Monthly Archives: May 2024

AGIs, Human Labor, and the Reciprocal Nature of Comparative Advantages

28 Tuesday May 2024

Posted by in Artificial Intelligence, Labor Markets

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You might know someone so smart and multi-talented that they are objectively better at everything than you. Let’s call him Harvey Specter. Harvey’s prospects on the labor market are very good. Economists would say he has an absolute advantage over you in every single pursuit! What a bummer! But obviously that doesn’t mean Harvey can or should do everything, while you do nothing.

Fears of Human Obsolescence

That’s the very situation many think awaits workers with the advent of artificial general intelligence (AGI), and especially with the marriage of AGI and advanced robotics (also see here). Any job a human can do, AGI or AGI robots of various kinds will be able to do better, faster, and in far greater quantity. The humanoid AGI robots will be like your talented acquaintance Harvey, but exponentiated. They won’t need much “sleep” or downtime, and treating wear and tear on their “health” will be a simple matter of replacing components. AGI and its robotic manifestations will have an absolute advantage in every possible endeavor.

But even with the existence of super-human AGI robots, I claim that work will be available to you if you want or need it. You won’t face the same set of pre-AGI opportunities, but there will be many opportunities for humans nonetheless. How can that be if AGI robots can do everything better? Won’t they be equipped to meet all of our material needs and wants?

Specter of the Super Productive

Let’s return to the example of you and Harvey, your uber-talented acquaintance. You’ll each have an area of specialization, but on what basis? Harvey has his pick of very lucrative and stimulating opportunities. You, however, are limited to a less dazzling array of prospects. There might be some overlap, and hard work or luck can make up for large differences, but chances are you’ll specialize in something that requires less talent than Harvey. You might wind up in the same profession, but Harvey will be a star.

Where will you end up? The answer is you and Harvey will find your respective areas of specialization based on comparative advantages, not absolute advantages. Relative opportunity cost is the key here, or its inverse: how much do you expect to gain from a certain area of specialization relative to the rewards you must forego.

For example, Harvey doesn’t sacrifice much by shunning less challenging areas of specialization. That is, he faces a low opportunity cost, while his chosen area offers great rewards for his talent.

You, on the other hand, might not have much to gain in Harvey’s line of work, if you can get it. You might be a flop if you do! Realistically, you forego very little if you instead pursue more achievable success in a less daunting area. You’ll be better off choosing an option for which your relative gains are highest, or said differently, where your relative opportunity cost is low.

A Quick Illustration

If you’re unwilling to slog through a simple numerical example, skip this section and the graph below. The graph was produced the old fashioned way: by a human being with a pencil, paper, ruler, and smart phone camera.

Here goes: Harvey can produce up to 100 units of X per period or 100 units of Y, or some linear combination of the two. Harvey’s opportunity costs are constant along this tradeoff between X and Y because it’s a straight line. It costs him one unit of Y output to produce every additional unit of X, and vice versa.

You, on the other hand, cannot produce X or Y as well as Harvey in an absolute sense. At most, you can produce up to 50 units of X per period, 20 units of Y, or some combination of the two along your own constant cost (straight line) tradeoff. You sacrifice 5/2 = 2.5 units of X to produce each unit of Y, so Harvey has the lower opportunity cost and a comparative advantage for Y. But it only costs you 2/5 = 0.4 units of Y to produce each additional unit of X, so you have a comparative advantage over Harvey in X production.

Reciprocal Advantages

In the end, you and Harvey specialize in the respective areas for which each has their lowest relative opportunity cost and a comparative advantage. If he has a comparative advantage in one area of production, and unless your respective tradeoffs have identical slopes (unlikely), the reciprocal nature of opportunity costs dictates that you have a comparative advantage in the other area of production.

Obviously, Harvey’s formidable absolute advantage over you in everything doesn’t impinge on these choices. In the real world, of course, comparative advantages play out across many dimensions of output, but the principle is the same. And once we specialize, we can trade with one another to mutual advantage.

