Border Adjustments, Tariffs, VAT, and the Corporate Income Tax

A tariff is a tax on imported goods. The "border adjustment" proposed by Republicans in the House of Representatives (and sometimes mentioned by the Trump administration) as part of a corporate tax reform also involves a tax in imported goods. But they aren't the same thing, not at all, and it's useful to sort out the categories and understand why. Indeed, you can't understand the general direction of what seems likely to be President Trump's proposal for replacing the existing corporate income tax without knowing the difference. 

Most countries around the world and all high-income countries other than the United States have "border adjustments" in their tax code, but a key point to recognize is that border adjustments are typically part of a value-added tax--not the corporate income tax. 

A value-added tax is essentially similar to a national sales tax in its economic effects. However, instead of being collected at the time of purchase, like the sales taxes with which Americans are familiar, a value-added tax is collected from firms throughout their production process. For example, the common "credit invoice" VAT works like this: As a starting point, the firm calculates what the value-added tax would be if applied to all of its sales. However, every time a firm buys a good or service from an outside supplier, it receives an invoice, and on that invoice is recorded the VAT previously paid by the supplier. The firm starts with what it would need to pay if the the VAT rate was applied to all of its sales, but then subtracts out the value-added tax that was already paid by its suppliers at an earlier stage of production. Through this "credit invoice" method, the value-added tax is only applied to the "value-added" that the firm itself has created. Also, as a matter of enforcement, every time a firm buy inputs it has an incentive to make sure that the previous firm paid the value-added tax that was due at that earlier stage of production.

It's important to notice that "value-added" is not equal to profits. The "value-added" of a firm includes both wages paid to its workers--who are the ones adding value, after all--as well as profits.  

To understand how the "border adjustment" comes into play, consider the situation across US states when different states have different sales tax levels: say state A has a sales tax of 5% and state B has no sales tax. If a firm based in state B makes a sale in state A, state A will charge sales tax on the product "imported" across the state border. But if a firm from state A sells in state B, then no sales tax is charged on the product "exported" to the other state. Similarly, imagine two countries with different rates of value-added tax. When imported goods arrive across international borders into a country with a value-added tax, they need to pay a border adjustment. The purpose is not to put imports at a disadvantage, but only to avoid giving imports a special advantage of being able to avoid the value-added tax. 

Alan Auerbach and Douglas Holz-Eakin provide a longer discussion in "The Role of Border Adjustments in International Taxation," written for the American Action Forum (November 30, 2016). As they write:

• "Unlike tariffs on imports or subsidies for exports, border adjustments are not trade policy. Instead, they are paired and equal adjustments that create a level tax playing field for domestic and overseas;

• "Border adjustments do not distort trade, as exchange rates should react immediately to offset the initial impact of these adjustments. As a corollary, border adjustments do not distort the pattern of domestic sales and purchases;

• "Border adjustments eliminate the incentive to manipulate transfer prices in order to shift profits to lower-tax jurisdictions; and

• "Border adjustments eliminate the incentive to shift profitable production activities abroad simply to take advantage of lower foreign tax rates."

To this point, the explanation answers one question, but opens up several others. The question that (I hope) is answered is why a tariff that places a tax on imports is different from a border adjustment. The typical border adjustment is not about disadvantaging imports relative to domestic production: it's just making sure that imports pay the same value-added tax as is paid by all other products in the country.

The question that is opened up sounds something like: "But the US doesn't have a value-added tax, and so why does the idea of border adjustment even come up when talking about corporate tax reform?"  The answer to this question is that the proposal from House Republicans for revising the corporate income tax is actually a first-cousin-once-removed of a value-added tax. The proposal is to eliminate the existing corporate profits tax, and then to replace it with what is sometimes called a "destination-based cash-flow tax."

The "destination-based" language means that US corporations would be taxed base on the destination of where their goods are sold, not based on where they are produced. The "cash-flow tax" language means that the tax  would look a lot like a value-added tax, except that firms would not need to pay the tax either on inputs purchased from other firms, and also not on wages paid to workers (as occurs in a standard value-added tax).

Most countries have both a value-added tax and also a corporate income tax, viewing them as two different creatures. The proposal to install a destination-based cash flow tax as a replacement for the corporate income tax is in some ways a hybrid of the two.

Alan Auerbach provides a readable academic discussion of how this kind of corporate tax can work in "A Modern Corporate Tax," published jointly by the Hamilton Project at the Brookings Institution and the Center for American Progress back in December 2010. He points to a number of advantages from this kind of change.

The new destination-based cash-flow tax would be a form of a consumption tax: that is, it taxes firms based what is consumed (whether through domestic production or imported goods), but would not have a corporate tax on exports. Firms would no longer depreciate equipment over time; instead, it would be treated as an expense the year such investments are made, which should tend to encourage investment. This plan would also stop the corporate gamesmanship of juggling the accounting so that profits seem to occur in low-tax jurisdiction, and should make the US an attractive place for foreign firms to invest. Auerbach writes:

"Most countries, including the United States, attempt to collect corporate taxes based on where a corporation’s profits are earned. The problems with this approach are that businesses and investments are increasingly internationally mobile and a business’s profits are intrinsically hard to attribute to a particular place; indeed, the fungibility of profits results in a system where a disproportionate share of the profits of multinational companies appear to occur in the world’s least-taxed countries. Current corporate tax systems generate incentives that result in the current environment where countries compete for multinational business activity by lowering their corporate tax rates. To remedy this situation, sales abroad would not be included in corporate revenue nor would purchases or investment abroad be deductible in the second major piece of the proposed corporate tax reform. As a result, the corporate tax would be assessed based on where a corporation’s products are used rather than where the corporation is located or where the goods are produced. Assessing the tax based on where a firm’s products are used eliminates issues of where to locate a business and incentives for U.S.-domiciled businesses to shift profits abroad to reduce U.S. taxes. 

"This plan therefore delivers a host of economic advantages to U.S. businesses and American workers. Promoting domestic corporate activity and encouraging investment would boost productivity, the key driver of increases in wages, employment, and living standards. Indeed, estimates of similar proposals suggest these changes could increase national income by as much as 5 percent over the long run. ... This new tax system also would retain or even increase the progressive element of the corporate tax system. The proposal would effectively implement a tax on consumption in the United States that is not financed out of wage and salary income." 

It's worth contrasting the ideas about corporate taxation here with the broader claim that this tax is one way that a Trump administration would "make Mexico pay for the wall." The border adjustment tax would apply to all imports, not just those from Mexico, for the reasons given above. As a consumption tax, it would raise prices to American consumers, who would be the ones  paying for the tax.  Assuming that it leads to a stronger US dollar, as pretty much all economists who study this subject expect, it won't end up affecting the US trade balance: basically, any effect of the border adjustment in reducing imports would be offset by a stronger dollar that will tend to raise imports by a roughly offsetting amount.

For a quick question-and-answer about the destination-based cash flow tax, a useful starting point is the short essay by William Gale on "Understanding the Republicans’ corporate tax reform proposals," (January 10, 2017). I've known Bill Gale more than 30 years, since graduate school days, and lest I be accused of invoking his name in a partisan context, I should note he's an interplanetary distance away from being a Trump supporter. He points out a number of potential difficulties with the Trump proposal as it stands: it would raise a lot less revenue than the corporate income tax it is replacing; it may contravene World Trade Organization rules; if it leads to a stronger dollar it will simultaneously reduce the value (in US dollars) of investments that have been made in other currencies; and it could even mean that some large corporate exporters become eligible for big tax refunds. But he also writes: "The corporate tax is ripe for reform. The DBFCT is an excellent way to kick-start the needed discussion."

In short, there's also a nubbin of a good idea here about reforming corporate taxes, although it has essentially zero to do with unfair trade, cutting better trade deals, reducing imports, or "making Mexico pay for the wall." If some suitable and substantial adjustments are made--starting with a higher tax rate than is included in the current proposal from the House Republicans--a corporate tax reform along these line is a potentially practical way of addressing many of the counterproductive incentives in the US corporate income tax. For example, US firms are currently holding about $2.5 trillion in cash outside the country, rather than bring it back and have it subject to the existing US corporate income tax. That's just one symptom of a deeper dysfunction with the US tax code.

Correction: An earlier version of this post referred to the DBFCT proposal as being from the Trump administration. Although it has been mentioned at times by the adminstration, the proposal itself is actually from Republicans in the House of Representatives. The text has been revised above to reflect this change.

Winter 2017 Journal of Economic Perspectives Available Online

For the past 30 years, my actual paid job (as opposed to my blogging hobby) has been Managing Editor of the Journal of Economic Perspectives. The journal is published by the American Economic Association, which back in 2011 decided--much to my delight--that the journal would be freely available on-line, from the current issue back to the first issue in 1987. Here, I'll start with Table of Contents for the just-released Winter 2017 issue. Below that are abstracts and direct links for all of the papers. I will almost certainly blog about some of the individual papers in the next week or two, as well.

