Economist's View

FOMC Raises Target Rate: Policy No Longer Measured

The FOMC decided to raise the target federal funds rate from 4.25% to 4.50%. Here are the differences from the previous statement:

1. The Fed still sees the expansion as solid, but altered its statement to indicate a bit more uncertainty going forward due to recent data. The phrase "Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appears solid" was replaced by "Although recent economic data have been uneven, the expansion in economic activity appears solid."
2. The long awaited removal of the word measured has been occurred.  The phrase "some further measured policy firming is likely to be needed" is replaced by  "some further policy firming may be needed." The change from "likely" to "may" is notable.
3. The voting representatives on the Committee have changed, but the vote was still unanimous. San Francisco, Cleveland, Richmond, and Atlanta replace Dallas, Chicago, Philadelphia, and Minneapolis as voting members.
4. Finally, and worthy of attention, Minneapolis did not request an increase in the discount rate potentially signaling the Minneapolis Fed was not in favor of further rate increases. We won't know for sure until the minutes are released.

Thus, it's likely that rates will go up again, but by no means assured. The December 13 FOMC statement is in italics. Here's the January 31st FOMC statement with substantive changes in bold:

For immediate release

The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4-1/2 percent.

[No substantive change from previous statement]

Although recent economic data have been uneven, the expansion in economic activity appears solid. Core inflation has stayed relatively low in recent months and longer-term inflation expectations remain contained. Nevertheless, possible increases in resource utilization as well as elevated energy prices have the potential to add to inflation pressures.

Despite elevated energy prices and hurricane-related disruptions, the expansion in economic activity appears solid. [After the first sentence, the statement is identical].

The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.

The Committee judges that some further measured policy firming is likely to be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. [Second sentence identical]

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Jack Guynn; Donald L. Kohn; Jeffrey M. Lacker; Mark W. Olson; Sandra Pianalto; and Janet L. Yellen.

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Mark W. Olson; Anthony M. Santomero; and Gary H. Stern.

In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 5-1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Kansas City, Dallas, and San Francisco.

[No substantive change in first sentence]. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.

News Reports: WSJ, New York Times, Washington Post, Bloomberg, Financial Times, CNN/Money.

The Ownership Society is Still for Sale

"For Mr. Bush, the ownership society initiative is temporarily gone -- but hardly forgotten.":

We Are What We Own, by Fred Barnes, Commentary, WSJ: When running for re-election in 2004, and again last year as he campaigned for Social Security reform, President Bush repeatedly advocated an "ownership society." ... But "ownership society" is not a phrase you're likely to hear from him tonight in his State of the Union address. ...

At best, there will be faint echoes. ... But after failing in his drive for Social Security reform last year, Mr. Bush has now gone incremental, hoping small steps will lead to bigger ones later. For 2006, however, he's reconciled himself to the fact that overhauling Social Security is an impossibility. And since Social Security reform is a necessary element of an ownership society, that idea is off the table this year, too.

But that's not the end of the matter. For Mr. Bush, the ownership society initiative is temporarily gone -- but hardly forgotten. ... Where the phrase "ownership society" came from, nobody knows, not even Mr. Bush or political adviser Karl Rove. Nor did the program emerge in full form. Rather, it was patched together, ... from a handful of programs. By 2004, it consisted of five separate proposals: Social Security private accounts, flexible "lifetime" IRAs, HSAs, tax reform and home ownership assistance. ...

Mr. Bush still yearns to modernize Social Security and create private investment accounts funded by payroll taxes. When informed last year that congressional Republicans wouldn't "scout" the political terrain ahead of him, he went ahead with his campaign for reform -- alone. Now, an aide insists, "If the president sees a political opportunity [for Social Security reform], he'll seize it in an instant." He brought it up again in a private White House meeting last week. ... Indeed, he's likely to keep talking about Social Security and private accounts and perhaps even an ownership society. But not tonight, when he addresses the nation.

Milton Friedman: Greenspan Ruled with Discretion

Milton Friedman is impressed that Alan Greenspan was able to achieve price stability without committing to a strict money rule:

'He Has Set a Standard', by Milton Friedman, Commentary, WSJ: Over the course of a long friendship, Alan Greenspan and I have generally found ourselves in accord on monetary theory and policy, with one major exception. I have long favored the use of strict rules to control the amount of money created. Alan says I am wrong and that discretion is preferable, indeed essential. Now that his 18-year stint as chairman of the Fed is finished, I must confess that his performance has persuaded me that he is right -- in his own case.

His performance has indeed been remarkable. There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind. For the first 70 years after it opened in 1914, the Fed did far more harm than good... We would clearly have been better off for those 70 years if the Federal Reserve System had never been established.

In 1979, Paul Volker was named chairman of the Fed... The great inflation of the 1970s was still raging ... Supported by President Reagan, Mr. Volker broke the back of inflation, in the process producing a recession. The recession produced a public reaction that seriously lowered the president's popular standing. Fortunately, President Reagan did not waver in his support, reappointing Mr. Volker to a second term. He later appointed Alan to succeed him as chairman. ...

Inflation averaged 3.7% per year from the end of World War II to the Volker era, but only 2.4% per year during the Greenspan era. Even more important, inflation was much less variable. ... Greater price stability had far-reaching effects. By greatly reducing the uncertainties, enterprises could use their resources more efficiently and steadily. Price stability fostered innovation and supported a high level of productivity. ...

