That Paul Krugman is an excellent economist goes without saying, but that’s not to insist that he’s perfect. How he is as a political columnist is another matter, of course — “excessively partisan” is perhaps not too strong a phrase to describe him in that respect. The new tax plan is just one example of his imperfections, though there’s no shame in this — as is said, even Homer nods.
In a recent piece on the Republican tax debate, Krugman got not only the size of an economic effect wrong, but the direction too. This is about that corporate tax cut and how it will increase wages, which it will – the argument among economists is not whether it will, but by how much it will.
Anyone arguing that companies themselves pay taxes is wrong: The effect is always split, in some manner, between stockholders and workers in the economy. This just isn’t something that’s an issue, this is known hard fact. The only arguments – well, among economists that is, leave the politicians and agitators aside – is how much do the workers pay the corporate tax bill, and thus how much will wages rise if the taxation falls?
Krugman is arguing that the wages won’t rise very much. But in one part of his analysis, he’s got the direction wrong. He writes, “First, a lot of the profits we tax are rents on monopoly, brand identity, etc., and won’t be competed away by capital inflows.”
No, that’s the wrong way around. As David Henderson says, competition is a hardy weed, the effects are rather strong. Or, we can look to more formal analysis, like this from the U.K. Treasury. Trade and the competition from it have two effects.
The first is the obvious one. Consumers get the cheap stuff that foreigners make, saving us money, and ain’t that great. But it’s the second effect which is more important. It’s really only the top 10 percent of companies in any economy who try to export – it’s easy enough to find mediocrity anywhere. Imports are, therefore, usually only those things produced by the top 10 percent of the rest of the world economy. The effect of this is to increase competition to our domestic producers.
This is what the protectionists complain about of course, that those more efficient foreigners are killing American businesses. But that’s kind of the point: That very competition to survive means that the other 90 percent of American businesses have to become more efficient in order to survive, making us all richer again in the process.
The same is entirely and absolutely true of foreign investment into our economy. As Henderson says, foreigners (of whom I am one) are going to invest where there are great big juicy profits to be had (and yes, we foreigners do think this way). Where are those great big profits? In exactly those monopolies and economic rents that Krugman is talking about. In fact, in the jargon, we often call what he is talking about “excess profits” and yes, excess here is a synonym for large.
That is, it is exactly those monopoly and excess profits, those rents, which foreign investment will aid in competing away. Because super-high profits are what us foreigners will be chasing.
Chair of the Council of Economic Advisers Kevin Hassett is insisting that the rise in wages will be, to borrow a phrase, winning bigly, and he may or may not be right in the details. Economists generally agree there will be some wage rise from a fall in corporate taxation, it’s only how much which is up for debate. But this specific argument, that much profit is from monopoly or other rents therefore they won’t be affected by foreign capital, is entirely wrong. Those are exactly the high profits that the foreigners will be targeting, because they’re nice and juicily high. The effect identified to reduce the wage rise is thus, in fact, the effect which will increase wages further.
Tim Worstall (@worstall) is a contributor to the Washington Examiner’s Beltway Confidential blog. He is a senior fellow at the Adam Smith Institute.
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