The Third Age of Financial Globalization

Here are the three ages of financial globalization, according to the Global Development Horizons report from the World Bank on the theme "Capital for the Future: Saving and Investment in an Interdependent World"  (as usual, citations and footnotes are omitted for readability). 

 "During the First Age of Financial Globalization, starting in the second half of the 19th century, large amounts of capital were directed from European countries to the New World, mostly for investment in railways, real estate, and large-scale agricultural projects. By the start of World War I in 1914, more than one-quarter of British wealth was invested outside of Great Britain, mainly in foreign government securities and railroads. In 1913, almost half of Argentine and one-fifth of Australian capital stock was owned by foreign investors in Europe. This age wound down as European countries dramatically reversed their nondefense capital outflows during World War I ...

"Progress toward full capital market liberalization among developed countries took a large step forward in the post–Bretton Woods period, which may be regarded as the Second Age of Financial Globalization. Obligations under the Organisation for Economic Co-operation and Development’s Code of Liberalization were broadened to include virtually all capital movements, including short-term transactions by enterprises and individuals. Rapid globalization in the financial industry in the 1990s and 2000s brought even more dramatic change to the landscape of the global financial system, not only encouraging steep increases in cross-border capital fl ows as money market instruments, forwards, swaps, and other derivatives were created, but also allowing developing countries to be integrated into the global financial system in earnest.

At present, the world appears to be in a transition into a Third Age of Financial Globalization. The beginnings of this shift would likely have occurred in the early 2000s as developing countries became more integrated into the global fi nancial system and capital inflows to them became significant in absolute terms for the first time. The trend became more noticeable during the global financial crisis, when gross inflows of capital to developing countries declined much less than inflows to advanced countries ... [D]eveloping countries will likely account for a steadily increasing share of inflows in the future—a continuation of the trend that began in the precrisis years."

Here are some graphs to illustrate this Third Age of Financial Globalization. Let's start by looking at investment. The first graph shows total gross investment: the amount done in developing countries has almost already caught up with that done in high-income countries. The second graph shows the same information as a share of global investment: developing countries hovered at about 20% of total global investment from the 1960s up through about 2000, but now are close to half of total investment. The third graph shows the annual investment rate. While the investment rate in  developing countries has been higher since about 1980, the lines for developing and high-income economies really start diverging around 2000. 

Now switch over to the savings side. The top graph shows that world saving as a share of global income hasn't changed much since 1980, but the share of that saving coming from developing countries has risen dramatically.

Sure, a substantial share of this change is the savings and investment patterns in China, but it shouldn't be dismissed on those grounds. First, saying that anything is "just about China" is a peculiar way of talking about what is headed toward being the world's largest economy. Second, the trend toward more saving and investment is also happening across the rest of the developing countries, although the trend isn't as pronounced. The first graph shows the share of investment relative to total global output for developing countries, and then for developing countries without China and India. The second graph shows savings rates for developing countries as a whole, and then without China and without the other BRIICs (that is, Brazil, Russia, India, Indonesia, and China).

A few decades ago, it was common to be taught that low-income countries were trapped by their low rates of saving and investment, and their inability to attract foreign capital. Maybe the trap was real a few decades ago, but it's a trap that is being shattered in this Third Age of Financial Globalization.

E-Learning for College Students

The Spring 2013 issue of  Future of Children is a symposium on "Postsecondary Education in the United States." There are thoughtful articles on costs, returns, student support, for-profit education, financial aid, and other issues. My eye was particularly caught by "E-learning in Postsecondary Education," by Bradford S. Bell and Jessica E. Federman. "During the fall 2010 term 31 percent of U.S. college students took at least one online course," report Bell and Federman. The percentage is surely rising. At this point, stripping away the hype about what might be possible someday, what do we know about the effectiveness of e-learning and the likely challenges it faces?

What is the evidence on effectiveness of e-learning?

The evidence on e-learning as compared to conventional teaching is a mess to interpret. In some studies, students are not randomly assigned to either the e-learning or conventional alternative, and so the quality of students may differ. In other cases, comparing an e-learning class that, say, requires a quiz every week to a conventional class with a midterm and a final may tell you more about the value of weekly quizzes than about e-learning itself. Thus, Bell and Federman turn to "meta-analyses," which is the term for studies that look at the results of dozens or hundreds of different studies, and thus can make statistical adjustments for what kind of e-learning is being done, how it is being evaluated, characteristics of students and teachers,and so on. The overall theme is that e-learning often does just as well as conventional learning. Here are summary statements about a few of the meta-analyses: I'll first give the citation for the study, and then use Bell and Federman's words to summarize the findings. 

Robert M. Bernard and others, “How Does Distance Education Compare with Classroom Instruction?
A Meta-Analysis of the Empirical Literature,” Review of Educational Research 74 (2004): 379–80.

Bell and Federman: "In summary, the meta-analysis revealed no significant overall difference between e-learning and traditional instruction in terms of overall achievement, but more negative student attitudes toward synchronous e-learning and higher dropout rates in asynchronous e-learning." This study considers both  "asynchronous (mostly correspondence and online courses, in which students participate at different times) and synchronous (mostly teleconferencing and
satellite-based delivery, in which all students participate simultaneously)."

Traci Sitzmann and others, “The Comparative Effectiveness of Web-Based and Classroom Instruction: A Meta-Analysis,” Personnel Psychology 59 (2006): 623–64.

Bell and Federman: "[W]eb-based instruction was 6 percent more effective than traditional classroom
instruction for teaching declarative knowledge (facts and principles), but not procedural knowledge (rules and procedures) or student reactions. Used as a supplement to classroom instruction (blended learning), web-based instruction was 13 percent more effective than classroom instruction for declarative knowledge and 20 percent more effective for procedural knowledge. ... Indeed, the authors found web-based and classroom instruction equally effective for teaching declarative knowledge when the instructional methods used in both were equivalent. They attribute the small overall advantage of web-based instruction to its use of more (and more effective) instructional
methods, rather than to the delivery media per se."

Barbara Means and others, Evaluation of Evidence-Based Practices in Online Learning: A Meta-Analysis and Review of Online Learning Studies, report prepared for the U.S. Department of Education, Office of Planning, Evaluation, and Policy Development (Washington: U.S. Department of Education, September 2010).

