Thursday, June 30, 2016

Corporate Boards: Stop Expecting the Impossible?

Economists have been worried about what is  often called the "separation of ownership and control" in large corporations since at least 1932, when Adolf A. Berle, Jr., and Gardiner C. Means wrote a book called The Modern Corporation and Private Property. The shareholders who legally own the company are technically represented by a board of directors, who then oversees the top executives who control the company on a daily basis. But when an Enron-style corporate scandal occurs, or when top executives receive very high levels of compensation, concerns arise that boards of directors have failed in their task of monitoring the firm.

But what if the entire vision of expecting corporate boards to monitor daily operations of large companies is simply implausible? Steven Bovie, Michael K. Bednar, Ruth V. Aguilera, and Joel L. Andrus argue that this is the case in "Are Boards Designed to Fail? The Implausibility of Effective Board Monitoring," which appears in a 2016 issue of the Academy of Management Annals (10:1, pp. 319-407). They offer an extensive review of the literature on how well corporate boards perform the function of monitoring companies, and conclude that such monitoring often doesn't work very well. They write:
"In fact, most academic research, popular press accounts, and even U.S. legislation all echo the sentiment and deeply held belief that boards should be able to actively monitor and control management. ...  Our review focuses on literature that directly or indirectly explores one of the core assumptions of governance research-that a correctly designed and staffed board will be  able to properly fulfill its primary function of effectively monitoring managerial action. The fundamental question that we hope to shed light on is the following: Is it reasonable to expect that boards can offer effective ongoing monitoring of firms, even if we assume that directors are sufficiently qualified and motivated? ... Specifically, we outline a number of barriers stemming from information-processing challenges that   ultimately inhibit directors from pro­viding effective oversight on an ongoing basis. ... Our review and assessment of the literature suggests that effective, ongoing monitoring of managerial  action is unlikely in most large corporations due in large part to these varied barriers."
What sort of barriers do they have in mind? For starters, effective board members should have what they call "board capital," meaning that they have personally invested the time and energy to have a fairly deep level of knowledge about the specific company, and also that board members should be compensated in a way that provides the right incentives to act in the interests of shareholders, not corporate insiders. The issues involved here are substantial! But drawing on their review of the literature on why board monitoring has often been ineffective, they argue that even when these conditions are reasonably well-met, directors typically face substantial problems in monitoring, which can stem from basic issues like firm size, firm complexity, outside job demands, complexity of those job demands, dissimilarity of those job demands, size of the board, frequency of board meetings, diversity of the board, norms of deference of the board, and power of the existing CEO.

Given the research reviewed in this article, we are pessimistic about the possibility of boards being able to effectively monitor managers on an  ongoing basis in many circumstances. ... Given the size and complexity of many modem firms, we believe some firms may effectively be "too  big to monitor", and that successful monitoring by boards may be highly unlikely in many large public firms. It might be time to concede that our conception of boards as all-encompassing monitors is doubtful ... After many of the  corporate scandals over the past several years, the initial reaction has often seemed to be  "where was the board?" Our review calls into question whether boards are really equipped to  catch or stop misbehavior. Governance failures are likely to often be the result of the many   barriers that we have outlined in this review, rather than directors who are shirking their duty as is often assumed.
What are some implications of this line of argument for corporate monitoring and the purposes of corporate boards of directors?

First, it's possible to improve the ability of boards to do monitoring on all of these dimensions, and such efforts can be worthwhile. Somewhat improved monitoring by corporate boards is likely better than no monitoring by boards.

Second, given that even improved board monitoring is likely to be highly imperfect, it's important to think about how to strengthen, emphasize, and rely on the other social mechanisms beyond corporate boards for monitoring the ongoing operations of firms. For example, there is analysis from investors and sources of finance like banks. There are reports of auditors, and government rules about how such audits should be done. There are articles in the financial press. Most industries have oversight in some dimensions (say, workplace safety, product safety, or environmental laws) by government regulators. There can be groups representing workers, including unions, and groups representing various community stakeholders.

Third, when evaluating whether a corporate board is performing well, it may be useful to knock expectations about the extent of monitoring down to more reasonable levels. Instead, in many cases the most important aspects of a corporate board may involve tasks like "providing resource," meaning as a source of expert advice and connections to corporate management, ans well as dealing with "punctuated events" like replacing the CEO or a big decision about a merger. Bovie, Bednar, Aguilera, and Andrus write: "Consequently, we believe that future research and theorizing needs to focus on boards as advice-giving bodies, or bodies that get involved in punctuated events, and look to  other corporate governance mechanisms to secure monitoring."

For a quite different vision of overhauling corporate boards, a couple of years ago I discussed a proposal to "Outsource Corporate Boards?" (August 28, 2014).

Wednesday, June 29, 2016

Alfred Marshall: Not Competition, But Deliberateness and Freedom

A common complaint against economics and economists is that their theories and outlook place an emphasis on competition, when instead they should encourage cooperation and altruism. I've offered some of my own thoughts that the supposed opposition between competition and cooperation is a false dichotomy here,  and posted on the topic here and here.

