Voluntary Doesn’t Work

Milton Friedman once said that “”there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” Whether this is true as a normative claim is up for debate, but it certainly is (and if you’re a stockholder, you better hope so) from a positive claim. In the long run, corporations will do (or least will try to do) what is best for its stockholders.

So what happens to companies that volunteer to reduce their carbon footprint? Some new research by Karin Thornburn of Dartmouth indicates that their stock prices go down:

Specifically, we studied the stock market’s reaction when companies joined Climate Leaders, a voluntary government-industry partnership in which firms commit to a long-term reduction of their greenhouse gas emissions. Importantly, when the firms announced to the public that they were joining Climate Leaders their stock prices dropped significantly. Controlling for general market movements, the average abnormal stock return was -0.9% over a three-day window and -1.5% over a five-day window around the announcements. For the 46 sample firms that joined Climate Leaders, the total loss in market value was $16 billion. The stock price decline was smaller for firms in carbon-intensive industries, where regulatory action is more likely (and thus partially anticipated in the stock price), and greater for high-growth firms, suggesting that the green investments crowd out growth-related capital expenditures.

Firms joining Climate Leaders conduct a careful inventory of their greenhouse gas emissions before they subsequently announce a reduction goal. The average firm in our sample set a goal to cut its total emissions of greenhouse gases by 17%. Interestingly, the stock price plummeted even further (on average -1.3%) when the greenhouse gas goal was announced, and the more aggressive the goal, the greater the price decline. The study also included 22 firms joining Ceres, a network addressing sustainability challenges whose principles are adopted by its members as an environmental mission statement. Stock returns were largely unaffected by the Ceres announcements, perhaps reflecting—in contrast with Climate Leaders—the lack of specific environmental investment commitments in Ceres. In addition, we looked at portfolios of industry competitors, but found little movement in stock prices when their rivals joined an environmental program.

Of course, we all knew that only coordinated, mandatory action could ever convince corporations to reduce their carbon footprint, but it’s nice to have some empirical data showing that voluntary action will never work.

High Taxes That People Like

Chicago recently raised its sales tax to make it the second highest in the nation.  If the Wall Street Journal editorial page was able to accurately read the temperament of most Americans, then we’d expect massive out-immigration from Chicago.  Perhaps they’d all move to Delaware, which has incredibly low state taxes.  But we don’t in WSJ editorial page world and it turns out that the states with the least “economic freedom”and the highest taxes have the highest populations.  It’s easy to see why.  First of all, there’s much less labor elasticity if you have an appealing place to live, and so people in New York City, for instance, are willing to put up with higher taxes.  The slightly more sinister way of putting this is that people are essentially locked into cities for economic opportunity, and even if Delaware has lower taxes than Philadelphia, there isn’t exactly as much opportunity there.

And while it’s unfortunate that these jobs are (according to the WSJ) going to fund patronage jobs, surely people who live and work in Chicago know that patronage and petty corruption are as much a part of the city as the Cubs.  Municipal income taxes are by their very nature  easy to drive down by a race to the bottom. Cities’ jurisdictions aren’t that large and it’s relatively easy to buy goods outside of a city.  So why exactly does the WSJ really care about how high municipal  taxes are?  It seems that by complaining about how desirable, populous places have high taxes, all they’re saying that high tax rates aren’t that bad.  After all, you can pay high taxes and live in Chicago, and Chi-town’s tight!

Democrats Manage to Be Democrats

Last night, I got really worried that Max Baucus was going to push through a stimulus bill that gave checks to high  income people (75K for individuals, 150K for families).  This would, of course, be really stupid, as rich people are unlikely to spend their stimulus checks, thus increasing the deficit without getting a bump in consumer spending.  This wouldn’t have been the first time Baucus betrayed core Democratic ideals — he voted for the Bush tax cuts and the Bankruptcy Bill.  But, luckily, Harry Reid found his spine and, according to the Politico, is “confident the caps will be there.”  So while this stimulus bill maybe ill-timed and likely ineffective, at least we won’t be sending rich people checks.

Automated Stimulus

With all this talk of economic stimulus, there seems to be a lot of agreements on the basics.  We need to stimulate demand among those of the lowest income, whose “permanent income” takes the biggest hit in an economic downturn, we need to shore up local spending which always gets slashed when the economy slows because tax revenues dry up and state and local governments can’t run deficits.  The big reason many economists who agree on these basics, like Bruce Bartlett, are skeptical or downright opposed to stimulus plans is because they see them as just another excuse for special interest handouts and, even if correctly targeted, they are still too slow  to do much.  This point is well borne out in the historical record, which generally shows that automated fiscal changes like increased welfare and unemployment outlays, and quick monetary policy changes, like slashes interest rates, are likely to provide a boost to the economy.  Discretionary fiscal policy, because of the long time it takes to get implemented and its imperfect, political formulation, is basically ineffective.

