Friday, December 30, 2011

Can Auctioning the Spectrum Go Too Far?

How should the scarce resource of the radio spectrum for communication be allocated? One of the classic triumphs of economic analysis has been that spectrum should be auctioned off, rather than being allocated by government. But some prominent economists are now raising the possibility that even if some spectrum should be auctioned off, another portion should be left simply unlicensed.

In the early days of broadcasting, back in the 1920s, one signal often struggled to overpower another. Legislation as early as 1912 sought to address this problem, and the eventual result was the creation of a government regulatory system for allocating spectrum in 1927, under the auspices of the Federal Radio Commission, which morphed into the Federal Communications Commission in 1934.

More than 50 years ago, that arrangement was famously challenged by Ronald Coase in an October 1959 article in the Journal of Law and Economics called "The Federal Communications Commission." It's available a few places on the web (for example, here and here), and is also available through JSTOR. As Coase pointed out, the situation in which users might struggle over a common resource arises often enough--for example, in the case of shared farmland. However, in the case of farmland such conflicts are resolved through property rights and ownership, along with the possibility of selling the resource to others. Thus, Coase drew together the work of earlier writers and proposed that the FCC could auction off spectrum, keep records of who owned which frequencies, and keep track of future changes of ownership.

In the 1990s, Coase's advice, which seemed outrageous to many back in 1959, had been adopted. For a discussion of U.S. spectrum auctions in my own Journal of Economic Perspectives, see this 1994 article by John McMillan. For a follow-up article on spectrum auctions around the world, including some poorly designed auctions with embarrassingly bad results, see this 2002 article in my journal by Paul Klemperer.
But my theme here is not to review the design of spectrum auctions, but to explore a counterintuitive point.
Paul R. Milgrom, Jonathan Levin, and Assaf Eilat  published in October The Case for Unlicensed Spectrum. 
They write (footnotes, citations and paragraph numbers omitted): 

"In the US, the most common approach to managing radio spectrum for commercial non-governmental use has been to assign licenses that give the licensee exclusive rights to a particular band of spectrum for a set period of time. The development of spectrum license auctions in the 1990s helped to pave the way for the growth of the mobile phone industry while generating billions in auction revenues for national governments. Yet some of the most valuable and important innovations in wireless communication, in particular the development of Wi-Fi, have taken place on bands of spectrum for which no exclusive licenses were issued. ...
While selling exclusive licenses to radio spectrum has been a valuable tool for eliminating conflicting uses and encouraging related investments, it has also contributed to concentrated market structures in wireless telephony and created barriers to entry and innovation. Leaving portions of the radio spectrum unlicensed has created multiple benefits, including encouraging the development of complementary technologies that enhance the effectiveness of devices that use licensed spectrum, triggering the development of alternative technologies that compete with licensed uses, and promoting innovative business models and technologies that have brought unexpected benefits.
There is considerable evidence that unlicensed spectrum has huge economic value. Recent past estimates, which already look too conservative, place the value created by current applications of unlicensed spectrum at $16-37 billion dollars a year in the United States alone. However, the primary benefits of unlicensed spectrum may well come from innovations that cannot yet be foreseen. The reason, as we discuss below, is that unlicensed spectrum is an enabling resource. It provides a platform for innovation upon which innovators may face lower barriers to bringing wireless products to market, because they are freed from the need to negotiate with exclusive license holders. Indeed, allocating a mix of licensed and unlicensed spectrum is attractive precisely because the two approaches have diverse advantages in terms of triggering investment and innovation.
 They argue that auctions cannot work as a way of allocating unlicensed spectrum, because the future innovators who might experiment by using such spectrum (along with the consumers who would ultimately benefit from such experiments) can never be organized in advance in a way that would allow them to participate in such an auction. While Wi-Fi is to this point the most important innovation to make use of unlicensed spectrum, they point out that similar arguments apply to Bluetooth and other "wireless personal area networks," to WirelessHD and WiGig which can transfer large amount of data over a distance of a few meters with a line-of-sight connection, and radio-frequency identification tags, the small tag that are attached to products or embedded in cards for tracking purposes. 

In juxtaposition to the work of the 1991 Nobel laureate Ronald Coase, Milgrom, Levin and Eilat point to the work of a 2009 Nobel laureate, Elinor Ostrom. "The Nobel laureate Elinor Ostrom has written extensively on the diversity of governance systems for managing common pool resources. Her work identifies several key principles: the creation of clear rules that respond to local conditions; collective decision-making that allows the participation of most community members; effective monitoring, enforcement, and conflict-resolution mechanisms; and coordination between organizations that manage common-pool resources.  As she emphasizes, these principles do not necessarily imply the creation of exclusive property rights; in many cases, alternative systems can work better."

An intriguing commonality here is that these innovations all  happened in parts of the radio spectrum that were viewed as useless for larger-scale communication--which is why they were unlicensed and thus were available to innovators. What innovations might emerge if some spectrum suitable for long-range and far more reliable communication--like that which has for decades been used for broadcast television--was instead reserved for unlicensed use and innovation?
The Milgrom, Levin, and Eilat argument is also intriguing because it points out an inherent conflict between property rights and innovation. For example, those who invent something today and seek out a patent must often be concerned that they are potentially overlapping with other patents that have already been granted to others. In some cases, the property rights of already-existing patents can choke off innovation from new competitors. As another example, when many people own property rights to many different plots of land, it may be difficult for a new use of that land to arise--whether it be a nature preserve or a natural gas pipeline--because the existing splintered property rights make it difficult to negotiate for an alternative use of the land. Property rights and market exchange are excellent at finding efficient ways for existing uses, but when it comes to certain kinds of change and innovation, they can sometimes pose drawbacks. 

Thursday, December 29, 2011

Is Free Worth It? A Textbook Story

There are two extreme reactions to "free": with an irrational spurt of enthusiasm, or with "you get what you pay for" suspicion.When it comes to free textbooks, my experience is that suspicion is stronger.

Dan Ariely offers a nice discussion of the irrational attraction of "free" in his book Predictably Irrational. He writes in Chapter 3: "Have you ever grabbed a coupon offering a FREE! package of coffee beans--even though you don't drink coffee and don't even have a machine with which to brew it? What about all those FREE! extra helpings you piled on your plate at a buffet, even though your stomach had already started to ache from all the food you had consumed? And what about the worthless FREE! stuff you've accumulated--the promotional T-shirt from the radio station, the teddy bear that came with the box of Valentine chocolates, the magnetic calendar your insurance agent sends you each year? It's no secret that getting something free feels very good. Zero is not just another price, it turns out. Zero is an emotional hot button--a source of irrational excitement. ... Have you ever stood in line for a very long time (too long), just to get a free cone of Ben and Jerry's ice cream? Or have you bought two of a product that you wouldn't have chosen in the first place, just to get the third one for free?"

For some of Ariely's more detailed research on free, see his article "Zero as a Special Price: The True Value of Free Products," written with Kristina Shampanier and Nina Mazar in the November/December 2007 issue of Marketing Science. Ariely makes an argument that the huge allure of free is that people are afraid of making a bad deal and suffering a loss. "Free" eliminates this fear, which feels almost giddy. Indeed, Ariely finds that if people are offered a $10 gift certificate for free, or a chance to buy a $20 gift certificate for $7, they prefer the free choice. In his interpretation, a free $10 gift certificate has no risk of remorse, but paying $7 for a $20 gift certificate raises a possibility of regretting that $7 expenditure.

This sort of research encouraged me, when I published the first edition of my Principles of Economics textbook a few years back, to offer the book through a company called Textbook Media, which was following a "freemium" business model: that is, offer something on-line for free, and make your money in other ways. In their case, they hoped to make money through on-line advertising, and by selling various supplements for the textbook. 

However, this business model didn't work well for my book or any of their other books, and they have now moved to charging for their books--albeit being able to charge much less than mainline publishers. In a post last August, I wrote about Sky-High Textbook Prices--And My Suggested Solution for Intro Economics,
pointing out that a number of intro econ textbooks are selling for $200 and up, while a combination paper and e-version of my textbook sells for $33. (If you're teaching or taking an intro economics course, you can check out the book here.)

Why didn't "free" work out well in the case of this textbook? There are at least four plausible reasons.