Bell and Federman: "[Students who took a course online did not perform significantly differently than those taking the same course through traditional face-to-face instruction. Students in courses that combined online and face-to-face instruction (blended learning) had stronger learning outcomes than
did those in face-to-face instruction alone. Both instructor-directed and collaborative and interactive online instruction (both fully online and blended) led to stronger outcomes than classroom instruction, but outcomes in independent online learning and face-to-face instruction had no significant difference."

Traci Sitzmann, “A Meta-Analytic Examination of the Instructional Effectiveness of Computer-Based
Simulation Games,” Personnel Psychology 64 (2011): 489–528.

Bell and Federman: "Simulation games were more effective than lectures, assignments, and readings, but less effective than computerized tutorials. Trainees learned more from simulation games when they had unlimited access to the games (presumably leading to more time spent learning) and when
the games were embedded in a program of instruction (blended learning). In fact, when simulation games were the sole instructional method, trainees in the comparison group learned more than those in the simulation game group. Finally, in studies that matched the simulation and comparison groups in terms of the activity level of instruction, learning was similar across conditions. Once again, this finding suggests that the learners in the simulation games condition may have been advantaged not because of the delivery media per se, but rather because they often received more active instruction than those in the comparison group."

I was a little surprised at the findings of these meta-analyses, given that they are looking at studies of e-learning as it existed several years ago. I suspected that e-learning would catch up with classroom learning at some point, but it may already have done so. I'm probably not alone in being surprised: "A survey of the general public conducted by the Pew Research Center using a nationally representative sample of 2,142 adults found that only 29 percent believe online courses are as valuable educationally as courses taken in the classroom."

Given the tone of these  study results, Bell and Federman argue that the issue is no longer whether e-learning can be effective. Clearly, it can be. The issue is now one of instructional design: that is, what characteristics of a particular course are especially important. They write:

"[S]tudies designed to evaluate the effectiveness of a particular e-learning technology are of limited value. Indeed, any form of instruction can be effective if it is able to create the conditions necessary for students to learn specific content. ... Empirical research is also shifting away from evaluating whether e-learning works and toward examining the instructional features that influence its effectiveness. Rather than comparing different forms of delivery such as e-learning versus classroom, studies are beginning to compare e-learning programs that differ on important instructional dimensions, including interactivity, engagement and activity, and feedback." 

Along with this focus on specific instructional features, what are some of the other main questions facing e-learning at the college level? Here are three that I took away from the essay.


How to deal with cheating? In a pure online course, how do you know who is at the other end of the screen answering questions? One can imagine various security measures, like having a camera snap a series of photos at random times during an exam (but what if someone is whispering answers from off-camera), or having student take their exams in a campus testing center.

What about students who are uncomfortable or unprepared for e-learning? Students learn in all kinds of ways, some by reading, some by listening, some by talking in study groups, some by writing out answers by hand, and so on. Some students won't do well with e-learning, either because it's just not their thing, or because they don't yet have a high comfort level with computers in general. Some students will learn the material quickly in any format. But figuring out how to make e-learning work for as broad an audience as possible, and thinking about alternative versions of e-learning for different audiences, is a big task.

Does e-learning  save money? A lot of the hope of e-learning is that it will provide education less expensively, but at least so far, that doesn't seem to be true. Bell and Federman: "[F]ew institutions believe e-learning reduces their costs, and, in fact, most believe that online courses are at least as expensive to provide as traditional courses. This perspective is based largely on the significant start-up costs of e-learning, including investments in technology, course design, and the training of instructors, but also on recurring costs, such as those that result from increased coordination demands and technical support."

Maybe the high costs of e-learning are mainly start-up costs? Maybe as technology improves, the costs will come down and the effectiveness will go up? Maybe some kinds of e-learning courses, after they are developed, can then be scaled up to very large numbers of students ? On the other side, e-learning is going to keep offering new capabilities, which are sure to be expensive to develop, and likely to be costly to maintain. If e-learning is to have the desired qualities and outcomes, it won't come cheap.

ADDED: For answers to the three questions above from Daniel Lemire, a computer science professor with considerable experience in on-line teaching, see here. 

Some International Minimum Wage Comparisons

The Global Wage Report 2012/13 from the International Labour Organization has this useful figure comparing minimum wages across high-income countries.

The horizontal axis shows the minimum wage as a percentage of the median wage for the country. By this measure, the U.S. minimum wage ranks among the lowest in the world at less than 40% of the median wage, although comparable to Japan and Spain. France and New Zealand have a minimum wage that is about 60% of the median wage.

The vertical axis shows the minimum wage converted to dollars (using the purchasing power parity exchange rate). By this measure, the U.S. minimum wage is middle-of-the-pack, above Japan and similar to Canada, although well below the United Kingdom, France, Australia, and Netherlands.


For a post on how the minimum wage affects employment and prices, see my February 2013 post on "Minimum Wage and the Law of Many Margins."  For a post on proposals to raise the minimum wage, see my November 2012 post on "Minimum Wage to $9.50? $9.80? $10?"

China and the Environmental Kuznets Curve

The original Kuznets curve posited, back in 1955, that inequality of incomes would follow an inverted-U pattern as a nation's economy developed, first rising, and then declining. In 1955, this looked reasonable! The "environmental Kuznets curve" suggests that pollution may follow an inverted-U pattern as a nation's economy develops. Pollution first rises as a low income nation industrializes with few limitations on pollution. But then the nation becomes better-off and more able and willing to pay the costs of limiting pollution, and the nation's economy shifts from industry to services, and pollution levels fall. For a useful overview article, Susmita Dasgupta, Benoit Laplante, Hua Wang, and David Wheeler wrote on "Confronting the Environmental Kuznets Curve" in the Winter 2002 issue of the Journal of Economic Perspectives. (Like all articles in JEP, it is freely available online compliments of the American Economic Association. Full disclosure: I've been the Managing Editor of JEP for the last 26 years.)

