Human Capital Contracts

Summary: Human Capital Contracts would allow people sell a certain % of their future income in return for upfront cash, as opposed to taking out a loan. This would be less risky for them, would give them valuable information about different college majors, and would help give people de facto ‘mentors’, among other advantages. Adverse selection could reduce the benefits, and reducing inter-state competition poses a major possible disadvantage. We also discuss two niche applications: parents and divorce.

Debt vs equity financing

There are two methods of financing for companies; debt and equity.

Debt is fundamentally very simple. I give the company $100 now; it promises to give me $105 in a year’s time. They owe me a fixed amount in return. Hopefully in the meantime the company has invested that $100 in a project or piece of equipment that produces more than $105; if so they made a profit on the transaction as a whole. Here the risk is borne by the company; they have no choice but to pay me back, even if they didn’t make a profit this year. This form of financing is familiar to most people, as they personally use savings accounts, credit cards, mortgages, auto loans and so on.

Equity, unlike debt, does not represent a fixed level of obligation. Instead the company owes you a certain fraction of future profits. If you give a company $100 in return for a 10% share, and they made a $50 profit, your share of the profit is $5. Hopefully they will make growing profits for many years, in which case your portion will grow to $6, to $7, and so on. Here the risk is borne by you; if they don’t make a profit, you get nothing. This form of financing is much less familiar to most people; about the only experience they are likely to have would be investing in the stock market, but that is now highly abstract so the underlying mechanics are obscured.

Equity: Less Risky than Debt

One of the biggest advantages of this system is it moves the risk from the individual borrower to the investor. When you borrow money, you put yourself at substantial risk. What if you struggle to find a good job after college? You’re still obliged to make repayments, which could be very difficult if you only have to accept a very low-paying job. Or if you borrow money after college, what if you lose your job? Or have a family emergency? Your circumstances have deteriorated, but you’re still obliged to make the same level of payments – meaning your post-debt income falls by even more than your pre-debt income.

With equity, on the other hand, you don’t have the risk. If you don’t find a job after college, your income will be zero, so your repayments will be X% of 0 – namely 0. If you find a low-paying job, your repayments will be low. The investors will be made whole by the people who instead find high-paying jobs – who can also afford to repay more. So equity investments better match up your repayment obligations with your ability to repay.

Here is an chart showing the difference, in terms of the % of income you’d be spending on repayment, from an example worked out later in the article:

Debt burden under adversity

The risk is transferred to the investor, who now loses out if you don’t have much income. But they are in a much better position to deal with the risk – they can diversify, investing in many different people, and also in other asset classes. Some human capital contracts could be a good diversifying addition to a conventional portfolio of stocks and bonds.

Education

Funding higher education is perhaps the best application for Human Capital Contracts.

Firstly, this is an extremely risky investment. There are countless stories of people who took out huge student loans to fund an arts degree and then have their lives dominated by the struggle to repay. Alternatively, if people could discharge education debts through bankruptcy, the risk to the lender would be too great, as the borrowers typically lack collateral, so loans would be available only at prohibitively high interest rates, if at all. Selling equity shares would avoid this problem; people who did badly after school would only have to repay a minimal amount, but lenders could afford to offer relatively generous terms because the average would be pulled up by the occasional very successful student.

The other appeal is the information such a market would provide students. It is fair to say that many students don’t really understand the long-term consequences of their choices. The information available on the future paths opened up by different majors is poor quality – at best, it tells you how well people who studied that major years ago have done, but the labor market has probably changed substantially over time. What students really want is forecasts of future returns to different colleges and majors, but this is very difficult! And many people are not even aware of the backwards-looking data. The situation isn’t improved by professors, who generally lack experience outside academia, and sometimes simply lie! I remember being told by a philosophy professor that philosophers were highly in demand due to the “transferable thinking skills” – despite the total lack of evidence for such an effect. Human Capital Contracts would largely solve this problem.

