CONVERSABLE ECONOMIST

Putting a Value on State Parks

2012-02-27T12:01:00.001-06:00

In the latest issue of Resources magazine, from Resources for the Future, Juha Siikamäki inquires into "State Parks: Assessing Their Benefits."

"Each year, more than 700 million visits are made to America’s 6,600 state parks. ... Using conventional economic approaches to estimate the value of recreation time combined with relatively conservative assumptions, the estimated an annual contribution of the state park system is around $14 billion. That value is considerably larger than the annual operation and management costs of state parks."

Siikamäki's approach goes like this. Start with estimates of how people use their time. Combining data from a number of time use surveys over time provides this overall pattern for hours of nature recreation per person.

This data on time use can be broken down to the state level. Siikamäki then also created a data base on how state parks have changed over time. "Between 1975 and 2007, about 3,000 new parks totaling about 2 million acres were established in the United States, increasing the total area of the state park system by nearly one-quarter." It's then possible to try to determine the relationship between how changes in state parks affect the how nature recreation time changes in a certain state--using statistical methods to try to hold constant other possible confounding factors.

The Resources article is a highly readable overview of this work. Those who want the gory details need to turn to Siikamäki's more technical article in article in the Proceedings of the National Academy of Sciences, August 23, 2011, "Contributions of the US state park system to nature recreation." Here's the result of the calculation:

"This expansion of the state parks is estimated to contribute about 9 percent of all current time use for nature recreation. Overall in the United States, this equals annually about 600 million additional hours of nature recreation, or about 2.7 hours of nature recreation per capita. ... Valuing recreation time monetarily requires determining the opportunity cost of time. To illustrate the potential magnitude of recreation’s time value, I used a conventional and commonly adopted approach where recreation time is valued at one-third the wage rate. ... Extrapolating from the above results, I estimate about 33 percent of current time use for nature recreation can be attributed to the U.S. state park system. This equals annually about 9.7 hours of nature recreation per capita, or about 2.2 billion hours of nature recreation in total in the United States. The estimated time value of nature recreation generated by the entire U.S. state park system is about $14 billion annually (about $62 per person annually, on average)."

Of course, these results, like all statistical results, need to be handled with care. Even if state parks encourage considerable recreation on average, it is surely still true that some state parks have bigger payoffs while others have smaller payoffs. It could be that states where the citizens had a high demand for nature recreation are also the states that are more likely to add to the state park system--and perhaps the quantity of nature activities would have risen in those states even without the expansion of the state parks. Even if the state parks had not been expanded, people would have done something with their time, so the value of the state parks should be the marginal increase over that alternative use--an inevitably tricky task.

On the other side, by measuring the benefits of state parks purely in terms of recreation benefits leaves out other benefits and thus underestimates total social benefits from state parks. Siikamäki concludes: "Nature recreation represents only a partial assessment of the full range of ecosystem services produced by natural areas. Examples of other potentially relevant ecosystem services include carbon sequestration and storage through biological processes, contributions to surface and groundwater services, and benefits from preserving endangered and threatened species. A full assessment of ecosystem services from state parks should consider these nonrecreation contributions, yielding an even more comprehensive—and presumably larger—estimate of the value of America’s state park system."

Economics (Almost) Never Sleeps

2012-02-27T06:00:00.002-06:00

Catherine Rampell at Economix, the economics blog at the New York Times, reports on "America’s 10 Most Sleep-Deprived Jobs." She writes that Sleepy’s, the mattress chain " hired researchers to analyze data from the National Health Interview Survey to determine which occupations, on average, produce workers who sleep the least and the most. The jobs with the most sleep-deprived work forces are below, starting with the most sleep-deprived at the top:"

Most Sleep-Deprived
6h57m Home Health Aides
7h Lawyer
7h1m Police Officers
7h2m Physicians, Paramedics
7h3m Economists
7h3m Social Workers
7h3m Computer Programmers
7h5m Financial Analysts
7h7m Plant Operators
7h8m Secretaries

My own take is that the sleeplessness of economists is a fact begging for an unsubstantiated and unproveable hypothesis.

Does a miserable economy cause economists to sleep less, as they internalize the pain of others? This seems implausible, because it would require that economists care about others.

Is economics the kind of field that tends to attract those who have trouble sleeping? Perhaps only those who have physical trouble in sleeping can make it through the economics curriculum, while normal sleepers will perpetually be dozing off through the required classes.

Is economics a field that attracts hypercompetitive people who can't sleep because they fear that, somewhere, some other economist might be getting ahead of them? This would also help explain why economists have a tendency to believe that all other economic actors are hypercompetitive, too--they are just projecting their own personalities.

Perhaps the lack of sleep helps to explain why economists have such a difficult time perceiving the reality around them, and thus why their advice is sometimes so weirdly out-of-synch with the actual economy.

And of course, one possible response is: "Who cares why economists are sleeping less? As long as economists are suffering in some way, the sun will shine just a little brighter today."

Further hypotheses are solicited. Send suggestions to <conversableeconomist@gmail.com>.

Government Workers: It's Not the Wages, It's the Benefits

2012-02-24T09:00:00.002-06:00

On average, government worker are paid more than private-sector workers, at both the federal level and at the state and local level. But the comparison is not apples-to-apples. On average, government workers have much higher levels of education and experience. When adjusting for levels of education, it turns out that average wages are very similar for government and private-sector workers. The real advantage that government workers have in their compensation is that they receive noticeably better benefits--especially in their pensions and health benefits after retirement.

The most recent article of my own Journal of Economic Perspectives has an article by Maury Gittleman and Brooks Pierce called "Compensation for State and Local Government Workers." In January, the
Congressional Budget Office published "Comparing the Compensation of Federal and Private-Sector Employees." Here, I'll first summarize some of the main evidence from these studies, and then list some of the main reasons why studies that compare pay of government and private-sector workers can reach such different results.

Numbers of government workers in context

Here's the CBO summarizing patterns in total government employment in recent decades (footnotes and references to figures omitted):

"For the past 30 years, the number of civilians employed by the federal government has hovered around 2 million people. During that period, federal employees have accounted for a declining share of the total U.S. workforce, because employment by the private sector and by other levels of government has grown along with the economy. In 1980, when about 79 million people worked in the private sector and 13 million worked for state or local governments, federal employees made up 2.3 percent of the workforce. By 2010, private-sector employment had reached 111 million and employment by state and local governments had reached 20 million."

Higher Education and Skill Levels for Government Employees

Here are some illustrations of the education differences between government and private-sector workers. From Gittleman and Pierce, here's a table showing average pay and education levels for state government employees, local government employees, and private-sector employees. For example, 39% of private-sector workers have only a high school education, or less education than that. Among state government employees, only 18% have a high school education or less. Conversely, about 10% of private-sector workers have a post-graduate degree, compared with 29% of state government workers.

Here's some evidence from the CBO, making the same point about federal employees. In their data sample, 41% of private sector workers have a high school degree or less, compared with 20% of federal employees. Conversely, 10% of private sector worker have a post-graduate degree, compared with 21% of federal employees.

Similar Pay, Dissimilar Benefits

When comparing pay for state and local government employees, Gittleman and Pierce write:

"Government workers are much more likely to be offered health insurance and retirement plans, and are more likely to enroll in such plans if offered. In addition, public sector plan structures tend to offer more
comprehensive coverage. Public sector health plans tend to require lower employee contributions and have higher employer premiums, and are more likely to come bundled with supplemental dental, vision, or prescription drug plan components. ... [T]he costs per hour worked for the various benefits collected are
much greater in the public sector (about $14) than in the private sector (around $8). Spending on health insurance in the government ($4.30 at the state level and $4.56 at the local level) is more than double that in the private sector ($2.14), while expenditures on retirement and savings are more than triple ($3.18 and $3.37 versus $1.00). ... Paid leave is also more generous in government, more than double the private sector level in state government and more than 50 percent higher in local government."

Overall, Gittleman and Pierce conclude: "After controlling for skill differences and incorporating employer costs for benefits packages, we find that, on average, public sector workers in state government
have compensation costs 3–10 percent greater than those for workers in the private sector, while in local government the gap is 10–19 percent."

In comparing the wages, benefits, and total compensation of federal workers, the CBO report finds:

"Overall, the federal government paid 2 percent more in total wages than it would have if average wages had been comparable with those in the private sector, after accounting for certain observable characteristics of workers. ... On average for workers at all levels of education, the cost of hourly benefits was 48 percent higher for federal civilian employees than for private-sector employees
with certain similar observable characteristics ... The most important factor contributing to differences
between the two sectors in the costs of benefits is the defined-benefit pension plan that is available to most federal employees. ... Overall, the federal government paid 16 percent more in total compensation than it would have if average compensation had been comparable with that in the private sector, after accounting for certain observable characteristics of workers."

Why do comparisons of pay for government and private-sector workers reach varying conclusions?

1) Some comparisons don't adjust for education or skill level of the workers, which means that the comparison will inevitably find that government-sector workers are paid much more on average. But such comparisons are silly. It's a bit like saying that--surprise!--those with a college degree earn more than those without a college degree.

2) Some comparisons look only at wages and skip benefit. Such comparisons leave out a main advantage for government workers, and will tend to find that they are paid about as much as private sector workers.

3) Employees in larger firms tend to be paid more than employees in smaller firms. There are various theories for why this pattern holds true. Perhaps large employers do a better job of screening employees to get those with higher productivity. Perhaps in a large firm there is space for a more specialized division of labor, which leads to more productivity and higher pay for workers in those organizations. Perhaps in large organizations, pay becomes a little more detached from productivity, and workers can claim a larger share of the cash flow running through the organization. Ultimately, the question here is whether a worker who moved between the government and the private sector has a type of skill and expertise that would also lead to higher pay in the private sector--or not. If you adjust for size of employer, then it will look as if government employees should be paid more--because they work for a large employer. If you don't make such an adjustment, then pay for government workers will look relatively higher. The CBO study, for example, found that if one adjusts for size of employer (and education), federal employees get wages that are 2% above private sector workers, but if you don't adjust for size of employer, then federal employees get wages 9% above those of private sector workers.

4) A larger share of public-sector workers are unionized, and we know that unionized workers are paid more than other workers with equivalent skills. Again, the essential question here is whether a being unionized represents a skill set that the worker would take with them into private-sector employment, or not. I think it's more plausible to say that being unionized isn't a a portable "skill set." If a study adjust for unionization, it will tend to find that government workers deserve to be paid more.

5) One problem in comparing government and private sector jobs is that the jobs themselves can be so different. For example, think of jobs in the education sector: Private sector jobs in this area tend to be either with preschool children or with college students and adults, while public-sector jobs in this area tend to be with K-12 students. Conversely, most jobs in sales or manufacturing are in the private sector, with very few in the public sector. If the researcher tries to adjust for the exact kind of job, comparing public and private-sector workers become difficult or even impossible. But if the researcher doesn't adjust in some way for the sector of the economy, you end up comparing workers who are in potentially quite different industries. An in-between approach here is to adjust for broad sectors--like "education" or "services"--but not to try to adjust for highly specific job categories.

6) Pay scales are more compressed in government. As emphasized in the CBO study, workers with lower levels of skill are on average paid more in government work than in the private sector, but worker with higher levels of skill are on average paid less. An overall comparison between all government and all private-sector workers will miss this distinction.

7) Job are more than wages and benefits. For example, government jobs in the Great Recession and its aftermath have tended to be more secure than private-sector jobs, in the sense of a lower chance of being laid off and a lower chance of pay cuts. Jobs have other characteristics, too. Certain jobs pose greater health risks, like mining and manufacturing in the private sector, or police and firefighters in the civilian public sector. I'm not aware of studies that make a serious effort to value and adjust for these kinds of factors.

In short, when looking at a study comparing government and private-sector pay, run down this checklist of
seven points and it will tell you something about whether the study is likely to be leaning in one direction or another.

For-Profit Higher Education

2012-02-23T06:00:00.010-06:00

It has been common for some years for politicians and educators to vow that America will greatly increase the proportion of students attending college. For example, in a speech to Congress on February 24, 2009, President Obama said: "I ask every American to commit to at least one year or more of higher education or career training. This can be community college or a four-year school; vocational training or an apprenticeship. But whatever the training may be, every American will need to get more than a high school diploma. And dropping out of high school is no longer an option. It’s not just quitting on yourself, it’s quitting on your country – and this country needs and values the talents of every American. That is why we will provide the support necessary for you to complete college and meet a new goal: by 2020, America will once again have the highest proportion of college graduates in the world."

But how will the United States structure and pay for this expanded college attendance? For example, one policy approach would be to plan for dramatic expansion of enrollment in existing state colleges and universities, but with very tight state budgets, this isn't happening to any great extent. Instead, the answer that seems to be evolving, without ever really being enunciated and debated, is that the federal government will finance a dramatic expansion of higher education through an expansion of student loans, and because of limits on the number of slots at existing public colleges and universities, many students will take those loans to the for-profit higher education sector. In the Winter 2012 issue of my own Journal of Economic Perspectives, freely available on-line courtesy of the American Economic Association, Deming, David J., Claudia Goldin, and Lawrence F. Katz discuss the tradeoffs of this choice in "The For-Profit Postsecondary School Sector: Nimble Critters or Agile Predators?"

As the authors point out, the time since 2000 is "a period when enrollment in the for-profit sector tripled while enrollment for the rest of higher education increased by just 22 percent. The solid dark line shows
that the fraction of fall enrollments accounted for by the for-profits increased from 4.3 percent in 2000 to 10.7 percent in 2009." They point out that "almost 90 percent of the increase in for-profit enrollments during the last decade occurred because of the expansion of for-profit chains," where a "chain" is defined as an institution that operates across states or has more than five branches within a state."

Along with the flexibility to expand enrollments, for-profit higher education has shown considerable flexibility in teaching groups not well-served by traditional higher education. "African Americans
account for 13 percent of all students in higher education, but they are 22 percent of those in the for-profit sector. Hispanics are 11.5 percent of all students but are 15 percent of those in the for-profit sector. Women are 65 percent of those in the for-profit sector. For-profit students are older: about 65 percent are 25 years and older, whereas just 31 percent of those at four-year public colleges are, and 40 percent of those at two-year colleges are." In addition, for-profits are typically non-selective institutions, requiring only a high school diploma or a GED certificate.

For-profit institutions also have been quite flexible in providing the kinds of career-oriented classes that many students want: "For-profit programs typically are not meant to prepare students to continue to another form of higher education, as is the case with most community colleges. Rather, the for-profits almost always offer training for a vocation or trade.... Although 5 percent of all BAs are granted by for-profit institutions, 12 percent of all BAs in business, management, and marketing are. Other large for-profit BA programs are in communications (52 percent of all BAs in communications are granted by for-profits), computer and information sciences (27 percent), and personal and culinary services (42 percent). ... Among AA degrees just two program groups—business, management, and marketing, and the health professions—account for 52 percent of all degrees. In the BA group, the business program produces almost 50 percent of the total. Among certificates granted in the Title IV for-profit sector, health professions and personal and culinary services account for 78 percent of certificate completers."

Of course, there is controversy over for-profit higher education. The big firms that dominate the sector are, well, for-profit, and they tend to pay their executives well and their faculty not-so-well. A high proportion of students at for-profit institutions are financing their studies with debt, and if they don't complete the degree--which can be a big problem at some for-profit institutions--the students are still on the hook for that debt. Total student debt now exceeds the total amount of credit card debt, and will soon top $1 trillion. In their well-balanced essay, Deming, Goldin, and Katz discuss these issues.

But to repeat my earlier point, we have apparently made a social decision that a combination of student loans and for-profit institutions is the primary method by which the United States will raise college admissions. I would like to see a competitive response to the for-profits from public-sector non-profit higher education. I'd love to see the public sector aggressively increasing non-selective enrollments, offering on-line classes and flexible meeting times for nontraditional college students, using technology and nontenured lecturers aggressively to hold down costs, and expanding certificate and degree programs with a focus on what is demanded in the market. This kind of institutional change is undoubtedly difficult. But with a few local exceptions, the public higher education sector is reacting too much much like Kodak when that company was first confronted with low-cost competition for film and then with the change to digital photography--and the firm was too slow to adapt.

I know that for-profit higher education has its warts and flaws. But so far, the not-for-profit higher education sector has not shown that it is serious about being flexible or entrepreneurial in way that can meet the goal of expanding college enrollment.

Same Income, Varying Taxes: ERP #4

2012-02-22T13:00:00.004-06:00

This is the fourth of four posts based on figures from the 2012 Economic Report of the President. For the first post and an overview, start here.

Amid the complexity and confusion of the U.S. income tax code, it's quite possible for people with similar levels of income to pay widely varying level of tax. For illustration, consider the table. The rows of the table divide up the U.S. income distribution into fifths, or quintiles. The last row shows results for the top 1% of the income distribution. For each quintile--and for the top 1%--the columns of the table then tell about the distribution of taxes for that group.

For example, if one looks at the distribution of average tax rates for the bottom quintile, households at the 10th percentile of that distribution have a federal tax rate of -13.7% (that is, they receive refundable tax credits from the government). In the bottom quintile of the income distribution, those at the median pay 5.4% of income in federal taxes. (These calculations include income taxes and payroll taxes.)

Or look at the top 1%. Given the distribution of federal taxes for that group, the household at the 10th percentile of tax payments for this group pays 8.7% of income in federal taxes (presumably due to substantial tax-free investments, or perhaps to carrying forward losses from a previous tax year that count against income in this year). However, a household in the top 1% of the income distribution and the 90th percentile of the tax distribution for this group pays an average federal tax rate of 34.6%.

At least for me, there is something of a tendency when looking at tables like this one to feel as if some of those with high income are paying too little, and some of those with low incomes are paying too much. And maybe that quick reaction is correct. But the tax code has so many rules and provisions and exceptions and situations, that it's s also possible that if I knew the actual details of some of these taxpayers, the outcome would seem fairly reasonable to me.

The broader point here is that when a tax code becomes enormously complex and lengthy, it is also going to allow the possibility of considerable variation in taxes paid even for those with similar incomes. Even if all the individual provisions of such a tax code are defensible (an enormous "if"!), the tax code as a whole is likely to end up appearing arbitrary and unfair.

Job Market Churn is Slowing: ERP #3

2012-02-22T11:00:00.001-06:00

This is the third of four posts based on figures from the 2012 Economic Report of the President. For the first post and an overview, start here.

The U.S. job market has long been famous for its "churn" -- that is, the simultaneously large inflows and outflows out of jobs which suggest a fluid and adjustable labor market. Thus, it's disturbing to observe a long-term trend toward less churn in the U.S. labor market. Here's a figure using the Business Dynamics Statistics from the Bureau of Labor Statistics:

Here's commentary from the Economic Report of the President: "The rates of both gross gains and gross losses have been declining over time. Whereas, on average, 18.2 percent of private-sector jobs in the 1980s were newly created positions in startups or expanding firms, gross job gains fell to 16.8 percent of total private-sector employment in the 1990s and to 15.8 percent between 2000 and 2009 (Figure 6-3). Similarly, gross job losses were slightly more than 16.2 percent of overall private-sector employment in the 1980s but fell to 14.9 percent in the 1990s and then remained largely the same between 2000
and 2009. These secular declines also are apparent when one focuses more narrowly on startups."

Here's a similar pattern from another source: quarterly data from the Business Employment Dynamics (BED) survey.

What explains this drop in job churn over time, and is it a cause for concern? The report says (citations omitted): "Now that researchers have documented the long-term secular slowdown in job gains and losses, the underlying reasons for the slowdown and its implications for the future of the U.S. economy are fast becoming the subject of an active debate. One possible reason for the slowdown in job reallocation is the aging of the population. Older workers may be less likely to become entrepreneurs, and research has documented a positive correlation between worker age and job tenure."

An aging workforce probably is part of the explanation. But one also wonders if there isn't another dynamic at work: for a variety of reasons, it may be getting harder to start up a business in the United States, and harder to be an employer. In turn, workers perceive fewer outside opportunities, and become more likely to stick with their present job. Or perhaps the U.S. labor market is becoming less fluid and adjustable in other ways.

Why Wasn't the Risk of a Housing Price Decline Taken Into Account? ERP #2

2012-02-22T09:00:00.001-06:00

This is the second of four posts based on figures from the 2012 Economic Report of the President. For an overview and the first post, start here.

When I give talks about the causes of the recession, people often shake their heads in disbelief at the thought that few investors were taking the risk of a housing price decline into account. I think this disbelief is a case of 20:20 hindsight. Investors didn't take the risk of a national housing price decline into account because they hadn't seen anything like it before. Here's a figure showing comparing the housing price declines nationwide during the Great Depression, and then comparisons with more local housing price declines in Boston in 1989 and in California in 1990. Sure, investors knew that housing prices could nosedive in a local market, and some were even braced for the possibility of a modest housing price decline nationwide. But for the country as a whole, predicting in 2005 or 2006 that national housing prices would drop much farther and faster than during the Great Depression would have been a prediction outside all historical experience. I admire the clairvoyance of the few who truly saw it coming, but I can't reasonably blame those who didn't.

The evidence does offer some hints that the decline in U.S. housing prices may be just about over. For example, one measure of a price bubble is to look at the ratio of housing prices to rents. When this ratio rises sharply, then it may be a signal that prices are getting out of line. But that ratio has now fallen back to pre-crisis levels. Similarly, the ratio of mortgage value per home-owning household has trended up over time, as the economy has grown. During the housing price bubble, that trend launched like a rocket, but now it has been flat for a few years, and is not too far out of line with the longer-term trend.

At the most basic level, the national average of actual housing prices does seem to have levelled out since early 2009. Indeed, futures markets that were predicting a continued drop in housing prices as of January 2009 have seen housing prices hold up better than expected at that time.

The Relatively Mild U.S. Financial Recession: ERP #1

2012-02-22T06:00:00.002-06:00

I always enjoy looking through the annual Economic Report of the President, but I confess that I impose a couple of rules. I focus almost entirely on the figures and tables, and how they are discussed in the text. I ignore all economic projections for the future, and all comments about specific policies of the current administration. At least for me, this approach is useful in stripping away the politics, and focusing instead on some vivid facts and analysis. I'll offer four posts today using figures from the 2012 ERP:

The Relatively Mild U.S. Financial Recession
Why Wasn't the Risk of a Housing Price Decline Taken Into Account?
Job Market Churning is Slowing
Same Income, Varying Taxes

The Great Recession has been brutally deep, and the aftereffects seem likely to persist for at least five years after it officially ended in June 2009 (by the dating of the National Bureau of Economic Research). But in the context of financial recessions in other countries, the U.S. experience actually doesn't look so bad. Here's a table comparing the behavior of real GDP across 14 recessions associated with financial crises. The average peak-to-trough decline is a drop of 10.2%; in the U.S., the decline was 5.1%. The average length of these recessions was 6.6 quarters; in the U.S., peak-to-trough was 6 quarters.

The rise in U.S. unemployment rates has been similar to that in other financial crisis in this comparison group, but believe it or not, somewhat less prolonged. The next table shows the rising U.S. unemployment rate over time from the business cycle peak compared with the average of the other countries in the comparison group. The figure after that shows a country-by-country comparison of the total rise in the unemployment rate.

Even the pattern of the U.S. economic recovery, sluggish as it has been, has basically followed the time profile of the 14 comparison countries.

Sometimes people talk about the depth of the Great Recession as if it really couldn't have been any worse--as if the very depth of the recession and the sustained proves that macroeconomic policy to counter the recession was necessarily ineffective. The conclusion does not necessarily follow, of course. To me, these comparisons offer some (admittedly impressionistic) evidence that the monetary policy steps taken by the federal government--the huge budget deficits on the fiscal side, along with the near-zero federal funds interest rates and quantitative easing on the monetary side--did have beneficial effects. The Great Recession and its aftermath have been gruesome, but without the aggressive fiscal and monetary policy response, it could have been even worse.

Winter 2012 Journal of Economic Perspectives

2012-02-21T11:00:00.001-06:00

The Winter 2012 issue of my own Journal of Economic Perspectives is now up on the web. Courtesy of the American Economic Association, this issue and indeed back issues of the journal all the way back through 1994 are freely available on the web. I'll be blogging about some of these papers over the next week or so, but for now, here's the table of contents and and abstract for each article.