Alfred Marshall, a towering figure in the history of economics, offers some pointed comments on how to think about the interaction of competition and economics in the opening chapter of his Principles of Economics, which was originally published in 1890 and became the dominant economics textbook for several decades. Here, I quote from the eighth edition, published in 1920, which is freely available online from the ever-useful collection of writings of past economists available at the Library of Economics and Liberty. Marshall argues that while "poets and dreamers" may describe a world in which purely altruistic people work only for the common good, such a world has never existed, and that when thinking about potential evils of competition, it is also necessary to remember its benefits. Marshall writes:
"The term "competition" has gathered about it evil savour, and has come to imply a certain selfishness and indifference to the wellbeing of others. Now it is true that there is less deliberate selfishness in early than in modern forms of industry; but there is also less deliberate unselfishness. It is deliberateness, and not selfishness, that is the characteristic of the modern age."
To put that short comment in context, with more of how Marshall sees the interaction of deliberateness, freedom, and competition, here is an extended quotation:
"It is often said that the modern forms of industrial life are distinguished from the earlier by being more competitive. But this account is not quite satisfactory. The strict meaning of competition seems to be the racing of one person against another, with special reference to bidding for the sale or purchase of anything. This kind of racing is no doubt both more intense and more widely extended than it used to be: but it is only a secondary, and one might almost say, an accidental consequence from the fundamental characteristics of modern industrial life.
"There is no one term that will express these characteristics adequately. They are, as we shall presently see, a certain independence and habit of choosing one's own course for oneself, a self-reliance; a deliberation and yet a promptness of choice and judgment, and a habit of forecasting the future and of shaping one's course with reference to distant aims. They may and often do cause people to compete with one another; but on the other hand they may tend, and just now indeed they are tending, in the direction of co-operation and combination of all kinds good and evil. But these tendencies towards collective ownership and collective action are quite different from those of earlier times, because they are the result not of custom, not of any passive drifting into association with one's neighbours, but of free choice by each individual of that line of conduct which after careful deliberation seems to him the best suited for attaining his ends, whether they are selfish or unselfish.
"The term "competition" has gathered about it evil savour, and has come to imply a certain selfishness and indifference to the wellbeing of others. Now it is true that there is less deliberate selfishness in early than in modern forms of industry; but there is also less deliberate unselfishness. It is deliberateness, and not selfishness, that is the characteristic of the modern age.
"For instance, while custom in a primitive society extends the limits of the family, and prescribes certain duties to one's neighbours which fall into disuse in a later civilization, it also prescribes an attitude of hostility to strangers. In a modern society the obligations of family kindness become more intense, though they are concentrated on a narrower area; and neighbours are put more nearly on the same footing with strangers. In ordinary dealings with both of them the standard of fairness and honesty is lower than in some of the dealings of a primitive people with their neighbours: but it is much higher than in their dealings with strangers. Thus it is the ties of neighbourhood alone that have been relaxed: the ties of family are in many ways stronger than before, family affection leads to much more self-sacrifice and devotion than it used to do; and sympathy with those who are strangers to us is a growing source of a kind of deliberate unselfishness, that never existed before the modern age. ...
"Again, the modern era has undoubtedly given new openings for dishonesty in trade. The advance of knowledge has discovered new ways of making things appear other than they are, and has rendered possible many new forms of adulteration. The producer is now far removed from the ultimate consumer; and his wrong-doings are not visited with the prompt and sharp punishment which falls on the head of a person who, being bound to live and die in his native village, plays a dishonest trick on one of his neighbours. The opportunities for knavery are certainly more numerous than they were; but there is no reason for thinking that people avail themselves of a larger proportion of such opportunities than they used to do. On the contrary, modern methods of trade imply habits of trustfulness on the one side and a power of resisting temptation to dishonesty on the other, which do not exist among a backward people. Instances of simple truth and personal fidelity are met with under all social conditions: but those who have tried to establish a business of modern type in a backward country find that they can scarcely ever depend on the native population for filling posts of trust. It is even more difficult to dispense with imported assistance for work, which calls for a strong moral character, than for that which requires great skill and mental ability. Adulteration and fraud in trade were rampant in the middle ages to an extent that is very astonishing, when we consider the difficulties of wrong-doing without detection at that time.
"In every stage of civilization, in which the power of money has been prominent, poets in verse and prose have delighted to depict a past truly "Golden Age," before the pressure of mere material gold had been felt. Their idyllic pictures have been beautiful, and have stimulated noble imaginations and resolves; but they have had very little historical truth. Small communities with simple wants for which the bounty of nature has made abundant provision, have indeed sometimes been nearly free from care about their material needs, and have not been tempted to sordid ambitions. But whenever we can penetrate to the inner life of a crowded population under primitive conditions in our own time, we find more want, more narrowness, and more hardness than was manifest at a distance: and we never find a more widely diffused comfort alloyed by less suffering than exists in the western world to-day. We ought therefore not to brand the forces, which have made modern civilization, by a name which suggests evil.
"It is perhaps not reasonable that such a suggestion should attach to the term "competition"; but in fact it does. In fact, when competition is arraigned, its anti-social forms are made prominent; and care is seldom taken to inquire whether there are not other forms of it, which are so essential to the maintenance of energy and spontaneity, that their cessation might probably be injurious on the balance to social wellbeing. The traders or producers, who find that a rival is offering goods at a lower price than will yield them a good profit, are angered at his intrusion, and complain of being wronged; even though it may be true that those who buy the cheaper goods are in greater need than themselves, and that the energy and resourcefulness of their rival is a social gain. In many cases the "regulation of competition" is a misleading term, that veils the formation of a privileged class of producers, who often use their combined force to frustrate the attempts of an able man to rise from a lower class than their own. Under the pretext of repressing anti-social competition, they deprive him of the liberty of carving out for himself a new career, where the services rendered by him to the consumers of the commodity would be greater than the injuries, that he inflicts on the relatively small group which objects to his competition.
"If competition is contrasted with energetic co-operation in unselfish work for the public good, then even the best forms of competition are relatively evil; while its harsher and meaner forms are hateful. And in a world in which all men were perfectly virtuous, competition would be out of place; but so also would be private property and every form of private right. Men would think only of their duties; and no one would desire to have a larger share of the comforts and luxuries of life than his neighbours. Strong producers could easily bear a touch of hardship; so they would wish that their weaker neighbours, while producing less should consume more. Happy in this thought, they would work for the general good with all the energy, the inventiveness, and the eager initiative that belonged to them; and mankind would be victorious in contests with nature at every turn. Such is the Golden Age to which poets and dreamers may look forward. But in the responsible conduct of affairs, it is worse than folly to ignore the imperfections which still cling to human nature.
"History in general, and especially the history of socialistic ventures, shows that ordinary men are seldom capable of pure ideal altruism for any considerable time together; and that the exceptions are to be found only when the masterful fervour of a small band of religious enthusiasts makes material concerns to count for nothing in comparison with the higher faith. ... 
"We may conclude then that the term "competition" is not well suited to describe the special characteristics of industrial life in the modern age. We need a term that does not imply any moral qualities, whether good or evil, but which indicates the undisputed fact that modern business and industry are characterized by more self-reliant habits, more forethought, more deliberate and free choice. There is not any one term adequate for this purpose: but Freedom of Industry and Enterprise, or more shortly, Economic Freedom, points in the right direction; and it may be used in the absence of a better." 

Tuesday, June 28, 2016

Can the US Continue to be an Outlier in Long Term Care?

As population ages, it seems plausible that more people will rely on long-term care. Such care could be delivered in a variety of ways: for example, within their own home, or a specialty adapted house where care is available 24/7, or or in an institutionalized setting, and by some mixture of paid providers, volunteers, and family members. Compared with other high-income nations of the world, the US is something of an outlier when it comes to long-term care: spending less, fewer recipients of long-term care, as a result a healthier over-65 population. The figures below come from the OECD databook published last November, Health at a Glance 2015.

Here's a figure showing public spending on long-term care as a share of GDP. The OECD average is 1.7% of GDP. The US spends 0.5% of GDP. The other countries that spend this little tend to have lower GDP per capita than the rest of this comparison group.

The main reason for this lower level of spending on long-term care seem to be that a much smaller share of the sUS poulation is receiving long-term care. For the OECD countries with data available, an average of 2.3% of the population is receiving long-term care; for the US, it's just 0.4%.

In turn, a main reason why the share of over-65 Americans receiving long-term care is so low is because, compared with other countries, the American cohort feels it's in pretty good physical shape.  In the US and Canada, about 80% of the over-65 population reports being in good or very good health. For comparison, less than half of the over-65 population in for the other OECD countries is reports being in good or very good health.

It's wise to take these kinds of international comparisons with a bit of skepticism. For example, the figure above shows public spending on long-term care. The Congressional Budget Office estimated in 2013 that the value of informal care provided in the US without compensation by family and friends was  slightly larger than the amount of paid-for care. But other countries presumably have some long-term care that is informally provided, too. One might also wonder if Americans (and Canadians) over-65 are actually in better health than their counterparts in other countries, or just more likely to say that they are in better health. 

However, the US is falling so far below the average in its spending on long-term care and number of recipient of long-term care, and so far above the average in self-reported health status for the over-65 population, that it seems unlikely that either a greater prevalence of informal care or a greater degree of optimism about health status explains the difference. 

As I argued back in 2011, in the context of a previous OECD report, provision of long-term care is just one of many adjustments that countries will need to make in response to aging populations. The easy, costly, and unsatisfactory answer is to make it quite easy for elderly people to qualify for receiving long-term care in an institutional setting. The less costly, harder-to-implement, and more satisfactory answer is to encourage ways for people to receive only the degree of assistance they really need, so that they can live in their homes or their communities as long as possible while being supported by family and friends, but still have a backstop of public support for institutional care when needed. 

The "baby boom generation" refers to those born from roughly 1945-1960. Thus, members of that group will be turning 65 over the 15 years from 2010 to 2025, and will be reaching 80 over the 15 years from 2025 to 2040.  As that generation ages, designing and implementing long-term care policies will be a continual work in progress. 

Monday, June 27, 2016

Seven Reflections on Brexit

A long-planned family vacation had me visiting in Great Britain last week during the Brexit vote. Here are some reflections on the event, in no particular order.

1) The Brexit vote seemed to me a strangely American moment. Some of the lasting slogans handed down from the American revolution against England are "no taxation without representation" and "don't tread on me." Thus, for an American there was some historical irony in hearing many of the British argue, in effect, that there should be "no regulation without representation," or perhaps "no legislation without representation." There was similar irony in hearing some of the British turn loose their "don't tread on me" spirit while railing against annoying but in some sense small-scale regulatory impositions from the central power, like rules that sought to standardize shapes and sizes for fruit and vegetable produce, or the rules with force of law that sales of loose and packaged good use only metric measurements.  I found myself half-expecting some "Leave" advocates to start quoting the US Declaration of Independence: "When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them ..."

2) There was a widespread feeling, even among the Remain supporters with whom I spoke, that the nature of the European project had mutated over time. My sense was that many of the Leave voters were (mostly) fine with the progress of the greater European project from the founding of the European Economic Community back in 1957 up through the 1980s. But after the effort had transmogrified into the European Union in 1993, the project was no longer focused on facilitating trade between nations. Instead, it had become focused on an agenda of gradually erasing national boundaries, or in the phrase often-used, a push for "ever-closer union," which pushed beyond the comfort level of many of the British. For example, when the European Union describes its own history, it refers to early participants in the European project back in the 1950s as "Founding Fathers," a phrase with a strong resonance for Americans of those who seek to create a single nation.  The EU website also describes how the 1957 treaty aimed at a "common market" between countries, while the 1986 update treaty aimed at a "single market."