_______________________

Symposium: China 

"Is China Socialist?" by Barry Naughton
Full-Text Access | Supplementary Materials

It has been 40 years since Deng Xiaoping broke dramatically with Maoist ideology and the Maoist variant of socialism. Since then, China has been transformed. Forty years ago, in 1978, China was unquestionably a socialist economy of the familiar and well-studied "command economy" variant, even though it was more decentralized and more loosely planned than its Soviet progenitor. Twenty years ago--that is, by the late 1990s--China had completely discarded this type of socialism and was moving decisively to a market economy. China today is quite different both from the command economy of 40 years ago, and from the "Wild West Capitalism" of 20 years ago. Throughout these enormous changes, China has always officially claimed to be socialist. Does the "socialist" label make sense when applied to China today?


"Human Capital and China's Future Growth," by Hongbin Li, Prashant Loyalka, Scott Rozelle and Binzhen Wu
Full-Text Access | Supplementary Materials

In this paper, we consider the sources and prospects for economic growth in China with a focus on human capital. First, we provide an overview of the role that labor has played in China's economic success. We then describe China's hukou policy, which divides China's labor force into two distinct segments, one composed of rural workers and the other of urban workers. For the rural labor force, we focus on the challenges of raising human capital by both increasing basic educational attainment rates as well as the quality of education. For the urban labor force, we focus on the issues of further expanding enrollment in college education as well as improving the quality of college education. We use a regression model to show the typical relationship between human capital and output in economies around the world and demonstrate how that relationship has evolved since 1980. We show that China has made substantial strides both in the education level of its population and in the way that education is being rewarded in its labor markets. However, as we look ahead, our results imply that China may find it impossible to maintain what appears to be its desired growth rate of 7 percent in the next 20 years; a growth rate of 3 percent over the next two decades seems more plausible. Finally, we present policy recommendations, which are rooted in the belief that China continues to have substantial room to improve the human capital of its labor force.

"From `Made in China' to `Innovated in China': Necessity, Prospect, and Challenges," by Shang-Jin Wei, Zhuan Xie and Xiaobo Zhang

Full-Text Access | Supplementary Materials

After more than three decades of high growth based on its low-wage advantage and relatively favorable demographics--in combination with market-oriented reforms and openness to the world economy--China is at a crossroads with a much higher wage and a shrinking workforce. Future growth will depend, by necessity, more on the generation of increased productivity, and domestic innovation will play an important part in this. In this paper, we assess the likelihood that China can make the necessary transition. Using data on expenditure on research and development, and patent applications, receipts, and citations, we show that the Chinese economy has become increasingly innovative. We will argue that rising wages and expanding markets are among the important drivers of China's growth in innovation. On the other hand, we find evidence of resource misallocation in the innovation area: while state-owned firms receive more subsidies, private firms exhibit more innovation results. Innovation can presumably progress even faster if resource misallocation can be tackled.


"A New Era of Pollution Progress in Urban China?" by Siqi Zheng and Matthew E. Kahn
Full-Text Access | Supplementary Materials

Over the last 30 years, China's economy has boomed. This trend has lifted hundreds of millions of Chinese out of poverty but it has also sharply increased local, regional, and global pollution levels. We look at the rise in air pollution over recent decades, and the perhaps surprising finding that in many of China's urban areas, levels of particulates (of less than 10 microns) have been decreasing during the last 10 to 15 years. We then turn to the costs and tradeoffs of air pollution, including costs to human health, reductions in worker productivity, and how people are seeking to reduce their exposure to pollution as shown by compensating differentials in real estate prices and purchases of masks and air filters. We discuss how rising incomes tend to raise the demand for environmental amenities and thus increase political pressure for environmental protection, and then we turn to the policy tools that China has used to reduce pollution. We conclude by arguing that as China's government is preparing for an additional 300 million people to move to urban areas over the next 30 years, it will have a number of opportunities for China to reduce pollution through a shift from manufacturing to services, along with various steps to improve energy efficiency and resource conservation. Overall, it seems that China is on track to improve its environmental performance in the years ahead.

"A Real Estate Boom with Chinese Characteristics," by Edward Glaeser, Wei Huang, Yueran Ma and Andrei Shleifer

Full-Text Access | Supplementary Materials

Chinese housing prices rose by over 10 percent per year in real terms between 2003 and 2014 and are now between two and ten times higher than the construction cost of apartments. At the same time, Chinese developers built 100 billion square feet of residential real estate. This boom has been accompanied by a large increase in the number of vacant homes, held by both developers and households. This boom may turn out to be a housing bubble followed by a crash, yet that future is far from certain. The demand for real estate in China is so strong that current prices might be sustainable, especially given the sparse alternative investments for Chinese households, so long as the level of new supply is radically curtailed. Whether that happens depends on the policies of the Chinese government, which must weigh the benefits of price stability against the costs of restricting urban growth.

"Why Does China Allow Freer Social Media? Protests versus Surveillance and Propaganda," by Bei Qin, David Strömberg and Yanhui Wu

Full-Text Access | Supplementary Materials

In this paper, we document basic facts regarding public debates about controversial political issues on Chinese social media. Our documentation is based on a dataset of 13.2 billion blog posts published on Sina Weibo--the most prominent Chinese microblogging platform--during the 2009-2013 period. Our primary finding is that a shockingly large number of posts on highly sensitive topics were published and circulated on social media. For instance, we find millions of posts discussing protests, and these posts are informative in predicting the occurrence of specific events. We find an even larger number of posts with explicit corruption allegations, and that these posts predict future corruption charges of specific individuals. Our findings challenge a popular view that an authoritarian regime would relentlessly censor or even ban social media. Instead, the interaction of an authoritarian government with social media seems more 

"The Evolution of China's One-Child Policy and Its Effects on Family Outcomes," by Junsen Zhang
Full-Text Access | Supplementary Materials

In 1979, China introduced its unprecedented one-child policy, under which households exceeding the birth quota were penalized. However, estimating the effect of this policy on family outcomes turns out to be complicated. China had already enacted an aggressive family planning policy in the early 1970s, and its fertility rates had already dropped sharply before the enactment of the one-child policy. The one-child policy was also enacted at almost the same time as China's market-oriented economic reforms, which triggered several decades of rapid growth, which would also tend to reduce fertility rates. During the same period, a number of other developing countries in East Asia and around the world have also experienced sharp declines in fertility. Overall, finding defensible ways to identify the effect of China's one-child policy on family outcomes is a tremendous challenge. I expound the main empirical approaches to the identification of the effects of the one-child policy, with an emphasis on their underlying assumptions and limitations. I then turn to empirical results in the literature. I discuss the evidence concerning the effects of the one-child policy on fertility and how it might affect human capital investment in children. Finally I offer some new exploratory and preliminary estimates of the effects of the one-child policy on divorce, labor supply, and rural-to-urban migration.

Symposium: Women in the Labor Market

"The New Life Cycle of Women's Employment: Disappearing Humps, Sagging Middles, Expanding Tops," Claudia Goldin and Joshua Mitchell
Full-Text Access | Supplementary Materials

A new life cycle of women's employment emerged with cohorts born in the 1950s. For prior cohorts, life-cycle employment had a hump shape; it increased from the twenties to the forties, hit a peak, and then declined starting in the fifties. The new life cycle of employment is initially high and flat, there is a dip in the middle, and a phasing out that is more prolonged than for previous cohorts. The hump is gone, the middle is a bit sagging, and the top has greatly expanded. We explore the increase in cumulative work experience for women from the 1930s to the 1970s birth cohorts using data from the Survey of Income and Program Participation and the Health and Retirement Study. We investigate the changing labor force impact of a birth event across cohorts and by education, and also the impact of taking leave or quitting. We find greatly increased labor force experience across cohorts, far less time out after a birth, and greater labor force recovery for those who take paid or unpaid leave. Increased employment of women in their older ages is related to more continuous work experience across the life cycle. 

"Specialization Then and Now: Marriage, Children, and the Gender Earnings Gap across Cohorts," by Chinhui Juhn and Kristin McCue

Full-Text Access | Supplementary Materials

In this paper, we examine the evolution of the gender gap associated with marriage and parental status, comparing cohorts born between 1936 and 1985. The model of household specialization and division of labor introduced by Becker posits that when forming households, couples will exploit the gains from trade by having one spouse specialize in market work while the other specializes in household work. Given the historical advantage of men in the labor market, the model predicts specialization by gender and therefore an earnings advantage for married men and an earnings disadvantage for married women. Is this model of specialization useful for understanding the evolution of the gender gap across generations of women? And what about children? Academic papers have shown that wages of mothers are significantly lower than those of non-mothers with similar human capital characteristics. We do not attempt to build a structural model here, but rather document how changing associations between marriage and earnings, and between children and earnings, have contributed to the gender gap in an "accounting" sense.


