Arguing with Zombies: Economics, Politics, and the Fight for a Better Future
Cover & Diagrams
"Zombie ideas" simply refuse to die despite mountains of evidence to disprove them. How do you fight them? Paul Krugman, Nobel Prize winner in Economic Sciences, is the best person to shoot "zombie ideas" down.
In Arguing with Zombies: Economics, Politics, and the Fight for a Better Future, Krugman comprehensively debunks the simple economics behind some of the most compelling and controversial issues of our time: universal healthcare, tax cuts, social security and social inequality, so you can understand the economic dialogue in the United States and around the globe and make better-calculated financial and ethical decisions.
Top 20 insights
- Public intellectuals must be honest about dishonesty. Many pundits just lay out evidence to confront bad-faith arguments and stop there. Krugman says that journalists must also inform the public that the arguments are made in bad faith.
- How social security works is quite simple. The government uses a payroll earnings tax to fund the safety net, just like gasoline taxes fund highway maintenance. Unlike investment account-based corporate pensions that give uncertain returns, social security offers a stable, guaranteed income for retirees.
- While many think that governments have bloated bureaucracies and the private sector delivers efficiency, the opposite is actually true for social security. Privatization would significantly increase management fees to be paid to investment companies and reduce net returns by over 25%. In contrast, the government spends less than 1% of social security revenues on overheads.
- Privatized social security would also cause widespread poverty among the elderly unless the government stepped in. In Great Britain and Chile – countries with privatized social security – the government is still forced to intervene to plug the gap.
- Unlike most other sectors, competition and choice lead to higher costs and lower quality in healthcare. Government health insurance schemes like Medicare and Medicaid are far cheaper and involve less red tape than private insurance.
- The United States, which has the highest private sector involvement in healthcare among developed nations, fares worse than other advanced countries in terms of quality, access to needed care and health outcomes. The UK, which spends only 40% of the American spend per-person, has better health outcomes. Thus, a universal health care model would save thousands of lives every year and be far cheaper.
- The Veterans Health Administration (VHA) is an excellent model for universal and integrated healthcare. As it covers every veteran, VHA doesn't employ a bloated bureaucracy to check coverage. Since it offers end-to-end medical care, it has incentives to reduce treatment costs and invest in preventive care to lower long-term costs. VHA's scale allows it to bargain for cheaper drug prices.
- Before the Affordable Care Act (ACA), healthcare in America was covered by a patchwork of government and private insurance schemes. Medicaid covered much of the underprivileged, while Medicare took care of senior citizens. Companies offered insurance to working professionals. However, many groups, like the young unemployed, were left out.
- Health economics shows that it is cheaper and more efficient for America to offer universal health coverage for all citizens. However, it would be difficult to convince nearly 150 million Americans to give up their current coverage to migrate to the new model. So the ACA decided to leave employer insurance untouched and extended coverage to the uninsured through regulation and subsidies.
- The ACA provides healthcare to tens of millions of Americans and leaves the existing system intact. It has three components. First, insurers must offer the same plans at the same cost to every citizen irrespective of medical history. Second, individuals must sign up for a minimum level of health insurance. Finally, the government offers subsidies up to 100% to reduce costs for the underprivileged.
- Contrary to dire predictions, the ACA has been a great success. Signups have exceeded expectations, and there has been a sharp reduction in the number of uninsured. The average net premium was only $82 per month in 2014 and the vast majority of Americans have expressed satisfaction with the coverage.
- The 2008 global financial crisis led to soaring government deficits. Many policymakers demanded austerity measures to balance the budget when they should have focused on unemployment instead. They warned that increased borrowing would lead to investor pullout from government bonds, while austerity measures would increase investor confidence and lead the economic recovery.
- Austerity measures lead to a sharp rise in unemployment. Proponents argued that this was due to the "skills gap." However, multiple studies found no evidence that the "skills gap" causes unemployment.
- The doctrine that tax cuts for the wealthy are the secret of prosperity refuses to go away despite solid evidence. Bill Clinton raised taxes and it resulted in a huge economic expansion while George W. Bush's tax cuts led to lackluster growth. Many polls show that American voters want the rich to pay higher taxes.
- In the 1950s, the top income bracket's tax rate was 91%, and taxes on corporate profits were much higher. One-third of American workers were union members. Contrary to the tax cut theory, this period was marked by widely shared economic growth. The median income doubled between 1947 to 1973 – something that has not happened ever since.