Of course, the environmental Kuznets curve is a theory that needs to be supported or refuted with evidence, not a law of nature like the boiling point of water, and it's a theory that is under ongoing discussion and debate. And the experience of China, with its burgeoning economy and extraordinary environmental issues, is at the center of the debate. Dasgupta, Laplante, Wang, and Wheeler offer a summary of some possible outcomes in this diagram.

The conventional environmental Kuznets is that emissions of pollutants rise up until some level between about $5000 and $8000 in per capita income, and then fall after that point. There is some historical evidence to support this claim. However, skeptics suggest that even if some pollutants are reduced, new toxic materials are often created that continue to increase. Or perhaps a "race to the bottom" will occur, in which pollution levels first rise, but then society becomes unwilling to act to reduce pollution, for fear that economic activity will decline or depart, and so pollution doesn't fall.

On the other side, optimists point out that countries which are currently industrializing can draw on the anti-pollution technology and legislative experience of other countries, and thus may be able to find ways to increase pollution by less than historical experience, and have the peak of the environmental Kuznets curve at a lower level of per capita income.

According to the World Bank, China's per capita GDP was $5,445 in 2011, so it is just reaching the levels where its pollution should first start to level off, and then to decline. Sam Hill has published a report called "Reforms for a Cleaner, Healthier Environment in China" as a working paper for the OECD economics department. It can be read for free on-line via a clunky browser here.

China's environmental problems have enormous costs. Hill writes (citations omitted): "Combined health costs from PM [particulate matter] and water pollution reached nearly 4% of GNI by the late 2000s. The cost of CO2 emissions ... together with material damage from air pollution and soil nutrient depletion, adds some 2.5% of GNI. Incorporating additional costs associated with energy and mineral depletion brings the total costs of environmental degradation to around 9% of GNI." With costs this high, even cold-blooded analysis by those who do not hug trees in their spare time will justify a greater degree of environmental protection.

Interestingly, there are signs that for some pollutants, the level of pollution is no longer rising with the growth of China's economy. For example, here's a figure about air pollution. The top line shows the growth of GDP. Emissions of  sulfur dioxides and soot have not been rising with GDP, and even emissions of carbon dioxide have been lagging behind the rise in GDP in the last few years.

Here's a similar figure for water pollution. Chemical oxygen demand (COD) measures the level of organic pollutants in water. Both that measure and wastewater are at least not rising at the same pace as GDP.

It remains true that China's amount of pollution relative to its economic output is high by the standards of high income countries. Here's a graph showing measured for sulfur dioxide and nitrogen oxides. The following graphs show a measure for carbon dioxide. China's pollutants relative to its level of GDP remain high in part because its economy is just starting a transition from manufacturing to services, and in part because environmental rule and regulations in China are looser and more lightly enforced.

The policy prescription for reducing pollution in China is clear enough: close down older facilities, and make sure their replacements have up-to-date anti-pollution equipment; keep building sewage treatment facilities; put a price on polluting activities to encourage conservation; and so on. Sam Hill's paper has details.

But ultimately, China's path along the environmental Kuznets curve will be determined by politics and public pressure, and public pressure in China does seem to be building for stronger environmental protection.  The (wonderfully named) Elizabeth C. Economy at the Council of Foreign Relations recently wrote a brief piece on "China’s Environmental Politics: A Game of Crisis Management," which notes the growing number of environmental public protests in China. In a society under such a high degree of government control, environmental protests can become a place where those discontented with government have a semi-safe space for  dissent.

Interview with Christopher Carroll on Saving and Presidential Communications

The Richmond Fed publishes an insightful "Interview" with Christopher Carroll in its magazine Econ Focus for the First Quarter of 2013. Here are a few highlights:

Why the national savings rate matters

"What the saving rate is ultimately about is the aggregate capital stock and aggregate national wealth. You’re not going to put much of a dent in that with two or three years of a low saving rate. But if a country’s saving rate is low for 20 or 30 years, then you end up a lot poorer. I do think that before the crisis our saving rate was lower than is wise or sustainable. ... One way of saying a little bit more about that is to look at a longer history for countries that have been in a reasonably stable developed equilibrium for a long time. Most such countries tend to have personal saving rates somewhere
in the 5 percent to 8 percent range. I think when our saving rate gets below that range for a sustained period of time, that’s something that one ought to worry about."

Why don't fast-growing countries borrow instead of save?

"The theory in every textbook says that if you know you’re going to be richer in the future because you’re a fast-growing country, why in the world would you save now, when you’re poor, making your future rich self better off? It makes much more sense to borrow now since it’ll be easy for you to pay off that debt in the future when you’re richer. The latest example that’s on everybody’s minds is, of course, China, a country that has grown very fast for the last 20 years and has had a saving rate that just seems to get higher every year. ...  But what China is doing right now actually looks virtually identical to Japan 30 years ago. Japan didn’t have a particularly high saving rate in the 1950s, and by the 1970s it had the highest saving rate in the world, and that was a period of high growth in Japan. It’s also true in South Korea. It grew at a very rapid rate starting from the early 1960s, and its saving rate went up and up. We also see this in Taiwan, Singapore, and Hong Kong. And it’s not just East Asian countries; the same is true of Botswana and Mauritius. It’s also true in the opposite direction for European countries, which were growing pretty fast after World War II. ...  So it seems to be a pretty pervasive, large effect that is really very much the opposite of what you’d expect from the standard off-the-shelf models. ... In fact, what I really think is the right story is one that combines habit formation and a precautionary motive, such that they intensify each other. If I have these habits, then a good reason to resist spending when my income goes up is uncertainty over whether the factory that I’m working for will close down and I’ll have to go back to my rural peasant roots."

Why people let their employer choose their retirement savings rate

"There’s an impressive body of new research that finds that people’s retirement saving decisions are very much influenced by the default choices in their retirement saving plan. ... [In a recent paper, the] authors had data that basically covered the entire population of Denmark; 45 million data points, and they could see people for 15 years. They found that if an employer has a default 401(k) contribution rate of 6 percent, 85 percent of people will just go with 6 percent, rather than changing the contribution rate or opting out. If the default is 10 percent, then 85 percent of people will go with 10 percent. I think the evidence for default contributions is just overwhelmingly persuasive. That is a really big challenge to the economists’ standard modeling approach, which is to say that people rationally figure out how much they need to have when they retire and they figure out a rational plan to get there. ...