Symposium: Energy Challenges

"Is There an Energy Efficiency Gap?" by Hunt Allcott and Michael Greenstone

Many analysts of the energy industry have long believed that energy efficiency offers an enormous "win-win" opportunity: through aggressive energy conservation policies, we can both save money and reduce negative externalities associated with energy use. In 1979, Daniel Yergin and the Harvard Business School Energy Project estimated that the United States could consume 30 or 40 percent less energy without reducing welfare. The central economic question around energy efficiency is whether there are investment inefficiencies that a policy could correct. First, we examine choices made by consumers and firms, testing whether they fail to make investments in energy efficiency that would increase utility or profits. Second, we focus on specific types of investment inefficiencies, testing for evidence consistent with each. Three key conclusions arise: First, the evidence presented in the long literature on the subject frequently does not meet modern standards for credibility. Second, when one tallies up the available empirical evidence from different contexts, it is difficult to substantiate claims of a pervasive Energy Efficiency Gap. Third, it is crucial that policies be targeted. Welfare gains will be larger from a policy that preferentially affects the decisions of those consumers subject to investment inefficiencies.
Full-Text Access

"Creating a Smarter U.S. Electricity Grid," by Paul L. Joskow

This paper focuses on efforts to build what policymakers call the "smart grid," involving 1) improved remote monitoring and automatic and remote control of facilities in high-voltage electricity transmission networks; 2) improved remote monitoring, two-way communications, and automatic and remote control of local distribution networks; and 3) installation of "smart" metering and associated communications capabilities on customer premises so that customers can receive real-time price information and/or take advantage of opportunities to contract with their retail supplier to manage the consumer's electricity demands remotely in response to wholesale prices and network congestion. I examine the opportunities, challenges, and uncertainties associated with investments in "smart grid" technologies. I discuss some basic electricity supply and demand, pricing, and physical network attributes that are critical for understanding the opportunities and challenges associated with expanding deployment of smart grid technologies. Then I cover issues associated with the deployment of these technologies at the high voltage transmission, local distribution, and end-use metering levels.
Full-Text Access

"Prospects for Nuclear Power," by Lucas W. Davis

Nuclear power has long been controversial because of concerns about nuclear accidents, storage of spent fuel, and how the spread of nuclear power might raise risks of the proliferation of nuclear weapons. These concerns are real and important. However, emphasizing these concerns implicitly suggests that unless these issues are taken into account, nuclear power would otherwise be cost effective compared to other forms of electricity generation. This implication is unwarranted. Throughout the history of nuclear power, a key challenge has been the high cost of construction for nuclear plants. Construction costs are high enough that it becomes difficult to make an economic argument for nuclear even before incorporating these external factors. This is particularly true in countries like the United States where recent technological advances have dramatically increased the availability of natural gas. The chairman of one of the largest U.S. nuclear companies recently said that his company would not break ground on a new nuclear plant until the price of natural gas was more than double today's level and carbon emissions cost $25 per ton. This comment summarizes the current economics of nuclear power pretty well. Yes, there is a certain confluence of factors that could make nuclear power a viable economic option. Otherwise, a nuclear power renaissance seems unlikely.
Full-Text Access

"The Private and Public Economics of Renewable Electricity Generation," by Severin Borenstein

Generating electricity from renewable sources is more expensive than conventional approaches but reduces pollution externalities. Analyzing the tradeoff is much more challenging than often presumed because the value of electricity is extremely dependent on the time and location at which it is produced, which is not very controllable with some renewables, such as wind and solar. Likewise, the pollution benefits from renewable generation depend on what type of generation it displaces, which also depends on time and location. Without incorporating these factors, cost-benefit analyses of alternatives are likely to be misleading. Other common arguments for subsidizing renewable power—green jobs, energy security, and driving down fossil energy prices—are unlikely to substantially alter the analysis. The role of intellectual property spillovers is a strong argument for subsidizing energy science research, but less persuasive as an enhancement to the value of installing current renewable energy technologies.
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"Reducing Petroleum Consumption from Transportation," by Christopher R. Knittel

The United States consumes more petroleum-based liquid fuel per capita than any other OECD high-income country—30 percent more than the second-highest country (Canada) and 40 percent more than the third-highest (Luxembourg). The transportation sector accounts for 70 percent of U.S. oil consumption and 30 percent of U.S. greenhouse gas emissions. Taking the externalities associated with high U.S. gasoline consumption as largely given, I focus on understanding the policy tools that seek to reduce this consumption. I consider four main channels through which reductions in U.S. oil consumption might take place: 1) increased fuel economy of existing vehicles, 2) increased use of non-petroleum-based, low-carbon fuels, 3) alternatives to the internal combustion engine, and 4) reduced vehicle miles traveled. I then discuss how these policies for reducing petroleum consumption compare with the standard economics prescription for using a Pigouvian tax to deal with externalities. Taking into account that energy taxes are a political hot button in the United States, and also considering some evidence that consumers may not "correctly" value fuel economy, I offer some thoughts about the margins on which policy aimed at reducing petroleum consumption might usefully proceed.
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"How Will Energy Demand Develop in the Developing World?" by Catherine Wolfram, Orie Shelef and Paul Gertler

Over the next 25 to 30 years, nearly all of the growth in energy demand, fossil fuel use, associated local pollution, and greenhouse gas emissions is forecast to come from the developing world. This paper argues that the world's poor and near-poor will play a major role in driving medium-run growth in energy consumption. As the world economy expands and poor households' incomes rise, they are likely to get connected to the electricity grid, gain access to good roads, and purchase energy-using assets like appliances and vehicles for the first time. We argue that the current forecasts for energy demand in the developing world may be understated because they do not accurately capture growth in demand along the extensive margin, as low-income households buy their first durable appliances and vehicles. Within a country, the adoption of energy-using assets typically follows an S-shaped pattern: among the very poor, we see little increase in the number of households owning refrigerators, vehicles, air conditioners, and other assets as incomes go up; above a first threshold income level, we see rapid increases of ownership with income; and above a second threshold, increases in ownership level off. A large share of the world's population has yet to go through the first transition, suggesting there is likely to be a large increase in the demand for energy in the coming years.
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Symposium: Higher Education

"The For-Profit Postsecondary School Sector: Nimble Critters or Agile Predators?" by David J. Deming, Claudia Goldin and Lawrence F. Katz

Private for-profit institutions have been the fastest-growing part of the U.S. higher education sector. For-profit enrollment increased from 0.2 percent to 9.1 percent of total enrollment in degree-granting schools from 1970 to 2009, and for-profit institutions account for the majority of enrollments in non-degree-granting postsecondary schools. We describe the schools, students, and programs in the for-profit higher education sector, its phenomenal recent growth, and its relationship to the federal and state governments. Using the 2004 to 2009 Beginning Postsecondary Students (BPS) longitudinal survey, we assess outcomes of a recent cohort of first-time undergraduates who attended for-profits relative to comparable students who attended community colleges or other public or private non-profit institutions. We find that relative to these other institutions, for-profits educate a larger fraction of minority, disadvantaged, and older students, and they have greater success at retaining students in their first year and getting them to complete short programs at the certificate and AA levels. But we also find that for-profit students end up with higher unemployment and "idleness" rates and lower earnings six years after entering programs than do comparable students from other schools and that, not surprisingly, they have far greater default rates on their loans.
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"Student Loans: Do College Students Borrow Too Much--Or Not Enough?" by Christopher Avery and Sarah Turner

Total student loan debt rose to over $800 billion in June 2010, overtaking total credit card debt outstanding for the first time. By the time this article sees print, the continually updated Student Loan Debt Clock will show an accumulated total of roughly $1 trillion. Borrowing to finance educational expenditures has been increasing—more than quadrupling in real dollars since the early 1990s. The sheer magnitude of these figures has led to increased public commentary on the level of student borrowing. We move the discussion of student loans away from anecdote by establishing a framework for considering the use of student loans in the optimal financing of collegiate investments. From a financial perspective, enrolling in college is equivalent to signing up for a lottery with large expected gains—indeed, the figures presented here suggest that college is, on average, a better investment today than it was a generation ago—but it is also a lottery with significant probabilities of both larger positive, and smaller or even negative, returns. We look to available—albeit limited—evidence to assess which types of students are likely to be borrowing too much or too little.
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"American Higher Education in Transition," by Ronald G. Ehrenberg

American higher education is in transition along many dimensions: tuition levels, faculty composition, expenditure allocation, pedagogy, technology, and more. During the last three decades, at private four-year academic institutions, undergraduate tuition levels increased each year on average by 3.5 percent more than the rate of inflation; the comparable increases for public four-year and public two-year institutions were 5.1 percent and 3.5 percent, respectively. Academic institutions have also changed how they allocate their resources. The percentage of faculty nationwide that is full-time has declined, and the vast majority of part-time faculty members do not have Ph.D.s. The share of institutional expenditures going to faculty salaries and benefits in both public and private institutions has fallen relative to the share going to nonfaculty uses like student services, academic support, and institutional support. There are changing modes of instruction, together with different uses of technology, as institutions reexamine the prevailing "lecture/discussion" format. A number of schools are charging differential tuition across students. This paper discusses these various changes, how they are distributed across higher education sectors, and their implications. I conclude with some speculations about the future of American education.
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Articles

"Compensation for State and Local Government Workers," Maury Gittleman and Brooks Pierce

Are state and local government workers overcompensated? In this paper, we step back from the highly charged rhetoric and address this question with the two primary data sources for looking at compensation of state and local government workers: the Current Population Survey conducted by the Bureau of the Census for the Bureau of Labor Statistics, and the Employer Costs for Employee Compensation microdata collected as part of the National Compensation Survey of the Bureau of Labor Statistics. In both data sets, the workers being hired in the public sector have higher skill levels than those in the private sector, so the challenge is to compare across sectors in a way that adjusts suitably for this difference. After controlling for skill differences and incorporating employer costs for benefits packages, we find that, on average, public sector workers in state government have compensation costs 3-10 percent greater than those for workers in the private sector, while in local government the gap is 10-19 percent. We caution that this finding is somewhat dependent on the chosen sample and specification, that averages can obscure broader differences in distributions, and that a host of worker and job attributes are not available to us in these data. Nonetheless, the data suggest that public sector workers, especially local government ones, on average, receive greater remuneration than observably similar private sector workers. Overturning this result would require, we think, strong arguments for particular model specifications, or different data.
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"Recommendations for Further Reading," by Timothy Taylor
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Are the New Auto Fuel Economy Standards For Real?

2012-02-21T06:00:00.001-06:00

Politicians are predisposed to like a technology standard, like the Corporate Average Fuel Economy (CAFE) standards for automobile miles-per-gallon, as a way of holding down petroleum use. After all, it sounds a lot better to voters than enacting a gasoline tax or a carbon tax! Pass a law that better-mileage cars will be phased in over the next decade or two, and politicians can boast of their great achievement --sidestepping the fact that promised aren't achievements and rules are made to be changed.

Thus, when I heard about the plans for a dramatic increase in CAFE standards, I was skeptical. In the most recent issue of my own Journal of Economic Perspectives, Christopher R. Knittel discusses various aspects of "Reducing Petroleum Consumption from Transportation." As Knittel writes: "A new CAFE standard in place for 2011 seeks to increase average fuel economy to roughly 34.1 miles per gallon by 2016. The Environmental Protection Agency and Department of Transportation are currently in the rule-making process for model years 2017 and beyond, with President Obama and 13 automakers agreeing to a standard of 54.5 MPG by 2025." Knittel provides evidence to back up my skepticism about the past use of CAFE standards, but he also argues that those future standards--unbelieveable as they may at first appear--are technologically achievable.

Back in 1975, against a backdrop of a dramatic rise in oil prices and concern over dependence on imported oil, the U.S. enacted the Corporate Average Fuel Economy (CAFE) law, requiring that over the average of their cars sold by each company, the average had to start at 18 miles-per-gallon, and then rise to 27 mpg by 1985. Higher gasoline prices provided a strong inducement for people to buy these more fuel-efficient cars, but when gasoline prices dropped in the mid-1980s, the CAFE standards stagnated. Here's a figure from Knittel showing how CAFE standards flattened out after 1985--and also showing the planned increase to take place.

The lack of any increase in the CAFE standards was only part of the story. Knittel explains: "[T]wo features of the original CAFE standards reduced their effect. First, sport-utility vehicles were treated as light trucks, and thus could meet a lower miles-per-gallon standard than cars. Perhaps not coincidentally, in 1979 light trucks comprised less than 10 percent of the new vehicle fleet, but this share rose steadily
and peaked in 2004 at 60 percent. Second, vehicles with a gross vehicle weight of over 8,500 pounds, which includes many large pickup trucks and sports-utility vehicles, were exempt from CAFE standards."

Taking these factors together, actual fuel economy for the U.S. fleet of cars hasn't been rising much, although it has edged up in the last few years with higher gasoline prices. My own interpretation is that the CAFE standards effectively became nonbinding--that is, they weren't pushing anyone to buy a different car than they otherwise would have purchased, and they weren't adding to fuel economy. Here's the data:

So, is it technologically possible meet the future increase in miles-per-gallon standards? Knittel argues "yes." He points out: "By world standards, these [currently existing] miles-per-gallon standards are not aggressive. After accounting for differences in the testing procedures, the World Bank estimated that the European Union standard was roughly 17 MPG more stringent in 2010 than the U.S. standard ..."

Moreover, Knittel has carried out a series of studies looking at technological progress in cars, and the tradeoffs between weight, engine power, and fuel efficiency. He finds: "On average, a vehicle with a given weight and engine power level has a fuel economy that is 1.75 percent higher than a vehicle with the same weight and horsepower level from the previous year. ...In the medium run, automakers can adjust vehicle attributes by trading off weight and horsepower for increased fuel economy. In Knittel (2011), I find that reducing weight by 1 percent increases fuel economy by roughly 0.4 percent, while reducing horsepower and torque by 1 percent increases fuel economy by roughly 0.3 percent."

By Knittel's calculation, getting from the new-car average fuel economy standard of 29 mpg in 2010 to 34.1 mpg in 2016 is do-able. If technological progress continues to improve mileage by 1.75% per year, and ways are found to reduce weight and engine power by about 6%, the standard for 2016 is achieveable.

But what about that planned standard of 54.5 mpg by 2025? Knittel explains that the number is somewhat inflated: "Taken literally, it would require fundamental changes to rates of technological progress and/or the size and power of vehicles. The 2025 number is a bit misleading. In the law, the 54.5 miles-per-gallon standard is based on a calculation from the Environmental Protection Agency based on carbon dioxide tailpipe emissions. It also includes credits for many technologies including plug-in hybrids, electric and hydrogen vehicles, improved air conditioning effifi ciency, and others. On an apples-to-apples basis, Roland (2011) cites some industry followers that claim that the actual new fleet fuel economy standard in 2025 is more like 40 miles per gallon. Achieving 40 miles per gallon by 2025 is certainly possible. At a rate of technological progress of 1.75 percent per year, 40 miles per gallon requires additional reductions in weight and engine power of less than 7 percent."

But although the planned mileage standards do appear--to my surprise--technologically feasible, it remains to be seen whether they are politically feasible, and also whether they are even a sensible public policy idea.

On the political side, the U.S. political system found a way for most of the last three decades to have fuel economy standards on the books as a matter of law and public relations--but to have standards with very little bite. Let's see whether the fuel economy standards planned for the future actually cause some real changes in the U.S. auto fleet, or whether they are quickly riddled with exceptions.

But at a deeper level, it's not even clear that fuel economy standards are a good policy idea. Knittel explains: "At a basic level, it focuses on the wrong thing—fuel economy instead of total fuel consumption. CAFE only targets new vehicles and leads to subsidies for some vehicles. Finally, CAFE pushes consumers into more-fuel-efficient vehicles without changing the price of fuel, leading to more miles traveled. The empirical size of this last effect, known as “rebound,” is a matter of ongoing research,
but to the extent that rebound occurs, it necessarily leads to greater congestion, accidents, and criteria pollutant emissions relative to the status quo." A considerable body of economic research suggests that if your policy goal is to reduce petroleum consumption, a gasoline tax or a carbon tax accomplishes the goal at a far lower social cost than fuel economy standards--although for politicians the explicitness of that cost seems to make it a nonstarter.

For more discussion of this topic, I recommend "Automobile Fuel Economy Standards: Impacts, Efficiency, and Alternatives," by Soren T. Anderson, Ian W. H. Parry, James M. Sallee, and Carolyn Fischer, in the Winter 2011 issue of the Review of Environmental Economics and Policy. The publisher has made article freely available here.

The Big Decline in Housing Segregation

2012-02-20T09:10:00.000-06:00

Edward Glaeser and Jacob Vigdor document and discuss "The End of the Segregated Century: Racial Separation in America's Neighborhoods, 1890-2010," in Civic Report #66 written for the Manhattan Institute for Policy Research.

Here's a headline graph. Take the two most common measures of residential segregation, the "dissimilarity index" and the "isolation index" (both explained further in a moment). Apply them to the 10 largest American cities using Census data The pattern that emerges is a large increase in residential segregation from about 1910 to 1950, segregation remaining at that high level from about 1950 to 1970, and then a sharp decline in residential segregation from 1970 up through 2010.

Glaeser and Vigdor summarize the pattern in this way: "Segregation has declined steadily from its mid-century peak, with significant drops in every decade since 1970. As of 2010, the separation of African-Americans from individuals of other races stood at its lowest level in nearly a century. Fifty years ago, nearly half the black population lived in what might be termed a “ghetto” neighborhood, with an African-American share above 80 percent. Today, that proportion has fallen to 20 percent."

How is residential segregation measured?

"Residential segregation can be measured in a variety of ways. The most common method is to form an index that summarizes the level of segregation in a metropolitan area on a scale from zero, where every neighborhood is just as diverse as the entire region, to 100, where individuals of different races never share neighborhoods. Indices differ according to their coding of intermediate situations ... Some indices require more detailed geographical data than others, with the most sophisticated using census information collected on a block-by-block basis.

"This report focuses on two measures—the dissimilarity index and the isolation index—both of which have a long history in social-scientific writing on segregation. The two measures together adequately summarize segregation, being highly correlated with more sophisticated indices, while being simple enough to calculate that even data from the late nineteenth century are sufficiently rich to permit their computation."

What is intuitive interpretation of a dissimilarity index?

"The dissimilarity index measures the extent to which two groups are found in equal proportion in all neighborhoods. It can be interpreted as the proportion of individuals of either group that would have to change neighborhoods in order to achieve perfect integration. It is the most commonly used segregation measure, first introduced into the sociology literature shortly after World War II."

What is the intuitive interpretation of an isolation index?

"Dissimilarity is not a perfect measure. Consider the following scenario. There are two equal-size neighborhoods in a city: one is 100 percent white; and the other is 98 percent white and 2 percent black. According to the dissimilarity index, this city is fairly segregated, since about half of the black residents would need to move in order to achieve perfect integration. In an important sense, though, the black residents are not isolated—after all, they live in a neighborhood that is 98 percent white.

The isolation index is designed to distinguish this sort of scenario from one where neighborhoods have dramatically different racial character. It measures the tendency for members of one group to live in neighborhoods where their share of the population is above the citywide average. In this hypothetical example, black residents live in a neighborhood that is 2 percent black, which is just 1 percentage point higher than what would be expected under perfect integration. The isolation index would therefore be on the order of 1 percent, rather than 50 percent."

This paper is more about documenting the patterns than about inquiring into underlying causes, but Glaeser and Vigdor do offer an overview of causes.

In their telling, the dramatic rise in residential segregation from 1910 to about 1950 arose because it was a time of huge migration from rural areas to cities in the United States, and when African-Americans participated in this migration, they were met with a combination of white hostility and legal restrictions that pushed them into highly segregated neighborhoods. The decline in residential segregation over the last 40 years is a combination of factors: reductions in the legal and social barriers that enforced residential segregation; outflow of the African-American population from highly segregated neighborhoods; and in some parts of the country, inflow of Hispanic and Asian immigrants to neighborhoods that had been segregated before.

High levels of residential segregation have been an enormous and legitimate social concern, so the decline in those levels is worth noting and welcoming. But as Glaeser and Vigdor point out, the good news comes with a mournful undertone for those who remember some of the high hopes for housing desegregation back in the 1960s:

"The 1960s were the heyday of racial segregation. During those years, segregation seemed a likely cause of many of the troubles afflicting African-Americans. Segregation was so enormous, and so unfair, that it seemed to create a separate and unequal experience for African-Americans everywhere. During those years, the fight against housing segregation seemed to offer the possibility that once the races mixed more readily, all would be well.

Forty years later, we know that this dream was a myth. There is every reason to relish the fact that there is more freedom in housing today than 50 years ago and to applaud those who fought to create that change. Yet we now know that eliminating segregation was not a magic bullet. Residential segregation has declined pervasively, as ghettos depopulate and the nation’s population center shifts toward the less segregated Sun Belt. At the same time, there has been only limited progress in closing achievement and employment gaps between blacks and whites. ... While the decline in segregation remains good news, far too many Americans still lack the opportunity to achieve meaningful success."

Don't Know Nothing About Military Strategy

2012-02-17T06:00:00.004-06:00

I don't know anything about issues like the appropriate number of soldiers in the armed forces, or which weapons systems are really needed, or where forces should be based around the world. But I do know something about federal budget numbers. As the political debate unfolds over appropriate levels of defense spending in the years ahead, here are some historical and international perspectives.

Measured as a share of GDP, U.S. defense spending is down substantially from the figures of 10% or more that often occurred in the 1950s and 1960s, and down from the 6% reached during the Reagan defense build-up of the 1980s. Although defense spending as a share of GDP has nudged up since September 11, 2001, it was 4.7% of GDP in 2011.

Defense spending also doesn't dominate the federal budget as it once did. Back in January 1961, in President Dwight Eisenhower's farewell address, he warned of the dangers of the "military-industrial complex." But at that time, defense spending was still almost 10% of GDP and more than half of total federal spending. Indeed, defense spending was as much as 70% of all federal spending back in the early 1950s (and higher than that at the peak of WWII). But for the last two decades, defense spending has dropped to about 20% of all federal spending.

While U.S. defense spending at relatively low levels, historically speaking, both relative to GDP and relative to total federal spending, it remains high relative to spending by other countries. Here's a table showing that U.S. defense spending is more than 40% of the world total, and that U.S. defense spending comfortably exceeds the sum of defense spending by the next 10 largest spenders.

The U.S. economy is the largest in the world, and it also spends one of the greatest shares of that economy on defense. By my count, only eight countries in the world (for which SIPRI has data) spend a larger share of their GDP on defense than does the U.S.: Saudi Arabia, 11.2%; Chad, 6.2%; Georgia, 5.6%; Iraq, 5.4%; Israel, 6.3%; Jordan, 6.1%; Oman, 9.7%; and UAE, 7.3%.

Of course, spending isn't the only variable that matters in national defense: strategy, diplomacy, ideology, economic ties, even personal cross-border ties can affect the likelihood and extent of instability. Defense spending can be quite good at projecting certain kinds of power, but not especially useful at blocking a biological or nuclear weapon that fits in a panel truck or even a large suitcase. That said, these sorts of numbers cut both directions in the debate over levels of defense spending. Those who favor reductions in defense spending over time might take note of the fact that we haven't been living in Eisenhower's world for some time, and U.S. defense spending has a smaller share of the economy and of federal spending than the historical norm. Those who favor higher defense spending might take note of the fact that the U.S. is far and away the largest defense spending nation now--and that many of the other largest spenders are our allies.

For both sides, I'm always interested not just in hearing argument about "more" or "less," but about what is enough. If you prefer cutting defense, how low would you go before you would say "enough"? If you prefer increasing defense, how high would you go before you would say "enough"? If someone can't explain their answer to that question, I suspect that underneath their show of confident certainty, they don't really know any more about weighing the costs and benefits of military spending than I do.

Thanks for Danlu Hu for putting together the U.S. defense spending figures over time from the Historical Tables of the President's Budget for 2013.

Parental Leave in Other Countries

2012-02-16T06:00:00.002-06:00

Note: On February 22, 2012, two comments from readers added at the end of the post.
____________

The United States has far fewer laws that offer protections to parents with family responsibilities than do most other countries. Alison Earle, Zitha Mokomane, and Jody Heymann discuss "International Perspectives on Work-Family Policies: Lessons from the World’s Most Competitive Economies," in the Fall 2011 issue of the Future of Children. Indeed, the issue is devoted to issues of "Work and Family." From the "Summary" of the Earle, Mokomane, and Heymann article:

"The United States does not guarantee families a wide range of supportive workplace policies such as paid maternity and paternity leave or paid leave to care for sick children. ... Using indicators of competitiveness gathered by the World Economic Forum, the authors identify fifteen countries, including the United States, that have been among the top twenty countries in competitiveness rankings for at least eight of ten years. ... They find that every one of these countries, except the United States, guarantees some form of paid leave for new mothers as well as annual leave. And all but Switzerland and the United States guarantee paid leave for new fathers. ... The majority of these countries provide paid leave for new mothers, paid leave for new fathers, paid leave to care for children’s health care needs, breast-feeding breaks, paid vacation leave, and a weekly day of rest. Of these, the United States guarantees only breast-feeding breaks (part of the recently passed health care legislation)."

Here are some illustrative tables showing policies in these countries. The U.S. does not have paid parental leaves. All of the 14 comparison countries in the table offer such paid leaves for mothers, lasting at least 18 weeks and in some cases more than a year, and replacing at least 25% of salary and up to 100% of salary. Thirteen of the 14 comparison countries offer paid parental leave, ranging at the low end from a few days or a couple of weeks up to more than a year, and replacing from 25% of pay up to 100%.

The next figure looks at leave policies for attending to children's health care. U.S. law does have provisions for breast-feeding breaks, as do 7 of the 14 comparison countries. All of the countries, including the U.S., have provisions for leave to care for children's health needs--but unlike in the U.S., that leave is paid in 11 of the 14 comparison countries.

The final table looks at policies on paid annual leave, a weekly day of rest, or night work. These are not policies specifically aimed at parents, but at all workers. The United States has no law guaranteeing paid annual leave, while all 14 of the comparison countries do--often requiring four or five weeks of such leave. Thirteen of the 14 comparison countries also have legal guarantees of at least one day of rest each week.

Earle, Mokomane, and Heymann discuss evidence that paternal leave policies of various sorts are associated with improved infant health and lower infant mortality--in part by enabling more breastfeeding, in part by enabling parents to be more involved in preventive and other health care for their children. They argue that parental leaves help to foster "children’s social, psychological, behavioral, emotional, and cognitive functioning."

I'm enough of an American at heart that some of these international comparisons open my eyes pretty widely. In Germany, you can have more than two years of paid leave for both mothers and fathers? In Austria, Denmark, Sweden, and the United Kingdom, there is a national legal guarantee of five weeks of paid vacation? I'm enough of an economist to wonder about the incentives that such provisions give employers to avoid hiring women of child-bearing age, or to slot young people into into certain jobs where they can be replaced without too much fuss if they disappear for a couple of years. With workers who make middle-income salaries or higher, guarantees of paid vacation can be considered part of their overall compensation, but for low-paid, low-skill workers, such rules may discourage hiring them at all. I'd want to know more about how such policies are designed and enforced before enacting them in the United States.

But it is just a fact that the U.S. labor market is at the far end of the international spectrum of high-income countries in not offering these kinds of policies. Even with my born-in-America, economist-trained skepticism, I find myself thinking that experimenting with such policies at the firm level, the state level, and even the national level is worth a closer look. After all, the days when American society could count on nearly all mothers to exit the (paid) workforce and spend their time in childcare and homemaking are long behind us.

___________________

David Paul writes:

"I happen to be a student from Germany and just had this topic in school, so I wanted to clarify the laws a bit. You wrote: "I'm enough of an American at heart that some of these international comparisons open my eyes pretty widely. In Germany, you can have more than two years of paid leave for both mothers and fathers?"