1) When it comes to textbooks, all choices are equally "free" to the actual decision-maker, who in this case is the professor rather than the student. If students at the college bookstore could choose among equivalent books by price, the outcome might be rather different. Indeed, professors who are interested can get a few free lunches, a conference or two, and a few hundred dollars for reviewing intro econ textbooks.

2) For a producer, "free" needs to be made up some other way. In the case of textbooks, the prices in the online advertising market plunged when the recession deepened in 2008. Running an on-line advertising business is not the core competency of most textbook publishers. Most professors expect students to pay for the book, and then to have add-ons provided free to them or at low cost.

3) Free raises quality concerns. In the examples of getting a gift certificate, or picking up an extra dessert at the buffet line, quality concerns are diminished. But when something where low quality might cause us trouble or concern over a period of months, like a textbook, then the risk that "free" signals low quality is a real concern. Some feedback from professors was that students took a "free" book less seriously, because they hadn't paid for it.

4) It turns out that a number of students have a personal financial incentive to prefer expensive textbooks. When they purchase a new $200 book, the cost is covered by someone else--perhaps a college bookstore account funded by financial aid or college loans or parental tuition payments. However, when that student re-sells a $200 book for $120 in the used book market after the class is over, that $120 is cash in the student's pocket.  A book that sells new for $33 will sell for even less in the second-hand market.

I do still wonder if a business model of educational content that is free to college students can succeed. I dno't think it will be done by a big legacy publisher: they have too much overhead wrapped up in a conventional publishing model. But for example, perhaps a company like Google, with advertising and an array of related products, could partner with a consortium of colleges to explore the possibility of offering lots of educational content freely on-line as a way of attracting customers for its advertising content.The consortium of colleges would provide some assurance of quality, and perhaps also a ready-made market for the materials. The search engine company could customize advertising to the students in ways that would bring in the most revenue. The educational materials would also attract pageviews for other purposes, and perhaps even attract young adults who could become relatively "sticky" users of that search engine and its other related products for a time into the future.

Wednesday, December 28, 2011

New Trade Rules for the Evolving World Economy

I recently ran across a World Trade Organization working paper published last May by Richard Baldwin called 21st Century Regionalism: Filling the gap between 21st century trade and 20th century trade rules.
Baldwin begins: 

"The last time multilateral trade rules were updated, Bill Clinton was in his first term of office, data was shared by airmailing 1.4 megabyte HD floppy disks (few people had email), cell phones looked like bricks and calling costs were measured in dollars per minute. Trade mostly meant selling goods made in a factory in one nation to a customer in another. Simple trade needed simple rules – a fact reflected in both multilateral and regional trade agreements."

Baldwin points out that patterns of trade in the 21st century are fundamentally different than the make-it-in-a-factory, ship-it-to-another country trade that prevailed in the late 20th century. 
"The heart of 21st century trade is an intertwining of: 1) trade in goods, 2) international investment in production facilities, training, technology and long-term business relationships, and 3) the use of infrastructure services to coordinate the dispersed production, especially services such as telecoms, internet, express parcel delivery, air cargo, trade-related finance, customs clearance services, etc. This could be called the trade-investment-services nexus. ...

 "[T]he nexus entails two elements, each of which generated new demands for more complex international disciplines:
  • Doing business abroad. When firms set up production facilities abroad – or form long-term ties with foreign suppliers – they typically expose their capital as well as their technical, managerial and marketing know-how to new international risks. Threats to these tangible and intangible property rights became 21st century trade barriers. 
  • Connecting international production facilities. Bringing high-quality, competitively-priced goods to customers in a timely manner requires international coordination of production facilities via the continuous two-way flow of goods, people, ideas and investments. Threats to these flows became 21st century trade barriers.
For an illustration, here's a graph of the number of Japanese auto and electrical machinery plants  manufacturers in other countries in east Asia, and how they have increased in the last 20 years or so.

 The basic role of the World Trade Organization, as with the GATT before it, has been to reduce tariffs gradually over time, and to referee arguments over what trade practices are "unfair." But when thinking about 21st century trade, in which supply chains and ownership stretch across international borders, this focus is inadequate. Baldwin offers some examples of the kinds of international agreements that are needed to facilitate 21st century trade--or to put it another way, the kinds of agreements whose absence will tend to block the development of 21st century trade. Here are his examples:

  • The sharing of tacit and explicit technology and intellectual property is facilitated by assurances that foreign knowledge-capital owners will be treated fairly and their property rights will be respected.
  • Foreign investments in the training of workers and managers, physical plant, and the development of long-term business relationships are facilitated by assurances on property rights, rights of establishment, and anticompetitive practices.
  • Assurances on business related capital flows – ranging from new FDI to profit repatriation – also helped foster the investment part of the trade-investment-services nexus.
  • Connecting factories often involves time-sensitive shipping, world class telecoms and short-term movement of managers and technicians, so assurances on infrastructure services are also important.
  • Tariffs and other border measures also matter – just as they mattered in the 20th century but more so since the ratio of value added to value on individual shipment falls as the production chain fragments, even though tariffs are applied to the value of the goods as they cross borders.
 In short, tariffs still matter, and non-tariff barriers still matter, but in 21st century trade, they become a much smaller part of the overall trade liberalization agenda. In addition, negotiations over these matters tend to detailed and industry-specific. Baldwin argues that the need for a new kind of trade liberalization has contributed to the near-zero progress in recent years on an overall Doha trade agreement, while at the same time the world economy has seen a "regionalist" trade agenda, in which countries negotiate regional trade agreements, bilateral investment treaties, and even take unilateral steps to reassure potential trade partners. This graph shows on the right-hand axis the drop in world tariff rates over time, and on the left-hand axis the explosion of new regional trade agreements.

So far, as Baldwin readily admits, the regionalist trade agenda has not blocked a dramatic expansion in world trade: "Trade liberalisation has progressed with historically unprecedented speed in the 21st century ... As a result, trade volumes have boomed, lifting billions out of dire poverty. Twenty years ago, one could wonder whether regionalism would be a building or stumbling block; now we know there were no stumbling blocks on the road to zero tariffs. The road remained open and the world is driving down it as fast as ever."

But on the other side, the notion of global trading rules is being continually eroded. In such a world, the world's most powerful economies--which will include the U.S., the nations of Europe, along with rising global trading powers like China, India are Brazil --will write new ad hoc trading rules as they go. Baldwin notes:  "If the RTAs and their power asymmetries take over, there is a risk that the GATT/WTO would go down in future history books as a 70-year experiment where world trade was rules-based instead of power-based. It would, at least for a few more years, be a world where the world's rich nations write the new rules-of-the-road in settings marked by vast power asymmetries. This trend should worry all world leaders."

How to rethink the world trading rules so that they can focus clearly on the issues of 21st century trade is very much a work in progress. But as world trade rules march steadily toward an ad hoc set of bilateral and regional agreements based on the economic power of the participants, it's important to start considering what alternative paths might be viable.

Tuesday, December 27, 2011

Ebenezer Scroggie: Urban Legend?

The notion that Charles Dickens was inspired by the gravestone of a real-life character named Ebenezer Scroggie to invent a character called Ebenezer Scrooge may be an urban legend--a good story that's taken on a life of its own.

Last Friday, I posted some "Thoughts on Ebenezer Scrooge," which told the story. Tim Worstall linked to the post here at the Adam Smith Institute website, with some details of his own about Adam Smith. Worstall e-mailed me earlier today to say that he has been told on good authority that the story is an invention, "created entirely out of thin air by Peter Clarke back in 1996 as an amusing tale and no more. Bit of a pity really but there we are....." Tim adds: "Oh, and the signifier that it must be a spoof? The General Assembly of the Church of Scotland. Open even now only to priests, elders or deacons. And back then, most certainly not including women so there would be no Countess there to goose. I should have realised that before I ran with the story..."

With Tim's note in hand, I then asked a Dickens expert, who acknowledged having heard the Ebenezer Scroggie story, but was professorially reluctant to opine on whether it was actually true. He wrote: "I've read the same legend about Scrooge but can't say for certain if it's accurate or not.  I suspect not:  the name is too perfectly Dickensian, I think, to be anything other than his creation."