No Such Thing As a Free AGI Robot

That brings us back to AGI and AGI robots. Like Harvey, they might well have an absolute advantage in every area of specialization, or they can learn quickly to achieve such an advantage, but that doesn’t mean they should do everything!

Just as in times preceding earlier technological breakthroughs, we cannot even imagine the types of jobs that will dominate the human and AGI work forces in the future. We already see complementarity between humans and AGI in many applications. AGI makes those workers much more productive, which leads to higher wages.

However, substitution of AGIs for human labor is a dominant theme of the many AGI “harm” narratives. In fact, substitution is already a reality in many occupations, like coding, and substitution is likely to broaden and intensify as the marriage of AGI and robotics gains speed. But that will occur only in industries for which the relative opportunity costs of AGIs, including all of the ancillary resources needed to produce them, are favorable. Among other things, AGI will require a gigantic expansion in energy production and infrastructure, which necessitates a massive exploitation of resources. Relative opportunity costs in the use of these resources will not always favor the dominance of AGIs in production. Like Harvey, AGIs and their ancillary resources cannot do everything because they cannot have comparative advantages without reciprocal comparative disadvantages.

Super-Abundance vs. Scarcity

Some might insist that AGIs will lead to such great prosperity that humans will no longer need to work. All of our material wants will be met in a new age of super-abundance. Despite the foregoing, that might suggest to some that AGIs will do everything! But here I make another claim: our future demands on resources will not be satisfied by whatever abundance AGIs make possible. We will still want to do more, whether we choose to construct fusion reactors, megastructures in space (like Dyson spheres or ring worlds), terraform Mars, undertake interstellar travel, perfect asteroid defense, battle disease, extend longevity, or improve our lives in ways now imagined or unimagined.

As a result, scarcity will remain a major force. To that extent, resources will have competing uses, they will face opportunity costs, and they will have comparative advantages vis a vis alternative uses to which they can be put. Scarcity is a reality that governs opportunity costs, and that means humans will always have roles to play in production.

Concluding Remarks

I wrote about human comparative advantages once before, about seven years ago. I think I was groping along the right path. The only other article I’ve seen to explicitly mention a comparative advantage of human labor vs. AGIs in the correct context is by Andrew Mayne in the most recent issue of Reason Magazine. It’s almost a passing reference, but it deserves more because it is foundational.

Harvey Specter shouldn’t occupy his scarce time performing tasks that compromise his ability to deliver his most rewarding services. Likewise, before long it will become apparent that highly productive AGI assets, and the resources required to build and operate them, should not be tied up in activities that humans can perform at lesser sacrifice. That’s a long way of saying that humans will still have productive roles to play, even when AGI achieves an absolute advantage in everything. Some of the roles played by humans will be complimentary to AGIs in production, but human labor will also be valuable as a substitute for AGI assets in other applications. As long as AGI assets have any comparative advantages, humans will have reciprocal comparative advantages as well.

Scarce, Costly Housing as if a Regulatory Objective

19 Sunday May 2024

Posted by in Housing Policy, Regulation

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Housing costs are taking a toll on many Americans. Home prices have risen about 47% cumulatively since 2020, while higher mortgage rates have compounded the difficulties faced by potential homebuyers. Meanwhile, rents are up about 23% over the same period. There just aren’t enough homes available, and the primary cause is an extensive set of regulatory obstacles to increasing the supply of homes.

High housing costs are often blamed on various manifestations of greed. Renters tend to resent their landlords, while those suffering from housing sticker-shock sometimes cast paranoid blame on people with second homes, investor properties, Airbnb rentals, and even residential developers, as if those seeking to build new housing are at the root of the problem.

Quite the contrary: we have an acute shortage of housing. The chart below shows how home vacancy rates have fallen to a level that can’t accommodate the normal frictions associated with housing turnover.