"The explanation I proposed at the conference was to say that, within some range, people trust that their employer has figured this out for them. The job of the human resources department is to figure out what my default contribution ought to be, and it would be too hard to solve this problem myself, so I’m just going to trust that somebody else has done it. It’s not different from when you take an airplane and you trust that the FAA has made sure that it’s safe, or when you go to the doctor and you trust that the advice makes sense and is not going to poison you. Maybe people trust that the default option is going to be a reasonable choice for them. ... If people are going to trust the employer to make a good decision, we ought to make some effort to give the employer the incentives to actually make that good decision."

Carroll was a senior economist at the Council of Economic Advisers in 2008-09. Why doesn't the president offer the best possible economic arguments in his speeches?

"The CEA tends to vet speeches that the president and sometimes other officials are going to make, and to help set the priorities for what’s going to be in the speeches. A number of times we would help to reshape the speech to make sure that key points were highlighted, and the arguments that we thought were the soundest economic arguments were made. And then the president would go out and give the speech, and I would later hear from economist friends, who would write to me complaining, “Why didn’t the president say this obvious point in the speech that he just made?” And that obvious point was the thing that the CEA had deliberately made sure was actually a highlight of the speech! But, of course, what your friend actually sees is the 15 seconds that gets excerpted on the news or some blogger’s two-paragraph reaction to the president’s speech. ... The president has a greater ability to express his point of view and get it heard than any other single person. But I think the extent to which even the president can’t penetrate through the fog of information and the vast number of sources of data that people pay attention to is underappreciated."

U.S. Public Schools: Unequal Spending Across States

Mark Dixon of the U.S. Census Bureau has authored  Public Education Finances: 2011. The headline finding is that in 2011, per capita spending on K-12 education declined. The drop was a small one, only about 0.4%, but it's also the first and only drop in the last 40 years. It's yet another symptom of how brutal the Great Recession and its aftermath have been for state and local finances.

But the other pattern that especially jumped out at me from the report is the difference in what is spent per student across states--a difference that has been large for a long time. Here's a map:

For the U.S. as a whole, average public school K-12 current spending per student was $10,560 in 2011, with 61% of that going to "instruction," and 35% going to "support services." 









But four jurisdictions--New York, Wyoming, Alaska, and the District of Columbia--spend more than $16,000 per K-12 student, with New York leading the way at $19,076 per student. Conversely, Idaho, Utah, Arizona, Oklahoma,and Mississippi spend less than $8,000 per student, with Utah having the lowest tally at $6,212 per student. That is, New York spends on average three times as much per K-12 student as does Utah.

It would of course be a vulgar error to assume that high spending is what's important in K-12 education, when what actually matters is how the students achieve. Spending on education will reflect factors like the local cost of living, the extent of poverty and special needs in the state, and the legacy of past negotiations with the teachers' unions. Still, the discrepancies in what states spend is striking.

Preschool for At-Risk Children, Yes; Universal Preschool, Maybe Not

In January, I blogged in "Head Start is Failing Its Test" about a high-quality study being done by the U.S. Department of Health and Human Services, which found: "In summary, there were initial positive impacts from having access to Head Start, but by the end of 3rd grade there were very few impacts found for either cohort in any of the four domains of cognitive, social-emotional, health and parenting practices. The few impacts that were found did not show a clear pattern of favorable or unfavorable impacts for children."

In the most recent issue of the Journal of Economic Perspectives,  Greg J. Duncan and Katherine Magnuson offer a broader and modestly more  hopeful angle in their paper, "Investing in Preschool Programs,"(Like all papers in JEP back to the first issue in 1987, this is freely available on-line compliments of the American Economic Association. Full disclosure: I've been the Managing Editor of JEP since the journal started in 1987.)

 One of the main difficulties in evaluating preschool programs is that just comparing children in such  programs and not in such programs won't be a fair approach. After all, families differ in many ways, some of them not easily measureable, and these differences need to be taken into account. Thus, a preferred method is an "experimental" approach, in which out of a group of families, some are randomly assigned to the preschool program and some are not. Of course, one can then look at observable characteristics to see if the assignment was really random: that is, families with children randomly chosen to be enrolled in the preschool program should have the same average income, education level, employment level, proportion of single parents, and so on, compared with the families whose children were not randomly enrolled in the program. But random enrollment also offers a plausible way of adjusting for unobservable differences in families, like the level of emphasis that the family puts on school or persistence or work.

Duncan and Magnuson focus on the studies of preschool done with these kinds of random assignment experimental methods, and identify 84 such studies over the last half-century (including the Head Start study mentioned earlier. They summarize the results of these 84 studies in this figure.

The horizontal axis of the figure shows the year the study was done. The vertical axis shows the size of the effect found in the study, measured as the average of the cognitive and achievement gains found for those attending preschool. For perspective, the achievement gap between black and white .children entering kindergarten is about one standard deviation. Circles with a black outline are Head Start programs. The gains are measured at the end of the preschool enrollment period--before such gains have had a chance to fade out. From this figure and their surrounding discussion, here are some key points:

1) There is evidence of short-term gains from preschool programs.
2) The average level of gains from such programs seems to be falling over time (as shown by the downward-sloping line). This finding is distressing, because one would hope that such programs could become more effective over time. But a likely reason is that parents (especially the mothers) of children in these preschool program are not as deeply disadvantaged in recent years as they were back in the 1960s, when levels of literacy, health, and income were much lower. Because the parents better educated and have higher income, the gains from preschool are smaller.
3) Academic gains from preschool programs tend to fade out. As they write: "Most early childhood education studies that have tracked children beyond the end of the program treatment find that effects on test scores fade over time."
4) However, some very long-term studies have found that although measures of cognitive and achievement gains fade, there are often still observable behavioral effects like improved high school graduation rates, lower rates of teen parenthood, and lower rates of criminal behavior. This finding creates a puzzle, because even with batteries of questionnaires and tests for the children, their teachers, their parents, and others, researchers have not yet been able to measure what it is in preschool programs that might produce these positive long-term results.