"The Economic Consequences of Family Policies: Lessons from a Century of Legislation in High-Income Countries," by Claudia Olivetti and Barbara Petrongolo
Full-Text Access | Supplementary Materials

By the early 21st century, most high-income countries have put into effect a host of generous and virtually gender-neutral parental leave policies and family benefits, with the multiple goals of gender equity, higher fertility, and child development. What have been the effects? Proponents typically emphasize the contribution of family policies to the goals of gender equity and child development, enabling women to combine careers and motherhood, and altering social norms regarding gender roles. Opponents often warn that family policies may become a long-term hindrance to women's careers because of the loss of work experience and the higher costs to employers that hire women of childbearing age. We draw lessons from existing work and our own analysis on the effects of parental leave and other interventions aimed at aiding families. We present country- and micro-level evidence on the effects of family policy on gender outcomes, focusing on female employment, gender gaps in earnings, and fertility. Most estimates range from negligible to a small positive impact. But the verdict is far more positive for the beneficial impact of spending on early education and childcare. 

Articles

"How to Write an Effective Referee Report and Improve the Scientific Review Process," by Jonathan B. Berk, Campbell R. Harvey and David Hirshleifer

Full-Text Access | Supplementary Materials

The review process for academic journals in economics has grown vastly more extensive over time. Journals demand more revisions, and papers have become bloated with numerous robustness checks and extensions. Even if the extra resulting revisions do on average lead to improved papers--a claim that is debatable--the cost is enormous. We argue that much of the time involved in these revisions is a waste of research effort. Another cause for concern is the level of disagreement amongst referees, a pattern that suggests a high level of arbitrariness in the review process. To identify and highlight what is going right and what is going wrong in the reviewing process, we wrote to a sample of former editors of the American Economic Review, the Journal of Political Economy, the Quarterly Journal of Economics, Econometrica, the Review of Economic Studies, and the Journal of Financial Economics, and asked them for their thoughts about what might improve the process. We found a rough consensus that referees for top journals in economics tend to make similar, correctable mistakes. The italicized quotations throughout this paper are drawn from our correspondence with these editors and our own experience. Their insights are consistent with our own experiences as editors at the Journal of Finance and the Review of Financial Studies. Our objective is to highlight these mistakes and provide a roadmap for how to avoid them.


"Retrospectives: Do Productive Recessions Show the Recuperative Powers of Capitalism?Schumpeter's Analysis of the Cleansing Effect," by Muriel Dal Pont Legrand and Harald Hagemann
Full-Text Access | Supplementary Materials

chumpeter has often been interpreted as a "liquidationist," someone who is convinced that economic crises are necessary and unavoidable, and thus that government nonintervention is a sound policy in such crises. The first two sections of this paper discuss Schumpeter's views in greater detail and suggest that categorizing him as a "liquidationist" is an oversimplification and as an unrepentant "noninterventionist" is incorrect. Although Schumpeter was certainly not a strong supporter of public interventions, he did see a role for public expenditure programs in particular circumstances. During periods of recession, Schumpeter believed firmly in what he described as the "recuperative powers of capitalism." However, when a depression becomes "pathological," there could be a role for government to intervene. In order to understand the overall picture of Schumpeter's message, we will first try to explain Schumpeter's analysis of recessions, depressions, and the other stages of business cycles. We will also discuss how Schumpeter perceived the recuperative powers of capitalism, a core concept in Schumpeter's analysis that allows him to distinguish between physiological and pathological recessions. In the 1990s, an active line of research examined the possibility that recessions may have a productive character along with their more obvious negative outcomes, because recessions in some way might hasten the process of reallocating economic recourses from slower-growth to faster-growth sectors. Such models were sometimes referred to as "neo-Schumpeterian," but given our analysis of Schumpeter's work, we will question whether this label is appropriate. 

"Recommendations for Further Reading," by Timothy Taylor
Full-Text Access | Supplementary Materials

How Did the Misery Index Become Irrelevant?

When unemployment and inflation both rose sharply during the "stagflation" of the 1970s, Arthur Okun came up with the "misery index," which is simply calculated by adding the unemployment rate and the inflation rate. (Okun was then at the Brookings Institution, and had previously been Chair of the Council of Economic Advisers at the tail end of the Johnson administration and a professor at Yale before that.) Okun certainly didn't view this little idea as any conceptual breakthrough, but it seemed a useful shorthand in his writing and speeches for characterizing some of what was happening in the 1970s.

But the "misery index" came to broader prominence during the 1976 and 1980 presidential campaign, when it was first used by Jimmy Carter to criticize the state of the US economy under Gerald Ford, and then in turn used by Ronald Reagan to criticize the state of the US economy under Carter (here's a clip of Reagan making this point from the 1980 presidential debates). To see why it was an issue, here are three graphs: the annual unemployment rate over time, the annual inflation rate over time, and the "misery index" adding the two.

You can see the spikes in 1976 and 1980. But you can also see that the misery index--which was a major factor in the 1976 and 1980 presidential elections--is at historically low levels.  So why do so many people talk about the US economy in such near-apocalyptic terms? How did historically low rates of unemployment and inflation become seemingly irrelevant? I don't have a clear answer to this question, and indeed, the answer probably involves a cluster of factors.

It's not just party politics. One might expect Republicans running against a Democratic incumbent to do all they can to make economic performance sound grim, but Bernie Sanders and Hillary Clinton were willing to speak up about how they saw US economic performance as grim. 

Maybe some of it is just ongoing shellshock from the Great Recession, but that recession did end back in June 2009.

Some of it is that the US economy has no recent experience with significant inflation in the last 25 years, so boasting that inflation is low in 2016 would have sounded peculiar. 

Some of it is that when people vote in presidential elections, they seem to be influenced both by the rate of economic growth in the year leading up to the election and also by whether there have been some faster spurts of growth  during some quarters of the previous four years. But while the upswing from the end of the Great Recession in 2009 has been uninterrupted, it has also been characterized by relatively slow growth in productivity and output.

I think that a combination of slow growth and shifts in US labor markets are the main reasons why the misery index has become so irrelevant. A low unemployment rate doesn't feel like sufficient reason for satisfaction if the new jobs are mostly in the "alternative" workforce of contingent job arrangements, where there's no expectation of an ongoing relationship with an employer that can lead to building experience and knowledge and a career. When the economic pie is growing slowly and Americans are moving less, the high levels of inequality that have come to prevail become especially irritating. 

Such changes are often traced to modern economic forces like how job patterns are altered by robots and new technology, or by globalization. I've got no magic recipe for a US economy with better growth and more career-type jobs, although at some point I'll try to put together a collection of some ideas that might help. But I'm quite confident that American economic progress won't be found in trying somehow to sidestep or ignore 21st century technology and trade and instead striving to re-create 1970s jobs at 1970s wages--back when the misery index mattered. 

Changes in Enrollment and Costs: Affordable Care and Patient Protection Act

Expanding the number of people with health insurance is the main achievement of the Patient Protection and Affordable Care Act of 2010. In 2017, the Patient Protection and Affordable Care Act is projected to have added about 12 million people to Medicaid, while providing subsidies for about 9 million people to purchase health insurance through the exchanges each month. But there's no magic in how this happened. In 2017, it cost the federal government about $70 billion for the Medicaid expansion, plus $49 billion for the subsidies. Moreover, the law has been (as expected even by its supporters) only a partial fix. About 27-28 million remain without health insurance in 2017, and that
number isn't expected to change much under current law. So says the Congressional Budget Office in "The Budget and Economic Outlook: 2017 to 2027" (January 2017). Here's CBO: 

"By CBO’s estimates, an average of 12 million noninstitutionalized residents of the United States under age 65 will have health insurance in any given month in calendar year 2017 because they were made eligible for Medicaid under the ACA [Affordable Care Act]. That expanded eligibility for Medicaid applies principally to adults whose income is up to 138 percent of the federal poverty guidelines; the federal government pays nearly all of the costs of expanding Medicaid coverage to those new enrollees. ...

"In addition, CBO and JCT [Joint Committee on Taxation] estimate that, in calendar year 2017, 9 million people per month, on average, will receive subsidies for nongroup coverage purchased through the health insurance marketplaces established under the ACA. Subsidized health insurance is now available to many individuals and families with income between 100 percent and 400 percent of the federal poverty guidelines who meet certain other conditions; they can purchase coverage through designated marketplaces and receive tax credits that subsidize their insurance premiums, as well as cost-sharing subsidies. ...

"From 2017 through 2027, under current law, the number of uninsured people under age 65 would remain around 27 million or 28 million. ...

"CBO and JCT currently estimate that federal spending for people made eligible for Medicaid by the ACA [Affordable Care Act] will be $70 billion, or 0.4 percent of gross domestic product (GDP), in fiscal year 2017. Such spending is projected to rise at an average annual rate of about 7 percent, reaching $142 billion (or 0.5 percent of GDP) in 2027. ... The agencies also estimate net federal subsidies for coverage obtained through the marketplaces to be $49 billion, or 0.3 percent of GDP, in fiscal year 2017. Those subsidy amounts are projected to rise at an average annual rate of about 9 percent, reaching $110 billion (or 0.4 percent of GDP) in 2027." 

