The Economic Problem

A New Blog

2007-07-23T19:24:00.000-07:00

I've set up shop with my very own blog, Twenty-Cent Paradigms. It will be mostly macro- and international stuff. I've got a few posts up there now, and I'm hoping for a steady state rate of 2 or 3 a week once the semester starts (but we'll see how it goes...).

The Low Cost of Fighting Global Warming

2007-07-16T14:44:00.000-07:00

In an article titled "Climate Change Debate Hinges on Economics," the Washington Post's Steven Mufson reports on the costs of reducing carbon emissions:

Here's the good news about climate change: Energy and climate experts say the world already possesses the technological know-how for trimming greenhouse gas emissions enough to slow the perilous rise in the Earth's temperatures.
Here's the bad news: Because of the enormous cost of addressing global warming, the energy legislation considered by Congress so far will make barely a dent in the problem, while farther-reaching climate proposals stand a remote chance of passage.

Enormous cost?

The potential economic impact of meaningful climate legislation -- enough to reduce U.S. emissions by at least 60 percent -- is vast. Automobiles would have to get double their current miles to the gallon. Building codes would have to be tougher, requiring use of more energy-efficient materials. To stimulate and pay for new technologies, U.S. electricity bills could rise by 25 to 33 percent, some experts estimate; others say the increase could be greater.... Measures taken by the world's governments to reduce greenhouse gases could cost 1 percent of world economic output, according to a report commissioned by the British government and written last year by former World Bank chief economist Nicholas Stern. But Stern said the cost of not taking those steps would be at least five times as much, hitting the developing world hardest...

Considering what's at stake for the future of the human race (and cute polar bears, too), a 25%-33% increase in electricity bills seems a small price to pay. Sign me up! But some folks in Washington seem to think their constituents have a very narrow view of their self-interest:

"I sincerely doubt that the American people are willing to pay what this is really going to cost them," John D. Dingell (D-Mich.), chairman of the House Energy and Commerce Committee, said in a recent C-SPAN interview, adding that he intended to introduce legislation that would impose a carbon tax "just to sort of see how people really feel about this." He said his proposal would boost the gasoline tax by 50 cents a gallon and establish a "double-digit" tax on each ton of all carbon-dioxide emissions.

Carbon-tax supporter Greg Mankiw commented on Dingell's proposal. Here's the transcript of Mufson's chat with readers. If this seems a bit familiar, an article in The Economist which reached a similar conclusion was blogged here in May.

Fair Taxes?

2007-07-15T23:49:00.000-07:00

The federal tax system is a very confusing hodgepodge: the income tax has different rates for labor and capital income, and has all sorts of deductions and credits (giving tax breaks appears to be the preferred way of making social policy these days); for many people payroll taxes (social security and medicare contributions) are larger than income taxes; and corporations pay some taxes too, the burden of which ultimately falls on their owners and customers. The Congressional Budget Office (CBO) has performed a very useful service in calculating the effective tax burden faced by people at different places in the income distribution. In the NY Times, Greg Mankiw writes up the CBO's study. He writes:

The C.B.O.’s most recent calculations of federal tax rates show a highly progressive system. (The numbers are based on 2004 data, but the tax code has not changed much since then.) The poorest fifth of the population, with average annual income of $15,400, pays only 4.5 percent of its income in federal taxes. The middle fifth, with income of $56,200, pays 13.9 percent. And the top fifth, with income of $207,200, pays 25.1 percent.

He goes on to say that "Fairness is not an economic concept. If you want to talk fairness, you have to leave the department of economics and head over to philosophy." Mankiw discusses the fairness of the tax code in terms of the thinking of John Rawls and Robert Nozick, though Brad de Long argues that he mischaracterizes them.

Economist Smackdown!

2007-07-12T08:24:00.000-07:00

Harvard's Greg Mankiw comments on his "friend," Princeton's Alan Blinder (for those of you who aren't familiar with the academic world, pointing out that something is not in a refereed academic publication is actually pretty harsh, since the peer-review process of journals is how the profession validates quality).

Lifting the Resource Curse?

2007-07-12T06:07:00.000-07:00

In the NY Times, Tyler Cowen writes about the "resource curse" that afflicts many low-income countries:

It is unfortunate that economists have to debate whether natural resources are a blessing or a curse for a developing nation. Minerals, diamonds or oil may appear to represent automatic wealth but resource-rich countries usually become mired in corruption. High oil revenues, for instance, allow a government to maintain power and reward political supporters without doing much for its people. The government of Nigeria has taken in billions from high oil prices, yet the average person was probably better off 40 years ago. The easy-to-reach wealth of a resource also encourages coups, and thus political stability is problematic.

He goes on to describe a potential solution.

Laying the Groundwork for Inflation Targeting?

2007-07-10T15:39:00.000-07:00

In a speech today to an NBER conference, Ben Bernanke expressed concerned that inflation expectations are not sufficiently "anchored." From the Washington Post story by Nell Henderson:

Fed officials believe it is critical to hold down inflation expectations because of the danger that they can be self-fulfilling: if consumers expect prices to rise, they may more readily pay higher prices; if businesses expect inflation to pick up, they may be quicker to raise their own prices to cover their costs.
"Undoubtedly, the state of inflation expectations greatly influences actual inflation," Bernanke said.
Ideally, if inflation expectations are very stable, or "anchored," they won't vary with swinging oil prices, economic booms or busts, employment data or other changing aspects of a dynamic economy. Bernanke said expectations are better anchored than in the past, but not completely -- they still respond to economic news.

The chairman was careful not to make any specific suggestions, but certainly one way to "anchor" expectations would be to adopt inflation targeting. Under inflation targeting, the central bank announces a specific target level or range for inflation, and conducts monetary policy with the goal of meeting its stated target. Britain, Canada and New Zealand all use inflation targeting, and it has generally been regarded as a success. However, it might constrain the Fed's flexibility under unexpected circumstances (Greenspan's objection), and it it would seem to contradict the Fed's "dual mandate" to achieve price stability and low unemployment by giving primacy to price stability (the likely objection of Congressional Democrats).
As an academic Bernanke was an advocate of inflation targeting and his speech today might be a gentle attempt at nudging people in that direction.

Misreading Adam Smith

2007-07-06T16:37:00.000-07:00

Economists' View posted "Morality and Economics," a great commencement address by Joan Robinson from 1977. She makes the case that Adam Smith is a believer in morality after all, and those who interpret Smith an advocate of the untrammeled pursuit of self-interest are mistaken. Read the whole thing, but here's her conclusion:

I hope that the moral consciousness which has grown up in modern times in the youth of America, which has led them to protest against the unequal balance prevailing between morality and the market, will continue to prosper in this generation and that you will find that the doctrines of Adam Smith are not to be taken in the form in which your professors are explaining them to you.

An Incentive Too Far?

2007-07-05T06:33:00.000-07:00

The New York City schools are instituting a plan devised by Harvard economist Roland Fryer to pay students for getting good grades. In a NY Times op-ed, psychologist Bernard Schwartz argues that it reflects a naive view of incentives on the part of economists. He writes:

...Unfortunately, these assumptions that economists make about human motivation, though intuitive and straightforward, are false. In particular, the idea that adding motives always helps is false. There are circumstances in which adding an incentive competes with other motives and diminishes their impact. Psychologists have known this for more than 30 years.
In one experiment, nursery school children were given the opportunity to draw with special markers. After playing, some of the children were given “good player” awards and others were not. Some time later, the markers were reintroduced to the classroom. The researchers kept track of which children used the markers, and they collected the pictures that had been drawn. The youngsters given awards were less likely to draw at all, and drew worse pictures, than those who were not given the awards.
Why did this happen? Children draw because drawing is fun and because it leads to a result: a picture. The rewards of drawing are intrinsic to the activity itself. The “good player” award gives children another reason to draw: to earn a reward. And it matters — children want recognition. But the recognition undermines the fun, so that later, in the absence of a chance to earn an award, the children aren’t interested in drawing...

The Economist's Free Exchange is more sympathetic to the idea. Jared Bernstein was prompted to ponder a broader question: "Why Are Economists' Predictions So Often Wrong?" (in doing so, he takes a swipe at Mankiw, who responds).

A European Turns the Tables

2007-07-02T23:01:00.000-07:00

It has become conventional wisdom that the European economies are held back by "structural rigidities" - in particular, too much labor-market regulation - in contrast to the "flexibility" of the "dynamic" US economy. In an essay titled "Structural Rigidities in the US and Europe," Belgian economist Paul De Grauwe turns the tables, identifying "structural rigidities" in the US. In particular, the US lags Europe in social mobility, and that the US gets less output per unit of energy input.

De Grawe's piece is at VoxEU, a useful new website publishing commentary by (mostly) European economists.

But Will They Enforce It?

2007-06-29T12:39:00.000-07:00

The NY Times reports that "China Passes a Sweeping Labor Law:"

China’s legislature passed a sweeping new labor law today that strengthens protections for workers across its booming economy, rejecting pleas from foreign investors who argued that the measure would reduce China’s appeal as a low-wage, business-friendly industrial base....

Its almost as if China's legislature has been taken over by a bunch of Communists or something. Why the sudden interest looking out for the working man?

....Passage of the measure came shortly after officials and state media unearthed the widespread use of slave labor in as many as 8,000 brick kilns and small coal mines in Shanxi and Henan provinces, one of the most glaring labor scandals since China began adopting market-style economic policies a quarter century ago.
Police have freed nearly 600 workers, many of them children, held against their will in factories owned or operated by well-connected businessmen and local officials.
Abuses of migrant laborers have been endemic in boom-time China, where millions of temporary workers have faced unsafe working conditions, collusion between factory owners and local officials and unpaid wages. Party-run courts often fail to enforce their legal rights.

Whence comes the iPod

2007-06-29T08:02:00.000-07:00

In his NY Times "Economic Scene" column, Hal Varian examines where the iPod comes from. Its a good illustration of how a growing portion of world trade is in intermediate goods (e.g. the hard drive in the iPod), which is a potential problem for international economists since our traditional models are based on trade in final goods.

The Economic Role of Unions

2007-06-27T09:25:00.000-07:00

Earlier this week, Senate Republicans blocked the Employee Free Choice Act (EFCA), a bill that would enable unions to organize by having a majority of workers sign membership cards, rather than through elections. The issue prompted David Leonhardt to reconsider the role of unions in the economy in a thoughtful NY Times "Economix" column:

...Thanks to a large body of economic research, we can get a sense for how much the decline of unions has to do with these larger economic trends. Unions, the research has shown, do not do much to affect the overall performance of the economy, one way or the other. “Do unions raise or reduce productivity,” Richard B. Freeman, a Harvard economist, asked in his recent book, “America Works,” an excellent overview of the labor market. “The evidence is clear: they do not.”
But if they don’t change the size of the economic pie, they do influence how it’s divvied up. All else equal, a union worker makes about 15 percent more per hour than a nonunion worker and also gets better benefits. So while there are many reasons inequality has increased over the last three decades — like technology and global trade — the decline of unions is certainly one of them...

Leonhardt is against the EFCA itself - he writes, "I think it’s pretty clear that the bill’s opponents have the stronger argument here. In the best of worlds, secret ballots are simply fairer." The case in favor - that illegal intimidation campaigns by employers have become widespread during the election process - was made by the Washington Post's Harold Meyerson last week:

...The goal of the Employee Free Choice Act is simply to give workers the right to join unions without facing the (currently) one-in-five chance of being fired for playing an active role in a campaign to do so.

Firing employees for endeavoring to form unions has been illegal since 1935 under the National Labor Relations Act, but beginning in the 1970s, employers have preferred to violate the law -- the penalties are negligible -- rather than have their workers unionize. Today, employer violations rank somewhere between routine and de rigueur. Over half -- 51 percent -- of employers illegally threaten workers with the specter of plant closings if employees choose to unionize (1 percent actually go through with this threat, according to Cornell University professor Kate Bronfenbrenner). And even when workers vote to unionize, companies can refuse to bargain with them and can drag out the process for years -- indeed, forever...

Full disclosure: as a former union treasurer, you can guess where my sympathies lie on this one...
Here's Mankiw's take (clearly not a former union treasurer!)

Putin on the Corporate Board

2007-06-26T17:42:00.000-07:00

Washington Post columnist Sebastian Mallaby forsees "The Next Globalization Backlash":

The next globalization battle lurks over the horizon, but you can already guess its contours. It will be shaped by two revolutions in finance and business: the growth of vast government-controlled investment funds abroad and the muddled progress toward shareholder democracy in this country. Taken together, these changes will give foreign governments a say in how corporate America is run. Lou Dobbs is going to love this one...