"It's actually not quite that extreme. 14 weeks vacation for the mother at 100% pay are standard (6 before birth and 8 after - the 8 after are mandatory - paid by the statutory health insurance). After that, either the mother or the father can stay at home for a year at ~66% previous pay (this is paid by the government). They can switch in that time, for instance mother half the time and father half the time - in that case it goes up to 14 months. Or alternatively one parent can stay at home for 2 years, but then at only ~33% of previous wages. This doesn't change the basic point on the difference between the US laws and those of the other countries of course." David adds: "The laws can be found in the MuSchG and the BEEG."

Michael Cain writes:

"As I am inclined to say, the US, particularly over the last 30 years, has made policy on the basis of making the country be a good place to be a capitalist, while most of the other developed economies have made policy on the basis of making their countries be a good place to be a worker. Personally, I tend to believe that the latter works out better for social outcomes, although it's possible to go overboard, of course. Business owners, once forced into the corner where they must have and keep employees, and must pay a living wage, and must contribute as necessary to provide benefits such as universal health care access, are *very* good at finding ways to increase the efficiency of the employees so that the owners still make money: they demand better education, they invest in better equipment, they listen to their workers (eg, Japanese auto companies make their engineers design for easy construction as well as other attributes). The US has let business owners take the easy way out: drop health insurance, relocate the factory to a different region or foreign country, and so forth."

Six Adults and One Child: The Coming Baby Bust

2012-02-15T06:00:00.001-06:00

Wendell Cox and Emma Chen tell the story of "Six Adults and One Child" in their chapter in
"The New World Order," edited and largely written by Joel Kotkin for the Legatum Institute. Much of the report is about thinking of the world as dominated by three spheres: the Indian sphere of influence,
the Sinosphere and the Anglosphere. But Cox and Chen are focused on the demographics of the coming baby bust. Here's their story from China (footnotes omitted):

"On a Saturday afternoon at The Bund, Xiao Ming (or “Little Ming”) clings tightly onto the hands of his paternal grandparents. His maternal grandparents walk slightly ahead, clearing a path for him in the midst of all the buzz and traffic. Retracing the imprints of their imaginary footsteps, Xiao Ming takes his first tentative steps as a three year old in town for the first time. Slightly behind him, the watchful eyes and
ready hands of his own parents spur him on.

Xiao Ming’s personal parade epitomises the popular quip in Shanghai and across China, that “it takes six adults to raise one child”. These six individuals form the unspoken support structure of China’s youth: While the OECD points out that 80% of students in Shanghai attend after-school tutoring, it fails to capture the “soft factors” behind Shanghai’s top rankings in the Program for International Student Assessment (PISA). Popular Chinese dramas such as 房奴 (House Slave) depict this in meticulous detail: Grandparents spend hours brewing “brain tonics” for their grandchildren, and parents pack austere work lunchboxes to save up for their child’s tuition fees. ...

Here’s the big issue down the historical road: Thirty years from now, how will Xiao Ming handle six elderly parents and grandparents, all by himself? Xiao Ming’s impending dilemma is not unique to China. Overall what author Phil Longman calls a “gray tsunami” will be sweeping the planet, with more than half of all of population growth coming from people over 60 while only six percent will be from people under 30. The battle of the future – including in the developing world – will be, in large part, how to maintain large enough workforces required for the economic growth needed to, among other things, take care of and feed the elderly. ...

Already the global fertility rate, including the developing countries, has dropped in half to an estimated 2.5 today. Close to half the world’s population lives, notes demographer Nicholas Eberstadt, in countries with below replacement rate birth-rates. The world, he suggests, is experiencing a “fertility implosion”."

Here's a figure to illustrate. The "dependency ratios" here refer to the number of either elder people over 65 or children age 14 and under compared to every 100 members of the working-age population between ages 15-64. Thus:

The dark blue line shows that in regions of the world with more developed economies, there were more than 40 children for every 100 working-age people back in 1950, but that has now fallen to about 30.
The light blue line shows that in those same regions of the world with more developed economies, there were about 10 over-65 elderly for every 100 workers back in 1950, but that ratio has now reached 30 and is headed for 40 by mid-century.
The orange line shows that less developed regions (leaving aside the poorest countries) had about 75 children for every 100 workers back in 1965, but that ratio has now fallen to about 40 and is headed for 30 by mid-century.
The scarlet line shows that in the less developed regions (again leaving aside the poorest countries) have only about 10 elderly for every 100 workers today--not much of an increase in the last half-century--but that this ratio is about to rise sharply to about 30 by mid-century and 40 by the end of the century.

The question of how the workers of tomorrow will support the elderly of tomorrow is a global issue. Ultimately, the only answer I can see to the policy question is an expectation that most people will retire later than their current expectations. But I also suspect that living in a society where the elderly outnumber the children will reshape all sorts of institutions of everyday life. Schools and playgrounds will become more scarce; libraries and senior centers will proliferate. Holidays like Halloween are already moving from being child-centered to being adult-centered.

Many people will find that they are part of a tall, slender family "tree." Instead of experiencing three generations of relatives--children, parents, grandparents--more and more people will be living in families where there are four or even five generations living at the same time. However, with smaller family sized these generations will not include large numbers of people. Thus, you can imagine a typical family "tree" of the future as consisting of two grandparents approaching age 60, who had one child, who in turn married and had one child, but who are also feeling responsible for two of their own parents who are about 80 years of age, and also also for one of their grandparents who has just turned 100. Families with fewer children will spend less of their adult lives in raising children. There will also be ever-greater numbers of adults who never become parents. For example, will we rely more on close family members, because each generational tie feels more precious? Or of necessity, will we all need to rely more on non-relatives? We do not have mental templates for how we organize or family ties and responsibilities in these tall slender family trees.

The Remarkable Consistency of Long-Run U.S. Economic Growth

2012-02-14T06:00:00.004-06:00

President Obama's proposed budget for FY 2013 came out yesterday, and I did what I usually do: Skip the details of the budget proposals, and in particular skip the projections for years off in the future , which are under every president a mix of political calculations and feigned optimism about what will be enacted into legislation. Instead, head for the volumes labelled "Analytical Perspectives" and "Historical Tables."

For example, the "Analytical Perspectives" volume of the proposed FY 2013 budget has some discussion of whether the U.S. economy will eventually bounce back all the way from the Great Recession to its earlier trendline of growth, or whether the Great Recession will cause a drop of the economy to a lower growth path. A figure illustrates that from 1890 to the present, the U.S. economy has followed a very consistent growth path.

The vertical axis of the graph shows per capita GDP measured by it natural logarithm. For those eyeballing the graph, the natural log of $40,000 is 10.6--roughly the present level of per capita GDP. The natural log of $5,000 is 8.5--roughly the level of real per capita GDP back in 1890. A straight line on a log graph means that the variable is growing at a constant percentage rate: in this case, at about 1.8% per year.

Here's how the budget discusses the question of whether the economy will eventually return to trend:

"Recent recoveries have been somewhat weaker than average, but the last two expansions were preceded by mild recessions with relatively little pent-up demand when conditions improved. Because of the depth of the recent recession, there is much more room for a rebound in spending and production than was true either in 1991 or 2001. On the other hand, lingering effects from the credit crisis and other special factors have limited the pace of the recovery until now. Thus, the Administration is forecasting a slower than normal recovery, but one that eventually restores GDP to near the level of potential that would have prevailed in the absence of a downturn. Some international economic organizations have argued that a financial recession permanently scars an economy, and this view is also shared by some American forecasters. On that view, there is no reason to expect a full recovery to the previous trend of real GDP. The statistical evidence for permanent scarring comes mostly from the experiences of developing countries and its relevance to the current situation in the United States is debatable. Historically, economic growth in the United States economy has shown considerable stability over time as displayed in Chart 2-7. Since the late 19th century, following every recession, the economy has returned to the long-term trend in per capita real GDP. This was true even following the only previous recession in which the United States experienced a disastrous financial crisis – 1929-1933 ..."

Of course, past performance is no guarantee of future results, as the investment adviser are quick to remind you. Still, those who believe that the Great Recession will move the U.S. economy to a permanently lower growth path are making a prediction that flies in the face of the last 120 years of U.S. economic experience.

Labor's Declining Share of Total Income

2012-02-13T06:00:00.003-06:00

Margaret Jacobson and Filippo Occhino of the Cleveland Fed offer a short overview of what is "Behind the Decline in Labor's Share of Income" in the February 2012 issue of Economic Trends.

Back in the day, when I was first getting familiar with these numbers, the standard summary of the data was that labor income was about two-thirds of total output in the U.S. economy, although the share fluctuated over the business cycle. As Jacobson and Occhino write: "Over the cycle, the labor income share tends to increase during the early part of recessions, because businesses lower labor compensation less than output, and compensation per hour continues to increase even as productivity slows down. Then, after reaching a peak sometime during the recession, the labor income share tends to decrease during the rest of the recession and the early part of the recovery, as output picks up at a faster pace than labor compensation, and compensation per hour grows at a slower pace than productivity. Only later in the recovery, as the labor market tightens, does labor compensation catch up with output and productivity, and the labor income share recovers."

But this basic fact--labor as two-thirds of economic output--no longer seems to be holding true. It's not just that the ratio is at historic lows in the post-World War II period, as shown in the figure; after all, given the depth and length of the Great Recession, and the sluggishness and sustained high unemployment of the tepid recovery, it's no surprise that the labor share of income would be low about now. But the data seems to show an overall pattern of a dropping labor share of income even before the Great Recession started, and reaching back to the 1980s or the late 1970s.

When output is rising faster than labor income, it necessarily follows that labor compensation is rising more slowly that output per hour. Here's the figure. Note that up until about the early 1980s, productivity as measured by output per hour rose more-or-less in step with compensation per hour (although it appears that even then, output/hour was trying to creep ahead). But the gap has expanded since then, and was expanding even before the Great Recession.

What explains this change? Jacobson and Occhino list the possibilities: "Economists have identified three long-term factors that can explain why the wage-productivity gap has widened and the share of income accruing to labor has declined. The first is the decrease in the bargaining power of labor, due to changing labor market policies and a decline of the more unionized sectors. Another factor is increased globalization and trade openness, with the resulting migration of relatively more labor-intensive sectors from advanced economies to emerging economies. As a consequence, the sectors remaining in the advanced economies are relatively less labor-intensive, and the average share of labor income is lower. The third factor is technological change connected with improvements in information and communication technologies, which has raised the marginal productivity and return to capital relative to labor."

This list seems basically right to me, although my reading of the evidence is that the items are listed in inverse order of importance. But I also find it useful to think about the fall in labor income in reverse, as the rise of capital income. For example, the Dow Jones index roughly tripled from 1980 to 1990 (rising from 900 to 2700), and then more than tripled from 1990 to 2000 (rising from 2700 to 10,800). While the Dow was basically flat over the decade from 2000 to 2010, large non-labor income was generated during the earlier part of the decade by housing prices. While many of us participate in gains in the stock market or the housing market in some ways, the bulk of those gains do tend to flow to those with higher income levels.

But looking ahead, another rapid tripling of stock market, as in the 1980s and again in the 1990s, seems unlikely, as does another housing price bubble. Meanwhile, the U.S. labor market is showing some feeble signs of resurgence, and may well strengthen over the next couple of years. Over the next 3-5 years, I'd expect the labor income share of output to rise--although I don't expect labor income to re-attain the old level of two-thirds of national output in the near- or the middle-term.

Medicaid in Transition

2012-02-10T13:30:00.004-06:00

"Medicare is for the elderly and Medicaid is for the poor." I've heard it a million times, and probably said it myself, but of course the distinction isn't quite correct. Medicaid was from the start focused on the "deserving" poor, which at the time was low-income families with children, along with the poor who were also disabled or elderly, but it didn't cover single adults below the poverty line.

The vast majority of Medicaid's spending is not on low-income families of able-bodied adults with children, but instead on those with low incomes who are also blind, disabled, and elderly. The 2010 Actuarial Report on the Financial Outlook for Medicaid reports that in 2009, Medicaid covered 50 million people on average at any given point in time, and had outlays of $380 billion. Thus, the elderly represented about one-tenth of all Medicaid enrollees, but about one-fifth of all Medicaid expenditures. As the Medicaid actuaries report:

"Per enrollee spending for health services was $6,890 in 2009. Per capita spending for non-disabled children ($2,848) and adults ($4,123) was much lower than that for aged ($15,678) and disabled beneficiaries ($16,563) ... While blind or disabled enrollees and aged enrollees are the smallest enrollment groups in Medicaid, they are projected to account for the majority of spending. ... [F]or FY 2009, benefit spending was estimated to be $148.4 billion for blind or disabled enrollees and $74.6 billion for aged enrollees. Combined, spending on these two groups constituted 66 percent of Medicaid expenditures ... Medicaid spending on non-disabled children represented about 20 percent of total Medicaid benefit expenditures, and spending on non-disabled non-aged adults accounted for about 14 percent."

Medicaid is a huge part of the U.S. health care system. The actuaries report that in 2008, "Medicaid spending for that year represented 14.7 percent of total NHE [national health expenditures]. Private health insurance was the largest source of spending on health care in 2008, accounting for 33.5 percent of total NHE, while Medicare paid for 20.1 percent." If you're adding up at home, yes, Medicaid plus Medicare pays a higher share of the nation's health care bills than does private health insurance. At any given time, Medicaid also covers more people than Medicare: in 2009, Medicaid was covering an average of 50 million people at any given time compared to 46 million for Medicare.

However, Medicaid is about to start into two major changes that will drive up its costs. One set of changes is related to the Affordable Care Act of 2009, and the other to the aging of the U.S. population.

One of the main ways in which the Affordable Care Act plans to expand health care insurance to those who not presently have it is through an expansion of who is eligible for Medicaid. The actuaries write: "The Affordable Care Act will have a substantial effect on Medicaid trends over the next 10 years and beyond. In terms of the magnitude of changes to the program’s projected expenditures and enrollment, it is likely that the Affordable Care Act will be the largest legislative change to Medicaid since the program’s inception." The Affordable Care Act is projected to add about 20 million enrollees to Medicaid by 2019, with roughly three-quarters of them being adults. Medicaid is now funded about two-thirds by the federal government and one-third by state governments, but for the first few years (with no promises for after that time!), the federal government will pick up essentially 100% of the cost of these additional enrollees.

The issues of "Medicaid and the elderly" are explored by Mariacristina De Nardi, Eric French, John Bailey Jones, and Angshuman Gooptu in the most recent issue of Economic Perspectives, published by the Federal Reserve Bank of Chicago. In particular, Medicaid has become a major provider of long-term care. The authors write: "The principal public provider of long-term care is Medicaid, a means-tested program for the impoverished. Medicaid now assists 70 percent of nursing home residents and helps the elderly poor pay for other medical services as well. ... Although Medicaid is available only to “poor” households, middle-income households with high medical expenses usually qualify for assistance also. Given the ongoing growth in medical expenditures, Medicaid coverage in old age is thus becoming as much of a
program for the middle class as for the poor ..."

Here's a figure from the actuaries showing Medicaid's share of total U.S. spending in certain markets. Again, notice that Medicaid spending is a lot less about doctor visits for low-income children and a lot more about nursing home care and home health care:

As the actuaries put it: "Medicaid has a major responsibility for providing long-term care because the program covers some aged and many disabled persons, who tend to be the most frequent and most costly users of such care, and because private health insurance and Medicare often furnish only limited coverage for these benefits, particularly for nursing homes. Many people who pay for nursing home care privately become impoverished due to the expense; as a result, these people eventually become eligible for Medicaid."

At least so far, payments for long-term care are not yet a major driver of Medicaid expenses. The front edge of the baby boomer generation is just hitting its retirement years, but the really substantial demand for nursing home care kicks in more at age 85 than at age 65. The Medicaid actuaries write: "As the oldest members of the baby boom generation begin to reach age 65, both the number of aged enrollees in Medicaid and eventually the rate of long-term care spending growth are projected to increase. While the baby boom generation is not estimated to have a major effect on long-term care spending during FY 2010 through FY 2019, the increase in the number of people over age 85 in the next 10 years is expected to do so."

For a more detailed discussion of Long-Term Care Insurance in the U.S. and its interaction with Medicaid, see also my post of November 22, 2011. For a broader discussion of Long-Term Care in International Perspective, see my post of August 9, 2011.

It's worth remembering that unlike Medicare, Medicaid has no dedicated tax or revenue stream. Unlike private health insurance, Medicaid isn't financed by premiums. Instead, the ongoing rise in Medicaid costs will be in direct competition with other government programs funded from general tax revenues.

U.S. and World Perspective: Immigration Policy #5

2012-02-09T14:00:00.018-06:00

This is the fifth of five posts on immigration policy. For the first post and an overview, see here.

American public discourse on immigration is so hot-blooded that it often sounds as if the fate of the republic--or at least the economy--is at stake. But oddly enough, the economic issues related to U.S. immigration are in all likelihood dwarfed in size by the global gains.

While I believe that that an expansion of immigration offers gains to those already in this country, the gains seem likely to be small. For example, in the Cato Journal symposium, Raúl Hinojosa-Ojeda uses a computable general equilibrium approach to estimate that a substantial rise in immigration could increase U.S. GDP by 0.8%--and even this modest gain is well above other estimates I've seen. Similarly, while I argued in the third post in this series that the effects of immigration on government budgets were probably positive, they arguments over gains and losses to different levels of government, and the gap between the two, are measure in billions or at most tens of billions of dollars--which isn't much in the context of an annual federal budget now approaching $4 trillion.

The main gains from immigration, perhaps not surprisingly, go to the immigrants themselves, who may easily increase their incomes by a multiple of four or five times when moving from a low-income country to a high-income country. Large increases in immigration thus offer a possibility of a massive increase in world GDP Giovanni Peri sums up some of the evidence in "Immigration, Labor Markets, and Productivity."

"[I]f one looks at several recent reports and studies on international migrations by economists and research institutions, their main emphasis is on the large size of global gains obtainable by increasing, even by a small measure, the mobility of people. A study by the World Bank (2005) estimated that an increase in international
migration equal to 3 percent of the labor force of developed countries would produce gains (to be shared globally) of $356 billion. Pritchett (2006) argues that the gains from increasing international mobility, even by a little, are much larger than those that can be obtained by fully liberalizing international trade, estimated in 2005 to be $104 billion. In the more extreme case of a full opening of more wealthy, Organization for International Cooperation and Development (OECD) countries to workers from the rest of the world, Klein and Ventura (2007) calculate a potential massive increase in the world GDP on the order of 150 percent over 50 years. For economists, in short, international migration has the formidable ability of increasing total world income and productivity, generating huge global economic opportunities. The reason is very simple. By allowing people to move to countries where they can produce four to five times more value per hour of work on average than in their country of origin, migrations allow the deployment of world human resources in a massively more efficient way ..."

My own Journal of Economic Perspectives had some articles on emigration in the Summer 2011 issue that emphasized the possibility of substantial Gains from Emigration, as I posted last August 22. (Current and back issue of my journal going back to 1994 are freely available to all, courtesy of the American Economic Association.)

In short, the strongest case for immigration is not that it conveys huge benefits to the U.S. economy--it probably doesn't. But it certainly conveys huge benefits to those who migrate. I believe that national boundaries matter, and I'm an American at heart. When it comes to public policy, I place a lower value on what happens to non-Americans than I do on what happens to Americans. Thus, I do believe that any costs to Americans resulting from immigration are a legitimate policy issue. But placing a lower value on what happens to non-Americans doesn't mean placing no value on what happens to them. The truly enormous gains received by migrants predispose me toward policies that would allow more immigration to the U.S.--and to seek alternatives for dealing with potential costs.

Enforcement: Immigration Policy #4

2012-02-09T12:01:00.003-06:00

This is the fourth of five posts on immigration policy. For the first post and an overview, start here.

Discussions of enforcing limits on immigration often seem to begin and end with border security: how many guards, how long a fence, how many arrests and deportations. Such policies have been pursued with vigor since the 1990s, and they appear to have been effective.For example, here's a figure from Pia M. Orrenius and Madeline Zavodny showing that southwest border apprehensions peaked back around 2000, and have had a generally downward trend since then.

Edward Alden sums up the current situation in "Immigration and Border Control."

"For the past two decades the United States, a country with a strong tradition of limited government, has been pursuing a widely popular initiative that requires one of the most ambitious expansions of government power in modern history: securing the nation’s borders against illegal immigration. Congress and successive administrations—both Democratic and Republican—have increased the size of the Border Patrol from fewer than 3,000 agents to more than 21,000, built nearly 700 miles of fencing along the southern border with Mexico, and deployed pilotless drones, sensor cameras, and other expensive technologies aimed at preventing illegal crossings at the land borders. ... [T]the U.S. borders are far harder to cross illegally than at any time in American history, and the number of people entering illegally has dropped sharply. Evading border enforcement has become more difficult, more expensive, and more uncertain than ever before. ...

The United States will never again be a country with loosely guarded borders. The political coalition in favor of tough border control is strong and probably durable; the threats from terrorism or other transnational crime are severe enough to necessitate effective border measures; and the desire by many to migrate illegally to the United States will remain strong enough that deterrence through enforcement is essential. The challenge, therefore, is how to make border security compatible with a sensible immigration system that strengthens the U.S. economy rather than weakens it."

My own sense of the evidence is that it is time to stop this continually increasing spending on border security and instead move to other ways of discouraging illegal immigration, including better tracking of those who legally enter the country on temporary visas, and steps to assure that employers can reasonably be held accountable for when they hire illegal immigrants.

Many of the writers in the Cato Journal special issue are not enamored of strong efforts to enforce limits on immigration. For example, the Alden essay is insightful on costs and problems of border enforcement, while Jim Harper discusses potential problems with the e-Verify system that lets employers check on the immigration status of potential workers. However, contributors to the symposium seem often willing to entertain all sorts of alternatives, without a lot of practical skepticism. For example, Bryan Caplan suggests the possibility that how we could allow in very large numbers of immigrants, but make them ineligible to vote? We could also make their descendants ineligible to vote! Or we could not let them vote until their lifetime tax payments reach $100,000. We could impose special higher taxes on immigrants. We could make immigrants ineligible for welfare benefits. We could require tests of English fluency and cultural literacy for immigration. A number of other authors in the issue emphasize the possibilities of large but temporary flows of immigrants, who would sweep back and forth across the border in waves.

I understand the intellectual rationale for these sorts of proposals, but they seem to me overly clever, and thus likely to be impractical. Jagdish Bhagwati likes to quote the Swiss novelist Max Frisch on the subject of how western Europeans let in lots of guestworkers, on the explicit understanding that they could be sent home, but then found that in practical and political terms they could not be deported. Frisch said: "We imported workers and got men instead." The idea of making immigrants and their descendants unable to vote works fine if the immigrants are just "workers," but not so well if they are also human beings. A vision of crowds of immigrants arriving and departing as needed by the economy views those people solely in their role as workers, not as people with a wide range of goals--like falling in love with people and communities, or getting a better education for their children. Ultimately, it does not seem credible to me that such policies will be enforced in the long term. When it comes to practical enforcement, I place my trust in good old-fashioned policies like continued border security, along with visa enforcement and mechanisms for employers to be able to check whether they are hiring U.S. citizens.

Government Budgets: Immigration Policy #3

2012-02-09T10:00:00.002-06:00

This is the third of five posts on immigration policy. For the first post and an overview, start here.

A common and plausible concern about immigration is that many immigrants don't pay much in taxes, but the government faces costs for education of the children of immigrants, health care of those with low incomes, and law enforcement. Thus, it is feared that immigrants contribute to the fiscal problems of government. To be clear, this concern over the effect on government budgets is really about immigrants with low skill levels and about illegal immigrants. Everyone accepts that legal high-skilled immigrants are on average a net plus for government in terms of the taxes they pay and the government benefits they receive. Daniel Griswold tackles this question head-on in "Immigration and the Welfare State."

Griswold points out that immigrants--even illegal immigrants--do typically have taxes withheld from paychecks, as well as paying sales and property taxes. Recent legal immigrants aren't eligible for welfare benefits, and many illegal immigrants don't dare try to claim such benefits. For the federal government, immigration is almost certainly a net plus. However, certain state and local governments with high levels of immigration do face high costs of education, health care, and law enforcement related to immigration. He notes the straightforward policy fix: "If Congress wants to more equitably share the fiscal benefits of immigration, it could distribute funds to states and localities based on the impact of immigration on health and education spending. This need not, and should not, require an overall increase in government spending and taxation, but merely a transfer of resources from the federal level, where immigration represents a net fiscal gain, to state and local governments, where it often imposes a net fiscal loss."

Griswold also makes the insightful point that low-skill immigrants are not choosing to locate primarily in high-benefit states--which strongly suggests that gaining access to such benefits is not their primary motivation. (Citations and references to tables omitted from the quotation.)

"If we consider changes in the foreign born populations in individual states, for example, we can see that the largest gains have generally been in states that are relatively stingy in offering public assistance. ... The 10 states with the largest percentage increase in foreign-born population between 2000 and 2009 spent far less on public assistance per capita in 2009 compared to the 10 states with the slowest-growing foreign-born populations—$35 vs. $166 .... In the 10 states with the lowest per capita spending on public assistance, the immigrant population grew 31 percent between 2000 and 2009; in the 10 states with the highest per capita spending on public assistance, the foreign-born population grew 13 percent. If immigrants were primarily concerned with collecting welfare, they would not be flocking to such states as Kentucky, Tennessee, North Carolina, South Carolina, and Georgia. Instead, they would be drawn to such states
as Michigan, Rhode Island, and Vermont, which in fact have seen very slow growth in their immigrant populations.

Undocumented immigrants are even more likely to self-select states with below-average social spending. Between 2000 and 2009, the number of unauthorized immigrants in the low-spending states grew by a net 855,000, or 35 percent. In the high-spending states, the population grew by 385,000, or 11 percent. One possible reason why unauthorized immigrants are even less drawn to high-welfare spending states is that, unlike immigrants who have been naturalized, they are not eligible for any of the standard welfare programs. A second reason is that illegal immigrants are less likely to be well-educated and thus are not as attracted as more highly skilled immigrants to higher-income urban centers in such states as New York, Illinois,
and California. The higher-skilled immigrants gravitate to those states, not because of the higher social spending, but because of the higher rewards for skilled labor."

