On the margin

Iglika reported to me that Kevin Milligan made the argument in favour of the HST that its presence was economically beneficial because it induces additional investment on the margin, as projects that previously did not meet a certain profit threshold would become real investments. This is a net gain (forget about who benefits from those investments) even if the vast majority that would have made investments anyway also benefit from the tax cut.

But when it comes to energy efficiency programs, economists (Mark Jaccard, for example) argue against subsidies for efficiency retrofits because most of the cost of these programs goes to “free riders” who would have made the investment anyway, and only some to the marginal consumer induced to make the upgrade.

I’m not sure what the answer is but seems like one cannot have it both ways. If you want gains on the margin, you must accept that there will be free riders. If you do not like free riders, then you will not pursue marginal efficiency gains.

There is a bigger issue in here, too. So much of “competitiveness” (whatever that means) policy is focused on the supply side (tax cuts, deregulation) to induce additional gains on the margin (forget that investments made under a high degree of uncertainty, and other factors like environmental problems). But are not these microeconomic gains on the margin almost always swamped by macro forces, and in fact, investment is more determined by demand conditions, anyway. That is the one robust conclusion of a review of econometric analyses from the IMF I read a few years ago.

That is, if the economy is booming and demand is strong, business will invest even in the face of tax and regulatory hurdles. But eliminate those taxes and regulations in the midst of a recession, and they will have no meaningful effect because business won’t invest anyway due to weak demand. This is basic stuff, for anyone who’s thought about Keynes I know. But it is a big reason why most economists, business commentators and politicians that focus on supply side gains and neglect demand conditions get it wrong.

3 comments

  • Nice Post

    Both investment and profits are pro-cyclical with normal output levels (demand) putting in the floor. Anybody who can use a basic spread sheet package to plot time series data can see this without running a regression analysis. The US manufacturing sector invested at +/- 4 % of output from 70-00 regardless of volatile (but increasing since the 80s) profit rates.

    I think the marginal issue might be more powerfully put in terms of location decisions but then, as you say, there is the free rider problem. That leaves direct locational subsidies which I suspect the boyz would hate even more although on inconsistent grounds. Ideology will do that to you.

  • For the “commentators”, when the conclusion (increasing income shares at the top end of the income ladder) is decided in advance, the test of the argument is not whether it gets it right or “gets it wrong” ~ the test of the argument is whether it is sufficiently persuasive in context to advance the objective.

    Surely the ideal is an argument that is both persuasive and correct, but the priority is the former.

    For the economists, this is rather a selection issue. If you step back and look at which social scientists are privileged with getting their advice most widely repeated, it is those working under a radically incomplete analytical framework that biases them to arrive at conclusions convenient to the above ~ the economic mainstream.

    Indeed, we have just gone through a test of whether the appeal of the advice of mainstream economists was the strength of the argument or the convenience of the conclusions ~ if it was the former, those who saw no major crisis looming would have suffered a dramatic drop in access relative to those who did.

  • As Tom Palley once remarked for insiders, it takes a lot of Harberger’s Triangles to fill an Okun Gap.

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