An increase in foreign ownership of American shares is a likely consequence of the massive trade deficit with the rest of the world. We're buying goods - including defective tires, lead-contaminated toys, and shiploads of a certain gooey black liquid - and paying for them with financial assets (stocks and bonds). Or, alternatively, our trading partners are buying American financial assets and paying for them with goods. Much of this accumulation of assets is ending up in foreign government hands for two main reasons: (i) much of the global oil business is in the hands of state-owned companies and (ii) foreign central banks are piling up dollars as a consequence of intervening in foreign exchange markets to keep their currencies cheap.

Traditionally, foreign governments invest their dollars in US Treasury bonds (which helps keep US long-term interest rates low), but there is a trend towards setting up investment funds to diversify into other, higher-return assets; China's recent purchase of a stake in Blackstone, a private-equity firm, being a noted example. If foreign governments end up with significant holdings of equities (stocks), they will have a voice, as shareholders, in corporate America's decision-making. And this is where Mallaby forsees trouble:

...Chunks of corporate America could be bought by Beijing's government -- or, for that matter, by the Kremlin. Given the Chinese and Russian tendency to treat corporations as tools of government policy, you don't have to be paranoid to ask whether these would be purely commercial holdings.
But the final straw may be that even the least threatening form of investment -- the purchase of publicly traded equities -- will not escape controversy. This is because of that second upheaval: the advent in the United States of something approaching shareholder democracy. As Alan Murray writes in his new book, "Revolt in the Boardroom," companies are no longer controlled by all-powerful CEOs. Instead, chief executives increasingly live in fear of activist shareholders and directors. Bosses from Harry Stonecipher of Boeing to Carly Fiorina of Hewlett-Packard have been ejected from the corporate suite in a manner that would not have been conceivable a generation earlier.
What if the Chinese are seen to have a hand in the firing of some future Fiorina? The more shareholders exercise power, the surer the backlash against governments that buy up chunks of the stock market.

Hmmm.... maybe Vladimir Putin can do something about the obscene compensation packages our CEO's (with the help of their cronies on the corporate board) like to give themselves.

America's Productivity Edge (?)

2007-06-20T23:23:00.000-07:00

In his NY Times Economic Scene column, Austan Goolsbee discusses some research on the fascinating and important issue of productivity - that is, how much output is produced from a given quantity of inputs. The study of productivity recently has moved on from analyzing the "productivity slowdown" that began in 1973 to the "productivity miracle" of the late 1990's. The US seems to have gotten more out of the miracle than Europe. Perhaps because we're better at computers. Goolsbee writes:

The popular explanation, of course, pointed to information technology and, specifically, to the fact that the price of semiconductors began falling at an even more rapid rate than they had been, starting in the 1990s.
Rather than a traditional drop of 20 percent a year, computer prices began falling more like 30 percent a year. This may sound subtle, but it couldn’t be more dramatic. After 10 years of such declines, the 20 percent rate would have left computer prices almost four times higher than the 30 percent rate did. Low computer prices drove mass adoption of technology and, hence, the productivity miracle was born. Or so the story goes.
The only problem is, the explanation doesn’t work, according to John Van Reenen at the London School of Economics... He said that the prices of information technology fell in Europe, too. And Europeans bought information technology. But they had no productivity miracle.
To explain the experience in the United States, one would have to believe that Americans have some better way of translating the new technology into productivity than other countries. And that is precisely what Professor Van Reenen’s research suggests...

In his conclusion, Goolsbee takes a gratuitous swipe at France:

We hate experiencing major adjustments and industry transformations that force people to look for new jobs. That experience has made many skeptical about the future of the United States in the world economy. Yet the evidence seems to show that for all our dissatisfaction, we are the most flexible economy around and may be best poised to take advantage of the coming changes on a global scale precisely because we are so good at adjusting.
Perhaps the lesson from the research can be boiled down to something most Americans clearly understand: The world economy may be tough on your industry but look on the bright side: you could be French.

Dissing the French is soooo 2003. They may be "cheese eating surrender monkeys," but according to the OECD productivity database, French GDP per hour worked - that is, productivity - is slightly (1%) higher than America's. France does have lower per capita GDP, but that's because French workers work significantly less (1546 hours per year vs. 1713 in the US). Oh, and they don't have to worry about losing their health insurance.

Meta-Sillynomics

2007-06-20T21:05:00.000-07:00

George Mason's Bryan Caplan, guest blogging for the Economist's Free Exchange, explains the boom in "fun" economics books:

It’s Econ 101 – if you earn enormous profits selling a unique product, you won’t be unique for long. As soon the competition smells money in the air, they’ll be hard at work trying to catch the bandwagon. Case in point: Two years after Freakonomics proved that writing about economics in an engaging way could make you rich, the market for fun books about economics is filling up.

Caplan has some more recomendations. Personally, I prefer The General Theory.

Mind the Stature Gap

2007-06-15T18:02:00.000-07:00

Paul Krugman just flew in from Europe - and, boy, are his arms tired. While there, he noticed that everyone was taller then him. In his NY Times column today, he wrote about the disparity between the US and Europe in average height:

The data show that Americans, who in the words of a recent paper by the economic historian John Komlos and Benjamin Lauderdale in Social Science Quarterly, were “tallest in the world between colonial times and the middle of the 20th century,” have now “become shorter (and fatter) than Western and Northern Europeans. In fact, the U.S. population is currently at the bottom end of the height distribution in advanced industrial countries.”
This is not a trivial matter. As the paper says, “height is indicative of how well the human organism thrives in its socioeconomic environment.” There’s a whole discipline of “anthropometric history” that uses evidence on heights to assess changes in social conditions...
There is normally a strong association between per capita income and a country’s average height. By that standard, Americans should be taller than Europeans: U.S. per capita G.D.P. is higher than that of any other major economy. But since the middle of the 20th century, something has caused Americans to grow richer without growing significantly taller.

If nothing else, this is a good reminder of how flawed per capita GDP is an indicator of well-being. If you don't have access to the full column through TimesSelect, you can find a more extensive excerpt at Economist's View.

Pitfalls of Privatization

2007-06-13T08:03:00.000-07:00

College loans may be another example of an area where the government does a better job than the private sector, according to this NY Times op-ed by Madeline Kunin, former Vermont Governor and Deputy Secretary of Education.

Migration and Development

2007-06-11T22:07:00.000-07:00

The NY Times Magazine has a feature on Lant Pritchett, an economist working on development. Pritchett has an unconventional approach to global poverty - and one that seems politically far-fetched at the moment - he believes that rich countries should take a much larger number of guest workers from poor countries.

The rich world has lots of well-paying jobs and an aging population that cannot fill them. The poor world has desperate workers. But while goods and capital can easily cross borders, modern labor cannot. This strikes Pritchett as bad economics and worse social justice. He likens the limits on labor mobility to “apartheid on a global scale.” Think Desmond Tutu with equations.

The whole article is worth reading, but here are a couple of amusing tidbits:

Pritchett’s Harvard students rallied against all kinds of evils, he writes, but “I never heard the chants, ‘Hey, ho, restrictions on labor mobility have to go.’ ”
But the greatest risk posed by the Pritchett plan is cultural conflict, or even conflagration, which Pritchett greets with a shrug. “I don’t think about it a lot because I’m an economist,” he says.

Exploding Toasters and Mortgages

2007-06-11T21:30:00.000-07:00

In an article entitled "Unsafe at Any Rate," Elizabeth Warren suggests that financial products should be regulated in a similar manner to consumer products. She writes:

It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street–and the mortgage won’t even carry a disclosure of that fact to the homeowner. Similarly, it’s impossible to change the price on a toaster once it has been purchased. But long after the papers have been signed, it is possible to triple the price of the credit used to finance the purchase of that appliance, even if the customer meets all the credit terms, in full and on time. Why are consumers safe when they purchase tangible consumer products with cash, but when they sign up for routine financial products like mortgages and credit cards they are left at the mercy of their creditors?
...Consumers can enter the market to buy physical products confident that they won’t be tricked into buying exploding toasters and other unreasonably dangerous products. They can concentrate their shopping efforts in other directions, helping to drive a competitive market that keeps costs low and encourages innovation in convenience, durability, and style. Consumers entering the market to buy financial products should enjoy the same protection. Just as the Consumer Product Safety Commission (CPSC) protects buyers of goods and supports a competitive market, we need the same for consumers of financial products – a new regulatory regime, and even a new regulatory body, to protect consumers who use credit cards, home mortgages, car loans, and a host of other products. The time has come to put scaremongering to rest and to recognize that regulation can often support and advance efficient and more dynamic markets.

But doesn't regulation interfere with an efficient market outcome? Only when there are no externalities, perfect competition and perfect information. In this particular case, the relevant market failure is imperfect information. As Warren discusses, the "disclosure" associated with financial products is deliberately obfuscatory and makes it very costly for consumers (even those of us with PhDs in Economics) to fully learn what they are getting themselves into.

Warren's article came to my attention due to Gretchen Morgenson's NY Times column (only free for TimesSelect subscribers), on the issue of "exploding mortgages":

Anyone who believes that the worst is over in the subprime mortgage fiasco need merely wait awhile. A tsunami of interest rate increases on these loans is headed your way.

Adjustable-rate mortgages, with interest rates that recalibrate according to market fluctuations, have been among the more questionable “innovations” sweeping through the staid world of home lending in recent years. Especially ingenious — for lenders, at least — were so-called exploding A.R.M.’s that lured borrowers with unusually low teaser rates that then reset skyward two or three years later (typically pegged to the London Interbank Offered Rate, plus six percentage points).

During the next five years, some $1 trillion in adjustable-rate mortgages will reset. But in the here and now — from just June to October this year — more than $100 billion of that amount is scheduled to reset, and all of it is in loans that are in the riskier subprime category. Given the recent interest rate spike, many of those loans that once carried low teaser rates are on track to reset to at least 11 percent — or more than four percentage points higher than the current rate on a conventional, 30-year home loan.

Very scary indeed - even more frightening than exploding toasters!

Sympathy for the Federalists

2007-06-09T06:40:00.000-07:00

New York Times op-ed columnist David Brooks says there are four schools of thought on economic policy:

First, there are the limited government conservatives, who think taxes should be low and the state should be as small as possible. Second, there are the Hamiltonians, who believe in free market capitalism but think government should help people get the tools they need to compete in it.
Third, there are the mainstream liberals, who think government should intervene in small ways throughout the economy to soften the effects of creative destruction. Fourth, there are the populists, who believe the benefits of the global economy are going to the rich and we need to fundamentally rewrite the rules.

Brooks places himself in the "Hamiltonian" camp. What makes a Hamiltonian?

We Hamiltonians disagree with the limited government conservatives because, on its own, the market is failing to supply enough human capital... We Hamiltonians disagree with the third group, the mainstream liberals, because their programs haven’t worked out... We Hamiltonians disagree with the populists because we don’t find their storyline persuasive...
The global economy radically decreased poverty and increased living standards. It’s crazy to upend this complex system to return to some nostalgic vision of a 1950s industrial wonderland.

When it comes to what Hamiltonians are actually for, two big themes stand out. First, the overall economy has to remain dynamic... The second big theme is a human capital agenda. No one policy can increase the quality of human capital, but a lifelong portfolio of policies can make a difference.

It may help Brooks to sell his ideas - which mostly aren't bad - to associate them with a venerated founding father, but his reading of history is questionable. Hamilton advocated tariffs and government subsidies for industry. His thinking might be viewed as a precursor to the idea of "industrial policy" - active government intervention to develop certain sectors of the economy - which is pretty far out of fashion these days. One of Hamilton's arguments for industrialization in the famous "Report on Manufactures" was: "women and children are rendered more useful and the latter more early useful by manufacturing establisments than they otherwise would be."

If anyone had a "human capital agenda" among the founding fathers, it was Hamilton's rival, Thomas Jefferson, who advocated universal (for white males, anyway) public schooling in Virginia and founded the University of Virginia. Unlike Hamilton, Jefferson was also a beliver in free trade.