I suppose one lesson here is that of simpleton colonials (that would be me) being snookered by that sophisticated British sense of humor. But a number of newspapers, websites, and the city of Edinburgh might be wise to get this straightened out, too. A 2010 article in the Scotsman newspaper reported the Scroggie story with this information: "Now a memorial may be erected, along with interpretation panels charting Scroggie's fascinating life story. Scroggie, who died in 1836, may also feature in material promoting Edinburgh as a Unesco World City of Literature. Edinburgh World Heritage, the Cockburn Association, the Edinburgh City of Literature Trust and tour guides all want to see more done to raise awareness of Scroggie's claim to fame."

Feldstein, the Euro, and Optimal Currency Areas

Martin Feldstein has an essay in the January/February 2012 issue of Foreign Affairs on "The Failure of the Euro"  (it's not available free on-line). I found it especially interesting because Feldstein is a long-term skeptic on the euro and explained his skepticism the Fall 1997 issue of my own Journal of Economic Perspectives,
in   "The Political Economy of the European Economic and Monetary Union: Political Sources of an Economic Liability."  (Like all JEP articles from the current issue back to 1994, it is freely available on-line courtesy of the American Economic Association.) But while Feldstein is a long-time skeptic on the euro, his argument has shifted slightly over the last 14 years.  

Here's Feldstein's critique from the 2012 article: "The euro should now be recognized as an experiment that failed. This failure, which has come after just over a dozen years since the euro was introduced, in 1999, was not an accident or the result of bureaucratic mismanagement but rather the inevitable consequence of imposing a single currency on a very heterogeneous group of countries."

Feldstein has long argued that the euro is best understood not as an economic policy, but as a step toward an attempted political unification of Europe. In both the 2012 and 1997 articles, he quotes a comment from German Chancellor in 1956, after the U.S. forced England and France to abandon their attack on the Suez Canal. As quoted in the JEP article, Adenauer said: "France and England will never be powers comparable to the United States and the Soviet Union. Nor Germany, either. There remains to them only one way of playing a decisive role in the world; that is to unite to make Europe. England is not ripe for it but the affair of Suez will help to prepare her spirits for it. We have no time to waste: Europe will be your revenge."

The Treaty of Rome launched the European Common Market a year later. But it wasn't until the Maastricht treaty in 1992 that a common currency became part of the project. In retrospect, it's obvious to point out that lots of countries have extensive trade with low trade barriers--say, the U.S. and Canada, or the countries of Europe circa 1995--without any particular need for a common currency to facilitate such trade.

The potential difficulties with a common currency have been widely discussed among economists at least since the work on "optimal currency areas" by Robert Mundell and others back in the 1960s. When countries share a currency, they also share a one-size-fits-all monetary policy. Some countries might prefer lower interest rates to stimulate their economy, some might prefer higher interest rates to hold down inflation; but with a single currency, the countries all get the same monetary policy. Thus, countries must find other ways to adjust.

This theory suggests four key factors: if a group of nations has these four factors that affect economic adjustment, a single currency may work well; if it lacks these factors, the single currency may turn out badly. The four factors are: 1) fiscal transfers to and from a central government, overall moving funds to where the economy is doing less well; 2) geographic movement of families and companies away from areas where the economy is doing poorly to where it is doing better; 3) flexibility in prices and wages so that areas doing poorly see prices fall and become more attractive locations for business, and vice versa; and finally 4) that the economies of these different geographic areas move more-or-less in unison, so that economic differences across the regions don't require these other adjustments to do too much.

The United States, for example, scores pretty well on these four categories, which is part of what makes a single currency workable and beneficial. Europe doesn't score especially well on any of these four categories. Thus, the euro was an attempt to put the cart before the horse: instead of first creating a European economic and political structure where a single currency would work, the idea was to first create the single currency, and then follow up later with the needed economic and political structure. As a result, the euro created a situation in which national economies suffering difficult times, like Greece, no longer had an independent monetary policy to help, and also didn't have many other methods of adjustment. Perhaps not surprisingly, they turned to another short-term method of soothing their economic pain: large domestic budget deficits.

However, the euro's troubles in the last year or so did not arrive in the way Feldstein envisioned back in 1997. Back then, he was concerned that the new European Central Bank might not be very independent of political pressure,and thus would allow a higher rate of inflation to emerge along with an ongoing depreciation of the euro as a way of stimulating European exports. Back in 1997, Feldstein discussed the rules that as part of belonging to the euro, countries would have to limit their budget deficits. While he discussed the likelihood that these rules would not be strictly enforced (and that arguments over the deficit limit rules might even derail the euro negotiations), he did not seem to envision that the runaway levels of government debt in Greece and elsewhere would cause the euro to tremble. At that time, Feldstein was relying on another part of the treaty--the part which banned the European Central Bank from bailing out member states. That provision is being bent, although not yet totally abandoned, in the present crisis.

What actually happened, as Feldstein explains in the 2012 article, is that the European Central Bank did stay tough on inflation. As a result, countries around the periphery of Europe that had long experienced high interest rates--from fear of future inflation and instability--now found that they could borrow at low interest rates. Households borrowed and poured much of the money into housing; governments borrowed more and poured the money into everything. But bond-buyers seemed to ignore the provision in the euro treaty that there would be no bail-outs.  In the U.S. economy, it is accepted as a fact of life that some U.S. states and cities will need to pay higher interest rates when they borrow, because their finances are in dodgier shape. But
debt levels rose in Greece, Ireland, Italy, and Spain, they treated debt issued by these countries as if it had the same risk level and thus the same interest as debt issued by, say, Germany or France. When investors finally took notice of the greater risks, and started jacking up the interest rates they demanded on additional borrowing, severe overborrowing had already occurred.

At this point, there's no good way out of the euro tangle.  For example, one set of proposals are that Europe should now take steps toward a meaningful fiscal union, where countries like Greece would get funding from the rest of Europe in exchange for tight oversight of their future government borrowing. But ordinary Germans don't want to send money to Greece, and ordinary Greeks don't want Germany controlling their country's budget. Having the European Central Bank print euros to buy all the dodgy debt would flatly contradict the euro treaty provisions against bailing out countries, and would leave the ECB holding a bunch of financial securities that are unlikely to pay off.

Meanwhile, European banks hold large amounts of the bonds issued by governments, so any agreement for the governments to default on a substantial portion of their debts means that Europe's banks will be badly underwater. (In a way, this is similar to how U.S. banks were underwater when they thought they were holding safe mortgage-backed financial securities, but then those securities turned out not to be safe.) In facing the risk of these losses, European banks are trying to build up their capital ratios by holding down on lending, which slows Europe's economy more.

But more fundamentally, the euro has linked together quite disparate economies--like Germany and Greece--with a common exchange rate. In a post last November 18, I called this "The "Chermany" Problem of Unsustainable Exchange Rates." Just as China's long-term refusal to let its exchange rate relative to the U.S dollar move (much) has contributed to enormous ongoing trade surpluses for China and corresponding trade deficits for the U.S. economy, the locked-in common currency (in effect, a fixed exchange rate) between Germany and Greece has locked in large trade surpluses for Germany and large trade deficits for Greece.

Feldstein concludes his 2012 essay: "Looking ahead, the eurozone is likely to continue with almost all its current members. The challenge now will be to change the economic behavior of those countries. Formal constitutionally mandated balanced-budget rules of the type recently adopted by Germany, Italy, and Spain would, if actually implemented, put each country’s national debt on a path to a sustainable level. New policies must avoid current account deficits in the future by limiting the volume of national imports to amounts that can be financed with export earnings and direct foreign investment. Such measures should make it possible to
sustain the euro without future crises and without the fiscal transfers that are now creating tensions within Europe."

Back in the 1990s, I was dubious as to how the euro would actually work long-term. As a practical matter, I find it hard to believe that the EU will be able to enforce limits on government fiscal policies or on total volumes of trade across countries. I find it hard to believe that the needed economic adjustments when a country has slow productivity growth, like Greece, will happen through changes in wages and prices, or geographic mobility of people, or fiscal transfers. The euro will probably hobble on for awhile, because breaking up is hard to do. But it will probably hobble from one economic crisis to another until its underlying economic and political context has been fundamentally changed. 