It has long been an open question whether central banks have the technical ability to maintain stable prices. Their repeated failures to do so suggested that they did not -- whence, in part, my preference for rigid rules. Alan Greenspan's great achievement is to have demonstrated that it is possible to maintain stable prices. He has set a standard. Other central banks around the world, whether independently or by following his example, are following suit. The timeworn excuses for central bank failure to stem inflation will no longer do. They will have to put up or shut up.

Who Would Cross the Bridge of Death Must Answer Me These Questions Three!

The chairman of Intel, Craig Barrett, joins Gary Becker in saying we need to open our doors to the “best and brightest”:

America should open its doors wide to foreign talent, by Craig Barrett, Commentary, Financial Times: America is experiencing a profound immigration crisis but it is not about the 11m illegal immigrants... The real crisis is that the US is closing its doors to immigrants with degrees in science, maths and engineering – the “best and brightest” ... who flock to the country for its educational and employment opportunities. ... This is not a new issue; the US has been partially dependent on foreign scientists and engineers ... for several decades. After the second world war, an influx of German engineers bolstered our efforts in aviation and space research. During the 1960s and 1970s, a brain drain from western Europe supplemented our own production of talent. In the 1980s and 1990s, our ranks of scientists and engineers were swelled by Asian immigrants who came to study in our universities, then stayed to pursue professional careers.

The US simply does not produce enough home-grown graduates in engineering and the hard sciences to meet our needs. ... So while Congress debates how to stem the flood of illegal immigrants across our southern border, it is actually our policies on highly skilled immigration that may most negatively affect the American economy.

The US does have a specified process for granting admission or permanent residency to foreign engineers and scientists. The H1-B visa programme sets a cap – currently at 65,000... But the programme is oversubscribed because the cap is insufficient to meet the demands of the knowledge-based US economy. The system does not grant automatic entry to all foreign students who study engineering and science at US universities. I have often said, only half in jest, that we should staple a green card to the diploma of every foreign student who graduates from an advanced technical degree programme here.

At a time when we need more science and technology professionals, it makes no sense to invite foreign students to study at our universities, educate them partially at taxpayer expense and then tell them to go home and take the jobs those talents will create home with them. ... Certainly ... security must always be a foremost concern. But that concern should not prevent us from having access to the highly skilled workers we need. ..

In a global, knowledge-based economy, businesses will naturally gravitate to locations with a ready supply of knowledge-based workers. ... Deciding to compete means reforming the appalling state of primary and secondary education, ... and urgently expanding science education in colleges and universities – much as we did in the 1950s after the Soviet launch of Sputnik gave our nation a needed wake-up call. ...

At a minimum the US should vastly increase the number of permanent visas for highly educated foreigners, streamline the process for those already working here and allow foreign students in the hard sciences and engineering to move directly to permanent resident status. Any country that wants to remain competitive has to start competing for the best minds in the world. Without that we may be unable to maintain economic leadership in the 21st century.

If they had a 95 mph fastball or the talent to play in the NBA, we'd find a way to let them in.

Mom, and the Tax Code, Always Liked You Best

Gene Sperling looks at inefficiencies and inequities in our tax system by comparing twin brothers, one with labor income, the other with investment income, and looking at how the tax code treats each:

How to reform a winner-takes-all economy, by Gene Sperling, Financial Times: ...Lawrence Katz, the Harvard economist, has documented the increasing polarisation in the US labour market as earnings grow at the high end while opportunities for middle-class jobs dry up. Such extreme gains and losses are often due to significant differences in education or skill but as Robert Shiller ... has written, the unpredictability, speed and vastness of global markets have also enhanced the role of luck ... in determining who falls into the winners’ or losers’ circles.

Consider twin brothers with [identical] ... histories, who each took good jobs six years ago – one, fortunately, with Google, the other, less fortunately, with Lucent. Since the investment community was still betting on Lucent in early 2000 and Google was just getting established, it is hard to say that skill led one worker to $2m in stock options and the other to a pink slip and a job retraining programme.

Even though such differential outcomes can seem unfair ..., this is a price we gladly pay for a free market economy. Our progressive tax system has been part of the way the US has balanced the desire for a free economy with the values of equity. Yet, eliminating taxation on investment income exacerbates – not moderates – winner-takes-all outcomes. Consider our brothers. If the one at Lucent finds a new, $60,000 a year job, he could pay about 25 per cent in federal taxes (including payroll taxes). Yet, ... if his twin at Google can find a solid 6 per cent return investing his $2m, he can make at least $120,000 a year while paying a lower 15 per cent tax rate. If we move closer ... to zero taxes on dividends, capital gains and inheritances, the Google twin could watch his gains accumulate tax-free year after year and then pass on his wealth to an heir, tax free.

Moving the US tax code in this direction is wrongheaded on both economic growth and value grounds. ... [A] tax system that eases the Googler’s tax-free wealth accumulation but forces his brother to pay higher taxes on income earned through labour betrays American values that honour the hard work of the middle class... A better tax reform plan would prevent the most privileged Americans from paying lower taxes on their investment than typical families pay on their wages...