Brooks is not the only one experiencing Alexander Hamilton nostalgia - the recently established "Hamilton Project" is trying to develop "centrist" policy ideas. Though many of the people associated with the project are Democrats - for whom Alexander Hamilton should still be a dirty word - maybe its not surprising that they've chosen to use his name. One of the project's founders is Robert Rubin, who served in the Clinton administration after working at Goldman Sachs and is now at Citigroup. Hamilton founded a bank, and was criticized for being overly sympathetic to financial interests.

Institutions and Inequality

2007-06-07T15:18:00.000-07:00

MIT's Frank Levy and Peter Temin argue that changes in "institutions" - labor unions, social norms and government policies - play a significant role in the widening of income inequality in the US in the last 30 years. [the paper is here - you should be able to download it if you are on-campus, and read the abstract anywhere]
They construct a statistic called the "bargaining power index (BPI)": median annual compensation divided by the annualized value of output per hour. This captures the share of total output paid to the median worker - if median wages rise proportionally to output, the BPI would stay constant. The BPI began to decline in the 70's, and the decline accelerated in the 1980's.
One common story is that there is growing gap between workers with and without college degrees, which may be due to skill-biased technological change. Temin and Levy show this hypothesis is inadequate, because the BPI has declined for college-educated workers (it has declined even faster for non-college educated, hence the gap between the two groups). Interestingly, there is a considerable gender gap: the decline for female high school graduates is much less severe than for males, and the BPI is flat for female college graduates.
The postwar period was characterized by strong labor unions, high top marginal tax rates and a high minimum wage which reflected social norms that placed a high value on equality. This changed for a number of reasons in the late 1970's and 1980's - among the factors Levy and Temin cite are the cuts in marginal tax rates in the 1980's, the Volcker fed's tight money policy and less union-friendly government policies (e.g. President Reagan fired striking air traffic controllers). The tight monetary policy combined with large budget deficits led to high real interest rates and a dollar apprieciation which devastated the manufcturing sector, which was heavily unionized.
Washington Post columnist Robert Samuelson wrote about the paper. Samuelson came to some strange conclusions, as Mark Thoma explains in his post on the topic.
Separately, Brad de Long has a podcast on the rise in income inequality.

The Grey Lady Has A Deal For You

2007-06-01T10:06:00.000-07:00

Students: the NY Times now offers "TimesSelect" for free to college students.

This gets you access to some of the columns (including Krugman, Thomas Friedman, David Brooks and Nicholas Kristof) and features not available on the "free" web site, as well as archives since 1981.
Its an interesting example of how "the media" is groping to find a "business model" that works in the internet age. Very few newspapers have had much success with charging for content (the Wall St. Journal and Financial Times may be counter-examples). One can certainly see some price discrimination in the Times' strategy - as well as an attempt to shape the habits of consumers while they're young (reading the Times every day is one of the best habits I acquired in my youth).
The really good news is that the new policy applies to anyone with a ".edu" e-mail address, so us liberal college professors no longer have to pay the "tax" of $50 per year to read Paul Krugman.

No good times, no bad times,
There's no times at all,
Just The New York Times,
Sitting on the windowsill
Near the flowers.
- Paul Simon, "Overs" (1967)

S&P Really Down 17%

2007-05-31T07:55:00.000-07:00

The S&P 500 stock market index just surpassed the old record of 1526 set in March 2000, closing at 1530 on Wednesday. Of course, stock market indicies are in nominal terms, i.e. not adjusted for inflation. The consumer price index (CPI) has risen from 171 in March 2000 to 206 last month (1982-84 = 100). Therefore, the real value of the S&P 500 is about 17% lower. So, even though the price of a share of an index fund is the same as it was at the last peak, if you sell that share, you could buy about 17% less stuff with the proceeds than you could have if you'd sold it in 2000. (Incidentally, the BLS has a handy chart-making tool for the CPI and other data on its web site - click on the green dinosaurs to use it).

More on Heterodox Economics

2007-05-29T20:59:00.000-07:00

There's a good discussion at TPM Cafe of Christopher Hayes' Nation article (see previous post) on heterodox economics. Tyler Cowen defends orthodoxy (Max Sawicky notes the irony of this coming from a George Mason guy), James K. Galbraith (son of John Kenneth) makes a vigorous argument for heterodoxy, and Thomas Palley offers some philosophy and sociology of the social sciences. They promise a comment from Krugman is forthcoming.

Heterodoxy and Conventional Wisdom in Economics

2007-05-28T06:38:00.000-07:00

A fascinating article in The Nation by Christopher Hayes examines how "mainstream" (or "neoclassical") economics marginalizes challenges to our conventional wisdom:

Mafia is probably a tad hyperbolic, but there is undoubtedly something of a code of omertà within the discipline. Just ask Alan Blinder and David Card. Blinder, a renowned Princeton economist and former Clinton economic adviser, has long been a zealous advocate of trade liberalization. But this past March, the Wall Street Journal ran a front-page article on Blinder's concerns about the massive dislocations that the current trade regime and outsourcing trends might bring for American workers. He suddenly found himself under fire from fellow economists for stepping out of line. Card, a highly esteemed economist at the University of California, Berkeley, caught flak for his heresy not on trade but on the minimum wage. In 1994 he conducted a study to see whether an increase in the minimum wage in New Jersey had the negative effect on employment that basic neoclassical theory would predict. He found it didn't. In fact, his regression analysis showed that, controlling for other factors, New Jersey gained fast-food jobs after increasing its minimum wage, compared with Pennsylvania, which hadn't raised wages. The paper attracted a tremendous amount of attention and criticism, and Card himself largely abandoned working on the minimum wage. In a 2006 interview, he explained his decision to leave the topic behind this way: "I've subsequently stayed away from the minimum wage literature for a number of reasons. First, it cost me a lot of friends. People that I had known for many years, for instance, some of the ones I met at my first job at the University of Chicago, became very angry or disappointed. They thought that in publishing our work we were being traitors to the cause of economics as a whole."
As Card's and Blinder's experiences show, the "mafia" still flexes its muscles, but there are also signs that its hold on power is slipping. While the discipline remains dominated by a "neoclassical" consensus that is generally pro-market and suspicious of government intervention, an explosion of new research programs and methods have provided strong evidence that many of the pillars of that consensus rest on a foundation of sand. In fact, just before the reception, AEA president George Akerlof, a Nobel laureate as respected in the profession as they come, gave what was in many senses a radical address, attacking some of the discipline's most basic assumptions about what drives human economic behavior. (Three men standing near me in the Friedman reception had referred to it as "crap.")

Much of the article is devoted to the state of non-mainstream schools of economic thought. At a place like Miami, you may not learn much about these marginalized heterodox economists. Who are they?

...Heterodox economists... are economists who don't "think like economists." Many point out that humans aren't rational, or not nearly as rational as the theory would have them be (and, further, that in the aggregate this creates market failures). Others point out that humans are social creatures, not individual agents, and their preferences and behaviors are forged by social structures: institutions, habits, social mores and culture all mediate and drive economic behavior. Others say that price and value aren't interchangeable and that prices don't arise from the simple intersection of supply and demand curves, while some argue that unequal power between different sectors of society affects how markets operate. Dissent from the mainstream of economics is not new; indeed, it's nearly as old as the profession itself. Marx was a kind of heterodox economist, as was Thorstein Veblen.

On his blog, Dani Rodrik has (as always) a thoughtful response:

Hayes makes a number of good points about how ideology permeates a lot of thinking by orthodox economists. Anybody who strays from conventional wisdom is in danger of being ostracized. Some years ago, when I first presented an empirical paper questioning some of the conventional views on trade to a high profile economics conference, a member of the audience (a very prominent economist and a former co-author of mine) shocked me with the question "why are you doing this?"

On the other hand I have never found neoclassical methodology too constraining when it comes to thinking about the real world in novel and unconventional ways. See the Carlos Diaz-Alejandro rule here. To me it represents nothing other than a methodological predilection for deriving aggregate social phenomena from individual behavior--and as such it is a very useful discipline for any social science. You say people have some preferences, they face certain constraints, take others' actions into account, and go from there. Neoclassical economics teaches you how to think, not what to think.

I agree, though it is continually frustrating to see so many economists, and students of economics, thoughtlessly use (abuse) conclusions derived from assumptions of perfect competition and perfect information as cover for libertarian "free market" ideology. Smart economists like Rodrik recognize that we live in an imperfect competition/imperfect information world (and neoclassical tools can be useful in understanding it). Advice to students: don't leave college without reading Marx, Veblen and Galbraith (who coined the phrase "conventional wisdom").

Mankiw: Thanks, China, for the Money

2007-05-26T18:02:00.000-07:00

On his blog, Greg Mankiw offers some perspective on the US trade deficit with China:

Suppose the U.S. President were to propose the following policy: "My fellow Americans, I have just asked the Congress to increase taxes on all of us. After they pass my tax increase, I will instruct the Treasury to lend the additional tax revenue to the government of China."

Most Americans would, I suspect, be opposed to this proposal. They would see it as beneficial to China but without much benefit to the United States. With America eager to lend, China would enjoy lower interest rates. Why should Americans pay higher taxes to finance Chinese borrowing and spending?

I agree that this would be a strange and not very sensible policy for the U.S. government to pursue. But isn't it a bit odd that many Americans today are objecting to precisely the opposite of this policy. China is not borrowing from the U.S. government but is instead lending to the U.S. government by buying large quantities of Treasury bonds. The money used to buy these bonds could be returned to Chinese citizens in lower taxes. In other words, Chinese taxpayers are financing American spending and keeping our interest rates lower than they otherwise would be. And many Americans, including the President and Treasury Secretary, are complaining.

As a professor of economic principles, Mankiw understands the identity: the current account + the capital and financial account = 0, so a current account deficit implies a capital and financial account surplus (aka a "capital inflow"). The main part of the current account is net exports (exports - imports), while the capital and financial account is investment - net savings. Net savings is private savings less the part borrowed by the government (on the rare occasions when the government runs a surplus, it adds to net savings).

US: Trade deficit / Capital inflow
China: Trade surplus / Capital outflow

The essence of the US-China economic relationship is that China is sending goods to the US (we have a bilateral trade deficit), and is getting financial assets (e.g. government bonds) in return. Or, another way of saying the same thing is that China is buying American financial assets and paying for them with goods. China's purchases of assets finance investment in the US in excess of our national savings (which is low, partly due to the federal budget deficit). If we weren't able to borrow from the Chinese (and others), interest rates in the US would have to rise to equate our domestic savings with investment (i.e. increase savings and reduce investment until an equilibrium is attained). So, as Mankiw points out, arguably its the Chinese who should be unhappy with the US-China economic relationship.

The Condition of the Working Class in China

2007-05-23T18:50:00.000-07:00

On the Managing Globalization blog, Daniel Altman has a Q&A with Zhang Rongde, a migrant worker in a Chinese shoe factory. One can find some parallels between the conditions he describes and those faced by American workers as the country industrialized in the late 19th century. America responded with the reforms of the progressive era. Does China have a Robert LaFollette? And if they do, is he in jail? A good student of Marxism (i.e. not the current Chinese leadership) might think China is long overdue for a "Bourgeois revolution."

China at the Barbarians' Gate

2007-05-22T20:23:00.000-07:00

As previously noted, China recently created a fund to invest some of its $1 trillion of foreign exchange reserves. The fund's first big US purchase is a $3 billion stake in Blackstone, a private equity firm. Firms like Blackstone buy the shares (equity) of corporations thereby taking them off the public markets like the New York Stock Exchange (hence "private equity"). The companies are usually restructured - sometimes by merging them, sometimes by splitting them up, and almost always with massive layoffs - and eventually re-sold on the stock market. Often private equity transactions are financed with a large amount of debt ("leverage"), both from banks and from the "junk bond" market, which ends up on the balance sheet of the company itself (not the private equity firm).

There's recently been quite a boom in private equity (a prominent example is the recent Chrysler deal) for two main reasons: (i) low interest rates, which means that banks and investors are desperate for anything with a higher return and (ii) probably of less importance, the increased regulation and scrutiny of publicly traded companies in the wake of the corporate governance scandals (Enron, Worldcom, etc.) a few years ago has made operating privately more attractive. Oh, and maybe some "animal spirits" too.

The first big wave of what we used to call "Leveraged Buy Outs" (LBOs) back in the 1980's was famously chronicled in "Barbarians at the Gate." Supposedly the Chinese word for "foreigner" really means "barbarian"... so now the barbarians have Chinese at the gate.