The Low-Skilled: Immigration Policy #2

2012-02-09T08:00:00.006-06:00

This is the second in a series of five posts on immigration policy. For the first post and an overview, see here.

The effect of immigration on wages seems as if it must be obvious from Econ 101: increase the supply of something and you drive down its price. So immigration must reduce wages, right? The issues isn't that simple, for a number of reasons. Four such reasons are laid out by Giovanni Peri in "Immigration, Labor Markets, and Productivity." Peri points out that immigrant labor is often focused on providing home services, in a way that has tended to free up high-skilled native women to enter the workforce or to work more hours.

"In the United States (and in many European countries) one sector in which the presence of the foreign-born has been large and growing fast is that of home services (cleaning, food preparation, gardening, and similar) and personal services (child and elderly care). These are often characterized as “household production” services. This has allowed a significant share of female workers, often highly educated, to afford these services and to join the formal labor force outside the home or to increase their hours worked."

But even if low-skilled immigrant labor may be complementary to high-skilled native labor, surely it must depress wages of low-skilled native workers? Peri argues that this conclusion need not follow, because of ways in which firms and the economy respond to an influx of immigration. He writes (citations omitted): "In summary, an economy will respond to immigration along several margins—through increased investment by firms, specialization of natives, complementarities between natives and immigrants, technological response by firms, and job creation. ...This explains why a long tradition of empirical economic studies has found very small to no effect of U.S. immigration on native wages and employment at the national and at the local level."

Here is a bit more detail on each of Peri's four margins for economic adjustment in response to low-skilled immigration.

1) Investments

"As a consequence of the availability of more workers firms invest: existing firms expand their capacity, and new firms are born. Returns to capital increase when more workers are available, and firms take advantage of this by investing."

2) Differences among Workers: More and Less Educated

"Workers are not homogeneous. In terms of their labor market skills and productive activity there is a large difference between workers with high levels of schooling (tertiary education) and those with secondary or less. They use different skills and take different jobs. ... In the United States as a whole, however, because of the combination of immigrants at the top and at the bottom of the schooling distribution, if we consider two groups of workers (more and less educated), immigrants have a distribution similar to that of natives. Hence their inflow did not alter much the relative supply of the two groups."

3) Specialization and Technology: Job Upgrades

"Even more interesting is the differentiation of skills and productive characteristics between natives and immigrants within each of the two schooling groups. One very strong tendency among immigrant workers with low schooling is to concentrate in manual jobs. In manufacturing, construction and agriculture, for instance, they work as farm laborers, construction workers, roofers, drivers and so on. In services they work in food preparation, house services, child and elderly care. In contrast, similarly educated natives work in jobs which
use more intensively communication and interaction skills such as cooks, construction supervisors, farm coordinators, or clerks. In Peri and Sparber (2009) we show that, due to the limited knowledge of the language, immigrants have a comparative advantage in manual type of jobs. Hence they specialize in those, and in firms and sectors that hire immigrants, this produces higher demand for jobs of coordination and interaction typically staffed by natives, whose language skills are superior. This dynamic specialization in tasks according to skills pushes natives to upgrade their jobs (as communication-intensive occupations pay better than manual intensive ones) and protects their wages from competition with immigrants. By taking the manual jobs that natives progressively leave, immigrants often push a reorganization of production along specialization lines that may also increase effectiveness and efficiency of labor ... In some studies the mechanism described here, combined with the other effects described earlier in this section, results in a small positive effect of immigration on wages of less educated native workers."

4) Lower Wages of Immigrants: An Opportunity for Cost Cutting and Job Creation

"One common empirical finding in the literature is that immigrants are paid less than natives with similar characteristics and skills. This is in part due to the fact that many immigrants, because of less attractive outside options (such as having to go back to their home country), have lower bargaining power with the firm. In this case firms pay immigrants less than their marginal productivity, increasing the firms’ profits. Such cost-savings on immigrants act as an increase in productivity for firms. Ottaviano, Peri, and Wright (2010) show that if a firm can cut costs in some productive tasks by hiring immigrants, this allows the firm to expand production and employ more people in the complementary tasks, many of which are supplied by natives."

In short, the economy is not a static mechanism with a fixed number of jobs that require a predetermined set of skills. Instead, the number of jobs moves over time. Even among those with low skills as measured by education, there can be vast differentiation of skills between, say, those who are proficient in English and those who aren't. Low-skilled native workers can in many ways be complements with low-skilled immigrants, not substitutes. Firms can and do adjust their methods of production in many ways. An economy is a flexible organism. That flexibility can be difficult for workers, who need to change and adapt, and will sometimes find their old jobs altered or even ended. But the flexibility is also the source of a gradually rising standard of living over time.

The High-Skilled: Immigration Policy #1

2012-02-09T06:00:00.001-06:00

U.S. Immigration policy is a combustible topic, so I'll just list five of my main beliefs up front.

Allowing substantially higher immigration from high-skilled labor--in particular, by finding ways to let those who complete science and technology degrees or graduate programs in the United States remain in the country--should be a no-brainer.
Allowing higher levels of low-skilled immigration is admittedly a tougher call, although I would favor this as well.
When it comes to government budgets, immigration is an overall benefit to government budgets, but certain state and local governments that suffer losses.
Increasing enforcement at the border may have reached diminishing returns--that is, high costs for relatively little benefit in limiting enforcement. However, but other ways of enforcing immigration limits could be increased, like keeping better tabs on those with temporary visas and discouraging employers from hiring illegal immigrants.
Immigration is a much smaller policy issue for the United States than it potentially could be for the world as a whole.

For some additional background, see my post of July 29, 2011, Thoughts on Immigration. But here I take my text from the most recent issue of the Cato Journal, which is devoted to the subject "Is Immigration Good for America?" The essays go beyond my five points, to tackling issues like birthright citizenship and future U.S. demographic trends. There is reasonable support for my points 1-3 and 5, but some disagreement when it comes to enforcement issues. To avoid making this post of encyclopedic length, I'll divide it into five parts: one for each of my five themes.

The U.S. higher education system is widely acknowledged as the best in the world, and especially at the graduate level, it attracts top-notch students from all over the world. We invite them in, we provide financial support for their education, we often connect them to industry--and then we make it hard for them to stay. In a world economy where future economic growth depends largely on science and technology, U.S. immigration policy essentially chases away tens of thousands of highly qualified workers each year. Whatever one thinks about reducing illegal immigration or overall immigration, this policy of chasing away the high-skilled is hugely counterproductive.

Here is Gordon Hanson making the point in "Immigration and Economic Growth" (references omitted for readability):

"Each year, U.S. universities conduct a global talent search for the brightest minds to admit to their graduate programs. Increasingly, foreign students occupy the top spots in the search. Data from the National Science Foundation’s Survey of Earned Doctorates show that between 1960 and the late 2000s, the share of PhDs awarded to foreign students rose from one fifth to three fourths in mathematics, computer science, and engineering; from one fifth to three fifths in physical sciences; and from one fifth to one half in life sciences. U.S. university departments that have more foreign graduate students produce more academic publications and have their work cited more frequently. Once they graduate, U.S.-educated foreign workers patent at a significantly higher rate than U.S.-born workers. As a consequence, U.S. cities that attract these workers produce larger numbers of patents in electronics, machinery, pharmaceuticals, industrial chemicals, and other technology-intensive products. Simply put, high-skilled immigration promotes innovation. An additional benefit is that high-skilled immigrants are likely to pay far more in taxes than they use in public services, generating a positive net contribution to government fiscal accounts. ...

"Today, the difficulty is not in attracting top foreign students to America but in keeping here them after they graduate. High-skilled immigrants have three primary channels for obtaining permission to work in the United States. The H-1B visa, which targets highly trained professionals, permits holders to work in the United States for a period of three years. It is renewable once, with the annual number of visas capped at 65,000. Employer-sponsored green cards permit holders to live and work in the country indefinitely. The annual number of new visas is capped at 150,000. The third channel is a family-sponsored green card, which requires marrying a U.S. citizen (visas for which there is no cap) or having a close relative already in the country legally (visas for which are capped at 640,000). Because of the limited number of work-based visas, the family visa route remains the most common path to legal residence for skilled workers. Rosenzweig (2007) reports that in the early 2000s among immigrants who entered the United States on student visas and ultimately obtained green cards, 55 percent did so by marrying a U.S. citizen. To make it in America, foreign students not only need to be smart enough to get into a U.S. university. They also need to be proficient at dating."

Hoping for proficiency in dating is not a well-conceived immigration policy. It used to be, not that long ago, that foreign graduate students from places like India or China or Brazil would remain in the U.S. after graduation in part because they didn't see attractive professional opportunities back in their home countries. Those days are behind us. The U.S. is highly attractive to footloose global talent--it just needs to make it straightforward for that talent to locate here.

Tax Expenditures: A Way to End Budget Gridlock?

2012-02-07T06:00:00.000-06:00

Back in 1987, the very first issue of my own Journal of Economic Perspectives had a symposium on the just-passed Tax Reform Act of 1986, which famously (among economists, at least) reduced various exemptions, exclusions, deductions, and credits in the tax code, and then used the extra money to reduce marginal tax rates. In that issue, Nobel laureate James Buchanan offered a trenchant analysis of the political economy behind such legislation. He argued that politicians love to hand out tax breaks to specific groups, but as they do so, it becomes necessary to raise tax rate on remaining income that isn't getting a special break. Eventually, the tax rates get so high, and the tax breaks get so numerous, that Congress girds up its loins and passes a bill like the Tax Reform Act. However, Buchanan continued, it would be imprudent to view this bill as proof that Congress actually believe in a simpler tax code with lower rates. Instead, it is just politically necessary to pass such a bill from time to time, so that the political cycle of more tax breaks and higher rates can unwind again.(My journal is freely available on-line back to 1994, but the first issue is not yet freely available. However, it is available through JSTOR, and many academics will have access in that way.)

In our current impasse over crafting middle-run and long-run ways to reduce budget deficits, many conservatives would like to have a tax code with lower marginal tax rates and with fewer government efforts to micro-manage aspects of the economy, while many liberals would like to have a tax code that raises more revenue--in particular from those with high incomes. Reducing the reach of tax deductions, credits, exemptions, and exclusions--which collectively go under the name of "tax expenditures"--could offer a way to provide some satisfaction for all sides.

Daniel Baneman, Joseph Rosenberg, Eric Toder, Roberton Williams discuss "Curbing Tax Expenditures" in a paper just published by the Tax Policy Center. They point out that a George W. Bush tax commission back in 2005 proposed limits on tax expenditures, as did more recently President Obama's President Obama’s National Commission on Fiscal Responsibility and Reform and a commission from the Bipartisan Policy Center.

Tax expenditures comprise large sums. The authors of the TPC paper point out: "Despite significant variation over the years, tax expenditures impose substantial costs on the federal budget and will continue to do so. In 2011, they were projected to cut revenues and raise outlays by $1.1 trillion, more than we collected from individual income taxes and nearly half of total federal revenue collections for the year."

Of course, the problem with altering tax expenditures is that people are used to them, and don't want to see them disrupted. By far the biggest tax expenditure is the fact that employer-provided health insurance isn't taxed as income: if it was, the U.S. Treasury would collect about $174 billion per year more. The second-biggest tax break is the deductibility of mortgage interest, which costs the Treasury about $89 billion per year. Other big-ticket tax expenditures include deductibility of state and local taxes, deductibility of charitable contributions, lower tax rates for capital gains and dividend income, and others. You can make all the tough-minded policy arguments you want about how in a U.S. economy where rising health care costs are a major policy concern, maybe having a $174 billion tax break subsidizing health insurance isn't the best idea, or in a U.S. economy that has just seen the destructive power of a housing price bubble, maybe a tax break to make it easier to spend more on houses isn't a great idea. But it's tilting at windmills to attack these sorts of provisions one at a time.

Instead, the TPC authors point out: "While an ideal tax reform process would comprehensively evaluate each tax expenditure on its merits, eliminating some and restructuring or retaining others, broad-based limitations on tax expenditures may be easier to enact and would still produce net benefits. This paper examines alternatives for implementing across-the-board limits applied to a selected group of the largest and most widely utilized tax preferences." Thus, they offer proposals like converting most tax expenditures into a single tax credit at a 15% rate, or putting a cap (as a share of income) on the total tax expenditures that could be claimed on any tax return, or even just reducing the cost of all tax expenditures across-the-board by a fixed percentage amount. In other words, don't tackle individual tax expenditures head-on, but instead try to rein back on many tax expenditures all at once.

Such proposal would mostly affect the tax bills of those with high incomes, because tax expenditures mainly flow to those with higher incomes. On their calculations, 41% of the total value of tax expenditures goes to the top 5% of taxpayers by income, and 24% of the total value goes to the top 1%. Remember, those in the upper part of the income distribution are far more likely to itemize deductions. And because those with high incomes face higher marginal tax rates, the amount of taxes they save from tax expenditures is also higher.

The next figure shows effective (that is, average) tax rates for different income levels, and then shows what the tax rates would be without tax expenditures. The federal income tax is progressive: on average those with higher incomes do pay a higher share of income in taxes than those with lower incomes. But at the upper income levels, the presence of tax expenditures reduced the extent of that progressivity.

Reducing tax expenditures would arguably reduce certain ways in which the government is influencing economic outcomes. It would free up revenue both to pay for reducing marginal tax rates, and also to pay for some reduction of long-germ budget deficits. I believe there is a deal waiting to be cut, although I'm admittedly dubious as to whether the current crop of politicians can achieve it.

For a previous take on tax expenditures with some additional background and argument, see my post of last August 3, "Tax Expenditures: One Way Out of the Budget Morass?"

The "Instant Economist": Early Reviews and Reactions

2012-02-06T11:00:00.001-06:00

Last week my book The Instant Economist: Everything You Need to Know About How the Economy Works was published by Penguin/Plume. For a description of the book, see my January 31 post here.
To buy copies for yourself, as well as for those in your family, club, company, or community, head for a local or click here for Amazon or here for Barnes and Noble--or just check a copy out of your local library. Here are some early reviews:

In the February 2012 issue of Better Investing, Angele McQuade has written a view called "Fun With Numbers--Making Economics Make Sense." It's not freely available on-line at this time, but here are a few excerpts:

"If your only exposure to economics was a class so boring you yawn at even the memory of it, you’re missing out on a lot of useful — and even fascinating — information, says author Timothy Taylor. With so much election year talk of budget deficits, health care costs, wealth disparity, foreign trade and unemployment, it’s not surprising that economic statistics and theories are flying fast and hard. No better time to brush up your knowledge of economics, especially with the help of Taylor’s latest book, The Instant Economist: Everything You Need to Know About How the Economy Works. ..."

"What I liked: That Taylor branches beyond a purely domestic viewpoint into the heavily interconnected world of international economics. There’s a reason economists care so much about international trade, and Taylor does an excellent job explaining its importance. ..."

"What I loved: How truly relevant Taylor’s lessons are.Yes, we all hear and read economic statistics all the time, but how often do we stop to think about their meaning in our daily lives? Taylor seems to delight in pointing out the many ways economics matters, as well as the ways we can put the knowledge he’s offering to use. ..."

"I’m not going to sugarcoat the truth: The Instant Economist isn’t written in a finish-it-over-a-cup-of-coffee style. The content is rich, though, as will be your intellectual reward if you devote even a little effort to it."

In the December 1, 2011, issue of Booklist, Mary Whaley writes:

"[T]his handbook on economics is a readable, nontextbook approach on the level of an undergraduate introductory course. ... We learn how markets work in the context of goods, labor, and financial capital and also about unregulated markets, including monopoly, the environment, and poverty; he notes that although these issues can attract democratic government involvement, such intervention can fail. He concludes with macroeconomics (an overall view of the economy), with topics including economic growth, unemployment, and inflation. Taylor wants us to respect the power of market forces but understand where those forces fall short; he encourages a belief that government policy can be useful but, in some cases, can be useless or even counterproductive. This guide to the key principles of economics is an important source of information for many library patrons. Excellent book."

From on-line sources, the first review up at Amazon, by Gene Chamson, gives the book five stars and is titled: "Should be required reading for anyone who wants to participate in the economy. In other words, everyone." He adds:

"I am generally not a fan of books that dumb down important subjects, adding a veneer of folksy prose to make them appealing to "dummies" or "complete idiots". This is not such a book.
"The Instant Economist", despite its simplistic title, is a thoughtful, engaging survey of modern economic principles and issues. In 36 short, easy to digest chapters, the author provides a foundation in economic literacy, beginning with the basics of how markets work, then covering the main topics in microeconomics and macroeconomics. ... Highly recommended."

From the blogosphere, here's Brian L. Belen, a graduate student in economics, writing from the Philippines.

"Economics is such an important field of study, yet it is often perceived as too technical and complex for the everyman. ... For this reason, there is plenty of room for accessible books that demistify what economics is all about ... It is in this context that Timothy Taylor makes an important contribution with his new book The Instant Economist: Everything You Need to Know About How the Economy Works.

From the title alone, it's obvious that Taylor seeks to achieve two things: to explain the essentials and to do so in a practical way. He manages both quite ably, beginning with the requisite discussion on demand, supply and pricing, and thereafter branching off into weighty topics in macro- and international economics. When he does so, his presentation is often fairly Socratic: he identifies several specific issues (such as the minimum wage), poses an apparently polarizing question about them ("Should it be higher or lower?"), and then proceeds to present both sides, often with some statistics to back up the analysis. As a consequence, readers are left with a very balanced perspective on relevant economic concerns, and are hopefully empowered to make their own judgments accordingly. ....

In fact, there are several chapters that I particularly appreciated, having taught undergraduate macroeconomics myself. For example, the chapter on the monetary system (i.e. Federal Reserve, to use the U.S. case) is excellent, and I wish I had it as a reference back in my teaching days. Likewise, Taylor very capably devotes a chapter to exchange rates, and it is positively enviable that anyone can write so clearly about the subject.

The Instant Economist isn't your usual introductory economics book, even for casual reading. It's a little more than that -- a little more advanced, a little more practical, and arguably a little more interesting. For that reason, it's material well worth having a look at in order to delve a little deeper into topics from Econ101, whether you took it last semester or years ago."

Europe's Growing Imbalances Before Its Debt and Financial Crisis.

2012-02-06T06:00:00.002-06:00

Europe's financial and debt problems were doubtless made worse and brought to a head by the global financial crisis that began in late 2007. But in the U.S., the financial crisis is fundamentally about the bursting of the bubble in housing prices and overborrowing, while in Europe, the current financial and debt problems have different economic roots, tracing to the arrival of the euro as a common currency in the late 1990s.

Nils Holinski, Clemens Kool, and Joan Muysken offer many key ingredients of the story in "Persistent Macroeconomic Imbalances in the Euro Area: Causes and Consequences." It appears in the January/February 2012 issue of the Federal Reserve Bank of St. Louis Review. As a useful expository tool, they discuss "North" and "South" Europe, where North includes Austria, Germany, Finland, and Netherlands, while South includes Greece, Ireland, Portugal and Spain. In the figures that follow, North and South refer to the averages of these groups not weighted by economy or population--because if they were weighted in that way, "North" would basically be Germany and "South" would basically be Spain. They focus only on the period of time from 1992-2007--that is, the financial crisis has not yet erupted. But their analysis strongly suggests that an eruption of some sort was coming.

As a starting point, look at trade balances. For the euro countries as a whole, the trade balance has been fairly close to zero in recent years. But as the euro got started, North countries began to run ever-larger trade surpluses, while South countries began to run ever-larger trade deficits.

What are the underlying causes of these trade deficits? A standard economic relationship, sometimes called the national savings and investment identity, lays out certain possibilities. If a trade deficit rises, it MUST be accompanied by some combination of the following: more government borrowing, less private saving, or more private investment. Conversely, if a trade deficit falls, it MUST be accompanied by some combination of the following: less government borrowing, more private saving, or less private investment. What was happening in Europe from 1992-2007?

When it comes to net public savings, both North and South countries were reducing their borrowing in the lead-up to the euro and in the early 2000s. In other words, the large trade deficits in the South weren't caused by higher government borrowing.

However, private saving did make a major contribution to the trade deficits in the South. Back in the mid-1990s, gross private saving was about the same in the North and South, at about 22-24% of GDP. It remained at about that level in the North, although there is an increase in the yeas from the arrival of the euro in 1999 up to 2007. But in the South, saving fell by more than one-third to about 14% of GDP by 2007. This drop in saving reflects higher consumption of imports, and thus is linked to the larger trade deficits of the South.

When it comes to private investment, the South has done shown a modest rise and the North a modest decline.

When an economy runs trade surpluses, it accumulates financial capital to purchase foreign assets; for example, this is why the Chinese have come to own so much in U.S. Treasury bonds. When a country runs trade deficits, on the other side, it experiences an inflow of financial capital from other countries. At least in theory, such inflows and outflows of financial capital can in some cases be a healthy form of economic adjustment. For example, one can imagine the possibility of German investment capital flowing into Spain, being invested prudently, and helping Spain's economy grow rapidly while providing a good rate of return to German investors. One can also come up with less-pleasant scenarios, in which German investment capital flows into Spain, is not invested prudently, and leads to a situation where German investors do not receive a good rate of return. As the authors put it:" In particular, in the presence of integrated real and financial markets, countries with a lower per capita income would be expected to attract domestic and foreign investment since higher productivity and economic growth rates promise above-average rates of return. The productivity of the invested capital ensures that the accumulated foreign debt can ultimately be repaid."

Of course, now that the debt and financial crisis has hit, all earlier expectations have been confounded. But the evidence up to 2007 doesn't suggest that the South countries--with the exception of Ireland--were using their inflows of financial capital to increase levels of productivity. Thus, it appears that the inflows of financial capital were either being invested unproductively or were financing a consumption boom.

Long story short: The situation in the euro zone between North and South was already headed toward severe instability before the financial and debt crisis. Large and unsustainable imbalances of trade and capital flows were already happening within the euro area. This story is a re-telling of what I called in a November 18 post The "Chermany" Problem of Unsustainable Exchange Rates. When trading partners are locked together by fixed exchange rates that are generating large surpluses in one country and large deficits in the other--whether in the case of China and the U.S economy, or in the case of Germany and northern Europe as compared to much of southern Europe--substantial economic stresses can be created.

Holinski, Kool, and Muysken conclude this way: "In our view, in a common currency area—or an irrevocably fixed exchange rate system, for that matter—fiscal policy in the end will be forced to step in to address unsustainable current account imbalances. This is exactly what experience in the euro area over the past few years shows. To maintain and defend the euro area, northern euro area countries will need to bail out southern countries, willingly or not, and are doing so as witnessed by implicit and explicit guarantees and continuing emergency financial support. And they probably will need to keep doing so for a substantial period ahead."

This perspective emphasizes that Europe's debt and financial crisis isn't just another chapter of the U.S. financial crisis, but has distinctively European roots. It also emphasizes that Europe's imbalance aren't something that can be solved by cutting one mega-deal. Either the South needs to increase its saving so that its trade deficits diminish, or else raise productivity so that it can pay off the financial consequences of its trade deficits over time--or else the North will have to pay continued subsidies if it wishes to keep the fixed exchange rate of the euro area.

What Are the Top Five Global Risks for the Next Decade?

2012-02-03T06:00:00.002-06:00

The World Economic Forum has published Global Risks 2012, the seventh edition of an ongoing report. The report is based on survey data, so what it really reveals is what those at high-levels are worrying about--and how those worries are evolving over time.

Here's a description of the overall project from the report: "Data and analysis are based on a newly designed survey covering a meaningfully expanded set of 50 global risks across five categories. The assessments of these risks more than doubled as a result of this year’s survey, with 469 experts and industry leaders responding worldwide. The survey captures the perceived impact and likelihood for each risk over a 10-year
time horizon using a clear and simple five-point scale ..."

As a starting point, consider the top five risks as rated by impact, and the top five risks as weighted by likelihood, and how they have changed during the last few years. The figures are below. The report sums up the change this way: "The risk landscape in this 2012 report is based on a refined and expanded set of 50 risks, compared to 37 in previous years. This means that comparisons to the 2011 report are not like-to-like. However, it is clear that respondents’ concern has shifted from environmental risks in 2011 to socioeconomic risks in 2012, as shown in Box 1. Economic risks have displaced environmental risks as those considered most likely. In 2011, the risks perceived as having the highest potential impact were economic and environmental; in 2012, they are economic and societal."

The colors on these figures represent the category of risk: blue is economic, green is environmental, orange is geopolitical, red is societal, and purple is technological. The report itself offers a lot of interesting analysis of how these risks and others are interrelated, and how the risks may cluster into groups or scenarios.

My own main reaction is that when you are asked each year about risks over the next decade, your answers shouldn't change too dramatically. After all, if your answers change a lot in one year, it implies that you are reacting too much to current events, rather than trying to look ahead over the ten-year horizon. Of course, answers will evolve over time as new information arrives. Still, it's intriguing to me to look at the concerns that seem to fallen from the top of the lists, and wonder whether they are being underemphasized in the press of current events.

For example, when looking at the table showing "Global Risks in Terms of Impact," there is a lot of consistency in the answers. There's also a lot of blue in the figure, showing that economic concerns appear to loom largest: asset price collapse, fiscal crisis, financial crisis, energy price volatility, a slowdown in China's economy. Even some of the geopolitical concerns, like backing away from globalization, are important largely for their economic consequences. In the early years, pandemic and chronic disease hit the top five, but by 2012 food and water supply crises--again often economic in essense--in the top five. Environmental issues are not seen as ranking in the top group, the only green in the figure is "Climatological concerns" in 2011, in the aftermath of Japan's devastating earthquake, but it then drops off in 2012. There is no purple in the figure: that is, technological concerns are not thought to be in the top five in terms of impact.

Remember, the questions in the surveys are about the size of risks over the next 10 years. But in assessing what risks have the largest size, it feels to me as if the lists are being driven pretty heavily by the Great Recession and its aftermath, as well as a few other current economic concerns.