So where does all of this mean for proposals for universal preschool, like the "Preschool for All" initiative announced by President Obama along with his 2014 proposed budget? I know that for some people, the word "universal" is a sort of talisman that carries echoes of equality and justice. But it's perhaps worth noting as a starting point that although preschool attendance has been increasing over time, it is far from universal now for any income group. Duncan and Magnuson provide this figure showing the share of 3 and 4 year-olds enrolled in preschool, divided up by income level. Preschool attendance has risen over the decades but it now represents about half of all children. In discussions of "universal" preschool, it's never quite clear to me whether universality is intended to apply to all income levels, or whether only the children of low-income families are to "universally" attend pre-school.

A more detailed look at the studies also suggests that there is no one-size-fits-all universal answer to the best experiences for 3 and 4 year-olds. For example, some of these studies suggest that children from low-income families benefit more than children from high-income families. Often the academic benefits of preschool are higher for girls, but the behavioral benefits are higher for boys. Children with very low birthweights often do not benefit much from preschool, perhaps because low birthweights can be a signal of reduced capabilities. Preschool programs vary quite widely how their teachers are trained, in how their classroom balance academic and emotional needs of children, and in their curriculum.  There are alternative early interventions that may be more productive for some children: for example, home visitation for high-risk, first-time mothers, or interventions for children living in families with documented domestic violence

The word "universal" is no guarantee of quality. After all, we have "universal" K-12 schooling, but that certainly doesn't mean that all children across the United States are in high-quality or even roughly equivalent schools. "Universal" is certain to be costly. There is a strong case for further experiments with an array of early childhood interventions, including preschool, to have a better sense of what works, and why. Right now, the sad truth is that there is so much we don't know. 

Spending on America's Pets

Steve Henderson of the U.S. Census Bureau pulls together data from the Consumer Expenditure Survey and looks at "Spending on pets." He writes (footnotes omitted):

"Nearly three-quarters of U.S. households own pets. There are about 218 million pets in the United States, not counting several million fish. ... Americans spent approximately $61.4 billion in  total on their pets in 2011. On average, each U.S. household spent just over $500 on pets. This amounts to about 1 percent of total spending per year for the average household. ... Expenditures on pets include pet food, pet purchases, supplies and medicine, pet services, and veterinarian services."

Two comparisons leaped to mind when I saw these figures. First, all through last year there were stories about high spending of the 2012 U.S. election campaign. The Federal Election Commissions reports that about $7 billion was spent. But to put the number in the context of dogs and cats, America spent about nine times as much on pet care as it did on choosing all its federally elections in 2012.

Second, the World Bank often uses a poverty line of $1.25/day in consumption to measure deep destitution in developing countries. Nearly one-third of the population of South Asia and nearly half the population of Africa has a consumption level below this line.  Over 365 days in a year, $1.25/day works out to $456.25.  Thus, the average U.S. household spends more on pets than the poverty line for humans in the developing world. And the statistics don't include the fact that pets live rent-free.

In his short essay, Henderson offers some less combustible comparisons. He writes: 

• "In 2011, households spent more on their pets annually than they spent on alcohol ($456), residential landline phone bills ($381), or men and boys clothing ($404).
• "Average household spending on pet food alone was $183 in 2011. This was more than the amount spent on candy ($87), bread ($107), chicken ($124), cereal ($175), or reading materials ($115).
• "Even when spending at restaurants dropped during the recent recession (December 2007–June 2009), spending on pet food stayed constant. (See chart 1.)"

I am deeply aware of all the grim news for the U.S. economy during the last five years. But when the average household is spending $500/year on pets, it's a reminder that America's average standard of living remains quite high.

Global Urbanization and the Governance Challenge

The overall focus of the Global Monitoring Report, jointly published by the World Bank and the IMF, is on how the world is doing in achieving the "Millennium Development Goals" or MDGs. But the annual reports also look at some particular angle or topic more closely, and the 2013 GMR focuses on urbanization and its linkages to economic development. Here's a taste of some main themes:

"Urbanization matters. In the past two decades, developing countries have urbanized rapidly, with the number of people living in urban settlements rising from about 1.5 billion in 1990 to 3.6 billion (more than half of the world’s population) in 2011. ... Nearly 50 percent of the population in developing countries was urban in 2011, compared with less than 30 percent in the 1980s. Urban dwellers are expected to double between 2000 and 2030, from 2 billion to 4 billion people, and the number of

Chinese urban dwellers will increase from more than 622 million today to over 1 billion in 2030. This trend is not unique to developing countries—today’s high-income countries underwent the same transformation in the 20th century. In fact, virtually no country has graduated to a high-income status without urbanizing, and urbanization rates above 70 percent are typically found in high-income

countries."

Overall, the report emphasizes that the global shift to urbanization works together with many development goals.

"Cities and towns are hubs of prosperity—more than 80 percent of global economic activity is produced in cities by just over half of the world’s population. Economic agglomeration increases productivity, which in turn attracts more firms and creates better-paying jobs. Urbanization provides higher incomes for workers than they would earn on a farm, and it generates further opportunities to move up the income ladder. Between 1990 and 2008, rural poverty rates were, without exception, higher than urban poverty rates ... 

"Location remains important at all stages of development, but it matters less in rich countries than in poor ones. Estimates from more than 100 Living Standard Surveys indicate that households in the most prosperous areas of developing countries such as Brazil, Bulgaria, Ghana, Indonesia, Morocco, and Sri Lanka have an average consumption almost 75 percent higher than that of similar households in the lagging areas of these countries. In comparison, the disparity is less than 25 percent in developed countries such as Canada, Japan, and the United States."

The gains from urbanization are not just in terms of income, but also in terms of other development goals like access to clean water, education, and health care.

 "For example, on average, the cost of providing piped water is $0.70–$0.80 per cubic meter in urban areas compared with $2 in sparsely populated areas. South Asia and Sub-Saharan Africa have the largest rural-urban disparities in all service delivery indicators. The poor often pay the highest price for the water they consume while having the lowest consumption levels. For example, in Niger, the average price per cubic meter of water is CFAF 182 for piped water from a network, CFAF 534 from a public fountain, and CFAF 926 from a vendor. And poor access to basic infrastructure disproportionately affects rural women, because they perform most of the domestic chores and

often walk long distances to reach clean water. ...

