Thursday, February 14, 2019

Thinking about Pay-What-You-Can Restaurants

The idea of a pay-what-you-can restaurant raises obvious questions. Could it sustain itself? Or would those paying more than face value be swamped by those paying less? Are there ways of running such a venture that might be more sustainable than others?

The question arises because the Panera company starting in 2010 ran a group of up to five stores called Panera Cares that operated on a "pay-what-you-can" basis. The last one of these stores, based in Boston, is closing this week. Ben Johnson offers some background and reflections in "‘Pay what you can afford’ runs Panera out of bread," published at the Acton Institute blog (February 12, 2019).  He notes: “`Panera Cares' were indistinguishable from other Panera eateries in their branding, menu, or furnishings, except they announced that no one would be turned away if they did not pay one cent of the `suggested prices.' Those who could not afford to pay full price could volunteer for an hour at the store in exchange for the food."

Johnson emphasizes what went wrong, and it's more-or-less what you would expect. Some homeless people start eating there for every meal, but high school students dropped in for free food as well. The stores tried to explain their mission, telling the poor that they should be an irregular stop, rather than every day, and asking the high school principal to rein in the students. But trying to discourage misuse or overuse then led to accusations of profiling, followed up by requirements for sensitivity training.

Meanwhile, drug users were taking over the bathrooms, and the Panera Cares stores were typically covering only about 60-70% of their costs. Panera was sold in 2017 to a new set of investors in 2017, and probably not coincidentally, the Panera Cares experiment is now shutting down.

Clearly, those who are cynical about pay-what-you-can have some justification. But  just as clearly, cynicism isn't the whole story here. The Panera Cares experiment didn't last nine weeks or nine months, but more like nine years. Very large numbers of people got free or low-priced food. Others were willing to use Panera Cares as a charitable mechanism by paying more for food.

How widespread are pay-what-you-can restaurants? An organization called One World Everybody Eats serves as a clearinghouse for this model, offering expertise and network-building. The organization is now trying to find a replacement for Panera Cares to use a pay-what-you-can model in Boston. From the organization's website:
There are more than 60 community cafes around the world that have adopted the One World Everybody Eats model, including Panera Bread’s Panera Cares Cafes and the Jon Bon Jovi Soul Kitchens. Dozens of cafes are in development. New cafe development teams are joining our network of community cafes every month, proving that a cafe can thrive when guests are invited to pay what they can afford or offered the opportunity to volunteer for their meals.
Cafes in the OWEE network operate predominately with volunteers. Together, they serve nearly 4,000 meals a day, or more than 1.4 million meals a year.


Pay-what-you-can pricing
Patrons choose their own portion size
Healthy, seasonal food is served whenever available
Patrons may volunteer in exchange for a meal
Volunteers are used to the maximum extent possible to staff the organization
Paid staff earn a living wage
I haven't looked over the full list of the 60 or so pay-what-you-can places, but I checked the one location in my state of Minnesota. It's in a smaller city about 25 miles from Minneapolis. It's run by a church, and it's only open on Tuesdays and Thursdays for a couple of hours in the morning. This operation seems to me a valuable and praiseworthy and useful method of involving the community in helping the hungry. But it's not what most people would call a "restaurant."

What determines the feasibility of a pay-what-you-can restaurant? The key seems to be whether it can attract a decent-sized clientele of those who are willing to pay full price, and more than full price. Otherwise, if this kind of operation runs almost entirely on volunteer labor and donated money, then it may be a worthwhile and worthy operation, but if hardly anyone is paying, it's probably not appropriate to refer to it as pay-what-you can.

Giana M. Eckhardt and Susan Dobscha look at these issues in "The Consumer Experience of Responsibilization: The Case of Panera Cares," published in the Journal of Business Ethics in January 2018. To have a sense of how Panera Cares was operating, consider this description:
Greeters called “Ambassadors” are situated at the front of the café to explain to the customers that when they get to the counter, they can pay what they want, and that the café is a nonprofit, as most people think they are in a Panera Bread rather than a Panera Cares. Greeters must be able to “diffuse potentially difficult situations,” which as we will see arise fairly frequently when the food insecure eat at the restaurant. The food secure are encouraged to pay above what their meal is worth. Because the cafés tend to be overwhelmed with homeless people, the food insecure can only eat one entrée for free per week, and must earn it via 1 h of volunteering. To discern between the two groups, the greeter relies on consumer profiling, done solely via physical appearance and dress. 
After studying the operation of Panera Cares, talking with managers and in particular looking at online reviews posted at, Eckhardt and Dobscha describe the social tensions that arise in this way:
We demonstrate that consumers feel discomfort with the conscious pricing policy. This discomfort takes three forms: physical, psychological, and philosophical. ...

Although most Panera Cares consumers profess to care broadly about the social problem of food insecurity, they are not comfortable with the very real experience of being proximal to those consumers. ... The food insecure are also not comfortable with eating
in close proximity to the food secure. An important principle that undergirds the notion of serving a temporarily food insecure population, and providing dignity, is that of anonymity. ... Yet the reality within the cafés differs from this, and because of the proximity to food secure customers, results in discomfort stemming from physical proximity. ...