This pattern is more evident in the lists of the top risks that are most likely to arise. Back in 2007, the most likely risk to occur over the next 10 years was "Breakdown of critical information infrastructure." Then when the recession hits, that concern doesn't appear again in the top five from 2008-2012. "Middle east instability" is the #2 most likely risk to occur over the next 10 years in 2008--but then it doesn't appear again in the top five from 2009-2012. No environmental (green-colored) concerns appear in the most-likely list from 2007-2010--and then environmental concerns are four of the five most likely in 2011. "Severe income disparity" isn't in the top five most risky issues from 2007-2011--but then is the risk most likely to occur in 2012.

To me, these sorts of fluctuations are mildly disturbing. They suggest that the high-powered folks answering these kinds of surveys are often reacting to current headlines, and haven't actually given a lot of serious thought to what risks are most likely to arise in the next 10 years nor to how bad those risks might be. Of course, that's also why reports like this one are useful and potentially important. Taking actions to reduce future risks now can often be much cheaper than cleaning up after they occur. But that requires forcibly lifting our eyes up from the headlines of today and trying to develop a clear-minded vision of future risks over the middle-term and the long-term.

For the record, here are the 50 risks listed in the survey, by category:

How Globalization Nearly Exterminated the Buffalo

2012-02-02T06:00:00.001-06:00

M. Scott Taylor (no relation!) offers a new and persuasive explanation of why the American buffalo population declined from 10-15 million in the early 1870s to about 100 by the late 1880s in "Buffalo Hunt: International Trade and the Virtual Extinction of the North American Bison." The article is in the December 2011 issue of the American Economic Review (which isn't freely available on-line, but many in academia will have on-line access to it through their library or a membership in the American Economic Association.)

Taylor summarizes his argument: "This paper examines the slaughter using theory, empirics, and first-person
accounts from diaries and other historical documents. It argues that the story of the buffalo slaughter is surprisingly not, solely, an American one. Instead, I argue that the slaughter was initiated by a tanning innovation created in Europe and maintained by a robust European demand for buffalo hides."

Of course, it's not a shock that the buffalo population declined as settlers spread across the western states in the mid-19th century. But the decline seemed to be happening gradually.

"By 1830, buffalo were largely gone east of the Mississippi. During much of this early period natives hunted the buffalo not only for their own subsistence needs but also to trade buffalo robes at forts and towns. A buffalo robe is the thick and dark coat of a buffalo that is killed mid-winter. Robes could be used as throws for carriages, or cut to make buffalo coats and other fur items. They were a common item in the 19th century, and they made their way to eastern markets via transport along the Missouri river to St. Louis or overland via the Santa Fe trail. In the 1840s settlers pushed through the Great Plains into Oregon and California. The movement of the 49ers to California and the Nevada gold rush years brought a steady stream of traffic through the Platte River valley. Subsistence hunting along the trail plus the movement of cattle and supplies divided the existing buffalo herd into what became known as the Northern and Southern herds.

"The division of herds became permanent with the building of the Union Pacific Railroad through the Platte River valley in the 1860s. While subsistence hunting for the railroad crews surely had some effect on buffalo numbers, as did the railroad’s popular day trips to kill buffalo, the harried buffalo herds withdrew from the tracks, creating a corridor centered on the Union Pacific line. The railroads also provided transportation for buffalo products to eastern and foreign markets, but in the 1860s railway cars were not refrigerated, and, hence, buffalo meat was marketed only as salted, cured, or smoked."

"Despite the railroads, the market for buffalo robes, the increase in subsistence hunting, and the conversion of the high prairie to agriculture, most observers expected the population to decline gradually as it had east of the Mississippi. The force of habitat destruction was minimal on the Great Plains. In 1860, they held only 164,000 people. Farms occupied less than 1 percent of the land area."

This pattern of gradual decline for the buffalo changed abruptly not long after 1870, when tanners in England figured out a way to tan buffalo hides for leather:

"The hardest evidence comes from a London Times article reporting from New York City in August of 1872. It reports that a few enterprising New Yorkers thought that buffalo hides might be tanned for leather, and when the hides arrived they were “sent to several of the more prominent tanners who experimented upon them in various ways, but they met with no success. Either from want of knowledge or a lack of proper materials, they were unable to render the hides soft or pliable, and therefore they were of no use to them.”

The report continues to note “several bales of these hides were sent to England, where they were readily taken up and orders were immediately sent to this country for 10,000 additional hides. These orders were fulfilled, and since then the trade has continued.” Further still, the methods are spelled out: “The hides are collected in the West by the agents of Eastern houses; they are simply dried, and then forwarded to either New York or Baltimore for export… The low price that these goods have reached on the English market, and the prospect of a still further decline, may in time put an end to this trade, but at present the hides are hunted for vigorously, and, if it continues, it will take but a few years to wipe the herds out of existence” (my emphasis). ...

The market for buffalo hides boomed; buffalo hunters already in the field—like George “Hodoo” Brown—started to skin buffalo for their flint (hairless) hides, and hundreds if not thousands of others soon joined in the hunt. Previous to the innovation, hides taken from the Southern herd or hides taken in all but three winter months were virtually worthless as fur items. The only saleable commodity from a buffalo killed in these regions or times was its meat, but this market was severely limited by transportation costs. With the advent of a flint-hide market, killing a buffalo anywhere and anytime became a profitable venture. By 1872, a full-scale hide boom was in progress."

Taylor acknowledges and discusses the standard explanations for the decline of the buffalo: hunting by the United States Army, the presence of the railroads, and changes in native American hunting practices. While each of these may have contributed a bit to the decline, his estimates suggest that demand from the global market played a central role: "[T]he newly constructed export data support the export-driven slaughter hypothesis, while the evidence for the alternative hypotheses that hold the railroads, the Army, or native Americans responsible is far weaker. The magnitudes of the implied export flows are considerable. My findings suggest approximately six million buffalo hides are exported over the 1871–1883 period, and this represents a buffalo kill of almost nine million."

Taylor boils down three crucial economic factors behind the buffalo slaughter: "[A] combination of a tanning innovation, open access to buffalo herds, and fixed world prices delivers a punctuated slaughter matching that witnessed on the Great Plains.... The slaughter is not a unique example of resource overuse created by burgeoning demand and poor regulation. It may, however, be unique in its scale, its speed, and the critical role played by international markets. ... Although the bison slaughter was a major event in US history, it was a minor event on the world stage. And being small on world markets meant that some of the typical insulating and signaling properties provided by a market price system were missing."

In short, when smaller countries and economies around the world express concern that combinations of new technology and global demand might devastate their natural habitat or resources, Americans should be willing to listen. In our own history, it's what nearly exterminated the buffalo.

As a coda, the slaughter of the buffalo was one of the events leading to the creation of an American environmentalist movement: "The slaughter of the North American buffalo surely represents one of the saddest chapters in American environmental history. To many Americans at the time, the slaughter seemed wasteful and wrong, as many newspaper editorials and letters to congressmen attest, but still, little was done to stop it. The destruction of the buffalo and the wanton slaughter of other big game across the West did, however, pay some dividend. The slaughter of the buffalo in particular was pivotal in the rise of the
conservation movement in the late nineteenth and early twentieth century. Almost all of the important players in the conservation movement experienced the slaughter firsthand—Teddy Roosevelt, John Muir, and William Hornaday. The creation of the national park system in general, and the Yellowstone herd in particular, reflect
the revulsion many felt to the Slaughter on the Plains."

Recovery Delayed, Says CBO

2012-02-01T06:00:00.001-06:00

Twice a year, the Congressional Budget office puts out "The Budget and Economic Outlook," which provides budget and economic forecasts. After the report last August, I called my blog post Unrequited Economic Optimism from the Congressional Budget Office, because it predicted that in 2012, the fall in housing prices would bottom out and the unemployment situation and growth would improve a bit, which would finally be followed by much better news in 2013 and thereafter. However, the just-released January 2012 report dials back the optimism. Here's CBO (footnotes omitted):

"CBO’s current economic forecast differs in some respects from its previous one, which was issued in August, as well as from the January Blue Chip consensus forecast (which is based on about 50 forecasts by private-sector economists) and the consensus of January forecasts by Federal Reserve Board members and Federal Reserve Bank presidents. 1 Compared with what it forecast in August, CBO is currently projecting weaker growth of real GDP in 2012 and 2013 but slightly stronger economic growth over the remainder of the decade ... The current forecast also includes a higher unemployment rate and lower interest rates through 2021. CBO’s current projections for the growth of real GDP in 2012 and 2013 are also weaker than those by the Blue Chip consensus and the Federal Reserve— perhaps owing to different assumptions about federal
fiscal policy—and CBO’s projections for the unemployment rate are higher."

Growth
Overall, CBO writes: "A large portion of the economic and human costs of the recession and slow recovery remains ahead. In late 2011, according to CBO’s estimates, the economy was about halfway through the cumulative shortfall in output that will result from the recession and its aftermath." Here's a figure comparing the projected growth rate of the U.S. economy with a group of leading trade partners of the U.S., where their growth rates are weighted by their shares of U.S. exports. The countries are Australia, Brazil, Canada, China, the euro zone, Hong Kong, Japan, Korea, Mexico, Singapore, Switzerland, Taiwan, and the United Kingdom. A forecast like this one, which suggests the bad news slower growth than the comparison group now and for for several years, but faster growth later on, is inherently discomforting.

Unemployment

With bounceback more-rapid growth not kicking in to 2014, the unemployment rate is predicted not to fall much in the near-term, either. "In CBO’s forecast, the unemployment rate in 2012 and 2013 remains largely
unchanged from its value last year. However, in the forecast, as growth picks up after 2013, the unemployment rate falls to 6.9 percent by the end of 2015 and 5.6 percent by the end of 2017."

Housing

CBO continues to believe that housing prices will bottom out in the second half of 2012, which would help a lot of U.S. households feel more secure. However, a historically large share of U.S. housing stock is vacant, which means that the house construction industry won't rebound until a few years later.

Business Investment

"Net" business investment is the amount of investment after depreciation has been subtracted out: that is, it is the amount added to the capital stock after replacing what has worn out. This is a modest bright spot for the U.S. economy, having already turned up, with CBO expecting that it will continue to rise back toward historical averages.

My standard line about the U.S. economy, as we all buckle our seat belts for the election next fall, is that whoever is elected president in November 2012 is like to be regarded as an economic saviour by the end of his first or second year of office. But a lot of the eventual turnaround won't have much to do with whatever policies are enacted between now and then; it will just be that the economy will have finally managed to work through most of the backlog of problems from the Great Recession.

My New Book -- "The Instant Economist: Everything You Need to Know About How the Economy Works."

2012-01-31T08:00:00.000-06:00

Here's the start of my new book called The Instant Economist: Everything You Need to Know about How the Economy Works. It's available as of today on Amazon here, or at Barnes and Noble here.

"Talking about the wisdom of economists in polite company is like talking about the honesty of politicians or the lips of chickens. Yet in the face of this prejudice, I maintain that economics has useful lessons for understanding the world. My wife says I hold this belief because I am an evangelist, with economics as my religion. Perhaps so, but I have also been asked many times, by many people—at venues as diverse as conferences and cocktail parties—to recommend “just one book” that explains economics. These people aren’t looking for a treatise on the beauty of the free market, or for a lecture on the need for government regulation. They have their own views on politics and policy, but they are self-aware enough to recognize that at least some of their views are built on a shaky or nonexistent understanding of economics. I can sympathize. There are dozens of books out there on economics—freaky and otherwise—but I’m hard-pressed to point to a readable non-textbook that would give a soup-to-nuts understanding of the key principles of economics. I hope that the book you’re reading will impart a working understanding of both micro- and macroeconomics, not enough to prepare you for setting up your own economic forecasting business, but enough that you can read and speak about economics topics with greater confidence and conviction."

"I know what you’re thinking. You’re wondering if I’m out to push a certain set of economic policies, and if so, whose side of the political fence I’m on. Such skepticism is understandable, but here’s the honest truth: If you’re wondering whether this book’s contents are slanted toward liberal or conservative economic policy—or toward the Democratic or Republican Party—the short answer is no. Professional economists of all political leanings use the tools and concepts I will discuss here. Economics is not a set of answers, but a structured framework for pursuing those answers."

For an idea of what the book tries to accomplish, maybe it's useful to tell the back story of how this material has percolated a long time, through five episodes of thinking about how to teach intro economics.

Episode #1 started in the late 1980s was when I worked with Joseph Stiglitz in putting together his introductory economics textbook. This led to episode #2, which was when I started teaching large-lecture introductory economics courses at Stanford University in the late 1980s. This in turn led to episode #3 a few years later, when Stanford got a Pew Foundation grant to bring over groups of young diplomats from countries of eastern Europe. Many of them had been educated and trained with the expectation that they would become part of the larger Soviet diplomatic apparatus, but with the break-up of the Soviet Union, those expectations has become obsolete. Groups would come over and spend a few months based at Stanford, with side trips to see other parts of the U.S. They sat in on various courses, but also had an international affairs course and an economic course just for their group. For a few years while the grant money lasted, I gave the economics lectures, which were were an intuitive and nontechnical 15-hour version of the intro economics course.

This led to episode #4, which was a call from the Teaching Company, a firm based near D.C. I'd won a student-voted award as the outstanding teacher of a large lecture class at Stanford, and they wanted to know if I would record a version of that course for their adult education lectures. I'd never heard of the company, but I had the lecture notes pretty much ready to go from my talks to the eastern European diplomats, so I said "sure." That course was first recorded in 1994; the most recent edition (the third) was recorded in 2005. This led to episode #5, when Penguin/Plume started having talks with the Teaching Company about turning some of their more popular courses into books. They asked if I would take a stab at doing this with the economics book. This involved a huge cut in the word count from the 18 hours of lectures, because they didn't want a tome, and then updating the material as needed so that it would cover the economic events of the Great Recession and its aftermath.

I'm pleased with the book. For those looking for an actual introduction to economic thinking, and a bunch of examples and applications, this book should help to organize the concepts and clarify the tradeoffs. I suspect that the book may also be used as background reading for those who want to teach an intro economics course with almost no graphs or equations. Buy a bunch and give 'em out as party favors! Send a copy to political figures! Use them as paperweights!

Here's the review from Library Journal, which I thought captured the flavor of the book:

"Taylor’s (managing editor, Journal of Economic Perspectives) volume can help conversationalists looking to raise the bar for their watercooler chats and casual readers who want to understand better the current economic condition of the United States. Taylor uses simple language with field-specific vocabulary to explain economic concepts, and each concept is successfully reinforced with a real-life—and usually entertaining—example. He hits all the subjects that might interest a layperson, such as division of labor, supply and demand, wages, competition and monopoly, inflation, banking, and trade, for a total of 36 petite chapters—just enough information to give the reader a basic but well-rounded understanding of the subject. VERDICT This highly readable, nonpoliticized look at some of the economic principles that shape our society, presented in an engaging, anecdotal fashion, is highly recommended for armchair economists and anyone with a general interest in the state of our economy. —Poppy Johnson-Renvall, Central New Mexico Community Coll. Lib., Albuquerque

Economic Underpinnings of the U.S. Revolutionary War

2012-01-31T06:00:00.001-06:00

The U.S. war for independence from Britain is often described in terms a desire for democratic self-government and protection of the rights of citizens. But among historians, there has been a long tradition arguing that economic factors were more important. Perhaps most famously, Charles Beard argued back in 1913 in his book, An Economic Interpretation of the Constitution of the United States that the Founding Fathers were just out to protect their own personal property. But as the decades passed, a consensus developed that Beard's arguments was so simplistic and contentious and stark that it was just wrong.

Staughton Lynd and David Waldstreicher offer a refreshing take on the role of economic forces in the U.S. Tevolution in "Free Trade, Sovereignty, and Slavery: Toward and Economic Interpretation of American Independence." It appears in the October 2011 issue of the William and Mary Quarterly, which is not freely available on-line, but will be available to many with academic ties if their institution has a certain kind of JSTOR subscription. Here's their opening (footnotes omitted):

"What kind of revolution was the American Revolution? Four basic answers, all first suggested before 1800, continue to shape the scholarship. They can be denoted Answers A, B, C, and D.

Answer A was advanced by the Revolution's leaders and echoed by their friends in Great Britain, such as Edmund Burke: The American Revolution was a struggle for constitutional rights.

Answer B was that of the Revolution's opponents, again both in the American colonies and in Great Britain: The American Revolution was a struggle for economic independence from the British Navigation Acts and other economic restrictions.

Answers C an D were put forward in a second round of controversy during the 1790s, as Americans tried to determine their proper relationship to the French Revolution. Answer C was that of the Jeffersonians: The American Revolution was a democratic movement essentially similar to the French Revolution. Their Federalist opponents responded with Answer D: The American Revolution was a colonialist independence movement essentially different from the French Revolution. ...

We offer for further exploration what might be described as a B-D interpretation. That is, the American Revolution was basically a colonial independence movement and the reasons for it were fundamentally economic."

I can't hope to summarize their argument point-by-point, but in large part, it comes down to pointing out how economic conflicts were often prior in time other events of the Revolution, and loomed large in importance. Britain often sought to tax or even to embargo various kinds of trade from the American colonies to the West Indies: for example, the import tax with the Molasses Act of 1733, or the way in which the British Navy tried to cut off trade between the colonies and the French West Indies during the Seven Years' War. The "single most contentious issue" in the First Continental Congress in 1774 was about the extent to which the British Parliament could regulate the U.S. economy, including these and other limits on navigation as well as acts that sought to prohibit manufacturing in the colonies (so that the colonies would need to import from Britain, instead). After reviewing the history in some detail, they write:

"The commercial dispute preceded the constitutional, not just once but again and again in these years. It is important that colonists melded economic and constitutional arguments under the category of sovereignty--but not so important that we should ignore the originating nature of economic forces."

To anyone who has passed through the U.S. public school system, or who has listened to the rhetoric of politicians, thinking of U.S. independence has nearly sacrilegious overtones. Lynd and Waldstreicher respond like this:

"If the American Revolution had fundamentally economic causes, it is not thereby demeaned. Post-World War II colonial independence movements should have taught us something about the many-sided meanings of economic sovereignty for developing nations. If not only merchants but also artisans, tenant farmers, cash-strapped yeoman, fishermen, and debt-ridden slave-owning planters can be shown to have had compelling economic reasons to favor independence, it should not seem too narrow or conspiratorial to suggest that they acted on these reasons and sought to combine them with a language that spoke to principles as well as to the bottom line."

To me, it seems quite plausible and believable that the urge of the colonists to move beyond protest and into actual war and rebellion needed the push of economic factors. In addition, if we have learned nothing else from last two centuries, it should be that when anyone starts talking about a revolution is needed for freedom and justice and for people to get their "rights," warning sirens should go off in your brain. Such promises from revolutionaries have certainly been betrayed far more than they have been honored.

But it also seems to me that the cause of an event is often quite different than the lasting legacy of that same event. The causes of the U.S. Revolution probably were largely economic, albeit expressed in a language of constitutionalism. But the lasting legacy of American Independence was the creation of a constitutional structure that is flexible enough to adapt and strong enough to endure.

Robert Kennedy on Shortcomings of GDP in 1968

2012-01-30T06:00:00.001-06:00

Every year or two, I run across this lovely quotation from Robert F. Kennedy about the fundamental shortcomings of gross national product as a measure of well-being. It's from a speech he gave at the University of Kansas on March 18, 1968, and a transcript is available here. Here's RFK:

"Too much and for too long, we seemed to have surrendered personal excellence and community values in the mere accumulation of material things. Our Gross National Product, now, is over $800 billion dollars a year, but that Gross National Product - if we judge the United States of America by that - that Gross National Product counts air pollution and cigarette advertising, and ambulances to clear our highways of carnage. It counts special locks for our doors and the jails for the people who break them. It counts the destruction of the redwood and the loss of our natural wonder in chaotic sprawl. It counts napalm and counts nuclear warheads and armored cars for the police to fight the riots in our cities. It counts Whitman's rifle and Speck's knife, and the television programs which glorify violence in order to sell toys to our children. Yet the gross national product does not allow for the health of our children, the quality of their education or the joy of their play. It does not include the beauty of our poetry or the strength of our marriages, the intelligence of our public debate or the integrity of our public officials. It measures neither our wit nor our courage, neither our wisdom nor our learning, neither our compassion nor our devotion to our country, it measures everything in short, except that which makes life worthwhile. And it can tell us everything about America except why we are proud that we are Americans."

Although economists sometimes stand accused of worshiping GDP, this charge is untrue. Every introductroy economics textbook, including my own (available here through Textbook Media), acknowledges these shortcomings, although I confess we lack the poetic cadences of RFK. But the quotation can be a nice supplement when introducing students to the concept of GDP, or when looking for a topic for a short writing assignment or essay question.

The speech isn't long, and if you are a connoisseur of political rhetoric, it's worth reading. Of the current politicians on the national stage, I don't think any of them has the lovely touch with self-deprecating humor at the start of this kind of talk. Here's RFK warming up the audience--and remember that there are many Kansas students in the audience who don't especially support him:

"I'm very pleased and very touched, as my wife is, at your warm reception here. I think of my colleagues in the United States Senate, I think of my friends there, and I think of the warmth that exists in the Senate of the United States - I don't know why you're laughing - I was sick last year and I received a message from the Senate of the United States which said: "We hope you recover," and the vote was forty-two to forty. And then they took a poll in one of the financial magazines of five hundred of the largest businessmen in the United States, to ask them, what political leader they most admired, who they wanted to see as President of the United States, and I received one vote, and I understand they're looking for him. I could take all my supporters to lunch, but I'm - I don't know whether you're going to like what I'm going to say today but I just want you to remember, as you look back upon this day, and when it comes to a question of who you're going to support - that it was a Kennedy who got you out of class."

It's also hard to imagine that the speechwriters for any contemporary politician would let them finish a speech with this kind of classical reference and slightly obscure flourish: " I want the next generation of Americans to look back upon this period and say as they said of Plato: "Joy was in those days, but to live.""

Economic Underpinnings of Arab Spring

2012-01-27T06:00:00.006-06:00

Adeel Malik and Bassem Awadallah discuss "The economics of the Arab Spring" in a working paper (WPS/2011-23) for the Center for the Study of African Economies at the University of Oxford. They point out that despite rapid growth in education levels, access to water, and urbanization--all patterns that are often associated with sustained economic development--the region has failed dismally to develop a robust private sector. As a result, well-educated and youth-heavy populations see little chance for economic advancement. Here are some excerpts:

On large numbers of young and unemployed workers:

"Over the last few decades, the Middle East has witnessed an unprecedented youth bulge that has dramatically changed its demographic profile. An overwhelming proportion of its population--in many countries about three-quarters--now consists of young people under the age of 30. Together with a greater female participation in the labour force, these demographic trends have greatly enhanced the number of people looking for jobs. During the period 1996=2006, labour force in Middle East and North Africa has grown three times as much annually as in the rest of the developing world, resulting in one of the larges rates of youth unemployment in the world."

On the collision between rising education and thwarted aspirations:

"Of the tip 10 countries that made the most impressive strides in human development during the last 40 years, five were from the Arab world. Starting from one of the lowest levels of educational achievement in the 1960s, adult education rose faster in the Middle East during the 19890-2000 period than any other region in the World. Despite reservations about the quality of education imparted, even this quantitative expansion of education has led to a silent revolution of sorts. It is a revolution of aspirations. Even as aspirations have become more mobile with the new gadgets of globalization, the local systems of governance are ossified and offer limited economic mobility to the region's youth."

On the centrality of government in the economic sphere:

"The state in most Arab economies is the most important economic actor, eclipsing all independent productive sectors. When it comes to essentials of life, such as food, energy, jobs, shelter, and other public services, the state is often the provider of both first and last resort. The functioning of this system rests on a heavy dose of subsidies, economic controls, and a variety of other uncompetitive practices. ... The state-centred development paradigm rests on an uninterrupted flow of external windfalls. In fact, many of the region's pathologies--whether it is a weak private sector, segmented labor markets, or limited regional trade--are ultimately rooted in an economic structure that relies overwhelmingly on rents derived from fuel exports, foreign aid, or remittances. Reliance on such unearned income streams is the "original sin" for Arab economies."

On the paucity of intra-Arab trade:

"With a population of 350 million people that share a common language, culture, and a rich trading civilization, the Arab world doesn't function as one common market. ... Few Arab countries consider their neighbors as their natural trading partners. Pan-Arab trade is noticeably insignificant. Despite having tripled between 2000 and 2005, the share in intra-Arab trade in total merchandise trade still hovers around 10 percent. ... The share of intra-Arab imports, despite having fluctuated widely, is only marginally higher than that in 1960. ... Even this limited trade is geographically clustered, with countries in the Gulf and North Africa trading predominantly within their own sub-regions."

Location and water access don't seem to be helping:

"The Arab world is well-positioned to be a global trade and production hub. Geographically, it lies at the cross-roads of major sea and trading routes with easy access to Europe, Africa, and the near East. ... Strictly speaking, there is not even a single landlocked country in the Arab world, even if Iraq and Jordan have narrow coastal strips. ... It is ironical that a region that connects Asian merchants with European markets is itself stuck in primary production. Everywhere in the world proximity to coasts tends to be associated with lower transport costs and better access to global markets. The Arab world defies these forces of gravity, however."

Urbanization doesn't seem to be helping:

"[C]ities offer a range of mutually supportive activities. Bringing together machinery, skills, suppliers and resources together in a single location can be tremendously advantageous for firms. Such agglomeration economies are missing in the Middle East, even if it is more urbanized today than several developing regions: 58 percent of the region's population lives in urban areas, compared to 30-37 percetn in sub-Sarharan Africa and south Asia. ... Yet, Arab firms are failing to reap the cost advantages that growing urbanization confers on them."

The jobs challenge and the private sector:

"The private sector is at once the most despised as well as the most desirable aspect of reform. Business in the Arab world is often comfortably embedded within the state, wtiht eh result that it invokes images of crony capitalism. At the same time, an estimated 100 million jobs need to be created in the MENA [Middle East and North Africa] region in the next decade or so. This employment challenge cannot be addressed without a strong private sector. .. An independent business sector will also serve a vital political function: it can generate a middle class that can serve as a powerful constituency for political reform. ... Viewed in this light, the struggle for a new Middle East will be won or lost in the private sector."