The Rise in Global Per Capita GDP

Seems like every week or two, I see a book or article about how the world economy is a disaster. Sometimes the thesis of the book is about too much reliance on markets; other times, too little reliance on markets. As a backdrop for all such claims, here's a figure showing GDP per capita since 1960 (in constant 2010 US dollars), created with the ever-useful FRED website run by the Federal Reserve Bank of St. Louis.

The annual growth rate works out to about 1.9% annual growth over the full 55 years. This figure shows the year-to-year percentage changes. In the 1960s, the growth rate of world GDP was consistently above the long-run average, but since then, there have been years where it was lower and even negative.

Of course, I'm aware that these kinds of figure don't settle any arguments. Some skeptics will argue that the gains would have been much larger if only their preferred policies had been followed. Some of those criticisms are surely correct. Other skeptics will argue that per capita GDP is a limited measure of welfare doesn't cover lots of topics of interest. They are surely correct. Still other skeptics will point out that there are severe measurement problems with GDP in the first place, and especially with comparisons of GDP across countries, and even more so with comparisons across countries and across time, so that these kinds of numbers involve a substantial margin of error. They are also correct. Some skeptics will go so far as to argue that per capita GDP is such a flawed statistic that it should be considered irrelevant to thinking about human well-being. They are incorrect.

I don't take economic growth for granted. Confronted as I often am with claims that the world economy is sinking like the Titanic, I find the overall upward trend in per capita GDP during the last half-century to be moderately good news.

Trade: Engine or Handmaiden of Growth?

How does international trade affect economic growth? This question has a pedigree. A half-century ago, it was common for economists to observe that the second half of the 19th century had seen a large wave of globalization and also a large wave of economic growth across many countries. Seemed as if the two might be connected! Back in 1970, the economist Irving Kravis challenged this consensus by drawing what has become a classic distinction in his article, "Trade as a Handmaiden of Growth: Similarities Between the Nineteenth and Twentieth Centuries," Economic Journal (December 1970, 80: 320, Dec. 1970, pp. 850-872).

Kravis's theme, which was controversial at the time and since, was that the connection from international trade to greater productivity did not arise primarily from an outright expansion of trade. He argued th at in the 19th century, some growth success stories expanded their trade while other did not. Instead, Kravis argued, economic growth was usually driven primarily by domestic factors like investment and education, and the presence of trade (not necessarily its expansion) played a smaller complementary role in translating these changes into economic growth. Thus, he argued that trade was not an "engine" of growth, but rather a "handmaiden" of growth.  For example, Kravis wrote:

"This evidence, it is argued below, does not support any simple generalisations about the dominant role of trade in the success stories of nineteenth- century growth. Export expansion did not serve in the nineteenth century to differentiate successful from unsuccessful countries. Growth where it occurred was mainly the consequence of favourable internal factors, and external demand represented an added stimulus which varied in importance from country to country and period to period. A more warranted metaphor that would be more generally applicable would be to describe trade expansion as a handmaiden of successful growth rather than as an autonomous engine of growth. ... 

"Perhaps the most important role played by trade is one that cannot be measured by trade statistics, viz., that a relatively open market enabled the growing country to find its areas of comparative advantage and to avoid the development of insulated, high-cost, inefficient sectors. In their direct impact, however, trade and capital movements were supplementary factors; they were handmaidens not engines of growth. The mainsprings of growth were internal; they must be sought in the land and the people, and in the system of social and economic organisation."

There's an ongoing argument in the research literature about how this argument applies to the 19th century evidence on globalization and growth. Those who are interested in the historical arguments can start by taking a look at "Trade as a Handmaiden of Growth: An Alternative View," by N. F. R. Crafts in the Economic Journal (September 1973, 83: 331, 875-884).

Here, I want to focus on the implications of Kravis's distinction at present. If trade is a main engine of growth, then it becomes important for trade to keep expanding as a share of GDP. If trade is a handmaiden of growth, then the presence of vigorous international trade is important, because it avoids what Kravis called "the development of insulated, high-cost, inefficient sectors," but continual expansions of trade don't matter nearly as much.

It's of course clear in the time since Kravis's 1970 essay, certain countries like Japan, Korea, and China have experienced a wave of economic growth that is related to their access to international markets. However, it's also clear that those countries have had very high levels of investment, as well as boosting the educational attainment and human capital of their population and being very willing to seek out and adopt new technologies. The US has had a large rise in its exports and imports in recent decades as a share of GDP, but economic growth in the US has fluctuated: fast in the 1960s, slow for much of the 1970s and 1980s, a surge roughly a decade long starting in the mid-1990s, and a growth slowdown since then. Up through about 2008, it was fair to say that the US economy has had the globalization, but not a corresponding large and sustained surge of productivity growth as a result. Since then, the US has experienced both a slowdown in trade growth and a slowdown in productivity, but of course this correlation doesn't prove a causal connection between the two.

For a modern overview at the relationship between international trade and productivity, Gary Clyde Hufbauer and Zhiyao (Lucy) Lu lay out the background in "Increased Trade: A Key to Improving Productivity" (October 2016, Peterson Institute for International Economics Policy Brief 16-15). They point out:"Global trade growth slowed abruptly after 2010,  following decades of expansion." They also offer a nice overview of recent developments in trade theory. (Those who would like more on developments in trade theory might begin with the four-paper symposium in the Spring 2012 issue of the Journal of Economic Perspectives.) Toward the end of the paper, they develop a rule-of-thumb for measuring the gains from trade.

To understand their approach, remember that it's certainly possible to have an expansion of trade with no particular gain in GDP.  Just consider an economy where both exports and imports rise by equal amounts, and the economy continues to produce the same amount. However, Hufbauer and Lu survey a number of studies about the effects of trade expansions and trade agreements on productivity. They argue that when trade expands, a certain percentage of that expansion represents efficiency gains from greater specialization in production and greater use of economies of scale. They write:

"[A] $1 billion increase in two-way trade increases potential GDP, through supply-side
efficiencies, by $240 million. ... Between 1990 and 2008, real US two-way trade in nonoil goods and services increased at an average rate of 5.86 percent a year. If two-way trade had increased at this pace after 2011, the real value of US two-way nonoil trade in 2014 would have been $308 billion greater than the observed value ($4.50 trillion versus $4.19 trillion). Based on the average dollar ratio of 0.24, the hypothetical increase in US two-way trade would have delivered a $74 billion increase in US GDP through supply-side efficiencies in 2014."

If you put this number in context, it's may not seem especially large. The US GPD was roughly $17 trillion in 2014, so an efficiency gain of $74 economy is less than half of 1%. To put it another way, say that size of US trade as a percentage of GDP increases by 0.4% per year over time. Then about one-fourth of that amount (the .24 figure from the Hufbauer and Lu estimates) represents an efficiency gain. By this quick-and-dirty measure, trade might add 0.1% per year to the US growth rate.

Even that estimate may be too high, because the effects of trade on productivity and growth are likely to differ quite substantially across countries. A boost in trade for a small economy that has been closed off from competition can help bring that economy into global supply chains, in a way that spurs growth through access to global technology and global markets. But the US is a very large economy with a reasonably competitive domestic market. For that kind of economy, an additional trade agreement is going to likely to have a much smaller effect. A number of studies (going back to Kravis and earlier) point out that trade may be of greater relative important for smaller economies, just as the North American Free Trade Agreement had a much larger positive effect for Mexico than the US economy.

But on the other side, the cautious reader may have noted that the Hufbauer-Lu estimate views trade from the "engine of growth" perspective: that is, the gains from trade come from expansions of trade, not from the "handmaiden of trade" effects like a competitive incentive for domestic firms to improve their efficiency and to focus on expanding into areas where their efficiency advantages are greatest, or the efficiency gains from trade that arise from learning more about other markets and technologies--even if trade itself isn't expanding.

It's also worth remembering that even seemingly small productivity gains, on the order of 0.1%, are cumulative over time. If several policies are all undertaken that can each raise growth by 0.1% per year, then after a few years the additional growth compounds to an economy that is noticeably bigger. A one-time gain of 0.1% of GDP in one year isn't a lot, but a permanent and ongoing gain of 0.1% of GDP every year is actually of meaningful if modest importance.

Overall, the world may have reached a pause in globalization, defined here as a rise in trade relative to GDP. In that sense, trade as an engine of growth has probably slowed. In addition, the gains for the US economy from signing additional trade agreements, given the enormous size and vast internal trade already present within the US economy, are not likely to be large--and certainly not large in the short-run. Long-run growth for the US economy is more likely to be based on investments in human capital, physicial capital, and technology. For smaller economies around the world, the possibility of greater participation in global markets can be considerably more important to their economic growth. For both large economies like the US and smaller economies around the world, the role of existing levels of international trade as a handmaiden of growth, providing competition and incentives and a check on industries that without such competition can become "insulated, high-cost, inefficient sectors," remains important.