I ran across a 1982 European court decision that involved imposing value-added taxes across countries, which included an explicit statement that the European project viewed itself as involving a smooth movement from a common market, to a single market, then to "bringing about conditions as close as possible to those of a genuine internal market." The Court decision said:
The concept of a common market as defined by the Court in a consistent line of decisions involves the elimination of all obstacles to intra-Community trade in order to merge the national markets into a single market bringing about conditions as close as possible to those of a genuine internal market. It is important that not only commerce as such but also private persons who happen to be conducting an economic transaction across national frontiers should be able to enjoy the benefits of that market.
3) A shuttle driver at Heathrow airport surprised me by explaining the Brexit vote by saying: "Well,
you know, we're a nation of shopkeepers." I don't get a casual conversational reference to Adam Smith's The Wealth of Nations every day! Smith uses the phrase in Book IV, Chapter VII, in a discussion "Of Colonies," and in particular, in part of the discussion subtitled "Of the Advantages which Europe has derived from the Discovery of America, and from that of a Passage to the East Indies by the Cape of Good Hope." In a frequently quoted passage, Smith wrote:
"To found a great empire for the sole purpose of raising up a people of customers may at first sight appear a project fit only for a nation of shopkeepers. It is, however, a project altogether unfit for a nation of shopkeepers; but extremely fit for a nation whose government is influenced by shopkeepers."
There are several odd twists and turns in relation to this passage. A first twist is that Smith using "shopkeepers" as a pejorative term. He is arguing that is after England and the colonists had gone to the effort and expense of developing the colonies, then "shopkeepers" in England wanted the British government to guarantee that the colonists would be required to buy what they needed only from English producers, and also to sell only to English producers. Here's some of what Smith writes in the same paragraph as the above quotation:
"England purchased for some of her subjects, who found themselves uneasy at home, a great estate in a distant country. The price, indeed, was very small, and instead of thirty years purchase, the ordinary price of land in the present times, it amounted to little more than the expence of the different equipments which made the first discovery, reconnoitred the coast, and took a fictitious possession of the country. The land was good and of great extent, and the cultivators having plenty of good ground to work upon, and being for some time at liberty to sell their produce where they pleased, became in the course of little more than thirty or forty years (between 1620 and 1660) so numerous and thriving a people that the shopkeepers and other traders of England wished to secure to themselves the monopoly of their custom. Without pretending, therefore, that they had paid any part, either ofthe original purchase-money, or of the subsequent expence of improvement, they petitioned the parliament that the cultivators of America might for the future be confined to their shop; first, for buying all the goods which they wanted from Europe; and, secondly, for selling all such parts of their own produce as those traders might find it convenient to buy. For they did not find it convenient to buy every part of it. Some parts of it imported into England might have interfered with some of the trades which they themselves carried on at home. Those particular parts of it, therefore, they were willing that the colonists should sell where they could; the farther off the better; and upon that account purposed that their market should be confined to the countries south of Cape Finisterre. A clause in the famous act of navigation established this truly shopkeeper proposal into a law.
"The maintenance of this monopoly has hitherto been the principal, or more properly perhaps the sole end and purpose of the dominion which Great Britain assumes over her colonies." 
A second twist is that that Napoleon (who was familiar with Smith's writings) is reputed to have snarked that England was not a worthy opponent in war, because it was merely "a nation of shopkeepers. There doesn't seem to be much evidence that Napoleon ever actually made this comment, but as the legend metamorphosed into what people thought they remembers, some in England began to treat Napoleon's intended insult about "nation of shopkeepers" as mark of pride. Indeed, news stories in recent years point out British government ministers who now argue that the country should become "a nation of shopkeepers,"  by which they mean entrepreneurs, along with poll results suggesting that "shopkeeper" is viewed as a quite desirable job.

Clearly, applying Smith's argument to the Brexit phenomenon in any direct way is a stretch! But it is true that in Smith's usage, Britain was a nation of "shopkeepers" who expected their government to cut them a profitable deal in world markets--and the seeming inability of the British government to cut such deals was part of the fuel for the "Leave" forces.

4) A comment I heard several times from "Leave" proponents is that the United Kingdom has fifth-largest economy in the world, and even outside the EU, it will remain an important player in the global economy. This argument strikes me as whistling in the dark. Yes, if GDP across countries is compared at market exchange rates, the United Kingdom ranks fifth (after the US, China, Japan, and Germany). But world GDP isn't a race, where finishing 5th of the 195 economies where the World Bank estimates a GDP level gives you a prize. Absolute size matters, and the UK is only about 3.8% of the global economy by size. In other words, if countries don't want to deal with the UK for whatever reason, there are lots of other options out there. If one compares GDP across countries using "purchasing power parity" exchange rates, then the UK ranks only 10th in the world, and is 2.4% of the total world economy. One of the main economic justifications for the EU is that with an internal market of more than 500 million people, and with a total GDP exceeding either the US or China (at market exchange rates), members will be better-positioned both to trade within the group and to be part of better deals negotiated outside the group.

5) Along with issues of democratic representation and the possibility of negotiating alternative international agreements, the other big issue in the Brexit vote concerned immigration. Here are a couple of graphs from the "Migration Statistics Quarterly Report: May 2016" published by the UK government. From 1970 up to the early 1990s, immigration and emigration were roughly equal in the UK. But then immigration rises rapidly, and in many year there is overall net in-migration of 200,000 per year or more.

Are Britain's migrants coming from inside the EU or outside? This figure shows "net" migration--that is, immigration minus emigration--for various groups. You can see that in starting around 1997, the main surge in net migration was at first from outside the EU, a change often said to be triggered by pro-immigration policies adopted by the government of then-Prime Minister Tony Blair. However, in since about 2010, net migration from within the EU has stepped up as well. After 2004, a substantial share of this migration from inside the EU was from eastern European countries. In the last few years since 2010, there has been increased immigration to the UK from countries in the so-called EU-15, which are the countries that were members of the EU up to early 2004, as well as from Romania and Bulgaria.

Thus, greater immigration had a fairly modest affect on the UK through the earlier decades of the European project, up through the 1990s. The big change in UK immigration around 1997 was mostly a result of decisions by Britain's government, not imposed by the EU. It was also a decision of Tony Blair's government, not imposed by the EU, to allow workers from the eastern European countries joining the EU after 2004 to work in the United Kingdom.  Although the more recent issues about refugees from Syria and north Africa who are seeking asylum in Europe and the United Kingdom have clearly added heat to the immigration issue, the underlying message here is that immigration--a rising share of it from within poorer countries of the European Union--has been shaking up the UK economy for the last 20 years.

Martin Ruhs offers an interesting overview of these issues in "Is unrestricted immigration compatible with inclusive welfare states? The (un)sustainability of EU exceptionalism," published in 2015 as Working Paper #125 for the Centre on Migration, Policy and Society at the University of Oxford. As Ruhs points out, a standard argument why high income countries cannot allow mass immigration from lower-income countries was given in a speech by Milton Friedman back in 1978. Friedman said:
"... it is one thing to have free immigration to jobs, it is another thing to have free immigration to welfare, and you cannot have both. If you have a welfare state, if you have a state in which every resident is promised a certain minimum level of income or a minimum level of subsistence regardless of whether he works or not, produces it or not, well then it really is an impossible thing.”
As Ruhs points out, this conventional wisdom doesn't quite summarize the issue accurately. Most intra-EU migrants are workers, not welfare recipients. He writes (citations omitted for readability:
The paper is not concerned with the intra-EU migration and social rights of EU citizens who are not workers, a group that has recently been much discussed in debates about alleged “benefit tourism”. This usually refers to claims that EU citizens move to other EU countries for the primary purpose of accessing benefits rather than working and contributing. Although popular in media and public debates across the EU, there is little evidence to support this claim. In the UK, for example, there is no evidence to support the idea that access to the welfare state is a major driver of EU immigration and EU migrants are significantly less likely than UK workers to access out-of-work benefits. In any case, the great majority of EU migrants across EU member states are labour migrants who qualify as “workers”.
But that said, the United Kingdom has a lightly regulated labor market compared to other high-income countries within the EU, and thus is more likely to attract unskilled workers. In addition, many of the benefits received by British workers are "non-contributory," meaning that they are paid out of general government revenues rather than out of payments from workers (and their employers). Ruhs sums it up this way:
In a free movement area with unrestricted labour migration across countries, the nature of the labour market plays an important role in shaping the scale of immigration in particular countries. More flexible labour markets tend to attract more migrant workers, especially for employment in lower-waged jobs, than more regulated labour markets. At the same time, the nature of the welfare state, especially the extent to which it provides non-contributory benefits, impacts on the net-fiscal contribution that new migrants make. In countries with welfare systems characterized by a high share of non-contributory benefits, low-skilled immigration will, ceteris paribus, create a smaller net-benefit (or greater net-loss) than in countries with welfare states that include a greater share of
contributory benefits.
Most economic studies (although not all) suggest that the native population of a country as a whole benefits from immigration. However, those who find themselves in most direct competition for jobs with the new migrants are more likely to incur costs. And the UK labor market and welfare policies, relative to the other high-income economies in the EU, are set up in a way that will raise the economic tensions from a more-open immigration policy. .

