One of my favourite things to do is to talk to the people who write the books I love, often they are hard to reach, others are surprisingly easy, some of them are hard to talk to, others are some of the nicest folks you could hope to have a conversation with, Bob Frank is very much the former and the latter, it took a while to reach him but it was worth waiting for, he has the quality I like best (and I mentioned it already in the review I did on his book ‘The Economic Naturalist’) – namely the ability to talk about complex ideas in plain language.
I called Bob at his house in Ithaca and below are the contents of some of that conversation.
KD: Bob, you have said before that you feel economics has gotten too numerical, that taking that direction can sometimes provide absolute ‘truths’ that simply are not what they seem, so where does the art come into it? Where do you see economics going (in terms of a secular trend) in the future?
RHF: ‘There has been a lot of movement on the ground in behavioural economics, there are many experiments and field tests being done, I think that the idea of a narrative that makes sense, or designed controlled experiments is catching on more and that what we learn from this will be the next area of breakthroughs.
KD: Will free marketers or keynesians be consigned to history?
RHF: Well, one is trying to put the other to bed, the Keynesians were almost an extinct breed, but they have made a comeback in the current downturn. The idea that the state is the only way out of a collapse in demand, and that only the government spending will get us out of it is once again alive and well, until recently these concepts were going down the tubes.
KD: Has the Keynesian response by the current US administration been sufficient?
RHF: There was a serious demand shortfall in the early months – the stimulus was probably too small by any measure. Ben Bernanke has been very aggressive though, my own expectation was that the recession would last longer than initially thought in the beginning, that we would see a long drawn out recover, but then when I was in the UK last month on the way to Italy, the FT had an article stating that there had been two months of positive growth in the UK, that doesn’t mean there is ‘actual recovery’ but somebody said it which is a start.
KD: You have said in some of your talks that the private sector is actually very wasteful in comparison to the public sector because the public sector don’t buy mansions, big cars and the like, if this is the case then what role does the private sector have in any receovery?
RHF: I should clarify that point, the private sector is unbelievably efficient when it comes to producing any given thing at the lowest cost, the incentives are strongly alligned for getting a result in that instance. However, when it comes to special goods sometimes these are things that need to be bigger and better than what others have (like military goods) and for that you need the state. Having said that, private sector waste is tricky, like private use of cars, for instance, when everybody stands up to see better nobody sees better than before, if everybody drives, nobody gets there faster, but at least its possible to attack it very efficiently, on the other hand it is very difficult to attack government waste.
KD: Are you a deficit dove or hawk?
RHF: The deficit is not a short run danger, the bigger problem is that 10% of the people have no job, and that output is lost forever, like a plan taking off with empty seats, you never get those seats back, if you want to stimulate the economy the only way to do it is with borrowed money, they have been printing too, which comes with an inflation risk but further down the line, right now the risk is deflation.
KD: Often we hear that pent up demand and innovation will be the drivers that bring us out of any economic slump, but where will pent up demand or innovation come from?
RHF: From everywhere, in fact, there is a lot of work to be done, climate change being taken seriously means you have to seriously tax carbon, if you have to pay to put carbon in the air then you have a lot of work to do! Engineering jobs need to be re-thought, business and individuals will have to change the way things are done and that will result in productivity.
KD: Is there enough political economy in place to solve this? Clearly many of the tasks will be unpalatable to the public?
RHF: With huge deficits there will be a need for coming up with more tax revenue, the most palatable is to tax activities that cause harm, carbon in the air is one of them. Congestion charges in cities are a good idea, cell phones when driving, even people who honk their horn when driving. It helps to make sure that those that can pay do pay, you have to watch out because if you do (for instance) congestion charges, the instant reaction is that the poor can’t afford to pay so its unfair, this is a very powerful tool that opponents will use, to make it work you have to indemnify them to a degree, so you could give out a few congestion vouchers a year which most of them wouldn’t use anyway, and maybe they can sell them on Ebay or give them to friends, but it is a hurdle that can be passed with the right approach from the outset.
KD: What about special interest groups, will they have undue leverage in the process?
RHF: Special interest is a huge problem in the USA, much more so than in Europe, campaign contributions are a big part of the process in the USA, the politicians can truthfully say that if they don’t back donors they don’t get re-elected, Obama was less dependent on big donors, he did it via smaller individual donors but that doesn’t make him immune from lobbying and special interest.