Malik and Awadallah lay particular emphasis, among all the policy steps that might be taken, on policies that would help to create a regional market across the Middle East: that is, policies and investments to make travel, shipping, business, and communication cheaper and easier. Such policies might be more politically acceptable (that is, less upsetting to local elites) than attempts to open more directly to the global economy. Riding the wave of discontented and well-educated young adults, such policies might also help to harness the power of Arab spring in a productive manner.

Doha Seems Dead: What Next for the WTO?

2012-01-26T06:00:00.000-06:00

The Doha round of trade talks kicked off in 2001. They now include 153 countries trying to reach agreement across nine areas at a time when the high-income countries are suffering the aftermath of a deep recession and watching a shift in global economic power toward emerging markets. After eleven years of negotiation, maybe it's time for the World Trade Organization to focus on something else.

Sure, there's a solid case to be made for the merits of the Doha trade round. Will Martin and Aaditya Mattoo edited a Vox e-book published last November called Unfinished Business: The WTO's Doha Agenda. In a column describing the main findings of the book, they point out: "The tariff cuts on the table compare favourably with those achieved in earlier rounds of multilateral negotiations. Even after allowing for flexibilities such as for sensitive and special products, Doha would cut the applied tariffs faced by exporters of agricultural and non-agricultural goods by around 20% ... The global real income gains from this market opening alone are conservatively estimated at around $160 billion per year. The agricultural proposals also include the abolition of export subsidies, and sharp reductions in maximum levels of domestic agricultural support in the EU and the US. ... A hard-to-quantify but nevertheless significant gain from the negotiations would be greater security of market access."

The main action in international trade talks in recent years has been through "preferential trade agreements" negotiated between two or more countries. The U.S. currently has such agreements with 17 countries. Worldwide, the WTO now has a list of 512 regional trade agreements.

Regional agreements can lead to reduced trade barriers within the group of participating countries, but greater trade barriers between that group and the rest of the world. Thus, their net effect on free trade is not clear. Caroline Evans of the San Francisco Fed points out in a recent newsletter that preferential/regional trade agreements often lead to complex "rules of origin" about what share of value-added was made in which country, and also to different tariff rates across countries. She gives an example of U.S. trousers imports:

"Rules of origin are put in place to eliminate cheating, whereby one country imports a product from a non-partner country and then re-exports it to the free-trade partner. Satisfying rules-of-origin requirements has become increasingly complex, since production processes now stretch across multiple countries. When an assembling country sources inputs from a number of other countries and then exports the finished product to another final market, it becomes difficult to determine exactly where the product originates. Since each PTA has its own rules of origin for particular parties to the agreement, meeting those requirements may become quite complicated."

"Different trade agreements also lead to separate tariff rates on imports from different countries. For example, U.S. imports of a certain kind of men’s trousers from most countries face a duty of $0.61 per kilogram plus 15.8% of the product’s value. However, if the trousers are imported from Bahrain, Canada, Chile, Israel, Jordan, Mexico, Peru, or Singapore, no duty is imposed. Trousers from Australia incur an 8% tariff; from Morocco $0.62 per kilogram plus 1.6%; and from Oman $0.488 per kilogram plus 12.6%. For non-WTO member countries, a $0.772 per kilogram plus 54.5% tariff is imposed. ... Rules of origin and the profusion of tariff rates increase the costs of trade, both for businesses involved in cross-border commerce and governments enforcing trade rules. Furthermore, they may distort production decisions as businesses navigate the web of rules and rates to minimize transaction costs."

So if the Doha round is becalmed and the alternative of regional trade agreements is imperfect at best, what should the WTO and other friends of free trade be focusing on these days? Last November, the Strategy, Policy and Review Department of the IMF put out a paper called "The WTO Doha Trade Round--Unlocking the Negotiations and Beyond" with some suggestions for multilateral steps that could perhaps be debated and even implemented through the WTO mechanism.

Some of the ideas seem potentially useful to me. For example, greater monitoring of protectionist measures, including nontariff barriers and rules that require governments to buy domestically produced goods and services, seems like a step in the right direction. There are concerns that some countries restrict food exports at certain times, which makes other countries unwilling to rely on food imports, and thus leads them to subsidize their own domestic food production. Perhaps this set of issues could be isolated and discussed. And perhaps it might be possible for WTO to negotiate a set of guidelines for the proliferating preferential trade agreements, so that they are more likely to reduce overall trade barriers for the world economy, rather than reducing trade barriers for participants but raising them for everyone else.

On the other side, some of the IMF suggestions seem implausible to me. For example, one suggestion is that WTO should get into climate change issues, which would mean trying to jump-start one set of dead-in-the-water negotiations by getting involved in another set of dead-in-the-water negotiations. Another suggestion is that the WTO might develop an international antitrust policy. I'm not feeling it.

The power of the World Trade Organization is often highly overstated in public discussions. It's not a colossus imposing its own vision of a new world economic order. It's an organization with a staff of about 600 people, where decisions are made by consensus of the 153 member nations. But it is useful to have a world meeting-place for hashing out international trade issues, and there's a lot of knowledge and experience and skill wrapped up in the WTO apparatus. But if the future of the WTO is wrapped up in the endlessly stalled Doha negotiations, the organization seems likely to marginalize itself into irrelevancy.

McKinsey on Reducing Debt and the Pathway to Economic Health

2012-01-25T06:00:00.006-06:00

The McKinsey Global Institute has just published "Debt and deleveraging: Uneven progress on the
path to growth." The report uses the cases of Sweden and Finland in the 1990s as a map for how recovery from too much debt, asset bubbles, and financial crisis might proceed. MGI writes:

"The examples of deleveraging in Sweden and Finland during the 1990s have particular relevance today. Both nations experienced credit bubbles that led to asset bubbles and, ultimately, financial crises. But both also moved decisively to bolster their banking systems and deal with debt overhang. And—after painful recessions—both nations went on to enjoy more than a decade of strong GDP
growth. The experiences of the two Nordic economies illustrate that deleveraging often proceeds in two stages. In the first, households, the financial sector, and nonfinancial corporations reduce debt, while economic growth remains very weak or negative. During this time, government debt typically rises as a result of higher social costs and depressed tax receipts. In the second phase, economic growth rebounds and then the longer process of gradually reducing government debt begins."

With this pathway to eventual recovery in mind, MGI makes an argument that the U.S. economy is actually further down the road to recovery than most other high-income countries:

"Since the end of 2008, all categories of US private-sector debt have fallen relative to GDP. Financial-sector debt has declined from $8 trillion to $6.1 trillion and stands at 40 percent of GDP, the same as in 2000. Nonfinancial corporations have also reduced their debt relative to GDP, and US household debt has fallen by $584 billion, or a 15 percentage-point reduction relative to disposable income. Two-thirds of household debt reduction is due to defaults on home loans and consumer debt. With $254 billion of mortgages still in the foreclosure pipeline, the United States could see several more percentage points of household deleveraging in the months and years ahead as the foreclosure process
continues.

Historical precedent suggests that US households could be as much as halfway through the deleveraging process. If we define household deleveraging to sustainable levels as a return to the pre-bubble trend for the ratio of household debt to disposable income, then at the current pace of debt reduction, US households would complete their deleveraging by mid-2013. ..."

Here's a figure showing the rapid increase in U.S debt by sector, and the recent change. In contrast to this U.S. pattern, MGI notes that in Japan private-sector debt levels didn't start falling until eight years after the bursting of the bubble.

What steps should we be seeing along the way in the next year or two that would reassure us that the U.S. economy is returning to health? The MGI report offers six "markers." Here, I'll focus on how the U.S. economy measures up on these markers, although the report offers many intriguing comparisons to other countries, especially the United Kingdom and Spain.

"Marker 1. Is the banking system stable?"
The U.S. economy does seem to have stabilized the banking system (at some cost!). "Net new mortgage lending only recently turned positive in the United States."

"Marker 2. Is there a credible plan for long-term fiscal sustainability?"
In terms of what Congress has enacted and President Obama has signed into law, the answer is clearly "no."

"Marker 3. Are structural reforms in place to unleash private-sector growth?"
"The United States should encourage business expansion by speeding up regulatory approvals for business investment, particularly by foreign companies, and by simplifying the corporate tax code and lowering marginal tax rates in a revenue-neutral way. Business leaders also say that the United States can improve infrastructure and the skills of its workforce and do more to encourage innovation."

"Marker 4. Are the conditions set for strong export growth?"
This step was especially important for Sweden and Finland, as small open economies. It's less crucial for the U.S., with its huge internal market and, by world standards, relatively low trade-to-GDP ratio. Still, the U.S. economy should be recognizing that the most rapid growth in the world economy in the next few decades is going to be happening outside our borders, and we need to be thinking about how we can tap into this growth, with everything from building connections for exporters to encouraging tourism.

"Marker 5. Is private investment rising?"
"Today, annual private investment in the United States and the United Kingdom is equal to roughly 12 percent of GDP, approximately 5 percentage points below pre-crisis peaks. Both business investment and residential real estate investment declined sharply during the credit crisis and the ensuing recession. While private business investment has been rising in recent quarters, total investment remains low because of slow housing starts." My own expectation is that real estate investment isn't going to be driving the U.S. economy forward in the next few years--at best, we can hope that it won't be a drag. So the key to U.S. investment is business investment levels.

"Marker 6. Has the housing market stabilized?"
"Both Macroeconomic Advisers and the National Association of Home Builders predict that new housing starts will not approach pre-crisis levels until at least 2013—coincidentally the year in which we estimate that US households may be finished deleveraging."

In my own view, the most important policy steps that flow from this analysis are the importance of building to an agreement on a credible middle-term plan for holding down the ongoing rise in U.S. government debt levels, and finding ways to encourage business investment.

U.S. Science Needs to Look Beyond Our Borders

2012-01-24T08:00:00.001-06:00

The U.S. has traditionally been the dominant world presence in science, although it of course needed to pay some attention to scientific efforts in western Europe, Japan and Canada as well. America is used to scientists and business people from other countries coming here to learn the latest breakthroughs. But the U.S. scientific edge is diminishing. As Caroline S. Wagner writes in "The Shifting Landscape of Science",

in the Fall 2011 issue of Issues in Science and Technology: "The days of overwhelming U.S. science dominance are over, but the country can actually benefit by learning to tap and build on the expanding wellspring of knowledge being generated in many countries." Here are some excerpts:

Here's Wagner with an overview of the past and what's coming: "Since the middle of the 20th century, the United States has led the world rankings in scientific research in terms of quantity and quality. U.S. output accounted for more than 20% of the world’s papers in 2009. U.S. research institutions have topped most lists of quality research institutions since 1950. The United States vastly outproduces most other countries or regions in patents filed. ... In 1990, six countries were responsible for 90% of R&D spending; by 2008, this number has grown to include 13 countries. According to the United Nations Educational, Scientific, and Cultural Organization (UNESCO), since the beginning of the 21st century, global spending on R&D has nearly doubled to almost a trillion dollars, accounting for 2% of the global domestic product. Developing countries have more than doubled their R&D spending during the same period. ...The UNESCO report documents that the global population of researchers has increased from 5.7 million in 2002 to 7.1 million in 2007. The distribution of talent is spread more widely, and the quality of contributions from new entrants has increased."

One common (if imperfect) measure of scientific output is the number of scientific papers published. By this metric, the European Union has taken the lead from the United States, and countries like China and Korea are rising rapidly.

Wagner's overall message is that in a world economy where science and technology are of increasing importance, and a world where a greater share of that research is happening elsewhere, and where pressures on government budgets mean that U.S. spending on R&D isn't likely to rise in a sustained and dramatic way--in that world, the U.S. scientific establishment needs to focus more on identifying excellent research happening around the world and in in keeping tabs on that research and finding ways to participate in it. Here's Wagner:

"Although the U.S. research system remains the world’s largest and among the best, it is clear that a new era is rapidly emerging. With preparation and strategic policymaking, the United States can use these changes to its advantage. Because the U.S. research output is among the least internationalized in the world, it has enormous potential to expand its effectiveness and productivity through cooperation with scientists in other countries.

"Only about 6% of U.S. federal R&D spending goes to international collaboration. This could be increased by pursuing a number of opportunities: from large planned and targeted research projects to small investigator-initiated efforts and from work in centralized locations such as the Large Hadron Collider in Geneva to virtual collaborations organized through the Internet. Most federal research support is aimed at work done by U.S. scientists at U.S. facilities under the assumption that this is the best way to ensure that the benefits of the research are reaped at home. But expanded participation in international efforts could make it possible for the United States to benefit from research funded and performed elsewhere.

"U.S. policy currently lacks a strategy for encouraging and using global knowledge sourcing. Up until now, the size of the U.S. system has enabled it to thrive in relative isolation. Meanwhile, smaller scientifically advanced nations such as the Netherlands, Denmark, and Switzerland have been forced by budgetary realities to seek collaborative opportunities and to update policies. ... An explicit U.S. strategy of global knowledge sourcing and collaboration would require restructuring of S&T policy to identify those areas where linking globally makes the most sense. The initial steps in that direction would include creating a government program to identify and track centers of research excellence around the globe, paying attention to science funding priorities in other countries so that U.S. spending avoids duplication and takes advantage of synergies, and supporting more research in which U.S. scientists work in collaboration with researchers in other countries."

"One recent example of movement in the direction of global knowledge sourcing is the U.S. government participation with other governments in the Interdisciplinary Program on Application Software toward Exascale Computing for Global Scale Issues. After the 2008 Group of 8 meeting of research directors in Kyoto, an agreement was reached to initiate a pilot collaboration in multilateral research. The participating agencies are the U.S. National Science Foundation, the Canadian National Sciences and Engineering Research Council, the French Agence Nationale de la Recherche, the German Deutsche Forschungsgemeinschaft, the Japan Society for the Promotion of Science, the Russian Foundation for Basic Research, and the United Kingdom Research Councils. These agencies will support competitive grants for collaborative research projects that are composed of researchers from at least three of the partner countries, a model similar to the one used by the European Commission. ..."

"Looking for the opportunity to collaborate with the best place in any field is prudent, since the expansion of research capacity around the globe seems likely to continue and it is extremely unlikely that the United States will dramatically increase its research funding and regain its dominance. Moreover, it may be that the marginal benefit of additional domestic research spending is not as great as the potential of tapping talent around the world. Thus, seeking and integrating knowledge from elsewhere is a very rational and efficient strategy, requiring global engagement and an accompanying shift in culture."

Thoughts on Ultra-Low Interest Rates

2012-01-23T06:00:00.001-06:00

Philip Turner asks "Is the long-term interest rate a policy victim, a policy variable or a policy lodestar? in a December 2011 working paper for the Bank of International Settlements.

Not all long ago, a number of papers tried to estimate the "normal" long-term real interest rate on safe assets. Estimates were typically in the range of 2-3%, which is a substantially higher than the barely-above zero percent rates of interest on safe borrowing, like 10-year U.S. bonds that pay an interest rate above the rate of inflation. Here's Turner: "There has been much debate among economists about the “normal” long-term interest rate. Hicks (1958) found that the yield on consols over 200 years had, in normal peacetime, been in the 3 to 3½% range. After examining the yield on consols from 1750 to 2006, Mills and Wood (2009) noted the remarkable stability of the real long-term interest rate in the UK – at about 2.9%. (The only exception was between 1915 and 1964, when it was about one percent lower). Amato’s (2005) estimate was that the long-run natural interest rate in the US was around 3% over the period 1965 to 2001 and that it varied between about 2½% and 3½%." [For the record, a "consol" is a kind of perpetual bond issued by the British government: that is, it paid interest but had no date of maturity.]

Here's a figure showing the U.S. federal funds rate, as well as yields on 10-year inflation-linked Treasuries in the U.S. and the UK:

Turner sorts through the possibilities: Are these ultra-low interest rates a result of U.S. monetary policy? Are they a result of a "savings glut"--historically high rates of saving in the global economy, driven primary by the growing and high-saving economies of Asia, which drives down interest rate? Or are they the result of the ability of private financial markets to produce a huge supply of "safe" financial assets--although many of those assets then turned out not to be so safe.

My own sense is that although other explanations may have been more relevant a few years ago, longer-term interest rates now are low largely as a result of policy decisions, and that the "quantitative easing" policies in which central banks buy and hold government debt are a sign that such debt would not be sold at the same low interest rate without a policy intervention. However, as Turner rightly points out after a discussion of the relevant theory: "This paper argues great caution is needed in drawing policy implications based on the real long-term interest rate currently prevailing in markets. This interest rate has moved in a wide range over the past 20 years. At present, it is clearly well below longstanding historical norms. Several explanations come to mind. But not enough is known about how far the long-term rate has been contaminated by government and other policies. Nor is the persistence of such effects clear. And the various policies will have impacted different parts of the yield curve in ways that are hard to quantify."

But whatever the reason behind the ultra-low long-term interest rates, what possible risks do they raise? The obvious possibility is that low interest rates encourage borrowing and discourage saving. At present, the ultra-low interest rates are keeping debt payments low, despite the historically high underlying levels of debt. Turner touches on this point in several places:

"From the mid-1950s to the early 1980s, this aggregate [debt of domestic US non-financial borrowers – governments, corporations and households] was remarkably stable – at about 130% of GDP. It was even described as the great constant of the US financial system. The subcomponents moved about quite a bit – for instance, with lower public sector debt being compensated by higher private debt. But the aggregate itself seemed very stable. During the 1980s, however, this stability ended. Aggregate debt rose to a new plateau of about 180% of GDP in the United States. At the time, this led to some consternation in policy circles about the burden of too much debt. It is now about 240% of GDP. Leverage thus measured – that is, as a ratio of debt to income – has increased. Very many observers worry about this. Whatever the worries, lower rates do make leveraged positions easier to finance. Once account has been taken of lower real interest rates, debt servicing costs currently are actually rather modest: Graph 3 illustrates this point."

Graph 3 shows nonfinancial debt in the U.S. economy as a share of GDP with the solid line, rising to aboug 240% of GDP as measured on the right-hand axis. It shows the falling real long-term Treasury yields as a measure of interest rates on the left-hand scale, with the thin dashed line. And it shows interest expenses as a share of GDP with the thick dashed line, measured on the left-hand axis. Notice that even thought debt is historically very high, interest payments are historically low."

In this setting, an ever-larger share of private assets are locked into very low real returns. Institutions that have liabilities far into the future, like insurance companies and pension funds, suffer greatly when interest rates are so low. It becomes much easier for the federal government to finance its huge budget deficits with such low interest rates. The pressure on households and firms to reduce their borrowing and to save more is greatly reduced, too.

This combination of high debt and low interest rates creates a potentially unstable situation. If or when interest rates rise again, the oversized debt burdens will be tougher to finance. All of those who are locked into long-term low interest rates--including large financial institutions and the Federal Reserve--would see the value of those investments fall if higher interest rates become available. Turner concludes:

"The concluding note of caution is this: beware of the consequences of sudden movements in yields when long-term rates are very low. Accounting and regulatory changes may have made bond markets more cyclical. There is no evidence that bond yields have become less volatile in recent years. Indeed, data over the last decade or so mirror Mark Watson’s well-known finding that the variability of the long-term rate in the 1990s was actually greater than it had been in the 1965–78 period. A change of 48 basis points in one month ... would have a larger impact when yields are 2% than when they are 6%. With government debt/GDP ratios set to be very high for years, there is a significant risk of instability in bond markets. Greater volatility in long-term rates may create awkward dilemmas in the setting of short-term rates and decisions on central bank holdings of government bonds. Because interest rate positions of financial firms are leveraged, sharp movements could also threaten financial stability."

One sometimes hears the argument that as long as inflation isn't noticeably rearing its head, ultra-low interest rates should continue onward, for years if necessary. I quite agree that inflation isn't a threat just now, or in the near future. But historically ultra-low interest rates raise other dangers, too.

Lessons for Europe's Debt Crisis from Early U.S. History

2012-01-20T06:00:00.003-06:00

For much of the last decade, all European governments that borrowed using the euro were viewed as equal credit risks: that is, they paid essentially the same interest rate when borrowing. For an American, the obvious parallel involves borrowing by state and local governments, who all borrow in the same currency of U.S. dollars but have different credit ratings and borrow at different interest rates. Not coincidentally, the U.S. federal government has a long tradition of not bailing out state or local governments in financial trouble, while there is clearly a widespread expectation that the European Union will somehow act to bail out Greece and others.

At a first glance, pointing out that the U.S. federal government doesn't bail out the state or local governments might seems to make the case that Europe should also avoid such bailouts. But C. Randall Henning and Martin Kessler point out that the historical patterns and potential lessons are more nuanced in "Fiscal Federalism: US History for Architects of Europe's Fiscal Union." It's available here as Working Paper 12-1 from the Peterson Institute for International Economics and also here as part of the Bruegel Essay and Lecture Series. They point out that in some ways, the centrality of the federal level of the U.S. system was created by assuming the debts of the states after the Revolutionary War. But around 1840, the federal government then ended this practice. Here is Henning and Kessler (footnotes and citations omitted):

"The first secretary of the Treasury, Alexander Hamilton, is by all accounts credited with creating a “modern” financial system for the new United States. The magnitude of his achievements emerges from considering the prior condition of the US economy. Before 1790, the United States was effectively bankrupt, in default on most of its debt incurred during the Revolutionary War, and had no banking system, regularly functioning securities markets, or national currency. Reliant on the 13 states to collect and share tax revenue, the federal government was unable to pay war veterans or service, let alone redeem, debts. Under the Articles of Confederation, the federal government had no executive branch, judicial branch, or tax authority...."

"The debt assumption plan involved the transfer of state debt to the federal government in the amount of $25 million. Added to existing federal debt incurred to foreign governments (France) and domestic investors in the amount of $11.7 million and $42.1 million, respectively, federal debt would then amount to $79.1 million —a very large sum compared with nominal GDP in 1790 estimated at $187 million."

Hamilton's plan was controversial at the time--so controversial that by around 1790, was a real chance that the new country might break up. Was the plan constitutional? How to deal with the fact that some states had borrowed far more than others, but after the federal government assumed the debt, all states would now need to repay it? Hamilton was also restructuring the debt at about the same time. However, as Hamilton and others perceived, making the federal government central in this way could help bind the states together into a union. In the end, the federal government did assume the debts of the states, did restructure them, and did pay them off. But would this pattern continue? Henning and Kessler:

"[T]he debt assumption of 1790 set a precedent that endured for several decades. The federal government assumed the debt of states again after the War of 1812 and then for the District of Columbia in 1836. During this period, the possibility of a federal bailout of states was a reasonable expectation; moral hazard was substantially present. This pattern was broken in the 1840s, when eight states plus Florida, then a territory, defaulted. ... The indebted states petitioned Congress to assume their debts, citing the multiple precedents. British and Dutch creditors, who held 70 percent of the debt on which states later defaulted, pressed the federal government to cover the obligations of the states. They argued that the federal government’s guarantee, while not explicit, had been implied. Prices of the bonds of even financially sound states fell and the federal government was cut off from European financiers in 1842. ...John Quincy Adams evidently believed that another war with Britain was likely if state debts were not assumed by the federal government."

What were the underlying reasons that caused the U.S. Congress to break the assumption that it would take over the debts of the states as needed?

"However, on this occasion Congress rejected the assumption petition and was able to do so for several reasons. First, debt had been issued primarily to finance locally beneficial projects, rather than national public goods. Second, domestically held bonds were not a large part of the US banking portfolio, and default had limited contagion effects at least through this particular channel. Third, the financially sound states were more numerous than the deeply indebted ones. And, finally, the US economy had matured to the point where it was less dependent on foreign capital. Foreign loans were critical to Hamilton’s plan in 1790, but they were a minority contribution when investments eventually resumed in the 1850s."

"Eventually, most states repaid all or most of their debt as a condition for returning to the markets. ...The rejection of debt assumption established a “no bailout” norm on the part of the federal government. The norm is neither a “clause” in the US Constitution nor a provision of federal law. Nevertheless, whereas no bailout request had been denied by the federal government prior to 1840 , no such request has been granted since, with one special exception discussed below [the District of Columbia in the 1970s].

"The fiscal sovereignty of states, the other side of the no-bailout coin, was thereby established. During the 1840s and 1850s, states adopted balanced budget amendments to their constitutions or other provisions in state law requiring balanced budgets. This was true even of financially sound states that had not defaulted and their adoption continued over the course of subsequent decades, so that eventually three-fourths of the states had adopted such restrictions."

Henning and Kessler suggest three lessons from U.S. history that Europeans should consider as they look at whether or how to assume some of the debts of countries like Greece.

"First, debt brakes are likely to be more durable and effective when “owned” locally rather than mandated centrally."

The U.S. states didn't have a no-deficits rule imposed on them. They volunteered for such rules as part of wanting to borrow for infrastructure projects. U.S. states could drop their no-deficits rules at any time if they wanted. This is fundamentally a different situation than having the European Union or the European Central Bank try to imposed debt limits on recalcitrant countries.

"'Second, maintaining a capacity for countercyclical macroeconomic stabilization is essential. Balanced budget rules have been viable in the US states because the federal government has a broad set of fiscal powers, including countercyclical fiscal action.

When a recession hits, U.S. states and their citizens often get some help from the federal government. With a common central bank and a common currency, many countries in the EU have already given up the paper to react to a recession within their borders by cutting interest rates or by depreciating their currency. If they also have debt limits imposed on them, they may be unable to react to a recession with fiscal policy, either. In the modern economy, arrangements that have the effect of preventing governments from reacting at all when their countries are in a recession are not likely to work well.

"Finally, because debt brakes threaten to collide with bank rescues, the euro area should unify bank regulation and create a common fiscal pool for restructuring the banking system."

The interaction between bank failures and government debt needs to be addressed. In some cases, like Ireland, bank failures were the main cause of government debt--when government offered guarantees that the banks would not go under. In other cases, like Greece, excessive government debt risks bringing a wave of bank failures, because Greek debt is so widely held by many large European banks. A unified and funded system of bank regulation across Europe would reduce both of these risks.