TIPs markets provide a forecast of future inflation. Population-linked bonds would provide similar forecasts of future population growth. Similarly, Human Capital Contracts could provide forecasts of the future returns to future degrees. Lenders would expect higher returns to some colleges and majors (Stanford Computer Science vs No-Name Communications Studies), and so would be willing to accept lower income shares for people who chose those majors. As such, being offered financing for a small percentage would indicate that the market expected this to be a profitable degree. Being offered financing only for a large percentage would be a sign that the degree would not be very profitable. Some people would still want to do it for love rather than money, but many would not – saving them from spending four years and a lot of money on a decision they’d subsequently regret.

What could make clearer the difference in expected outcomes than being offered the choice between Engineering for 1% or Fine Art for 3%?

Certainly I think I would have benefited from having this information available. Most people probably know that Computer Science pays better than English Literature, but that’s probably not a pair many people are choosing from. I was considering between Physics, Math, Economics or History for my major. I knew that History would probably pay less, but didn’t have a strong view on the relative earnings of the others. I probably would have guessed that math beat physics, for example, but in retrospect I think physics probably actually beats math.

Astute readers might object here that I am conflating the benefits of the type of financing (debt vs equity) with the mechanism for pricing the financing (free market or price fixed). If there was a free market in debt financing, lenders could charge different interest rates, and these would provide information to the students. This is true, except that 1) the interest rate would only tell you about the risk you’d end up super-poor, rather than providing information about the full distribution of outcomes, and 2) as student loans cannot be discharged through bankruptcy, there’s not really much reason for lenders to differentiate between candidates. If student loans could be discharged through bankruptcy, the interest rates charged would be informative but also probably very high. Perhaps this would be a good thing!

Education Funding – some illustrative examples.

Because it can be hard to think about these things in the abstract, I’ve tried to produce some worked-out examples. Suppose someone borrows $100,000, and then starts out earning $50,000 when they graduate. Their income grows over time, as they gain experience (maturity) and the economy grows (NGDP/capita). If we assume a 6% return for investors and a 20 year duration, they would have to give up just over 5% of their income of this time period. The repayments would be much more manageable – in year one, it would represent just 5% of their income, as opposed to 17% if they used debt.

Debt Equity Repayment Structures, equal r

Now, investors might demand a higher rate of return for equity investments, as they’re riskier than debt ( but then again maybe not . Here’s the same calculations, but assuming equity investors require a 10% return vs 6% on debt:

Debt Equity Repayment Structures, unequal r

What happens if the student runs into financial difficulty later in life? Here’s what happens if their income falls by 50% and never really recovers:

Debt Equity Repayment Structures, equal r, unexpected poverty

with equity, the hit is affordable, but with debt they have to pay 20% of their income in debt repayments – perhaps at the same time as having medical problems.

And what about the information value? Well, the investors would be willing to offer them $100,000 for just a 5.6% share, instead of 7.85%, if they took a major that would offer a $70,000 starting salary instead.

Debt Equity Repayment Structures, unequal r, higher initial

I hoped you enjoyed these tables. They are probably the closest you will ever get to a picture on this blog. I did add color to some of them though!

Mentors – Incentive Alignment

The modern world is very complicated, and we can’t expect people to understand all of it. Which is fine, except when it comes to understanding contracts, or credit cards, or multi-level-marketing schemes. At times the complexity of the modern world allows people to be taken advantage of, even in transactions which would be perfectly legitimate had the participants been better informed.

Equity investments have the potential to help a lot here. All of a sudden I have a third party who is genuinely concerned with maximizing my income. I could ask them for advise about looking for a job. Perhaps they could negotiate a raise for me. Indeed, they might even line up new jobs for me! Obviously their incentives are not totally aligned with me. Except insomuch-as happy workers are more productive, they might not put much weight on how pleasant the job is. But true incentive alignment is rare in general; even your parents or your spouse’s incentives aren’t perfectly aligned, and the government’s certainly aren’t. Even better, it’s very clear exactly how and to what degree my inventor’s incentives are aligned with mine: I don’t need to try and work out their angle. I can trust them on monetary affairs, and ignore their advice (if they offered any) with regards hobbies or friendships or whatever else.