What if Trump Skeptics, Like Me, Turn Out To Be Wrong?

I have been thinking back to the early 1980s, when I was graduating from college, and compiling a list of events that I never would have expected to see--but that have in fact happened. If you had asked me circa 1985:

• I would have said that the Berlin Wall would not come down in my lifetime.
• I would not have believed that the nations of Europe, and Germany in particular, would ever give up their traditional currencies for the euro. 
• I would not  have believed that China would within a few decades become the largest economy in the world. 
• I would not have believed that the Federal Reserve would take the federal funds interest rate down to near-zero and leave it there for seven full years. 
• I would not have believed that the real estate developer who in 1983 opened Trump Tower in Manhattan and in 1984 opened the Harrah's casino at Trump Plaza in Atlantic City would ever become the President of the United States.

Just to be clear, I wouldn't have just said back in the first half of the 1980s that these events were merely unlikely. I would have viewed them as essentially unthinkable. Additions to this "I would not have believed" list are welcome: send them to conversableeconomist@gmail.com. For example, one friend contributed: "I would not have believed that the US presence in space would end up being spearheaded by the private sector."

It seems to me a useful mental discipline to admit when you are wrong--and especially when your errors demonstrate a substantial failure of imagination. Donald Trump was not my preferred or expected choice, either among those running for the Republican nomination or in the presidential election. I fear some of the potential consequences of his election. But I can clearly be wrong on major events, and I could be wrong about the effects of a President Trump, too. 

If a Trump presidency turns out badly in various ways, then Trump skeptics like me will certainly say so.  But if matters don't go wrong, then in fairness, then it seems to me that Trump skeptics should take a pledge to admit and acknowledge in a few years that at least some of our doubts and suspicions were incorrect--and indeed, we should be pleased that we were wrong.  Here's my version of that pledge on a few economic issues. 

• If the US economy experiences a resurgence of manufacturing jobs, I will say so. 
• If US economic growth surges to a 4% annual rate, I'll say so.
• If the US economy does not actually retreat from foreign trade during four years of Trump presidency (which may well happen, given that globalization is driven by underlying economic forces, not just trade agreements), I will say so. 
• If US carbon emissions fall during a Trump presidency (which may happen with the resurgence of cleaner-burning natural gas and the larger installed base of noncarbon energy sources), I will say so.
• If the budget deficit does not explode in size during a Trump administration, despite all the promises for tax cuts and a huge boost in infrastructure spending, I will say so. 
• If the Federal Reserve has maintained its traditional independence after 3-4 years, I will say so. 
• If the number of Americans without health insurance is about the same in 3-4 years, or even lower, I will say so. 

These statements are not intended as predictions of what will or won't happen. My mother didn't raise any sons silly enough to make definite predictions about the future in print, and I have not tried to put a personal probability estimate on these outcomes. They are just possibilities. Of course, one can expand this list to include an array of other issues: what will happen in foreign policy hotspots from China and Latin America to the Middle East; patterns of economic and social inequality; fair treatment under the law for every single American; and many more.

On this Inauguration Day for President Donald Trump (and frankly, I still can't believe I am writing those words), I sincerely hope that I will turn out to be deeply incorrect about his readiness and fitness for office. I will try to observe what happens during a Trump administration clearly, without distortion through the prisms of my fears and disbeliefs, and without trying to justify my preexisting skepticism. After all, I've been wrong on big topics before. 

The Evolution of Medicaid and Health Financing Reform

Much of the public attention over the Patient Protection and Affordable Care Act of 2010 has focused on the "exchanges" through which households can receive subsidies for purchasing health insurance. But the main way in which the legislation expanded health insurance coverage is through altering eligibility for the Medicaid program. The Kaiser Family Foundation provides some details on how Medicaid works and how it has has changed in a  "Medicaid Pocket Primer" (January 3, 2017). As the report notes:

"The Medicaid program covers more than 70 million Americans, or 1 in 5, including many with complex and costly needs for care. ...  Medicaid covers a broad array of health services and limits enrollee out-of-pocket costs. The program is also the principal source of long-term care coverage for Americans. ... The Medicaid program finances over 16% of all personal health care spending in the U.S. ..

Before the Affordable Care Act (ACA), most low-income adults did not qualify for Medicaid because income eligibility for parents was very limited in most states – well below the federal poverty level (FPL) in most states ($11,880 in 2016) – and federal law excluded adults without dependent children from the program. These rules left many poor and low-income adults uninsured. As part of the broader framework the ACA established to cover uninsured Americans, the law expanded Medicaid to nonelderly adults with income up to 138% FPL – $16,394 for an individual in 2016. The ACA provided federal funding for the vast majority of the cost of the Medicaid expansion. ...

Under a 2012 Supreme Court ruling, the ACA Medicaid expansion is effectively optional for states. As of January 2017, 32 states including DC had expanded Medicaid and 19 states had not. ... Between Summer 2013, just prior to the ACA coverage expansions, and October 2016, Medicaid and CHIP enrollment rose by nearly 17 million. In 2015, an estimated 11 million enrollees were adults newly eligible for Medicaid under the ACA expansion and this number has likely grown as enrollment has continued to rise and additional states have expanded Medicaid. 

A few points are worth unpacking here. It's common in public discussions to refer to Medicaid as health insurance "for the poor," but that has never been quite correct. Adults without children have historically not been eligible for Medicaid, whether they were poor or not. Here are a couple of figures from the Kaiser report to illustrate the point. For example, the first bar shows that for the nonelderly below 100% of the federal poverty line, only 54% are covered by Medicaid, which as later bars show is breaks down into 76% of children and 40% of adults below the poverty line.



In fact, most Medicaid spending isn't aimed at the non-elderly poor. Here's another breakdown from Kaiser, showing that the disabled are 15% of Medicaid recipients, but receive 42% of all Medicaid spending, while the elderly are 9% of all Medicaid recipients, but receive 21% of all Medicaid spending (much of it for long-term care services).



The expansion of Medicaid enrollments has of course led to an increase in spending in what was already a very large program. The Kaiser report notes: "Total federal and state Medicaid spending was about $532 billion in FY 2015. Medicaid is the third-largest domestic program in the federal budget, after Social Security and Medicare, accounting for 9% of federal domestic spending in FY 2015. Medicaid is the second-largest item in state budgets, after elementary and secondary education, accounting for 18.7% of state general revenue spending and 28.2% of total state general revenue spending including federal funds to states, in 2015."

The Congressional Budget Office estimated last March that the expanded Medicaid enrollments in the Patient Protection and Affordable Care Act cost $67 billion per year.  One contributing factor is that the cost per patient of Medicaid expansion is turning out to be about 50% higher on a per capita than the earlier estimates, coming in at just over $6,300 per person, according to estimates last August from the Centers for Medicare and Medicaid Services.

Medicaid costs have climbed substantially over time as a share of GDP, from less than 0.5% of GDP when the program got underway in the late 1960s to more than 3% of GDP at present.



These patterns perhaps offer some useful context as the arguments over altering the Patient Protection and Affordable Care Act of 2010 gather momentum. As I've noted before, there's never been any secret that if the government was willing to spending tends of billions of dollars, it could expand health insurance coverage for millions of people.  Because I view the lack of health insurance coverage as a genuine problem, I'm fine with additional spending to expand Medicaid.

When President Obama addressed Congress about the pending health care legislation on September 9, 2009, he said: "So tonight, I return to speak to all of you about an issue that is central to that future -- and that is the issue of health care. I am not the first President to take up this cause, but I am determined to be the last." Even in September 2009, the notion that the US health care system could have a once-and-for-all fix was more of a rhetorical flourish than a practical reality. But given the form the actual legislation ended up taking, and given what has happened in the almost seven years since it was signed into law, the set of programs, regulations, and tax provisions affecting the US health care system clearly need some changes.  

Some Economics for Martin Luther King Jr. Day

On November 2, 1983, President Ronald Reagan signed the legislation establishing a federal holiday for the birthday of Martin Luther King Jr., to be celebrated each year on the third Monday in January. As the legislation that passed Congress said: "such holiday should serve as a time for Americans to reflect on the principles of racial equality and nonviolent social change espoused by Martin Luther King, Jr.." Of course, the case for racial equality stands fundamentally upon principles of justice, not economics. But here are five economics-related thoughts for the day excerpted from past posts, mostly but not entirely during the last year.


1) Inequalities of race and gender impose large economic costs on society as a whole, because one consequence of discrimination is that it hinders people in developing and using their talents. In "Equal Opportunity and Economic Growth" (August 20, 2012), I wrote:

--------

A half-century ago, white men dominated the high-skilled occupations in the U.S. economy, while women and minority groups were often barely seen. Unless one holds the antediluvian belief that, say, 95% of all the people who are well-suited to become doctors or lawyers are white men, this situation was an obvious misallocation of social talents. Thus, one might predict that as other groups had more equal opportunities to participate, it would provide a boost to economic growth. Pete Klenow reports the results of some calculations about these connections in "The Allocation of Talent and U.S. Economic Growth," a Policy Brief for the Stanford Institute for Economic Policy Research.