In addition to physical discomfort, consumers were also uncomfortable with other non-physical dimensions of conscious pricing in Panera Cares, including the social comparison with other consumers that takes place and the consumer profiling that the café employees engage into determine who is food secure and food insecure, which we label psychological discomfort. First, in the café, consumers monitor the donation behavior of other consumers. ...  In this case, social comparison takes the form of noticing how much other customers are paying, and interpreting the amount, if
it is low, as free rider behavior. ...In particular, how he food insecure look plays an important role. On the one hand, if they look presentable, they fulfill the temporarily food insecure profile that Panera Cares wants to cater to, and are more likely to be treated with dignity. On the other hand, by virtue of looking presentable, they are also questioned as to why they cannot pay more. In sum, consumers feel uncomfortable with the social comparison and profiling which regularly occur in Panera Cares, and this results in psychological discomfort. ...

There was also discomfort with motives and tactics behind the conscious pricing model, which we label philosophical discomfort. That is, consumers were uncomfortable with the general philosophy behind what Panera Cares was doing and how they were doing it. This manifested itself in two ways: discomfort with how the conscious pricing policy is
explained and questioning the motives of the parent company, Panera Bread. . ... Overall, this questioning of the motives and tactics of Panera Cares (a nonprofit) may be intensified because of the close connection it has to its for-profit parent company Panera Bread. Lee et al. (2017) argue that the distinction between companies that have a social mission versus those who have a profit mission is salient for consumers, and in the case of Panera Cares and Bread, is not clear. A nonprofit orientation can paradoxically drive consumer perception of organizational greed. This is because communal norms rather than exchange norms are invoked by consumers, and any perceived breach of communal norms is seen as an indication of greed. As we saw with customers using terms like tax haven and marketing gimmick to describe Panera Cares, this effect seems to be at play here. 
The evidence suggests that a pay-what-you can restaurant model is more likely to last if it is clearly a nonprofit, if it have an outside source of funding, if it is located in areas with a supply of customers willing to participate both by paying and by sharing space with the homeless, and if it able to establish a set of customary behavioral expectations for all parties who enter the restaurant. In one way or another, a pay-what-you-can restaurant will have to find ways of addressing these issues of physical, psychological, and philosophical discomforts.

Wednesday, February 13, 2019

Interview with Deidre McCloskey on Economic Growth and Liberal Values:

Eric Wallach offers "An Interview with Deidre McCloskey, Distinguished Professor Emerita of Economics and of History, UIC" in The Politic, Yale's undergraduate journal of politics and culture (February 10, 2019).  McCloskey is characteristically thought-provoking and quotable. Here are a few comments of her many comments that caught my eye:

"Liberty is liberty, and is meaningless by parts."
The central misconception is to think that one can claim the honorable title of “liberal” if one approves of one form of liberty, such as mutual consent in sexual partners or the ability to drill for oil where you wish, but excludes the other form. Liberty is liberty, and is meaningless by parts. You are still a slave if only on odd days of the month.
In Latin America, for example, the word “liberal,” once meaningful there, has long been appropriated by conservatives who like to drill for oil where they wish, but hate gays. In the United States, it has been appropriated by sweet, or not so sweet, slow socialists, who celebrate diversity, but regard economic liberty as not worthy of much consideration. ...
I used to think freedom was freedom of speech, freedom of the press, freedom of conscience. Here is what it amounts to: you have to have the right to sow what you wish to, to make shoes or coats, to bake into bread the flour ground from the grain you have sown, and to sell it or not sell it as you wish; for the lathe-operator, the steelworker, and the artist it’s a matter of being able to live as you wish and work as you wish and not as they order you.
"Put me down for 10 percent slavery to government." 
It’s unwise to turn the issue of helping the poor into an on/off, none/perfect, exist/not question. We need to be seriously quantitative about such matters. On/off doesn’t answer the important question, which is always more/less. People think they are making a clever remark against liberalism by saying, “Well, we need some government.” Yes, certainly. But how much? (Will Rogers in the 1920s used to say, “Just be glad you don’t get the government you pay for.”) ...

So here’s what a Liberalism 2.0 favors. It favors a social safety net, which is to say a clean transfer of money from you and me to the very poor in distress, a hand up so they can take care of their families. It favors financing pre- and post-natal care and nursery schools for poor kids, which would do more to raise health and educational standards than almost anything we can do later. It favors compulsory measles vaccination, to prevent the big spillover of contagion that is happening now in Clark County, Washington. It favors compulsory school attendance, financed by you and me, though not the socialized provision of public schools. The Swedes have since the 1990s had a national voucher system, liberal-style. It favors a small army/coast-guard to protect as against the imminent threat of invasion by Canada and Mexico, and a pile of nuclear weapons and delivery systems to prevent the Russians or Chinese or North Koreans from extorting us. All this is good, and would result in the government at all levels taking and regulating perhaps 10 percent of the nation’s production. Put me down for 10 percent slavery to government. Not the 30 to 55 percent at present that rich countries enslave.
"The Nordics ... are not thoroughly socialist, and in fact they are reasonably close to the U.S., and in some ways more anti-socialist."