Indeed, you could imagine schools that funded themselves entirely through equity investments in their students, and advertised this as a strength: their incentives are well aligned with their students. They would teach only the most useful skills, as efficiently as possible, and actively support your future career progression. This is basically the model App Academy uses:

App Academy is as low-risk as we can make it.

App Academy does not charge any tuition. Instead, you pay us a placement fee only if you find a job as a developer after the program. In that case, the fee is 18% of your first year salary, payable over the first 6 months after you start working.

source

Compare this to current universities, which actively push minority students out of STEM majors to maintain graduation rates.

Progressive

A clear implication of equity financing is that people who go on to earn more for ex ante unpredictable reasons will pay more than those who are ex post unlucky. As such, this system is mildly redistributive in a manner many people find attractive – like a sort of idealized social insurance that Luck Egalitarians like talking about. The lucky rich pay more and the unlucky poor pay less. Even better, it manages to do so in a voluntary way.

Taxation

The idea of human capital contracts may sound very strange. But we actually already have something similar in taxation. Governments invest in the education, health etc. of their citizens, and then levy taxes upon them. These taxes tend to be proportional to one’s ability to pay; they are some fraction of income, or expenditures (sales taxes). So Human Capital Contracts should feel familiar to socialists and the like.

There are of course a few differences between Human Capital Contracts and taxation. For example,

  • Human Capital Contracts are optional, whereas taxation is mandatory.
  • Human Capital Contracts give you more choice about what you spend the money on, whereas governments typically give you little choice.
  • Finally, Human Capital Contracts are customizable; you could negotiate different terms with the lender (like the % share you’re selling, or the income level at which you start repaying, or the timing of repayments), whereas individuals rarely get much choice about the taxes they will be made to pay.

Indeed, the advantages of human capital contracts suggest a new way of doing taxation: the state could simply claim a certain % ownership of its citizens. Perhaps it might demand a higher % for those who use public education or public healthcare.

The idea of the state literally owning (a stake in) its citizens, without their consent, might sound evil. But this is basically what the government already does with taxation – it claims a certain fraction of your income, leaving you no recourse. Even renouncing your citizenship will not persuade the IRS to let its property go. Human Capital Contracts just make it more explicit that the governments of most countries effectively own somewhere between 30% – 60% of their populations. Worse, if they want to they can increase their ownership stake without the consent of those affected. Compared to this, it is hard to make voluntary Human Capital Contracts sound problematic.

However, this suggests a danger with equity investments in people. At the moment you can escape most governments by fleeing abroad. The couple of exceptions are largely viewed as immoral aberrations, not the rightful state of affairs. This exit-right provides a vital check on their power, and forces them to compete to some degree. Without it they can descend to the most abusive tyranny. If equity investments became widely recognized, however, governments might start to recognize each other’s ownership of its population to a greater degree than now, which would make them harder to escape. Of course, virtually any innovation can be opposed by pointing out they make it easier for governments to oppress ‘their’ populace, from coinage to maps to cell phones. Perhaps a more powerful government would be a more benign one, as many different people have argued – though perhaps not.

Mechanics

Operationally this would be slightly more complicated than taking out a standard loan, because the amount owed to the lender would be variable. As such, they need to verify my income so they can check I’m repaying the correct amount. There are many ways this could be done, but an obvious one would be through the tax system; I would submit to the lender a copy of my tax return to show my annual income. Perhaps this could be automated through TurboTax. An even easier option would be if the payments were deducted from my paychecks – this is how English student loans work.

Possible Regulations

One option for regulating the system would be to impose a maximum amount of equity an individual could sell. This would prevent people from selling 100% of themselves, which might be a bad idea! Though for-profit investors would probably be uninterested in buying up to 100%, as the individual would lack any reason to actually work. Probably the only people interested in buying 100% ownership would be cults, communist co-ops and terrorist movements.

Another would be to regulate the contingencies that could be attached to such contracts.

A third would be to prohibit the investor from employing the investee, or vice versa.