"In 2010, 96 percent of the urban population but 81 percent of the rural population in developing countries had access to safe drinking water. Disparities in access to basic sanitation were greater: 80 percent of urban residents but only 50 percent of rural residents had access to a toilet. Schooling and health care can also be delivered with economies of scale in dense environments, close to where people actually live."

But of course, the wave of urbanization is also generating urban slums, which are different than rural poverty,  but pose difficult challenges of their own.

"Slums are the urban face of poverty and emerge when cities are unable to meet the demand for basic services and to supply the expected jobs. A likely 1 billion people live in urban slums in developing countries, and their numbers are projected to grow by nearly 500 million between now and 2020. Slums are growing the fastest in Sub-Saharan Africa, southeastern Asia, and western Asia. Currently, 62 percent of Africa’s urban population lives in slums. ...Those in slums lack ownership of property, or even  clearly legal rentals; poor services of many kinds; informal employment only, lack of access to credit and services."

 The issue of slums is in some ways a governance challenge: not just how to provide services in the present to slum-dwellers, but how to establish an appropriate institutional and physical infrastructure.

"Urbanization is largely a natural process, driven by the opportunities cities offer. Unregulated markets are unlikely to get densities right, however, and spontaneous development of cities can create negative side effects such as congestion or, alternatively, excessive sprawl. The consequences are pollution and inefficiencies. Without coordinated actions, cities will lack the proper investments to benefit from positive externalities generated by increased density. Higher-quality construction material and more sophisticated buildings are required to support greater densities, but if these higher

costs must be fully internalized by firms and households, underinvestment is the result. In addition, complementary physical infrastructure is critical: roads, drainage, street lighting, electricity, water, and sewerage, together with policing, waste disposal, and health care. While a market-driven process could possibly gradually increase densities through shifting land values over time, the long-lived and lumpy nature of urban investment often inhibits such a process. A city’s physical structures, once established, may remain in place for more than 150 years....  Under current trends, the expected increases in the urban population in the developing world will be accompanied

by a tripling in the built-up area of cities, from 200,000 to 600,000 square kilometers."

The challenge of thinking about how to address urban slums cannot be overstated. The slums already involve 1 billion people, a total that will grow by over 50% in the next decade. The built-up area of cities in the developing world is likely to triple. And major decisions about physical structure can have a life expectancy of more than a century. There is a delicate balance between needing an overall master plan and needing a lot of a flexibility for evolution and change over time. Even after deciding what to do, financing poses challenges of its own: in particular, how can developing countries establish ways for that poor people  can afford what they need, but also pay what they can afford. Then actually getting projects built is often quite difficult, too.  Urban areas will differ, of course, in their locations and needs. But there is a great need for rules of thumb, and ideas about best practices, that can offer some guidance for the urban developments that lie ahead.

A Defense of the Financial Sector

The financial sector needs some defenders, and John H. Cochrane steps forward with a bracing essay,
"Finance: Function Matters, Not Size," in a symposium in the Spring 2013 issue of the Journal of Economic Perspectives.  (Full disclosure: I've worked as Managing Editor of the JEP since 1987.) Here, I'll list some of the main points that I took away from Cochrane's essay in boldface type, with quotations from the article following.

Economists have been arguing for a half-century that active portfolio management isn't worth the fees paid for it (for example, see my post from yesterday). But when high-fee active portfolio management has persisted for decades in the face of such criticism, perhaps it's the critics who should be wondering if they are correct. 

"High-fee active management and underlying active trading have been deplored by academic finance for a generation. ... It seems the average investor should save 60 basis points a year and just buy a passive index such as Vanguard’s Total Stock Market Portfolio. It seems that the stock pickers should do something more productive, like drive cabs. Active management and its fees seem like a total private, and social, waste. Yet this hallowed view—and its antithesis—do not completely make sense. After all, active management and fees have survived 40 years of efficient-market disdain. Economists who would dismiss “people are stupid” as an “explanation” for a pricing anomaly that lasts 40 years surely cannot use the same “explanation” for the persistence of active management."

There are lots of inefficiencies in financial markets that can be exploited, at least for a time, to make profits.

"But the last 20 years of finance research is as clear as empirical research in economics can be: There is alpha relative to the market portfolio—there are strategies that deliver average returns larger than the covariation of their returns with the market portfolio justifies—lots of it, and all over the place. ... Examples of such strategies include value (stocks with low market value relative to accounting book value), momentum (stocks that have risen in the previous year), stocks of companies that repurchase shares, stocks of companies with accounting measures of high expected earnings, and stocks with low betas. The “carry trade” in maturities, currencies and, credit—buy high-yield securities, sell low-yield securities—and writing options, especially the “disaster insurance” of out-of-the-money put options, all generate alpha. Expected returns on the market and most of the anomaly strategies vary predictably over time, implying profitable dynamic trading strategies."

Highly sophisticated investors pay for active management of their financial assets, and apparently believe they are getting a good deal.  

"Delegating active management and paying large fees is common and increasing among large, completely unconstrained, and very sophisticated investors. For example, the Harvard endowment was in 2012 about two-thirds externally managed by fee investors and was 30 percent invested in “private equity” and “absolute return,” largely meaning hedge funds. The University of Chicago endowment is similarly invested  in private equity and “absolute return.” Apparently, whatever qualms some of its curmudgeonly faculty express about alphas, fees, and active management are not shared by the endowment. ... Why have these decision procedures become standard practice? Vague reference to “agency problems” and “naiveté” seem unpersuasive. Harvard’s endowment was overseen by a high-powered board, including its president Larry Summers, possibly the least naive investor on the planet. The picture that Summers and his board, or the high-powered talent on Chicago’s Investment Committee are simply too naive to demand passive investing, or that they really want the endowments to be invested in the Vanguard total market index, but some “agency problem” with the managers they hire and fire with alacrity prevents that outcome from happening, simply does not wash."