Ed Lazear to be Nominated to Head the CEA

As I reported here in early November when his name first came up, Bush will nominate Edward P. Lazear to replace Ben Bernanke as head of the White House Council of Economic Advisers. The link has a picture, links to his website, and covers his background. To me, the important factor to note is that he is a microeconomist, not a macroeconomist, an indication that issues such as tax reform will be on the future agenda. Here's a link to the Washington Post story, the Bloomberg report, and to Brad Delong's favorable comments on Lazear's selection from November.

The Human Costs of China's Industrialization

We've heard a lot about the environmental costs of China's industrialization, and of social unrest in rural areas and other problems, but less about how industrialization affects the army of migrant workers who come from the country to the cities in search of work:

In China, a Rare Return , by Peter S. Goodman, Washington Post: On almost every other day, Cai Weilan wakes up hundreds of miles away in a cramped factory dormitory, facing another long shift making sweaters... On this day, she wakes up at home. She ... lifts a pair of knitting needles and a ball of green wool to begin making a single sweater for her 2-year-old daughter... For one brief stretch -- this week's Chinese Lunar New Year festival -- mother and daughter are reunited. "Of course I miss her," says Cai, 23, who has been gone for a full year, leaving her daughter behind in the care of her mother-in-law while she endures the factory life for $80 a month. "At home, there is nothing for me to do. My family needs this money."

In this village ... as throughout most of China, migrant workers are heading home this week on packed overnight trains and buses for the most important holiday of the year. They are carrying home to their families things they did not have before -- televisions, sacks of clothing and cooking pots. They are bringing along glimpses of China's burgeoning urban wealth and tales of street hustlers and bosses who cheat them out of wages. They are bearing new expectations for their own lives and those of their children.

In this rapidly industrializing country ..., these workers send home nearly $80 billion a year... Many villages in bitterly poor interior regions have seen their incomes doubled and tripled by this flow of wages. ... "In many counties, as long as there is one migrant worker in the family, the whole family is lifted out of poverty."

But not without wrenching social costs. Migration has separated families, delivering a generation of rural children raised largely by grandparents. For many migrants, round-trip bus and train fare home can exceed $60 -- more than some monthly wages. ... The New Year is typically the only time workers go home. ... Wherever they sleep the rest of the year, migrant workers are clear that home remains home -- a concept laden with significance in Chinese culture. ...

Cai has been working in Guangdong province since she was 14, returning only to get married, give birth to her daughter and celebrate the Lunar New Year. She speaks of forced unpaid overtime and wages that have stayed flat for almost a decade in factories without air conditioning. But her eyes light up when she speaks of how her income has kept her younger sister in high school and how she and her husband are saving about $1,200 a year to build a brick home in the village. Some day. They figure they need $12,000.

Next door, Huang Meiyun, 28, and his father have returned from their jobs as carpenters in Guangzhou, where they occupy plywood bunks in a shed with seven other men. Huang's wife works at a factory in another city ... Their son, 6, stays here in the village with Huang's mother. "I will definitely return," Huang said... He will come back changed. In the city, Huang has grown accustomed to reading news and communicating with people all over China on chat boards at Internet cafes ... He wants a computer at home now... He graduated from high school. He wants his son to make it to university. "We see the other villagers going out to the city and their houses getting better, more money in their pockets," Huang said. "We need to keep up."

The Fed Debates via Encrypted Email

Will the Fed will become more democratic under Bernanke?:

New Chairman Will Take Over An Increasingly Democratic Fed, by Greg Ip, WSJ: ...An early glimpse of this democracy in action unfolded ... in the run up to the Fed's Dec. 13 policy meeting. Virtually all ... economists expected the Fed to raise interest rates ... Still unclear, however, was whether the Fed would signal a change in the future course of rates. For FOMC members, most of the suspense ended long before they gathered ... at Fed headquarters ..., according to people familiar with the process. About a week earlier, the five Fed governors and 12 regional reserve bank presidents ... had received three drafts of the statement from the Fed's staff. A debate ensued... Several presidents circulated extensive comments via encrypted email. By the day of the meeting, the FOMC had largely agreed on what the statement should say. The key point: it would no longer call interest rates "accommodative"...

This is not at all unusual, but the formal process is still evolving. It grew out of protests by Reserve Bank presidents that they did not have enough input on the wording of the statement. Initially, the process was:

Before meetings, Mr. Greenspan drafted the statement with a handful of advisers, primarily Donald Kohn... Governors sometimes discussed the draft the Monday before an FOMC meeting. At the midmorning coffee break on the day of the meeting, Mr. Greenspan huddled in his office with Mr. Kohn, along with the president of the New York Fed, the Fed board's vice chairman and its director of public affairs to decide if the morning discussion required changing the draft. The final statement was distributed to FOMC members after they voted on rates and released to the media at 2:15 p.m.

But that has changed:

Beginning in 2004, the presidents would receive drafts of the statement a few days before a meeting. Typically, there were three versions. Version A was dovish, version C hawkish, and version B ... somewhere in the middle. ... The consultation last December was the most extensive so far. ... December's process went smoothly in part because FOMC members broadly agreed on what to say. But if their views diverge, the process may take longer. ... Another big unanswered question is how Mr. Bernanke will deal with this ... process. ...