Here's Daniel Altman's comment on the deal. Bloomberg's William Pesek says its a "Marriage of Two Bubbles" (if you read it you'll see that Asia's richest man has a very appropriate name, indeed).

Is "Finance" Justifiable?

2007-05-16T09:02:00.000-07:00

Capital markets - Wall Street and all that - are vital for channeling the savings of households into investment by firms, and perform an important function in allocating resources - "capital" - to the most productive uses. But does our financial system do this efficiently, or is there quite a bit of economic rent scooped up along the way (another way of asking this: are investment bankers really paid their marginal products)?
On the op-ed page of the NY Times, Michael Kinsley chronicles the 17 times Avis rent-a-car has been sold or reorganized since its founding in 1946. Makes you wonder... Kinsley writes:

Modern capitalism has two parts: there’s business, and there’s finance. Business is renting you a car at the airport. Finance is something else. More and more of the news labeled “business” these days is actually about finance, and much of it is mystifying. Even if you can understand — just barely — how it works, you still wonder what the point is and why people who do it need to get paid so much. And you strongly suspect that the swirl of financial activity around Avis for the past six decades has had little or nothing to do with the business of renting cars.

Evolution and Protectionism

2007-05-13T19:55:00.000-07:00

In the Washington Post, the Cato Institute's Paul Rubin argues that popular support for protectionism and opposition to immigration is rooted in evolutionary psychology:

Our primitive ancestors lived in a world that was essentially static; there was little societal or technological change from one generation to the next. This meant that our ancestors lived in a world that was zero sum -- if a particular gain happened to one group of humans, it came at the expense of another.
This is the world our minds evolved to understand. To this day, we often see the gain of some people and assume it has come at the expense of others. Economists have argued for more than two centuries that voluntary trade, whether domestic or international, is positive sum: it benefits both parties, or else the exchange wouldn't occur. Economists have also long argued that the economics of immigration -- immigrants coming here to exchange their labor for money that they then exchange for the products of other people's labor -- is positive sum. Yet our evolutionary intuition is that, because foreign workers gain from trade and immigrant workers gain from joining the U.S. economy, native-born workers must lose.

At the Economist's Free Exchange Blog, Will Wilkinson has some questions:

Evolutionary psychology helps illuminate why we have a tendency to in-group/out-group thinking, and why we are unlikely to grasp the nature of an ever-growing surplus from cooperation. But, as far as I can tell, it does little to help us understand why we draw the in-group/out-group boundaries where we do. Trade and immigration, as political issues, embody nationalist assumptions -- people and goods going over political boundaries. But the modern nation state is a new idea: there were no nation states in the environment of evolutionary adaptedness. And the modern nation state is vastly larger than the cooperative coalitions for which we are likely evolutionarily adapted. There is something distinctly unnatural about nation-level coalitions. The interesting question to me is how it is that we have come to see the co-members of our nation states as members of the relevant in-group. Iowans don't get testy when Minnestotans move in, but Texans get cranky about Mexicans? Why is that? People in Delaware don't fret a lot about their jobs being outsourced to South Dakota. Why not?

Have a Nominal Rigidity and a Smile

2007-05-13T10:58:00.000-07:00

Nominal rigidities (aka price stickiness) - the failure of prices to adjust immediately to economic shocks - are central to New Keynesian Macroeconomics.
Slate's "Undercover Economist," Tim Harford writes about an extreme case: a bottle of Coke cost 5 cents for over 60 years. So, next time your grandparents pine for the good old days when a Coke only cost a nickel, you can explain to them how such price stickiness may contribute to economic downturns.

44 Out of 49 Economists Agree

2007-05-13T07:35:00.000-07:00

It wasn't the tax cuts.
The NY Times' Daniel Altman surveyed economists:

The e-mail message had just one question: “Which factor was most important for the economy’s growth from mid-2003 through the end of 2006?”
....Forty-nine economists responded to my message, including many of the best-known names in the field. Of these, only five, about 10 percent, said that the tax cuts were the most important factor in the economy’s growth.
Two were Nobel laureates known for their conservative views — Robert E. Lucas Jr. of the University of Chicago and Edward C. Prescott of Arizona State University. Two other professors, Martin S. Feldstein of Harvard and Gary D. Hansen of the University of California, Los Angeles, qualified their answers by mentioning other factors.

As for the other 44, well, you've heard that if you put all the economists end to end, they would not reach a conclusion...

Fixing Global Warming: Cheap But Not Easy

2007-05-05T18:37:00.000-07:00

The Economist reports on a study by the Intergovernmental Panel on Climate Change (IPCC):

Burning fossil fuels imposes a cost to society that is not reflected in their price. Economics says that it should be; and if it were, the price of using fossil fuels would rise in relation to the price of using renewable energy...
And what is the right price? The report says that to stabilise greenhouse-gas concentrations at 550 parts per million (a level most scientists think safeish) would require a price of $20-50 per tonne of carbon by 2020-30. That is along the lines of the carbon price established the European Emissions-Trading Scheme, which varied between $6 and $40 in 2005-06. It has not bankrupted the European economy so far. The IPCC’s economic models reckon, on average, that if the world adopted such a price the global economy would be 1.3% smaller than it otherwise would have been by 2050; or, put another way, global economic growth would be 0.1% a year lower than it otherwise would have been.

So, the costs of dealing with the problem are modest, and yet action may not be forthcoming because of a global public good problem:

The world would barely notice such figures; so one might think that climate change can be easily sorted. The problem, of course, is that the numbers work only if they are applied globally. If a few countries—even a few big countries—adopt a carbon price, it will make little difference. All the world’s big emitters need to do it. Which brings the world straight back to the problem that sank Kyoto. No country alone can make a difference, and it is in every country’s interest to ensure that everybody else bears the burden. As the IPCC report convincingly argues, the technology and the economics of this problem are easily soluble. It is the politics that is so difficult.

On a related note, Lawrence Summers once famously offended many people by suggesting that rich countries should pay poor countries to take their pollution. The International Herald Tribune's Daniel Altman observed that the credit trading under the Kyoto accord has had the opposite result (see also this subsequent post). Of course, Summers, now the former president of Harvard, was just getting started.

When You Assume

2007-05-04T18:50:00.000-07:00

A great post on Dani Rodrik's blog, cautioning economists (and our students) against a reflexive belief in the benefits of trade liberalization. He usefully reminds us that our results depend on a number of assumptions, which may not always be valid. He writes:

Well I really, really did not want to do this--because it is a curmudgeonly thing to do--but having wandered (without professional license) into the politics of trade policy, I cannot avoid the economics. Especially since so many of the comments around my recent posts leave the impression that the economics of trade liberalization is cut-and-dried, with only politicians and ignoramuses standing in the way....
So here is a straightforward economics question: under what conditions will trade liberalization enhance economic performance?
If you answered "under any and all," you flunk. Here is the correct answer...

Rodrik then ennumerates nine caveats (read them!). The broader point:

The point is that unconditional supporters of free trade take a whole lot for granted. Our professional training prepares us to be analysts who can make contingent statements. Policy A is good if conditions X, Y, and Z are in place. Rule-of-thumb economists sweep all the caveats under the rug, and in the end, are not true to their training.

L'Affaire Wolfowitz

2007-05-02T07:50:00.000-07:00

World Bank President Paul Wolfowitz has been caught up in a "conflict of interest" scandal over a huge pay raise given to his girlfriend, a World Bank employee.
Last night, John ("P.C.") Hodgman explained the World Bank to Jon Stewart - here's the video from the Daily Show.
Also, Ken Rogoff imagines a secret internal memo from Wolfowitz to the World Bank staff (hat tip to Mankiw).
But, seriously, from the Washington Post, here's Sebastian Mallaby's column on the issue, and a defense of Wolfowitz from Andrew Young.

Bernanke: Risin' Up to the Challenge of Our (Trade) Rivals

2007-05-01T22:28:00.000-07:00

Ben Bernanke's latest: "Embracing the Challenge of Free Trade: Competing and Prospering in a Global Economy." The well-footnoted speech provides a good survey of some of the issues (in addition to handling monetary policy, Bernanke serves as a walking, talking version of the Journal of Economic Literature). He usefully notes some of the benefits beyond the standard "comparative advantage" gains you know (and love) from principles:

In practice, the benefits of trade flow from a number of sources. By giving domestic firms access to new markets, trade promotes efficient specialization, permits economies of scale, and increases the potential returns to innovation...

Another substantial benefit of trade is the effect it tends to have on the productivity of domestic firms and on the quality of their output. By creating a global market, trade enhances competition, which weeds out the most inefficient firms and induces others to improve their products and to produce more efficiently.

Also, the long run answer to the worry that we're "losing jobs":

If trade both destroys and creates jobs, what is its overall effect on employment? The answer is, essentially none. In the long run, the workings of a competitive labor market ensure that the number of jobs created will be commensurate with the size of the labor force and with the mix of skills that workers bring. Thus, in the long run, factors such as population growth, labor force participation rates, education and training, and labor market institutions determine the level and composition of aggregate employment.

Conspicuous by omission is another prominent trade-related worry - the (stupendously huge) trade deficit. Of course, that's the issue where Federal Reserve policy might actually matter. Bernanke did offer an interesting hypothesis a couple of years ago (before he became chairman, of course).
Although the speech was given to the Montana Economic Development Summit, Bernanke failed to note Montana's gains from its comparative advantage in dental floss ranching.
Here's Macroblog's take on the speech.
Separately, two prominent Harvard economist/bloggers, Dani Rodrik and Greg Mankiw (nothing like tenure and a low teaching load to encourage blogging!) have been having a back-and-forth on trade issues. Economist's View has a summary and links.

America's Real "Entitlement" Problem

2007-04-24T22:14:00.000-07:00

Is health care, not social security

The Social Security and Medicare Trustees have released their 2007 annual report. As the summary makes clear, the more serious long-term financial problems are in medicare (officially known as "Hospital Insurance (HI)" and "Supplementary Medical Insurance (SMI)"), not social security.

The annual cost of Social Security benefits represented 4.2 percent of Gross Domestic Product (GDP) in 2006, is projected to increase to 6.2 percent of GDP in 2030, and then rise slowly to 6.3 percent of GDP in 2081...

Medicare's financial difficulties come sooner-and are much more severe-than those confronting Social Security. While both programs face demographic challenges, the impact is greater for Medicare because health care costs increase at older ages. Moreover, underlying health care costs per enrollee are projected to rise faster than the wages per worker on which payroll taxes and Social Security benefits are based. As a result, while Medicare's annual costs were 3.1 percent of GDP in 2006... are projected to surpass Social Security expenditures in 2028 and exceed 11 percent of GDP in 2081...Part B of the Supplementary Medical Insurance (SMI) Trust Fund, which pays doctors' bills and other outpatient expenses, and Part D, which pays for access to prescription drug coverage, are both projected to remain adequately financed into the indefinite future because current law automatically provides financing each year to meet next year's expected costs. However, expected steep cost increases will result in rapidly growing general revenue financing needs-projected to rise from 1.3 percent of GDP in 2006 to 4.7 percent in 2081-as well as substantial increases over time in beneficiary premium charges.

There's a nice assesment at Kash Mansouri's Street Light Blog.

So if we really want to deal with the future cost of entitlement programs, we need to take a hard look at our health care system. Perhaps a comparative perspective might help. As the World Baseball Classic reminded us, sometimes other countries get things right, and we might actually be able to learn from them. Or at least that's the message of this fascinating article, "The Health of Nations" by Ezra Klein in The American Prospect on the health care systems of Canada, France, England, Germany and the US Veterans Administration.

More Supply Side

2007-04-15T06:55:00.000-07:00

The discussion provoked by Bruce Bartlett's opinion column on "Supply Side Economics" (see earlier post) has continued at Economists View. James Galbraith, who was on the Democratic staff of the Joint Economic Committee of Congress defends the "vulgar Keynesians":

Reaganomics was aimed at enriching the rich and destroying the economic life of working Americans and the poor. And this is no joke: it did exactly that. Recession, unemployment, the wanton and irreversible destruction of major industries and the fiscal base of the cities, the destruction of unions: all that happened. The cost of curing inflation in 1981-82 was enormous, far higher than the airy comments made above concede. We crude Keynesians believed then, and I believe now, that the steps taken were brutal and unnecessary, and that with hard policy work the problem could have been managed in ways that were far less costly, but that were rejected on ideological rather than economic grounds.

