Krugman Wrong About Cause of Growing Deficits

Paul Krugman asks why deficits have grown. He gives the impression that the explosion in the deficit is due to tax revenue being too low, rather than spending being too high.

I have re-created the graph on his homepage using BEA data. From 2008 we observe tax revenue plummet, whereas spending just seems to continue its “natural” historical trend.


Looks pretty convincing, right? But we hopefully have the dear-bought wisdom at this point not to trust data from this particular source.

In fact, lower tax revenue - because of the recession, not because tax rates are lower - explain only one third of the increase in the deficit. Two thirds of the increase in the deficit is due to more spending. I will try to convince you of that in a moment.

First, let’s understand how Krugman's trick works.

Most importantly, notice that the graph is in nominal dollars. Krugman neglects to adjust for the overall size of the economy.

Here is the same exact graph, in terms of % of GDP, not cutoff to make small changes look bigger, and starting at the year 2000 rather than 2005 (which obscures longer trends).


Notice that the “natural” increase in spending isn’t there anymore. Between 2000 and the period of the crisis in late 2007, spending is essentially flat, while revenue decreases (thanks to the IT-bubble bursting and the Bush tax cuts). Between late 2007 and now however, spending rises sharply as a share of GDP.

This brings us to the most subtle trick Krugman uses. Go back to the original picture. Notice that during the crisis, tax revenue in nominal dollars drop, whereas spending just continued its path.

But wait a second. During the crisis, the American economy was shrinking rapidly. This helps explains why tax revenue dropped. Yet, government spending continued to increase at the same rate it did before the crisis! This political choice to continue expanding the government despite a shrinking economic base is what explains the lion share of the increase in the deficit.

Now it’s one thing to agree with this policy. I certainly believe the government should spend more during recessions. It is something quite different to – once you discover that the deficit spending policy you were the main cheerleader for was not popular – trying to trick people into believing it just never happened.

Here is the exact same graph Krugman used, with the same period, and the only difference that I plot Revenue and Spending as a share of GDP, rather than in nominal dollars.

I have plotted what would happen if the U.S. would be spending at late 2007 rates, as a share of GDP. The difference constitutes the share of the deficit due to increase in spending (red) and due to less revenue (blue). Remember that there was a deficit already there in 2007, which is not counted as an increase.


It is hopefully clear from the picture that Krugman is trying to hide why the U.S has such a big deficit: Mostly due to more spending. Particularly compare the size of the red and the blue line I added at the end.

Let me also give you the figures so you don’t have to trust a picture.

In the third quarter of 2007, according to the Bureau of Economic Analysis seasonally adjusted figures as a share of GDP spending was 31.4%, Revenue 29.6%, and the deficit 2.2%.

In the second quarter of 2010, the latest they report data for, spending was 36.1%, Revenue 27.0%, and the deficit 9.2%.

So the deficit grew by 7.0%, out of 4.7% was increase in spending and 2.7% a decline in Revenue.

So simple arithmetic tells us that 67% of the increase in the deficit as share of GDP between late 2007 and mid 2010 was due to spending going up.

Second generation Immigrants in Europe are de-assimilating

An important policy question about immigration is to what extent the children of immigrants assimilate. Not only does this tell us a lot about the forces at play, but because of the numbers second generation immigrant outcomes help determine our future.

I just read an important new paper about immigration and assimilation in Europe, that (if the information in it is correct) contains surprising results. The paper includes data on employment rate of first and second generation non-European immigrants in the 3 major European countries of France, Germany and U.K (the 4th largest European country - Italy - has few non-European immigrants).

Looking carefully at the data in some of the tables, we can see that non-European immigrants in Europe are de-assimilating, with the second generation doing worse than the parents.

I focus on the share of immigrants that work compared to the natives, and only on non-European immigrants (we all know that European immigrants usually assimilate).

First the data confirms that both first generation and second generation immigrants in all 3 countries work much less than natives, both for men and women.

For women, the second generation is slowly assimilating. Whereas the first generation works 35% less than natives, the second generation works 27% less than natives, an improvement of 8 percentage points. (the figures are the non-weighted, arithmetic mean of the 3 countries, below I have put data in each one).