6) After the vote, a number of "Remain" proponent often emphasized that the margin seemed very narrow. I disagree. In big elections with millions of voters, a 51.9% to 48.1% vote is actually pretty decisive. In absolute terms "Leave" won 17.4 million votes and "Remain" had 16.1 million. Thus, it would have taken a swing of something like 700,000 voters to alter the outcome--and that's a lot of voters. As another perspective, President Obama won reelection in 2012 over Mitt Romney with 51.9% of the two-party vote, and that isn't (and shouldn't be) thought of as a narrow marginal victory, either.

7) Finally, consider in broadest terms the many ways in which the relationship between the United Kingdom and European Union, or between the United Kingdom and various subsets of European countries, might be arranged. Such relationships have many possible dimensions, involving trade, competition policy, environmental policy, immigration policy, workplace regulation, welfare policies, spending, taxes,  monetary policy, and others. This very multidimensional set of policy choices can't really be distilled into a binary choice labelled either "Leave" or "Remain." 

The Brexit vote doesn't determine what the eventual outcome of the renegotiated relationships between the countries will be, but it may alter the default negotiating positions of the two sides. In some sense, it's similar to the change that occurred in marital divorce laws. When divorce required that one party be found to be at "fault," the person in the marriage who least wanted to divorce had greater power to block the divorce. When divorce shifted to "no-fault," the party who wanted to get divorce had more power in the negotiation that followed. Similarly, before the Brexit vote, the presumption in Britain's negotiations with the EU, or other countries around the world, was that Britain would more-or-less follow the consensus of the rest of the EU. With that negotiating position, the European Union wasn't willing to concede much at all to Britain's Prime Minister David Cameron in negotiations before the Brexit vote. After the vote, the presumption will be that Britain will not follow the group, so any negotiations either with the EU or with other countries will have a different tone. The default negotiating position will be shifted. The United Kingdom will have less leverage in cutting international deals than the EU as a whole, but it will also gain greater flexibility.

Friday, June 24, 2016

China's Share of Global Economic Growth

How much any country or region contributes to global economic growth is based on two factors: the size of the economy of that country or region, and how fast that region is growing. China's economy is now big enough, and is (still) growing quickly enough, that it is now contributing as much to global economic growth at the advanced economies of the world. Here's a figure from the African Development Outlook 2016, which is an annual report written by the African
Development Bank, the OECD Development Centre and the United Nations Development

The report notes:
China’s high growth has boosted global growth in recent years (Figure 1.3). From 2011 to 2015, China’s relative contribution to global growth was on a par with advanced countries, despite stagnating at a high level for a decade. India’s contribution to global growth has also risen since the early 2000s. However, China has contributed almost 30% to global growth in recent years, approximately 20 percentage points more than India. As India is more closed and still considerably poorer than China, it cannot yet offset the impact of China’s slowdown on global growth and trade."
I still fairly often run into an implicit attitude that the US, or perhaps the US and the rest of the high-income countries taken together, dominate the global economy and can set the rules. That's a very twentieth-century point of view.

Thursday, June 23, 2016

Global Overpopulation Circa 200 AD

Global population is now almost 7.3 billion. But almost two millennia in the past, when total world population was (roughly) 200 million people, concerns about overpopulation were already being expressed.

I am deeply ignorant concerning the early centuries of the Catholic Church, but even I have heard of Tertullian, for his formulation of Trinitarian doctrine and his nickname as "The Father of Latin Christianity." Here's a comment from his A Treatise on the Soul, in a  chapter where part of the heading reads, "The State of Contemporary Civilization" (from the 1868 translation by Peter Holmes):
Surely it is obvious enough, if one looks at the whole world, that it is becoming daily better cultivated and more fully peopled than anciently. All places are now accessible, all are well known, all open to commerce; most pleasant farms have obliterated all traces of what were once dreary and dangerous wastes; cultivated fields have subdued forests; flocks and herds have expelled wild beasts; sandy deserts are sown; rocks are planted; marshes are drained; and where once were hardly solitary cottages, there are now large cities. No longer are (savage) islands dreaded, nor their rocky shores feared; everywhere are houses, and inhabitants, and settled government, and civilized life. What most frequently meets our view (and occasions complaint), is our teeming population: our numbers are burdensome to the world, which can hardly supply us from its natural elements; our wants grow more and more keen, and our complaints more bitter in all mouths, whilst Nature fails in affording us her usual sustenance. In very deed, pestilence, and famine, and wars, and earthquakes have to be regarded as a remedy for nations, as the means of pruning the luxuriance of the human race ...

Of course, the fact that a writer in 200 AD had some mistaken views that the "teeming population" had already overwhelmed the natural resources of the the world doesn't mean that modern writers with similar views are incorrect in their concerns. Similarly, the fact that the economist Thomas Malthus was expressing concerns about global overpopulation back around 1800 when the world population had reached about 800 million doesn't doesn't mean that modern writers with similar views are incorrect in their concerns, either.

But these examples of the ongoing fear of overpopulation, and many more examples that can be given through history, do suggest that worries about overpopulation--together with an inability to imagine how the population might be fed--may represent an internal bias that is baked deeply into the human psyche. Sometimes biases turn out to be right, eventually--after all, even a stopped clock shows the correct time twice each day--but it's still worth being aware of their existence.

Wednesday, June 22, 2016

John Stuart Mill on Partial Truth and Many-sidedness

Perhaps especially during an election season, when one side is always 100% right and the opposition is always 100% wrong, it seems useful to reflect on the benefits of true diversity of opinion in a world where most opinions have at best a share of the overall truth.  Philosopher/economist John Stuart Mill offers some thoughts in his classic 1859 essay, On Liberty. Here, I quote from the fourth edition in 1869 (ch. 3, paragraph 34) freely available online at the ever-useful Library of Economics and Liberty website. (I've added some paragraph breaks for ease of reading.)

"It still remains to speak of one of the principal causes which make diversity of opinion advantageous, and will continue to do so until mankind shall have entered a stage of intellectual advancement which at present seems at an incalculable distance. We have hitherto considered only two possibilities: that the received opinion may be false, and some other opinion, consequently, true; or that, the received opinion being true, a conflict with the opposite error is essential to a clear apprehension and deep feeling of its truth. But there is a commoner case than either of these; when the conflicting doctrines, instead of being one true and the other false, share the truth between them; and the nonconforming opinion is needed to supply the remainder of the truth, of which the received doctrine embodies only a part. 
"Popular opinions, on subjects not palpable to sense, are often true, but seldom or never the whole truth. They are a part of the truth; sometimes a greater, sometimes a smaller part, but exaggerated, distorted, and disjoined from the truths by which they ought to be accompanied and limited. Heretical opinions, on the other hand, are generally some of these suppressed and neglected truths, bursting the bonds which kept them down, and either seeking reconciliation with the truth contained in the common opinion, or fronting it as enemies, and setting themselves up, with similar exclusiveness, as the whole truth. The latter case is hitherto the most frequent, as, in the human mind, one-sidedness has always been the rule, and many-sidedness the exception. 
"Hence, even in revolutions of opinion, one part of the truth usually sets while another rises. Even progress, which ought to superadd, for the most part only substitutes, one partial and incomplete truth for another; improvement consisting chiefly in this, that the new fragment of truth is more wanted, more adapted to the needs of the time, than that which it displaces.
"Such being the partial character of prevailing opinions, even when resting on a true foundation, every opinion which embodies somewhat of the portion of truth which the common opinion omits, ought to be considered precious, with whatever amount of error and confusion that truth may be blended. No sober judge of human affairs will feel bound to be indignant because those who force on our notice truths which we should otherwise have overlooked, overlook some of those which we see. Rather, he will think that so long as popular truth is one-sided, it is more desirable than otherwise that unpopular truth should have one-sided asserters too; such being usually the most energetic, and the most likely to compel reluctant attention to the fragment of wisdom which they proclaim as if it were the whole."