Americans of good will have long been persuaded, on the basis of breathless articles in the Sunday New York Times Magazine, that the Nordics are thoroughly “socialist” ...  No, they are not thoroughly socialist, and in fact they are reasonably close to the U.S., and in some ways more anti-socialist. They are in fact highly liberal in their economies (and their fastest rates of growth since 1850 were in fact when they were even more liberal). Almost all prices in Sweden and the rest, for example, are determined by supply and demand, and are nothing like the disastrous socialist interventions by way of price controls in, say, Venezuela. Setting up a business is not hard. Inherited wealth in Scandinavia and Finland is not honored. Innovation is (for example Svenska Kullagerfabriken, SKF, a pioneer in ball bearings, out of which in the 1920s rolled Volvo [Latin for “I roll”]).

And government ownership of the means of production is trivial in all the Nordic countries. When Saab Motors went bankrupt, it came to the Swedish government hat in hand, and the government said, “Get lost.” When Volvo recently became a Chinese company, the government said, “So what?” You don’t have to exercise much imagination about what the American government would do if General Motors was so threatened: “Here are billions of tax dollars, and so the Federal Government owns part of you.” The American government in 2008 of course did precisely that.
"Give this gentleman sixteen cents. That’s his share of the wealth." 
[Andrew] Carnegie himself is said to have made the same point in another way. A socialist came to his office and argued to him that the wealthy should redistribute their wealth to the poor of the earth. Carnegie asked an assistant to go get him a rough estimate of his current wealth and of the population of the earth. The assistant returned shortly with the figures, and according to the anecdote Carnegie performed a calculation, then turned to the assistant and said, “Give this gentleman sixteen cents. That’s his share of the wealth.” And then he gave every dime of his wealth away, in accord with his Gospel of Wealth. Another businesslike Scot, Adam Smith, by the way, also gave away his considerable fortune, though, unlike Carnegie, he did not sound a trumpet before him when he did his alms.

Tuesday, February 12, 2019

Economics of Medieval Guilds

Guilds played an important role in the economies of Europe from about the 11th century up through the 16th century, and a continuing if less important role up into the 19th century. Sheilagh Ogilvie, the go-to economic historian on this subject, has a new book out called The European Guilds: An Economic Analysis (published by Princeton University Press and of course available on Amazon, too). For a flavor, here are some comments from the opening chapter: 
"Guild membership was therefore reserved for the privileged few. Guilds were small relative to the consumer markets they monopolized. They were also small relative to the wider labour market, whose members they largely excluded. Guilds were not all-encompassing workers' associations analogous to twentieth-century labor unions, but exclusive organizations for relatively well-off, middle-class men. ... 
The effects of guilds on economy and society have always generated controversy. Contemporaries held strong view about them, with guild members and their political allies extolling their virtues, while customers, employees, and competitors lamented their misdeeds. Many early economic thinkers praised guilds, as, for example, the French government minister Jean-Baptiste Colbert, who ordered all French crafts to form guilds, "so as to compose by this means a group and organization of capable persons, and close the doors to the ignorant," and the Austrian imperial councilor Johann Joachim Becher, who argued that the authorities in past eras had wisely invented the guilds because "competition weakens the livelihood of the community". Others censured guilds, as did Adam Smith when he called them "a conspiracy against the public", and Ann-Robert-Jacques Turgot, when he told the King of France: "I do not believe that one can seriously and in good faith hold that these guilds, their exclusive privileges, the barriers they impose to work, emulation, and progress in the arts, are of any utility. ... The total removal of the obstacles that this system imposes on industry and on the poor and laborious sections of your subjects [is] one of the greatest steps to be taken towards the betterment, or rather the regeneration, of the realm". ...
Modern scholars are also deeply divided on guilds. Some claim that guilds were so widespread and long-lived that they must have generated economic benefits. They might, for example, have solved information asymmetries between producers and consumers, overcome imperfections in markets for human capital, created incentive favoring innovation, put pressure on governments to be business-friendly, or generated social harmony by reducing competition, conflict, and inequality. Other scholars take a darker view. Guilds, they hold, were in a position to extract benefits for their own members by acting as cartels, exploiting consumers, rationing access to human capital investment, stifling innovation, bribing governments for favours, harming outsiders such as women, Jews, or the poor, and redistributing resources to their members at the expense of the wider community. 
As this book will show, my own reading of the evidence is that a common theme underlies guilds' activities: guilds tended to do what was best for guild members. In some cases, what guilds did brought certain benefits to the broader public. But overall, the actions guilds took mainly had the effect of protecting and enriching their members at the expense of consumers and non-members; reducing threats from innovators, competitors, and audacious upstarts; and generating sufficient rents to pay off the political elites that enforced the guilds' privileges and might otherwise have interfered with them. 
For an incomplete and appetizer-sized portion of the arguments presented in the book, potentially interested readers might start with Ogilvie's article, "The Economics of Guilds," published in the Fall 2014 issue of the Journal of Economic Perspectives (28:4, pp. 169-92) and freely available online, like all JEP articles, from the American Economic Association. From the abstract of the JEP article: 
Occupational guilds in medieval and early modern Europe offered an effective institutional mechanism whereby two powerful groups, guild members and political elites, could collaborate in capturing a larger slice of the economic pie and redistributing it to themselves at the expense of the rest of the economy. Guilds provided an organizational mechanism for groups of businessmen to negotiate with political elites for exclusive legal privileges that allowed them to reap monopoly rents. Guild members then used their guilds to redirect a share of these rents to political elites in return for support and enforcement. In short, guilds enabled their members and political elites to negotiate a way of extracting rents in the manufacturing and commercial sectors, rents that neither party could have extracted on its own. First, I provide an overview of where and when European guilds arose, what occupations they encompassed, how large they were, and how they varied across time and space. I then examine how guild activities affected market competition, commercial security, contract enforcement, product quality, human capital, and technological innovation. The historical findings on guilds provide strong support for the view that institutions arise and survive for centuries not because they are efficient but because they serve the distributional interests of powerful groups.
Of course, the issues raised by the medieval guilds have continuing economic relevance. There are continuing efforts to reduce competition, through method ranging from occupational licensing to trade tariffs, always based on the claim that setting the stage for a certain group of producers to receive higher profits is actually in the interest of society as a whole. This broad argument is probably true in a few cases: for example, patents restrain competition for a period of time, but by allowing innovators to earn higher profits they also provide incentives for innovation.