On the editorial page, Robert Barro says goodbye to Greenspan and congraulates him on a great overall job. He also says:

Despite Mr. Greenspan's strengths, there is something akin to Peter Sellers's Chance the Gardener in the exaggerated popular view of his economic prowess. ... Fortunately, setting interest rates to ensure low and stable inflation does not require much economic sophistication.

This is as Barro is noting that his strength as a policy maker was his leadership ability, not his abilities as a research econmist.

If you just can't get enough of Greenspan farewells, here's John M. Berry defending his record. He says "...a cottage industry has sprung up questioning the strength of [Greenspan's] legacy. Most of the criticism is off base..." Kevin Hassett weighs in too with advice for Bernanke. The NY Times has a piece here. Update: William Polley has more on the Greg Ip WSJ story...

Paul Krugman: A False Balance

Paul Krugman wonders why some members of the media find it necessary to paint the Abramoff scandal as bipartisan when there is no evidence that it is:

A False Balance, by Paul Krugman, Media Imbalance, Commentary, NY Times: How does one report the facts," asked Rob Corddry on "The Daily Show," "when the facts themselves are biased?" He explained to Jon Stewart, who played straight man, that "facts in Iraq have an anti-Bush agenda," and therefore can't be reported. Mr. Corddry's parody of journalists who believe they must be "balanced" even when the truth isn't balanced continues, alas, to ring true. The most recent example is the peculiar determination of some news organizations to cast the scandal surrounding Jack Abramoff as "bipartisan." ...

Here's how a 2004 Washington Post article described Mr. Abramoff's background: "Abramoff's conservative-movement credentials date back more than two decades to his days as a national leader of the College Republicans." In the 1990's, reports the article, he found his "niche" as a lobbyist "with entree to the conservatives who were taking control of Congress. He enjoys a close bond with [Tom] DeLay." ...

Mr. Abramoff is a movement conservative whose lobbying career was based on his connections with other movement conservatives. His big coup was persuading gullible Indian tribes to hire him as an adviser; his advice was to give less money to Democrats and more to Republicans. There's nothing bipartisan about this tale, which is all about the use and abuse of Republican connections.

Yet over the past few weeks a number of journalists, ranging from The Washington Post's ombudsman to the "Today" show's Katie Couric, have declared that Mr. Abramoff gave money to both parties. In each case the journalists or their news organization, when challenged, grudgingly conceded that Mr. Abramoff himself hasn't given a penny to Democrats. But in each case they claimed that this is only a technical point, because Mr. Abramoff's clients ... gave money to Democrats as well as Republicans...

But the tribes were already giving money to Democrats before Mr. Abramoff entered the picture; he persuaded them to reduce those Democratic donations, while giving much more money to Republicans. ... donations to Democrats fell by 9 percent after they hired Mr. Abramoff, while their contributions to Republicans more than doubled. So in any normal sense of the word "directed," Mr. Abramoff directed funds away from Democrats, not toward them. ... Bear in mind that no Democrat has been indicted or is rumored to be facing indictment in the Abramoff scandal, nor has any Democrat been credibly accused of doing Mr. Abramoff questionable favors.

There have been both bipartisan and purely Democratic scandals in the past. Based on everything we know so far, however, the Abramoff affair is a purely Republican scandal. Why does [this] matter? For one thing, the public is led to believe that the Abramoff affair is just Washington business as usual, which it isn't. The scale of the scandals now coming to light, of which the Abramoff affair is just a part, dwarfs anything in living memory.

More important, this kind of misreporting makes the public feel helpless. Voters who are told, falsely, that both parties were drawn into Mr. Abramoff's web are likely to become passive and shrug their shoulders instead of demanding reform. So the reluctance of some journalists to report facts that, in this case, happen to have an anti-Republican agenda is a serious matter. It's not a stretch to say that these journalists are acting as enablers for the rampant corruption that has emerged in Washington over the last decade.

I wish the media would show more courage and stand up to the pressure that brings this about. Reporting the unpleasant truth will bring howls of protest, cries of bias, the usual chorus of voices attacking the credibility of the messenger. By some measure, some count of the number of words on the topic assessed subjectively as favorable or unfavorable, the number of guests on certain T.V. or radio programs, the particular page in the newspaper that stories appear on, how many minutes were devoted to reporting this or that, bias will be found in most any direction one is looking. I have the impression that fear of being attacked by the smear machine, fear of being labeled as biased or of some other tactic, has affected the way the news gets reported.

Previous (1/26) column: Paul Krugman:  Health Care Confidential
Next (2/3) column: Paul Krugman:  State of Delusion

Fed Watch: Now It Gets Interesting...

Tim Duy with a Fed Watch:

For the Fed watcher, the 4Q05 GDP report is a real brainteaser. The central focus of the many, many blogs covering Friday’s news was the disappointing growth numbers (see William Polley’s and James Hamilton’s views, the latter including a long list of similar concerns). To be sure, the weak headline number deserved attention. But I was surprised by the relatively little attention placed on the inflation reading. I doubt the Fed is going to let that number slip by so lightly. Weak growth and higher inflation? Now that’s interesting.