Paul Krugman, who was on the staff of the Council of Economic Advisors (yes, Paul Krugman was part of the Reagan Administration!) argues that "Keynesian" views are mis-characterized:

The key thing is that good Keynesianism, as embodied even in undergrad textbooks of the time, was *perfectly OK*: Dornbusch and Fischer, 1978 edition, offered a description of what disinflation would look like that matches the experience of the 80s reasonably well, and the textbook does not seem all that dated even now. The idea that we needed a new doctrine to get our heads straight is just all wrong.

Here's Brad de Long's take.
Separately, Greg Mankiw criticizes the Congressional Budget Office's finding that the effect of tax cuts is small.

Frank on Supply Side

2007-04-12T09:18:00.000-07:00

Bob Frank's column in todays NY Times, "In the Real-World of Work and Wages, Trickle-Down Theories Don't Hold Up," presents some evidence against 'supply-side' tax policies ("trickle down economics" being a more derisive term for the same idea):

Trickle-down theorists are quick to object that higher taxes would cause top earners to work less and take fewer risks, thereby stifling economic growth. In their familiar rhetorical flourish, they insist that a more progressive tax system would kill the geese that lay the golden eggs. On close examination, however, this claim is supported neither by economic theory nor by empirical evidence.
The surface plausibility of trickle-down theory owes much to the fact that it appears to follow from the time-honored belief that people respond to incentives. Because higher taxes on top earners reduce the reward for effort, it seems reasonable that they would induce people to work less, as trickle-down theorists claim. As every economics textbook makes clear, however, a decline in after-tax wages also exerts a second, opposing effect. By making people feel poorer, it provides them with an incentive to recoup their income loss by working harder than before. Economic theory says nothing about which of these offsetting effects may dominate.
If economic theory is unkind to trickle-down proponents, the lessons of experience are downright brutal. If lower real wages induce people to work shorter hours, then the opposite should be true when real wages increase. According to trickle-down theory, then, the cumulative effect of the last century’s sharp rise in real wages should have been a significant increase in hours worked. In fact, however, the workweek is much shorter now than in 1900.

On his blog, Greg Mankiw says "Frank Needs To Read More Widely" and presents some counter-evidence. Both agree, however, that it basically comes down to the relative strength of the income and substitution effects.

Economics Graduate School

2007-04-11T12:56:00.000-07:00

I've created an unofficial guide for folks considering graduate school in economics.

Trade Creation vs. Trade Diversion

2007-04-08T08:35:00.000-07:00

In the NY Times, Daniel Altman looks at some economic concerns raised by the new US - South Korea free trade agreement.
The economic issue: are these bilateral trade agreements (i.e. deals between just two countries) trade creating or trade diverting? If the reduction of barriers with South Korea leads us to import a good from them, rather than from a third country which is actually the low-cost producer (but doesn't have a trade deal with us), economic efficiency is actually decreased.
The political economy issue: does the increasing focus on bilateral and regional agreements reduce the effort devoted to the big multilateral deals like the Doha round of the GATT/WTO negotiations?

UPDATE: This issue is the subject of discussion in the FT's "Economists Forum," which has a panel of economists discussing Martin Wolf's columns (the column itself is subscription-only, but the discussion is free).

"Supply Side" and the Evolution (and Abuse) of Economic Ideas

2007-04-06T06:44:00.000-07:00

Though one must be wary of any claim that there is "a new consensus among economists on how to look at the national economy," (former Reagan and Bush official) Bruce Bartlett's op-ed in today's New York Times, "How Supply Side Economics Trickled Down" raises a number of interesting issues.
The basic idea of "supply side" economics is that, by altering incentives to work and save, changes in marginal tax rates will change the quantity of labor and capital supplied in the economy. This is in contrast to the traditional "Keynesian" focus on the effects on aggregate demand. Bartlett argues that supply side "has become a frequently misleading and meaningless buzzword that gets in the way of good economic policy." He continues:

But today it is common to hear tax cutters claim, implausibly, that all tax cuts raise revenue. Last year, President Bush said, “You cut taxes and the tax revenues increase.” Senator John McCain told National Review magazine last month that “tax cuts, starting with Kennedy, as we all know, increase revenues.” Last week, Steve Forbes endorsed Rudolph Giuliani for the White House, saying, “He’s seen the results of supply-side economics firsthand — higher revenues from lower taxes.”
This is a simplification of what supply-side economics was all about, and it threatens to undermine the enormous gains that have been made in economic theory and policy over the last 30 years. Perhaps the best way of preventing that from happening is to kill the phrase “supply-side economics” and give it a decent burial.

Mark Thoma has an extensive response, framed in terms of the contemporary academic debate between Real Business Cycle (RBC) models vs. New Keynesian models. RBC models are the modern incarnation of classical economics, and rely on the optimal response of utility maximising consumers and profit maximizing firms to productivity shocks - shifts of the production function - to generate economic fluctuations. Everything is driven by supply, and aggregate demand is irrelevant. In New Keynesian models, as in old Keynesian models, aggregate demand matters, though for different reasons. The New Keynesians use microeconomic frictions like menu costs and coordination failure to generate an upward sloping aggregate supply curve. Thoma writes:

Why does NK policy tend to focus on demand shocks rather than supply shocks? The answer is that although it would be ideal if we could use supply-side polices to smooth short-run fluctuations in output arising from supply shocks, the reality is that we cannot do this. As Bartlett notes, supply-side polices are very blunt, slow-acting policies that can affect output in the long-run, but they are all but useless in dealing with short-run fluctuations in the economy (thus, RBC theorists tend to focus mainly long-run growth).
Since supply cannot be managed in the short-run, that leaves demand management policies, i.e. monetary and fiscal policy. As we learned in the 1970s, demand side tools are not very effective instruments for offsetting supply-side shocks - trying to use demand side policy to offset supply shocks helped to generate the stagflation we saw at the time. We've learned since then, but practically we are still somewhat powerless to offset supply side shocks in the short-run - all we can do is manage demand to match changes in supply. That is, if a hurricane wipes out supply, we can use policy to reduce demand to match, but we can't do much to increase supply back to its initial level in the short-run.

Thoma picks up many of the important points that Bartlett seems to miss, but as Bartlett points out in his response to Thoma, RBC and New Keynesian models were developed in the 1980's, while the original debate over "supply side" started in the 197o's.
If there is any kind of "consensus" - or at least a "synthesis" - it is methodological. The work of Robert Lucas, among others, has convinced academic economists to build their macroeconomic models with more careful microeconomic foundations. Both the RBC and New Keynesian schools take utility maximization and expectations seriously.
On the specific issue of "supply side" tax cuts, if you are taking utility maximizing behavior seriously, then the effect of marginal tax rates on incentives should matter - in theory. Whether it does in practice is an empirical question that is difficult to resolve. For example, consider a cut in the marginal tax rate on labor income: whether this increases or decreases labor supply would depend on whether the income effect, which would cause people to work less (if leisure is a normal good, as your income rises you want more of it) is outweighed by the substitution effect (the opportunity cost of leisure increases). The supply-siders think the substitution effect is extremely strong. Perhaps if we follow Bartlett's wish and ditch the term "supply side" we should replace it with "substitution effect economics."
Incidentally, one of Reagan's supply side revolutionaries, David Stockman is back in the news.

Opening Day Economics

2007-04-02T20:06:00.000-07:00

On the op-ed page of the NY Times, baseball economist JC Bradbury explains "What Really Ruined Baseball." Not steroids, but expansion. According to Bradbury, hallowed records have been falling because the increase in the number of teams has diluted the talent pool. He writes:

Today, the variance in quality of major league pitchers, based on E.R.A., is at an all-time high. By letting in the riffraff for baseball’s elite to exploit, expansion increased the likelihood of great achievements. Without even bringing steroids into the discussion, it is no surprise that some already fine hitters performed even better after the early 1990s.

Economists Against Free Trade!

2007-04-01T21:49:00.000-07:00

Some heresy on trade from Harvard's Dani Rodrik, who argues in the Financial Times that the greatest threat to globalization is not from its opponents, but its "cheerleaders." He writes:

That is because the greatest obstacle to sustaining a healthy, globalised economy is no longer insufficient openness. Markets are freer from government interference than they have ever been. Import restrictions such as tariff and non-tariff barriers are lower than ever. Capital flows in huge magnitudes. Despite barriers, legal and illegal immigration approaches levels not seen since the 19th century.
Consequently, no country's growth prospects are significantly constrained by a lack of openness in the international economy. Even if the Doha trade round fails, poor countries will have enough access to rich country markets to achieve what countries such as China, Vietnam and India have been able to do. Closed markets may have been a fundamental problem during the 1950s and 1960s; it is hard to believe they still are. The greatest risk to globalisation is elsewhere. It lies in the prospect that national governments' room for manoeuvre will shrink to such levels that they will be unable to deliver the policies that their electorates want and need in order to buy into the global economy.
Globalisation's soft underbelly is the imbalance between the national scope of governments and the global nature of markets. A healthy economic system necessitates a delicate compromise between these two. Go too much in one direction and you have protectionism and autarky. Go too much in the other and you have an unstable world economy with little social and political support from those it is supposed to help.

The other side, from the Washington Post's Sebastian Mallaby, who takes on the argument that the US should take a "strategic pause" in pushing trade agreements:

If the United States refuses to do new trade deals, its partners will push ahead with agreements among themselves, reducing tariffs for each other's products while shutting out American ones. And if they are denied a chance to gain access to U.S. markets via negotiation, foreigners will seek it via litigation.

Meanwhile, over at Princeton, Alan Blinder is having doubts about trade, too, according to the Wall Street Journal. Greg Mankiw, who was an undergraduate student of Blinder's at Princeton, answered with a blog post "My Father is Darth Vader." Of course, that implies that Mankiw thinks he's Luke Skywalker. That's fine with me, provided I can be Lando Calrissian.

CEOs for Socialism Now!

2007-04-01T09:43:00.000-07:00

Not exactly... but according to Jonathan Cohn in the New York Times Magazine, support for universal health insurance is growing among business leaders:

For many years, the only business leaders openly calling for universal coverage were mavericks like Howard Schultz, the chairman of Starbucks, who has long preached the need for business to show greater social responsibility. The C.E.O.’s rallying to universal coverage now — particularly in the last few months — are acting not so much out of social solidarity as out of financial necessity, as the burden of financing workers’ premiums has become ever more onerous.

“The refrain from business was, ‘We can’t afford to do universal health care,’ ” says [Senator Ron] Wyden, whose plan calls for shifting responsibility for buying insurance from employers to individuals. “Now the refrain is, ‘We can’t afford not to do it.’ ” The Business Roundtable, one of Washington’s most influential business lobbies, now endorses universal coverage, at least in broad principle. And probably no spectacle captured the spirit of the times more than a joint conference held in February by [service employees union leader] Andy Stern and a man he has spent much of the last few years attacking, Lee Scott, the C.E.O. of Wal-Mart. Together the two pronounced the need for universal coverage by 2012.

Cohn's article provides some useful historical background. He reminds us there was initially significant business support for President Clinton's plan in 1993:

Though it is not widely remembered, Clinton tried hard to curry favor with business. Ira Magaziner, the chief architect of the administration’s plan, met repeatedly with corporate leaders to seek their advice, understand their needs and anxieties and test their tolerance for various provisions. Although the final White House plan included an “employer mandate” — meaning all businesses would be required to pay for a portion of their employees’ health-care costs — Clinton constructed that mandate so that many employers would actually benefit... why didn’t business support the Clinton health plan?
Actually, there was some support — at least initially. Most notably, the U.S. Chamber of Commerce at first embraced the concept of an employer mandate. But when the chamber, which represents both big and small companies, announced its endorsement, it came under attack from the National Federation of Independent Businesses, which represents only small firms. The chamber quickly started to lose members — and to field irate calls from Republican legislators warning against giving any support to the Clinton plan. The chamber and other allies backed off.

Many of the current generation of univeral health care plans are more the liking of business because they place the responsibility for obtaining insurance on individuals rather then business. The plan offered by Senator Wyden, for example:

Wyden is quick to share credit for the plan with [Safeway supermarkets CEO Steve] Burd, particularly when it comes to what is arguably its most significant provision: the severance of the longstanding relationship between where you work and how you’re insured. Under the Wyden proposal, most Americans would still use private insurance. But they would not get that coverage through employers anymore. Instead, all employers that offer insurance would “cash out” their benefits — in effect, giving their employees higher wages rather than health benefits. Once that was done, people would be required to buy coverage on their own, directly from insurers.