But in many cases, including guilds, a cycle forms in which government helps certain producers receive higher profits, and then a share of those profits goes to  helping government officials reach the conclusion that favoring one set of producers over consumers and other producers is a socially important goal.

Monday, February 11, 2019

Why US Financial Regulators Are Unprepared for the Next Financial Crisis

The Great Recession from 2007-2009 represented a toxic mixture of failures by market participants and financial regulators. The Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 patched some of the holes. but not nearly all of them. At least, that's the conclusion I reach from a three-paper "Symposium on Financial Stability Regulation" in the Winter 2019 issue of the Journal of Economic Perspectives. (Full disclosure: I have worked as Managing Editor of JEP since the first issue back in 1987, so I am perhaps predisposed to find its articles persuasive.) The papers are:
To understand the underlying perspective here, you need to think about recessions in two parts. All grown-ups know that bad things are going to happen to economies from time to time: oil price shocks, trade shocks, price bubbles in stock markets or housing markets, and so on.  If an economy is reasonably resilient, any resulting recessions can be fairly mild and brief. On the other side, if an economy and its financial sector is fragile, with high levels of debt that often need to be rolled-over and refinanced on a short-term basis, then a recession that could otherwise have been fairly mild turns into a Great Recession.

From this perspective, the role of financial regulators goes beyond the traditional tasks of looking at individual financial institutions to make sure they are reasonably solvent and are providing timely and accurate information to investors. For some years now, financial regulators have been talking about "macroprudential" regulation (for example, here and here), which goes beyond looking at individual financial institutions to see whether the financial system as a whole is robust. The idea is to avoid the mistake of looking at individual trees, while missing risks that involve the entire forest. This view recognizes that recessions will continue to happen, but hopes that with robust financial system, they will not mushroom into another Great Recession.

In the context of the Great Recession, the team of Aikman, Bridges, Kashyap, and Siegert argue that if US financial regulators had the legal authority and the foresight to take steps to protect the overall robustness of the US financial system in the years before 2008, the Great Recession would have been only one-third or one-fourth as large. They write: "Our diagnosis centers on two overlapping but distinct vulnerabilities: the increase in leverage and short-term funding at financial intermediaries, and the build-up in indebtedness in the household sector. These factors, we argue, can account for around two-thirds to three-quarters of the fall in US GDP that followed the financial crisis."

They describe what macroprudential policy tools would have been needed to address these issues. For example, at least in theory a government regulator could have required that mortgage lenders impose certain loan-to-income rules, to hold down on the rise in household debt. Or at least in theory, a  government regulator could have imposed rules to prevent investment banks from relying so heavily on extremely short-term borrowing that needed to be rolled over every day--which made them highly vulnerable when that borrowing was not rolled over. However, they point out that these changes were not part of the power given to regulatory authorities by the Dodd-Frank legislation They write:
We argue that the US Financial Stability Oversight Council would likely make little difference were we to experience a rerun of the factors that caused the last crisis. It has no macroprudential levers under its direct control, and not all of its members have mandates to protect financial stability. ... And given the role played by loosely regulated nonbank financial institutions prior to the last crisis—and the continuing evolution of the financial system—a successful macroprudential intervention would likely require political backing to be nimble in widening the perimeter of regulation to capture such institutions. More generally, such a regulator would have to be fairly aggressive in using its powers. Given the novelty of these powers, there is no clear evidence on whether such forceful interventions would be realistic were risks to escalate again. ...
As one example of the powers that US regulators do not have:
After the crisis, the Dodd–Frank Act did ban certain types of mortgages, such as interest-only mortgages or those with negative amortization. But it left the question of minimum down-payment restrictions to a group of six regulators involved in housing, which ultimately opted against introducing such a requirement. While risks in the housing market have significantly declined since the crisis, average loan-to-value ratios on mortgages are not lower than they were in the early 2000s. Furthermore, no US regulator has the ability to impose loan-to-income requirements, even if the Financial Stability Oversight Council wished to recommend this action. ... Moreover, the Fed lacks authority over many parts of the financial system and has no tools that can be used to tackle household debt vulnerabilities. A June 2015 “war game” exercise conducted by four Reserve Bank presidents concluded that the Fed had insufficient macroprudential powers to address a build-up in risks that resembled the earlier financial crisis. Also, Fed officials have cast doubt on whether its mandate permits it to use monetary policy to act against a build-up in financial stability risks.
Thus, Aikman, Bridges, Kashyap, and Siegert are pointing out that financial regulators are unprepared for a literal rerun of the financial crisis that already occurred. The regulators also remain unprepared for financial crises that arise form other sources or in other forms.