Tuesday, June 21, 2016

Ticket-Splitting in US Elections

Ticket-splitting refers to when a voter casts, say, a ballot for the presidential candidate from one party while also voting for a congressional candidate from another party. Obviously, a lot of factors about specific candidates and specific election will influence the extent of ticket-splitting. But at least in some broad sense, one can think of ticket-splitting as a willingness to consider candidates from both parties. Norm Ornstein, Tom Mann, and Michael Malbin offer some historical sense of the amount of ticket-splitting in some tables in their 2013 databook, Vital Statistics on Congress.

Here's a table showing the percentage of voters who cast a ballot for a presidential candidate from one party and a House of Representatives candidate from the other party for all presidential elections going back to 1900. What jumps out from the table?

1) The amount of ticket-splitting in 2012 was very low by historical standards. Not quite the lowest, because there was even less ticket-splitting in 1900 and 1904. But low. Moreover, the last four presidential elections going back to 2000 have had relatively low levels of ticket-splitting compared to other post-World War II elections.

2) The two years with the highest level of ticket-splitting were also years in which a presidential candidate won in a landslide. More or less by definition, winning by a landslide means picking up a lot of voters of the other party--but many of those voters presumably split their ticket and voted for a Congressman of their own party. Thus, the biggest years for ticket-splitting, according to this measure, were the Reagan wipeout in 1984, the Nixon landslide in 1972.

3) I don't know how to interpret this pattern, but it's interesting that the amount of ticket-splitting was about the same for the first-term election of Bush in 2000 and the first-term election of Obama in 2008, and then the amount of ticket-splitting diminished for both candidates in their second-term election.

Here's another Ornstein, Mann, and Malbin chart on ticket-splitting. (In this one, I cut a few of the columns to make it easier to focus on some main themes.) In this measure, voters are asked a series of questions to classify their party leanings. The question then is what share of voters cast a ballot aligned with their partisan preferences in presidential, Senate, and House elections.

1) Again, the general pattern is toward people being more likely to vote in a way that follows their partisan beliefs. The last few elections show partisan beliefs being followed by more than 80% of voters, which is higher than was common from the 1960s through the 1990s (although elections back in the late 1950s had a similar degree of partisanship).

2) There doesn't seem to be a clear pattern of partisanship being stronger in presidential than in congressional elections, or vice versa. It does appear that the extent of partisan voting across these three types of elections tends to rise and fall together--that is, some elections are more partisan at all levels than others.

There's certainly nothing wrong with taking a political side, and it follows that there's nothing wrong with partisanship. However, it does seems sometimes that people have strong attachments or reaction to the labels of "Democratic" or "Republican" or "Green" or "Libertarian" with relatively little thought about about what underlying beliefs they truly hold and the extent to which a given politician embodies those beliefs. Those on "your side" are forgiven everything; those on the "other side" are forgiven nothing. Jerry Seinfeld had a monologue at the start of a 1995 show about rooting for the trappings, rather than the person. He said:
"Loyalty to any one sports team is pretty hard to justify. Because the players are always changing, the team can move to another city, you're actually rooting for the clothes when you get right down to it. You know what I mean, you are standing and cheering and yelling for your clothes to beat the clothes from another city. Fans will be so in love with a player but if he goes to another team, they boo him. This is the same human being in a different shirt, they *hate* him now. Boo! different shirt!! Boo."
It seems to me that some of those who bewail a high degree of  political polarization and partisanship are also  people who may almost never have voted  for someone outside their own preferred party--no matter what actual person is running on their party's ticket. If a politician switched parties, their beliefs about that politician would also switch. In other words, they are opposed to partisanship on the other side, but not their own. Personally, I'm all for a healthy amount of partisanship, as long as its not just voting for the clothing, and is rooted in actual beliefs and skills of particular candidates. 

Monday, June 20, 2016

How Many Jobs in the Political Organizations Industry?

How many people work for the "political organizations industry," which the US Bureau of Labor Statistics defines as "political parties, political action committees (PACs), political campaign organizations, and political organizations and clubs that are engaged in promoting the interests of national, state, or local political parties or candidates"? Here's the BLS figure:

The relatively small size of the number, compared with the amount of attention, surprised me. Although the total number of jobs for people being professional athletes appears to be only about 13,700, and that group generates a lot of attention from the rest of us, too.

Friday, June 17, 2016

The Origins of the Producer Price Index

When it comes to measuring inflation, the Consumer Price Index gets most of the attention. But while the CPI just celebrated its centenary a couple of years ago, its elders sibling the Producer Price Index is celebrating its 125th anniversary this year. Lana Conforti offers an overview of "The first 50 years of the Producer Price Index: setting inflation expectations for today," in the June 2016 issue of the Monthly Labor Review, which is published by the US Bureau of Labor Statistics. For answers to questions about how the PPI now operates, a useful starting point is the BLS FAQs page on on the PPI

From a modern perspective, the original production of what was then called the Wholesale Price Index looks a little rough-and-ready in  how it defined goods, collected prices, and put together the index. But it meant that people and policymakers from the early 1890s on did have some actual data--not just anecdotes--on major deflationary and inflationary episodes of this time either as they were happening or soon after, including the deflation of the 1890s, the post-World War I inflation, and the deflation of the early 1930s. Here's is Conforti's overview of the origins of the PPI, with more detail about how the methods and approaches of the PPI evolved available at the link (footnotes omitted): 
March 3, 2016, marked the 125th anniversary of the PPI—one of the oldest economic time series compiled by the federal government. The index, known as the Wholesale Price Index (WPI) until 1978, was established as part of a U.S. Senate resolution on March 3, 1891, the last day of the last session of the 51st U.S. Congress. This Congress was famously known as the “Billion-Dollar Congress,” because of its expensive initiatives, such as expanding the Navy and creating pensions for families of military members who served in the Civil War. It operated in an era of industrialization, immigration, and economic growth. Two of its most well-known bills were the Sherman Antitrust Act, which sought to protect consumers from certain anticompetitive business practices that tended to raise prices (e.g., monopolies and cartels), and the McKinley Tariff Act of 1890, which raised duties on imports with the goal of protecting domestic industries from foreign competition. Born out of the necessity to measure the impact of such economic policies, the resolution marking the origin of the PPI read thus:
Resolved, The Committee on Finance be, and they are hereby, authorized and directed, by subcommittee or otherwise, to ascertain in every practicable way, and to report from time to time to the Senate, the effect of the tariff laws upon the imports and exports, the growth, development, production, and prices of agricultural and manufactured articles, at home and abroad…. 
In response to this resolution, Senator Nelson W. Aldrich, who later played a role in the establishment of the Federal Reserve System, authored a report on Retail Prices and Wages in July 1892. According to this report, the demand for price and wage data arose because the lack of reliable data had caused persistent disputes over economic facts. In addition, legislators realized it would be impossible to judge the relative economic progress of the United States and its people without measures of prices and wages. For these reasons, the Senate Committee on Finance made sure to establish a legacy of objective and accurate data:
There was no expectation that the members of the committee would agree about the political or even the economic bearings of the facts ascertained; but all were desirous that hereafter there should be no reason to question the integrity of the facts.
A Bureau of Labor Statistics (BLS) [which had been founded in 1884] committee headed by Dr. Roland Falkner, a statistics professor from the University of Pennsylvania, was tasked with collecting prices and producing the original index data. At the Senate committee’s request, prices were collected from seven main distribution centers across the country:
  • Baltimore
  • Boston
  • Chicago
  • Cincinnati
  • New Orleans
  • New York
  • San Francisco 
Over a 28-month period beginning in mid-1889, BLS obtained 52,393 price quotations for 218 items purchased by wholesalers (commonly referred to as “jobbers” at the time). In a rather informal collection process, experts in the field (today known as field economists) received the following instructions:
As soon as you have completed the collection of wages and prices in [your city], please collect the quotations for wholesale prices….You can change the word “retail” to “wholesale” and make the blank conform. By “wholesale prices” I mean…the prices to jobbers. 
Once collected, these data were compiled by BLS into the first WPI, which was made up of eight equally weighted groupings of products:
  • Food
  • Cloths and clothing
  • Fuel and lighting
  • Metals and implements
  • Lumber and building materials
  • Drugs and chemicals
  • House-furnishing goods
  • Miscellaneous 
The data produced by the BLS committee were published in Senator Aldrich’s 1892 report, which showed that prices fell 0.3 percent from June 1889 to September 1891. After this first publication, in 1893, the Senate committee and BLS completed their initial mission by publishing a report on historical prices for the years 1840–90. This massive compilation was the first of its kind in U.S. history and was made possible only by the dedicated efforts of field economists and with cooperation from the business community.
After several years of planning, in 1900, BLS published Wholesale Prices, 1890 to 1899, the first publication produced without congressional oversight. But it wasn’t until March 1902 that the regular annual publication of Course of Wholesale Prices (hereafter referred to as Wholesale Prices) began.