Some would say that by going elaborate lengths that to use "private" rather than "goverment" (socialism, gasp!) insurance, this plan - like President Clinton's - will not lead to the most cost-effective outcome:

Of course, some experts would argue that, strictly on the merits, a single-payer system might actually work better. Unlike plans like Wyden’s that rely on private insurers, a single-payer plan substantially reduces the amount of money spent on administration, since insurance companies spend far more on overhead (and marketing, and profits) than public systems. And while the data on medical outcomes are notoriously uneven and hard to interpret, they don’t show that the United States provides uniformly better care than single-payer nations like Canada or France. In fact, on measures like “Disability Adjusted Life Expectancy,” which social scientists use to measure the performance of national health-care arrangements, single-payer systems actually seem to perform slightly better on the whole.

One political lesson Senator Wyden, the business backers of his plan, and others should learn from 1993 is that even if you make a point of relying on the private sector, you'll inevitably be labelled a "socialist" anyway.

What Taxes Can Tell Us

2007-03-25T08:22:00.000-07:00

Federal tax revenues are surging, while state tax revenues are stagnating. In the NY Times, Daniel Gross examines the differences between state and federal taxes, and what the disparity in revenue growth tells us about the economy.

Is there such a thing as a healthy lunch?

2007-03-22T13:56:00.000-07:00

Tyler Cowen's "Economic Scene" column in the NY Times makes the argument that we're actually getting something for the high administrative costs of the US health care system. He concludes:

Middlemen and marketing costs have long been viewed with suspicion by critics of commerce. But these practices are usually signs of market sophistication, not waste. The gains from abolishing private insurance and its overhead costs are an illusion. TANSTAAFL, or “There Ain’t No Such Thing as a Free Lunch.”

Economist's view says there is such a thing as a wasted lunch and presents some counter-arguments from the writings of Paul Krugman, who wrote:

I'm not an opponent of markets. ... I've spent a lot of my career defending their virtues. But the fact is that the free market doesn't work for health insurance, and never did. All we ever had was a patchwork, semi-private system supported by large government subsidies. That system is now failing. And a rigid belief that markets are always superior to government programs - a belief that ignores basic economics as well as experience - stands in the way of rational thinking about what should replace it.

We've got Enron, China has...

2007-03-20T21:42:00.000-07:00

Is China catching up to the US in white-collar crime?

The Washington Post reports on a Chinese fraud scheme involving ant farms:

The company's advertisements called out to investors with an enticing offer: Invest the equivalent of about $1,300. Get two boxes of "rare" ants. Raise them for the company, and 10 times a year get $52 for your work. In one year, a participant would make about $520, a whopping 40 percent return.
People did get paid, at first, but it turned out that those high returns were being financed not by profits from real economic activity but by money flowing in from subsequent investors. The term doesn't exist in China, but in the United States, that would be called a Ponzi scheme, after Charles Ponzi, a Boston scammer who briefly became a millionaire in 1920 by using such a fraud.

If China is moving towards a "capitalist" economy, they definitely need to come up for a word for Ponzi scheme.

The authorities are taking it seriously - the perpetrator has been sentenced to death.

As China moves fitfully from a planned economy to a free-market system, cracking down on fraud, embezzlement and other financial schemes has become a major priority for the government. Among the cases taken most seriously are ones that harmed common people.
"This crime has seriously disrupted the financial order, social environment and the interests of ordinary people," said Wang Xinquan, vice director of financial affairs for the province.
In China, where more than 60 types of crimes -- including economic ones like tax fraud and bribery -- are punishable by death, the government has been criticized for its broad application of the death penalty. Some estimates put the number of court-ordered executions at as high as 10,000 a year. In 2005, Amnesty International logged 1,770 executions, or about 80 percent of the known total worldwide.

And you thought Sarbanes-Oxley was tough!

China Plans To Go Shopping

2007-03-09T09:25:00.000-08:00

China's intervention in the foreign exchange markets - selling yuan for dollars to keep the yuan cheap - has resulted in a massive pile (over $1 trillion) of dollar reserves. Hitherto, China has mainly invested its dollars in US Treasury bonds, but the New York Times reports:

China will create a new agency to invest the country’s immense reserves of foreign currency, now totaling more than $1 trillion, the country’s finance minister announced today...
The new agency will be able to invest some of the money more diversely and aggressively, analysts said, with the possibility of hundreds of billions of dollars put into acquiring “strategic assets” — mines, oil fields, whole companies — around world, especially in developing countries in Africa and Latin America...

$1 trillion goes a long way - in fact, it exceeds the market capitalization of Wal-Mart ($197bn) , Exxon ($409bn) and General Electric ($355bn) combined. Hmm... That would be pretty good "vertical integration" if China bought Wal-Mart!

Back in the 1980's, many Americans were rattled when the Japanese purchased Rockefeller Center, but that's peanuts compared to what China could do with its reserves. Fortunately for our national nerves, they are expected to start small:

Andy Rothman, a strategist at CLSA Asia-Pacific Markets, said the government was likely to proceed cautiously and give the agency only a relatively small part of the reserves to work with at first, perhaps $20 billion. “It’s not going all of a sudden going to change the world,” Mr. Rothman said. “I think they are going to move very, very slowly in diversify what they are doing. Nobody should expect that suddenly they are going to invest $1 trillion.”

$20 billion will only get you, say, a General Motors ($17.5 bn) or a Ford ($15.1bn).

Economic Possibilities for our Grandchildren, Revisited

2007-03-08T09:31:00.000-08:00

In his essay "Economic Possibilities for our Grandchildren," John Maynard Keynes made the case for optimism (definitely a daring view in 1930!)

The prevailing world depression, the enormous anomaly of unemployment in a world full of wants, the disastrous mistakes we have made, blind us to what is going on under the surface - to the true interpretation of the trend of things. For I predict that both of the two errors of pessimism which now make so much noise in the world will be proved wrong in our own time - the pessimism of the revolutionaries who think that things are so bad that nothing can save us but violent change, and the pessimism of the reactionaries who consider the balance of our economic and social life so precarious that we must risk no experiments.

The basis for his optimism: continuously compounding growth in the capital stock - "the power of compound interest over two hundred years is such as to stagger the imagination," he wrote.

I draw the conclusion that, assuming no important wars, and no important increase in popluation, the economic problem may be solved, or at least within sight of solution, within a hundred years. This means that the economic problem is not - if we look into the future - the permanent problem of the human race.
Why, you may ask is this so startling? It is startling because - if, instead of looking into the future, we look into the past - we find that the economic problem, the struggle for subsistence, always has been hitherto the primary, most pressing problem of the human race - not only of the human race, but of the whole of the biological kingdom from the beginnings of life in its most primitive forms.
Thus we have been expressly evolved by nature - with all our impulses and deepest insticnts - for the purpose of solvingsolving the eocnomic problem. If the economic problem is solved, mankind will be deprived of its traditional purpose....

Thus for the first time since his creation man will be faced with his real, his permanent problem - how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest have won for him, to live wisely and agreeably and well.

Seventy-seven years later, how are we doing?
Two of the New York Times "Economic Scene" columnists have revisited Keynes' essay. Today, Hal Varian discusses trends (0r lack thereof) in leisure time:

When you account for the much longer time in school, the more or less constant amount of time spent on housework, and make a few other adjustments, hours spent on purely enjoyable activities haven’t changed that much in the last century. Keynes may have been right that future generations will have a lot of time on their hands, but I wouldn’t bet on that happening anytime soon.

Last year, Robert Frank argued that Keynes missed the importance of the desire for higher quality goods, which he says is insatiable since we always care about relative quality:

Decisions to spend are also driven by perceptions of quality, the desire for which knows no bounds. But quality is an inherently relative concept. The same car that would have been deemed as having brisk acceleration and sure handling by drivers in Keynes’s day, for example, would be much less charitably evaluated by today’s drivers — even those with no desire to outdo their neighbors.

China's Bad Investment?

2007-03-05T21:48:00.000-08:00

By intervening in the market to keep its currency undervalued, China is lowering the purchasing power of its own consumers. Its trade surplus means that China is accumulating large amounts of foreign assets (what they're getting in return for all that stuff they're sending us), like US Treasury bonds. These assets will depreciate (in Yuan terms) when the Yuan is allowed to rise, so the Chinese government is setting itself up for a huge financial loss. Therefore, Brad Setser asks "Why is China's government trying so hard to hold down China's current living standard?"

The government of China, by contrast, seems determined to keep China poorer than it needs for to be. After all, the government of China, not the government of the US, actively intervenes in the market every day to hold China’s living standards down – or, if not China’s living standard, certainly the external purchasing power of all those paid in RMB.

....China’s policy of buying dollars (and to a smaller degree euros) also means that China is sinking a growing share of its national wealth into a set of assets that are almost certain to depreciate over time...

China – counting likely flows from Chinese banks as well as flows from the PBoC almost certainly bought about $200b of US debt in 2006. It paid – in RMB terms – a lot for those assets as well: China effectively has a policy of under-pricing its labor and overpaying for its external assets.

His worry is that when the Chinese government realizes the losses on its Dollar-denominated assets a new source of tension with the US will arise:

When the time comes for China to realize the losses that are now accumulating quietly on the PBoC’s balance sheet (and soon on the balance sheet of the state foreign investment company), I doubt China’s leaders will say, “you know, these losses were really incurred years ago, when we decided to sink a lot of Chinese savings into depreciating dollars in order to encourage our export sector and make it attractive for foreign firms to locate investment in China. We shouldn’t blame the US for the fact that China’s investments in the US haven’t done well. We were the ones who over-paid for US assets."

N.B.: "Yuan" and "Renminbi" (RMB) both refer to the same thing - the renminbi is China's currency, and the Yuan is the unit of account; and PBoC is the "People's Bank of China", their central bank.

Interesting answers to exam questions

2007-03-01T12:50:00.000-08:00

These are answers, but....(hat tip to econbrowser)

The Gdp revision

2007-03-01T06:05:00.000-08:00

Jim Hamilton reviews the revision and doesn't seem that worried, or at least more worried than was.

The Bureau of Economic Analysis reported today that U.S. real GDP grew at a 2.2%annual rate in the fourth quarter of last year, rather than the 3.5% originally reported. Of the 1.3% lost output growth, about half is due to a downward revision of the end-of-quarter inventories.

So, although a revision of reported GDP growth from 3.5% to 2.2% sounds worrisome, the details don't bother me that much. 2.2% is closer to what I was expecting for 2006:Q4 anyway, so essentially all this does is put us back where many of us thought we were in November.

Stocks plummet

2007-02-28T06:31:00.000-08:00

Macroblog has a good summary and many links about yesterday's sharp fall in stock prices around the world. There was some speculation that the expectation of a significant downward revision in 4th quarter gdp growth played a role. Turns out that the speculation on a large gdp growth revision was spot on. 4th quarter real gdp growth was revised from 3.5% to 2.2%, about a 45% error.

The ten principles of economics

2007-02-27T19:26:00.000-08:00

Greg Mankiw claims these are unofficial.

Go Ahead, Major in English!

2007-02-25T09:23:00.000-08:00

In the New York Times Magazine, Christopher Caldwell contemplates "What A College Education Buys."

Part of his answer:

But the education kids are rewarded for may not be the same education their parents think they are paying for. Economists would say that a college degree is partly a “signaling” device — it shows not that its holder has learned something but rather that he is the kind of person who could learn something. Colleges sort as much as they teach. Even when they don’t increase a worker’s productivity, they help employers find the most productive workers, and a generic kind of productivity can be demonstrated as effectively in medieval-history as in accounting classes.
Moreover, if you’re not planning on becoming, say, a doctor, the benefits of diligent study can be overstated. In recent decades, the biggest rewards have gone to those whose intelligence is deployable in new directions on short notice, not to those who are locked into a single marketable skill, however thoroughly learned and accredited... Something like the old ideal of a “liberal education” has had a funny kind of resurgence, minus the steeping in Western culture. It is hard to tell whether this success vindicates liberal education’s defenders (who say it “teaches you how to think”) or its detractors (who say it camouflages a social elite as a meritocratic one).

Wiki and Hayek

2007-02-24T11:19:00.000-08:00

Markets aggregate information and summarize that information in prices. Hayek argued that information aggregation was perhaps the most important feature of markets. The internet and "wikimania" has introduced new methods of information aggregation. Cass Sunstein desribes the spread of wiki.