For example, Daniel Tarullo points out in his essay that most of the regulatory attention has focused on banks. but potential dangers remain in the rest of the financial system. Tarullo writes:
Within the perimeter of prudentially regulated banking organizations, post-crisis financial regulation has made considerable strides, though liquidity regulation needs more work and capital requirements for the biggest banks should probably be somewhat higher.  ... While there is at least a chance for maintaining the progress toward more resiliency for the largest banks, it is considerably harder to conjure up a benign outcome with respect to financial activity that occurs outside the perimeter of banking organizations. Recycled or new forms of shadow banking will almost surely increase over time, whether from existing nonbank financial firms or from new fintech (financial technology) entrants. Some of these will present risks to financial stability. 
For an example of one set of shadow banking issues, Amit Seru argues that 'Regulation of the Mortgage Market Must Consider Shadow Banks" in a Policy Brief written for the Stanford Instituted for Economic Policy Research (December 2018). As he notes: " Mortgage lending in this country is highly segmented and traditional banks represent only an increasingly small part of the story. For many decades, banks have competed with independent mortgage companies that don’t take deposits and typically don’t have brick-and-mortar branches, a group that can be called `shadow banks.'” This figure shows that the share of mortgage lending that doesn't come from banks is over half and rising.

The mortgages from these independent companies are then bundled together into financial securities, which are in turn sliced and diced into pieces and resold to investors (including banks, pension funds, insurance companies, hedge funds, money market funds, and others). Because the financial reforms have focused so heavily on banks, they do not delve into the potential system risks from the nonbanks.

For other examples, Darrell Duffie discusses in his JEP essay "the run-prone designs and weak regulation of the markets for securities financing and over-the-counter derivatives." For example, one rule change is that there is now strong encouragement for financial derivatives to be bought and sold through central clearinghouses--but there has been little attention to the risks that might be accumulated in these clearinghouses. If a clearinghouse seemed close to failing, and as a result it appeared that many derivatives contracts could fail or go into limbo for a time, the effects on fhe financial system could be nasty. Duffie writes:
A key change is the increased use of central clearing, which was directly mandated in post-crisis regulation and further encouraged by new regulatory capital requirements that, in effect, expressed a preference for central clearing. A central counterparty (CCP), also known as a clearinghouse, enters a derivatives trade as the buyer to the original seller, and as the seller to the original buyer. In this way, original counterparties become insulated from each other’s default risk—provided of course that the clearinghouse meets its own obligations. Central clearing also improves the transparency of derivatives positions and enforces uniform collateral practices that are more easily supervised by regulators. ...
There do remain, however, important concerns over the ability to resolve the failure of central counterparties, which have become enormous concentrations of risk under post-crisis regulations. If a clearinghouse has insufficient resources to manage the default of the derivatives obligations of a clearing member, the consequences could be catastrophic, now that hundreds of trillions of derivatives have been cleared by a small number of systemically important central counterparties. The default management resources of the central counterparty consist primarily of the margins provided by clearing members against their positions, and by a default fund to which all clearing members contribute. If the initial margin of a failed clearing member is not enough to cover the losses, the default fund is then applied. If the clearinghouse burns through both of these paid-in default management resources, and a small layer of its own capital, it then has the contractual right to stop paying clearing members the amounts otherwise due on their derivatives, even to the point of “tearing up” their derivatives positions. In the worst scenarios, the cessation of payments to clearing members and tear-ups would be catastrophic, and contagious. The largest clearing members are generally also large members of other central counterparties. This tail contagion risk is subject to regulatory stress tests and ultimately to regulations that could trigger a failure resolution process for central counterparties. However, actual implementable plans for the failure resolution of clearinghouses have still not been designed, at least in the United States...
In November 2018, the Federal Reserve started publishing a Financial Stability Report, with lots of information about various possible sources of financial risk in the economy,  as well as a Supervision and Regulation Report about trends and patterns in these areas. My general sense is that there aren't any major systematic financial risks threatening the US economy right now. But one hopes that financial regulators can be proactive, rather than reactive, to risks that could easily emerge in the future.