I don't have a trail map for how Europe should tiptoe through its current debt and financial crises. The middle of an economic crisis can be a poor time to try to implement the long-term arrangements, that if only they had been in place, would have reduced the risk of the crisis in the first place. But the U.S. model of not bailing out states does depend, in part, on the fact that states adopted their no-borrowing rules themselves, on a powerful federal fiscal authority, and on a unified and funded system of banking regulation. Without these conditions in place, Europe may have set itself up for a situation where intermittent bank bailouts and government debt bailouts are better than the even less-palatable alternatives.

Health Care Costs are Eating Your Pay Raise

2012-01-19T06:00:00.012-06:00

Rand Research Highlights, based on the work of David I. Auerbach and Arthur L. Kellerman, asks: "How Does Growth in Health Care Costs Affect the American Family?"
"In the ten-year period between 1999 and 2009, U.S. health care spending nearly doubled, climbing from $1.3 trillion to $2.5 trillion. In 2009, while the rest of the U.S. economy plunged into recession and millions lost their jobs, health care costs grew by 4 percent. As a result, the percentage of our nation’s gross domestic product (GDP) devoted to health care reached 17.6 percent, up from 13.8 percent only ten years earlier.
Although these numbers are striking, they do not easily translate into figures that are meaningful to individual Americans.

"To paint an accurate picture of how health care cost growth is affecting the finances of a typical American family, RAND Health researchers combined data from multiple sources to depict the effects of rising health care costs on a median income married couple with two children covered by employer-sponsored insurance. The analysis compared the family’s health care cost burden in 1999 with that incurred in 2009. The take-away message: Although family income grew throughout the decade, the financial benefits that the
family might have realized were largely consumed by health care cost growth, leaving them with only $95 more per month than in 1999. Had health care costs tracked the rise in the Consumer Price Index, rather than outpacing it, an average American family would have had an additional $450 per month—more than $5,000 per year—to spend on other priorities."

Here are the calculations for that median family. The row showing "Taxes devoted to health care" is the cost of Medicare, Medicaid, and other public health programs.

In short, when you see comments about how pay hasn't gone up much in recent years, one big reason is that health care costs are swallowing the gains. Moreover, friends of mine in public policy circles sometimes point out, with a powerless shrug, that if the rate of increase in health care costs doesn't drop substantially, there isn't going to be room for any other government priorities--and that's true whether your priorities are lower taxes or preserving or even increasing spending on other programs.

The Role of Safe Assets in a Financial System

2012-01-18T06:00:00.002-06:00

Gary Gorton, Stefan Lewellen, and Andrew Metrick presented "The Safe-Asset Share," one of those rare academic papers with a basic empirical finding that shakes up your mental landscape, at the annual meetings of the Allied Social Science Associations a couple of weeks ago in Chicago. Here is their opening (citations and footnotes omitted):

"Over the past sixty years, the total amount of assets in the United States economy has exploded, growing from approximately four times GDP in 1952 to more than ten times GDP at the end of 2010. Yet within this rapid increase in total assets lies a remarkable fact: the percentage of all assets that can be considered “safe” has remained very stable over time. Specifically, the percentage of all assets represented by the sum of U.S. government debt and by the safe component of private financial debt, which we call the “safe-asset share”, has remained close to 33 percent in every year since 1952."

The dynamics of the safe-asset share are important for economists, policymakers, and regulators to understand because “safe” debt plays a major role in facilitating trade. ... Most financial-sector debt has the primary feature that it is information-insensitive, that is, it is immune to adverse selection in trading because agents have no desire to acquire private information about the current health of the issuer. Treasuries, Agencies, and other forms of highly-rated government debt also have this feature. To the extent that debt is information-insensitive, it can be used efficiently as collateral in financial transactions, a role in finance that is analogous to the role of money in commerce. Thus, information-insensitive or “safe” debt is socially valuable. Importantly, the stability of the safe asset share implies that the demand for information-insensitive debt has been relatively constant as a fraction of the total assets in the economy. Given the rapid amount of change within the economy over the past sixty years, the relatively constant demand for safe debt suggests an underlying transactions technology that is not well understood."

Here's figure showing the safe asset share over time:

However, the composition of these safe assets has shifted dramatically in recent decades. It used to be mainly bank deposits, but it has now become mainly private securities. They write: "The figure shows that bank deposits were near 80 percent of the total through the 1950s and 1960s, and remained as high as 70 percent as late as 1978. This percentage then began a steep 30-year decline, with the rise of money market mutual funds, broker-deal commercial paper, securitized debt from GSEs, and other asset-backed securities. On the eve of the financial crisis, the share of bank deposits had fallen to 27 percent. At the end of 2010, it stood at a little less than 32 percent."

Having documented the pattern, they end their paper with more questions than answer: "[W]e currently know very little about the demand for and supply of “safe” debt. While we hope that our work is a start in the right direction, our paper raises a number of important questions. Why is the safe-asset share constant? Did the demand for safe assets play a role in the rise of the shadow banking system? What is the underlying transactions technology that relates the safe asset share to the rest of the economy? We hope that these and other questions regarding safe debt will be addressed through future research."

However, there is a bit more to say here. Gorton in particular has been thinking through the role of safe assets in an economy and a financial system for some time. For example, the subject came up in an interview he did with the Region magazine, published by the Federal Reserve Bank of Minneapolis in December 2010. Here's Gorton from that interview, on how a "safe asset" can be conceived of as an asset that is insensitive to information, and how when that an asset thought to be safe becomes sensitive to information, a financial crisis can result:

"Global financial crises are about debt. About debt. But, obviously, we need to have a theory of debt to understand why people would use a security, bank debt, and how that could lead to a crisis. ... In my work with Tri Vi Dang and Bengt Holmström, we develop this idea, that you mention, of the optimality of debt arising from its information insensitivity. Roughly speaking, the argument for the optimality of debt is simply that it’s easiest to trade if you’re sure that neither party knows anything about the payoff on the debt. ...

That intuitive logic applies to repo as well. Nobody wants to be given collateral that they have to worry about. And the mechanics of how repo works is exactly consistent with this. Firms that trade repo work in the following way: The repo traders come in in the morning, they have some coffee, they go to their desks, they start making calls, and in a large firm they’ve rolled $40 to $50 billion of repo in an hour and a half. Now, you can only do that if the depositors believe that the collateral has the feature that nobody has any private information about it. We can all just believe that it’s all AAA.

This is a feature of an economy that is fundamental. It is fundamental that you have these kinds of bank-created trading securities. And the fact that it’s fundamental and that you need these is not widely understood in economics. ...

The way standard models deal with it is, I think, incorrect. A lot of macroeconomists think in terms of an amplification mechanism. So you imagine that a shock hits the economy. The question is: What magnifies that shock and makes it have a bigger effect than it would otherwise have? That way of thinking would suggest that we live in an economy where shocks hit regularly and they’re always amplified, but every once in a while, there’s a big enough shock … So, in this way of thinking, it’s the size of the shock that’s important. A “crisis” is a “big shock.”

I don’t think that’s what we observe in the world. We don’t see lots and lots of shocks being amplified. We see a few really big events in history: the recent crisis, the Great Depression, the panics of the 19th century. Those are more than a shock being amplified. There’s something else going on. I’d say it’s a regime switch—a dramatic change in the way the financial system is operating. This notion of a kind of regime switch, which happens when you go from debt that is information-insensitive to information-sensitive is different conceptually than an amplification mechanism."

In a post last June 17, I quoted Ricardo Caballero about "Demand for Safe Assets in an Financial Crisis." He argues that the world economy as a whole, with the rise of economies in Asia in particular, is suffering from a shortage of safe assets, that the financial sector tried to manufacture the desired safe assets out of mortgage-backed securities, and that when these assets were clearly seen to be not safe [Gorton would say they switched from being information-insensitive to being information-sensitive], the crisis erupted.

This story of how safe assets relate to the financial system and to the possibility of crisis is still being fleshed out. But to misquote Gertrude Stein, "There is a there there."

Consumer Price Index vs. Personal Consumption Expenditures Index

2012-01-17T13:00:00.000-06:00

The Consumer Price Index (CPI) from the Bureau of Labor Statistics is the measure of inflation that gets the most attention, both from the media and in most intro econ classrooms. But I'm thinking that the Personal Consumption Expenditures (PCE) index measure of inflation should start to get equal or perhaps even greater attention.

For starters, I hadn't known--although I probably should have known--that when the Federal Reserve looks at rates of inflation, it focuses more on PCE than on CPI. The announcement of this policy change was buried in a footnote in the Fed's Monetary Policy Report to the Congress, February 17, 2000. There's some jargon in the quotation, which I'll unpack in a minute, but here's the comment:

"In past Monetary Policy Reports to the Congress, the FOMC [Fed Open Market Committee] has framed its inflation forecasts in terms of the consumer price index. The chain-type price index for PCE draws extensively on data from the consumer price index but, while not entirely free of measurement problems, has several advantages relative to the CPI. The PCE chain-type index is constructed from a formula that reflects the changing composition of spending and thereby avoids some of the upward bias associated with the fixed-weight nature of the CPI. In addition, the weights are based on a more comprehensive measure of expenditures. Finally, historical data used in the PCE price index can be revised to account for newly
available information and for improvements in measurement techniques, including those that affect source data from the CPI; the result is a more consistent series over time. This switch in presentation notwithstanding, the FOMC will continue to rely on a variety of aggregate price measures, as well as other information on prices and costs, in assessing the path of inflation."

So what is all this stuff about a "PCE chain-type index" compared to the "fixed weight nature of the CPI, and how the PCE is "a more comprehensive measure of expenditures," and how "historical data in the PCE price index can be revised? For explanations of these differences, Phil Davies of the Minneapolis Fed offers a nice discussion of the CPI and PCE, along with much description of how price indexes have evolved over time, in "Taking the Measure of Prices and Inflation," appearing in the December 2011 issue of the Region. For a FAQ page at the Bureau of Economic Analysis website comparing the CPI and PCE, look here. For a more detailed discussion of differences, see this article in the November 2007 Survey of Current Business.

As a starting point, here's a graph showing the difference between the CPI and the PCE, showing annual percentage changes in inflation according to each measure. Clearly, the difference between them isn't large. But just as clearly, the rate of inflation tends to be a little lower when using the PCE (the blue line is more often below the red than not(, and the rate of deflation in 2009 was a little smaller using the PCE, too.

There are four ways in which PCE differs from the CPI. I'll use the names the BEA gives them:

1) The scope effect. The two indexes cover similar but not identical categories of personal spending. Here's Davies from the Minneapolis Fed: "[The PCE measures a broader swath of personal consumption than the CPI. For instance, the PCE captures expenditures by rural as well as urban consumers and includes spending by nonprofit institutions that serve households. And while the CPI records only out-of-pocket spending on health care by consumers, the PCE also tracks personal medical expenses paid by employers and federal programs such as Medicare. However, over 70 percent of the price data in the PCE is drawn from the CPI."

2) The weight effect. When combining all sorts of individual prices into an overall price index, those categories where people spend more get greater weight than those categories where people spend less. But the PCE and CPI use different weights. Davies explains: "The CPI reflects reported consumption in the Consumer Expenditure Survey, conducted for the BLS by the U.S. Census Bureau. To determine its expenditure shares, the PCE relies on business surveys such as the Census Bureau’s annual and monthly retail
trade surveys. Shelter accounts for the biggest difference in weighting between the two indexes; the share of personal spending devoted to housing is larger in the CPI because nonshelter expenditures in the CES are less than those estimated from business surveys."

3) The formula effect. Here's the simple way to think about a price index: Identify a basket of goods, which has a certain quantity of each good in the basket, which represents consumption for a typical household. Calculate what it would take to buy that basket of goods at one date, and then calculate what it would take to buy the basket of goods at year later. Prices of some individual goods will rise while others will fall, but the change in the cost of the total basket of goods will be the amount of inflation. For a long time, the Consumer Price Index was calculated with this "basket of goods" approach.

But as economists have long pointed out, this "basket of goods" approach oversimplifies in a way that surely overstates the true rise in the cost of living. There are two classic difficulties. One is that the basket of goods which represents consumption at the earlier time will not include newly created goods or improvements in the quality of goods that are available to people at the later time. Second, the basket of goods at the earlier time only made sense because it reflected prices at that time. Imagine that inflation was zero overall in a given year, but prices shifted about so that people will naturally adjust their consumption , buying less of what is relatively more expensive and more of what is relatively cheaper. Thus, the basket of goods at the earlier time won't be a fair representation of what households would buy in a different configuration of prices at the later time.

There are at least partial solutions to these problems, but they increase the level of complexity in the calculation. For example, those who put together the "basket of goods" now rotate continuously what is included in the basket, so that as new goods are invented and old ones improved, they can enter the basket of goods being measured. In addition, they use mathematical formulas which take into account how people substitute between goods that relatively are more or less expensive, so that the pure effect of overall inflation in the price level can be separated out. While the CPI uses a mathematical formula that allows for some substitution in response to changes in relative prices (the "fixed weight" to which the Fed was referring in 2000), the PCE uses a formula that allows for a greater degree of substitution (the "chain-type index" to whih the Fed was referring in 2000).

4) Other effects. There are some other minor differences in the CPI and PCE indexes, including how they do seasonal adjustments, how they treat airline fares, and some other issues.

Finally, one remaining difference between the CPI and the PCE is that the CPI, once published, is not revised. The CPI is used for contracts and for legislation--like adjusting Social Security benefits. The data series of the CPI over time was calculated using evolving methodologies,and when the way in which the CPI is calculated changes, no one goes back and recalculates historical CPI figures. The PCE is not tied up in such issues, and like the GDP estimates themselves, it is revised and altered over time, as adjustments are made to data and methods. When the methods for calculating PCE are revised, these methods are then applied to all of the historical data as well, so that the PCE shows you a measure of how inflation affects personal expenditures over time, using a common methodology.

It may seem highly unlikely to think about teaching and using the PCE, rather than the CPI, as a measure of inflation. But remember a few decades ago when it seemed highly unlikely to think about moving from GNP to GDP--and now GDP is used almost all of the time.

Eliminating the Statistical Abstract?

2012-01-17T06:00:00.005-06:00

I just clicked over to look up some numbers in the U.S. Statistical Abstract, which has been one of my standard starting points for fact-finding and fact-checking since I started needing to care about actual data as part of my high school debate team back in the 1970s. As it says at the website: "The Statistical Abstract of the United States, published since 1878, is the authoritative and comprehensive summary of statistics on the social, political, and economic organization of the United States. Use the Abstract as a convenient volume for statistical reference, and as a guide to sources of more information both in print and on the Web."

It also says that the U.S. Census Bureau has decided to save $3 million per year by eliminating the Stat Abstract.

The invaluable Robert Samuelson at the Washington Post has been on top of this story, which I had utterly missed. He lamented the likely loss of the Stat Abstract in an August 21 column, and followed up with a sad blog post on October 4. He writes: "I’ve been covering government for more than four decades, and this is one of the worst decisions I’ve seen." For those of us who spend large chunks of our time trying to track down actual facts, the end of a long-standing reference work is a genuinely grim day.

I found myself hoping that this this is just the Census Bureau's version of the infamous "Washington Monument strategy." Back in 1969, a director of the National Park Service named George Hartzog responded to proposed budget cuts for his agency by closing all the national parks for two days a week--including the Washington Monument. (A short biography of Hartzog is here.) Public outrage over these highly visible changes led Congress to restore the funding. Ever since then, when a government agency responds to a tightened budget by cutting its most publicly visible functions, it's been called a "Washington Monument" strategy.

But the Washington Monument strategy only works if the public cares, and when it comes to the Statistical Abstract, even I am not delusional enough to believe that it does.

What makes the elimination of the Stat Abstract even more annoying is that by government standards, it's dirt-cheap. Federal spending for 2012 is projected to be about $3.7 trillion. If I haven't slipped a decimal point in my calculations, this rate of spending works out to about $7 million per minute, 24 hours a day, 365 days per year. At $3 million, the Stat Abstract provides one-stop access to a vast range of statistics and sources, at a cost of less than a half-minute per year of federal spending. When you look at government websites, you see a vast array of cheery stories about how the government is there to help you, with photos of smiling people and shiny equipment. Government always seems to have money for public relations and self-promotion. But apparently not for offering the public a genuinely useful, if admittedly dry, collection of actual nonpartisan data in a volume with a history of more than 130 years.

For those of us who each year spend some time skimming through the Analytical Perspectives volume of the Federal Budget of the United States (welcome to my life!), there is always a section on "Strengthening Federal Statistics." Here's the opening paragraph:

"Federal statistical programs produce key information to illuminate public and private decisions on a range of topics, including the economy, the population, agriculture, crime, education, energy, the environment, health, science, and transportation. The share of budget resources spent on supporting Federal statistics is relatively
modest—about 0.04 percent of GDP in non-decennial census years and roughly double that in decennial census years—but that funding is leveraged to inform crucial decisions in a wide variety of spheres. The ability
of governments, businesses, and the general public to make appropriate decisions about budgets, employment, investments, taxes, and a host of other important matters depends critically on the ready availability of relevant, accurate, and timely Federal statistics."

Here's a table showing the main federal statistical agencies and their level of spending, in millions of dollars. The U.S. Census Bureau spent a lot in 2010, because of the Census, but is back to more normal levels by now.

Can't a few Senators and Congressmen take time out from earmarking pork barrel projects for their home districts and raising campaign contributions, and resurrect the Statistical Abstract? It's a bad civics lesson to have this volume disappear.

Certificate Programs for Labor Market Skills

2012-01-16T06:00:00.004-06:00

President Obama and many others have called for a dramatic increase in the number of U.S. students obtaining four-year and community college degrees. It's a popular goal, and easy to announce, but frankly, quite unlikely. Higher education as currently constituted is extremely expensive, and neither the federal government, nor state government, nor prospective students are flush with the needed funds. In addition, many of those not currently attending higher education aren't prepared to flourish in that setting, whether because of lack of academic preparation, lack of interest, or both.

Bruce Bosworth lays out the problem and limns a possible pathway in "Expanding Certificate Programs" in the Fall 2011 issue of Issues in Science and Technology. Here are some excerpts:

The underlying problems of stagnating workforce skills and the unlikeliness of college enrollment expanding quickly enough.

"Given current trends, the nation can expect little gain in the educational attainment of the workforce by 2040, at least as a consequence of young adults moving into and through the labor force. Older workers (ages 35 to 54) are now as well educated as younger workers (ages 25 to 34), especially in the percentage with at least a high-school degree, but also in the percentage with some postsecondary attainment. Thus, there will be no automatic attainment gain over the next several decades as current workers age and older workers leave the labor force. In fact, without some big changes in educational patterns, it is probable that the newer workers entering the workforce will have lower levels of attainment than the older workers leaving. Workforce attainment levels will stagnate or decline, and future economic growth will slow as a consequence."

"In the face of these trends, President Obama proposed to Congress in 2009 that “by 2020, America will once again have the highest proportion of college graduates in the world.” ... According to evaluations led by the National Center for Higher Education Management Systems, retaking international leadership would require U.S. college attainment rates to reach 60% in the cohort of adults ages 25 to 40. But in 2008, only 37.8% of this age group had degrees at the associate’s level or higher, and at present rates of growth, this figure would increase to only 41.9% by 2020. Closing the gap will require a 4.2% increase in degree production every year between 2008 and 2020."

Certificate programs are growing quickly.

"Certificate programs take a variety of forms nationwide. They are offered by two-year community colleges, by four-year colleges, and, increasingly, by for-profit organizations. Programs vary in duration, falling into three general categories, with some requiring less than one academic year of work, some at least one but less than two academic years, and some requiring two to four years of work. The programs collectively awarded approximately 800,000 certificates in 2009, up more than 250% from the roughly 300,000 certificates awarded in 1994. Across all programs, awards are heavily skewed toward health care, which represented 44.1% of all certificates awarded in 2009."

A Florida study suggests that certificate programs are paying off, especially for students who don't traditionally attend college.

"A study of educational and employment outcomes for students in Florida also has suggested that certificate programs, in addition to leading generally to good economic outcomes for completers, may have particular advantages for students from low-income families. The study drew from a longitudinal student record system that integrates data from students’ high-school, college, and employment experience. It followed two cohorts of public-school students who entered the ninth grade in 1995 and 1996.

"The research suggested that strong earnings effects of degree attainment (associate’s, bachelor’s, and advanced) were largely confined to students who had performed well in high school. They were continuing in postsecondary study a trajectory of success apparent in high school. However, the research found that obtaining a certificate from a two-year college significantly increased the earnings of students who did not necessarily perform well in high school, relative to those who attended college but did not obtain a credential. These students were finding new success in certificate programs, changing the trajectory of their high-school years. Moreover, the study confirmed other research that found strong returns to completion of good certificate programs, even relative to associate’s degree completers.

Across all certificate programs, the field of study is an important predictor of earnings outcomes. In some fields, individuals who complete long-term certificates make as much money, on average, as those who complete associate’s degree programs. This seems to be because certificate completers pursue and earn awards in fields with relatively high labor market returns and then take jobs where they can realize those returns. Many individuals who gain associate’s degrees do not go on to higher attainment, and a significant number of them hold majors in areas that offer limited labor market prospects for job seekers with less than a bachelor’s degree."

The Tennessee model of certificate programs

"Tennessee provides a clear example of what is possible and of what works. Tennessee has a statewide system of 27 postsecondary institutions that offer certificate-level programs serving almost exclusively nontraditional students. The Tennessee Technology Centers began as secondary-level, multidistrict, vocational technical schools in the 1960s under the supervision of the State Board of Education and began to serve adults in the 1970s. In most states, analogous institutions were merged into community- or technical-college systems, but in Tennessee (as in a few other states) they continue to operate as discrete non–degree-granting postsecondary institutions.

The technology centers award diplomas for programs that exceed one year in length, as well as certificates for shorter programs. Diploma programs average about 1,400 hours and some extend to more than 2,000 hours. They are designed to lead immediately to employment in a specific occupation. In 2008–2009, the centers enrolled roughly 12,100 students, and they awarded 4,696 diplomas and 2,066 certificates. Collectively, the centers offer about 60 programs, some just at the shorter-term certificate level but most at the longer-term diploma level. Some of the more popular diploma programs are Practical Nursing, Business Systems Technology, Computer Operations, Electronics Technology, Automotive Service and Repair, CAD Technology, and Industrial Maintenance.

Most students in the centers are low-income, with nearly 70% coming from households with annual income of less than $24,000 and 45% from households with annual income of less than $12,000.... The average age of the students is 32 years ... According to 2007 IPEDS data, 70% of full-time, first-time students in the centers graduated within 150% of the normal time required to complete the program. Every year for the past several years, at least 80% and sometimes as many as 90% of students who completed the program found jobs within 12 months in a field related to their program. ...

A growing consensus in Tennessee holds that the key explanation for the centers’ high completion rates can be found in the program structure. The centers operate on a fixed schedule (usually from 8:00 a.m. to 2:30 p.m., Monday through Friday) that is consistent from term to term, and there is a clearly defined time to degree based on hours of instruction. The full set of competencies for each program is prescribed up front; students enroll in a single block-scheduled program, not individual courses. The programs are advertised, priced, and delivered to students as integral programs of instruction, not as separate courses. Progression though the program is based not on seat time, but on the self-paced mastery of specific occupational competencies. ... The centers also build necessary remedial education into the programs, enabling students to start right away in the occupational program they came to college to pursue, building their basic math and language skills as they go, and using the program itself as a context for basic skill improvement."

The U.S. economy needs to build bridges from those who perform near the median and lower in high school to at least somewhat skilled jobs in the workforce. I'm sure there are other promising ideas besides certificate programs. For example, I posted last October 18 on "Apprenticeships for the U.S. Economy,"
and last November 3 on "Recognizing Non-formal and Informal Learning." But trying to push most or many of these median-and-below high school students through a conventional higher education degree is not likely to work well, and would be extremely expensive. Time to start experimenting with policies that could offer a better ratio of benefits to costs.

New Fed Nominee Jeremy Stein, Rethinking Monetary Policy

2012-01-13T06:00:00.002-06:00

Jeremy Stein is always worth reading, but when President Obama nominated him in late December for a seat on the Federal Reserve Board of Governors, he became must-reading. In the latest issue of the
American Economic Journal: Macroeconomics (2012, 4(1), pp. 266–282), Stein and co-author Anil Kashyap discuss "The Optimal Conduct of Monetary Policy with Interest on Reserves." In particular, they are thinking about how it might be possible to use monetary policy for two purposes: both in its traditional role of keeping inflation low and stimulating the economy in recessions, and also in an untraditional role of reducing the chance of future financial crises. The article isn't freely available on-line, although many students and faculty will have access to it through library subscriptions or membership in the American Economic Association.

When teaching the basics of monetary policy a few years ago, the emphasis was on how the Fed used "open market operations"--that is, buying and selling government bonds to banks--to make interest rates rise or fall. When the Fed bought bonds from banks, then the banks had more cash to lend out, and interest rates would fall. When the Fed sold bonds to band, and received cash from the banks, then the banks had less cash to lend out, and interest rates would rise. Through these open market operations, the Fed reacted to risks of higher inflation or economic slowdown, adjusting the lendable funds available to banks to achieve its desired level of interest rates.

This basic exposition pointed out that in theory the Federal Reserve had other policy tools, like adjusting the level of reserves that banks were required to hold with the Fed, but because those tools received little use in recent decades, little attention was paid to them.

But when the financial crisis hit in fall 2008, the Fed got a new policy tool: it can pay interest on the reserves that banks are require to hold at the Fed. Kashyap and Stein explain: "In October of 2008, the US Federal Reserve announced that it would begin to pay interest on depository institutions’ required and excess reserve balances, having just been authorized by Congress to do so. The Fed thereby joined a large number of other central banks that were already making use of interest on reserves (IOR) prior to the onset of the global financial crisis. Given the Fed’s current policy of keeping the federal funds rate near zero, IOR has not been a quantitatively important tool thus far. As of this writing, the rate being paid is only 25 basis points. However, IOR may turn out to be extremely useful going forward ..."