You can’t take the politics out of taxation because it was that which lead to the American revolution, you have to have an ongoing dialogue, most of Europe has a more sensible tax policy than the USA, in the USA the standard response is with any tax ‘The Govt. are evil etc. etc.’
KD: Is entitlement an issue? What about the new Healthcare Bill?
RHF: It is hard to provide more service but without the tax it to do it, people have a magical view that you can get things for free, its a bigger struggle in the USA, whatever comes out of the bill I can say this: it won’t be the bill he would have wanted.
KD: Where has a good system?
RHF: The Canadians have a good system, the waiting times are longer but basically you go to your own doctor, the doctor is private and the state pays the bill, no insurance companies etc. no bureaucracy, it has some downsides but the red tape is eliminated for the most part.
KD: Would a flat tax which is in an account owned by the individual work in the US? For instance, 10% tax and 6% goes towards an unemployment/retirement/health-care account? Perhaps something like the Singaporean model?
RHF: I’m not familiar with the Singaporean model but I’ll be lecturing there in September so I better read up on it!
KD: What are your feelings on inflations targets v.s. price targets?
RHF: Ben Bernanke said that inflation targeting should be the key and not price targeting, but it isn’t a line of thinking I follow closely.
KD: What is ben bernanke like?
RHF: On a personal level, he’s a regular guy, when we worked together he was very active in Princeton, and somehow lots of academics all loved him, normally when you get enough academics together they tend to trash eachother, but not Bernanke, he was the kind of guy who was very unassuming and would sit happily in a room without domineering the situation even though he was the smartest guy in the room and everybody there knew it too.
KD: You talk about taxing harmful activities, how does that fit with American ideals?
RHF: Americans are fairly libertarian, if you can make it more expensive to do things that harm others rather than prohibiting them it is probably the best solution.
KD: In my opinion prohibition clearly doesn’t work: crime and drugs are totally linked, the illegality creates the criminal, what do you think of that?
RHF: I think there are subtle lines in that argument, with marijuana legalisation would probably be good, with heroin it might be worse. Cocaine used to be legal, it was widely used and only a very small subset were very vulnerable, but ask yourself this: ‘imagine you had a child who might take a drug if it were legal’ and then decide if you think legalisation is palatable.
KD: That’s a rhetorical question! … Back to your book, for people who may not be into economics but who have an active interest in it,how do you become an economic naturalist?
RHF: Learn a few simple principles, the best way to do that is to see them work in a context you recognise, see how simple principles make patterns of behaviour seem clear to you, seeing those described and applied in that way is a good way to get started, the real way to learn is to do it yourself.
KD: Any suggested reading?
RHF: Tim Hartfords books are goods, Tyler Cowen’s work is really interesting, Stephen Levitts book ‘freakonomics’ is well worth reading too.
KD: If i said you have two years to turn around the economy or you’ll be shot, what would you do? What policies would you introduce to save your life?
RHF: I would announce that once unemployment goes back to 5.5% (or suitable target) that there is a phase in of progressive consumption tax, the people at the top would see that coming and they would say ‘we better buy things now’ and that would drive up demand fast, quick inflation. once it comes in it shifts away from consumption towards investment, and more on investment increases supply and is anti-inflationary.
This would be via a consumption tax: the way the tax would work is that you report your income then your savings then what’s left is your consumption, and different bands attract different amounts. There is a consumption tax already but the amount you can deduct is limited, you have tax free retirement options and that amount is fairly low (401k’s/IRA’s etc.) high income normally save way more so you allow them to do that and increase investment.
KD: Would this not result in a wave of frugality that would collapse demand?
RHF: The idea is that they would get frugal! It doesn’t serve society to build bigger mansions, will it affect utility? Not in the long run since it would phase in gradually, then consumption as a share of income would go down, but greater investment means greater capacity so in the ‘new’ long run more goes on investment than consumption but more absolute consumption than before.
KD: Why haven’t we done this already?
RHF: They tried in 1995 but it was shot down. Other issues crowded it out, Milton Friedman wrote to me in 1977 saying that it was a good idea – he had read a paper I did on it, he enclosed a copy of an article he had written in 1943 with the same idea, but he had put it forward as a way of paying for the war effort. So if I had one lever that would be it.
KD: OMFG! You knew Milton Friedman?
RHF: Yes, not too well, but yeah, we knew eachother.
KD: Has anybody thought about bringing this idea any further?
RHF: The Secretary of state of Vermont wanted to know if they could do it at the state level, but otherwise it hasn’t gained traction, until we start to re-think the way that we do things then the good ideas suffer along with the bad.