Here's a table that illustrates some of the movement to greater equality of opportunity in the U.S. economy. White men are no longer 85% and more of the managers, doctors, and lawyers, as they were back in 1960. High skill occupation is defined in the table as "lawyers, doctors, engineers, scientists, architects, mathematicians and executives/managers." The share of white men working in these fields is up by about one-fourth. But the share of white women working in these occupations has more than tripled; of black men, more than quadrupled; of black women, more than octupled.


Moreover, wage gaps for those working in the same occupations have diminished as well. "Over the same time frame, wage gaps within occupations narrowed. Whereas working white women earned 58% less on average than white men in the same occupations in 1960, by 2008 they earned 26% less. Black men earned 38% less than white men in the typical occupation in 1960, but had closed the gap to 15% by 2008. For black women the gap fell from 88% in 1960 to 31% in 2008."

Much can be said about the causes behind these changes, but here, I want to focus on the effect on economic growth. For the purposes of developing a back-of-the-envelope estimate, Klenow builds up a model with some of these assumptions: "Each person possesses general ability (common to
all occupations) and ability specific to each occupation (and independent across occupations). All groups (men, women, blacks, whites) have the same distribution of abilities. Each young person knows how much discrimination they would face in any occupation, and the resulting wage they would get in each occupation. When young, people choose an occupation and decide how
much to augment their natural ability by investing in human capital specific to their chosen
occupation."

With this framework, Klenow can then estimate how much of U.S. growth over the last 50 years or so can be traced to greater equality of opportunity, which encouraged many in women and minority groups who had the underlying ability to view it as worthwhile to make a greater investment in human capital.

"How much of overall growth in income per worker between 1960 and 2008 in the U.S. can be explained by women and African Americans investing more in human capital and working more in high-skill occupations? Our answer is 15% to 20% ... White men arguably lost around 5% of their earnings, as a result, because they moved into lower skilled occupations than they otherwise would have. But their losses were swamped by the income gains reaped by women and blacks."

At least to me, it is remarkable to consider that 1/6 or 1/5 of total U.S. growth in income per worker may be due to greater economic opportunity. In short, reducing discriminatory barriers isn't just about justice and fairness to individuals; it's also about a stronger U.S. economy that makes better use of the underlying talents of all its members.


_______


2) An "audit study" of housing discrimination involves finding pairs of people, giving them similar characteristics (job history, income, married/unmarried, parents/not parents) and sending them off to buy or rent a place to live. In "Audit Studies and Housing Discrimination" (September 21, 2016), I wrote in part:
______________

Cityscape magazine, published by the US Department of Housing and Urban Development three times per year, has a nine-paper symposium on "Housing Discrimination Today" in the third issue of 2015. The lead article by Sun Jung Oh and John Yinger asks: "What Have We Learned From Paired Testing in Housing Markets?" (17: 3, pp. 15-59). ...

There have been four large national-level paired testing studies of housing discrimination in the US in the last 40 years. "The largest paired-testing studies in the United States are the Housing Market Practices Survey (HMPS) in 1977 and the three Housing Discrimination Studies (HDS1989, HDS2000, and HDS2012) sponsored by the U.S. Department of Housing and Urban Development (HUD)." Each of the studies were spread over several dozen cities. The first three involved about 3,000-4,000 tests; the 2012 study involved more than 8,000 tests. The appendix also lists another 21 studies done in recent decades.

Overall, the findings from the 2012 study find ongoing discrimination against blacks in rental and sales markets for housing. For Hispanics, there appears to be discrimination in rental markets, but not in sales markets. Here's a chart summarizing a number of findings, which also gives a sense of the kind of information collected in these studies.


However, the extent of housing discrimination in 2012 has diminished from previous national-level studies. Oh and Yinger write (citations omitted): "In 1977, Black homeseekers were frequently denied access to advertised units that were available to equally qualified White homeseekers. For instance, one in three Black renters and one in every five Black homebuyers were told that there were no homes available in 1977. In 2012, however, minority renters or homebuyers who called to inquire about advertised homes or apartments were rarely denied appointments that their White counterparts were able to make.
_____________________

3) Many of the communities that suffer the most from crime are also the communities where the law-abiding and the law-breakers both experience a heavy law enforcement presence, and where large numbers of young men end up being incarcerated. Here are some slices of my discussion from "Inequalities of Crime Victimization and Criminal Justice" (May 20, 2016):


And law-abiding people in some communities, many of them predominantly low-income and African-American, can end up facing an emotionally crucifying choice. One one side, crime rates in their community are high, which is a terrible and sometimes tragic and fatal burden on everyday life. On the other side, they are watching a large share of their community, mainly men, becoming involved with the criminal justice system through fines, probation, fines, or incarceration. Although those who are convicted of crimes are the ones who officially bear the costs, in fact the costs when someone needs to pay fines, or can't earn much or any income, or can only be visited by making a trip to a correctional facility are also shared with families, mothers, and children. Magnus Lofstrom and Steven Raphael explore these questions of "Crime, the Criminal Justice System, and Socioeconomic Inequality" in the Spring 2016 issue of the Journal of Economic Perspectives. ...


It's well-known that rates of violent and property crime have fallen substantially in the US in the last 25 years or so. What is less well-recognized is that the biggest reductions in crime have happened in the often predominantly low-income and African-American communities that were most plagued by crime. Loftrom and Raphael look at crime rates across cities with lower and higher rates of poverty in 1990 and 2008:

"However, the inequality between cities with the highest and lower poverty rates narrows considerably over this 18-year period. Here we observe a narrowing of both the ratio of crime rates as well as the absolute difference. Expressed as a ratio, the 1990 violent crime rate among the cities in the top poverty decile was 15.8 times the rate for the cities in the lowest poverty decile. By 2008, the ratio falls to 11.9. When expressed in levels, in 1990 the violent crime rate in the cities in the upper decile for poverty rates exceeds the violent crime rate in cities in the lowest decile for poverty rates by 1,860 incidents per 100,000. By 2008, the absolute difference in violent crime rates shrinks to 941 per 100,000. We see comparable narrowing in the differences between poorer and less-poor cities in property crime rates. ... "

It remains true that one of the common penalties for being poor in the United States is that you are more likely to live in a neighborhood with a much higher crime rate. But as overall rates of crime have fallen, the inequality of greater vulnerability to crime has diminished.

On the other side of the crime-and-punishment ledger, low-income and African-American men are more likely to end up in the criminal justice system. Lofstrom and Raphael give sources and studies for the statistics: "[N]nearly one-third of black males born in 2001 will serve prison time at some point in their lives. The comparable figure for Hispanic men is 17 percent ... [F]or African-American men born between 1965 and 1969, 20.5 percent had been to prison by 1999. The comparable figures were 30.2 percent for black men without a college degree and approximately 59 percent for black men without a high school degree."

I'm not someone who sympathizes with or romanticizes those who commit crimes. But economics is about tradeoffs, and imposing costs on those who commit crimes has tradeoffs for the rest of society, too. For example, the cost to taxpayers is on the order of $350 billion per year, which in 2010 broke down as "$113 billion on police, $81 billion on corrections, $76 billion in expenditure by various federal agencies, and $84 billion devoted to combating drug trafficking." The question of whether those costs should be higher or lower, or reallocated between these categories, is a worthy one for economists. ...  Lofstrom and Raphael conclude:

"Many of the same low-income predominantly African American communities have disproportionately experienced both the welcome reduction in inequality for crime victims and the less-welcome rise in inequality due to changes in criminal justice sanctioning. While it is tempting to consider whether these two changes in inequality can be weighed and balanced against each other, it seems to us that this temptation should be resisted on both theoretical and practical grounds. On theoretical grounds, the case for reducing inequality of any type is always rooted in claims about fairness and justice. In some situations, several different claims about inequality can be combined into a single scale—for example, when such claims can be monetized or measured in terms of income. But the inequality of the suffering of crime victims is fundamentally different from the inequality of disproportionate criminal justice sanctioning, and cannot be compared on the same scale. In practical terms, while higher rates of incarceration and other criminal justice sanctions may have had some effect in reducing crime back in the 1970s and through the 1980s, there is little evidence to believe that the higher rates have caused the reduction in crime in the last two decades. Thus, it is reasonable to pursue multiple policy goals, both seeking additional reductions in crime and in the continuing inequality of crime victimization and simultaneously seeking to reduce inequality of criminal justice sanctioning. If such policies are carried out sensibly, both kinds of inequality can be reduced without a meaningful tradeoff arising between them."