Monday, December 26, 2011

McCloskey on the Great Fact of Economic Growth

In a characteristically ornate, well-considered, good-humored and provocative essay, Dierdre McCloskey has a lot to say about "A Kirznerian Economic History of the Modern World." This essay was originally presented at the 2010 Upton Forum at Beloit College, which focused on the work of Israel Kirzner. This link is from a post by Peter Boettke at Coordination Problem. The conference proceedings will eventually be available third Annual Proceedings of the Wealth and Well-Being of Nations, although the essays don't seem to be posted on the Upton Forum website yet. Here's McCloskey:

"What I got with a jolt around age 65 was that economic growth since 1800, the Great Fact of an increase of real income per head by a factor of anything from a factor of 16 (using the most conventional statistics in the countries that were richest at the outset) all the way to (if you properly account for improved quality) a factor of 100, had very little to do with routine, Samuelsonian/ Friedmanite/Douglass-Northian adjustment of marginal cost to marginal benefit. That is, mere supply-and-demand efficiency does not explain the modern world. ..."

"The problem with all the economistic explanations lies deep within classical and most of subsequent economic thought: the conviction that shuffling stuff around makes us a little better off, which is true; and therefore that the shuffling makes us as rich as modern people are, which is false. Trade. Transportation. Reallocation. Information flow. Accumulation. Legal change. ... Yet the path to the modern was not through shuffling and reshuffling. It was not by the growth of foreign trade or of this or that industry, here or there, nor by shifting weights of one or another social class. Nor indeed was it by reshufflings of property rights. Nor, to speak of another sort of reshuffling, was it by rich people piling up more riches by shuffling income away from their worker-victims. They had always done that. Nor was it through bosses being nasty to workers, or through strong countries being nasty to weak countries, and forcibly shuffling stuff toward the nasty and strong. They had always done that, too. Piling up bricks and money and colonies had always been routine. ... The new path was not about anciently commonplace theft or accumulation or commercialization or reallocation or conquest of foreign kings or any other reshuffling. It was instead about discovery, and a creativity supported by novel words. In terms of the seven principal virtues, the routine of efficiency that Samuelsonian economists love so passionately depends only on the virtue of Prudence ...  What I am claiming here is that Austrian discovery and creativity depends also on the other virtues, in particular on Courage and Hope. ... As a result, previously unknown inputs were discovered (coal for steam engines; then coke for iron; then natural gas to replace the sickening coke burnt in French kitchens), fresh hierarchies of ends were articulated (in the new political economy, for example, which tended to the democratic end of general vs. privileged prosperity; in the new politics, which tended to the radical end of strict equality), new goods and services were created (black tulips, common stocks, reinforced concrete). All of it was very far from routine Prudence. ...

To put it another way, economics in the style of Adam Smith, which is the mainstream of economic thinking, is about scarcity and saving and other Calvinistic notions ... In the sweat of thy face shalt thou eat bread, till thou return unto the ground. We cannot have more of everything. Grow up and face scarcity. We must abstain Calvinistically from consumption today if we are to eat adequately tomorrow. Or in the modern catchphrase: There Ain’t No Such Thing as a Free Lunch (TANSTAAFL). But over time, taking the long view, modern economic growth has been a massive free lunch. Discovery, not reshuffling, was the mechanism, and the springs were the nonprudential virtues."

All of this and much else in the essay is very well-said, as one expects from McCloskey, but at some level, the posited separation between supply-and-demand efficiency and economic growth seems to me a bit overstated. Yes, basic supply and demand is static and one-time, and economic growth is a dynamic process over time. But at least when I teach supply and demand, I emphasize that the interaction of utility-maximizing consumers looking and profit-seeking producers is an evolving process. Producers are continually attempting to entice consumers, through combinations of new qualities and new products, along with price competition. Consumers are continually seeking a better deal. To me, at least, even the most basic models of mainstream supply-and-demand economics are built on more than penny-pinching Prudence. They are also incorporate discovery, creativity, and even creativity and hope.

I fear that in McCloskey's effort to emphasize this broader perspective, she draws too bright a line between supply-and-demand and the Great Fact of economic growth, and thus veers close to a reductionist or perhaps a mechanistic view that if economic models don't include a specific variable for Courage or Hope or Creativity or Discovery, then the models can't encompass those motivations.  But being reminded of the importance of such concerns and motivations is always useful, and thus McCloskey's bracing and entertaining essay is well worth reading.

Friday, December 23, 2011

Thoughts on Ebenezer Scrooge

Added December 27: 
 Is the story of Ebenezer Scroggie that follows too good to be true? See follow-up post on December 27 at Ebenezer Scroggie: Urban Legend

Original post follows:

The story goes that Charles Dickens was visiting Edinburgh to give a public reading of his work in 1842, and spent some time looking around the Canongate church graveyard. He saw one grave that made him shudder. The name on the grave was Ebenezer Lennox Scroggie--mean man." According to Peter Clark, a British political economist who seems the starting point for this story, Dickens misread the inscription. It actually said "Meal man," because Scroggie was a corn merchant.

But Dickens was shocked by the inscription, and apparently noted it in  his diary. A geneology website reported Dickens's comment this way in 2010: "[T]o be remembered through eternity only for being mean seemed the greatest testament to a life wasted." In a 1996 telling, Clark reported the comment from Dickens diary in this way: "How bleak to have one's shrivelled soul advertised forever. It made me shudder. It made me feel for the flesh corrupting beneath me." Shortly afterwards, Charles Dickens published "A Christmas Carol," with a main character named Ebenezer Scrooge, and the plot revolving around what it would be like to be forever stamped as a "mean man," when there was still time to change your ways.

Apparently Ebenezer Scroggie was about as far from his fictional namesake as one can get. A "History of Leith, Edinburgh" website reported in 2010: "In life, Scroggie was apparently a rambunctious, generous and licentious man who gave wild parties, impregnated the odd serving wench and once wonderfully interrupted the General Assembly of the Church of Scotland by grabbing the buttocks of a hapless countess." However, for those seeking to link Ebenezer Scrooge more tightly to the heartlessness of economics, it may be comforting to know that Scroggie was apparently a cousin of Adam Smith. A 2004 article in the Scotsman newspaper reports: "Scroggie was born in Kirkcaldy, Fife; his mother was the niece of Adam Smith, the 18th century political economist and philosopher." There is now some talk in Edinburgh of erecting a monument to Scroggie, although his actual gravesite was apparently removed for redevelopment of the port back in the early 1930s.

Each Christmas you can find an economist or two taking the contrarian position that Ebenezer Scrooge was an unpleasant person, but in economic terms a useful contributor to society. For a good example, here's Steven Landsberg's 2004 half-serious, half tongue-in-cheek riff on the theme: "What I Like About Scrooge."
"In this whole world, there is nobody more generous than the miser—the man who could deplete the world's resources but chooses not to. The only difference between miserliness and philanthropy is that the philanthropist serves a favored few while the miser spreads his largess far and wide."

I like thinking about Scrooge in various roles: consumer, employer, and man of business.

As a consumer, Scrooge is famously a miser. He likes darkness, because it's cheap. He eats gruel. He uses microfragments of coal. All this is just fine with me. People get to choose how they want to live. Those who save also make a contribution to the economy. Of course, if Scrooge had not been miserly all those years, and instead had been greatly in debt from high living, he wouldn't have had the resources to help Bob Cratchit's family and Tiny Tim at the close of the book

As an employer, Scrooge is more harsh than necessary--and he knows it. When the Spirit of Christmas Past asks whether Fezziwig, where Scrooge was apprenticed, really deserves much praise. Scrooge describes Fezziwig as an employer in this way: "He [that is, Fezziwig] has the power to render us happy or unhappy; to make our service light or burdensome; a pleasure or a toil. Say that his power lies in words and looks; in things so slight and insignificant that it is impossible to add and count 'em up ..." In more modern terms, an employment relationship is more than a trade of hours for pay. Scrooge at the beginning of the book makes Bob Cratchit's life more difficult than it already is, and if Scrooge had been willing to use modest nonmonetary rewards like speaking pleasantly, their work relationship might well have been more productive on both sides.