Adverse Selection

One of the biggest impediments to such a system might be adverse selection. Students have ‘insider information’ about their future prospects – they know about their career plans. The less you expect to earn, the more attractive selling equity is over the fixed payments of debt. Conversely, the more you expect to earn, the less attractive equity is vs debt. As such, the students who opted for equity financing might be disproportionately the students with the lowest expected outcomes. This would increase the % investors would demand in return for funding, further deterring the higher-expectation students, until eventually only the very lowest-expectation students would remain in the pool.

We could imagine this being a big issue in some subjects, like physics, where there is a large variance in income for the different exit routes – grad school vs industry vs quant finance. For others it’s less of an issue; if you go to law school you’re probably aiming to become a lawyer, though even there you might choose between criminal or corporate law.

However, there are several factors which would mitigate against such an outcome. Firstly, the risk aversion we discussed earlier means students would probably be willing to pay a substantial amount to avoid the risk associated with debt. Adverse selection would mean it would be even more attractive to students pessimistic about their long-term earnings, but so long as it is attractive enough for the optimistic ones, it would still work.

Indeed, this is basically how it works for health insurance. In theory adverse selection is a problem for private health insurance; but in practice there is not much evidence this is actually a problem; healthy people still buy health insurance.

The effect would also be substantially reduced by students own lack of knowledge about their futures. Many students change their mind over the course of their studies about what they want to go on to do. So some low-expectation students might take out equity financing, thinking they were being cunning… and then change to a high paying career track! This seems to be the more common direction of travel in general; students go to college planning on becoming human rights lawyers, or engineers, or artists, but instead end up as corporate lawyers, investment bankers and advertisers.

So this is a problem I’d expect the bond/equity/insurance market to be more than capable of dealing with.

Addendum: Speculative Extensions

Here are some more ideas where equity investments in people could be useful. The idea could still be valuable even without these though; education is probably the best use-case.

Parents

Once upon a time the land was rich and fruitful, and the people were fecund with beautiful offspring.

… maybe that never happened, but fertility rates definitely have fallen over time, probably to our detriment. Future people matter, a lot! And even if they didn’t, we still need someone to fund social security.

One guess as to why fertility has dropped is once upon a time your children could be relied upon to live near you, following your customs, and supporting you in your old age, though its unclear if this ever made strictly economic sense. Now, however, children feel much less moved by filial piety, and frequently move far away. As such, parents seem much less value in having children, and only do so out of charity – raising a child takes a lot of effort, and the modern world is full of super-stimuli to distract you from productive procreation. Giving parents a small equity stake in their children would go some way towards recognizing the investment parents put into their children, and hopefully boost fertility rates.

It would also encourage parents to support their children and their careers; now the high-flying child is not merely a source of pride but also a source of retirement. A friend I discussed this with suggested that first-generation immigrants tended to give their children very practical advice about school, careers and relationships, whereas whites tend to be more wishy-washy; perhaps this would promote a return to reality-based parenting.

Divorce settlement

Another niche case where these could be useful would be divorce settlements. The classic feminist argument about divorce settlements was that the woman had invested in domestic and family labor, which was disrupted by the divorce, while the man had invested in his career, which he kept. Partly as a result of arguments like this, we now see divorce settlements where one party gets a claim to some of the resources of the other.

However, a fixed sum is not a very natural way of dealing with this. The woman, in entering marriage, assumed she would be benefiting from a certain share of the man’s output. If he were successful, this would be more; if he came upon poor fortune, this would be less – rather than taking a costly and messy court case to adjust the payments.  Human Capital Contracts would allow a divorce settlement to recognize this: in a divorce were the man were at fault, the woman might be granted a 1% equity share for each year of marriage.

Obviously if you thought permitting divorce was a mistake – “til death do us part” – then you’d have little interest in this application.

