Some Snapshots and Thoughts about US Entrepreneurship

A dynamic and healthy economy will always be undergoing a process of churn: new companies and new jobs starting, but also existing companies and jobs ending.  Thus, it's been troubling to see articles about "The Decline in US Entrepreneurship" (August 4, 2014), a lower rate of business startups, and a decline in how much new firms are offering in terms of job gains.

The Kauffman Foundation does regular surveys of US entrepreneurship. Robert Fairlie, Sameeksha Desai, and A.J. Herrmann wrote up the 2017 National Report on Early Stage Entrepreneuship (February 2019). The report offers some reasons for modest encouragement, but in the end seems overly optimistic to me.

On the positive side, the survey uses data from the nationally representative Current Population Survey conducted by the Census Bureau to calculate the "rate of new entrepreneurs." Specifically: "The rate of new entrepreneurs captures the percentage of the adult, non-business owner population that starts a business each month. This indicator captures all new business owners, including those who own incorporated or unincorporated businesses, and those who are employers or non-employers."

As the report notes: "The rate of new entrepreneurs in 2017 was 0.33 percent, which reflects that 330 out of every 100,000 adults became new entrepreneurs in an average month."

The Census data also lets the authors break down this data in various ways: for example, the rate of new entrepreneurs is about twice as high for immigrants: 

Overall, the Kauffman report is optimistic about early-stage entrepreneurship in 2017. But some of the results of the survey, as well as data from the Business Dynamics Statistics produced by the Census Bureau offer some reason for concern. 

For example, when one breaks down the rate of new entrepreneurs in more detail, it turns out that those with less than a high school education have a rising rate of starting firms--unlike any other educational group. 

In addition: "Older adults also represent a growing segment of the entrepreneurial population: adults between the ages of 55 and 64 made up 26 percent of new entrepreneurs in 2017, a significant increase over the 19.1 percent they represented in 2007." Conversely, these figures suggest that a smaller share of new companies are being started by highly educated workers in their peak earning years. 

At least to me, this pattern suggests the possibility that a larger share of new companies are aimed at providing income and independence for their owners, but may be less likely to grow and generate substantial numbers of jobs. Indeed, the Kauffman report also includes this figure, showing that the jobs per 1,000 people from early startups has been declining over time. 

The Business Dynamics Statistics is constructed from what is called the Longitudinal Business Database. In turn, this data uses Census data and links the records on individual companies over time. To keep the records of individual companies confidential, the data can only be accessed by qualified researchers through a network of Census Bureau Research Data Centers. However, the website does have a nice data tool for making quick-and-easy graphs of some overall patterns in this data, as well as sector-level and state-level patterns. 

Here's an example of a figure showing "Establishment birth rates" (black line) and "Establishment exit rate" (blue line). For example, back in the 1980s it was fairly common for the number of new establishments to be about 15 percent of the total number of firms; now, it's about 10%. Both rates of entry and exit have been declining over time, suggesting that new firms are having a harder time getting started and established firms are having an easier time staying in place. 

As another example, here a figure for the economy as a whole from the BDS database on the "job creation rate" (black line), "job destruction rate" (blue line), and "job creation rate from establishment births" (orange line). The gap between the job creation rate and the job destruction rate is the overall level of net new jobs for the economy in a year. Fortunately, job creation is above job destruction in most years, except in recessions. But even in years when the US economy is going well, its churning, changing, evolving job market is commonly in a situation where the 13-15% of existing jobs are destroyed, and a slightly higher share of new jobs are being created. 

In thinking about US entrepreneurship, the standard concern is that the churning of job market seems to be declining over time. The orange line shows that job creation by new establishments has been declining, too, similar to the finding from the Kauffman data. 

A dynamic churning economy is a mixture of benefits for firms and their workers on the rise  and costs for firms and their workers who are on the downside. But from an overall perspective, it also represents a shift in resources away from firms producing goods and services that not enough people want to buy, or goods and service that aren't being produced at a competitive levels of price and quality. Instead, those resources of workers and capital investment are moving to firms producing the goods and services with the desired mix of price and quality that people do want to purchase. I have argued from time to time that the government could play a larger role in facilitating, or at least not blocking, this process of dynamic movement--especially by assisting workers in transition. But overall, this dynamic process of economic reallocation has been one of the strengths of the US economy, and it is troublesome to see signs that it may be diminishing.   

The Eternal Majority Against the Way Things Are: Brexit, Health Care, Socialism:

It seems as if there's always a majority against the way things are. In a world full of problems and issues, how could it be otherwise? It's why politicians are always calling for "change," which strikes me as a slogan that is appealing and concealing in equal measure.  Because the real-world problem that arises is when those who are united in their opposition to the way things, and united in favor of "change," need to offer an actual alternative of their own. 

When advocating for change, problems and policies are the target. But if you advocate an actual policy, with inevitable costs and tradeoffs, then you become the target.

Consider the mess that has resulted from Brexit -- that is, the June 2016 vote in the United Kingdom to leave the European Union. There was (at least at the time) a majority in the UK in favor of leaving the EU. However, there is also apparently a majority against the "hard exit" option of crashing out of the EU without a replacement trade agreement in place. And there is a strong majority against Prime Minister Theresa May's actual concrete plan for a substitute trade agreement. Sure, there are a variety of other proposals for substitute trade agreement bubbling around. But the EU must also sign on to any substitute agreement. and the EU has an incentive to make it hard and disruptive for any of its members to exit, So it seems plausible to me that there would be a majority against any plausible substitute for May's proposal, too.

Easy to be opposed. Easy to advocate "change." But what should the UK do when there is a majority against any achievable policy?

Or consider health care financing in the US. A long-standing bipartisan majority has pointed out problems with the high cost of US health care by international standards, and with the number of people who lack health insurance. But calling for "change" is easy, and advocating a policy is hard.

When Democrats controlled the Presidency and Congress in 2010, they managed to wedge through the Patient Protection and Affordable Care Act of 2010. Of course, this new reality immediately became the new target. When Republicans controlled the Presidency and Congress in 2017 and 2018 were unified in expressing their opposition to the 2010 law, but unable to cobble together a bare majority that would wedge through an alternative plan. Meanwhile, most prominent Democrats seem to believe that the flaws of the 2010 legislation are quite sweeping, and thus require enacting a new and substantial set of changes. But when it comes to like whether private health insurance should be shut down in favor of a single-payer government plan like "Medicare for All," my guess is that the Democratic coalition in favor of "change" would splinter, too.

Many of the arguments about "socialism" have a similar dynamic: it's easy to be opposed to the present, but harder to defend concrete alternatives. The political columnist George Will wrote about this dynamic a few weeks back in the Washington Post (available here without a paywall). Will writes:

"Time was, socialism meant thorough collectivism: state ownership of the means of production (including arable land), distribution, and exchange. When this did not go swimmingly where it was first tried, Lenin said (in 1922) that socialism meant government ownership of the economy’s “commanding heights” — big entities. After many subsequent dilutions, today’s watery conceptions of socialism amount to this: Almost everyone will be nice to almost everyone, using money taken from a few. This means having government distribute, according to its conception of equity, the wealth produced by capitalism. This conception is shaped by muscular factions: the elderly, government employees unions, the steel industry, the sugar growers, and so on and on and on. Some wealth is distributed to the poor; most goes to the “neglected” middle class. Some neglect: The political class talks of little else."

The modern attraction of "socialism" is typically not that the advocate has a soft spot for Soviet-style or Venezuelan-style economic governance, or even that the advocate knows much about the actual trade-offs and choices of "socialist" countries like those of northern Europe. Instead, it's a watery notion of "socialism" as meaning "nice." This usage has a long tradition. As Will points out:

In his volume in the Oxford History of the United States (The Republic for Which It Stands) covering 1865–1896, Stanford’s Richard White says that John Bates Clark, the leading economist of that era, said “true socialism” is “economic republicanism,” which meant more cooperation and less individualism. Others saw socialism as “a system of social ethics.” All was vagueness.

This lack of clarity becomes a problem when advocates of socialism stop targeting the undoubted ills of society and instead propose actual changes of their own--thus making themselves the target for others. Agreeing on a critique, on opposing, on change, is easy. Agreeing on alternatives is hard. Will quotes an old political proverb: "Two American socialists equals three factions."

It's useful to point out social problems. But when those problems are long-standing and fairly well-known, pointing them out again and again offers little additional benefit. In my mind, calling for "change" is not very meaningful without saying what change is actually desired. Indeed, when someone points out a problem, I don't even know whether they are doing so in a constructive or a destructive spirit until I have some sense of their preferred alternatives. Calls for "change" can be intoxicating. But it feels to me that we have a tendency to lionize those who are uncompromising in their criticisms, in a way that makes it harder for those who are trying to work through costs and tradeoffs to enunciate a policy with practical gains. 