Doubts about this shortfall might owe to confusion over the meaning of one statistic: our high current level of housing units per capita. It does not indicate a plentiful stock of housing, as some assume. Alex Tabarrok, in commenting favorably on a lengthier post by Kevin Erdman, offers a simple example demonstrating that units per capita is not a reliable guide to the adequacy of housing supply:

“Suppose we have 100 homes and 100 families, each with 2 parents and 2 kids. Thus, there are 100 homes, 400 people and 0.25 homes per capita.  Now the kids grow up, get married, and want homes of their own but they have fewer kids of their own, none for simplicity. Imagine that supply increases substantially, say to 150 homes. The number of homes per capita goes up to 150/400 (.375), an all time high! Supply-side skeptics are right about the numbers, wrong about the meaning. The reality is that the demand for homes has increased to 200 but supply has increased to just 150 leading to soaring prices.”

Fewer kids have led to more homes per capita even as we suffer from a shortage of housing. In the long run, lower fertility might make it easier for housing supply to catch up with demand, but not if government continues to hamstring housing construction. Only new construction can rectify this shortfall.

That’s the message of Bryan Caplan’s “Build Baby, Build!”. Caplan has been a prominent advocate of eliminating obstacles to the construction of new housing. His book is rather unique in its contribution to economic literature because it tells the story of counterproductive housing policy in the form of a “graphic novel”, which is to say an elaborate comic book. Caplan appears in the book as protagonist, teacher and persistent gadfly.

Government obstructs additions to the supply of housing in a variety of ways: rent controls, zoning laws, density restrictions, height limits, environmental rules, and compliance paperwork. And very often these interventions are supported by existing occupants and even owners of existing homes as a matter of NIMBYism. Construction of new homes, the sure answer to the problem of an inadequate supply of housing, is actively resisted. These limitations have widespread implications for the health of the economy.

As Caplan points out, the scarcity and expense of housing limits mobility, so workers are often unable to exploit opportunities that require a move, particularly to areas of rapid growth. This makes it difficult for the labor market to adjust to negative shocks or long-term decline that might displace workers in specific locales. The mobility of resources is key to well-functioning economy, but our policies fail miserably on this count.

Rent control is an insidious policy option usually favored in dense urban areas by current renters as well as politicians seeking a visible and easy “fix” to rising rental rates. The problem is obvious: rent control destroys incentives to improve or even maintain properties. Depending on specific rules, it might even discourage development of new rental units. The result is a slow decay of the existing housing stock.

Zoning laws are an old tool of NIMBYism. The objective is to keep multifamily housing (or certain kinds of commercial development) safely away from single-family neighborhoods, or to prevent developments with relatively small lot sizes. There is also agricultural zoning, which can prevent new development along urban peripheries. It’s not difficult to understand how restrictive zoning causes rents and housing prices to escalate.

Similarly, density limits, height restrictions, burdensome filing requirements, and environmental rules all work to limit the supply of new homes.

As if crushing the supply side wasn’t enough, housing costs will come under pressure from the demand side as the Biden Administration pushes new home buying subsidies. They propose tax credits of $400 a month (at least while mortgage rates remain elevated) and an end to title insurance fees on government-backed mortgages. This would drive prices higher still. The Administration also threatens to prosecute landlords who “collude” in utilizing third-party algorithms for information in establishing rental rates. Finally, Biden proposes to dedicate billions to the construction of affordable housing, but the history of affordable housing initiatives and building subsidies is one of drastically inflated costs. This is unlikely to differ in that regard.

As wrongheaded as it is, the fact that the public is often favorably disposed to so much housing regulation is easy to understand. Rent controls prevent increases in rents to existing tenants, an easily “seen” benefit. The deleterious long-term consequences on the stock of housing are “unseen”, in the language of Frederic Bastiat.

As for zoning, homeowners are resistant to the construction of nearby “low-value” units for a variety of reasons, some aesthetic and some practical, like maintaining home values or preventing excessive traffic. “Keeping the riffraff out” is undoubtedly at play as well.

This resistance extends well beyond the limits of enforcing private property rights. It is pure rent seeking behavior in the public sphere for private benefit. Politicians and government officials tend to view the motives behind zoning as sensible, however, despite the long-term consequences of strict zoning for housing supply. Similarly, environmental restrictions sound well and good, but they too have their “unseen” negative consequences.