But before I get ahead of myself on the inflation topic, we need to think about how rattled the Fed will be by the growth decline. For this slice of the data, I will concentrate on the contributions to GDP, following in Hamilton’s footsteps with a closer look at the underlying numbers. Let’s toss out the consumption side of the story:

Pctg. pts. (annual):  2004  2005  05Q3  05Q4
Personal Cons. Exp.   2.71  2.49  2.85  0.79
 Durable goods......  0.51  0.37  0.76 -1.56
   Motor veh./parts.  0.06 -0.04  0.45 -2.06
   Furniture and  		            
    household equip.  0.34  0.28  0.37  0.35
   Other............  0.10  0.13 -0.06  0.14
 Nondurable goods...  0.94  0.90  0.73  1.04
   Food.............  0.48  0.49  0.61  0.51
   Clothing/shoes...  0.17  0.17  0.08  0.28
   Gas, fuel oil, and  			    
    energy goods....  0.03  0.04 -0.11  0.07
   Other............  0.26  0.20  0.15  0.17
					 
 Services...........  1.27  1.22  1.36  1.32
   Housing..........  0.30  0.24  0.20  0.18
   Household oper...  0.07  0.11  0.17  0.08
     Elect./gas.....  0.03  0.06  0.10  0.02
     Other..........  0.05  0.05  0.08  0.06
   Transportation...  0.03  0.04  0.05  0.11
   Medical care.....  0.49  0.56  0.66  0.61
   Recreation.......  0.11  0.06  0.02  0.08
   Other............  0.26  0.21  0.26  0.26

The end of the consumer? Oh, don’t get me wrong, the household spending slowdown will be coming. I am not sure how else the imbalances in the economy, summarized by the current account deficit, are resolved. But I am not so confident I see that adjustment in these numbers. No, seriously – the only component that looks out of whack is motor vehicles and parts. And none of us are really surprised too much here. Moreover, the Fed will look at that and note that if car sales simply stabilize in 1Q06, they will contribute nothing to GDP growth, about what they contributed in 2004 and 2005. This is not a make it or break it issue for Greenspan & Co.

For a very different perspective on the importance of the auto industry, see Jim Hamilton. I will only add that if you think it important that some rebalancing of economic activity occur to resolve the US current account deficit, then some category of household spending is going to have to take a hit. Perhaps others see a different way out, but I tend to think any rebalancing is going to involve some…how does one put it?...unpleasantness.

Much more important is the investment side of the story. Conventional wisdom, which I believe the Fed shares, is that investment swings drive business cycle fluctuations. And Fedspeak has clearly revealed policymaker’s expectation that investment spending will hold strong in 2006. They will be surprised if a different story evolves. More specifically, nonresidential fixed investment is the key here – the expectation at the Fed is that residential investment will ease this year. On to the tables:

Pctg. pts. (annual):  2004  2005  05Q3  05Q4
 Fixed investment...  1.47  1.28  1.31  0.51
   Nonresidential...  0.92  0.87  0.88  0.30
     Structures.....  0.06  0.05  0.06  0.02
     Equip./soft....  0.86  0.82  0.82  0.28
       Info. proc.    		    
        equip./soft.  0.49  0.48  0.42  0.34
       Comp./equip.   0.19  0.24  0.11  0.26	    
         Software...  0.11  0.17  0.14  0.13
         Other......  0.19  0.08  0.17 -0.05
       Ind. equip.... 0.04  0.08  0.20  0.13
       Trans. equip.  0.15  0.16  0.18 -0.27
       Other equip.   0.18  0.09  0.02  0.07
   Residential.....   0.55  0.42  0.43  0.21

I suspect this will puzzle policymakers more than the consumption figures. Is the weakness in nonres investment a fluke? The weakness is not widespread, and not like the massive swing in 3Q00 (was it that long ago?) in the equipment and software category. What about the transportation component? Is that related to the auto fallout we saw in consumption? Note that the Beige Book reported tight transportation markets, and expectations of more capital spending. Also, the story in the GDP report is just not consistent with last Thursday’s durable goods release, which revealed strong shipments of capital goods in 4Q and, bolstering the expectation that this was a one off event, a solid 3.5% gain in non defense, non aircraft capital goods orders in December. All in all, I think the Fed will be cautiously optimistic that the weak investment figure was an aberration. Given the other data, it won’t put them on hold this week, but they will be watching a bit more closely during the run up to the March meeting.

I will refrain from a long analysis on the inventory adjustment. If you are bearish, the inventory gain signals that the end is near with firms seriously misjudging demand. If you are more on the optimistic side, firms are confident about the future. The Fed will not likely place much emphasis on either story; instead, they will simply note that inventories were drawn down the previous two quarters, and many expected that trend would be reversed in the fourth quarter – nothing ominous, nothing exciting.

The swing in defense spending was hurricane related – see Gerald Prante via Mark Thoma. Not much policymaking meat here.

For some analysis of the trade figures, see Brad Setser and Menzie Chinn. At least one policymaker, New York Fed President Timothy Geithner, views the current situation as unsustainable (others do as well), but notes that it is not an appropriate focus of monetary policy. The solutions lie outside, far outside, those hallowed halls on Constitution Ave:

For global growth to be sustained at a reasonably strong pace during this period of adjustment, the desirable increase in U.S. savings, and the necessary slowing in U.S. domestic demand growth relative to growth of U.S. output, would have to be complemented by stronger domestic demand growth outside the United States, absorbing a larger share of national savings. Exchange rate regimes, where they are currently closely tied to the dollar, will have to become more flexible, allowing exchange rates to adjust in response to changing fundamentals. Reforms to financial systems and to social safety nets over time would help reduce the need for exceptionally high levels of domestic saving we see in many countries.