Gross National Happiness and Macro Indicators in Bhutan

A lot of people have heard, one way or another, that the country of Bhutan decided back in the early 1970s to pursue Gross National Happiness. The King at that time is supposed to have said:  “Gross National Happiness is more important than Gross Domestic Product.” But in practical terms, what does that actually mean?  Sriram Balasubramanian and Paul Cashin describe "Gross National Happiness and Macroeconomic Indicators in the Kingdom of Bhutan" in IMF Working Paper WP/19/15 (January 2019). They write:

"In this context, this paper will look at the relationship between the evolution of GNH and the evolution of GDP and other macroeconomic indicators. ... Using the case of Bhutan, this paper will examine the relationship between GDP growth and happiness (or well-being), using subjective well-being measures such as surveys of nationally-representative samples of the population (such as the GNH Surveys). That is, we will examine whether GDP growth is a useful proxy for and conduit to happiness, and whether happiness-driven policies can help raise economic growth rates."

At present, the working definition of Gross National Happiness in Bhutan involves four "pillars:" Sustainable and Equitable Social and Economic Development, Preservation and Promotion of Culture Conservation of the Environment, and Good Governance. These  in turn divided into nine "domains," which are then divided into 33 "indicators," which are measured by 124 variables, each with their own weights.  For a rough sense, here are the nine "domains" and what they are meant to cover.

Although the idea of Gross National Happiness has often been invoked in Bhutan since the 1970s, attempts to measure it with 124 indicators are more recent, and in fact have only been done in
directly are in 2008, 2010, and 2015. The authors explain: "To measure GNH, a profile is created for each person showing in which of 33 grouped indicators (formed from the abovementioned 124 indicator variables) the person has achieved sufficiency. As noted by the Gross National Happiness Commission (2015), not all people need to be sufficient in each of the 124 variables to be happy. Accordingly, in tabulating the Survey results the Commission divides Bhutanese into four groups depending on their degree of happiness, using three cutoffs: 50%, 66% and 77%."

Thus, a comparison between growth of per capita GDP in Bhutan and the Gross National Happiness Index for these three years looks like this.

From 1980 to 2017,  Bhutan's per capita GDP rose by a factor of 6, thanks in part to the development of its energy sector and to expanding trade ties with India. But given the data, it doesn't seem possible to say if Gross National Happiness has also risen sixfold.

There are also survey measures of happiness, in which people are asked to rank their own level of happiness:  for example, in the World Happiness Repot 2018, "the happiness ranking of Bhutan fell from 84th (2013–15) in the world to 97th (2015–17) out of 156 countries."

So what are we to make of Bhutan's Gross National Happiness?

1) It is bog standard economics that GDP was never intended to measure happiness, nor to measure broader social welfare. Any intro econ textbook makes the point.  A well-known comment from "Robert Kennedy on Shortcomings of GDP in 1968" (January 30, 2012) make the point more poetically. But for those who need a reminder that social welfare is based on a wide variety of outcomes, not just GDP, I suppose a reminder about Gross National Happiness might be useful.

2) Bhutan's measurement of 124 weighted indicator variables, and their distribution through the population,  is probably about as good a way of measuring Gross National Happiness as any other, and better than some. But it's also pretty arbitrary in its own way.

3) The interesting question about GDP and social welfare isn't whether they are identical, but whether they tend to rise together in a broad sense. For example, countries with higher per capita income also tend to have more education and health care, better housing and nutrition, more participatory governance, and a variety of other good things. .A few years ago I wrote about "GDP and Social Welfare in the Long Run" (April 6, 2015), or see "Why GDP Growth is Good" (October 11, 2012).

4) "Happiness" is of course a tricky subject, which is why it's the stuff of literature and love.  After a lot of consideration, Daniel Kahneman has argued that "people don't want to be happy."  Instead, they want to have a satisfactory narrative that they can tell themselves about how their life is unfolding. If incomes, education, and life expectancy rise over, say, 40-50 years but on a scale of 1-10 people don't express greater "happiness" with their live, does that really mean they would be equally happy with lower incomes, education and life expectancy--especially if other countries in the world were continuing to make gains on these dimensions? There is an ongoing argument over whether those who have higher income express more happiness because they get to consume more, or because they feel good about comparing themselves who are worse off. It's easy to say that "money doesn't bring happiness," and there's some truth in the claim. But for most of us, if we lived in a country with lower income levels and could watch the rest of the world through the internet and television, it would bug us at least a little, now and then.

It seems to me easy enough to make the case that looking at Gross National Happiness as is better than an exclusive focus on doing nothing but boosting short-term GDP. But outside the fictional mustachio-twirling econo-villains of anti-capitalist comic books, no one actually believes in an exclusive focus on GDP. For me as an outsider, it's hard to see how Gross National Happiness has made Bhutan's development strategy different. After all, lots of countries at all income levels emphasize lots of goals other than short-term GDP. And the government of Bhutan pays considerable attention to GDP, as the authors note, "While there is importance given to GNH in Bhutan, governmental organizations (especially commerce related ones) focus keen attention on GDP and how it measures trade, commerce and the economic prosperity of the country. In addition, the IMF has provided a great deal of technical assistance to Bhutan to help improve its national accounts ..."

My own favorite comment on the connection from GDP to social welfare is from a 1986 essay by Robert Solow ("James Meade at Eighty," Economic Journal, December 1986, pp. 986-988), where he wrote: "If you have to be obsessed by something, maximizing real National Income is not a bad choice." At least to me, the clear implication is that it's perhaps better not to be obsessed by one number, and instead to cultivate a broader and multidimensional perspective. If you want to refer to that mix of statistics as Gross National Happiness, no harm is done. But yes, if you need to pick one number out of all the rest (and again, you don't!), real per capita GDP isn't a bad choice. To put it another way, a high or rising GDP certainly doesn't assure a high level of social welfare, but it makes it easier to accomplish those goals than a low and falling GDP.

Universal Basic Income: Preliminary Results from the Finnish Experiment

The big selling points for a universal basic income are simplicity and work incentives. The simplicity arises because with a universal basic income, there are no qualifications to satisfy or forms to fill out. People just receive it, regardless of factors like income levels or whether they have a job. There are not bureaucratic costs of determining eligibility, and no stigma of applying for such benefits or in receiving them.

The gains for work incentives arise because many programs aimed at helping the poor have a built-in feature that as you earn more on the job, you receive less in government assistance. From one standpoint, this seems logical and fair. But economists have been quick to point out that if someone loses a dollar of government benefits every time they gain a dollar from working, the implicit tax rate is 100%. When there are a number of different programs aimed at the working poor, all phasing out on their own individual schedules as income rises, the result can be that low-income people face very high implicit tax rates--even in some situations close to 100%. But a universal basic income does not decline or phase out as someone earns more income. 

There are plenty of assertions about how a universal basic income would affect work incentives, but actual hard evidence is still accumulating. The province of Ontario announced that it would run a three- year experiment, but then cancelled it after one year. An organization called GiveDirectly is running a universal basic income experiment in Kenya, although results aren't available yet, but there is reason to be skeptical as to whether the cost and effects of such a program in a low-income country will offer natural lessons for high-income countries. A firm called YCombinator is planning to run a universal basic income experiment in two US cities starting in 2019, but details still seem sketchy. The city of Stockton in California has just started an experiment where 130 people will get monthly payments of $500 for the next 18 months.  The program in Alaska in which residents get a payment from the state based on oil royalties, typically $1000-$2000 per year, can be viewed as a form of a universal basic income, although it's clearly not enough to live on by itself.

Finland has been running an experiment with a university basic income for the last couple of years, and preliminary results on work behavior are now available. The report is  "The basic income experiment 2017–2018in Finland," edited by Olli Kangas, Signe Jauhiainen, Miska Simanainen, Minna Ylikännö and published by Finland's Ministry of Social Affairs and Health (February 2019). They write:

"[T]he amount of basic income was 560 euros per month. This corresponded to the monthly net amount of the basic unemployment allowance and the labour market subsidy provided by Kela (the Social Insurance Institution of Finland). Two thousand persons aged 25–58 years who received an unemployment benefit from Kela in November 2016 were selected for the actual experiment. They were selected through random sampling without any regional or other emphasis. ... Despite its deficiencies, the Finnish experiment is exceptional from an international perspective in that participation in the experiment was compulsory and it was designed as a randomised field experiment." 

The effects on employment during the first year of the experiment (that is in 2017) turn out to be essentially nonexistent

Of the persons who in November 2016 received an unemployment benefit from Kela, 57 per cent had no earnings or income from self-employment in 2017. The figures also reveal that the average income of those who had been in employment was only around 9,920 euros. ... [T]he experiment did not have any effect on employment status during the first year of the experiment. The number of annual days in employment for the group that received a basic income is on average about half a day higher than for the control group. Overall, receipt of any positive earnings or income from self-employment, either from the open labour market or the subsidised labour market, is about one percentage point more common in the treatment group. However, resulting earnings and incomes from self-employment turned out to be 21 euros smaller.