Friday, February 8, 2019

Building Connections with Active Labor Market Policies

"Passive" labor market policies involve paying money to the unemployed, like with unemployment insurance. "Active" labor market policies involve a range of programs to assist the unemployed with finding jobs. In both categories, the US has long lagged well behind other high-income countries. Chad P. Bown and Caroline Freund review the evidence in "Active Labor Market Policies: Lessonsfrom Other Countries for the United States" (Peterson Institute for International Economics, January 2019. 19-2).

Here's the difference in spending on passive and active labor market policies across countries. Notice that the US is second from the left, above only Mexico in this comparison group of OECD countries.
Not all active labor market policies are created equal. As different policies have been used and then studied in different countries, a body of evidence has built up that is overviewed by Bown and Freund. They write:
"The evidence documented in this paper shows that many other countries deploy “active” labor market policies (ALMPs) that have been more effective than those in the United States. Programs in other countries under review have improved the possibilities of workers and firms matching up with each other’s needs, and when these efforts have fallen short, governments have sometimes created jobs in the face of intractable local conditions. The research demonstrates that job placement services, training and education, wage subsidies, and other adjustment policies have been proven effective in helping workers find employment and stay in the job pool. Although public works programs and direct job creation have also been tried to address the problem, these programs tend to be ineffective in helping workers over the long run. ...
The most common ALMPs are placement services (public employment services [PES] and administration), training, employment incentives, and direct job creation. ...  There is significant variation across the major economies, with the United Kingdom and Germany relying largely on job placement services; Austria, Finland, and Denmark targeting training; Luxembourg and Sweden offering employment incentives; and Hungary, France, and Korea using direct job creation as their main form of assistance.
Here's a table from the authors summarizing the state of knowledge about active labor market policies.
There's a lot of talk in the US about problems faced by workers who have a hard time finding jobs, or who are displaced from their jobs. The menu of policy responses at this point seems to involve either: blame it all on the Chinese and impose tariffs, or have the government guarantee everyone a job. I view both of these options as posturing. Active labor market policies certainly aren't the only step toward building connections between US workers and potential employers, but they could be a useful step. While I don't think such programs would pay for themselves, a substantial part of the cost could be covered by the lower need for other government payments like unemployment insurance, disability, Medicaid, and other programs. Bown and Freund write: 
The United States currently spends about 0.1 percent of GDP on active labor market policies, compared with an average of 0.5 percent of GDP in 31 other OECD countries. Bringing the United States to the average could help stem the decline in labor force participation, return millions of working-age Americans to employment, supporting their well-being and US economic growth.
I try to beat the drum for active labor market policies every now and then. Some previous posts include:

Thursday, February 7, 2019

How to Reduce Health Care Costs?

The US spends about 18% of GDP on health care. Other high-income countries spend an average of about 11%, Thus, the Society of Actuaries and Henry J. Kaiser Family Foundation have created Initiative 18/11 to consider ways of holding down US heath care spending. A first report from the initiative, "What Can We Do About the Cost of Health Care?" (January 2019), doesn't yet offer proposals for action. But it offers a useful sense of what many of the main targets are likely to be of any serious effort to reduce healthy care costs. Here are some of my own reactions and takeaways from the report.

Although the report doesn't emphasize this point, it's worth noting that 18-11=7, and with a US GDP of about $20 trillion, 7% is $1.4 trillion. If you find yourself wondering why other countries can apparently afford improvements in physical infrastructure or higher support for education or higher social benefits of certain kinds,  part of the reason is that a much lower level of their social resources is going to health care spending. If you wonder why your paycheck seems to go up so slowly, part of the reason is that your employer keeps paying more for you health insurance. My point here isn't that a substantial share of US health care spending is wasteful or even harmful, although that does seem to be true. It's just that output going to health care has a tradeoff of less output available for other uses--even when some of those other uses might do more to improve health.

When thinking about cutting health care spending, and obvious approach is to look at how the money is being spent, and the bulk of health care spending is on those with multiple chronic conditions. The Kaiser report notes:
"Remarkably, 86 percent of health care spending is for patients with one or more chronic conditions—conditions expected to last three months ... Among the chronic population, people with more than one condition account for 71 percent of total spending. The cost of chronic diseases goes far beyond the direct amounts spent on these diseases. In the United States, seven out of every 10 deaths are caused by chronic diseases each year. There are indirect costs through lost productivity and an unmeasurable loss in the quality of life and the loss of ability to perform activities of daily living, such as bathing and eating. For adults, the most prevalent conditions are uncontrolled hypertension (uncontrolled blood pressure) and hyperlipidemia (high cholesterol and high triglycerides). For children, the most common conditions are allergies and asthma."
One way of thinking about chronic conditions is that if they are managed properly (medicine, diet, exercise. whatever is needed),  then health care costs are usually low. But if such conditions are not not managed properly, very expensive episodes of hospitalization become likely.