- The optimal tax rate depends on Diminishing Marginal Utility, the idea that a dollar is worth lesser to those with higher incomes. Tax rates must raise the maximum possible revenue and preserve the incentive to generate wealth. The optimal tax must be above 70%, according to the Nobel Prize in Economic Sciences laureate, Peter Diamond and other experts.
- Business investments are far more sensitive to market demand than tax rates. Few investments become viable because the profit tax rate drops from 35% to 21%. Corporations mostly leverage tax cuts to buy back their stock; instead, they should expand capacity and create jobs.
- Between 1947 and 1973, incomes of all groups roughly rose at the same rate. But from 1977 and 1989, a stunning 70% of the rise in family incomes went to the top 1%. Today, CEOs are paid 300 times more than ordinary workers.
- Inequality in the U.S. isn't due to education, Krugman says. The real earnings of college graduates fell 5% between 2000 and 2004. Between 1972 and 2001, incomes at the 90 percentile rose at just 1% per year while incomes at the 99 percentile rose at 87% per year. Inequality is due to the rise of oligarchy.
- Automation is not the cause of inequality either. Until the 1970s, labor productivity rise resulted in the rise of wages for most workers. But over the last 50 years, the federal minimum wage adjusted for inflation has fallen more than 30% while labor productivity has increased by 150%. The critical factor in wage stagnation is the reduction in worker bargaining power due to the decline of unions.
"Zombie ideas" are ideas that should have been killed a long time ago by compelling research that testifies against them, but live on infecting one brain after another. We deal with them every day: from the tax cut "zombie scheme" to the healthcare one. Krugman, however, shows us how to take "zombie ideas" head-on, so we don't have to put up with them anymore.
In the early 2000s, there was a significant policy debate on revamping America's social security by introducing privatization. Social security had stayed nearly unchanged over 70 years. During this time, corporate pensions shifted from a system that paid a fixed amount every month to defined contribution plans that put money into investment accounts. Many policy analysts argued for a similar approach to social security. However, the riskiness of private retirement plans meant that it became even more critical for people to have a stable, guaranteed income in case these investments went sour. First, privatization would dissipate a significant percentage of worker contributions in fees to investment companies. Second, it would leave many retirees in poverty.
The economics of social security
In an ideal world, young workers make a realistic projection of their life expectancy and invest in the right market instruments after understanding the tradeoffs. However, in the real world, many Americans save much less than required for retirement and invest poorly. It is unfair to expect everyone to be expert investors. The economy is supposed to work for people. Social security is an excellent example of what works with low operating costs and minimal bureaucracy.
The economics of social security is not too complicated: over 99% of social security's revenues go toward benefits and less than 1% for overhead. In countries with privatized systems, the fees are far higher. In Britain, alarm over large fees charged by investment companies led to government regulators imposing a "charge cap." A system with British-level management fees will reduce net returns by over a quarter while increasing risks. Worse, in countries with privatized systems like Britain and Chile, government spending is still necessary to avoid widespread poverty among the elderly.
Such reforms hurt everyone. However, the politics of privatization depend on convincing everyone that there is a social security crisis. Calling for cuts in social security has long been seen as a "badge of seriousness" among policymakers. But real seriousness is based on what works and what doesn't. Social security works well and privatized security works very poorly.
There are certain things that governments do better than the private sector. Public goods, like air traffic control and national defense, which cannot be produced without making it available for everyone, are classic examples because firms have no incentive to produce them. The government also does a better job offering pensions and state-funded health insurance. Medicare and Medicaid are substantially cheaper, more efficient and even involve less bureaucracy than private insurance.
The U.S. healthcare is unique in the extent to which it depends on private players. The country spends far more on healthcare than other countries and ranks near the bottom among industrial countries in healthcare indicators like life expectancy and infant mortality. In healthcare, competition and personal choice do lead to higher costs and lower quality. The U.S. has the most privatized healthcare system among advanced countries – the highest costs with the worst results.
Study the veterans
The success of the VHA has been one of the best-kept secrets in American policy. While the organization had a tarnished reputation in the late 80s, reforms in the mid-90s transformed the system, making it a public health delivery model. In 2005, surveys showed that customer satisfaction with the veterans' healthcare system exceeded private healthcare centers six years in a row. While delivering high-quality care, the VHA has avoided much of the enormous cost surge in U.S. medicine.