The existence of financial bubbles suggests that markets are inefficient, too. But many of those who are most insistent that financial markets are inefficient often shy away from the logical implication that if the market is inefficient, it might benefit from additional trading. 

"The common complaints “the financial crisis proves markets aren’t efficient,” or that tech and mortgages represented “bubbles,” are at heart complaints that there was not enough active information-based trading. All a more “efficient” market could have done is to crash sooner, by better expressing the pessimist’s views. ... If information is not incorporated into market prices and to such an extent that simple strategies with big alphas can be published in the Journal of Finance, there are not enough arbitrageurs. If asset prices fall in “fire sales,” only to rebound later, there are not enough buyers following the fire trucks. If credit constraints are impeding the flow of capital, there is a social benefit to loosening those constraints."

Do we care about the size of the financial sector or the instability of the financial sector? (And no, they aren't the same thing.)

"The increase in fees for residential loan origination is easily digested as the response to an increase in demand. The increase in housing demand may indeed not have been “socially optimal” (!). There are plenty of government policies and perhaps a few market dislocations to blame. But it doesn’t make much sense to criticize growth in the financial industry for responding to this increase in demand, whatever its source, or for passing along the subsidized credit—which was and remains the government’s explicit intention to increase—with the customary fee. ... There was a lot of financial innovation in mortgage-backed securities, some of which notoriously exploded. But here again, whether we spend a bit of GDP filling out forms or paying fees is clearly the least of the social benefit and cost questions. The “shadow banking” system was prone to a textbook systemic run, which happened. This fragility, not the size or fraction of GDP, is the important issue."

We don't really understand the process of price discovery in financial markets, and as a result, passive investing may be less intuitively attractive on a second glance.

"The fact staring us in the face is that “price discovery,” the process by which information becomes embedded in market prices, uses a lot of trading volume, and a lot of time, effort, and resources. And we are only beginning to understand it.... [P]erhaps we should work just a little harder before dismissing the hundreds of years of trading activity, and the entire existence of the New York Stock Exchange, Chicago Mercantile Exchange, and other markets, as monuments to human folly, or before advocating regulations such as transactions taxes —the perennial favorite answer in search of a question—to reduce trading volume whose size, function, and operation we do not understand. Are we sure that they should not be transactions subsidies? And before we deplore, it’s worth remembering just how crazy passive indexing sounds to any market participant. “What,” they might respond, “would you walk in to a wine store and say ‘I can’t tell good from bad, and the arbitrageurs are out in force. I sure won’t pay you 1 percent for recommendations. Just give me one of everything’?”"

The important aspects of the financial sector that we don't understand are a good basis for research, but in the real world of political economy, they could well be a bad basis for additional regulation.

"Surveying the current economic literature on these issues, it is certain that we
do not very well understand the price-discovery and trading mechanism, nor the
economic forces that allowed high-fee active management to survive so long.
Unless we adopt the arrogant view that what we don’t understand must be bad,
it is clearly far too early to make pronouncements such as “There is likely too much
high-cost, active asset management,” or “Society would be better off if the cost of
this management could be reduced.” Such statements are not supported by theory
or evidence. Nor is their not-so-subtle implication that resources devoted to greater
regulation—by politicians and regulators no less naive than current investors, no
less behaviorally-biased, armed with no better understanding than academic economists,
and with much larger agency problems and institutional constraints—will
improve matters."

Cochrane's paper is part of a five-paper symposium on "The Growth of the Financial Sector" in the Spring 2013 issue of the Journal of Economic Perspectives.

Economies of Scale in Asset Management: Who Benefits?

The total assets managed by domestic equity funds rose from $26 billion in 1980 to $3.5 trillion in 2010. Would you expect the expenses charged by such funds to rise in proportion to the amount that they manage? Or by less?

Burton G. Malkiel argues in "Asset Management Fees and the Growth of Finance," in the Spring 2013 issue of my own Journal of Economic Perspectives,  that there should be considerable economies of scale in managing a stock portfolio. (Like all articles in JEP back to the first issue in 1987, it is freely available on-line compliments of the American Economic Association.) Malkiel writes:

"There should be substantial economies of scale in asset management. It is no more costly to place an order for 20,000 shares of a particular stock than it is to order 10,000 shares. Brokerage commissions (which are usually set in a flat dollar amount per transaction, at least within broad ranges of transaction size) are likely to be similar for each purchase ticket, as are the “custodial fees” paid to the bank that holds the securities that are owned. The same annual report and similar filings  to the Securities and Exchange Commission are required whether the investment fund has $100 million in assets or $500 million. The due diligence required for the investment manager is no different for a large mutual fund than it is for a small one. Modern technology has fully automated such tasks as dividend collection, tax reporting, and client statements."

Malkiel also cites more rigorous academic studies that find economies of scale. But despite the more than 100-fold increase in share of assets under management for these funds, the average amount paid as expenses has not declined in three decades. Here's the table, showing an expense ratio of 66 basis points of assets under management in 1980, but 69.2 basis points as a share of assets under management in 2010.

As Malkiel writes: "Surely, there had to be enormous economies of scale that could have been passed on to consumers, resulting in a lower cost of management as a percentage of total assets. But we will see below that the scale economies in asset management appear to have been entirely captured by
the asset managers. The same finding appears to hold for asset managers who cater to institutional investors."

The table shows some other interesting factors. Equity funds can either be "actively managed," by those trying to anticipate where the market is headed, or "passively managed," by index funds that seek only to replicate what happens in the market. In 1980, 99.7% of all stock market funds were actively managed; by 2010, 71% were actively managed. 

The expense ratios for passively managed funds are often very low, at 7 basis points or less. The expense ratios for actively managed funds alone (shown in the second column of the table) have actually risen from 66 basis points back in 1980 to over 90 basis points as a share of assets in the last decade or so. And remember, this is during a period when economies of scale should have been a force for driving down expenses as a share of assets!