Being a "man of business" is often an epithet in Christmas Carol, so it's worth noting that the book includes examples of men of business in the book who are clearly meant to be admirable characters--with Fezziwig leading the way. But  to me, one of the most grim passages in the book is when Scrooge is visiting with the last of the Spirits, and nearly broken by what he has seen, he says to the Spirit: "If there is any person in the town, who feels emotion caused by this man's death ... show that person to me, Spirit, I beseech you!" The Spirit takes him to a room where a mother and children are waiting for a husband to arrive. When the husband arrives, his face has an odd look: "There is a remarkable expression in it now; a kind of serious delight of which he felt ashamed, and which he struggled to repress." He has learned that Scrooge has died, and the man and his wife are grateful to hear of this, and ashamed for being grateful. The wife asks: "To whom will our debt be transferred?" The husband answers: "I don't know. But before that time we shall be ready with the money, and even though we were not, it would be bad fortune indeed to find so merciless a creditor as his successor. We may sleep tonight with light hearts, Caroline!"

To me, this passage suggests that Scrooge had moved well beyond the category of being an unloved but tough but essentially fair businessman. Just as he had abused his power as an employer over Cratchit, and enjoyed it, he was abusing his power as a lender. Scrooge wrapped himself in the comforting rhetoric of "man of business" as a self-justification for his actions. A lot of other misanthropes and predators over time have used "man of business" as justification for their actions, so the acid in the term stings. But working in business doesn't require these traits; indeed, one might argue that true "man of business" perceives and pursues all sorts of opportunities for adding value, while Scrooge was actually practicing a machismo of self-congratulatory greed and surliness.

Thursday, December 22, 2011

Consumer Financial Obligations Nearly Back to 1979 Levels

One reason underlying the Great Recession that followed the financial crash is that U.S. households had over-committed themselves with excessive borrowing. As households were faced with the task of paying off these debts and reducing their debt burdens, they weren't consuming as much as they otherwise would have done--which slowed the economy.

This pattern can be tracked with a couple of statistics that the Federal Reserve calls the "debt service ratio" and the "financial obligations ratio." The terms are defined in this way: "The household debt service ratio (DSR) is an estimate of the ratio of debt payments to disposable personal income. Debt payments consist of the estimated required payments on outstanding mortgage and consumer debt. The financial obligations ratio (FOR) adds automobile lease payments, rental payments on tenant-occupied property, homeowners' insurance, and property tax payments to the debt service ratio."

Here's the household debt service ratio, as generated by the ever-useful FRED website at the St. Louis Fed:

Christoffer Koch and J.B. Cooke of the Dallas Fed point out that the "financial obligations ratio"--that is, financial obligations as a share of disposable income--has now nearly dropped back to the lower levels observed in the last few decades. Here is their figure:

It's clearly good news that U.S. households as a group have largely worked through the problem of dealing with their oversized debt obligations. However, this success in reducing debt service and financial obligations remains a bit fragile. These obligations have two major ingredients: how much debt you have, and the interest rate you are paying on that debt. As Koch and Cooke explain: "

"Debt-to-income ratios are still elevated; they have been receding, but some of this improvement can be attributed to lenders writing down mortgage debt at unusually high levels. Improvements in household debt burdens positively impact consumer spending by affecting both housing-related consumption and—via net wealth and liquidity effects—overall consumption. In the same vein, financial obligations ratios (FOR) suggest de-levering may be nearing an end, with these ratios nearly back to post-1979 lows (Chart 4). The decline reflects increased write-downs on and paying off of mortgage debt, amplified by lower interest rates across the maturity spectrum." 

In short, household debt levels are still "elevated," but household financial obligations are nonetheless low because of the ultra-low interest rates in the U.S. economy. The low interest rates are, in a way, buying some time for U.S. households to continue reducing their debt burdens.

Wednesday, December 21, 2011

Will Federal Debt Lead to High Inflation?

In the Fall 2011 issue of the National Interest, John H. Cochrane explores the "Inflation and Debt" connection. He points out that most economists don't see it as very likely that government debt will be the proximate cause of inflation. They point to the sluggish economic recovery, which tends to hold down price and wage levels. They believe that if inflation gets started, the Federal Reserve can act to nip it in the bud.

Cochrane takes the other side of this argument. He writes: "As a result of the federal government's enormous debt and deficits, substantial inflation could break out in America in the next few years. ... The key reason serious inflation often accompanies serious economic difficulties is straightforward: Inflation is a form of sovereign default. Paying off bonds with currency that is worth half as much as it used to be is like defaulting on half of the debt. And sovereign default happens not in boom times but when economies and governments are in trouble."

Can the Federal Reserve stop inflation? Cochrane argues that much of the conventional economic thinking about anti-inflation policy assumes a background of a reasonably sound fiscal policy. "[R]easonably sound fiscal policy .. is the central precondition for stable inflation. Major explosions of inflation around the world have ultimately resulted from fiscal problems, and it is hard to think of a fiscally sound country that has ever experienced a major inflation. So long as the government's fiscal house is in order, people will naturally assume that the central bank should be able to stop a small uptick in inflation. Conversely, when the government's finances are in disarray, expectations can become "unanchored" very quickly. ... But what if our huge debt and looming deficits mean that the fiscal backing for monetary policy is about to become unglued?"

Cochrane cites familiar evidence that federal indebtedness  is on an unsustainable path. He suggests that a process of "fiscal inflation" will unfold in this way:
 "[O]ur government is now funded mostly by rolling over relatively short-term debt, not by selling long-term bonds that will come due in some future time of projected budget surpluses. Half of all currently outstanding debt will mature in less than two and a half years, and a third will mature in under a year. Roughly speaking, the federal government each year must take on $6.5 trillion in new borrowing to pay off $5 trillion of maturing debt and $1.5 trillion or so in current deficits."
"As the government pays off maturing debt, the holders of that debt receive a lot of money. Normally, that money would be used to buy new debt. But if investors start to fear inflation, which will erode the returns from government bonds, they won't buy the new debt. Instead, they will try to buy stocks, real estate, commodities, or other assets that are less sensitive to inflation. But there are only so many real assets around, and someone has to hold the stock of money and government debt. So the prices of real assets will rise. Then, with "paper" wealth high and prospective returns on these investments declining, people will start spending more on goods and services. But there are only so many of those around, too, so the overall price level must rise. Thus, when short-term debt must be rolled over, fears of future inflation give us inflation today — and potentially quite a lot of inflation."
Cochrane argues that investors are already worrying about even the current low rates rates inflation, given the prevailing ultra-low interest rates, and that the result could be a slow-motion financial run:
"Just how low are today's rates? The one-year rate is now 0.2%; the ten-year rate is about 2%, and the 30-year rate is only 4%. We have not seen rates this low in the post-war era. Furthermore, inflation is still running at around 2-3%, depending on exactly what measure of inflation we choose. If an investor lends money at 0.2% and inflation is 2%, he loses 1.8% of the value of his money every year. Such low rates are therefore unlikely to last. ... But both the Fed's desire to keep rates this low and its ability to do so are surely temporary. ...
"A "normal" real interest rate on government debt is at least 1-2%, meaning a 4-5% one-year rate even if inflation stays at 2-3%. A loss of the special safety and liquidity discount that American debt now enjoys could add two to three percentage points. A rising risk premium would imply higher rates still. And of course, if markets started to expect inflation or actual default, rates could rise even more. ...
"These dynamics essentially add up to a "run" on the dollar — just like a bank run — away from American government debt. Unlike a bank run, however, it would play out in slow motion. ... The United States rolls over its debt on a scale of a few years, not every day. So the "run on the dollar" would play out over a year or two rather than overnight.... Like all runs, this one would be unpredictable.... For that reason, I do not claim to predict that inflation will happen, or when. This scenario is a warning, not a forecast. Extraordinarily low interest rates on long-term U.S. government bonds suggest that the overall market still has faith that the United States will figure out how to solve its problems.... But we are primed for this sort of run. All sides in the current political debate describe our long-term fiscal trajectory as "unsustainable."... As with all runs, once a run on the dollar began, it would be too late to stop it.... Neither the cause of nor the solution to a run on the dollar, and its consequent inflation, would therefore be a matter of monetary policy that the Fed could do much about. Our problem is a fiscal problem — the challenge of out-of-control deficits and ballooning debt. Today's debate about inflation largely misses that problem, and therefore fails to contend with the greatest inflation danger we face."
As Cochrane readily states, his analysis of the threat of a fiscal inflation is unconventional, and I'm not yet a  convert. But I do think that his analysis hits a number of key points that deserve serious consideration.