Thursday, June 16, 2016

The US Trade Surplus in Services

The US has been running a trade surplus in services for the last few decades, and it's getting larger. Here's a figure generated with the help of the ever-useful FRED website run by the Federal Reserve Bank of St. Louis. It shows monthly trade data. The blue line shows the monthly US trade deficit in goods. The red line shows the monthly US trade deficit in goods-plus-services. The red line being above the blue line shows that the US trade surplus in services

In the 1990s and early 2000s, the US monthly trade surplus in services (that is, the amount the red line is above the blue line) was typically in the range of $8 billion per month: in the last few years, it's been more like $18 billion per month. It's likely that the predominant area of growth in US trade in the future will come from exporting services--managerial expertise, legal, financial, entertainment, technological, design, logistics--rather than physical objects. This figure shows that exports of services used to be about 27-29% of exports of goods-plus-services combined, but the share of services in total goods-and-services exports is now above 33% and rising.

A fair number of Americans and politicians argue that a trade deficit is in large part a result of unfair trade practices by other countries. Essentially all actual economists disagree with that claim. Economists instead see trade deficits are arising from broad patterns of national production, consumption, and saving. A low-saving economy like the US consumes more than it produces--which it can do by running a trade deficit and importing more than it exports. A high-saving economy produces more than it consumers--which it can do by running a trade surplus and exporting more than it imports. Unfair trade practices can certainly restrict overall flows of trade, but they aren't a main cause of trade deficits and surpluses.

That said, I wonder how many of those who think that trade deficits are a result of unfair trade practices by other countries are willing to stick to the logic of their position when it comes to US trade surpluses in services. If trade surpluses are a sign of unfair trade practices, then doesn't the ongoing US surpluses in services trade prove that the US is using unfair trade practices in services? My own sense is that too much attention gets focused on whether other countries are trading unfairly, and not nearly enough attention gets focused on how US producers can hook themselves up to the faster economic growth rates happening in the emerging economies of the world.

Wednesday, June 15, 2016

Still Living in a Fossil Fuel World

An enormous number of pixels are spent on renewable energy, but when one looks at actual numbers, we are still living in a fossil fuel world. Here are some illustrative charts from the most recent annual BP Statistical Review of World Energy, released June 2016.

Here's a breakdown of world energy consumption. The big slices are all fossil fuels: green is oil; red is natural gas; grey is coal. The little slices are carbon-free sources of energy: nuclear is light orange, hydroelectric is blue, and renewables are darker orange. As the report notes: "Oil remains the world’s dominant fuel and gained global market share for the first time since 1999, while coal’s market share fell to the lowest level since 2005. Renewables in power generation accounted for a record 2.8% of global primary energy consumption."

Reserves of fossil fuels are not running down. Here are figures showing the years remaining of reserves of oil, natural gas, and coal. The figures show a breakdown by region, which isn't especially relevant given that energy can be shipped between regions. Instead, focus on the gray line showing reserves at the world level. Reserves of oil and natural gas, as measured by years remaining, are not declining over time. Reserves of coal are declining, but there is more than century of reserves remaining. It may seem obvious that reserves must decline over time, but technological change doesn't just work with renewables like solar and wind. It also finds new sources of fossil fuels and new methods of extraction.

In short, if your environmental goals involve a reduction in the use of fossil fuels over time, this goal is unlikely to happen because the world starts running low on fossil fuels. Instead, it's more likely to require some significant policy changes to discourage the use fossil fuels. For a more detailed version of this argument, along with a complementary argument that technological progress by itself is unlikely to drive a smooth shift over to renewable energy sources, a nice starting point is the article by Thomas Covert, Michael Greenstone, and Christopher R. Knittel, "Will We Ever Stop Using Fossil Fuels?" in the Winter 2016 issue of the Journal of Economic Perspectives.  (Full disclosure: I've worked as Managing Editor of JEP since the first issue back in 1987.)

Tuesday, June 14, 2016

Harrod and Keynes on the Scope and Method of Economics

Back in 1938, Roy Harrod delivered the Presidential Address for the British Economic Association on the topic "Scope and Method of Economics." It was published in the September 1938 issue of the Economic Journal, which at the time was edited by John Maynard Keynes, and and thus led to some friendly back-and-forth between them. I'll highlight three parts of the exchange here.

1) At the start of Harrod's talk, he readily acknowledges the concern, which I hear often among economists, that actually doing economic research is what's interesting, and methods can only be judged after their results are known, so talking about what methods should be used in future research is a waste of time. Here's Harrod on why many economists actively seek to avoid discussion methodological issues.
In my choice of subject to-day, I fear that I have exposed myself to two serious charges: that of tedium and that of presumption. Speculations upon methodology are famous for platitude and prolixity. They offer the greatest opportunity for internecine strife; the claims of the contending factions are subject to no agreed check, and a victory, even if it could be established, is thought to yield no manifest benefit to the science itself. The barrenness of methodological conclusions is often a fitting complement to the weariness entailed by the process of reaching them.
 Exposed as a bore, the methodologist cannot take refuge behind a cloak of modesty. On the contrary, he stands forward ready by his own claim to give advice to all and sundry, to criticise the work of others, which, whether valuable or not, at least attempts to be constructive; he sets himself up as the final interpreter of the past and dictator of future efforts. ...
The principles by which progress in a science proceeds can only be reached by observing that progress. They cannot be deduced a priori or prescribed in advance. ...  And for this reason the methodologist is bound to occupy the rear, and not the vanguard. He studies the specific nature of the selected principles after the selection has been made. ... The function of the methodologist is to say what it in fact is, or, more strictly, has so far been. The proper and final reply to the would-be reformer is, " Stop talking and get on with the job; apply your method, and, if it is productive, you will be able to display your results."

2) There's a widespread quick-and-dirty version of the relationship between theory and empiricism in economics, which is that one first creates theories, tests those theories with data, and then iterates with new theories and empirical tests. But in the 21st century, I'm not sure anyone really believes this. It's well-known that you can create an internally consistent theory to reach pretty much any conclusion you want, as long as you tinker with the underlying assumptions. Moreover, it's well-known that when doing empirical work, one can try out a bunch of different statistical tests until you find one that reaches the conclusion you want. To make matters worse, there's no particular reason to believe that if some particular economic theory is validated by some particular empirical estimate in one context that it will also hold true in all other times and places. These concerns prove the case that a social science is not a natural science, but it would be as severe overreaction to hype them up into a claim that social sciences can't lead to meaningful knowledge. Much of Harrod's essay is aimed at an argument that economists can and should strive for general insights applicable in a number of settings. I'll include here a quotation from Keynes, in their correspondence, in which Keynes argues for a central task for economists is weeding through models and choosing the applicable one--and that empirical tests offer only limited help in this task.

This is part of a letter from Keynes to Harrod, upon receipt of the draft of Harrod's talk, dated July 4, 1938. It is taken from a website, "The Collected Interwar Papers and Correspondence of Roy Harrod," edited by Daniele Besomi. It's letter #787 at that website, and it's easy to click from letter to letter through the correspondence.

Progress in economics consists almost entirely in a progressive improvement in the choice of models. ... But it is of the essence of a model that one does not fill in real values for the variable functions. To do so would make it useless as a model. For as soon as this is done, the model loses its generality and its value as a mode of thought. ... The object of statistical study is not so much to fill in missing variables with a view to prediction, as to test the relevance and validity of the model.
Economics is a science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world. It is compelled to be this, because, unlike the typical natural science, the material to which it is applied is, in too many respects, not homogeneous through time. The object of a model is to segregate the semi-permanent or relatively constant factors from those which are transitory or fluctuating so as to develop a logical way of thinking about the latter, and of understanding the time sequences to which they give rise in particular cases.
Good economists are scarce because the gift for using "vigilant observation" to choose good models, although it does not require a highly specialised intellectual technique, appears to be a very rare one.