In other results based on phone surveys, those who received the universal basic income expressed greater confident in their own future, and they expressed a belief that it would be easier to accept a future job offer. It will be interesting to see if these attitudes lead to actually higher employment as the 2018 data becomes available .

It's important to note that like all practical experiments, the Finnish experiment was not a completely pure universal basic income. For example, the experiment targeted the long-term unemployed, not the working poor as a group, and those receiving the benefit still dealt with the government for other support programs, like housing assistance. In adidtion, the experiment would need to be considered in the context of Finland's overall labor market. So the results are preliminary in a number of ways. But it's hard to spin them as encouraging.

For those who would like a bunch of links to discussion of the Finnish experiment and broader recent discussions of a universal basic income, a useful starting point is the extended blog post at the Brueghel website by Catarina Midoes, "Universal basic income and the Finnish experiment" (February 18, 2019).

For a pragmatic discussion of how a true universal basic income--that is, a payment to everyone that does not phase out regardless of income--might work in a US context, interested readers might start with Universal Basic Income: A Thought Experiment" (July 29, 2014).  If one took all the money from US (nonhealth) antipoverty programs, as well as a number of tax breaks that tend to benefit the middle-and upper-class, one could fund a universal basic income for the US of about $5800 per year.

China's High Savings Rate

China has a remarkably high savings rate in a typical year--and sometimes its higher than that. In fact, the main reason for China's high trade surpluses is that with such a high savings rate, China doesn't consume either a lot of imports or domestically produced goods. A reason that China can invest so much, year after year, is that the investment is financed by high savings rates. A standard recommendation for China's economy for at least the last 15 years or so is to "rebalance" toward being an economy driven by domestic consumption, not by investment.

A team of economists from the IMF--Longmei Zhang, Ray Brooks, Ding Ding, Haiyan Ding, Hui He, Jing Lu, and Rui Mano--discuss these issues and others in "China’s High Savings: Drivers, Prospects, and Policies," written as IMF Working Paper WP/18/277 (December 11, 2018).

Here's a comparison of national savings around the world in 2017. The US had national savings of 18.9% of GDP. The savings rate for the world as a whole was 26.4%. China was saving 45.8% of GDP, easily more than double the US level. And China's national savings rate is actually down a bit from when it peaked at 52% of GDP back in 2008.

To get a sense of what these high rates of saving imply for the mixture of consumption and investment in aneconomy, consider this figure. The horizontal axis shows a country's level of consumption; the vertical axis shows its level of fixed capital investment. China is way in the upper left, with low consumption and high investment,. The authors write: "With GDP per capita in PPP terms being similar to Brazil’s, consumption per capita in China is only comparable to Nigeria. If Chinese households consumed comparably to Brazilian households, their consumption levels would be more than double." One sometimes hears saying applied to China: "Country rich, people poor." The high savings rate is why it can feel that way. 

Government in China has not run especially large budget deficits or budget surpluses, so the mixture of household and corporate saving is what drives China's high savings rate. Corporate savings in China were quite high in the early 2000s, but as a percent of GDP are now pretty much in line with global averages. China's high savings rate thus traces to its household sector. The authors write:

"Household savings in China have been trending up since the early 1990s and peaked at 25 percent in 2010 and moderated slightly in recent years. Globally, household savings have been falling (from 14 percent of GDP in 1980 to about 7 percent today). The diverging trend has led to an increasing gap between China and the rest of the world. At 23 percent of GDP, today China’s household savings are 15 percentage points higher than the global average and constitute the main drivers of higher national savings in China."

Why do China's households save so much? Some of the likely factors include:

Low birthrates and the one-child policy meant less need to spend on children, but less ability to rely on children in retirement--and thus an incentive for more saving. This can explain perhaps half of the rise in China's household savings rate in recent decades. 

As China's economy shifted from state-owned to privately owned firms in the 1990s, the safety net got a lot thinner. The authors write: 

For example, the health care coverage of urban workers declined by 17 percentage points between 1990 and 2000. Furthermore, the average replacement rate for urban workers (pension benefits in percent of wages) dropped sharply from close to 80 percent to below 50 percent (He at al., 2017). Nationwide, individuals have been paying increasingly larger shares of healthcare expenditures out of pocket, rising from 20 percent in 1978 to a peak of 60 percent in 2000. In addition, households also began paying more for education out of their own pocket, rising from 2 percent in 1990 to 13 percent in 2001.

Households saved so that they could invest in housing, both as a store of wealth and as an investment that has delivered high returns in the last 15-20 years. 

Up until just a few years ago, the options for making financial investments were fairly limited. Interest rates were controlled, and many people didn't have access to a wide range of other financial instruments. So if you wanted to accumulate a certain level of wealth by retirement, and your financial options paid only low interest rates, you had to save a lot. 

Where is China's high savings rate headed? Countries across east Asia have seen their household saving rate rise in a way similar to China, but then decline fairly rapidly. The authors write: 

East Asian economies experienced a rapid decline in household savings after the peak. Japan’s household savings rate peaked in 1974 at about 25 percent and has fallen to almost zero. In Korea, household savings peaked in the early 1990s at 27 percent, and are at about 15 percent today. Similarly, household savings in Taiwan POC also fell rapidly after peaking in 1993 at about 30 percent, although they stabilized a decade later at about 20 percent. Household savings in these countries or areas peaked at income levels similar to China’s, suggesting that the stage of development plays an important role in savings dynamics. In addition, microdata suggest that the decline in aggregate household savings in those countries or areas was driven by lower savings rates across all income deciles, although the drop was much more pronounced for low-income households, likely reflecting the improvement in social safety nets. With the aging population and strengthening of the social safety net, China is likely to follow the regional trend.

As China's population ages, household savings rates will decline and public pressures for more spending on pensions and health care will rise. Thus, the movement to lower savings rates could be reinforced if China's government shifted its pattern of spending from investment-heavy to more consumption-heavy. Here's a figure showing public investment as a share of GDP across a number of countries. 

And here's a figure showing government spending on consumption-related areas like health, education, social assistance, and pensions. The red diamond shows average levels of spending in these areas as a share of GDP for OECD countries. The yellow diamonds show the average for emerging markets around the world. The blue bars show China. .

In a low-saving, low-investment economy like the US, it's a little hard to conceive that its possible for savings and investment rates to be too high for a country's economic health. But that's where China has been, and shifting away from established patterns is rarely simple.

SOFR Replaces LIBOR

But those with medium-term memories will remember that a scandal erupted around LIBOR in 2010. But you may not know that as a result, LIBOR is probably going to disappear in the next few years to be replaced by SOFR. Since several hundred trillion dollars of financial contracts will be different as a result, it's useful to have at least some sense of what the change means

Jessie Romero tells the story in "Leaving LIBOR: The Fed has developed a new reference rate to replace the troubled LIBOR. Will banks make the switch?" which appears in Econ Focus from the Federal Reserve Bank of Richmond (Third Quarter 2018).

 LIBOR stands for the London Interbank Offered Rate. It's a benchmark interest rate, which means that when LIBOR goes up or down, the payments owed in a few hundred trillion dollars of contracts go up or down, too. The problem is that LIBOR has been calculates as a survey response to hypothetical question. Romero explains:

LIBOR is based on how much banks pay to borrow from one another. Each day, a panel of 20 international banks responds to the question, "At what rate could you borrow funds, were you to do so by asking for and then accepting interbank offers in a reasonable market size just prior to 11 a.m.?" The highest and lowest responses are excluded, and the remaining responses are averaged. Not every bank responds for every currency; 11 banks report for the franc, while 16 banks report for the dollar and the pound. For each of the five currencies, LIBOR is published for seven different maturities, ranging from overnight to 12 months. In total, 35 rates are published every applicable London business day.

About 95 percent of the outstanding contracts based on LIBOR are for derivatives. (See chart below.) It's also used as a reference for other securities and for variable rate loans, such as private student loans and adjustable-rate mortgages (ARMs). In 2012, the Cleveland Fed calculated that about 80 percent of subprime ARMs were indexed to LIBOR, as well as about 45 percent of prime ARMs. Prior to the financial crisis, essentially all subprime ARMs were linked to LIBOR.

What happened in the LIBOR scandal was that some too-smart traders at Barclay's, JP Morgan Chase, and Citigroup figured out that if just a few of the people answering the LIBOR survey would slant their responses just a bit, this benchmark interest rate could be manipulated a tiny bit higher or lower. And any trader who knows where the benchmark is headed--even if the movement is a tiny one--is well-positioned to consistently make a lot of money. Romero writes:

As regulators investigated ... [b]eginning at least in 2003, banks had been submitting LIBOR reports that would benefit their trading positions. Rate submitters and traders at different banks and brokerages also conspired with each other to manipulate LIBOR, promising each other steaks, Champagne, and Ferraris (among other perks). Internal emails and instant messages revealed the scheme. As one trader wrote, "Sorry to be a pain but just to remind you the importance of a low fixing for us today." Another wondered "if it suits you guys on hiking up 1bp on the 6mth Libor in JPY [one basis point on the six- month LIBOR in Japanese yen] ... it will help our position tremendously." At least 11 financial institutions faced fines and criminal charges from multiple international agencies, including the Commodity Futures Trading Commission (CFTC) and the Justice Department in the United States. Separately, in 2014 the FDIC sued 16 global banks for manipulating LIBOR, alleging that their actions had caused "substantial losses" for nearly 40 banks that went bankrupt during the financial crisis.