The global nature of these requirements does not imply that the United States can put the principal burden for adjustment on others. If we focus adequate political capital on the factors within our control, we will have more credibility internationally in encouraging policy changes outside the United States that might reduce our collective risks in the adjustment process ahead.

Is that all?

Monetary policy doesn’t have a direct role in addressing this imbalance, according to Geithner. Of course, the Fed needs to be aware that the globalization of capital flows may be holding longer term interest rates lower than normal, complicating efforts to calibrate monetary policy (read as: the yield curve is no longer an accurate predictor of recessions). But that’s about it – policymakers are left with the chore of maintaining credibility in the event the US current account adjusts in a disruptive fashion. And maintaining credibility means keeping your eye on the prize, a focus on low and stable inflation.

(I know that many feel the Fed had a role in the creating role in creating the deficit by flooding the world with cheap money, and Geithner’s speech leaves the Fed unaccountable. I am only the messenger.)

Ah yes, it all comes down to inflation. And now, after two quarters of declining core-PCE inflation, we pop back up to an annualized 2.2% rate. If you saw weak growth in this GDP report, you should be especially unhappy with this inflation reading – it suggests that visions of a Fed pause are not quite as simple as a disappointing headline number. As Greg Ip at the WSJ notes, this is “around the top of incoming Fed chairman Ben Bernanke's comfort zone of 1% to 2%.” Are we seeing some pass through of this summer’s high energy costs? Very possibly, and policymakers will not like this, especially with oil within striking distance of $70. Firms that thought this summer’s energy surge a temporary phenomenon may start thinking that it is time to get more forceful about pushing higher prices onto customers. So far, pushing higher prices down the line hasn’t been easy, and the Fed will want to keep it that way – especially with signs that some firms, like Proctor & Gamble (WSJ subscription) are getting away with it.

I think the bond markets summed this up nicely on Friday. Interest rates ended just about where they began. Yes, headline GDP was weak, and red flags were raised, particularly in investment spending. But, from the Fed’s perspective, no smoking gun, especially when placed in light of higher frequency data. Couple that with higher inflation and the combination suggests little change in the course of policy – one more tomorrow, with slightly better than even odds on a March hike.

Hopefully the final statement of the Greenspan era will provide a clearer path to March. But I tend to think they will be waiting on data to guide them, just like the rest of us. [All Fed Watch posts.]

Structural Change in Monetary Policy

Here are scatter plots of monthly non-borrowed reserves (horizontal axis) and the monthly federal funds rate (vertical axis) for the full sample from 1959-2005 and before and after 1982:

I was looking for a dummy variable and piecewise linear regression example for my introductory econometrics course. This ought to do the trick, though piecewise might be a bit of a stretch. I can also ask about potential problems with the approach, e.g., for one, ask how the presence of a trend in NBR might affect the conclusions. For example, here's what happens with a very quick, very simple (and crude) linear detrending of NBR:

Looks like two different policy regimes to me. Finally, here's the last diagram with the observations connected through time:

The one obvious outlier (FF=3.07, NBR=6.68) is September 2001 when reserves were increased following the terrorist attacks. 

Junk Medicaid ... and Replace it With Universal Health Insurance

Alex Gerber, M.D., clinical professor of surgery emeritus at the University of Southern California, adds his voice to those calling for universal health insurance, the only viable replacement he sees for a Medicaid program in danger of "meltdown":

Junk Medicaid, by Alex Gerber, Commentary Washington Times: Medicaid, the government health-care plan for low-income people, has been targeted ... as a prime source for savings in a bloated federal budget. ... A lowering of Medicaid costs by $6.9 billion is proposed over the next five years, which will decrease benefits and raise out-of-pocket expenses for the 47 million Americans... The nonpartisan Congressional Budget Office predicts an appreciable number of Medicaid recipients ... will join the ranks of the medically uninsured. The adverse morbidity and mortality statistics of the uninsured are well documented...

Few are happy with Medicaid today. Patients are unhappy with eligibility red tape and the declining number of doctors willing to treat them. Doctors are unhappy with the mountains of paper work and unrealistically low fees. Most hospitals are unhappy because Medicaid's reimbursement doesn't cover the cost of patient care.... But unhappiest of all are government agencies struggling to control costs... Meanwhile, the public hospitals are alive but not well. ... After 40 years, we must reluctantly conclude Medicaid has been a well-intentioned program that has fallen short of expectations....

The great majority of Americans ... believe health care should be a fundamental right and a public rather than a private good. A single standard of health care, regardless of ability to pay... What, then, should replace Medicaid? ...

Our outmoded, employer-based, privately financed, multipayer health-care system ... is an anachronism in the 21st century. The world's richest and most powerful nation is unique in not sponsoring government-controlled Universal Health Insurance (UHI) other industrialized nations have enjoyed for decades. Unlike Medicaid, Medicare -- UHI for the elderly -- has been a resounding success. Medicare, though also targeted by Congress for budget cuts by increasing patient-out-of pocket payments, is indeed widely recognized as the most important advance of the last century in our health-care socioeconomics. Medicare for our entire population is probably the most likely answer to Medicaid's "meltdown."