Most puzzling is the animus with which so many regard private residential developers, who generally build what people want: low-density suburban enclaves. Developers do it for profit, but this alienates voters who are ignorant of the economic role of profit. As in any other pursuit, profit creates a basic incentive for development activity, and to provide the kinds of homes and neighborhood amenities demanded by consumers, and to do so efficiently.

On the other hand, sprawling development inflicts external costs on incumbent residents due to added congestion, and developers and their home buyers benefit from the provision of roads that are free to users. The solution is to internalize the cost of building roads by pricing their use. Homebuyers would then weigh the value of buying in a particular area against the full marginal cost, including road use, while helping to defray the cost of maintenance and upgrades to roads and other infrastructure.

Our housing policies restrict the actions of landlords, developers, and ultimately consumers of housing. The misallocations of resources occur every time a tenant or homeowner feels they can’t afford to move in response to changing circumstances. Here is Veronique de Rugy, in an article inspired by Ryan Bourne’s “The War on Prices”, on the constraints imposed on individuals by one form of misguided intervention (my bracketed additions):

“Prices and wages [and housing rents] set on market dynamics reflect underlying economic realities and then send out a signal for help. Price [rent] controls only mask these realities, which inevitably worsens the economy’s ability to respond with what ordinary consumers and workers need.“

But our housing problem is not solely caused by interference with the price mechanism. Rather, excessive regulation of rents and a panoply of other details of the legal environment for housing have led to our current shortfall. The lesson is deregulate, and to let developers build (and rehabilitate) the housing that people need.

Big Spending, Explosive Debt, and the Inflation Tax

07 Tuesday May 2024

Posted by in Deficits, Fiscal policy, Inflation

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The chart above makes a convincing case that we have a spending problem at the federal level. Really, we’ve had a spending problem for a long time. But at least tax revenue today remains reasonably well-aligned with its 50-year historical average as a share of GDP. Not spending. Even larger deficits opened up during the pandemic and they haven’t returned to pre-pandemic levels.

We’ve seen Joe Biden break spending records. His initiatives, often with questionable merit, have included the $1.8 trillion American Rescue Plan and the nearly $0.8 trillion Infrastructure Investment and Jobs Act, along with several other significant spending initiatives such as the Promise to Address Comprehensive Toxics Act and the subsidy-laden CHIPS Act. Meanwhile, emergency spending has become a regular occurrence on Biden’s watch. More recently, he’s made repeated efforts to forgive massive amounts of student loans despite the Supreme Court’s clear ruling that such gifts are unconstitutional.

Indeed, while Biden keeps pretty busy spinning tales of his days driving an 18-wheeler, cannibals devouring his Uncle Bosie Finnegan, his upbringing in black churches, synagogues, or in the Puerto Rican community, he still finds time to dream up ways for the government to spend money it doesn’t have. Or his kindly puppeteers do.

Biden’s New Budget

Eric Boehm expressed wonderment at Biden’s fiscal 2025 budget not long after its release in March. He was also mystified by the gall it took to produce a “fact sheet” in which the White House congratulated itself on fiscal responsibility. That’s how this Administration characterizes deficits projected at $16 trillion over the next ten years. No joke!

Furthermore, the Administration says the record spending will be “paid for”. Well, yes, with tax increases and lots of borrowing! There are a great many fabulist claims made by the White House about the budget. This link from the Office of Management and Budget includes a handy list of propaganda sheets they’ve managed to produce on the virtues of their proposal.

The Congressional Budget Office (CBO) projects ten-year deficits under current law that are $3 trillion higher than Biden’s proposed budget. That’s the basis of the White House’s boast of fiscal restraint. But the difference is basically paid for with a couple of accounting tricks (see below). More charitably, one could say it’s paid for with higher taxes, aided by the assumption of slightly faster economic growth. The latter will be a good trick while undercutting incentives and wages with a big boost to the corporate tax rate.

The revenue projected by the While House from those taxes does not come anywhere close to eliminating the gap shown in the CBO’s chart above. Federal spending under Biden’s budget grows at about 4% annually, just a bit slower than nominal GDP. Thus, the federal share of GDP remains roughly constant and only slightly higher than the CBO’s current projection for 2034. Nevertheless, spending relative to GDP would continue at an historically high rate. Over the next decade, it would average more than 3% higher than its 50-year average. That would be about $1.3 trillion in 2034!