The current path of federal borrowing is unsustainable--not this year or next year, but probably in the middle-term and certainly in the long term. Investors are not going to be eager to hold these burgeoning levels of debt. If the very low nominal interest rates and negative real rates that such debt is currently paying continue, investors will start looking for other assets. (Gold, anyone?)  If the interest rates on federal debt start rising, the federal debt problem will become much more severe in a hurry--and investors will continue to be less interested in investing. In this setting, the Federal Reserve is likely to be in an unpleasant pickle. The Fed has already taken up, at least in part, the task that it had during and after World War II of making it cheaper for the government to borrow--if necessary, by having the Fed buy Treasury debt directly. There will be heavy political pressure on the Fed to keep doing this--in effect, protecting the U.S. government from the costs of heavy borrowing by printing money. This scenario could play out as inflation, although I'm less confident of that prediction than Cochrane. It might result in a heavy shock to the U.S. financial system, which is still struggling to recover from the problems of 2008 and 2009.

The bottom line is that the government needs to enact actual policies--not vague promises about policies that could be enacted in the future--that will reduce the path of future budget deficits. I'd start with some steps that should be relatively (if not actually) easy, like phasing in a later retirement age a month per year over the next few decades. This step would make a substantial difference to Social Security and a modest difference to Medicare (because  such a large share of Medicare expenses happen later in life, not in the year or two right around retirement). A next step might be to resurrect many of the recommendations of the National Commission on Fiscal Responsibility and Reform--the so-called Bowles-Simpson commission--that  President Obama first appointed, but then ignored. I don't know whether Cochrane is correct that the federal debt problems will cause an inflation problem in the next few years, but on the present path, federal borrowing is going to bring a highly unpleasant crunch of some sort.

Tuesday, December 20, 2011

A Global Shift from Equity to Debt?

The McKinsey Global Institute has an intriguing report out on "The emerging equity gap." The starting point is that listed equities are 28% of the $200 trillion or so in global financial assets in 2010, but are on track to drop to 22% of global assets by 2020.

This change isn't because stock market values are expected to melt down! Instead, it's mainly because growth in the world economy is happening in places like China and India and other emerging market economies where stock markets are not well-established. Households in those countries are much more likely to put their money in bank accounts, rather than in stock market funds. Businesses in those countries get their financing through debt markets: banks, bonds, and other loans. 

What economic issues arise if stock markets don't expand with the economic growth in emerging markets? The McKinsey report explains:

"Expansion of equity markets has provided an important source of funding for companies; it has offered an exit option for venture funders who are so important to innovation; it ushered in a new era of corporate ownership and governance, as families and founders transferred control of companies to a diverse set of shareholders; and it has spurred greater competition within industry sectors and fostered faster entry and exit of firms through M&A and spin-offs. In most countries, equity investments have offered investors higher returns on savings over the long term than bonds or deposits, helping them to accumulate wealth and fund retirement. Reducing this enabler of dynamic performance will have implications for economic performance and global rebalancing. ...

"GDP growth rates could be slowed somewhat by a reduction in the relative role of equity funding and a rise in debt financing. Equities provide not only long-term funding, but also an important means of absorbing risk and dispersing it across many investors. During economic downturns, high levels of debt in the economy—in households, or in the corporate or government sectors—create a higher risk of bankruptcy. By contrast, companies that are financed with higher levels of equity have less risk of financial distress than those financed mainly with debt. The procyclical dynamic of high leverage exacerbates the depth of recessions, forcing more companies to cut back employment to meet debt payments and leaving more firms in danger of bankruptcy. In addition, over-reliance on debt financing may help fuel asset bubbles. When a downturn does occur, more diversified financial systems can withstand the strain better and can resume growth more rapidly because their companies are less indebted and have alternative means of raising financing. ...

Today, policy makers and economists continue to debate the relative merits of equity financing versus bank financing and there are certainly ample examples of countries that have sustained strong growth with limited equity markets: South Korea during its fastest growth phase, Germany, and recently China, for example. Current academic thinking suggests that the optimal financial market structure for a country depends on its stage of economic and industrial development: as economies advance, firms need larger and more robust equity markets to facilitate innovation and supply large amounts of capital for new industries. Empirical evidence suggests that if legal protections for shareholders are strong, financial systems that include robust capital markets—in addition to bank financing—promote faster economic growth than purely bank-based ones.
The broad outlines of a policy response to this issue are clear enough: emerging-market economies can start taking steps to develop their equity markets, and the financial sector can start figuring out how to make it  easier for American and European investors to buy such equities. Both changes are likely.

Historically, as economies grow, they place a greater emphasis on stock markets: "Over the past century, there has been a clear pattern: with few exceptions, as countries have grown richer, investors have become more willing to put some money at risk in equities to achieve higher rates of return. We have seen this pattern not only in the United States and Europe, but more recently in Singapore,South Korea, and Hong Kong. However, other factors must also be in place for equity markets to thrive: rules and regulations that protect minority investors, transparency by listed companies, sufficient liquidity in the stock market, the
presence of institutional investors, and easy access to markets by retail investors."

If American investors as a group want to own a larger quantity of stocks over time, they will need to turn to stocks in emerging market economies. McKinsey explains: "In the United States and several other developed countries, investor demand for equities will most likely continue to exceed what companies will need because
many companies in these economies generate sufficient profits to finance investment needs. Indeed, US companies at the end of 2010 had more than $1.4 trillion in cash, and over the past decade nonfinancial corporations have been buying back shares, rather than issuing new ones."

Globalization isn't just about trade in goods and services. It's about financial flows and allocations of risks and returns across international borders as well. IMF data from its Coordinated Portfolio Investment Survey shows that international portfolio investment (that is, cross-border positions in debt and equity securities) rose from $6 trillion in 1997 to about $40 trillion in 2010. Bigger changes are coming.

Monday, December 19, 2011

Saving Jaguars and Elephants with Property Rights and Incentives

When it comes to saving endangered species, many people have the instinctive reaction that that the policy answer is to pass a law that forbids disturbing or hurting the species. Economists have long pointed out that while such a law may be a useful first step, the incentives of those who live locally to avoid hurting the animal and to protect its habitat matter a lot. If finding an endangered species on your land means that you are deprived of the use of that land, there is a counterproductive incentive, as the old saying goes, to "shoot, shovel, and shut up." In low-income countries, in particular, protecting endangered species and their habitat will require active cooperation of nearby villages and farmers.

A classic example is whether to allow hunting of elephants in Africa. Terry Anderson  and Shawn Regan provide a lively and opinionated overview last June in "Shoot an Elephant, Save a Community."  

"Anti-hunting groups succeeded in getting Kenya to ban all hunting in 1977. Since then, its population of large wild animals has declined between 60 and 70 percent. The country’s elephant population declined from 167,000 in 1973 to just 16,000 in 1989. Poaching took its toll on elephants because of their damage to both cropland and people. Today Kenya wildlife officials boast a doubling of the country’s elephant population to 32,000, but nearly all are in protected national parks where poaching can be controlled. With only 8 percent of its land set aside as protected areas, it is no wonder that wildlife in general and elephants in particular have trouble finding hospitable habitat. ...

"In sharp contrast to Kenya, consider what has happened in Zimbabwe. In 1989, results-oriented groups such as the World Wildlife Fund helped implement a program known as the Communal Areas Management Programme for Indigenous Resources or CAMPFIRE. This approach devolves the rights to benefit from, dispose of, and manage natural resources to the local level, including the right to allow safari hunting. Community leaders with local knowledge about wildlife and its interface with humans help establish sustainable hunting quotas. Hunting then provides jobs for community members, compensation for crop and property damage, revenue to build schools, clinics, and water wells, and meat for villagers ... By granting local people control over wildlife resources, their incentive to protect it has strengthened. As a result, poaching has been contained and human-wildlife conflicts have been reduced. While challenges remain, especially from the current political climate in Zimbabwe, CAMPFIRE has quietly produced results with strikingly little activist rhetoric. ... Ten years after the program began, wildlife populations had increased by 50 percent. By 2003, elephant numbers had doubled from 4,000 to 8,000. The gains have not just been for wildlife, however. Between 1989 and 2001, CAMPFIRE generated more than $20 million in direct income, the vast majority of which came from hunting. During that period, the program benefitted an estimated 90,000 households and had a total economic impact of $100 million. 