Further Reading

Further Reading: Risk-Based Student Loans

The War on Drugs as Make-Work

An argument for ending the War on Drugs is that it would undermine the drug gangs. At the moment we have a baptists and bootleggers situation, where the drug ban benefits illegal providers, because it raises the price of drugs a lot. If drugs were legal, supply would increase a lot, lowering prices. Criminal gangs don’t actually have a comparative advantage at running efficient supply chains – if they did they would be running WalMart instead – so they will be out-competed by new, legal entrants to the market. This would dramatically reduce their revenues, making joining them less attractive, and leave them with less money to spend on sinful things.

And all of this is probably true. But…

Here’s another way of looking at it. At the moment some argue the US has a zero-marginal-product-worker problem; there are people who aren’t worth hiring at any price, because you can’t trust them not to steal from you, or break things, or insult customers, or get you into legal trouble. But, like the army before them, criminal gangs can make use of such people – perhaps because criminal gangs can make use of extra-legal motivational techniques. Normally, this would be bad, if criminal gangs were hiring such people to do immoral things like theft. But at present many of them are usefully employed in the socially productive activity of consumer product distribution.

And another group of thugs, who lack skills beyond the ability to yell loudly and order people around, get make-work as DEA agents.

So actually the War on Drugs is job security for semi-criminal ZMP workers, providing them with employment and protecting them from competition. Maybe pretty rubbish protection – it leaves many of them dead or imprisoned – but other forms of ‘protection’ for low-skilled workers also have some pretty negative consequences.

2015/01/28 Shadow FOMC statement

The members of the Shadow FOMC would like to apologize for our extended absence; we were held under house arrest by the agents of Stanley Fisher.

Release Date: January 28, 2015

For immediate release

Information received since the Shadow Federal Open Market Committee met in September suggests that economic activity has been expanding at a pretty reasonable pace.  Labor market conditions have improved further, with strong job gains and a lower unemployment rate, and the employment to population ratio has improved, albeit off a low base. The end of extended unemployment insurance seems to have significantly boosted employment; we suggest that the federal government would benefit from privatizing and making optional the remaining unemployment insurance.  On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish.  Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power, though we worry they may have been caused by a fall in global aggregate demand.  Business fixed investment is advancing, though recent profitability among industrial companies has been disappointingly weak. The recovery in the housing sector remains slow. House prices remain well below the net present value of avoided future rent payments, probably due to regulation hindering the supply of mortgage financing, though recent data there has been encouraging.  Inflation has declined further below the Light Committee’s longer-run objective, as predicted by the Shadow FOMC, and they should not blame energy: while energy prices have fallen dramatically, inflation ex. shelter has been running below target for years, due to the unconsciously tight monetary policy the light committee has followed. Market-based measures of inflation expectations have declined substantially in recent months, and are now indicating that the Light Committee will miss its target for the next 10 years. We are highly disappointed that the Light Committee chose the Orwellian step of renaming them ‘inflation compensation’ instead of ‘inflation expectations’, ignoring the enormous predictive power the market gives us. Yes, survey-based measures of longer-term inflation expectations have remained stable, but who cares? These surveys have been awful forecasters in the past.

The recent rise in the value of the dollar against a trade-weighted basket of other currencies (or, indeed, virtually any other currency other than the Swiss Franc) shows the high level of global demand for the USD. Since this is a product that can be created at basically zero cost, the Shadow Committee would accommodate this demand and print some more USD.

Inconsistent with its statutory mandate, the Light FOMC is failing to foster maximum employment and price stability. Unemployment is low, so the Light Committee’s actions could be justified if it was targeting that… but it is ostensibly targeting employment instead. Employment is still pretty awful; both employment and inflation suggest the need for loser monetary policy. The Shadow Committee expects that, even with a lack of appropriate policy accommodation, economic activity will expand at a moderate pace, as free markets have a tendency to grow. As the economy is kind of like a martingale; risks to the outlook for economic activity and the labor market will always be nearly balanced.  Inflation is anticipated to decline further in the near term, and though the Committee expects inflation to rise gradually as energy is a one-time shock and the oil forward curve is very steep, we have no idea why the Lighties expect it to reach the target at any point in the foreseeable future.  The Shadow Committee continues to monitor inflation developments closely; evidently more closely than the Light FOMC!