Stiglitz on Globalization

2007-02-21T22:14:00.000-08:00

Columbia University's Joseph Stiglitz, Nobel Laureate in Economics and author of "Globalization and its Discontents," answered questions about globalization (and plugged his new book) on Daniel Altman's International Herald Tribune blog. Scroll down a bit for a particularly interesting discussion on Latin America.

Health Care Reform Redux

2007-02-15T10:12:00.000-08:00

Memories of Harry and Louise have faded, and once again health care "reform" is back on the national agenda

Robert Frank, who visited us in the fall, makes the case against the President's proposal and for Canadian-style "single payer" in his NY Times column:

That Mr. Bush’s proposal will not shrink the ranks of the uninsured is not its most serious problem. Far more troubling is its embrace of a system under which we spend more than twice as much on health care, on average, as the 21 countries in which life expectancy exceeds ours. American costs are so high in part because the reliance on private insurance multiplies administrative expenses, currently about 31 percent of total outlays.
Most health economists agree that government-financed reimbursement is the only practical way to control these expenses, many of them stemming from insurers’ efforts to identify and avoid unhealthy people. Canada’s single-payer health system, which covers everyone, spends less than 17 percent on administrative expenses.

Washington Post columnist Steven Pearlstein writes up a McKinsey study on America's health care costs:

Even after adjusting for wealth, population mix and higher levels of some diseases, McKinsey calculated that we spend $477 billion a year more on health care than would be expected if the United States fit the spending pattern of 13 other advanced countries. That staggering waste of money works out to 3.6 percent of the nation's entire economic output, or $1,645 per person, every year.
In laying out with remarkable clarity how and where we overpay, the McKinsey report punctures myths, exposes common misconceptions and highlights realities long ignored in the health-care debate.

Paul Krugman likes John Edwards' plan. Macroblog has some thoughts on it, too.

Hyperinflation

2007-02-08T19:47:00.000-08:00

Greg Mankiw's blog points to this NY Times article on the hyperinflation in Zimbabwe. As always, the culprit is very rapid money growth, money is currently growing at over 1000% per year. As far as causes go, this analysis probably gets things backwards

Hyperinflation has bankrupted the government, left 8 in 10 citizens destitute and decimated the country’s factories and farms.

Bankrupt governments often turn to rapid money creation to generate government revenue. This was true for the German hyperinflation in the 1920s, the Russian hyperinflation in the 1990s, many others as well, and is likely true for Zimbabwe.

Bernanke on Inequality

2007-02-06T12:53:00.000-08:00

Fed Chairman Ben Bernanke discussed income inequality in a speech to the Omaha Chamber of Commerce. He provides a thorough overview of the evidence and the issues (its as if he has access to a huge research staff...). Near the end of the speech, he turns to the policy implications:

What, if anything, should policymakers do about the trend of increasing economic inequality? As I noted at the beginning of my remarks, answering this question inevitably involves some difficult value judgments that are beyond the realm of objective economic analysis--judgments, for example, about the right tradeoff between allowing strong market-based incentives and providing social insurance against economic risks. Such tradeoffs are, of course, at the heart of decisions about tax and transfer policies that affect the distribution of income as well as countless other policy debates.
Policy approaches that would not be helpful, in my view, are those that would inhibit the dynamism and flexibility of our labor and capital markets or erect barriers to international trade and investment. To be sure, the advent of new technologies and increased international trade can lead to painful dislocations as some workers lose their jobs or see the demand for their particular skills decline. But hindering the adoption of new technologies or inhibiting trade flows would do far more harm than good, as technology and trade are critical sources of overall economic growth and of increases in the standard of living.
A better approach for policy is to allow growth-enhancing forces to work but to try to cushion the effects of any resulting dislocations. For example, policies to facilitate retraining and job search by displaced workers, if well designed, could assist the adjustment process. Policies that reduce the costs to workers of changing jobs--for example, by improving the portability of health and pension benefits between employers--would also help to maintain economic flexibility and reduce the costs that individuals and families bear as a result of economic change.

The Year in GDP

2007-02-02T08:15:00.000-08:00

The Bureau of Economic Analysis released its advance estimate of GDP for 2006 on Wednesday. For the year, real GDP increased 3.4%, which is very close to the average for the postwar period. The fourth quarter was slightly better, with an annual rate of 3.5%.

Here is the breakdown of the contributions to the total from Consumption, Investment, Government and Net Exports:

2006 Total: 3.4% (C: 2.25, I: 0.75, G:0.4, NX: -0.02)
Fourth Quarter: 3.5% (C: 3.05, I: -1.92, G: 0.7, NX: 1.64)

In the last three months of 2006, the consequences of the housing bust are reflected in investment. Residential investment fell at an annual rate 19.2%, contributing -1.16 to the overall GDP change. The decline of the dollar is finally having an effect - with an assist from oil prices - exports increased at a 10% pace and imports decreased at a 3.2% rate in the fourth quarter.

The Washington Post wrote up the GDP numbers, and Econbrowser and Nouriel Roubini blogged.

Bernanke reign ends is first year

2007-02-01T17:31:00.000-08:00

Ben Bernanke's first year as the Fed Chair ended as the FOMC held the federal funds rate at 5.25%. Greg Ip And Mark Whitehouse of the Wall Street Journal write

As he finishes his first year as Federal Reserve chairman, Ben Bernanke has dispelled early doubts about his ability to steer the world's largest economy. But his biggest challenge -- bringing the economy in for a soft landing -- lies ahead.

It looks like Bernanke is making the meetings more interesting too. Maybe that is why they are having more two day affairs.

Some of Mr. Bernanke's accomplishments are less visible. He has made Fed discussions more freewheeling and collegial, colleagues say. But he has fallen short of his goal of innovating Fed communications. He has wanted to set a public, numeric inflation target, make more-frequent and more-detailed forecasts and issue more descriptive, less formulaic post-meeting statements. But sensitive to colleagues less enthusiastic about such changes, he has subjected debate to an internal review. That review is expected to wrap up this fall.

More Milton Friedman

2007-01-26T19:42:00.000-08:00

Who Was Milton Friedman? In the New York Review of Books, Paul Krugman explains:

Milton Friedman played three roles in the intellectual life of the twentieth century. There was Friedman the economist's economist, who wrote technical, more or less apolitical analyses of consumer behavior and inflation. There was Friedman the policy entrepreneur, who spent decades campaigning on behalf of the policy known as monetarism—finally seeing the Federal Reserve and the Bank of England adopt his doctrine at the end of the 1970s, only to abandon it as unworkable a few years later. Finally, there was Friedman the ideologue, the great popularizer of free-market doctrine.

Krugman gives Friedman thumbs up on the first role, thumbs down on the other two.

Meanwhile, Econbrowser asks: What Would Milton Do? (Answer: Look at M2 Growth)

Bush Health Insurance Proposal

2007-01-24T08:37:00.000-08:00

The Bush administration is proposing to change the tax treatment of health insurance. Employee health benefits would become taxable income (i.e. a tax increase - gasp!), but people who have health insurance would get a deduction ($7500 for individuals, $15ooo for couples). You get the same deduction whether you get insurance from your employer or buy it individually and no matter how much is actually paid for the insurance. The idea is to "level the playing field" by removing the tax advantage to employer provided insurance and to give consumers more incentive to take into account the costs of the care they purchase. Essentially, the "problem" this would solve is over-consumption of health care by people with good (i.e. low deductibles and copayments) employer-sponsored health insurance. Whether that's really a major problem seems to be the source of some disagreement among economists. Economist's View has a good roundup from the econo-blogo-sphere, and Mankiw finds supportive analysis, but the (leftish) Economic Policy Institute is critical.

Dealing drugs: the worst job in America

2007-01-22T10:17:00.000-08:00

Steve Levitt describes life as drug dealer in this video. It is a very interesting talk that is based on his work from Freakonomics. (hat tip to Mark Mcbride)

Samuelson on Keynes

2007-01-17T23:12:00.000-08:00

Economist's View unearthed a delightful essay by Paul Samuelson on John Maynard Keynes. A good intro to the man and his contributions, for those of you not quite ready to take on Robert Skidelsky's magisterial three-volume bio.

Economists: Still Dealing with New Deal

2007-01-13T11:41:00.000-08:00

Seventy years on, the Great Depression continues to be the subject of argument among economists. It sometimes seems to be an economic Rorschach test that reveals fundamental beliefs about the ability of markets to correct themselves and the govenment to intervene effectively in the economy.

Another round of argument was sparked by this George Will column in the Washington Post criticizing the proposed increase in the federal minimum wage. Will writes: "A federal minimum wage is an idea whose time came in 1938, when public confidence in markets was at a nadir and the federal government's confidence in itself was at an apogee. This, in spite of the fact that with 19 percent unemployment and the economy contracting by 6.2 percent in 1938, the New Deal's frenetic attempts had failed to end, and perhaps had prolonged, the Depression."

Brad deLong says "A normal person would not argue that the New Deal prolonged the great depression... but George Will is not a Normal Person." James Hamilton gave more thoughtful consideration to the effects of the New Deal. Economist's View has Paul Krugman's take, and links to another of other posts on the subject.

Chinese Capitalism?

2007-01-09T19:40:00.000-08:00

In an extract from his forthcoming book about China, "The Writing on the Wall," British thinker Will Hutton argues that China's economy is far from a free enterprise success story:

"The truth is that China is not the socialist market economy the party describes, nor moving towards capitalism as the western consensus believes. Rather it is frozen in a structure that I describe as Leninist corporatism - and which is unstable, monumentally inefficient, dependent upon the expropriation of peasant savings on a grand scale, colossally unequal and ultimately unsustainable. It is Leninist in that the party still follows Lenin's dictum of being the vanguard, monopoly political driver and controller of the economy and society. And it is corporatist because the framework for all economic activity in China is one of central management and coordination from which no economic actor, however humble, can opt out."

Hutton describes rampant corruption in China, which he attributes to the lack of institutions such a free press and an independent judiciary which might check the power of Communist party officials. He argues that true capitalism requires much stronger property rights and greater individual freedom than currently exists in China.

"The west is unforgivably ignorant about China's shortcomings and weaknesses, which leads it vastly to exaggerate the extent of the Chinese "threat"....Rather, the west needs to understand the depth of China's problems and the possibility, if not probability, of an economic and political convulsion as China seeks their resolution."

Productivity Revival, We Hardly Knew Ye?

2007-01-03T14:24:00.000-08:00

The Washington Post's Robert Samuelson worries about a slowdown in the growth of labor productivity:

"The start of a new year is a good time to take stock, and there are few better indicators of our long-term economic prospects -- and also our prospects for political and social peace -- than productivity... The good news is that productivity has been growing strongly; the bad news is that it may be moving to a much slower path."

According to the BLS, US annual labor productivity fell in the mid-1970's and picked up in the mid-1990's...

Annual labor productivity growth rate
1948-73 - 2.79%
1974-95 - 1.40%
1996-05 - 2.84%

The statistical basis for Samuelson's fretting is that the average for the last 4 quarters is 1.4%. It may be premature to declare a slowdown, but as he points out the lack of saving by US households, and the dis-saving by the government are not exactly conducive to investment.

The minimum wage increases next week

2006-12-30T17:52:00.000-08:00

The new year brings the first increase in the minimum wage in Ohio in a decade. The minimum increases from $5.15/hour to $6.85/hour. The effects of the minimum wage on employment is controversial and subtle. The increase changes relative wages and this relative change is a concern to David Tramontana, chief executive of Black Stone Health Care, a home health care provider:

"Would you be trekking around Ohio in December, spending five hours a week in your car, battling the elements to go to senior citizens' homes to cook their meals, give them baths, when for the same pay, you could work in a restaurant
without those challenges?"

In Arizona some people worry about the effect of their minimum wage hike on workers in disabled job centers. Randy Gray worries

“I have been working around the clock with high-paying labor attorneys who are saying that unequivocally, the net effect of this is we have to cease and desist all center-based workshop operations effective Jan.
1.”

The devil is often in the details.

More on Ford, or "Price Stability is Job 1"

2006-12-29T19:22:00.000-08:00

In the econo-blogo-sphere, discussion of President Ford's tenure has focused on Federal Reserve Chairman Arthur Burns. Macroblog attempts a defense of Burns; who Econbrowser finds indefensible.

Burns' reputation will not be helped by new evidence from the Nixon tapes indicating he may have had a political motive for an overly-expansionary monetary policy -

October 10, 1971, Nixon to Burns: “I don’t want to go out of town fast…. This will be the last conservative administration in Washington.”