For example, just looking at noncompliance with taking prescriptions drugs, the report notes:
In a 2011 Consumer Reports survey, one of the leading complaints among primary physicians is that patients do not take the doctor’s advice or follow treatment. For example, although 3.8 billion prescriptions are written every year, more than 50 percent of them are not taken or are taken incorrectly. The cost of noncompliance has been estimated at $290 billion. Also, 125,000 deaths each year are attributed to poor medication compliance.
Interestingly, the report doesn't make an argument that Americans overall live less healthy lifestyles than those in other high-income countries. Yes, obesity is bigger problem in the US. But compared to other high-income countries, the US has a smaller share of smokers and a lower share of elderly. Thus, taken as a whole, it's not clear that US lifestyles and demographic factors are less favorable than other high-income countries.

The report is also bracingly honest about what can be accomplished by going after "indirect" costs. The report notes:
"In its simplest form, the total cost of health care has two components: the direct cost of care and the indirect expenses needed to develop systems and administer the program. According to national health expenditures reports, indirect expenses have been around 15 percent of total spending for more than 25 years. Currently, 8 percent of the total is associated with costs related to administering a program, such as billing and claims payments. The remaining costs are associated with other indirect services, such as research, public health and infrastructure."
Let's say for the sake of argument that we could agree on steps that would have the effect of cutting these indirect expenses from the 15% level of the last 25 years by half, with no effect on the quality of care actually received. Sounds good to me! If we can do it, it certainly seems worth doing. But with health care spending rising at about 4% per year, these cost reduction savings would be cancelled out in about two years--at which point we would face exactly the same health care cost problem that we do now. This is of course not an argument against finding ways to cut health care administrative costs. But it suggests that such changes are only a short-term palliative for the long-term of health care costs. It's certainly not going to get the US from spending 18% of GDP on healthc are to 11%.

The US pays more for health care compared with other countries not because the US is sicker, but because the US pays higher prices for health care services. The report notes: "For example, a 2018 Journal of the American Medical Association (JAMA) study concluded that the major drivers of the increase in health care costs were due to the `prices of labor and goods, including pharmaceuticals, and administrative costs.' They also noted that utilization rates in the United States were similar to those in other countries."

The specific study is "Health Care Spending in the United States and Other High-Income Countries," by Irene Papanicolas, Liana R. Woskie, and Ashish K. Jha (JAMA, March 13, 2018). From the "findings of that study:
The US did not differ substantially from the other countries in physician workforce (2.6 physicians per 1000; 43% primary care physicians), or nursing workforce (11.1 nurses per 1000). The US had comparable numbers of hospital beds (2.8 per 1000) but higher utilization of magnetic resonance imaging (118 per 1000) and computed tomography (245 per 1000) vs other countries. The US had similar rates of utilization (US discharges per 100 000 were 192 for acute myocardial infarction, 365 for pneumonia, 230 for chronic obstructive pulmonary disease; procedures per 100 000 were 204 for hip replacement, 226 for knee replacement, and 79 for coronary artery bypass graft surgery). Administrative costs of care (activities relating to planning, regulating, and managing health systems and services) accounted for 8% in the US vs a range of 1% to 3% in the other countries. For pharmaceutical costs, spending per capita was $1443 in the US vs a range of $466 to $939 in other countries. Salaries of physicians and nurses were higher in the US; for example, generalist physicians salaries were $218 173 in the US compared with a range of $86 607 to $154 126 in the other countries.
This report from Kaiser Society of Actuaries and Kaiser Foundation the is about setting the stage for further discussion, not about concrete recommendations. While such discussions are certainly needed, I confess that the hints about possible solutions don't fill me with great hope. There's talk about how future health care technologies might be cheaper and money-saving, rather than expensive and expenditure-increasing. Maybe! There's talk about how certain kinds of budgeting and incentives might focus more on improving health outcomes, and thus reduce the need for care. Sounds good!

But I feel as if I've been hearing similar arguments for several decades, about how managed care would alter incentives of health care providers, and new technologies might help drive down costs. Across the high-income countries, there does seem to have been slower growth in the rate of health care spending starting back around 2005.  But with all of that said, the fact remains that the US is spending 18% of GDP on health care.

As health care economists like to note, every dollar of US health care spending is income to someone. Any steps that reduce the income received by someone will lead to protests. In a broad social sense, reducing health care spending from 18% to 11% of GDP would involve a very large shift of (mostly) well-paid workers to other jobs, with industries that provide supplies for health care receiving less revenue, and facilities devoted to health care being shifted to other uses. The build-up of US health care spending to 18% of GDP has taken decades, and a substantial reduction from that level will involve disruptive and controversial changes. 

Wednesday, February 6, 2019

Some Puzzles About Asset Returns in the Long Run

It can be hard to draw broad lessons about macroeconomics from the experience of one country alone, or from the experience of one or two recessions. Thus, a group of researchers including Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, and Alan M. Taylor have been working to compile macroeconomic and financial data for 16 high-income countries going back to 1870.  Alan Taylor provides a readable overview of several puzzles that emerge from the long-run financial data in "The Rate of Return on Everything" (NBER Digest, December 2018, pp. 20-23).