Thus, in the future, when the time comes for the Fed to raise interest rates, how should it do so? As Kashyap and Stein write: "When the Fed seeks to tighten monetary policy, should it raise the rate paid on reserves, contract the quantity of reserves, or some combination of the two?"

I had not known before reading this article that many central banks around the world have both tools available to them. Of course, because it’s a research journal of economics, Kashyap and Stein feel compelled to explain algebraic labels rather than using words: in particular, they discuss the level of interest on reserves, which they label r_IOR, and the “scarcity value of reserves,” which they label as keep y_SVR and can be thought of as the interest rate that would result from the level of reserves created by the traditional system of open market operations. They write:

"This question can be further motivated by observing the diversity of central bank practices before the financial crisis. At one extreme of the spectrum was the Federal Reserve, which set r_IOR to zero, so that any variation in the funds rate had to come from quantity-mediated changes in y_SVR . At the other extreme was the Reserve Bank of New Zealand, which in July 2006 adopted a “floor system” in which reserves were made sufficiently plentiful as to drive y_SVR to zero, meaning that the policy rate was equal to r_IOR . And in between were a number of central banks (e.g., the ECB and the central banks of England, Canada, and Australia) which used variants of a “corridor” or “symmetric channel” system. One approach to operating such a system is for the quantity of reserves to be adjusted so as to keep y_SVR at a constant positive level (100 basis points being a common value), with r_IOR then being used to make up the rest of the policy rate."

"Note that these corridor systems share a key feature with the floor system used by New Zealand. In either case, all marginal variation in the policy rate comes from variation in r_IOR , with no need for changes in quantity of reserves. In this sense, the pre-crisis US approach was fundamentally different from that in many other advanced economies."

Kashyap and Stein point out that with these two separate policy tools--that is, the new tool of interest paid on reserves and the old tool of managing the level of bank reserves--it becomes possible for a central bank to tackle two goals. "We argue that, in general, it will be optimal for the central bank to take advantage of both tools at its disposal by varying both r_IOR [the level of interest paid by the Fed to banks on their reserves] and y_SVR [the "scarcity value" of reserves], with the mix depending on conditions in the real economy and in financial markets. The two-tools argument begins with the premise that monetary policy may have an important financial stability role in addition to its familiar role in managing the inflation versus output tradeoff."

During the financial crisis, banks and other financial institutions found themselves in trouble because they had all ramped up their level of short-term debt--that is, debt which came due quite soon on a daily or monthly basis and was commonly being rolled over (and over and over) each time it came due. When the financial crisis hit, it became impossible to roll over all this short-term debt, and so many financial institutions suddenly found themselves without funding. Kashyap and Stein argue that financial institutions will often have a tendency to take on too much short-term debt from society's point of view, because individual financial institutions are looking only at their own finances and not taking into account the risk that if they all take on too much short-term debt, the risk of a system-wide financial crisis goes up. Thus, a way to reduce the risk of financial crisis is to put limits on bank holdings of such short-term debt.

One way to do this is to use a broad notion of "reserve requirements." In theory, banks wouldn't just hold reserves based on the deposits from customers, but on any debt that they are depending on renewing in the short run. Kashyap and Stein explain: "First, within the traditional banking sector, reserve requirements should in principle apply to any form of short-term debt that is capable of creating run-like dynamics, and hence
systemic fragility. This would include commercial paper, repo finance, brokered certificates of deposit, and so forth. ... Going further, given that essentially the same maturity-transformation activities take place in the shadow banking sector, it would also be desirable to regulate the shadow-banking sector in a symmetric fashion. This suggests imposing reserve requirements on the short-term debt issued by nonbank broker-dealer firms, as well as on other entities (special investment vehicles, conduits, and the like) that hold credit assets financed with shortterm instruments, such as asset-backed commercial paper and repo. Alternatively, to the extent that many of these short-term claims are ultimately held by stable value money market funds that effectively take checkable deposits, a reserve requirement could be applied to these funds."

Kashyap and Stein explain that central banks around the world have been using changes in the reserve requirement as a policy tool to limit bank holdings of short-term debt, and to assure that banks have a sufficient capital cushion. "[A] number of central banks around the world use changes in reserve requirements as a key policy tool. For example, the Chinese central bank changed the level of reserve requirements six times in 2010, while moving their policy interest rate just once. ... India offers another intriguing case study. Since November 2004, the Reserve Bank of India has operated a corridor system of monetary policy. In the aftermath of Lehman Brothers’ bankruptcy filing, the Reserve Bank cut reserve requirements from 9.0 percent to 5.0 percent in a series of four steps between October 2008 and January 2009.... Finally, Montoro and Moreno (2011) study the use of reserve requirements in three Latin American countries: Brazil, Colombia, and Peru. They note that central banks in these countries raised reserve requirements in the expansion phase of the most recent credit cycle, and then, like the Reserve Bank of India, cut them sharply
after the bankruptcy of Lehman Brothers. They also argue that the motivation for this approach was explicitly rooted in a financial stability objective ..."

However, Kashyap and Stein suggest that rather than varying reserve requirements to limit short-term debt of financial institutions, instead the same goal can be accomplished by using the quantity of reserves that the Fed encourages financial institutions to hold. They conclude: "The introduction of interest on reserves gives the Federal Reserve a second monetary policy tool that, used properly, may prove helpful for financial stability purposes.By adjusting both IOR [interest paid to banks on their reserves] and the quantity of reserves in the system, the Fed cansimultaneously pursue price stability, as well as an optimal regime of regulating the
externalities created by short-term bank debt. Though to be clear, the latter would also require, in addition to the use of IOR, a significant expansion in the coverage of reserve requirements, as well as possibly an adjustment to their level."

Assuming that Stein makes it through the confirmation process and ends up on the Fed Board of Governors--which in a just world will happen more-or-less instantaneously--it will be interesting to see how these issues emerge. Will the Fed begin to focus on how to reduce the systemic risk of another financial crisis? Will it revive changes in reserve requirements as an active tool of monetary policy? Will the Fed's reserve requirement be expanded so that it is based not just on deposits but on all forms short-term borrowing, and for all financial institutions (not just banks)? Will it start to use interest paid on bank reserves as a way of moving interest rates, while controlling the quantity of bank reserves as a way of holding down on the amount of short-term debt in the financial sector? Will the central bank perhaps decide to pay different rates of interest on those bank reserve it requires from those bank reserves that are held in excess of the requirement?

Leave aside all the potential complexities here, many of which are discussed in the article, and which are certainly real enough. The most basic ways that we have thought about and taught monetary policy in the last few decades may be on the verge of change.

(Full disclosure: Jeremy Stein was a co-editor of my own Journal of Economic Perspectives from 2007-2009.)

Robert Frank on Context Externalities and Positional Goods

2012-01-12T06:00:00.004-06:00

Romesh Vaitilingam has in informative interview with Robert Frank at the VoxEU website, recorded November 2011, posted December 23, 2011. It is in podcast form, or if you prefer, there's a transcript. I'll first offer some excerpts in which Frank explains his position, and then offer some observations and criticism. Here's Frank:

On Darwin's exposition of why competition doesn't always lead to socially desirable outcomes

"I've made a fearless prediction that in 100 years time, people like you and me will check Darwin's name when they're asked to fill out a survey identifying the father of modern economics. ... It will eventually be seen as an encompassing vision that includes Adam Smith's invisible hand theory as an interesting special case. ... So the antlers of the bull elk, for example. They are primarily to help males battle successfully against other bulls for access to mates. Darwin saw that males in most vertebrate species took more than one mate if they could. The qualifier obviously is the important step because if some succeeded, that means others don't take any mates at all, which is the real loser slide in the Darwinian scheme of things. So of course males fight bitterly for access to females. Antlers are the weapons for that particular species. And some mutations that coded for bigger ones were strongly favored in each case. They spread quickly, the mutations accreted. Now we get animals with antlers four feet across, weighing 40 pounds. That's too big for bulls as a group. Antlers don't grow forever, that's true. Natural selection puts a stop to the growth. There's an equilibrium, but it's not an optimum size when viewed from the perspective of bulls as a group. They'd much rather be half as big, because they're such an encumbrance when they're chased into a wooded area by wolves. They're easily surrounded and killed. If they could take a vote or put their hoof on a red button at the count of three, “all antlers shrink by half”, they'd have compelling reasons to do that. It's relative antler size that matters in battle, so it wouldn't affect the outcome of any fight. But they'd all be more mobile. They'd all be better able to escape from predation by wolves. From the perspective of the bulls themselves, that would be a good thing."

On "context externalities"

"I think more in terms of “context externalities”, I would call them. Is my car OK? Is my house OK? ... They're not socially scarce, but people's evaluations of them are very heavily context dependent. Is my house OK? I lived in a two room house in Nepal when I was a Peace Corps volunteer. It didn't have any plumbing. It didn't have any electricity. The roof leaked when it rained hard. It was nonetheless a perfectly OK house in that context. If you lived in that house here in the UK, you'd be ashamed for your friends to know where you lived. Your kids wouldn't want their friends to know where they lived. It would be a house that was by no stretch of imagination conceivably evaluated as being OK. It's just an inadequate house by the current standards. If you look at context externalities, they're not here or there, they're everywhere. They're more intense in some domains than others. ...[O]ne of the main results of looking at the world this way is you get arms races always that focus on the categories where context matters more. And they suck resources out of the categories where context matters less. In the house and leisure example, people would work longer hours thinking they're going to get ahead by being able to buy a bigger house. ... It's that kind of arms race that leads to the misallocation. That's why the invisible hand doesn't steer things to the best uses. ... Now the US family, on average, spends $28,000 on a wedding. That's in 2009, the most recent figure I could find. In 1980 the inflation adjusted figure was $11,000. Nobody could pretend that the people getting married in 2009 were happier because of that extra spending. It was just that the people at the top spent more. That led the people just below them to spend more. There was a cascade."

Policy implications?

"I focus almost exclusively on remedies of the sort that try to make behaviors that cause harm to others less attractive to individuals by making them more expensive, usually by taxing them. That doesn't prohibit somebody from doing anything, so if somebody has got a really important stake in continuing to do what he's doing, he can but he pays the fee. ... Tax harmful behavior is the mantra that I repeat again and again .... Mainly the biggest remedy is to tax consumption at a steeply progressive rate."

Some reactions
As Frank says, he sees what he calls "context externalities" everywhere. I'm queasy about thinking of these social pressures as "externalities," that is, as market failures in which a tax reflecting the social costs of the externality would improve social welfare. Claims that social pressures are making most of us consume items or do things we otherwise would not do are of course true, as they have been for every society since the dawn of time. But implicitly claiming that people's "optimal" decisions are the ones they would make if they had no social pressure at all, and social pressures must therefore drive them away from what would have been their optimal choice, seems like an offbeat claim for an avowedly "social science" like economics.

After all, the range of behaviors influenced by social pressure is very large: not just conspicuous consumption, but also many other decisions in various social groups: about working, or not; focusing on finishing certain levels of education, or not; taking certain drugs, or not; worshiping in a certain church, or not; becoming a parent at a young age, or not; and many others. In all of these cases, local and social pressures probablyl cause people to alter their behavior from what they would otherwise have done. But it would seem overly broad to call these all "context externalities" that are potentially ripe for policy intervention.

The alternative position usually taken by economists is that people are treated as having the autonomy and individuality to form their own preferences in a context that is mysterious and largely unexamined (by economists)--but a context that includes social pressures--and then economists study how demand based on these tastes and preferences interact with supply based on technology and production in the market. If some people work harder because they want to outdo their neighbors, that's not usually considered a "market failure." If a certain social group decides to live a highly simple life where they strip their consumption down to as little as possible, that form of social pressure isn't considered a "market failure," either.

I do like the idea of a progressive consumption tax that Frank emphasizes, but not because of any argument about "context externalities." The emphasis on progressivity--that is, those with high incomes paying a greater share of their income in taxes--is to pursue goals of social equity. (Indeed, it seems to me that Frank's "context externalities" are best-understood as a way of saying that the marginal utility of income for those with high income levels is low, and so higher tax rates with those on high incomes are justified.) The emphasis on consumption, rather than income, is because the U.S. economy would benefit from a higher rate of saving, and a consumption tax falls only on what is consumed, not on what is saved.

For What Majors Does College Pay Off?

2012-01-11T06:00:00.006-06:00

Anthony P. Carnevale, Ban Cheah, and Jeff Strohl of the Georgetown Center on Education and the Workforce have published "Hard Times: College Majors, Unemployment, and Earnings."
The main focus of the report is to look at what people majored in in college, and then to compare unemployment and earnings between majors. Before showing some highlights, two warnings are appropriate.

First, the data behind these figures is from 2009 and 2010. The study compares recent college graduates who are 22-26 years of age, experienced workers who are 30-54 years of age, and graduate degree holders who are limited to 30-54 years of age--all from the 2009 and 2010 data. But how things looked in 2009 and 2010 may not be a good predictor of the future: for example, recent architecture graduates were doing poorly in the aftermath of the housing market collapse in 2009 and 2010, but that wasn't true back in 2005.

Second, the classic problem in thinking about benefits of education is to isolate cause and effect. The problem is that those who go on to get additional years of education may well be different in a number of ways: for example, they may have more persistence in their work habits, or they may come from a social background with higher expectations of educational achievement, or they may have higher intelligence in a way that makes it easier for them to perform well in school, or they may be better at deferred gratification, or they may have other personality types that flourish to greater extent in an educational setting. Thus, when you see that, on average, people with a college degree have higher income than those with a high school degree, or that those who major in chemistry have higher income than those who major in English, it would be highly unwise to attribute all of the income gap just to what courses they took. If you could somehow transplant the characteristics of all the chemistry majors into English majors, and vice versa, the resulting income gaps might look quite a bit different.

So here is one figure showing unemployment rates by major, and another figure showing earnings rates by major. In each figure, there are separate marks for recent graduates, experienced graduates, and those who hold graduate degrees.

As noted earlier, one shouldn't overinterpret these results. But when looking at unemployment rates, along with the architects, those who majored in humanities or in in the arts have relatively high rates, while those who had majored in health and education had relatively low unemployment rates.

When it comes to income, the highest income levels are for those who majored engineering, computer science/mathematics, life sciences, social sciences, and business. The lower income went to those majoring in arts, education, and psychology/social work.

Iceland, Ireland, and Latvia: Three Stories of Banking Crisis and Recovery

2012-01-10T06:00:00.001-06:00

Zsolt Darvas offers a useful meditation in "A Tale of Three Countries: Recovery After Banking Crisis,"a December 2011 working paper for Bruegel, a Brussels-based think tank. In effect, Darvas offers a case study approach by picking three small economies that went through a broadly similar banking crisis, but reacted with different policy choices.He starts this way (footnotes and references to tables and figures omitted):

"Three small, open European economies —Iceland, Ireland and Latvia with populations of 0.3, 4.4 and
2.3 million respectively—got into serious trouble during the global financial crisis. Behind their problems were rapid credit growth and expansion of other banking activities in the years leading up to the crisis, largely financed by international borrowing. This led to sharp increases in gross (Iceland and Ireland) and net
(Iceland and Latvia) foreign liabilities. Credit booms fuelled property-price booms and a rapid increase in the contribution of the construction sector to output – above 10 percent in all three countries. While savings-investment imbalances in the years of high growth were largely of private origin, public spending kept up with the revenue overperformance that was the consequence of buoyant economic activity. During the crisis,
property prices collapsed, construction activity contracted and public revenues fell, especially those related to the previously booming sectors. All three countries had to turn to the International Monetary Fund and their European partners for help."

Darvas points out that "the crisis hit Latvia harder than any other country, and Ireland also suffered heavily, while Iceland exited the crisis with the smallest fall in employment,despite the greatest shock to the financial system." What policy difference across the three countries might explain this pattern?

Iceland let its currency depreciate as part of its policy response, while Ireland was locked into the euro and Latvia stayed fixed with the euro.
"Ireland has been a member of the euro area since 1999, and therefore adjustment through the nominal
exchange rate against the euro was not an option. Latvia has had a fixed exchange rate with the euro since 2004, and Latvian policymakers chose not to exercise the option to devalue. Both Ireland and Latvia decided to embark on a so called ‘internal devaluation’, ie efforts to cut wages and prices. Iceland has a floating exchange rate. When markets started to panic and withdrew external lending, given the size of the country’s obligations, there was no choice but to let the currency depreciate. The Icelandic krona depreciated by about 50 percent in nominal terms– depreciation would have been sharper without
capital controls ..."

In Iceland, the banks were allowed to fail. In Ireland, the government assumed the liabilities of the banks. In Latvia, most banks were foreign-owned and absorbed losses.
"In Iceland, where credit to the private sector reached 3.5 times Icelandic GDP, the combined balance sheet of banks reached an even greater number, and banks heavily borrowed from the wholesale market, the government did not have the means to save the banks. Therefore, there was no choice but to let the banks default when global money markets froze after the collapse of Lehman Brothers in September 2008....

In Ireland, the balance sheet of Irish-owned banks was 3.7 times GDP in 2007 ... . The Irish government guaranteed most liabilities of Irish-owned banks. ... Taxpayers’ money was used to cover bank losses above bank capital (which was wiped out) and subordinated bank bondholders (whose loss is estimated to be about
10 percent of Irish GDP in the form of retiring €25 billion subordinated debt for new debt or equity of
€10 billion). ...

In Latvia about two thirds of the banking system was owned by foreign banks (mostly Scandinavian banks), which assumed banking losses and supported their Latvian subsidiaries, thereby making the lender-of-last-resort role of the Latvian central bank less relevant. ... According to the ECB’s data on consolidated banking statistics, the loss incurred by foreign banks was about 5.7 percent of GDP and the loss of domestic banks about 3.6 percent of GDP by 2010 – a large amount, but well below the banking sector losses in the two other case study countries. IMF calculated that bank support boosted the public debt/GDP ratio by about 7 percentage points of GDP by 2010.

Iceland introduced capital controls; Ireland and Latvia did not.
"Due to fear of further capital outflows and additional depreciation of the Icelandic krona, in late 2008 strict capital controls were introduced in Iceland. This has locked in non-resident deposits and government paper holdings in Iceland and locked out Icelandic krona assets held outside the country, in addition to prohibiting
transfers across the border by both residents and non-residents."

Lessons?
Comparing the outcomes across these three countries, Latvia's GDP fell 25%, with an employment drop of 17%. Ireland had a GDP decline of 10%, with a fall in employment of 13%. Iceland had the biggest shock to its financial system, but had a GDP decline of 9%, and a fall in employment of 5%.

Without overinterpreting the lessons to be learned from this three-country comparison, a few themes do emerge.

1) Latvia was fearful of allowing its currency to depreciate against the euro. But the Iceland example suggests that in time of crisis, if you have the flexibility to let your exchange rate fall, do it. Of course, Ireland was locked into the euro without such flexibility.

2) Think twice before socializing bank losses. Iceland didn't take this step; Ireland did. As Darvas writes: "Little is known about what would have happened to financial stability outside Ireland in the event of letting Irish banks default, but one thing is clear: other countries have benefited from the Irish socialisation of a large share ofbank losses, which has significantly contributed to the explosion of Irish public debt." The result is that while Iceland and Latvia have their public debt under control, it has risen by much more in Ireland. Darvas writes: "Before the crisis, gross government debt was below 30 percent of GDP in all three countries, but started to balloon quickly. ... [B]ank support boosted Irish public debt by about 40 percent of GDP, Icelandic public debt by about 20 percent and Latvian public debt by about 7 percent. Since Iceland and Latvia gained bettercontrol over the budget deficit than Ireland – partly due to the difference in bank support –European Commission forecasts stabilisation of the debt ratio in the two countries, but in Ireland a further 20
percentage points of GDP increase is expected till 2012."
3) In the short run of the time during and immediately after the crisis, imposing capital controls hasn't seemed to hurt Iceland's economic recovery. But it's not clear when or how these controls will be loosened over time.

Of course, applying lessons from particular countries is always tricky. But economic recovery has started in all three of these countries. As Darvas writes: "If the adjustment experiences of the three countries could be a lesson for other countries, such as the Mediterranean countries of the euro area, should be the subject of a different study."

Cancer Rates Continue Falling

2012-01-09T13:00:00.002-06:00

My wife sometimes notes, with wry incredulity, that economists seem to feel as if they have a more-informed opinion than non-economists on every topic. Thus, I smiled when ran across this press release last week: American Cancer Society report finds continued progress in reducing cancer mortality." As they report: "The American Cancer Society's annual cancer statistics report shows that between 2004 and 2008, overall cancer incidence rates declined by 0.6% per year in men and were stable in women, while cancer death rates decreased by 1.8% per year in men and by 1.6% per year in women. The report, Cancer Statistics 2012, published online ahead of print in CA: A Cancer Journal for Clinicians says over the past 10 years of available data (1999-2008), cancer death rates have declined in men and women of every racial/ethnic group with the exception of American Indians/Alaska Natives, among whom rates have remained stable. The reduction in overall cancer death rates since 1990 in men and 1991 in women translates to the avoidance of more than a million total deaths from cancer during that time period."

Of course, economists also believe that we have useful contributions to make to the debate over reducing cancer. (Cue wife and children, rolling their eyes.) In the Fall 2008 issue of my own Journal of Economic Perspectives, David M. Cutler wrote: "Are We Finally Winning the War on Cancer?" The article is freely available to anyone, like all issues of the JEP from the current issue back to 1994, courtesy of the American Economic Association. Here's the abstract:

"President Nixon declared what came to be known as the "war on cancer" in 1971 in his State of the Union address. At first the war on cancer went poorly: despite a substantial increase in resources, age-adjusted cancer mortality increased by 8 percent between 1971 and 1990, twice the increase from 1950 through 1971. However, between 1990 and 2004, age-adjusted cancer mortality fell by 13 percent. This drop translates into an increase in life expectancy at birth of half a year--roughly a quarter of the two-year increase in life expectancy over this time period and a third of the increase in life expectancy at age 45. The decline brings cancer mortality to its lowest level in 60 years. In the war on cancer, optimism has replaced pessimism. In this paper, I evaluate the reasons for the reduction in cancer mortality. I highlight three factors as leading to improved survival. Most important is cancer screening: mammography for breast cancer and colonoscopy for colorectal cancer. These technologies have had the largest impact on survival, at relatively moderate cost. Second in importance are personal behaviors, especially the reduction in smoking. Tobacco-related mortality reduction is among the major factors associated with better health, likely at a cost worth paying. Third in importance, and more controversial, are treatment changes. Improvements in surgery, radiation, and chemotherapy have contributed to improved survival for a number of cancers, but at high cost. The major challenge for cancer care in the future is likely to be the balancing act between what we are able to do and what it makes sense to pay for."

How Republican and Democratic Professors Grade

2012-01-09T06:00:00.005-06:00

Talia Bar and Asaf Zussman article explore "Partisan Grading" in the most recent issue (vol. 4, number 1) of the American Economic Journal: Applied Economics. The article is not freely available on-line, although many can get on-line access to it if your library has a subscription to the publications of the American Economic Association. As they explain in their abstract: "We study grading outcomes associated with professors in an elite university in the United States who were identified—using voter registration records from the county where the university is located—as either Republicans or Democrats. The evidence suggests that student grades are linked to the political orientation of professors."

Their useful starting point is that they have data on SAT scores for students--which are on average a good predictor of college grades. Measured by this standard, they show that the distribution of students headed into the classrooms of Republican and Democrat professors is essentially the same. However, the grading outcomes are not the same.

They have data from "the College of Arts and Sciences of an elite university in the United States between the spring semester of 2000 and the spring semester of 2004." More specifically, they have grades of 17,062 students taking 3,277 undergraduate level courses with 417 professors. They find:

"[T]he variance of grades is higher in courses taught by Republicans than in courses taught by Democrats. Moreover, in additional analysis, we find that relative to their Democratic colleagues, Republican professors tend to assign more very low and very high grades. The share of the lowest grades (F, D−, D, D+, and C−) out of the total is 6.2 percent in courses taught by Republican professors and only 4.0 percent in courses taught by Democratic professors. The share of the highest grade (A+) out of the total is 8.0 percent in courses taught by Republican professors and only 3.5 percent in courses taught by Democratic professors. Both differences are highly statistically significant."

This general pattern holds up after adjusting for differences in grading across academic departments. Here's a graphical illustration of the same general theme. The horizontal axis shows SAT scored of students; the vertical axis shows the average grade received by students. Notice that students with low SAT scores--say, under 1200--receive an average grade of about 2.4 in classes taught by Republican professors, but 2.9 in classes taught by Democrat professors. At the higher end of the range, students with about 1400 on their SATs up to about 1600 get roughly the same grades on average from Democrat professors, at about 3.4. However, students with SAT scores in the top 1560-1600 range on average get grades of about 3.6 from Republican professors.

The authors are at pains to emphasize that there are multiple possible interpretations of these findings.

"One interpretation is that it reflects a difference in grading practices but not in student performance. In other words, an identical distribution of student performance will translate into different distributions of grades, with Republican professors tending more than their Democratic colleagues to assign low grades to low-ability students and high grades to high-ability students.

"An alternative way to interpret the finding is that it reflects a difference in student performance but not in grading practices. The difference in student performance could be related to the amount of effort professors are willing to invest in helping students of different abilities or in the extent to which professors encourage students of different abilities. For example, it is possible that Democratic professors would devote more resources (e.g., in office hours time) to helping low-ability students, while Republican professors would devote more resources to nurturing high-ability students. It may also be the case that Republicans have different teaching or testing styles than Democrats (for example, with different needs for memorization or creativity), and that student performance varies across these heterogeneous learning environments. An additional possibility is that Democrats differentially reward something other than pre-existing talent.

"These interpretations are all consistent with our hypothesis. ... The important point from our perspective is that the evidence suggests that Republican professors are associated with less egalitarian grading outcomes."

While Barr and Zussman are professionally cautious in their interpretation, readers are of course free to offer their own interpretations. Let the parade of anecdote, speculation, innuendo and overstatement commence!

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