I have previously advocated on these pages a change to the Canadian, single-payer health-care plan funded by national health insurance. ... Canada's medical results equal ours at a huge savings. Perhaps the superiority of Canada's health-care system was best expressed by a Harris Interactive Poll among the leading industrial societies that evaluated patient satisfaction with their system: Canada ranked first and the U.S. last. ... Significantly, The new Conservative government in Canada did not advocate major changes in the UHI program.

Of interest is a comparison of prescription drug prices in the U.S. and Canada. ... The attempt to constrain skyrocketing drug prices was hamstrung ... by President Bush's insistence there be no price negotiations with pharmaceutical companies. Thus, our Medicare population, ... has been denied the advantage of bulk-buying economies of scale. Imagine the uproar if Hertz and Avis were, by law, denied discounted prices on autos they purchased in huge lots. ...

The future for national health insurance looks bleak. The issue has never been on President Bush's agenda. ... A major reform of our wasteful health-care system will help put the brakes on an inexorably rising national debt that will eventually fall on our children and grandchildren. It would be well to recall an admonition from George Washington's 1796 Farewell address: "by vigorous exertion to discharge the debt" -- not ungenerously throwing upon posterity the burden which we ourselves ought to bear.

Corporate Wealth Share Rises for Top Income Individuals

Following up on "The Evolution of Top Incomes" which Brad DeLong comments on here, new government statistics show that the concentration of corporate wealth at the high end of the income distribution is continuing to increase:

Corporate Wealth Share Rises for Top-Income Americans, by David Cay Johnston, NY Times:  New government data indicate that the concentration of corporate wealth among the highest-income Americans grew significantly in 2003, .. a trend that began in 1991 [and] accelerated in the first year that President Bush and Congress cut taxes on capital. In 2003 the top 1 percent of households owned 57.5 percent of corporate wealth, ... The top group's share ... has grown ... since 1991, when it was 38.7 percent. ... according to a Congressional Budget Office analysis of the latest income tax data. ... In 2003, incomes in the top 1 percent of households ranged from $237,000 to several billion dollars. For every group below the top 1 percent, shares of corporate wealth have declined since 1991. ...

iLecture

Another follow up, this time to Technology and Class Attendance:

Apple Offers College Lectures Via Podcasts, AP/NYT: In its latest move to broaden its iPod and iTunes franchises, Apple Computer Inc. has introduced ''iTunes U,'' a nationwide expansion of a service that makes course lectures and other educational materials accessible via Apple's iTunes software. The company ... had been working with six universities on the pilot project for more than a year and expanded the educational program this week, inviting other universities to sign up. ... Apple's service offers universities a customized version of the iTunes software, allowing schools to post podcasts, audio books or video content on their iTunes-affiliated Web sites. ...

I *guess* this is a good thing...

The Demand for Business Ethics

Do customers care about business ethics? They say they do, mostly anyway:

A Company's Ethics Do Concern Shoppers (or So They Say), by Hubert B. Herring, NY Times: ...[D]o more modest ethical taints affect buying behavior? On the eve of the biggest Enron trial, that's an intriguing question — and one asked in a survey by Opinion Research for LRN, which consults on business ethics and governance. ... Nearly three-quarters of shoppers said they would prefer to buy stuff from a company with ethical practices, even if it meant paying more [graph]. That's what they said, at any rate. Given Americans' passion for rooting out bargains, their resolutions just might teeter when spying an alluring price tag. Shaky ethics seem far from rare. Nearly half of working Americans say that at some point they've had to choose between what a supervisor ordered and what they thought was right...

You in 1905

On the PBS web site is "You in 1905," part of Manor House:

You in 1905
Get a snapshot of your life as it might have been had you been living in Britain 100 years ago. Just enter your gender and your fathers profession.

So I entered:

Kill the Messenger

The administration does not like the results of greenhouse gas and global warming research from a leading researcher in the area and, according to this report, is attempting to control what he is allowed to say in public:

Climate Expert Says NASA Tried to Silence Him, by Andrew C. Revkin, Washington Post: The top climate scientist at NASA says the Bush administration has tried to stop him from speaking out since he gave a lecture last month calling for prompt reductions in emissions of greenhouse gases linked to global warming. The scientist, James E. Hansen, longtime director of the agency's Goddard Institute for Space Studies, said ... officials at NASA headquarters had ordered the public affairs staff to review his coming lectures, papers, postings on the Goddard Web site and requests for interviews from journalists. Dr. Hansen said he would ignore the restrictions. "They feel their job is to be this censor of information going out to the public," he said. ...

Dr. Hansen said that nothing in 30 years equaled the push made since early December to keep him from publicly discussing ... clear-cut dangers from further delay in curbing carbon dioxide. ... He said he was particularly incensed that the directives affecting his statements had come through informal telephone conversations and not through formal channels, leaving no significant trails of documents. Dr. Hansen's supervisor, Franco Einaudi, said there had been no official "order or pressure to say shut Jim up." But Dr. Einaudi added, "That doesn't mean I like this kind of pressure being applied."

The fresh efforts to quiet him, Dr. Hansen said, began in a series of calls after a lecture he gave ... and the release of data ... showing that 2005 was probably the warmest year in at least a century, officials at the headquarters of the space agency repeatedly phoned public affairs officers, who relayed the warning to Dr. Hansen that there would be "dire consequences" if such statements continued, those officers and Dr. Hansen said in interviews.