While accusations of police brutality are often the flashpoint for public protests over the criminal justice system, my own suspicion is that some of the anger and despair focused on the police is because they are the visible front line of the criminal justice system. It would be interesting to watch the dynamics if protests of similar intensity were aimed at legislators who pass a cavalcade of seemingly small fines, which when imposed by judges add up to an insuperable burden for low-income families. Or if the protests were aimed at legislators, judges, and parole boards who make decisions about length of incarceration. Or if the protests were aimed at prisons and correctional officers. My own preference for the criminal justice system (for example, here and here) would be to rebalance the nation's criminal justice spending, with more going to police and less coming in fines, and the offsetting funding to come from reducing the sky-high levels of US incarceration. The broad idea is to spend more on tamping down the chance that crime will occur or escalate in the first place, while spending less on years of severe punishments after the crime has already happened.
______________

4) There is a popular movement toward "ban-the-box," which prohibits employers from including a question on their application forms that asks if you have a criminal history. The hope behind such a rule is that it will improve educational opportunities for African-Americans, who are statistically more likely to have a criminal history. But several empirical studies suggest that it has the opposite effect, as I explained in "How Ban the Box Reduces Job Opportunities for African-Americans" (September 16, 2016): 

_________

The study is called "Ban the Box, Criminal Records, and Statistical Discrimination: A Field Experiment," by Amanda Agan and Sonja Starr (Princeton University International Relations Section, Working Paper #5998, July 2016). ... As Agan and Starr write at the start of the paper (citations omitted):

In an effort to reduce barriers to employment for people with criminal records, more than
100 jurisdictions and 23 states have passed “Ban-the-Box” (BTB) policies. Although the details vary, these policies all prohibit employers from asking about criminal history on the initial job application and in job interviews; employers may still conduct criminal background checks, but only at or near the end of the employment process. Most BTB policies apply to public employers only, but seven states (including New Jersey) and a number of cities (including New York City) have now also extended these restrictions to private employers. These laws seek to increase employment opportunities for people with criminal records. They are often also presented as a strategy for reducing unemployment among black men, who in recent years have faced unemployment rates approximately double the national average ... 

Agan and Starr carried out an experiment. They sent out about 15,000 fictitious online job applications to entry-level positions in New Jersey and New York city, both before and after the "ban-the-box" policy went into effect. The resumes were set up in pairs, so that they were largely the same resume except for a difference in race; in particular, out of each pair, one job applicant could be identified as white and one as black. In addition, some of the pairs of hypothetical applicants checked "the box" early on, while others did not; some had a high school diploma, or a GED high-equivalency, or neither; some had a gap in their job history, while others did not.

The study found that whites with the same credentials are more likely to get a call-back than blacks: as they write, "white applicants overall received about 23% more callbacks compared to similar black applicants." Before "ban-the-box" went into effect, admitting to a criminal record definitely made it harder to be hired: that is, "among employers that asked about criminal convictions in the pre-period, the effect of having a felony conviction is also significant and large: applicants without a felony
conviction are 62% ... more likely to be called back than those with a conviction, averaged across races ..."

However, when ban-the-box (BTB) was enacted, the black-white gap in the chances of being called back got larger, not smaller. "Our estimates of BTB’s effects on callback rates imply that BTB substantially increases racial disparities in employer callbacks. We find that BTB expands the black-white gap by about 4 percentage points, multiplying the gap at affected businesses by a factor of about six. In our main specification, before BTB, white applicants to BTB-affected employers received 7% more callbacks than similar black applicants, but after BTB this gap grew to 45% ..."

The authors suggest that what economists call "statistical discrimination" is a possible explanation for these findings. ... Consider an employer who is both mildly biased against blacks, but also would strongly prefer not to hire someone who has a criminal record. If that employer has information on whether someone has a criminal record, they will continue to be biased against blacks. But if this employer is banned from collecting information on criminal record, they will tend to act on the statistical knowledge that blacks are more likely to have a criminal record than whites. As a result, blacks without a criminal record will have a lower chance of a job callback, and whites with a criminal record will have a higher chance of a job callback. ...

Thanks to Catherine Rampell for pointing out to me that there's another recent empirical study of ban-the-box, different methods, but similar results. The study is "Does "Ban the Box" Help or Hurt Low-Skilled Workers? Statistical Discrimination and Employment Outcomes When Criminal Histories are Hidden," by Jennifer L. Doleac and Benjamin Hansen, published as NBER Working Paper No. 22469 (July 2016). ... Thanks to Stan Veuger for pointing out yet another recent working paper on this subject, which uses a different approach and emphasizes a different set of tradeoffs. In "No Woman No Crime: Ban the Box, Employment, and Upskilling," Daniel Shoag and Stan Veuger look at employment with a focus on the outcome of ban-the-box an employment rates of those living in high-crime neighborhoods.
_______________________

5) Is it possible to draw a reasonably clear line between equality of opportunity and equality of result? Here are some excerpts from my thoughts on Equality of Opportunity and Equality of Result (June 17, 2015):

______

In discussions about inequality of income or wealth, it's common to hear an argument along the following lines: "I'm not much bothered by inequality of results, as long as there is fairly good equality of opportunity."

As a quick example of this distinction, consider two siblings of the same gender that grow up in the same family, attend the same schools and colleges, and get similar jobs. However, one sibling saves money for retirement, while the other does not. When the two of them reach retirement, one sibling can afford around-the-world cruises and extensive pampering of the grandchildren, while the other sibling can afford the early-bird discount diner buffet line. This inequality of after-retirement results between the two siblings doesn't seem especially bothersome, because of the earlier equality of opportunities.

However, the notion that the inequality resulting from different opportunities or discrimination can be more-or-less separated from the inequality that results from choices and effort, while appealing at an intuitive level, turns out to quite difficult in practice. Ravi Kanbur Adam Wagstaf discuss the issues in "How Useful Is Inequality of Opportunity as a Policy Construct?" in World Bank Policy Research Working Paper 6980 (July 2014). The authors have also written a recent short summary/overview of the arguments. As a starting point, they write:

In policy and political discourse, “equality of opportunity” is the new motherhood and apple pie. It is often contrasted with equality of outcomes, with the latter coming off worse. Equality of outcomes is seen variously as Utopian, as infeasible, as detrimental to incentives, and even as inequitable if outcomes are the result of differing efforts. Equality of opportunity, on the other hand, is interchangeable with phrases such as ‘leveling the playing field’, ‘giving everybody an equal start’ and ‘making the most of inherent talents.’ In its strongest form, the position is that equality of outcomes should be irrelevant to policy; what matters is equality of opportunity. ... However, attempts to quantify and apply the concept of equality of opportunity in a policy context have also revealed a host of problems of a conceptual and empirical nature, problems which may in the end even question the practical usefulness of the concept.

My sense that their argument can be divided into two parts. One problem is that it's not easy to divide up the inequalities that are observed in society into one portion based on differences in opportunity, which should be rooted in the circumstances in which people find themselves through no decision or fault of their own, and another portion based on the choices or efforts that people make. The other problem is that moral intuition in some cases suggests an aggressive role for acting against unequal opportunities, and other cases where the moral intuition is not as strong: for example, the argument for fighting race and gender discrimination in support of equality of opportunity seems considerably stronger than the argument for seeking to offset most differences in genetic talent as a way of ensuring equal opportunity. ...

The difficult bottom line here is that seeking to draw a distinction between equality of opportunity and equality of results hides a deeper question: What sources of unequal results should a society regard as acceptable or justified, and what sources of unequal results should we regard as unacceptable or unjustified? It's easy to claim that such a distinction exists, but knowing in practical terms where it can be difficult.

In a 1965 speech, President Lyndon Johnson discussed the importance of true equality of opportunity in a famous passage:

But freedom is not enough. You do not wipe away the scars of centuries by saying: Now you are free to go where you want, and do as you desire, and choose the leaders you please. You do not take a person who, for years, has been hobbled by chains and liberate him, bring him up to the starting line of a race and then say, "you are free to compete with all the others," and still justly believe that you have been completely fair. Thus it is not enough just to open the gates of opportunity. All our citizens must have the ability to walk through those gates.Johnson's comment contains a deep truth, but the poetic phrasing about starting lines of races and walking through gates of opportunity offers a hint that practical difficulties are being sidestepped.

For example, it is straightforward to argue that children should have at least some minimum level of opportunity, a feeling which is expressed by laws requiring compulsory and taxpayer-funded schooling and public health measures like vaccinations. But beyond that minimum, the extent to which society should intervene with parents or seek to counterbalance or offset parental decisions about raising children can become quite controversial. It is straightforward to argue that racial and ethnic discrimination should be banned. But beyond the essential step of banning explicit discrimination in employment or housing or public services, the extent to which society should act to offset the results of past discrimination becomes controversial, too. ...

Overall, it seems that the distinction between equality of opportunity and equality of result can be the starting point for some minimum level of public policy to reduce certain causes of unequal outcomes. But given the analytical problem with separating why unequal results occur, the equality of opportunity/equality of result distinction is often not much help in resolving how aggressive such inequality-reducing policies should be.

Want to Watch Some Economists Talk?