For men however the trend is the opposite. The second generation non-European immigrants are less likely to work than the previous generation! While the first generation work 10% less than natives, the second generation works 24% less, a deterioration of 14 percentage points.

So things are getting worse in the 3 largest European countries, not better. (The paper had no data on second generation immigrants to Sweden, but I am pretty sure they do better than the first generation).

Why is this happening? One reason may be that the first generation contains people who moved to Europe in order to work. Because they were selected on this trait, they have above average work ethic for their group. The second generation only has some of this advantage left.

Perhaps these are not actually parent-children pairs, and the only cause of the results is that the composition of first generation immigrants changed for the better before they had time to have children (I doubt this).

Another, more troubling possibility is that the second generation are assimilating into a completely new culture. This is not the standard, successful western-European culture, but a new kind of mixed ghetto culture that emphasizes grievances, hostility to the host society, weak norms and a lack of a work ethic.

What the trends suggests is happening that for men, the immigrant culture that has emerged in Europe is worse even than the culture they brought with them from Turkey, Algeria etc. Women instead are less oppressed, and work more than their mothers.


Appendix

Comparing Second generation male immigrant relative employment rates with the first generation immigrants:

UK -10%
France -13%
Germany -19%

Comparing Second generation female immigrant relative employment rates with the first generation immigrants:

UK +15%
France +8%
Germany +2%

Employment rates (the figure in the parenthesis compared immigrants to the native born):

U.K

Native Men: 79.0%
First generation non-European immigrant Men: 67.8% (-14%)
Second generation non-European immigrant Men: 60.0% (-24%)

Native women: 66.5%
First generation non-European immigrant Women: 43.3% (-35%)
Second generation non-European immigrant Women: 53.5% (-20%)



France

Native Men: 66.3%
First generation non-European immigrant Men: 61.6% (-7%)
Second generation non-European immigrant Men: 53.0% (-20%)

Native Women: 58.9%
First generation non-European immigrant Women: 37.6% (-36%)
Second generation non-European immigrant Women: 42.4% (-28%)



Germany

Native Men: 75.3%
First generation non-European immigrant Men: 68.5% (-9%)
Second generation non-European immigrant Men: 53.9% (-28%)

Native women: 65.8%
First generation non-European immigrant Women: 42.5% (-35%)
Second generation non-European immigrant Women: 43.8% (-33%)

Immigration to Europe is not a human right

A democratic principle shared by most people is that sovereign countries have the right to determine their immigration policy. The elites are increasingly abandoning this position. Swedish bishop Eva Brunne in her opening of the parliament made statements that have been celebrated by the Swedish media:


"Yesterday evening thousands of people gathered in Stockholm and in various parts of the country to make their voices heard. To call out their disgust at that which divides people. The racism which says that you don’t have as much worth as I do; that you shouldn’t have the same rights as me; aren’t worthy of living in freedom, and that is the only reason – that we happen to born in different parts of our world – that is not worthy of a democracy like ours to differentiate between people."

Reading this carefully you will see that the text extolled by the Swedish elite contains a radical left agenda that denies the nation any sovereign rights. She is saying it is "racism" to tell people that they don't have the same right to live in Sweden as someone born to Swedish parents, because they "happen" to be born somewhere else.

But Sweden is the collective property of Swedish citizens, just as Brazil belongs to Brazilians, just as GM belongs to its shareholders and just as a condo-association belongs to the owners. While there are human rights that are inalienable, (such as the right to live your life in peace without oppression), there is no "right" to come live in Sweden because your own country is bad.

Intellectuals noticed that when Socialists allocated more and more "rights" to people, they were simultaneously taking the freedom away from the people who were assigned the responsibility to fulfill those rights. Positive rights such as the right to a job doesn't increase freedom, it reduces freedom because it imposes on others the obligation to create a job for you.

The "right" to immigrate to Sweden similarly forces Swedish people to give away their property right (to the collective assets of Sweden, such as its land), forces Swedes to finance the living standard of poor immigrants, up to Swedish levels, and most importantly forces Swedes to give away much of their own political power, because the immigrant is given the right to vote, with the vote carrying the power of political coercion.