Although LIBOR has continued under stricter management, it seems clear that it was a bad idea to have a benchmark interest rate determined by answers to a survey. Instead, the challenge was to choose an interest rate for very safe borrowing--remember, LIBOR was banks borrowing from each other for very short terms, including overnight--but determined in a market that had lots of liquidity and volume.

Various groups of brainiacs tackles the problem. As one example from a few years ago in 2015, Darrell Duffie and Jeremy C. Stein surveyed the possible options in "Reforming LIBOR and Other Financial Market Benchmarks" published in the Journal of Economic Perspectives (29 (2): 191-212). Eventually an Alternative Reference Rates Committee was convened by the Federal Reserve, with representation from both government agencies and the private sector, and it published its recommendation in a March 2018 report.

Bottom line: It recommends using the SOFR as the preferred benchmark interest rate, which stands for Secured Overnight Financing Rate. It refers to the cost of borrowing which is extremely safe, because the borrowing is only overnight, and there are Treasury securities used as collateral for rthe borrowing. The SOFR rate is based on a market with about $800 billion in daily transactions, and this kind of overnight borrowing doesn't just include banks, but covers a wider range of financial institutions. The New York Fed publishes the SOFR rate every morning at 8 eastern time.

But perhaps the best reason for using SOFR is that an agreed-upon benchmark interest rate is needed, and LIBOR is going away. As Romero reports, banks have been trying to duck out of answering the LIBOR survey for a few years now, and have continued to participate only because of threats from regulators. After all, with hundreds of trillions of financial contracts using LIBOR, it was important for the stability of global financial markets that the reference rate didn't become volatile or vanish altogether. But by around 2021, the financial regulators are ready to let LIBOR die. New financial contracts are often now being written with SOFR, instead.

For most of us, the shift from LIBOR to SOFR doesn't affect our daily lives. But when you are discussing a risk-free interest rate, or a benchmark interest rate for a contract or mortgage with adjustable rates, you are soon going to stop hearing about LIBOR. For practical purposes, just remember that SOFR serves the same benchmark interest rate function.

Some Proposals for Improving Work, Wages, and Skills for Americans

The Aspen Institute Economic Study Group has published a collection of 12 papers on the theme Expanding Economic Opportunity for More Americans Bipartisan Policies to Increase Work, Wages, and Skills, edited by Melissa S. Kearney and Amy Ganz (February 2019). I'll list the complete Table of Contents for the volume below. Here, I'll just focus on four of the proposals that struck me as especially thought-provoking: caught

1) A Boost for Community Colleges

From "A Policy Agenda to Develop Human Capital for the Modern Economy," by  Austan Goolsbee, Glenn Hubbard, and Amy Ganz:

The United States should make a bold and dedicated commitment to increasing the skills and productivity of its workforce by leveraging the potential of the community college sector. We propose a federal grant program to provide new funding to community colleges, contingent on institutional outcomes in degree completion rates and labor market outcomes. We believe a program of a similar scale to the 19th century Morrill Land Grant Program, which dramatically expanded access to higher education for working-class Americans, is needed to ensure our workforce meets the demands of the modern economy. ...

In 1910, fewer than 10% of Americans had a high school degree. By 1935, nearly 40% of the population had earned their degrees. This inflection point came from substantial new investments in the nation’s education resources. We aim to achieve increases of a similar magnitude ...by 2030:

1. Close the completion gap between two-year college students aged 18 to 24 and their peers at four-year institutions by increasing the average completion/transfer rate among 18- to 24-year-olds at community colleges from 37.5% to 60% by 2030.3 This would result in 3.6 million additional 18- to 24-year-olds with college degrees in 2030.
2. Increase the share of Americans aged 25 to 64 with a college degree or other high-quality credential from 46.9% to 65% by 2030, which reflects the expected share of jobs requiring advanced skills by that year. This goal would require 28 million additional workers to earn first-time degrees or high-quality credentials by 2030. ... 

We estimate an annual investment of $22 billion. 

2) A Boost for Apprenticeships

From "Scaling Apprenticeship to Increase Human Capital," by Robert I. Lerman

[T]he United States has lagged far behind other developed countries—countries like Germany and Switzerland, but also Australia, Canada, and England—in creating apprenticeships. In these countries, apprentices constitute about 2.5-3.0% of the labor force, or about 10 times the U.S. rate. Increasing the availability of apprenticeships would increase youth employment and wages, improve workers’ transitions from school to careers, upgrade those skills that employers most value, broaden access to rewarding careers, increase economic productivity, and contribute to positive returns for employers and workers. ...

The experiences of Australia, Canada, and England demonstrate that scaling apprenticeship is quite possible, even outside countries with a strong tradition of apprenticeship. While none of these countries have the strong apprenticeship tradition seen in countries like Austria, Germany, or Switzerland, they have nonetheless grown significant programs. In fact, if apprenticeships as a share of the U.S. labor force reached the levels already achieved in Australia, Canada, and England (on average), the United States would attain over 4 million apprenticeships, about 9 times the current number of registered apprenticeships in the civilian sector. ...

Overall, the federal government has devoted less than $30 million (per year) to the Office of Apprenticeship (OA) to supervise, market, regulate, and publicize the system. Many states have only one employee working under their OA. Were the United States to spend what Britain spends annually on apprenticeship, adjusting for differences in the size and composition of the labor force, it would provide at least $9 billion per year for apprenticeship. In fact, the British government spends as much on advertising its apprenticeship programs as the entire U.S. budget for apprenticeship. ...

Today, funding for the “academic only” approach to skill development in the United States dwarfs the very limited amounts available to market and support apprenticeship. Yet apprenticeship programs yield far higher and more immediate gains in earnings than do community or career college programs and cost students and the government far less.

3) Sharing the Costs of Higher Minimum Wages with a Tax Credit

From "The Higher Wages Tax Credit," by David Neumark

In recent years, there has been a torrent of state and local minimum wage increases. For example, as of the end of 2017, 30 states (including the District of Columbia) had minimum wages above the $7.25 federal minimum wage, with an average difference of 26%. At the state and local level, California, New York, Seattle, and the District of Columbia have or will soon have a $15 minimum wage; other localities may follow. Finally, a change in the national political alignment could result in a $15 national minimum. ...

While the effects of minimum wage increases are contested, it is impossible to dismiss the sizeable body of evidence that suggests minimum wage hikes reduce employment among the least skilled (including recent research that addresses criticisms of earlier evidence). In addition, it is uncontested that higher minimum wages do not target low-income families very well, in part because of the large number of teenagers earning the minimum wage, and in part because poverty is more strongly related to whether or not one works and how many hours one works, rather than low wages ....

I propose a Higher Wages Tax Credit (HWTC) to partially offset the costs imposed by minimum wage increases on firms that employ low-skilled labor. Following a minimum wage increase, the HWTC would provide a tax credit of 50% of the difference between the prior minimum wage and the new minimum wage, for each hour of labor employed; the credit would phase out at wages higher than the minimum wage, and as wage inflation erodes the real cost of higher nominal minimum wages. The HWTC would reduce the incentive for employers to substitute away from low-skilled workers in the face of minimum wage increases, thus mitigating the potential adverse effects of minimum wage increases while simultaneously preserving and possibly enhancing some of the benefits of minimum wage hikes.

4) Minimum Zoning to Ease Movement to Higher-Cost, Higher-Wage Locations

From "How Minimum Zoning Mandates Can Improve Housing Markets and Expand Opportunity," by Joshua D. Gottlieb

Dramatic differences in income, productivity, and housing costs within the United States make geographic mobility important for spreading prosperity. But Americans’ ability to move to places like San Francisco, Boston, and New York in search of economic opportunities is limited by severe restrictions on new housing supply in these productive places.State-level Minimum Zoning Mandates (MZMs) allowing landowners to build at a state-guaranteed minimum density, even in municipalities resistant to development, would be an effective means of encouraging denser housing development. These MZMs would improve housing affordability, spread economic opportunity more broadly, and limit the environmental impact of new development. ...

I propose that state governments adopt Minimum Zoning Mandates (MZMs). These MZMs would be explicit zoning codes that provide a baseline minimum density that land owners, such as developers, can invoke when municipal zoning and permitting processes prevent useful development.