This leads many, and I’m very sympathetic to this argument, to simply abandon talk of stimulus.  And under the current political structure, they’re probably right.  But considering the wide range of agreement among economists that it’s possible for short term fiscal policy to have an effect, why not put the power for enacting those policy changes in an institution similar to the Fed?  Maybe if Congress could simply vote yes or no on implementing a narrow range of fiscal responses — like a payroll tax rebate and increased outlays to state and local government — without any room for changing the policy.  I just see no reason to be so fatalistic about this matter — if we’ve managed to wrest long-term monetary policy from the hand of politics, why not extremely short term fiscal policy as well?

Good Stimulus Commentary

Robert Reich has a good take on the entire economic mess and various plans to address it. Basically, any proposed stimulus is targeted the wrong people, is too small and will arrive too late to do much. Reich, I imagine because of his background in political science and government instead of economics, has the good sense to note that any stimulus would probably devolve into a series of special interest hand-outs for valued constituents.

Reich also cites a Merril Lynch study showing that consumer spending is expected to take a 360 billion dollar hit, meaning that the 140 billion Bush stimulus, even if it spurred consumer spending that much, wouldn’t even make much of a dent in the coming downturn.

But the real reason I like Reich’s column is his forthwright appraisal of the only real solution to our economics woes: a falling dollar and foreign investment:

As a practical matter, our only real hope for avoiding a deep recession or worse depends on loans and investments from abroad — some major U.S. financial firms have already gotten key cash infusions from foreign governments buying stakes in them — combined with export earnings as the dollar continues to weaken. But this is something no politician wants to admit, especially in an election year. So we’re going to go through weeks of posturing about stimulus packages of one sort or another, and then see enacted the big fat bonanza of a temporary tax break that will likely have little effect. That, perhaps along with a few more rate cuts by the Fed. The presidential candidates will be asked what should be done about the worsening economy, and they’ll give vague answers. None will likely admit the truth: We’re going to need the rest of the world to bail us out.

And there ain’t nothing wrong with that.

Stimuli Don’t Work

The Financial Times reports that the Congressional Budget Office has found that any tax rebate will take six months to  have any impact on consumer spending or the economy:

Peter Orszag, whose agency provides impartial fiscal and economic advice to Congress, said that it would be a “major challenge” to send out tax rebates before June as the IRS is tied up with annual tax returns. “It is remarkable the world’s leading economic power cannot get cheques out faster than that,” he told a hearing of the Senate finance committee.

He added that experience with the 2001 tax rebate suggested the full effect of the move

The consensus among policy pros and economists seems to be that, in theory a stimulus could be effective, but that any congressional, fiscal stimulus is likely to be ridden with special interest hand-outs, targeted for votes and political support and will not be big enough or quick enough.  It seems to be a flaw in our political system that the professionals can all agree on something — literally from Robert Reich to Kevin Hassett - and yet it seems inevitable that some sort of stimulus package will be approved by Congress.  I guess the risk of having a system that is even remotely democratic is that handing out free candy, so to speak, will always be a temptation.

Why Do People Get Paid So Much?

Robert Samuelson, who sells himself as an authority on financial matters, asks a pretty dimwitted question:

Just why investment bankers and traders out-earn, say, doctors or computer engineers is a question I’ve never heard convincingly answered. Are they smarter? Unlikely. Do they contribute more to the economy? Questionable. True, Wall Street often performs a vital function. It channels savings into productive investments. It helps provide access to capital and credit. In 2006, U.S. companies raised nearly $4 trillion through new stocks and bonds. Many financial innovations, including mortgage-backed securities, have benefited individuals and companies.

While it’s true that computer engineers generally earn less than a select few investment bankers and traders, there are certainly those that earn more. Sergei Brin and Larry Page of Google are two computer engineers and they are earning more than just about any investment banker or hedge-fund manager.  Why is that?  It’s because Google just so happens to be insanely profitable.  Wall Street types get high pay for similar reasons.  Samuelson mentions a crucial statistic that seems to devastate his case that Wall Street get paid too much.  A Wall Street bond trader with 15 years of experience gets paid, on average,  $1.5 million, “with $240,000 in base pay, $975,000 in cash bonus and $310,000 in long-term bonus.”  Notice that more than 80% of that total is in bonuses.  In the dry years where bond traders and their firms aren’t raking in the cash, those bonuses shrivel up, sometimes to zero.  I’m not telling you to feel sorry for the bond trader than makes a mere $285,000 a year, but they’re not exactly twiddling their thumbs.

There’s a good case to be made that making so much of the year-to-year compensation rewards short-term profit making over long term stability, but it’s hard to think of a system that would work out differently.  There is a lot of money to be made in the financial industry, and if one firm started to pay people on a less performance based metric, then other firms could easily snatch up the most talented who want to be paid on year-to-year returns.

Stimulus Chart of the Day

Bruce Bartlett has a great chart in today’s Times.

I see little reason to believe that this stimulus, unlike nearly every other one, will be properly timed so as to hit before the business cycle bottoms out.  I have more thoughts on stimuli coming sometime later, but mull over this for a while.