The classic socialists wanted to give away private property that successful people had created to the poor in our own nations who had not managed to create wealth of their own. The modern, multi-culturalist socialists (including many who call themselves liberal, classically liberal or libertarian) demand that we give away the collective property that the west has created (wealthy, free societies with a high standard of living) to the poor in the rest of the world that have not managed to create good societies of their own.

This absurdity is what happens when you take concepts designed for one society (the "right" to freedom and a good life) and apply them to everyone everywhere.

This is why deep philosophers such as Friedrich von Hayek who thought carefully about the issue defined individual "rights" as relevant within a society, not across societies. Within a society rights, even positive rights, can be absolute (say the right not to starve), but between societies, rights are reciprocal, and we decide what right we grant others. As free people we simply do not have an obligation to, say, invade and pacify Somalia in order provide Somalians with the right to live in peace.

These "rights" that Eva Brunne so generously bestowed on the entire world dramatically reduced the rights and freedoms of Sweden.

As a side note, the example of Somalia above is not merely made in jest. George Bush's argument, for instance, was simple: If people in another country lack "freedom", then they have the right to expect that the west will fix that problem for them, either through migration or invasion.

Proving Bo Rothstein wrong: Why do Swedes trust more? Culture, not welfare state policy.

Sweden and Scandinavia have some of the highest rates of trust in the world, higher than the United States. Trust is not merely fluff to scoff at. Trust and trustworthiness are both signs of a well functioning society and important lubricants for the economy in their own right. Countries with high levels of trust tend to have higher quality of life.

Swedish political science professor Bo Rothstein is one of the people who has claimed that welfare state policies is the cause for high levels of trust in Sweden and Scandinavia. Since trust is good for the economy and society, this would, if true, indeed be a powerful argument in favor of the welfare state.

Rothstein thus writes:

"it is obvious that the countries that score highest on social trust also rank highest on economic equality, namely the Nordic countries, the Netherlands, and Canada. Secondly, these are countries have put a lot of effort in creating equality of opportunity, not least in regard to their policies for public education, health care, labor market opportunities and (more recently) gender equality."

I am going to show to you with a few data points that Bo Rothstein is most likely wrong in his explanation of the the source of Nordic trust.

This paper by other Swedish researchers provides the values for trust for 63 countries from the world value survey.

Sweden has 27% higher trust than the average for the United States. The average of the Nordic countries (Sweden, Norway, Denmark and Finland) have 21% higher trust than the United States.

So far so good for Rothstein's policy-based theory. Welfare state policies and a kind and forgiving society have made trust levels in Sweden and Scandinavia high, whereas Americans living in a brutal market economy cannot trust each other.

My standard critique of this explanation is that it ignores culture, norms and selection. Culture, broadly defined, is tremendously important, and countries with different cultures are likely to have both different outcomes and different policies, without this being an evidence that one caused the other.

So now let's look at trust levels within the U.S, using the General Social Survey (The General Social Survey has large enough sample size to make measurement of small groups meaningful). Millions of Americans are descendants of Scandinavian immigrants. They have lived in the U.S for generations, and their lives are as much influenced by the American (relatively) small government economic system as other Americans.

The results are striking. Americans of Swedish descent have 33% higher trust than average for the United States. Americans of Nordic descent have 39% higher trust than the average for the United States.

How is this possible if the explanation is:

"policies for public education, health care, labor market opportunities and (more recently) gender equality"?

If we notice that Scandinavians in welfare state Scandinavia and Scandinavians in the free-market U.S share the trait of being more trusting than other groups, the most likely explanation is to be found in cultural differences rather than economic policy.

The treatment effect of those policies is virtually identical for all Americans, regardless if their grandfather was Swedish or not. It's not like Americans from Scandinavia living in the Midwest get to enjoy lots of secret welfare state programs that Italians in New Jersey don't have access too. Same country, more or less the same policies. Yet levels of trust are very different within the U.S depending on your cultural heritage.

Once again not accounting for selection ruins the Social Democratic theory: Which states that develop a welfare state is not random. The high trust states have lower costs of doing so. And once again, I show that demography and culture can be more important explanatory variables than policy differences.

Here is a graph plotting trust in countries, with the trust level of people from that country in the U.S (remember, overwhelmingly these are recent not immigrants, but American born people who originated from these countries generations ago).

Both series normalize the average U.S trust level at 1.