(The detailed research behind this short article is available as National Bureau of Economic Research Working Paper #24112: Ò. Jordà, K. Knoll, D. Kuvshinov, M. Schularick, and A. Taylor, "The Rate of Return on Everything, 1870–2015," December 2017. It's also available as a Centre for Economic Policy Research Discussion Paper #12509: Jordà, O, K Knoll, D Kuvshinov, M Schularick, and A M Taylor (2017), “The Rate of Return on Everything, 1870–2015.” A short readable overview of the work that is very similar to the version I'm referring to here, with the same title but listing  Òscar Jordà, Katharina Knoll, Dmitry Kuvshinov, Moritz Schularick, Alan Taylor as the authors appeared at the VOX website on January 2, 2018).

#1 The Housing Puzzle

In general, economists would expect that assets with more risk--that is, more likely to rise or fall over time--will tend to have higher returns on average. From the standpoint of investors, the higher returns are needed to make up for the higher risk. This logic suggests that over the long run, a risky asset with volatile prices like corporate stock should have a higher average rate of return than a less risky asset with less volatile prices like housing. But that doesn't seem to be true. The blue line shows returns to housing, while the black line shows returns to corporate stock across the 16 countries in this sample.. Corporate stock is more volatile, but the average rates of return are quite similar.


Why might this pattern hold true? One possibility is that the risks for housing are higher than they at first appear, because it's harder to diversify the risks of owning housing, and perhaps also because it's harder to buy and sell housing quickly or in incremental chunks when prices change. But these factors don't seem nearly enough to explain the housing puzzle.

#2 The "Safe Rate" Puzzle

A lot of theories in finance and macroeconomics start with idea of a "safe" investment that pays a low rate of return but also has low risk. A common example would be investing in US Treasury debt, where the risk of default is near-zero. The theory then discusses how the safe assets might be combined with riskier assets. The puzzle is that "safe" assets like government debt actually can have quite volatile rates of return, once factors like inflation are taken into account. Here's a figure showing international returns on government debt.
For a concrete example, think about US experience since the 1970s. When inflation went way up in the 1970s, it mean that those who were holding government debt paying a low fixed rate were experiencing negative real returns for a time. The nominal rates paid on government debt rose by the early 1980s, but then when inflation declined substantially, those holding the "safe" asset for a time had substantially positive real returns for a time. Since then, a combination of declining nominal interest rates and low inflation have meant a steady decline in the real rate of return on "safe" assets. In real terms, the "safe" rate doesn't look all that safe.

Indeed, if you look at the "risky" assets like housing and corporate stock, but focus on moving averages over any given ten-year period rather than annual returns, the returns on the "risky" assets actually look rather stable.

#3 The r > g Question

If wealthy people can invest and receive a rate of return r, while the economic grows at a slower rate g, then wealth might grow faster than the economy over time (at least if wealthy people don't spend all of the returns on wealth), leading to greater inequality of wealth. This was a common interpretation of the work of Thomas Piketty in Capital in the Twenty-First Century on causes of income and wealth inequality a few years back. The findings here are that returns on risky assets like stocks and housing are often twice as large as rates of economic growth, or more.

But interestingly, Piketty himself doesn't view this r>g dynamic as central to the processes that generate wealth inequality. In an article her wrote for the Winter 2015 issue of the Journal of Economic Perspectives, "Putting Distribution Back at the Center of Economics: Reflections on Capital in the Twenty-First Century," Piketty commented:
"[T]he way in which I perceive the relationship between r > g and wealth inequality i soften not well-captured in the discussion that has surrounded my book—even in discussions by research economists. ... I do not view r > g as the only or even the primary tool for considering changes in income and wealth in the 20th century, or for forecasting the path of income and wealth inequality in the 21st century. ... I certainly do not believe that r > g is a useful tool for the discussion of rising inequality of labor income: other mechanisms and policies are much more relevant here, for example, the supply and demand of skills and education.  ...  The gap between r and g is certainly not the only relevant mechanism for analyzing the dynamics of wealth inequality. As I explained in the previous sections, a wide array of institutional factors are central to understanding the evolution of wealth. Moreover, the insight that the rate of return to capital r is permanently higher than the economy’s growth rate g does not in itself imply anything about wealth inequality. Indeed the inequality r > g holds true in the steady-state equilibrium of most standard economic models ..."
What are some of the main factors that affect the rise or fall of wealth inequality over time? Examples would include taxes on wealth, the extent to which wealth is saved or consumed, and even the birth and death rates of the population, which affects how long concentrations of wealth will stay together and how many slices they will be divided into when passed to a new generation. There are questions about the extent to which whether the new fortunes being created in businesses around the globe will displace earlier fortunes, and whether the new fortunes will be long- or short-lived. There are also events of history like World Wars, and events of politics like surges of populist sentiment. For more on these topics, see "Piketty and Wealth Inequality" (February 23, 2015), or the four-paper symposium on these issues in the Winter 2015 issue of the Journal of Economic Perspectives.