The recipe for its success is the universal and integrated healthcare system. Because it covers all veterans, VHA doesn't have to employ a vast bureaucracy to check patient coverage and demand insurance from employers. It covers end-to-end medical care and has taken the lead in innovations to reduce costs and deliver effective treatment. The VHA can bargain better and pay lower costs of drugs than other suppliers. Finally, because the VHA has a lifetime relationship with its patients, it has the incentive to invest in preventive care and effective disease management to reduce long-term costs and maximize its resources. Unlike the rest of the medical sector, it can pursue quality healthcare without viability being a threat.
Imperfect but good enough
The economics of healthcare showed that it was possible to extend Medicare-like coverage to every American, as most advanced countries do. However, the difficulty was convincing over 150 million Americans to give up their existing insurance to make the switch happen. Therefore, policymakers and politicians converged on the second-best approach that was politically feasible. They left employer insurance untouched but used regulation and subsidies to extend coverage to the uninsured.
Before the ACA, American healthcare was a quilt of different schemes with Medicare covering senior citizens and Medicaid covering many of the underprivileged. Both these were government programs that directly paid bills. Many working professionals got insurance through their employers. However, many groups, like young professionals whose jobs didn't offer insurance and who were not qualified for Medicaid, were left out. The ACA deliberately left as much of the existing healthcare system in place as possible. It was incomplete and imperfect legislation when compared to the universal healthcare model. But the act provided essential healthcare to tens of millions of Americans.
The ACA rests on three legs. First, it requires insurers to offer the same plans at the same price to everyone regardless of their medical history. However, this leads to people signing up only when they get sick. To address this, the second pillar is a mandate for individuals to sign up for a minimum level of health insurance. The final leg is subsidies that limit the cost for those with lower incomes up to a 100% subsidy for the most underprivileged. Without even one of these three pillars, the program can't work.
While many predicted disaster when the ACA was passed, none of the predictions have come true. There was a sharp reduction in the number of uninsured Americans within a year. The decline in uninsured residents has been three times higher in states that allowed Medicaid-expansion than in states that rejected it. In 2015, ACA cost 20% lesser than expected, according to the Congressional Budget Office (CBO).
After the global financial crisis of 2008, government deficits soared as revenues plunged, and spending on unemployment benefits naturally increased. This spending was a good thing because government spending would limit the damage in a vicious contraction.
Bond vigilantes and confidence fairies
However, many policymakers urged the government to balance the budget and endure "austerity." Greece's genuine budget crisis was widely used as an example, even though the situation in advanced economies didn't resemble Greece in any manner. Policymakers decided to pivot from reducing unemployment to fiscal austerity through spending cuts. This seemingly hardheaded realist argument was not based on sound economics but instead on what Krugman humorously calls the "invisible bond vigilante" and the "confidence fairy."
Bond vigilantes are investors who withdraw from government bonds because they think governments run the risk of defaulting on their dues. Every few months, policymakers claimed that any further stimulus spending would lead to investor pullout. They called for more austerity measures instead. Pundits argued that austerity would not cause stagnation as the confidence fairy would take care of everything. Austerity measures would create investor confidence leading to economic recovery. Unfortunately, buying these "fairytales" have caused much suffering to millions of Americans.
There was a significant spike in mass unemployment due to austerity measures. However, the proponents of austerity explained this away using the "skills gap" theory, saying that Americans did not have the skills required for available jobs. Multiple studies have found no evidence that inadequate worker skills cause high unemployment, but the "skills gap" zombie idea refuses to die, distracting focus from the central problem of bad fiscal policy.
Few doctrines have been so thoroughly tested and disproved as the claim that tax cuts for the wealthy are the secret of prosperity. It was tested when Bill Clinton raised taxes and presided over a substantial economic expansion and when George W. Bush's tax cuts resulted in lackluster growth followed by a collapse. Finally, when Barack Obama allowed Bush-era tax cuts to expire, the economy absorbed it quite well. Polls consistently show that voters want the rich to pay more, not fewer taxes. But all it takes is a few billionaires who are willing to spend a fraction of their wealth to foster this "zombie idea.'
Both high taxes and growth
In the 1950s, those in the top income bracket faced a marginal tax rate of 91%, and taxes on corporate profits were nearly twice as large relative to national income as in recent years. In 1960, the top 0.01% of Americans paid an effective federal tax rate of 70%. Between 1920 and 1950, the real income of the wealthiest Americans fell sharply in absolute terms. Contrary to the "zombie idea," this period was marked by spectacular economic growth that was widely shared. There was a doubling of median income between 1947 to 1973 that has not been matched to date.