3) Finally, Harrod closes his essay by responding to an argument that economists often hear from social reformers, which is basically that the economists should stop playing intellectual games, and become part of the movement for needed change. Harrod's response is that there are lots of articulate advocates for social change, but what economists can bring to the party is a set of general lessons about the likely causes of social problems and the likely effects of proposed reforms. (The last part of the quotation below, after the final ellipses, actually appears earlier in the essay, but I inserted it at the end here for clarity.) Here's Harrod:
Zealous humanitarians may be impatient for quick results. All men of goodwill may see without more ado that there is much amiss with the world. Should not social students postpone their abstruse intellectual problems, of fascination mainly to themselves, and get together in a sort of academic tea-party to list our known abuses and our known resources and arrive at a programme of reform on the basis of mutual goodwill ? And do they not in fact, so the critic proceeds, bury themselves in unintelligible jargon, because they fear that, if they proceeded with their more immediate duties, they would disturb vested interests, incur social odium and signally fail to feather their own nests ?
The criticism misconceives the duty of the student and the true source of his power for good. It may be the case that much could be put to rights without further scientific knowledge. But the sociologist will agree that if known abuses are not redressed it is not for lack of a catalogue of them, or even for lack of men of goodwill. ... [H]is experience will lead him to suspect that the equilibrium is not likely to be shattered by the breath of an academic tea-party. Nor have academic students a monopoly of goodwill or the power to express it.
Only in one way can the academic man change the shape of things, and that is by projecting new knowledge into the arena. In goodwill he may partake in greater or less degree along with more practical persons, and he is at liberty to join with them in political parties or social-welfare groups. His specific contribution is the enlargement of knowledge, and particularly of the knowledge of general laws. ... To reach general laws it is usually necessary to abandon the straightforward terms of common sense, to become immersed for a time in mysterious symbols and computations, in technical
and abstruse demonstrations, far removed from the common light of day, in order to emerge finally with a generalisation which may then be re-translated into the language of the workaday world.

Monday, June 13, 2016

Accessing the Financial System

When it comes to processing transactions and borrowing money, the financial system works beautifully for my family. The bank doesn't charge us for depositing checks or withdrawing money, and we have enough money in the bank to qualify for a "free" checking account. The annual fee for our credit cards is smaller than the benefits they offer in terms of airline tickets, hotel rooms, and money back, so that as long as we make the payments on time, we come out ahead each year.  Getting a  home mortgage or a car loan is straightforward. If I needed a serious chunk of emergency cash, I could take out a home equity loan.

But for many low-income Americans, the financial system imposes additional costs that make it a harder for households that are already struggling to make ends meet. If they don't have a bank they pay for cashing checks and they pay for money orders. If they do have a bank account or credit cards, they often end up paying overdraft fees at the bank or late fees to the credit card company. Getting a home loan or a car loan is somewhere from difficult-and-costly to impossible. If they need short-term cash, they end up turning to pawn shops, payday loans. The Council of Economic Advisers offers some background on these issues in its June 2016 Issue Brief, "Financial Inclusion in the United States." 

As a starting point, here are a couple of figures showing the trends in whether households have a "transaction account"--basically, a bank account. The share of households with a bank account is rising, but for families in the lower income percentiles, or for families with lower education levels (of course, these are often the same families), the chance of having a bank account remains substantially lower.

These families face out-of-pocket costs when dealing with the financial system. 
The unbanked pay anywhere from 1 to 5 percent in fees to cash a check (depending in part on whether it is a paycheck or a government check since the latter come with lower risk for the check-casher). At an annual salary of $22,000 (the average for unbanked households), such fees can total over $1,000 a year in extra costs for unbanked households. ...
Many of the households that fall into this category have impaired credit histories and would fall into the “subprime” category. The products and services that these individuals may obtain from both bank and non-bank providers typically include money orders, check cashing, remittances, payday loans, auto title loans, and pawn shop loans (collectively known as small-dollar credit). ...
Unbanked and underbanked households also face additional costs due to their reliance on other, non-mainstream financial services, such as payday loans (used by roughly 5 percent of households in 2013) and auto title loans (used by roughly 0.6 percent of households in 2013), among other forms of so-called small dollar credit. These products’ costs can be quite substantial—anywhere from $10 to $30 in extra costs per $100 borrowed in the case of payday loans. 
My main quibble with the report is its use of the currently fashionable term of "financial inclusion." As the text of the report notes, the underlying issues here are more prosaic and obvious than a broad term like "inclusion" might suggest.
Despite the many benefits to financial inclusion, there are a number of barriers. One potential barrier is the upfront cost associated with opening a bank account, including fees associated with opening an account, minimum balance requirements, and gathering the necessary documentation and proof of identity, as well as the opportunity costs associated with opening an account or traveling to a bank branch to conduct business ... 
There are ways to address some of these issues, like the widespread shift toward having government checks paid directly to bank accounts, rather than delivered through the mail, which can create a tie to a bank for those who have not previously had such a connection.  But most of the new financial technology firms or smartphone applications that one reads about require overcoming these more basic hurdles.

In my own thinking, there are two issues here that are somewhat separable. One is being able to carry out transactions like receiving checks or paying bills without needing to pay much in transactions costs for doing so. The other question, and it's a harder question, is about what happens to low-income Americans who need short-term loans. Because of low and sporadic income levels, they are not good candidates for conventional loans, and thus end up turning to the "small-dollar credit" options above. Not only do these short-term lending options have relatively high up front costs, if they are not repaid on time they often impose additional costs. But what's to be done? As the report notes:
Despite the potentially adverse impacts that arise from a reliance on unconventional sources of small dollar credit, these products provide a source of funds for households who might not otherwise be able to cover such crucial but often unanticipated expenses as emergency medical treatment, funeral and burial preparations, and urgent home or automobile repairs, or sometimes even to cover regular expenses. These types of products often take the place of conventional accounts. ... Moreover, some households depend on access to small-dollar credit not just for big, one-time expenditures but also for covering general, day-to-day living expenses, such as rent and utility payments. One survey found that 2 in 5 title loan users report using the borrowed funds for rent or utilities while about a quarter of borrowers used the loan for medical expenses or car repairs. 
It's easy enough to deplore how these small-dollar credit institutions operate, and how people start by taking out one loan and end up trapped in a web of ever-growing debts. (Incidentally, the public sector isn't innocent here, either, with a growing practice in recent years of imposing ever-greater fines, and then additional fines for not paying the earlier fines on time, which can weigh heavily on low-income families.) I've written here in the past about the issues with payday loans, in particular (for example, here, here and here).

But those with low incomes who are facing a sudden need for cash--an emergency medical costs, or a car repair that's the difference between getting to work or not, or the possibility of having their power and water cut off, or being evicted from an apartment--may not have any especially appealing options. Before acting to limit or reduce the options that they do have, like the recent rules that seek to limit payday lending, it's useful to think about what is going to happen to some of the people who can't get that loan they need.

Aaron Klein of the Brookings Institution offers a useful primer on these issues in "Understanding non-prime borrowers and the need to regulate small dollar and "payday" loans," a short, readable paper published on-line on May 19, 2016.

Friday, June 10, 2016

Some Economics of Stop and Frisk

If almost every time the police stopped and frisked someone, they found an illegal weapon or drugs, or identified a wanted criminal, then complaints about the practice would ring hollow. On the other hand, if the police almost never found evidence of a crime during a stop and frisk, then complaints about the practice would take on a sharpened urgency.

Other evidence would be nice, too. It would be nice to know on what grounds the police are making decisions to stop and frisk, and whether some reasons for stop and frisk are more likely or less likely to lead to evidence of a crime. It would be nice to know the extent to which the well-known racial differences in stop-and-frisk are related to the practice occurring more in higher poverty, higher crime areas, which also have a racial imbalance. It would be nice to have some evidence on whether stop-and-frisks are more likely to lead to evidence of a crime for whites or blacks.

Sharad Goel, Justin M. Rao And Ravi Shroff offer some evidence and analysis on these kinds of questions in their research paper "Precinct Or Prejudice? Understanding Racial Disparities In New York City’s Stop-And-Frisk Policy," which appeared earlier this year in  the Annals of Applied Statistics (2016, 10:1, 365–394).