The MZMs should provide all land owners with a meaningful right to build housing up to a certain density significantly beyond single-family houses. Medium-density rowhouses and small apartment buildings should be allowed in every location where any sort of development is allowed. This is the type of density that is associated with some of America’s most-loved neighborhoods: Greenwich Village and other parts of Lower Manhattan, Boston’s North End and South End, the Mission in San Francisco, Lincoln Park in Chicago, and much of historic Philadelphia. It meshes well with existing single-family homes, as we see in places like Cambridge, Massachusetts. MZMs need not enable high-rise condo towers that would change the character of leafy, low-density neighborhoods. Even medium-density zoning rules could generate interesting new neighborhoods and resolve the housing shortages in productive cities.

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Full Table of Contents

Part I: Developing Human Capital for the Modern, Global Economy

"A Policy Agenda to Develop Human Capital for the Modern Economy," by Glenn Hubbard, Austan Goolsbee, and Amy Ganz
"What Works in Career and Technical Education (CTE)? A Review of Evidence and Suggested Policy Directions,"  by Ann Huff Stevens
"Scaling Apprenticeship to Increase Human Capital,"  by Robert I. Lerman
"The Challenges of Leveraging Online Education for Economically Vulnerable Mid-Career Americans," by Joshua Goodman

Part II: Increasing Prime-Age Labor Force Participation 

"A Policymaker’s Guide to Labor Force Participation," Keith Hennessey and Bruce Reed
"Restoring Economic Opportunity for `The People Left Behind': Employment Strategies for Rural America." by James P. Ziliak
"Policies to Reintegrate Former Inmates Into the Labor Force," by Manudeep Bhuller, Gordon B. Dahl, and Katrine V. Løken

Part III: Promoting Private Sector Wage Growth and Job Creation 

"Economic Strategy for Higher Wages and Expanded Labor Participation," Jason Furman and Phillip Swagel
"The Link Between Wages and Productivity Is Strong," by Michael R. Strain
"Creating Economic Opportunity for More Americans Through Productivity Growth," by Chad Syverson
"The Higher Wages Tax Credit," by David Neumark
"How Minimum Zoning Mandates Can Improve Housing Markets and Expand Opportunity." bny Joshua D. Gottlieb

Capitalism with Scandinavian Characteristics

Here's an op-ed piece by me that was published on the editorial page of the local Star Tribune newspaper yesterday, February 17.

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Capitalism with Scandinavian characteristics
What it is, why it's not socialism, and what we in the U.S. might be surprised to learn about it.
By TIMOTHY TAYLOR


MAGNUS LAUPA • NEW YORK TIMES
Outside an H&M store in Stockholm, the Swedish capital. The country is capitalist, but Scandinavian capitalism is different from that in the United States.



It is a truth universally acknowledged that arguing about the definitions of terms like “capitalism” and “socialism” is a waste of time. So I will simply assert that the world has many flavors of capitalism — U.S./British, Japanese, Scandinavian, German, French/Italian/Southern European and others.

I’ve known some genuine socialists who favor outright government ownership and control of the means of production, which necessarily means government making all the decisions about what is produced, where it is produced, how it is priced, who gets hired and how much workers get paid.

But most people who talk a socialist game, when asked for real-world examples, tend to sidestep the more extreme (and less attractive) possibilities and point to European countries — in particular, to Northern European countries like Sweden, Denmark, Norway and sometimes Finland.

The genuine socialists I know view these countries as sellouts to capitalism. The Scandinavians themselves are quick to deny that they are socialists, too. For example, the prime minister of Denmark gave a talk at Harvard in 2015 and said:

“I know that some people in the U.S. associate the Nordic model with some sort of socialism. Therefore, I would like to make one thing clear. Denmark is far from a socialist planned economy. Denmark is a market economy. … The Nordic model is an expanded welfare state which provides a high level of security for its citizens, but it is also a successful market economy with much freedom to pursue your dreams and live your life as you wish.”

If we want to avoid quibbling over the s-word and instead just refer to a Scandinavian style of capitalism, what are some of its key elements?

The question is tricky, because the Scandinavian style of capitalism has gone through several stages in the last 50 years or so. In a 1997 article, the prominent Swedish economist Assar Lindbeck described how in the decades after World War II Sweden had a growing economy, generous public services, full employment and a fairly equal distribution of income. But this was followed by slower growth in the 1970s and a collapse of full employment and rise of inequality by the early 1990s.


In Lindbeck’s words, the Swedish model looked “less idyllic” by the early 1990s. Problems include “disincentive effects, problems of moral hazard and cheating with taxes and benefits, deficiencies in competition … as well as inflexible relative wages … [and] the ever higher ambitions of politicians to expand various government programs, and the gradually rising ambitions of union officials to compress the distribution of wages as well as to expand the powers of unions.”

In short, the Swedes themselves didn’t think the Scandinavian model of capitalism was working all that well in the 1980s and early 1990s, and they carried out a hardheaded redesign.

For example, there was a broad recognition that as a small, market-oriented economy open to international trade, Sweden needed healthy companies and skilled workers, so top tax rates were rolled back. Many government benefit programs were redesigned and rolled back. A ceiling was put on public spending. Sweden’s ratio of national debt to GDP fell from 80 percent in 1995 to 41 percent in 2017.

The U.S. system of capitalism relies on financial incentives to encourage work. In the Scandinavian model of capitalism, high taxes reduce the financial incentive to work but pay for social services that encourage work.

Henrik Jacobsen Kleven described this trade-off in a 2014 article. He calculated that “in the Scandinavian countries … an average worker entering employment will be able to increase consumption by only 20 percent of earned income due to the combined effect of higher taxes and lower transfers. By contrast, the average worker in the United States gets to keep 63 percent of earnings when accounting for the full effect of the tax and welfare system.”


But Kleven also points out that the higher Scandinavian taxes finance government policies that make it easier for many people to work — in particular “provision of child care, preschool, and elderly care.” He writes: “Even though these programs are typically universal (and therefore available to both working and nonworking families), they effectively subsidize labor supply by lowering the prices of goods that are complementary to working. … [T]he Scandinavian countries … spend more on such [labor] participation subsidies … than any other country. …”

The resulting higher tax burden is substantial. The total tax burden in the Scandinavian countries is almost half of GDP, while the combined spending of all U.S. levels of government is about 38 percent of GDP.

Some in the U.S. claim a Scandinavian level of social protection could be financed by taxing corporations and the rich. The Scandinavians recognized the unreality of that hope back in the 1990s. An October 2018 report from the Council of Economic Advisers (CEA) noted:

“The Nordic countries themselves recognized the economic harm of high tax rates in terms of creating and retaining businesses and motivating work effort, which is why their marginal tax rates on personal and corporate income have fallen 20 or 30 points, or more, from their peaks in the 1970s and 1980s.”

In addition, the Scandinavian countries impose a value-added tax of 24 or 25 percent on purchases. (A VAT functions like a sales tax, although it is collected from producers rather than at the point of sale.) The CEA report notes that, as a result, taxation of households in the Scandinavian economies is overall less progressive than in the U.S.


The Scandinavian model of capitalism has more equal economic outcomes. But for advocates for a higher U.S. minimum wage, it’s perhaps worth noting that the Scandinavian countries do not have minimum wage laws. However, rates of unionization are typically 70-90 percent of the workforce in Norway, Denmark and Sweden, as opposed to about 11 percent of the U.S. workforce. Negotiating pressure from these unions is a powerful reason for the greater equality of wages and benefits for labor.

Last fall, New York Times columnist Paul Krugman illustrated the greater economic equality in Scandinavian countries by citing estimates of income levels for people at different points in the income distribution. This comparison looks at income after taxes are paid and transfer payments are received.

Below about the 30th percentile of the income distribution, income levels are higher in Nordic countries. This shows both the greater equality of wages and greater government support for economic equality in those countries. (For perspective, the 30th percentile of the U.S. income distribution is roughly $32,000 per year.)

A low-income person at the 10-20th income percentile in Denmark or Finland has an income about 20 percent higher than an American’s at that place in the U.S. income distribution. But among middle-income people in the 55th-60th percentile of the income distribution, incomes in Denmark and Finland are 20 percent below those of the similar person in the U.S. income distribution. Overall, average income levels are about 20 percent higher in the United States.

(Health care benefits provided through government programs are not included in the estimates cited by Krugman. The omission is interesting to consider. U.S. health care spending per person is much higher than in other countries. Thus, including it would make U.S. income levels look much higher — and would probably close much of the income gap at lower levels of income.)


In my experience, a number of the features of the Scandinavian system of capitalism come as a surprise to Americans. Here are some additional examples:

• In the early 1990s, Sweden set up its equivalent of the K-12 school system so that parents have vouchers that can be used at public, private and for-profit schools.

• College tuition in the Nordic countries is free to the student. However, college graduates in these countries don’t earn substantially higher wages. As a result, Americans are more likely to attend college, even needing to pay for it.

• The Scandinavian countries have national programs of health insurance coverage, but with substantial co-payments. For example, data from the Organization for Economic Cooperation and Development (OECD) suggest that out-of-pocket health care spending is only a little lower in Norway than in the United States.