Wildlife imposes real costs on African communities. Those communities need the right incentives to protect wildlife and its habitat. The results go beyond the CAMPFIRE areas. Between 1989 and 2005, Zimbabwe’s total elephant population more than doubled from 37,000 to 85,000, with half living outside of national parks. Today, some put the number as high as 100,000."

A more recent example focuses less on hunting, and more on a combination of tourism and property rights as the local incentive. The October 2011 issue of Smithsonian magazine has an article about "The Jaguar Freeway: A bold plan for wildlife corridors that connect populations from Mexico to Argentina could mean the big cat's salvation."  The article discusses an effort to connect existing jaguar habitats from Mexico to Argentina with corridors in which the jaguars could travel, in an attempt to preserve their biodiversity and to prevent the animals from being confined in nature preserves. Here's a map of the plan, where the green areas are jaguar population centers, the yellow lines are corridors that are pretty likely, and the red lines are jaguar corridors at risk: 

This article isn't written by or for economists, but the negotiations with government, local landowners and farmers over whether to create these jaguar corridors often refer to incentives for tourism. Here is a scattering of comments from the article: 

"[I]n 1984, Belize’s Cockscomb Basin became the world’s first jaguar preserve. Now en­compassing about 200 square miles, it is part of the largest contiguous forest in Central America. Jaguars are now thriving in Belize, where ecotourism has made them more valuable alive than dead."

Here's a description of two "conservation ranches" in Brazil: "The ranches straddle two preserves, making them an important link in the corridor chain and together creating 1,500 square miles of protected habitat. ...
These ranches are expected to be more successful than others by using modern husbandry and veterinary  techniques, such as vaccinating cattle herds. Because disease and malnutrition are among the leading killers of cattle in this region, preventing those problems more than makes up for the occasional animal felled by a jaguar. “My vision was to ranch by example,” Kaplan says, “to create ranches that are more productive and profitable and yet are truly jaguar-friendly.”"

"In Belize, where jaguars serve increasingly as an attraction for ecotourists, Maya who once killed the animals are now their protectors. “It’s not born-again enlightenment,” says Rabinowitz. “It’s economics.” Jaguar tourism is also bringing money into the Pantanal [in Brazil]. Carmindo Aleixo Da Costa, a 63-year-old rancher, says that hosting a few foreign tourists doubles his annual income. “Now is the time of the jaguar!” he says, beaming."

Friday, December 16, 2011

Government Redistribution : International Comparisons

Income inequality has been growing in most high-income countries around the world. How much do the redistribution policies of government hold down this growth in inequality? The OECD has published Divided We Stand: Why Inequality Keeps Rising. (The report can be read for free on-line with a slightly clunky browser, and a PDF of an "Overview" chapter can be downloaded.) Chapter 7 of the report discusses "Changes in Redistribution in OECD Countries Over Two Decades," which basically means from the mid-1980s to the mid-2000s. The chapter draws on a longer background paper that is freely available on-line: Herwig Immervoll and Linda Richardson's paper, "Redistribution Policy and Inequality Reduction in OECD Countries: What Has Changed in Two Decades?"

The United States does relatively little redistribution in comparison with other OECD countries. This graph from the "Overview" of the OECD report compares the inequality of market incomes to the inequality of disposable income after taxes and benefit payments. Inequality is measured by a Gini coefficient. For a more detailed explanation of how this is measured, see my November 1 post on Lorenz curves and Gini coefficients. But as a quick overview, it suffices to know that a Gini coefficient measures inequality on a scale from zero to 1, where zero is perfect equality where everyone has exactly the same income and 1 is perfect inequality where one person has all the income. The United States has one of the most unequal distributions of market income and of disposable income, and in this comparison group, U.S. policy does relatively little to reduce the disparity. The OECD writes: "Public cash transfers, as well as income taxes and social security contributions, played a major role in all OECD countries in reducing market-income inequality. Together, they
were estimated to reduce inequality among the working-age population (measured by the Gini coefficient) by an average of about one-quarter across OECD countries. This redistributive effect was larger in the Nordic countries, Belgium and Germany, but well below average in Chile, Iceland, Korea, Switzerland and the United States (Figure 9).

Any economy that has a progressive tax code and benefits for those with low incomes will find that as inequality increases, redistribution will also increase automatically as a result of these preexisting policies Some countries may also take additional steps, when faced with rising inequality of market incomes, to raise the amount of redistribution. A table in Ch. 7 of the OECD report calculates how much of the increase in increase in market incomes from the mid-1980s to the mid-2000s was offset by a rise in redistribution.

Denmark is the extreme case: increased redistribution from the mid-1980s to the mid-2000s offset more than 100% of the rise in inequality of market incomes. In a number of countries, the rise in redistribution offset from 35-55% of the rise in inequality of market incomes over this time period: Australia, Canada, West Germany, Netherlands, Norway, Sweden. By comparison, in the U.S. the rise in government redistribution from the mid-1980s to the mid-2000s offset just 9% of the rise in market inequality.

It's useful to look at redistribution policies both from the tax side and the benefits side. The striking theme that emerges is that in most countries, benefits for those with low incomes are much more important in reducing inequality than are progressive tax rates.

On the tax side, the U.S. tax code is already highly progressive compared with these other countries. The OECD published at 2008 report called "Growing Unequal: Income Distribution and Poverty in OECD Countries, which states (pp. 104-106): "Taxation is most progressively distributed in the United States, probably reflecting the greater role played there by refundable tax credits, such as the Earned Income Tax Credit and the Child Tax Credit. ... Based on the concentration coefficient of household taxes, the United States has the most progressive tax system and collects the largest share of taxes from the richest 10% of the population. However, the richest decile in the United States has one of the highest shares of market income of any OECD country.After standardising for this underlying inequality ... Australia and the United States collect the most tax from people in the top decile relative to the share of market income that they earn."

This finding is surprising to a lot of Americans, who have a sort of instinctive feeling that Europeans must be taxing the rich far more heavily. But remember that European countries rely much more on value-added taxes (a sort of national sales tax collected from producers) and on high energy taxes. They also often have very high payroll taxes to finance retirement programs. These kinds of taxes place a heavier burden on those with lower incomes.

In addition, top income tax rates all over the world have come down in recent decades, and the U.S. top rate is near a fairly common level. From the "Overview: "Top rates of personal income tax, which were in the order of 60-70% in major OECD countries, fell to around 40% on average by the late 2000s." From the
Immervoll and Richardson working paper: "Reductions in top [personal income tax] rates were steepest in Japan (from 70 to 37 percent), Italy (65 to 43), United Kingdom (60 to 40), and France (65 to 48). The flattening of schedules mostly concerned higher income ranges (Australia, Austria, Finland, France, Germany, Japan, United Kingdom, United States)."

The real difference in how much redistribution affects inequality arises from differences in benefits. The OECD writes: "Benefits had a much stronger impact on inequality than the other main instruments of cash distribution -- social contributions or taxes. ... The most important benefit-related determining factor in overall distribution, however, was not benefit levels but the number of people entitled to transfers." This theme applies to a number of benefit programs, including disability payments. But here is an illustrations with regard to unemployment insurance, taken from the Immervoll and Richardson working paper. They write: "Figure 11 indicates that the shares of unemployed reporting benefit receipt have dropped in a majority (two thirds) of the countries shown, while only a few recorded significant increases." Notice that the share of the unemployed in the U.S. who get unemployment benefits is on the low end of the spectrum.

This pattern also fits with my post on November 1 about a Congressional Budget Office report which found that Federal Redistribution is Dropping. It pointed out that the share of federal redistribution spending programs going to the elderly has been steadily rising, while the share going to the non-elderly poor and near-poor has not been rising. The working paper also notes: "[O]ver time, almost all countries devoted declining shares of total spending to cash benefits that mostly benefit children and working-age individuals."

