEO pay” and the alleged 300-to-1 pay gap between CEOs and ordinary workers (modified and updated slightly):

We can get a more accurate and complete picture of CEO compensation in the US by looking at wage data released recently by the Bureau of Labor Statistics in its annual report on Occupational Employment and Wages for 2013. The BLS report provides “employment and wage estimates by area and by industry for wage and salary workers in 22 major occupational groups, 94 minor occupational groups, 458 broad occupations, and 821 detailed occupations,” including the occupational category “chief executives.” In 2013, the BLS reports that the average pay for America’s 248,760 chief executives was only $178,400. The multi-million dollar salaries of the CEOs of the 200-350 S&P500 firms reported recently represent only one out of about every 1,000 firms in the country (or 1/10 of 1%) that have a CEO at the head. The larger sample of almost a quarter-million CEOs reported by the BLS gives us a much better understanding of “average CEO compensation.”

For the larger sample of CEOs reported by the BLS, their average pay of $178,400 last year was an increase of only 0.88% from the average CEO pay of $176,840 in 2012. In contrast, the BLS reports that the average pay of all workers increased by 1.42% last year to $46,440 from $45,790 in 2012. That’s right, the average worker last year saw an increase in their pay that was more than 60% greater than the increase in pay for the average US CEO. And the “CEO-to-worker pay ratio” for the average CEO compared to the average worker is only about 5-to-1, nowhere close to the pay ratio of 331-to-1 ratio reported by the AFL-CIO using the 350 highest-paid CEOs in the country or the 300-to-1 ratio that Robert Reich claims.

So at the same time that Reich complains about the excessive compensation of a small group of a few hundred highly paid CEOs, he actually makes 36% more than the average CEO in the US for lecturing a few hours a week (see chart above). Even considering additional work preparing lectures and grading papers or exams, it’s probably safe to assume that Professor Reich is putting in 50-60 hours per week like the majority of America’s CEOs for his very generous pay of more than a quarter-of-a-million dollars per year.

In addition to his annual CU-Berkeley salary of $242,613, Professor Reich is also a popular speaker on the nation’s lecture circuit, and he commands a handsome speaking fee of $40,000 for a one-hour talk (including Q&A) plus first class travel for one or two people from California, hotel accommodations for up to two nights, ground transportation, meals and incidentals. That’s the quote I got today from one of Professor Reich’s speaking bureaus for his fee to give a presentation as part of a “university program” — it’s possible that he charges even more for corporate events. So we have the former labor secretary complaining about a pay gap between CEOs and average workers, when he gets almost as much in compensation for a one-hour talk as the average American worker earns working full-time for an entire year (see chart above)! If he gives only six speeches a year, his annual income approaches half-a-million dollars a year, putting him solidly in America’s “top 1%” by income – a group the “class warrior” frequently criticizes (see examples here and here). .

As I said in a previous post, I think it’s actually great that Robert Reich gets a market-based fee for his speeches, and I applaud him for commanding $40,000 per one-hour speech that allows him to enjoy a very comfortable life in the “top 1%.” But it then seems deeply hypocritical when he complains that airlines are “deeply exploitative” when they use market-based, surge pricing (see post at the link above) or when he complains that the pay for several hundred CEOs relative to the average worker’s pay is excessive. In all cases – Robert Reich’s $242,613 UC-Berkeley salary, his $40,000 speaking fees, CEO pay, airline pricing, and the average worker pay – those salaries, prices and fees are not determined independent of the market, but in each case primarily determined by market forces. Therefore, it seems deeply inconsistent for Reich to complain about the market forces that determine CEO pay, airline surge pricing and average worker pay, but then take advantage of those same market forces to earn a $242,613 salary for teaching one class per semester and charge $40,000 for a one-hour talk and enjoy life in the “top 1%.” And in any discussion of CEO pay we should remember that the average CEO in America earned only $176,400 last year (not multi-millions of dollars), received an increase in salary less than the average worker, and earned only about 5 times more than the average worker (not 300X more).

HT: Steve Bartin, see his post today about Robert Reich here."