The authors have data on 2.9 million stops conducted by New York City police officers between 2008 and 2012. They write:
"Following a stop, officers complete a UF-250 stop-and-frisk form, recording various aspects of the stop, including demographic characteristics of the suspect, the time and location of the stop, the suspected crime and the rationale for the stop (e.g., whether the suspect was wearing clothing common in the commission of a crime). ... After an individual is stopped, officers may conduct a frisk (i.e., a quick patdown of the person’s outer clothing) if they reasonably suspect the individual is armed and dangerous; officers may additionally conduct a search if they have probable cause of criminal activity. Frisks and searches occur in 56% and 9% of cases, respectively. An officer may decide to make an arrest (6% of instances) or issue a summons (6% of instances), all of which is recorded on the UF-250 form."
Of course, it's sensible to be skeptical about the quality of this evidence. For example, one might raise questions about how frequently or accurately these UF-250 forms are filled out. One answer to this concern is that because of past court cases, the NYPD has some explicit emphasis on filling out the forms, and filling them out accurately. Also, with data on several million forms, one should be able to learn something, even if lessons should be drawn with appropriate caution.

The researchers focus most of their discussion in this study on the 760,000 cases where the reason for the stop was suspicion of criminal possession of a weapon. This group of stops is useful to study because it's the largest single reason for such stops, and because the data shows whether a weapon was actually found, or not, which focuses on a specific crime, rather than jumbling all crimes together. The authors look at data mostly from 2009-2010, and calculate what factors listed on the UF-250 form--including personal characteristics of the suspect, the specific factors that the officer observed that led to the stop, and the location as determined by the police precinct-- make it more or less likely that a weapon was actually found.  The result is a big messy statistical calculation, which for 2009-2010 includes 301,000 stops and 7,705 different variables (the large number of variables is because they look at a bunch of potential variables both individually and in how the variables might interact with each other).

Here's the payoff:  The authors can use the answers from their calculations on the first few years of the data to predict how likely any given stop-and-frisk looking for criminal possession of a weapon was to find such a weapon in the 2011-2012 data. For example, if an officer in a certain precinct stopped someone for criminal possession of a weapon because the person was acting furtively, and wearing suspicious clothing at a certain time of day in a certain  precinct, what was the chance (based on data from the earlier time period) that the person actually had a weapon? If an officer in another precinct stopped someone for criminal possession of a weapon who was near a crime scene, fitted a witness report, and changed direction when the officer came into view, what is the chance that that person actually had a weapon?  The researchers write (citations, footnotes, and references to figures omitted for readability):
We find that in 43% of the approximately 300,000 CPW [criminal possession of a weapon] stops between 2011 and 2012, there was at most a 1% chance of finding a weapon on the suspect. We note that the recovered weapons are typically knives, with guns constituting approximately 10% of found weapons. ...
In particular, consistent with past results, the overall hit rates for blacks and Hispanics (2.5% and 3.6%, resp.) are considerably lower than for whites (11%). In other words, these results indicate that when blacks and Hispanics are stopped, it is typically on the basis of less evidence than when white suspects are stopped. Moreover, while 49% of blacks stopped under suspicion of CPW [criminal  possession of a weapon] have less than a 1% chance of in fact possessing a weapon, the corresponding fraction for Hispanics is 34%, and is just 19% for stopped whites. Thus, if we equate reasonable suspicion with a particular probability threshold (say 1%), a far greater fraction of stops of blacks and Hispanics are unwarranted than are stops of whites. ... 
However, ... whites and minorities are typically stopped in different contexts, and so differing hit rates may not be the result of racial bias. Indeed, as we discuss below, stop-and-frisk is an extremely localized tactic, heavily concentrated in high-crime, predominantly black and Hispanic areas, and so lower tolerance for suspicious activity (and hence lower hit rates) in these areas could account for the racial disparity. ...
[T]here is an almost one-to-one correspondence between areas with heavy use of stop-and-frisk. While this is a natural and possibly effective policing strategy, a consequence of the tactic is that individuals who live in high-crime areas, but who are not themselves engaged in criminal activity, bear the costs associated with being stopped. ... [T]hese high-crime areas are overwhelmingly black and Hispanic. Accordingly, the cost of stop-and-frisk is largely shouldered by minorities. ... [W]e see that the racial composition of stopped individuals is similar to the racial composition of the neighborhoods in which stop-and-frisk is heavily employed. Thus, the striking racial composition of stopped CPW [criminal possession of a weapon] suspects (61% are black, 30% are Hispanic and 4% are white) appears at least qualitatively attributable to selective use of stop-and-frisk in minority-heavy areas ...
In a more detailed analysis of the data, they find that the differing use of stop-and-frisk across neighborhoods accounts for part of gap by which blacks and Hispanics are stopped and frisked more than whites, but not for all of it. 

Another intriguing aspect of the study is that it can answer the question of what reasons--and remember, these are the reasons given by the police themselves--are more likely to uncover a concealed weapon. The UF-250 report lists 18 specific "stop circumstances" (there's also a category for "other," which they ignore). The 18 circumstances are: suspicious object, fits description, casing, acting as lookout, suspicious clothing, drug transaction, furtive movements, actions of violent crime, suspicious bulge, witness report, ongoing investigation, proximity to crime scene, evasive response, associating with criminals, changed direction, high crime area, time of day, sights and sounds of criminal activity.

The question is whether some of these are more likely, as revealed by the actual evidence, to lead to actual discovery of a criminal concealed weapon than others. The authors look at these 18 factors together with each of the 77 police precincts and also whether the stop-and-frisk happened at a public housing location, a transit stop, or elsewhere. Notice that this is not an exercise in 20:20 hindsight: instead, it's looking at the circumstances that police actually reported seeing at the time, and then seeing what worked. Basically, they find that three  of the circumstances were good predictors of a criminal concealed weapon: suspicious object, sights and sounds of criminal activity, suspicious bulge. The other 15 circumstances were either barely connected to finding a concealed weapon, or not connected at all.

An obvious policy choice suggests itself here. The NYPD are often using stop-and-frisk to look for weapons based on the policy observing certain circumstances that are quite unlikely to be associated with a concealed weapon. If the NYPD no longer stopped people on suspicion of  suspicion of criminal possession of a weapon based on furtive movements, acting as a lookout, changing direction, and many of the other reasons given, it could focus on the circumstances that are more likely to actually end up finding a concealed weapon. The authors write:
In particular, we show that one can recover 50% of weapons by conducting only the 6% of CPW [criminal possession of a weapon] stops with the highest ex ante hit rate, and 90% of weapons by conducting 58% of CPW stops. These ex ante hit rates are based only on information observable to officers prior to the stop decision, and so it is at least in theory possible to implement such a strategy. Further, since low hit rate stops disproportionately involve blacks and Hispanics, optimizing for weapons recovery would simultaneously bring more racial balance to stop-and-risk.To facilitate adoption of such strategies by police departments, we develop stop heuristics that approximate our full statistical model via a simple scoring rule. Specifically, we show that with a rule consisting of only three weighted stop criteria, one can recover the majority of weapons by conducting 8% of stops.
An obvious concern about these results is that perhaps stopping and frisking people for criminal possession of a weapon is just an excuse, but it's nonetheless a useful excuse for reducing the rate of crime. The authors discuss the point this way:
A possible objection to our approach is that even for CPW [criminal possession of a weapon] stops, recovering weapons is not the only—or perhaps not even the primary—goal of the police. Officers, for example, may simply consider stops a way to advertise their presence in the neighborhood or a means to collect intelligence on criminal activity in the area, regardless of how many weapons are directly recovered. Stops conducted for these alternative motives could quite plausibly deter individuals from carrying weapons and might lead to information helpful in solving cases, both of which presumably would lower the incidence of violent crime over time. In the instances we consider, however, the explicitly stated reason for a stop is suspicion of criminal possession of a weapon, not one of the various other reasons that may or may not withstand legal or public scrutiny, and so it seems most natural to consider whether individuals were in fact likely to be carrying weapons. Moreover, as we have previously noted, simply because a strategy may be effective does not make it legal. ... A related worry is that “criminal possession of a weapon” is a catchall category for a variety of criminal offenses, and so by focusing on whether a weapon was found, we underestimate the value of a stop. Addressing this issue, we observe that our results are qualitatively similar if we instead use arrests [for any reason] as the outcome variable, mitigating cause for concern.
The authors instead draw the conclusion that stop-and-frisk can be a useful tool for police work, but when it comes to criminal possession a weapon, it's a tool that's being overused. They conclude:
By focusing on the relatively small number of high hit rate situations—situations that can be reliably identified via statistical analysis—one may be able to retain many of the benefits of stop-and-frisk for crime prevention while mitigating constitutional violations. This observation has the potential to not only improve New York City’s stop-and-frisk program, but could also aid similar policies throughout the country.