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. However, we wish to remind people that this by no means represents a lower bound on interest rates; in the event the economy deteriorates further, we would be willing to lower interest rates further, or to deploy an array of other policy tools. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objective of a certain NPGDP level, which increases by 6% a year.  This assessment will take into account a wide range of information, including market indicators, what people say on facebook, and the behaviour of our cats.

We regret that the Light Committee completed the taper of its bond holdings, though we believe that resuming the program now could be destabilizing and reduce the credibility of the Bed. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.  This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and NPGDP of 6 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Shadow Committee views as more consistent with the fundamental level of human time preference, which implies long-run real rates of around 3-4%. Over the longer term, the Shadow remains concerned about value drift resulting in a future devoid of moral significance.

Voting for the SFOMC monetary policy action were: everyone, because I rule with an Iron Fist.

What Diversity can do, Design can do better.

People sometime argue that diversity in an organization is good because it improves the quality of ideas generated. Different backgrounds bring different perspectives, which provide different insights, whereas having many people with the same background causes partial redundancy.

This argument seems to be mainly made as a rationalization rather than as a true reason. It’s typically employed to support hiring more blacks, or less frequently more women and hispanics. But rarely do advocates explain exactly what new perspectives these people are meant to bring. Does one’s race give one a unique insight into how to write good code? If not, this argument seems pretty poor as a justification for discriminating in favor of blacks for programming jobs. Do women have special, vagina-based insights into maths or physics? If not, it doesn’t seem to work as a justification for discriminating in favor of women for STEM positions.

Indeed, if you actually wanted a diversity of opinions, you would probably just seek to hire that directly. Maybe your investment team should have majored in Economics, Physics, History and Statistics rather than Economics, Economics, Economics and Economics. Perhaps you should hire some social conservatives to your sociology department rather than actively and openly discriminating against them. Sometimes this strategy is employed – Corporate Boards do try to have people from a wide variety of backgrounds, both inside the company, different companies and even different industries. But I’ve never seen the pro-diversity crowd realize this purported benefit of racial diversity could be much more directly achieved.

Indeed, suppose different races did have different insights into programming. Then you would probably benefit from seeing each race represented. But while you might want some people from each race, there’s no reason to think you’d want them in the same fractions as appear in the overall population. At the moment having a racial breakdown significantly different from the US is enough to have you branded as un-diverse, but is there any reason to think the overall US has the optimal racial make-up for your company? Probably not. Indeed, as the racial make-up of the US is changing over time, even if your organization’s optimal make-up was fashionably diverse at the moment, it won’t be in the future, as the hispanic share increases and the white share decreases.

And if you were actually looking to take advantage of different racial perspectives and advantages, you wouldn’t have a corporate-wide quota or such. Instead, individual job openings would come with desired races attached. We would see a return to “No Blacks or Irish” notices on job postings, brought back at the auspices of political correctness.

Economies of Scale in Individual Labor Supply

Here are two stylized facts about labor economics:

  1. Utility is roughly logarithmic in income
  2. People who earn more per hour also work longer hours.

Together they present a puzzle – those higher income people are higher income primarily because they earn more dollars/hour, not because they work more hours. Yet if utility is logarithmic, there are diminishing returns to income, so we should expect people with higher hourly rates to work fewer hours.

Essentially, the first stylized fact suggests the income effect dominates, while the second suggests the substitution effect dominates.

One solution to this conundrum would be if the hourly rate changed with the number of hours worked. Maybe there are some jobs that simply cannot be done unless you put a huge amount of effort into them: you can’t be a part-time investment banker or corporate lawyer. If so, your productivity would increase dramatically with hours worked, so the demand curve for your labor would be upwards sloping. It’s a bit like a Giffen Good, except the causation goes

  • Higher Quantity -> More Valuable -> Higher Demand -> Higher Price

rather than

  • Higher Price -> More Valuable -> Higher Demand -> Higher Quantity

At the same time, every extra dollar is worth less and less to you, and each hour of leisure lost hurts more than the previous one, so you demand a higher hourly wage the more hours you work. So your supply curve is upwards sloping, roughly exponentially (to offset the logarithmic dollars->utility conversion)

When both supply and demand curves and upwards sloping, it is not clear there is a unique equilibrium – there could be multiple equilibria.