Back in 1973, Burton Malkiel published the first edition of his classic A Random Walk Down Wall Street.  (I think the 9th edition came out a couple of years ago.) The book offers a readable and persuasive statement of the argument that stock prices are based on past information, and that they will rise and fall based on new information. Because new information is, by definition, not predictable (or else it would be part of past information!), stock prices will move up and down unpredictably. Malkiel has been making the case for 40 years that while actively managed equity funds  charge higher fees than passively managed funds, they do not on average have higher returns.  In this essay, he writes:

"Clearly, one needs some active management to ensure that information is properly reflected in securities prices. Those professionals who act to exploit any differential—however small—between price and estimated value deserve to be compensated for their efforts. But it appears that the number of active managers and the costs they impose far exceed what is required to make our stock markets reasonably efficient, in the sense that no clear arbitrage opportunities remain unexploited. Worldwide, vast numbers of highly trained independent experts are expressing estimates of value each day. Outperforming the consensus of hundreds of thousands of professionals at the world’s major financial institutions is next to impossible, as it has been for decades. ... The major inefficiency in financial markets today involves the market for investment advice, and poses the question of why investors continue to pay fees for asset management services that are so high."

I'm sure there are people and institutions that can benefit from sophisticated investment advice that seek to hedge the specific risks they face while leaping to exploit the occasional profit opportunities provided by temporary anomalies in financial markets. But most average investors in actively managed funds are not following this pattern. They are following either their own gut reactions, or the gut reactions of an active portfolio manager, about what is likely to rise and fall. In doing so, they are paying much higher fees over what an index fund would have cost. Malkiel cites one study that found if the average mutual fund investor in actively managed funds had just bought and held a passive index fund from 2000 to 2011, rather than trying to chase every trend, that average investor would have increased return on investment by almost 2 percentage points per year--a gain of more than 20% over the decade.

Why Did the U.S. Financial Sector Grow?

It's widely known that the U.S. financial sector has grown substantially in recent years. But by how much? And in what specific areas? Robin Greenwood and David Scharfstein offer a useful breakdown in "The Growth of Finance," which appears in the most recent (Spring 2013) issue of my own Journal of Economic Perspectives. Like all JEP papers from the most recent back to the first issue in 1987, it is freely available on-line compliments of the American Economic Association. Greenwood and Scharfstein write at the start: "During the last 30 years, the financial services sector has grown enormously. This growth is apparent whether one measures the financial sector by its share of GDP, by the quantity of financial assets, by employment, or by average wages. At its peak in 2006, the financial services sector contributed 8.3 percent to US GDP, compared to 4.9 percent in 1980 and 2.8 percent in 1950."

But what is actually meant by "the finance sector"?  Here's a useful figure dividing the sector into three parts: securities, credit intermediation, and insurance.

In their discussion, they set aside the insurance part of the financial services sector. Of course, there are important issues in health insurance, liability insurance, and other types of insurance. But when people argue that "the financial sector" is too big, or that an over-expansion of the financial sector helped to bring on the Great Recession, they aren't referring to standard insurance markets. Greenwood and Scharfstein summarize the other two main sectors in this way:

"The securities subsector ... includes the activities typically associated with investment banks (such as Goldman Sachs) and asset management firms (such as Fidelity). These activities include securities trading and market making, securities underwriting, and asset management for individual and institutional investors. The credit intermediation industry performs the activities typically associated with traditional banking—lending to consumers and corporations, deposit taking, and processing financial transactions."

The authors turn over the available evidence on what happens within these sectors over time (and no, this sort of data is not easily available), and argue (citations omitted here and throughout):

"Our main finding is that much of the growth of finance is associated with two activities: asset management and the provision of household credit. The value of financial assets under professional management grew dramatically, with the total fees charged to manage these assets growing at approximately the same pace. A large part of this growth came from the increase in the value of financial assets, which was itself driven largely by an increase in stock market valuations (such as the price/earnings multiples). There was also enormous growth in household credit, from 48 percent of GDP in 1980 to 99 percent in 2007. Most of this growth was in residential mortgages. Consumer debt (auto, credit card, and student loans) also grew, and a significant fraction of mortgage debt took the form of home equity lines used to fund consumption. The increase in household credit contributed to the growth of the financial sector mainly through fees on loan origination, underwriting of asset-backed securities, trading and management of fixed income products, and derivatives trading."

Their conclusions on these points are balanced, but lean toward the view that even if much of the growth in financial services has been productive, it went too far on the margin. They write:

"Thus, any assessment of whether and in what ways society benefited from the growth of the financial sector depends in large part on an evaluation of professional asset management and the increase in household credit. In our view, the professionalization of asset management brought signififi cant benefits. The main benefit was that it facilitated an increase in financial market participation and diversification, which likely lowered the cost of capital to corporations. Young firms benefited in particular, both because they are more reliant on external financing and because their value depends more on the cost of capital. At the same time, the cost of professional asset management has been persistently high. While the high price encourages more active asset management, it may not result in the kind of active asset management that leads to more informative securities prices or better monitoring of management. It also generates economic rents that could draw more resources to the industry than is socially desirable."

"While greater access to credit has arguably improved the ability of households to smooth consumption, it has also made it easier for many households to overinvest in housing and consume in excess of sustainable levels. This increase in credit was facilitated by the growth of “shadow banking,” whereby many different types of nonbank financial entities performed some of the essential functions of traditional banking, but in a less-stable way. The financial crisis that erupted late in 2007 and proved so costly to the economy was largely a crisis in shadow banking."

The Spring issue of the JEP actually includes four other papers with varying perspectives on the growth of the financial sector. In the next couple of days, I'll post about some of these very divergent views.

But as a prelude, I'll point out that most of the time, when economic activity grows in a certain area, those of us who believe in economic prosperity tend to view that growth as a good thing. If the U.S. car industry or computer industry racked up large sales, that would be viewed in a positive light. Clearly, many people feel differently about the financial sector. But is that negative reaction just a manifestation of the long-standing generalized prejudice against finance? After all, I'm delighted that I can put my retirement savings into a no-load mutual fund, and that I don't have to try to construct and manage such a fund on my own. I'm delighted when it's easy for me to get a mortgage.

It seems undeniable to me that excesses in the financial sector played a large role in the run-up to the Great Recession. But maybe the problem isn't the size of the financial sector, but rather its instability. After all, many of the proposals for a higher level of regulation will impose higher costs that in turn will tend to make the financial sector larger, not smaller.