• Although the Scandinavian countries have greater government regulation of labor markets than the U.S., they tend to have lower levels of regulation for product markets and companies.


• Sweden’s social security system is based on mandatory contributions to individual accounts, with people having a wide range of several hundred possible investment options for their accounts, or a default fund mostly invested in stocks.

Whether these various aspects of the Scandinavian model appeal, or not, it’s worth remembering what works in one country may not transplant easily.

After all, the combined population of Sweden (10 million) Denmark (5.8 million) and Norway (5.3 million) is roughly comparable to that of the greater New York City metropolitan area, and rather less diverse. The Nordic countries have intimate economic and regulatory ties with the much larger European Union. However, Sweden, Norway and Denmark have kept their own currencies and don’t use the euro.

It seems inaccurate to me to label the Scandinavian model of capitalism as “socialism,” but arguing over definitions of imprecise and emotionally charged terms is a waste of breath. What does bother me is when the “socialist” label becomes a substitute for actually studying the details of how different varieties of capitalism have functioned and malfunctioned, with an eye to what concrete lessons can be learned.

Timothy Taylor is managing editor of the Journal of Economic Perspectives, based at Macalester College. He blogs at http://conversableeconomist.blogspot.com.

Note: Regular readers of this blog may recognize this op-ed as a tightened-up version of the blog post from last year, "The Scandinavian Style of Capitalism" (November 5, 2018). There are additional links, quotations, and detail in that post. 

Thinking about Pay-What-You-Can Restaurants

The idea of a pay-what-you-can restaurant raises obvious questions. Could it sustain itself? Or would those paying more than face value be swamped by those paying less? Are there ways of running such a venture that might be more sustainable than others?

The question arises because the Panera company starting in 2010 ran a group of up to five stores called Panera Cares that operated on a "pay-what-you-can" basis. The last one of these stores, based in Boston, is closing this week. Ben Johnson offers some background and reflections in "‘Pay what you can afford’ runs Panera out of bread," published at the Acton Institute blog (February 12, 2019).  He notes: “`Panera Cares' were indistinguishable from other Panera eateries in their branding, menu, or furnishings, except they announced that no one would be turned away if they did not pay one cent of the `suggested prices.' Those who could not afford to pay full price could volunteer for an hour at the store in exchange for the food."

Johnson emphasizes what went wrong, and it's more-or-less what you would expect. Some homeless people start eating there for every meal, but high school students dropped in for free food as well. The stores tried to explain their mission, telling the poor that they should be an irregular stop, rather than every day, and asking the high school principal to rein in the students. But trying to discourage misuse or overuse then led to accusations of profiling, followed up by requirements for sensitivity training.

Meanwhile, drug users were taking over the bathrooms, and the Panera Cares stores were typically covering only about 60-70% of their costs. Panera was sold in 2017 to a new set of investors in 2017, and probably not coincidentally, the Panera Cares experiment is now shutting down.

Clearly, those who are cynical about pay-what-you-can have some justification. But  just as clearly, cynicism isn't the whole story here. The Panera Cares experiment didn't last nine weeks or nine months, but more like nine years. Very large numbers of people got free or low-priced food. Others were willing to use Panera Cares as a charitable mechanism by paying more for food.

How widespread are pay-what-you-can restaurants? An organization called One World Everybody Eats serves as a clearinghouse for this model, offering expertise and network-building. The organization is now trying to find a replacement for Panera Cares to use a pay-what-you-can model in Boston. From the organization's website:

There are more than 60 community cafes around the world that have adopted the One World Everybody Eats model, including Panera Bread’s Panera Cares Cafes and the Jon Bon Jovi Soul Kitchens. Dozens of cafes are in development. New cafe development teams are joining our network of community cafes every month, proving that a cafe can thrive when guests are invited to pay what they can afford or offered the opportunity to volunteer for their meals.

Cafes in the OWEE network operate predominately with volunteers. Together, they serve nearly 4,000 meals a day, or more than 1.4 million meals a year.

OUR SEVEN CORE VALUES:

Pay-what-you-can pricing
Patrons choose their own portion size
Healthy, seasonal food is served whenever available
Patrons may volunteer in exchange for a meal
Volunteers are used to the maximum extent possible to staff the organization
Paid staff earn a living wage

I haven't looked over the full list of the 60 or so pay-what-you-can places, but I checked the one location in my state of Minnesota. It's in a smaller city about 25 miles from Minneapolis. It's run by a church, and it's only open on Tuesdays and Thursdays for a couple of hours in the morning. This operation seems to me a valuable and praiseworthy and useful method of involving the community in helping the hungry. But it's not what most people would call a "restaurant."

What determines the feasibility of a pay-what-you-can restaurant? The key seems to be whether it can attract a decent-sized clientele of those who are willing to pay full price, and more than full price. Otherwise, if this kind of operation runs almost entirely on volunteer labor and donated money, then it may be a worthwhile and worthy operation, but if hardly anyone is paying, it's probably not appropriate to refer to it as pay-what-you can.

Giana M. Eckhardt and Susan Dobscha look at these issues in "The Consumer Experience of Responsibilization: The Case of Panera Cares," published in the Journal of Business Ethics in January 2018. To have a sense of how Panera Cares was operating, consider this description:

Greeters called “Ambassadors” are situated at the front of the café to explain to the customers that when they get to the counter, they can pay what they want, and that the café is a nonprofit, as most people think they are in a Panera Bread rather than a Panera Cares. Greeters must be able to “diffuse potentially difficult situations,” which as we will see arise fairly frequently when the food insecure eat at the restaurant. The food secure are encouraged to pay above what their meal is worth. Because the cafés tend to be overwhelmed with homeless people, the food insecure can only eat one entrée for free per week, and must earn it via 1 h of volunteering. To discern between the two groups, the greeter relies on consumer profiling, done solely via physical appearance and dress. 

After studying the operation of Panera Cares, talking with managers and in particular looking at online reviews posted at Yelp.com, Eckhardt and Dobscha describe the social tensions that arise in this way:

We demonstrate that consumers feel discomfort with the conscious pricing policy. This discomfort takes three forms: physical, psychological, and philosophical. ...

Although most Panera Cares consumers profess to care broadly about the social problem of food insecurity, they are not comfortable with the very real experience of being proximal to those consumers. ... The food insecure are also not comfortable with eating
in close proximity to the food secure. An important principle that undergirds the notion of serving a temporarily food insecure population, and providing dignity, is that of anonymity. ... Yet the reality within the cafés differs from this, and because of the proximity to food secure customers, results in discomfort stemming from physical proximity. ...

In addition to physical discomfort, consumers were also uncomfortable with other non-physical dimensions of conscious pricing in Panera Cares, including the social comparison with other consumers that takes place and the consumer profiling that the café employees engage into determine who is food secure and food insecure, which we label psychological discomfort. First, in the café, consumers monitor the donation behavior of other consumers. ...  In this case, social comparison takes the form of noticing how much other customers are paying, and interpreting the amount, if
it is low, as free rider behavior. ...In particular, how he food insecure look plays an important role. On the one hand, if they look presentable, they fulfill the temporarily food insecure profile that Panera Cares wants to cater to, and are more likely to be treated with dignity. On the other hand, by virtue of looking presentable, they are also questioned as to why they cannot pay more. In sum, consumers feel uncomfortable with the social comparison and profiling which regularly occur in Panera Cares, and this results in psychological discomfort. ...

There was also discomfort with motives and tactics behind the conscious pricing model, which we label philosophical discomfort. That is, consumers were uncomfortable with the general philosophy behind what Panera Cares was doing and how they were doing it. This manifested itself in two ways: discomfort with how the conscious pricing policy is
explained and questioning the motives of the parent company, Panera Bread. . ... Overall, this questioning of the motives and tactics of Panera Cares (a nonprofit) may be intensified because of the close connection it has to its for-profit parent company Panera Bread. Lee et al. (2017) argue that the distinction between companies that have a social mission versus those who have a profit mission is salient for consumers, and in the case of Panera Cares and Bread, is not clear. A nonprofit orientation can paradoxically drive consumer perception of organizational greed. This is because communal norms rather than exchange norms are invoked by consumers, and any perceived breach of communal norms is seen as an indication of greed. As we saw with customers using terms like tax haven and marketing gimmick to describe Panera Cares, this effect seems to be at play here. 

The evidence suggests that a pay-what-you can restaurant model is more likely to last if it is clearly a nonprofit, if it have an outside source of funding, if it is located in areas with a supply of customers willing to participate both by paying and by sharing space with the homeless, and if it able to establish a set of customary behavioral expectations for all parties who enter the restaurant. In one way or another, a pay-what-you-can restaurant will have to find ways of addressing these issues of physical, psychological, and philosophical discomforts.