The annual meetings of the American Economic Association were held in Chicago from January 6-8. The AEA offers webcasts of a number of popular sessions, often panel discussions or prominent lectures in which the discussion should be reasonably accessible to nonspecialists. A sampling of these webcasts is below; a full list of the available webcasts from the meetings is here. If you would like to hear actual economists of differing views talk about issues, with enough time for sentences and even paragraphs rather than just soundbites, these webcasts offer a nice starting point.

Brexit: Six Months Later (Panel Discussion)
Presiding: Olivier Blanchard
Jonathan Portes
Andrew Lilico
Karl Whelan
View Webcast

Nobels on Where is the World Economy Headed?
Presiding: Dominick Salvatore
Where in the World Is the World Headed? Angus Deaton
Seeking Political Keys for Economic Growth Roger Myerson
How the Left and Right Are Failing the West Edmund Phelps
Economic Risks Associated with Deep Change in Technology Robert J. Shiller
New Divisions in the World Economy Joseph E. Stiglitz
View Webcast


AEA Richard T. Ely Lecture: The Economist as Plumber: Large Scale Experiments to Inform the Details of Policy Making
Esther Duflo, introduced by Alvin E. Roth
View Webcast

Economic Issues Facing the New President (Panel Discussion)
Presiding: Greg Mankiw
Jason Furman
Glenn Hubbard
Alan Krueger
John Taylor
View Webcast

AEA Presidential Address - Narrative Economics
Robert J. Shiller, introduced by Alvin E. Roth
View Webcast

A New Era of Price Discrimination?

"Price discrimination" has a specific technical meaning for economists. It's not about sellers charging more to certain groups because of biased attitudes about gender, race/ethnicity, religion, or sexual orientation. Instead, it's about setting up a varying set of prices in order to charge more to those who are willing to pay more--unlike the standard situation in a plain vanilla market in which everyone pays the same price.

There are lots of examples of price discrimination. When a movie is first released, the ticket prices are typically higher in "first-run" theaters than when the movie arrives at "second-run" theaters a few months later. Books are often released first in more-expensive hard-cover editions, and later in less-expensive paperbacks. Those who aren't sure about going out for dinner are enticed by happy hour and early-bird specials, while those willing to pay more arrive later in the evening. There are discounts for students or senior citizens. There are volume discounts for buying a larger quantity of a good. Such arrangements often seem potentially beneficial to both buyers and sellers.

But there's one more kind of price discrimination called "personalized pricing," in which prices would vary across individuals so that everyone would be charged as much as they were willing to pay. This seems more problematic, and a combination of big data and online retail may be bringing it our way. Ariel Ezrachi and Maurice E. Stucke write about "The rise of behavioural discrimination," in the European Competition Law Review (2016, 12: 485-492; not freely available online). They also refer to an Executive Office of the President report from February 2015, "Big Data and Differential Pricing." That report sets up the issue in this way:

"Economics textbooks usually define three types of differential pricing. Personalized pricing, or first-degree price discrimination, occurs when a seller charges a different price to every buyer. Individually negotiated prices, such as those charged by a car dealer, are an example of personalized pricing. Quantity discounts, or second-degree price discrimination, occur when the per-unit price falls with the amount purchased, as with popcorn at the movie theater. Finally, third-degree price discrimination occurs when sellers charge different prices to different demographic groups, as with discounts for senior citizens.

Big data has lowered the costs of collecting customer-level information, making it easier for sellers to identify new customer segments and to target those populations with customized marketing and pricing plans. The increased availability of behavioral data has also encouraged a shift from third-degree price discrimination based on broad demographic categories towards personalized pricing. Nevertheless, differential pricing still presents several practical challenges. First, sellers must figure out what customers are willing to pay. This can be a complex problem, even for companies with lots of data and computing power. A second challenge is competition, which limits a company’s ability to raise prices, even if it knows that one customer might be willing to pay more than another. Third, companies need to prevent resale by customers seeking to exploit price differences. And finally, if a company does succeed in charging personalized prices, it must be careful not to alienate customers who may view this pricing tactic as inherently unfair. ...

Ultimately, whether differential pricing helps or harms the average consumer depends on how and where it is used. In a competitive market with transparent pricing, the benefits are likely to outweigh the costs.  ...  Ultimately, differential pricing seems most likely to be harmful when implemented through complex or opaque pricing schemes designed to screen out unsophisticated buyers. For example, companies may obfuscate by bundling a low product price with costly warranties or shipping fees, using “bait and switch” techniques to attract unwary customers with low advertised prices and then upselling them on different merchandise, or burying important details in the small print of complex contracts.When these tactics work, the economic intuition that differential pricing allows firms to serve more price-sensitive customers at a lower price-point may even be overturned. If price-sensitive customers also tend to be less experienced, or less knowledgeable about potential pitfalls, they might more readily accept offers that appear fine on the surface but are actually full of hidden charges. ...."

Ezrachi and Stucke point out a number of ways in which these issues are becoming a practical reality. The collection and interconnection of big data from a wide variety of sources creates the possibility that when you shop on-line, the seller may already know quite a lot about you. They write:

"As the volume, variety and value of personal data increases, self-learning pricing algorithms can use the data collected on you and other people to identify subgroups of like-minded, like-price-sensitive individuals, who share common biases and levels of willpower. Pricing algorithms can use data on how other people within your grouping react, to predict how you will likely react under similar circumstances. This then enables the self-learning algorithm to more accurately approximate the user's reservation price, observe behaviour, and adjust. The more time we spend online--chatting, surfing, and purchasing--the more times the algorithm can observe what you and others within your grouping do under various circumstances; the more experiments it can run; the more it can learn through trial and error what your group's reservation price is under different situations; and, the more it can recalibrate and refine (including shifting you to another group). 

"To better train their algorithms and categorize even smaller groups of individuals, firms will need personal data. Among other things, this trend will accelerate the "Internet of Things", as firms compete to collect data on consumers' activities at home, work, and outside. Smart appliances, cars, utensils, and watches can help firms refine their consumer profiles and gain a competitive edge. Thus in making use of our demographics, physical location (via our phones), browser and search history, friends and links on social networks, and online reviews and blog posts, firms can target us with personalised advertisements with ever increasing proficiency. Also, at the point of sale, the categorisation can help sellers approximate our price sensitivity."

It used to be said that when you go to a website, you are like a person with a name-tag at a convention: that is, you could be identified, but others didn't necessarily know much about you. But in the future, when you go to a website, certain sellers at least will already know a great deal about you. With this information, the seller will be able to customize your retail experience by manipulating the information presented about products, choices, prices, and deals in ways that makes someone with your specific characteristics more likely to buy and to pay higher prices.

This could be done in literally dozens of ways. One example from Ezrachi and Stucky is that the first item presented in an online list of possibilities will both be a decoy designed with your characteristics in mind: it will also be higher-priced, and perhaps lacking in some features.  When you scroll down the list, you will find other items that have lower prices or more features. Compared to the decoy item, these look like good deals. A standard example in regular retailing is that many restaurants report that the second most-expensive bottle of wine and the second least-expensive bottle of wine are among their top seller, because those who want to splurge can feel they are being a little thrifty, and those who want inexpensive can feel they aren't being totally cheap. "So we may have originally intended to purchase a cheaper item, but chose a more expensive item with perhaps a few more attributes, as it was relatively more attractive than the personalised decoy option."

Another option is "price-steering," where a website makes it easier to find more expensive options. Or firms can make strategic use of complexity: "To better discriminate, companies can take advantage of consumers' difficulty in processing many complex options. Companies may deliberately increase the complexity by adding price and quality parameters, with the intent to facilitate consumer
error or bias and manipulate consumer demand to their advantage. By increasing their products' complexity, firms can also make it difficult to appraise quality and compare products, increase the consumers' search and evaluation costs, and nudge consumers to rely on basic signalling that benefits the firms. Once the customer is snagged, the complexity in contract terms can increase
the customers' switching costs and increase the likelihood of customers retaining the personalised default option.  This enables firms to inch closer to perfect behavioural discrimination."

Notice that none of these strategies involve the seller actually lying. In fact, one can easily think of circumstances where these options could benefit consumers, by providing them with the selection of products and information that they actually find most attractive. But it's also easy to think of ways in which people can be manipulated. Ezrachi and Stucke write:

The road to near-perfect behavioural discrimination will be paved with personalised coupons and promotions: the less price-sensitive online customers may not care as much if others are getting promotional codes, coupons, and so on, as long as the list price does not increase. Online sellers will increasingly offer consumers with a lower reservation price a timely coupon-ostensibly for being a valued customer, a new customer, a returning customer, or a customer who won the discount. The coupon may appear randomly assigned, but only customers with a lower reservation price are targeted. Indeed, the price discrimination can happen on other, less salient aspects of the purchase. Retailers can offer the same price, but provide greater discounts on shipping (or faster delivery), offer complimentary customer service, or better warranty terms to attract customers with lower reservation prices, greater willpower, or more outside options.

In the brave new world of big data and online purchases. buyers really do need to be wary. And one suspects that the Federal Trade Commission and other consumer protection agencies are going to become active participants in determining what tools sellers can use.