The OECD report been criticized for suggesting that higher taxes on those with the very highest incomes might be worth considering, but this is certainly not the main focus of the report. Indeed, given that the U.S. tax system is already one of the most progressive, this recommendation seems aimed more at other countries than at the United States. The "Overview" of the OECD report states: "However, redistribution strategies based on government transfers and taxes alone would be neither effective nor financially sustainable. First, there may be counterproductive disincentive effects if benefit and tax reforms are not well designed. Second, most OECD countries currently operate under a reduced fiscal space which exerts strong pressure to curb public social spending and raise taxes. Growing employment may contribute to sustainable cuts in income inequality, provided the employment gains occur in jobs that offer career prospects. Policies for more and better jobs are more important than ever." In particular, the OECD report emphasizes as policy tools to fight unemployment job-related training and education, continuing education over the work life, and reforming rules prevalent in many countries that separate the workforce into temporary and permanent employment contracts.

As part of an overall plan to get the budget deficit under control, and given the rise in inequality over recent decades, I would be favor a somewhat higher marginal tax rate on those with very high income levels. But it seems to me that U.S. political discourse has focuses way too much on taxing the rich. Hard-core Democrats and Republicans both like the familiar arguments over taxes: it gets their blood pumping and their base motivated. But U.S. political discourse has far too little about reforming labor markets to open up more jobs, or about how to stimulate job-related education for life. And neither party stands up for raising government spending in ways that would affect those with lower income levels more, whether through income payments to families (especially to the working poor) or through spending on public goods like neighborhood safety (police, lighting and activities), parks and libraries, or education and public health that would have a greater effect on the quality of life for those with lower incomes.

Thursday, December 15, 2011

Africa's Prospects: Half Full or Half Empty?

There has been a flurry of articles recently with optimistic economic news about sub-Saharan Africa. For example, the December 3 issue of the Economist featured "Africa’s hopeful economies--The sun shines bright--The continent’s impressive growth looks likely to continue."  The December 2011 issue of the IMF publication Finance & Development has a group of articles about Africa; for example, an article by Calestous Juma titled "Africa's New Engine: Africa looks to its middle-class consumers to drive prosperity." These articles draw to some extent on a September 2011 report from the African Development Bank: "Africa in 50 Years Time: The Road Towards Inclusive Growth."  

Good economic news about Africa has been hard to come by these last few decades, but in the last 5-10 years, there have been some encouraging signs. For example, I posted last June 13 on how Africa was making up a growing share of international trade in Africa's Economic Development, and on September 19 about Africa's Growing Middle Class (!?!). I'll re-cap here some of the optimistic news, but buried a little deeper in these reports is some gloomy reality, too. 

Here's the Economist: "From Ghana in the west to Mozambique in the south, Africa’s economies are consistently growing faster than those of almost any other region of the world. At least a dozen have expanded by more than 6% a year for six or more years. Ethiopia will grow by 7.5% this year, without a drop of oil to export. Once a byword for famine, it is now the world’s tenth-largest producer of livestock. ... Severe income disparities persist through much of the continent; but a genuine middle class is emerging. According to Standard Bank, which operates throughout Africa, 60m African households have annual incomes greater than $3,000 at market exchange rates. By 2015, that number is expected to reach 100m—almost the same as in India now. These households belong to what might be called the consumer class."

Here's Juma in F&D: "Cell phone use has grown faster in Africa than in any other region of the world since 2003, according to the United Nations Conference on Trade and Development. Africa became the world’s second most connected region after Asia in late 2011, with 616 million mobile subscribers, according to U.K.-based Informa Telecoms & Media. Of course, South Africa—the most developed nation—still has the highest penetration, but across Africa, countries have leapfrogged technology, bringing innovation and connectivity even to remote parts of the continent, opening up mobile banking and changing the way business is done. Seeing the cell phone success, banking and retail firms are eyeing expansion in Africa to target a growing middle class of consumers."

Unlike many areas of the world with aging populations, Africa is on the brink of a "demographic dividend" of rising numbers of prime-age workers. The last few decades have seen real strides in health and education. The region is urbanizing. The business climate is improving. It has vast quantities of natural resources and 60% of the world's undeveloped arable land. Africa's economies have strong and developing connections to China and to India, with their rapid growth rates. Africa's diaspora outside the continent of 30 million or so sends back something like $60 billion per year to the region--along with connections to other markets and skills. Capital inflows to the region are rising and now substantially outstrip foreign aid to the region: here's a figure from the Economist:
The Economist cites a World Bank report from last March, "Africa’s Future and the World Bank’s

Support to It," which says: "Putting these factors together, the Bank concludes that Africa could be on the brink of an economic take-off, much like China was 30 years ago, and India 20 years ago."

Good economic news about Africa's economic development  is welcome, and it may be churlish--or a sign of short days and looming Minnesota winter--to look at the gloomier side. But Africa's current growth projections, although they are presented in an optimistic tone, still mean odiously high levels of severe poverty even a half-century from now. Juma writes: "Poverty will be a fact of life for a long time: one-third of all Africans will still be extremely poor in 2060, living on less than $1.25 a day, according to the AfDB." The African Development Bank writes: "A dramatic decline in Africa’s poverty would require the continent to grow at an average of 7%. These projections fall short of that level. And there are still serious risks ahead to Africa’s growth path."

Developing Africa's possibilities for trade will require infrastructure investment, perhaps $500 billion over the next decade.  Paul Collier writes about the possibilities for African railroads in F&D: "The continent is a huge landmass, well suited to railroads. Yet during the past half-century Africa’s rail network, never very extensive, has shrunk. Even the United States, a huge landmass with relatively low population density, has one kilometer of track for every 43 square kilometers of land. By contrast, Nigeria, home to one-fifth of the population of sub-Saharan Africa and one of its most densely populated countries, has but one kilometer of rail for every 262 square kilometers. Nigeria is not atypical: by radically reducing transportation costs, railways could open up vast tracts of Africa to economic opportunities, especially in agriculture and mining, which many countries are relying on for future growth. The continent needs a decade of massive investment in rail networks. Railways are hardly technologically challenging. They represent the oldest continuous industrial technology. Africa’s lack of railways compared with other regions is primarily a consequence of politics." But as Collier points out, rail in Africa would need to cross many national borders, which raises questions of who will invest, how the railroad would be governed, and how it would be priced. 

Electricity is another infrastructure need. Here's the African Development Bank: "Africa’s electrification rate
as at 2009 was estimated at 42%, with coverage of 69% and 25% for urban and rural areas, respectively.
Available projections for electrification rates indicate a steadily rising trend in the coming three decades to a
rate of 51% in 2030." Investment in this area also raises questions of electrical generation and distribution systems that would cross multiple national borders. The AfDB again: "Africa’s road infrastructure development is quite low in quantity, quality and access. Under 20 percent of roads are currently paved, and a study by the World Bank found that a significant share of the road networks built in the 1970s and 80s were in poor condition due to lack of maintenance."
African agriculture has been in reverse. Here's Juma: "There is also vast untapped potential for African agriculture, which has actually regressed. World food production has increased by 145 percent since 1960, but sub-Saharan African food production is 10 percent lower today than it was 50 years ago, largely as a result of underinvestment in agriculture. For example, fertilizer use is strikingly low—only 13 kilograms a hectare in sub-Saharan Africa compared with 71 kilograms in northern Africa. Only 24 percent of cereal production uses improved seeds compared with 85 percent in eastern Asia. The lack of nutrient input has led to a dramatic depletion of soil quality; 75 percent of farmland in sub-Saharan Africa has been degraded by overuse. Only about 4 percent of Africa’s crops are irrigated, compared with about 40 percent in south Asia, which leaves sub-Saharan Africa vulnerable to fluctuations in world food prices."

Of course, one can look at these issues of investment and infrastructure not as problems, but as potential opportunities to accelerate Africa's growth. The current 50-year projections, although they sound optimistic, don't offer enough progress for me. Here's a graph from the African Development Bank. The top line, with the tan diamonds, shows a decline in extreme poverty for those living on less than $1.25 per day, but it would still be one-third of Africa's population in 50 years. The bottom line with green squares shows a second poverty line: those living on between $1.25 and $2 per day. This would still be another 10% of Africa's population 50 years from now. Yes, the line with diamonds, showing the "middle class" living on $4-$20 per day is rising. But my eyes just keep returning to the two poverty lines and their distressingly high predictions even 50 years from now.