Interview with Deidre McCloskey on Economic Growth and Liberal Values:

Eric Wallach offers "An Interview with Deidre McCloskey, Distinguished Professor Emerita of Economics and of History, UIC" in The Politic, Yale's undergraduate journal of politics and culture (February 10, 2019).  McCloskey is characteristically thought-provoking and quotable. Here are a few comments of her many comments that caught my eye:

"Liberty is liberty, and is meaningless by parts."

The central misconception is to think that one can claim the honorable title of “liberal” if one approves of one form of liberty, such as mutual consent in sexual partners or the ability to drill for oil where you wish, but excludes the other form. Liberty is liberty, and is meaningless by parts. You are still a slave if only on odd days of the month.

In Latin America, for example, the word “liberal,” once meaningful there, has long been appropriated by conservatives who like to drill for oil where they wish, but hate gays. In the United States, it has been appropriated by sweet, or not so sweet, slow socialists, who celebrate diversity, but regard economic liberty as not worthy of much consideration. ...

I used to think freedom was freedom of speech, freedom of the press, freedom of conscience. Here is what it amounts to: you have to have the right to sow what you wish to, to make shoes or coats, to bake into bread the flour ground from the grain you have sown, and to sell it or not sell it as you wish; for the lathe-operator, the steelworker, and the artist it’s a matter of being able to live as you wish and work as you wish and not as they order you.

"Put me down for 10 percent slavery to government." 

It’s unwise to turn the issue of helping the poor into an on/off, none/perfect, exist/not question. We need to be seriously quantitative about such matters. On/off doesn’t answer the important question, which is always more/less. People think they are making a clever remark against liberalism by saying, “Well, we need some government.” Yes, certainly. But how much? (Will Rogers in the 1920s used to say, “Just be glad you don’t get the government you pay for.”) ...

So here’s what a Liberalism 2.0 favors. It favors a social safety net, which is to say a clean transfer of money from you and me to the very poor in distress, a hand up so they can take care of their families. It favors financing pre- and post-natal care and nursery schools for poor kids, which would do more to raise health and educational standards than almost anything we can do later. It favors compulsory measles vaccination, to prevent the big spillover of contagion that is happening now in Clark County, Washington. It favors compulsory school attendance, financed by you and me, though not the socialized provision of public schools. The Swedes have since the 1990s had a national voucher system, liberal-style. It favors a small army/coast-guard to protect as against the imminent threat of invasion by Canada and Mexico, and a pile of nuclear weapons and delivery systems to prevent the Russians or Chinese or North Koreans from extorting us. All this is good, and would result in the government at all levels taking and regulating perhaps 10 percent of the nation’s production. Put me down for 10 percent slavery to government. Not the 30 to 55 percent at present that rich countries enslave.

"The Nordics ... are not thoroughly socialist, and in fact they are reasonably close to the U.S., and in some ways more anti-socialist."

Americans of good will have long been persuaded, on the basis of breathless articles in the Sunday New York Times Magazine, that the Nordics are thoroughly “socialist” ...  No, they are not thoroughly socialist, and in fact they are reasonably close to the U.S., and in some ways more anti-socialist. They are in fact highly liberal in their economies (and their fastest rates of growth since 1850 were in fact when they were even more liberal). Almost all prices in Sweden and the rest, for example, are determined by supply and demand, and are nothing like the disastrous socialist interventions by way of price controls in, say, Venezuela. Setting up a business is not hard. Inherited wealth in Scandinavia and Finland is not honored. Innovation is (for example Svenska Kullagerfabriken, SKF, a pioneer in ball bearings, out of which in the 1920s rolled Volvo [Latin for “I roll”]).

And government ownership of the means of production is trivial in all the Nordic countries. When Saab Motors went bankrupt, it came to the Swedish government hat in hand, and the government said, “Get lost.” When Volvo recently became a Chinese company, the government said, “So what?” You don’t have to exercise much imagination about what the American government would do if General Motors was so threatened: “Here are billions of tax dollars, and so the Federal Government owns part of you.” The American government in 2008 of course did precisely that.

"Give this gentleman sixteen cents. That’s his share of the wealth." 

[Andrew] Carnegie himself is said to have made the same point in another way. A socialist came to his office and argued to him that the wealthy should redistribute their wealth to the poor of the earth. Carnegie asked an assistant to go get him a rough estimate of his current wealth and of the population of the earth. The assistant returned shortly with the figures, and according to the anecdote Carnegie performed a calculation, then turned to the assistant and said, “Give this gentleman sixteen cents. That’s his share of the wealth.” And then he gave every dime of his wealth away, in accord with his Gospel of Wealth. Another businesslike Scot, Adam Smith, by the way, also gave away his considerable fortune, though, unlike Carnegie, he did not sound a trumpet before him when he did his alms.

Economics of Medieval Guilds

Guilds played an important role in the economies of Europe from about the 11th century up through the 16th century, and a continuing if less important role up into the 19th century. Sheilagh Ogilvie, the go-to economic historian on this subject, has a new book out called The European Guilds: An Economic Analysis (published by Princeton University Press and of course available on Amazon, too). For a flavor, here are some comments from the opening chapter: 

"Guild membership was therefore reserved for the privileged few. Guilds were small relative to the consumer markets they monopolized. They were also small relative to the wider labour market, whose members they largely excluded. Guilds were not all-encompassing workers' associations analogous to twentieth-century labor unions, but exclusive organizations for relatively well-off, middle-class men. ... 

The effects of guilds on economy and society have always generated controversy. Contemporaries held strong view about them, with guild members and their political allies extolling their virtues, while customers, employees, and competitors lamented their misdeeds. Many early economic thinkers praised guilds, as, for example, the French government minister Jean-Baptiste Colbert, who ordered all French crafts to form guilds, "so as to compose by this means a group and organization of capable persons, and close the doors to the ignorant," and the Austrian imperial councilor Johann Joachim Becher, who argued that the authorities in past eras had wisely invented the guilds because "competition weakens the livelihood of the community". Others censured guilds, as did Adam Smith when he called them "a conspiracy against the public", and Ann-Robert-Jacques Turgot, when he told the King of France: "I do not believe that one can seriously and in good faith hold that these guilds, their exclusive privileges, the barriers they impose to work, emulation, and progress in the arts, are of any utility. ... The total removal of the obstacles that this system imposes on industry and on the poor and laborious sections of your subjects [is] one of the greatest steps to be taken towards the betterment, or rather the regeneration, of the realm". ...

Modern scholars are also deeply divided on guilds. Some claim that guilds were so widespread and long-lived that they must have generated economic benefits. They might, for example, have solved information asymmetries between producers and consumers, overcome imperfections in markets for human capital, created incentive favoring innovation, put pressure on governments to be business-friendly, or generated social harmony by reducing competition, conflict, and inequality. Other scholars take a darker view. Guilds, they hold, were in a position to extract benefits for their own members by acting as cartels, exploiting consumers, rationing access to human capital investment, stifling innovation, bribing governments for favours, harming outsiders such as women, Jews, or the poor, and redistributing resources to their members at the expense of the wider community. 

As this book will show, my own reading of the evidence is that a common theme underlies guilds' activities: guilds tended to do what was best for guild members. In some cases, what guilds did brought certain benefits to the broader public. But overall, the actions guilds took mainly had the effect of protecting and enriching their members at the expense of consumers and non-members; reducing threats from innovators, competitors, and audacious upstarts; and generating sufficient rents to pay off the political elites that enforced the guilds' privileges and might otherwise have interfered with them. 

For an incomplete and appetizer-sized portion of the arguments presented in the book, potentially interested readers might start with Ogilvie's article, "The Economics of Guilds," published in the Fall 2014 issue of the Journal of Economic Perspectives (28:4, pp. 169-92) and freely available online, like all JEP articles, from the American Economic Association. From the abstract of the JEP article: 

Occupational guilds in medieval and early modern Europe offered an effective institutional mechanism whereby two powerful groups, guild members and political elites, could collaborate in capturing a larger slice of the economic pie and redistributing it to themselves at the expense of the rest of the economy. Guilds provided an organizational mechanism for groups of businessmen to negotiate with political elites for exclusive legal privileges that allowed them to reap monopoly rents. Guild members then used their guilds to redirect a share of these rents to political elites in return for support and enforcement. In short, guilds enabled their members and political elites to negotiate a way of extracting rents in the manufacturing and commercial sectors, rents that neither party could have extracted on its own. First, I provide an overview of where and when European guilds arose, what occupations they encompassed, how large they were, and how they varied across time and space. I then examine how guild activities affected market competition, commercial security, contract enforcement, product quality, human capital, and technological innovation. The historical findings on guilds provide strong support for the view that institutions arise and survive for centuries not because they are efficient but because they serve the distributional interests of powerful groups.

Of course, the issues raised by the medieval guilds have continuing economic relevance. There are continuing efforts to reduce competition, through method ranging from occupational licensing to trade tariffs, always based on the claim that setting the stage for a certain group of producers to receive higher profits is actually in the interest of society as a whole. This broad argument is probably true in a few cases: for example, patents restrain competition for a period of time, but by allowing innovators to earn higher profits they also provide incentives for innovation.