This could explain why we see such a difference between the incomes of

  1. The increasing number of people who do not work at all
  2. People who do ordinary jobs for around 40 hours a week
  3. Extremely high earning extremely hard working people

each group occupies a different one of these equilibria.

 

Against Double-Counting Virtue: the Many Faces of Value

At times I fear that the highlight of my blogging career will be pointing out minor errors in Scott’s otherwise excellent posts. But his quality is so high that this is probably a commendable achievement anyway – or so I reassure myself. Anyway, now I’m back from the Midwest and have internet again, I can continue this sacred quest.

Recently, Scott wrote a post about how charity is a better mechanism than political activism for discharging any positive moral obligations we might have. As an aside, he points out that it’s credible that he actually has no such obligations, as his net impact on the world is positive anyway:

The marginal cost of my existence on the poor and suffering of the world is zero. In fact, it’s probably positive. My economic activity consists mostly of treating patients, buying products, and paying taxes. The first treats the poor’s illnesses, the second creates jobs, and the third pays for government assistance programs.

However, while I agree that ordinary productive members of society plausibly do not have such obligations, this argument involves double-counting. He basically does two positive things:

  1. Treating patientshttps://effectivereaction.wordpress.com/wp-admin/post.php?post=142&action=edit&message=1 in his job (imagine Scott does surgery)
  2. Buying things (say bread)

(We’ll ignore the bit about taxes.1)

Now consider Scottlynn, the farmer. She figures her net impact is positive as well. She basically does two things:

  1. Growing corn and turning it into bread
  2. Buying things (say surgery)

Yet now we have the same activities appearing in two people’s lists!  Scott considers both his buying from, and selling to, Scottlynn as his positive impact. Yet Scottlynn counts those exact same transactions as part of her positive impact!

This is because (ignoring for the moment the inherent dignity that comes from productive work) Scottlynn doesn’t really value being employed per say – she values it because it gets her money, which she can then use to buy surgery. Buy surgery… from Scott. He shouldn’t count his purchases as part of his positive impact; the only reason it’s good is because it will later on allow her to buy the other thing he counted as positive impact! To avoid double-counting, he needs to pick one or the other. This is similar to how we have multiple ways of measuring GDP – the production method, the income method and the expenditure method – but we can’t mix them together.

The money/price system serves three purposes; it rations scarce resources, it signals which need to be produced more, and it incentives their production. But it is only a means to an end; ultimately, what matters is the goods and services that are produced, and that they go to those who want them.

Some macroeconomic theories do suggest that there might be times when simply spending money is a good thing; for example, if you have cyclical under-utilization of resources due to sticky prices. But it is unclear if that’s actually ever really an issue; other equally plausible theories of macroeconomics say it’s not. And even if the Neo-Keynesians are right, their theory implies that sometimes (when you have cyclical over-utilization of resources) simply spending money is a bad thing! Over the long run the economy operates at above and below capacity roughly as often, so these two effects will cancel out.

I’m sure there are other positive non-charity things Scott does. For example, he’s probably pleasant to his coworkers, and he creates a lot of value through his blog. But buying stuff isn’t one of them.

 


  1. We’ll assume Scott works for the private sector, and otherwise ignore the government, though if you thought the government was very evil, or taxes very immoral this might change the conclusion. 

2014 Shadow FOMC Statement

Firstly I would like to thank the FOMC for allowing the creation of the Shadow FOMC. In these times of controversial monetary policy, it seems only prudent to have a loyal opposition. And with the increased importance of the Shadow Banking System, whose ranks have been swelled by refugees fleeing the forces of Genghis Frank and Khan Dodd, it is vital that said loyal opposition should be a Shadow FOMC.