December 10, 1971, Burns to Nixon: “I wanted you to know that we lowered the discount rate… got it down to 4.5%... [I] put them [FOMC] on notice through this action that I want more aggressive steps taken by that committee on next Tuesday”
Nixon to Burns: “Great. Great, you can lead ‘em. You can lead ‘em. You always have, now. Just kick ‘em in the rump a little.”

Source: Burton A. Abrams: “How Richard Nixon Pressured Arthur Burns: Evidence from the Nixon Tapes” Journal of Economic Perspectives, Fall 2006

Central bank independence, indeed!

Ford-onomics

2006-12-28T12:39:00.000-08:00

Although most coverage of President Ford's legacy has focused on the political and foreign policy turmoil of the mid-1970's, students of economics will associate his tenure with "stagflation" (simultaneous high inflation and unemployment) and the "misery index" (the sum of the inflation and unemployment rates). The Washington Post gives Ford credit for making the best of a difficult situation.

The Money Trust

2006-12-20T06:58:00.000-08:00

Washington Post columnist Steven Pearlstein suggests that Wall Street's bonuses ($24 billion this year) result from something other than a high marginal productivity of labor.

Update:
Pearlstein chatted with readers about his column.
Meanwhile, over at the NY Times, Henry Blodget argues that the folks at Goldman Sachs deserve every penny. [The very same Blodget was fined and banned from the securities industry for his behavior as a Merrill Lynch stock analyst during the internet bubble... He's made a comeback as a commentator, further evidence that F. Scott Fizgerald was completely wrong when he said "there are no second acts in American lives"]

Discounting: Morally indefensible but mathematically indispensible?

2006-12-17T08:58:00.000-08:00

When we make choices that have very long-term implications, how much weight goes on the welfare of future generations? Most economic models assume that we "discount" the future - a custom often dictated by mathematical necessity. In the NY Times, Hal Varian explains that discounting is at issue in some economists' critiques of a recent British government report on global warming.

Can Hank and Ben fix the world?

2006-12-12T21:28:00.000-08:00

With the dollar sliding, and Treasury Secretary Hank Paulson and Fed Chairman Ben Bernanke on their way to China, more attention than usual is being paid to "global macroeconomic imbalances."

In the Washington Post, Sebastian Mallaby ponders whether world trade rules should limit the ability of countries to promote exports by keeping their currencies undervalued and Robert Samuelson looks at the unique role of the US dollar. The Economist argues that our fixation on China is misdirected.

A quick refresher on the relevant economics: A country's net exports are the difference between its national savings and investment - the large US trade deficit implies that national saving insufficient to finance domestic investment, while China and the oil exporters are saving more than they are investing domestically. Their "excess" saving flows to finance US investment. The surplus countries receive financial I.O.U.s (Treasury Bonds, Stocks, etc...) in return for the goods they send us.
If a government is intervening to keep its currency "undervalued" relative to its market equilibrium price there will be excess demand. The government sells its currency to meet the excess demand, thereby accumulating reserves (e.g. China is depressing the value of the Yuan by selling it cheaply for dollars, in doing so it is piling up a massive hoard of dollars). In the short run, a cheaper currency may increase exports by making them less expensive to foreigners.

Do demand curves slope up or do colleges price discriminate?

2006-12-12T13:00:00.000-08:00

I opt for the latter conclusion, but this NY Times article at first suggests the former. (hat tip to Jared Barton)

What do economists believe?

2006-12-01T22:33:00.000-08:00

Greg Mankiw reports on a recent survey of economists.

Friedman v. Keynes

2006-12-01T22:30:00.000-08:00

Brad Delong compares and contrasts the views of Friedman and Keynes; and frames questions that still fire debate.

Lure of Great Wealth Affects Career Choices

2006-11-28T07:35:00.000-08:00

Hmmm, sounds like something I've heard before. This article is getting a lot of attention. (Hat tip to Dennis Sullivan)

Very important advice on buying stocks

2006-11-21T20:26:00.000-08:00

Charles Schultz, President Carter's chief economist and long time Brookings economist, gives Borat some very important advice on buying stocks. (via Marginal Revolution via Mankiw's blog)

A giant rests

2006-11-16T18:23:00.000-08:00

Milton Friedman died today at the age of 94. Here is a NY Times report on his life. Here are a bunch of links from the Instapundit blog. Here is a touching tribute from his son, David. Read the comments to get an idea of his influence on individuals. Here are a bunch of Friedman videos. If you are pressed for time, scroll down through the YouTubes and watch the one with the pencil. There are several other posts with more to come at Marginal Revolution. A lot of people agree with the title of this post from Greg Mankiw. This book was wacky when it was published. It sounds old hat now. That is a tribute to his impact on public policy. If you haven't figure it out yet, I count myself as one influenced and inspired by him. Thank you Milton Friedman.

update: Here is an inteview of Milton and Rose Friedman.

update II: Friedman plays tennis (via Instapundit)

update III: Here is a nice review of many of his intellectual contributions. (hat tip to Bill Craighead)

update IV: If you think only right of center folks appreciated Friedman, read this piece by Brad Delong.

Why are some countries rich and some not?

2006-11-02T11:04:00.000-08:00

Jared Diamond addressed this question in Guns, Germs, and Steel. Tyler Cowen of George Mason and the Marginal Revolution reviews another take on this question from Greg Clark. Here is the Marginal link and here is the link to the review and the book. (hat tip to Jens)

Games theory of a different sort

2006-10-20T17:17:00.000-07:00

Would you rather take Eco 201 this way? (Hat tip to Marginal Revolution via Jared Barton)

Election roundup...

2006-10-18T06:17:00.000-07:00

I love elections. Love them, love them, love them. In that spirit, I wish to offer a few election-related links that may, however tangentially, relate to economics.

1. NPR has a discussion of which U.S. House districts the national political parties have targeted in the last weeks of the campaign. This is a non-technical way of thinking about optimization of spending over multiple goods. Republicans are playing defense; Democrats, offense. The question, of course, is whether each team treats the marginal utility of a seat equally or if they're examining marginal utility over price (see this guy for an analysis of whether individual House candidates do just that).

2. Tradesports has GOP control of the U.S. Senate trading at about 67%, but control of the U.S. House at 35%. Note that both probabilities trend downward. Here's a fun question: will these markets, based in England, become more or less predictive once the federal law on Internet gambling takes effect.

3. Finally, another question of optimizing. It appears that the Republicans may abandon Mike DeWine here in Ohio. If you read any of the articles on Tailrank, you'll discover that the abandonment is not complete, but that the national GOP will reduce its advertising purchases in Ohio over the next three weeks. As a former intern for He-Who-Must-Not-Be-Named, I'm a little bit pleased. As a supporter of free trade? Not so much.

Peace and economics

2006-10-14T08:04:00.000-07:00

Muhammed Yunnus won the Nobel Peace Prize for the financial innovations embodied in the Grameen Bank.

Mr Yunus, an economist, founded the bank, which is one of the pioneers of micro-credit lending schemes for the poor, especially women, in Bangladesh. ...
Mr Yunus set up the bank in 1976 with just $27 from his own pocket. Thirty years on, the bank has 6.6 million borrowers, of which 97% are women, according to the Grameen website.

There is a nice introduction to the notion of microfinance here.

Rates up, rates down?

2006-10-13T20:12:00.000-07:00

We must be near some switchpoint. Two Fed president's voice different concerns about the near term future of the economy.cvxtv

An oil price primer

2006-10-12T09:07:00.000-07:00

Here is a short interview with Stephen Brown, the director of energy economics at the Dallas Fed, on the recent movements in oil prices.

A Nobel defense of capitalism

2006-10-12T08:58:00.000-07:00

Edmund Phelps describes and defends capitalism. Phelps focuses on the role of capitalism, and economic organization more generally, in nuturing change. He writes

The American and Continental systems are not operationally equivalent, contrary to some neoclassical views. Let me use the word "dynamism" to mean the fertility of the economy in coming up with innovative ideas believed to be technologically feasible and profitable--in short, the economy's talent at commercially successful innovating. In this terminology, the free enterprise system is structured in such a way that it facilitates and stimulates dynamism while the Continental system impedes and discourages it.

A Nobel in the Dismal Science...

2006-10-09T10:29:00.000-07:00

Edmund Phelps has won the Nobel Prize in economics. Marginal Revolution has a complete run-down here. It seems to me that one of the coolest things about Phelps' work is that many students of economics know of it without knowing that they know it because of Phelps! That is likely true about a good many economic insights, but even Tyler Cowen admits "...Phelps is not an economist who has influenced my own thinking much if at all. His major contributions were absorbed, and were standard fare, by the time I was a young'un" [emphasis mine]. To be so foundational, it seems to me, is the mark of Nobel-worthy work.

BOG board room

2006-10-07T09:46:00.000-07:00

Why do all good monetary economist want to grow up and be on the Board of Governors? A very cool board room has to be near the top of the list, but I don't think the fellow at the end of the table is Ben Bernanke. Ben has a beard.

Dynamic game theory in action

2006-10-07T09:37:00.000-07:00

This story, from here, is probably not true.

Three economists and three mathematicians were going for a trip by train.Before journey the mathematicians bought 3 tickets(they could count to three)and the economists only one. The mathematicians were glad their stupid colleagues were going to pay a fine. However, when the conductor was approaching their ompartment, all three economists went to the nearest toilet. The conductor, noticing that somebody was in the loo, knocked on the door and in reply saw a hand with the ticket. He checked it and the economists saved 2/3 of the ticket price.Next day the mathematicians decided to use the same strategy - they bought only one ticket, but the economists did not buy tickets at all. When the mathematicians saw the conductor they went to the loo, and when they heard knocking they handed in the ticket. They did not get it back. Why? The economists took it and went to the other toilet.

James Hamilton plays Whac-a-Mole, kind of

2006-10-06T19:11:00.000-07:00

James Hamilton reflects on some the conspiracy theories discussed in this Washington Post article to explain the recent swings in oil prices.

dumping the penny is a Sharpe idea

2006-09-25T14:34:00.000-07:00

In the first half of this year alone, the U.S. government minted 4.8 billion of these useless coins, and since it costs 1.4 cents to make each one and maybe two more cents each to distribute them, that robbed taxpayers of $115 million.

Sebastian Mallaby of the Washington Post reports on the fate, or what should be the fate, of the penny. (Hat tip to Bill Craighead)

Chimpanzes and very cool graphics

2006-09-22T21:05:00.000-07:00

Hans Roling uses very cool graphics to describe data on demographics and income distribution. Give it a chances.

Income inequality in the 90s

2006-09-22T20:54:00.000-07:00

Hal Varian describes a recent explanation by James Galbraith on the increase in income inequality in the 1990s. It may have been because of Bill Gates, Stanford, and Berkely.

Milton's the man

2006-09-19T12:02:00.000-07:00

Russ Roberts interviews Milton Friedman. The interview focuses on two of Friedman's books, A Monetary History of the United States and Capitalism and Freedom. These books both came out in the early 1960s and their influence persists. In Capitalism and Freedom you'll read about many modern reforms and suggestions for reforms that were radical at the time. Among other ideas, Friedman advocated for a volunteer army, a negative income tax, and education vouchers well before it was popular.

Interest rates up, interest rates the same?

2006-09-09T07:03:00.000-07:00

The Washington Post reports on some controversey at the Fed. Janet Yellen, a member of the Fed Board of Governors, believes that the federal funds rate has reached a level consistent with inflation at the "comfort level". The article suggests that the funds rate hikes in the past two years have cooled the housing market and the economy in general; and the slowing of the economy will bring and keep inflation down. The federal funds rate is an overnight rate between banks and the mortgage rate is a rate that spans over many years; and there has always been a question of how close is the connection between the two. The Fed clearly can and does move the federal funds rate. The picture nearby (produced at the very cool FRED site) shows why there is a question as to the Feds influence on the mortgage rate.

Banana peels, the perfect fine?

2006-09-05T08:38:00.000-07:00

In 1906, a Londoner died as the result of injuries from slipping on a banana peel. The London County Council enacted a penalty for those caught skinning the pavement. But, was it a perfect fine? Heavy Lifting pursues the answer.

Health controversey

2006-09-03T16:40:00.000-07:00

This post at the New Economist offers very few answers about health spending and outcomes, but raises a bunch of interesting questions.