The optimal tax rate
Experts like Nobel Prize in Economic Sciences Laureate Peter Diamond, in collaboration with Emmanuel Saez, have estimated the optimal tax rate to be 73%. These rates are based on Diminishing Marginal Utility, the idea that a dollar is worth less to those with very high incomes compared to those with far lower incomes. Therefore, a policy that makes the rich a bit poorer will impact very few people and will barely affect their life satisfaction. The optimal tax rate on people with very high incomes is the rate that raises the maximum possible revenue while still preserving the incentive to generate wealth.
Business decisions do not depend on tax cuts
Corporations primarily use tax cuts to buy back their stock instead of adding jobs and expanding capacity. This is because business decisions are a lot less sensitive to tax rates than what the proponents of the low tax theory claim. Business investment is instead driven by perception about the market demand. Not many potential business investments are worth doing at a 21% profit tax that was not worth doing at the previous 35% rate. A substantial portion of corporate profits represents rewards to monopoly power instead of returns on investment, making a tax cut more of a giveaway than a reason to invest.
The myth of capital flight
The idea that in a global capital market, companies flock to countries with the lowest tax rate isn't very compelling either. Companies manage their accounting in such a way that reported profits to show up in low-tax jurisdictions. This shows up in the paper as large overseas investments. The vast sums corporations have supposedly invested in Ireland have led to remarkably few jobs and little income for the Irish. Similarly, the money that moved back to the United States after the tax cut was also an accounting fiction. It hasn't resulted in increases in jobs, wages or investments.
Today, CEOs are paid nearly 300 times as much as an average worker. The shift of a growing share of income to a small elite was seen from the late 80s. Between 1947 and 1973, all groups' incomes rose roughly at the same rate – around 2.5% annually. Between 1977 and 1989, a startling 70% of the rise in family incomes went to the top 1%. This inequality meant that ordinary workers did not share America's economic progress. There was a loss of living in a shared society.
It's not education
The argument that growth in income inequality is due to education is untrue. We aren't seeing the rise of a broad class of knowledge workers. The real earnings of college graduates actually fell more than 5% between 2000 and 2004. Income and wealth are becoming concentrated in the hands of a small privileged elite. Between 1972 to 2001, the top 10 percentile incomes rose at just 1% per year. But incomes at the 99 percentile rose at 87% per year; income at the 99.99 percentile rose at a staggering 497% per year. The real problem is the rise of oligarchy in the U.S. that poses a real threat to its democratic society. It's time to come to terms with the problem to begin thinking of appropriate policy responses.
It's not values either
Among rich countries, The United States stands out as a country where wealth is most likely to be inherited. However, there is a conservative argument that this is more due to the decline of traditional family values than income inequality. But this is not true. Rising inequality has caused a decline in family values among the working class.
Entry-level wages for male high school graduates have fallen 23% since 1973. The percentage of high school graduates working in the private sector with health benefits had declined from 65% in 1980 to 29% in 2009. The United States has become a society where less-educated men had great difficulty finding jobs with fair wages and benefits. This lack of opportunities leads to these men being less likely to participate in the workforce or get married. Social changes taking place in America's working class are the result of sharply rising inequality and not its cause, Krugman says.
Automation is not stealing jobs
Many of those who advocate a universal basic income believe that jobs will become rarer as robots take over larger parts of the economy. However, technological disruption isn't new. Strip mining and mountaintop removal techniques in the '60s and 70's utterly transformed the coal industry, doubling outputs and reducing the number of jobs from 470,000 to 80,000. If the rate of technological disruption were accelerating, labor productivity would have soared. Though, labor productivity grew much faster from the 1990s to the mid-2000s than it has ever since.
Technology change is not new. What is new is that the benefits are not shared with workers. Until the 1970s, rising labor productivity resulted in rising wages for a great majority of workers. Then the connection was broken. This wage stagnation resulted from a reduction in worker bargaining power, mostly due to the decline of unions. Over 50 years, the federal minimum wage adjusted for inflation has fallen by more than 30%, even as worker productivity has risen by 150%. The discourse about automation causing inequality is just a diversion from the real causes that matter.
In a world of rising disinformation and polarization, it becomes essential for policy to be based on solid economic research and not political beliefs. As Krugman clearly shows, many issues may have counterintuitive solutions, and there is just too much at stake to risk amateurism. In other words, ignore the "zombies" and listen to the real experts.