Meanwhile, the ratio of tax revenue to GDP under Biden’s proposal, as they project it, would average slightly higher than its 50-year average, reaching a full percentage point above by 2034 (and higher than the CBO baseline). That’s probably optimistic.

There is little real effort in this budget to reduce federal deficits, with Treasury borrowing rates now near 15-year highs. Interest expense has grown to an alarming share of spending. In fact, it’s expected to exceed spending on defense in 2024! Perhaps not coincidentally, the White House assumes a greater decline in interest rates than CBO over the next 10 years.

Treats or Tricks?

The situation is likely worse than the White House depicts, given that its budget incorporates assumptions that look generous to their claim of fiscal restraint. First, they frontload nondefense discretionary spending, allowing Biden to make extravagant promises for the near-term while pushing off steep declines in budget commitments to the out-years. The sharp reductions in this category of spending pares more than $2 trillion from the 10-year deficit. From the link above:

Biden also proposes to restore the expanded the child tax credit — for one year! How handy from a budget perspective: heroically call for an expanded credit (for a year) while avoiding, for the time being, the addition of a couple of trillion to the 10-year deficit.

Code Red

So where does this end? The ratio of federal debt to GDP will resume its ascent after a slight decline from the pandemic high. Here is the CBO’s projection:

The Biden budget shows a relatively stable debt to GDP ratio through 2034 due to the assumptions of slightly faster GDP growth, lower Treasury borrowing rates, and the aforementioned “fiscal restraint”. But don’t count on it!

The government’s growing dominance over real resources will have negative consequences for growth in the long-term. Purely as a fiscal matter, however, it must be paid for in one of three ways: revenue from explicit taxes, federal borrowing, or an implicit tax on the public more commonly known as the inflation tax. The last two are intimately related.

Bond investors always face at least a small measure of default risk even when lending to the U.S. Treasury. There is almost no chance the government would ever default outright by failing to pay interest or principal when due. However, investors hold an expectation that the value of their bonds will erode in real terms due to inflation. To compensate, they demand an “inflation premium” in the interest rate they earn on Treasury bonds. But an upside surprise to inflation would constitute a “soft default” on the real value of their bonds. This occurred during and after the pandemic, and it was triggered by a burgeoning federal deficit.

Brief Mechanics

John Cochrane has explained the mechanism by which acts of fiscal profligacy can be transmitted to the price of goods. The real value of outstanding federal debt cannot exceed the expected real value of future surpluses (a present value summed across positive and negative surpluses). If expected surpluses are reduced via some emergency or shock such that repayment in real terms is less likely, then the real value of government debt must fall. That means either interest rates or the price level must rise, or some combination of the two.

The Federal Reserve can prevent interest rates from rising (by purchasing bonds and increasing the money supply), but that leaves a higher price level as the only way the real value of debt can come into line. In other words, an unexpected increase in the path of federal deficits would be financed by money printing and an inflation tax. The incidence of this unexpected “implicit” tax falls not only to bondholders, but also on the public at large, who suffer an unexpected decline in the purchasing power of their nominal assets and incomes. This in turn tends to free-up real resources for government absorption.

Government Debt Is Risky

It appears that investors expect the future deficits now projected by the CBO (and the White House) to be paid down someday, to some extent, by future surpluses. That might seem preposterous, but markets apparently aren’t surprised by the projected deficits. After all, fiscal policy decisions can change tremendously over the course of a few years. But it still feels like excessive optimism. Whatever the case, Cochrane cautions that the next fiscal emergency, be it a new pandemic, a war, a recession, or some other crisis, is likely to create another huge expansion in debt and a substantial increase price level. Joe Biden doesn’t seem inclined to put us in a position to deal with that risk very effectively. Unfortunately, it’s not clear that Donald Trump will either. And neither seems inclined to seriously address the insolvencies of Social Security and Medicare. If unaddressed, those mandatory obligations will become real crises over the next decade.