But in many cases, including guilds, a cycle forms in which government helps certain producers receive higher profits, and then a share of those profits goes to  helping government officials reach the conclusion that favoring one set of producers over consumers and other producers is a socially important goal.

Why US Financial Regulators Are Unprepared for the Next Financial Crisis

The Great Recession from 2007-2009 represented a toxic mixture of failures by market participants and financial regulators. The Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 patched some of the holes. but not nearly all of them. At least, that's the conclusion I reach from a three-paper "Symposium on Financial Stability Regulation" in the Winter 2019 issue of the Journal of Economic Perspectives. (Full disclosure: I have worked as Managing Editor of JEP since the first issue back in 1987, so I am perhaps predisposed to find its articles persuasive.) The papers are:

• "Financial Regulation: Still Unsettled a Decade after the Crisis," by Daniel K. Tarullo 
• "Prone to Fail: The Pre-crisis Financial System," by Darrell Duffie 
• "Would Macroprudential Regulation Have Prevented the Last Crisis?" by David Aikman, Jonathan Bridges, Anil Kashyap, and Caspar Siegert

To understand the underlying perspective here, you need to think about recessions in two parts. All grown-ups know that bad things are going to happen to economies from time to time: oil price shocks, trade shocks, price bubbles in stock markets or housing markets, and so on.  If an economy is reasonably resilient, any resulting recessions can be fairly mild and brief. On the other side, if an economy and its financial sector is fragile, with high levels of debt that often need to be rolled-over and refinanced on a short-term basis, then a recession that could otherwise have been fairly mild turns into a Great Recession.

From this perspective, the role of financial regulators goes beyond the traditional tasks of looking at individual financial institutions to make sure they are reasonably solvent and are providing timely and accurate information to investors. For some years now, financial regulators have been talking about "macroprudential" regulation (for example, here and here), which goes beyond looking at individual financial institutions to see whether the financial system as a whole is robust. The idea is to avoid the mistake of looking at individual trees, while missing risks that involve the entire forest. This view recognizes that recessions will continue to happen, but hopes that with robust financial system, they will not mushroom into another Great Recession.

In the context of the Great Recession, the team of Aikman, Bridges, Kashyap, and Siegert argue that if US financial regulators had the legal authority and the foresight to take steps to protect the overall robustness of the US financial system in the years before 2008, the Great Recession would have been only one-third or one-fourth as large. They write: "Our diagnosis centers on two overlapping but distinct vulnerabilities: the increase in leverage and short-term funding at financial intermediaries, and the build-up in indebtedness in the household sector. These factors, we argue, can account for around two-thirds to three-quarters of the fall in US GDP that followed the financial crisis."

They describe what macroprudential policy tools would have been needed to address these issues. For example, at least in theory a government regulator could have required that mortgage lenders impose certain loan-to-income rules, to hold down on the rise in household debt. Or at least in theory, a  government regulator could have imposed rules to prevent investment banks from relying so heavily on extremely short-term borrowing that needed to be rolled over every day--which made them highly vulnerable when that borrowing was not rolled over. However, they point out that these changes were not part of the power given to regulatory authorities by the Dodd-Frank legislation They write:

We argue that the US Financial Stability Oversight Council would likely make little difference were we to experience a rerun of the factors that caused the last crisis. It has no macroprudential levers under its direct control, and not all of its members have mandates to protect financial stability. ... And given the role played by loosely regulated nonbank financial institutions prior to the last crisis—and the continuing evolution of the financial system—a successful macroprudential intervention would likely require political backing to be nimble in widening the perimeter of regulation to capture such institutions. More generally, such a regulator would have to be fairly aggressive in using its powers. Given the novelty of these powers, there is no clear evidence on whether such forceful interventions would be realistic were risks to escalate again. ...

As one example of the powers that US regulators do not have:

After the crisis, the Dodd–Frank Act did ban certain types of mortgages, such as interest-only mortgages or those with negative amortization. But it left the question of minimum down-payment restrictions to a group of six regulators involved in housing, which ultimately opted against introducing such a requirement. While risks in the housing market have significantly declined since the crisis, average loan-to-value ratios on mortgages are not lower than they were in the early 2000s. Furthermore, no US regulator has the ability to impose loan-to-income requirements, even if the Financial Stability Oversight Council wished to recommend this action. ... Moreover, the Fed lacks authority over many parts of the financial system and has no tools that can be used to tackle household debt vulnerabilities. A June 2015 “war game” exercise conducted by four Reserve Bank presidents concluded that the Fed had insufficient macroprudential powers to address a build-up in risks that resembled the earlier financial crisis. Also, Fed officials have cast doubt on whether its mandate permits it to use monetary policy to act against a build-up in financial stability risks.

Thus, Aikman, Bridges, Kashyap, and Siegert are pointing out that financial regulators are unprepared for a literal rerun of the financial crisis that already occurred. The regulators also remain unprepared for financial crises that arise form other sources or in other forms.

For example, Daniel Tarullo points out in his essay that most of the regulatory attention has focused on banks. but potential dangers remain in the rest of the financial system. Tarullo writes:

Within the perimeter of prudentially regulated banking organizations, post-crisis financial regulation has made considerable strides, though liquidity regulation needs more work and capital requirements for the biggest banks should probably be somewhat higher.  ... While there is at least a chance for maintaining the progress toward more resiliency for the largest banks, it is considerably harder to conjure up a benign outcome with respect to financial activity that occurs outside the perimeter of banking organizations. Recycled or new forms of shadow banking will almost surely increase over time, whether from existing nonbank financial firms or from new fintech (financial technology) entrants. Some of these will present risks to financial stability. 

For an example of one set of shadow banking issues, Amit Seru argues that 'Regulation of the Mortgage Market Must Consider Shadow Banks" in a Policy Brief written for the Stanford Instituted for Economic Policy Research (December 2018). As he notes: " Mortgage lending in this country is highly segmented and traditional banks represent only an increasingly small part of the story. For many decades, banks have competed with independent mortgage companies that don’t take deposits and typically don’t have brick-and-mortar branches, a group that can be called `shadow banks.'” This figure shows that the share of mortgage lending that doesn't come from banks is over half and rising.


The mortgages from these independent companies are then bundled together into financial securities, which are in turn sliced and diced into pieces and resold to investors (including banks, pension funds, insurance companies, hedge funds, money market funds, and others). Because the financial reforms have focused so heavily on banks, they do not delve into the potential system risks from the nonbanks.

For other examples, Darrell Duffie discusses in his JEP essay "the run-prone designs and weak regulation of the markets for securities financing and over-the-counter derivatives." For example, one rule change is that there is now strong encouragement for financial derivatives to be bought and sold through central clearinghouses--but there has been little attention to the risks that might be accumulated in these clearinghouses. If a clearinghouse seemed close to failing, and as a result it appeared that many derivatives contracts could fail or go into limbo for a time, the effects on fhe financial system could be nasty. Duffie writes:

A key change is the increased use of central clearing, which was directly mandated in post-crisis regulation and further encouraged by new regulatory capital requirements that, in effect, expressed a preference for central clearing. A central counterparty (CCP), also known as a clearinghouse, enters a derivatives trade as the buyer to the original seller, and as the seller to the original buyer. In this way, original counterparties become insulated from each other’s default risk—provided of course that the clearinghouse meets its own obligations. Central clearing also improves the transparency of derivatives positions and enforces uniform collateral practices that are more easily supervised by regulators. ...

There do remain, however, important concerns over the ability to resolve the failure of central counterparties, which have become enormous concentrations of risk under post-crisis regulations. If a clearinghouse has insufficient resources to manage the default of the derivatives obligations of a clearing member, the consequences could be catastrophic, now that hundreds of trillions of derivatives have been cleared by a small number of systemically important central counterparties. The default management resources of the central counterparty consist primarily of the margins provided by clearing members against their positions, and by a default fund to which all clearing members contribute. If the initial margin of a failed clearing member is not enough to cover the losses, the default fund is then applied. If the clearinghouse burns through both of these paid-in default management resources, and a small layer of its own capital, it then has the contractual right to stop paying clearing members the amounts otherwise due on their derivatives, even to the point of “tearing up” their derivatives positions. In the worst scenarios, the cessation of payments to clearing members and tear-ups would be catastrophic, and contagious. The largest clearing members are generally also large members of other central counterparties. This tail contagion risk is subject to regulatory stress tests and ultimately to regulations that could trigger a failure resolution process for central counterparties. However, actual implementable plans for the failure resolution of clearinghouses have still not been designed, at least in the United States...

In November 2018, the Federal Reserve started publishing a Financial Stability Report, with lots of information about various possible sources of financial risk in the economy,  as well as a Supervision and Regulation Report about trends and patterns in these areas. My general sense is that there aren't any major systematic financial risks threatening the US economy right now. But one hopes that financial regulators can be proactive, rather than reactive, to risks that could easily emerge in the future.