We intend to issue quarterly statements, coinciding with the releases of the Light FOMC .

Release Date: September 19, 2014.

For immediate release.

Information received since the Shadow Federal Open Market Committee last met, which was never, suggest that the early universe rapidly expanded due to cosmic inflation. However, the expansion was disjointed due to quantum fluctuations. The effects of these imbalances continue to have a major effect on the universe, as they are the cause of all variation, including galaxies, planets, and the fractional reserve banking system. More recently, fear of another kind of inflation lead to mistakenly tight monetary policy during 2008, a key cause of the recession, from which the economy has now partially recovered.  Private Sector GDP is running at a trend rate almost as high as during the Clinton and Bush II bull years, though many analysts miss this due to a mistaken focus on total NGDP, which includes government spending at cost. Industrial production rose. The S&P500, which appeared on the verge of mass bankruptcy, is now at record levels, seeing a 30% rise in 2013. Unemployment, painfully high for a very long time, has started to accelerate downwards. Employment figures, however, have been very disappointing; partly because of demographics, many of the unemployed have simply given up looking for a job. Only recently have we seen the employment/population ratio begin to rise.

More recently, since the Light FOMC met in July incremental data suggests that economic activity is expanding at a moderate pace. On balance, labor market conditions improved somewhat further; however, the employment rate has only improved slightly and wage inflation is muted, suggesting there remains significant underutilization of labor resources. The minimum wage continues to distort labor markets, suggesting a need for higher inflation to reduce its effects. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Restrained fiscal policy is encouraging true economic growth, although it is confusing accountants who mistakenly assume government spending is by definition useful activity. 10-year breakevens have recently fallen back to 2%, and 5-year breakevens are below 1.7%, slightly below the Light Committee’s longer-run objective. The US government has not issued NGDP-linked bonds, so we lack market implied growth figures, but trailing Nominal Private Sector GDP (NPGDP) growth has been trending around 5%, almost at our 6% target – and substantially closer than the irrelevant NGDP, which is closer to 4%.

If it was acting consistently with its somewhat misguided statutory mandate, the Light FOMC would not have initiated tapering, as low employment and low inflation both suggest a need for lose monetary policy. The Shadow Committee agrees that, with current mediocre policy, economic activity will expand at a moderate pace. The Light Committee thinks that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year, which is very strange, given that breakevens have fallen since then. Maybe the Light Committee could not afford a Bloomberg terminal.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions, but that this does not excuse irresponsible monetary policy. In light of the hugely reduction in the employment/population ratio since 2006, but improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to maintain the pace of its asset purchases. In October, the Shadow Committee will continue to add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month. Both Light and Shadow Committees are maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that NPGDP, over time, is at the rate most consistent with the Shadow Committee’s mandate.

The Committee will monitor incoming information on economic and financial developments in coming months as closely as it can be bothered, and will continue its purchases of Treasury and agency mortgage-backed securities, until the outlook for the labor market has improved substantially in a context of NPGDP growth. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and the Committee’s optimistic hope of NPGDP moving back toward its longer-run objective, the Shadow Committee will end its current program of asset purchases at sometime in early 2015. However, asset purchases are not on a preset course, and the Shadow Committee’s decisions about their pace will remain contingent on the Shadow Committee’s outlook for the labor market and broader economy, as well as its assessment of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Shadow Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate, and suggests that the Light Committee might like undertake one, rather than merely talking about it. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 6% NPGDP growth. This assessment will take into account a wide range of information, including market indicators, what witty people say in our twitter feed, and patterns we see in clouds. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected NPGDP growth continues to run below the Committee’s 6 percent longer-run goal, and provided that longer-term NPGDP expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and NPGDP of 6 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Shadow Committee views as more consitant with the fundamental level of human time preference, which implies long-run real rates of around 3-4%. Over the longer term, the Shadow remains concerned not only about technological stagnation but also about the risks from Superintelligent Artificial Intelligence.

Voting for the FOMC monetary policy action were: everyone, because of the Aumann Agreement Theorem.