Among the restrictions, according to Dr. Hansen and an internal draft memorandum he provided to The Times, was that his supervisors could stand in for him in any news media interviews. In one call, George Deutsch, a recently appointed public affairs officer at NASA headquarters, rejected a request from a producer at National Public Radio to interview Dr. Hansen, said Leslie McCarthy, a public affairs officer responsible for the Goddard Institute.

Citing handwritten notes taken during the conversation, Ms. McCarthy said Mr. Deutsch called N.P.R. "the most liberal" media outlet in the country. She said that in that call and others Mr. Deutsch said his job was "to make the president look good" and that as a White House appointee that might be Mr. Deutsch's priority.

But she added: "I'm a career civil servant and Jim Hansen is a scientist. That's not our job. That's not our mission. The inference was that Hansen was disloyal." ... Mr. Acosta, Mr. Deutsch's supervisor, said that when Mr. Deutsch was asked about the conversations he flatly denied saying anything of the sort. ... Ms. McCarthy, when told of the response, said: "Why am I going to go out of my way to make this up and back up Jim Hansen? I don't have a dog is this race. And what does Hansen have to gain?" ...

"He's not trying to create a war over this," said Larry D. Travis, an astronomer who is Dr. Hansen's deputy at Goddard, "but really feels very strongly that this is an obligation we have as federal scientists, to inform the public, and this kind of attempted muzzling of the science community is really rather dangerous. If we just accept it, then we're contributing to the problem." ...

"He really is one of the most productive and creative scientists in the world," Dr. Cicerone said. "I've heard Hansen speak many times and I've read many of his papers, starting in the late 70's. Every single time, in writing or when I've heard him speak, he's always clear that he's speaking for himself, not for NASA or the administration, whichever administration it's been." ...

Many people who work with Dr. Hansen said that politics was not a factor in his dispute with the Bush administration. "The thing that has always struck me about him is I don't think he's political at all," said Mark R. Hess, director of public affairs for the Goddard Space Flight Center in Greenbelt, Md... "He really is not about concerning himself with whose administration is in charge, whether it's Republicans, Democrats or whatever," Mr. Hess said. "He's a pretty down-the-road conservative independent-minded person. "What he cares deeply about is being a scientist, his research, and I think he feels a true obligation to be able to talk about that in whatever fora are offered to him."

The administration is set to reveal a new science education initiative soon to encourage more people to enter science related fields. Showing more respect for science and the dedicated scientists behind it would be a good way to begin.

The Tax Policy Blog: Hurricanes, Government Spending, and GDP

Gerald Prante at the The Tax Policy Blog looks at the difference between GDP and net domestic product growth rates (in levels, NDP=GDP-CFC, where CFC is the consumption of fixed capital, i.e. a measure of depreciation, see the BEA for more). He also notes that much of the spending on hurricane Katrina is reflected in defense spending which rose in the 3rd quarter but fell in the 4th leading to corresponding swings in the GDP figures:

Gerald Prante, The Tax Policy Blog, Hurricanes, Government Spending, and GDP: The Bureau of Economic Analysis today released GDP numbers for the 4th quarter and it showed GDP rising at only 1.1 percent, down significantly from the 4.1 percent growth witnessed in the 3rd quarter of 2005. ... There are two main factors associated with the high volatility of recent GDP growth: (1) Hurricane Katrina and (2) defense spending.

Remember that GDP is Gross Domestic Product, meaning that if our economy is just replacing capital destroyed by Katrina, gross production will increase. But also during Katrina, federal defense spending—part of the government portion of GDP—rose dramatically. Defense spending includes much of the costs to government from hurricane relief ... Specifically, defense spending rose 10 percent in the 3rd quarter, only to fall 13.1 percent in the 4th quarter. That means the 3rd quarter GDP number was “artificially” high thanks to these added costs of rebuilding and spending, and the percent change in the 4th quarter was “artificially” low as spending and rebuilding subsided.

If, on the other hand, we examine Net Domestic Product (NDP)—which accounts for huge capital stock losses from natural disasters—one can see a much different picture of the recent economy. NDP fell dramatically in the 3rd quarter—an 8.4 percent annualized decline—but rose dramatically in the 4th quarter by 12 percent. Contrast that with GDP, which increased at a rapid pace of 4.1 percent in the 3rd quarter, yet only rose by 1.1 percent in the 4th quarter.

Take a look at the chart below of the quarterly growth rates in GDP and NDP since 2003 and the timing of when the two indicators diverge. The first large divergence comes in the 3rd quarter of 2004 ... when we saw the destruction caused by Hurricanes Ivan and Charley. During the 3rd quarter of 2004, defense spending rose by 13.8 percent, spiked by the hurricane relief expenses, and then only increased by 0.8 percent in the 4th quarter.

The second large divergence between the two indicators appeared in the 3rd quarter of 2005 with Hurricanes Katrina and Rita. Notice too from the chart that this phenomenon does not occur in 2003 as its hurricane season was very light relative to other years. Hurricane Isabel was the only big storm of the 2003 season and only struck land as a Category 2 storm.

Click on figure to enlarge

Here's the same two series for a slightly longer time period, since 1990:

The magnitude of the changes in NDP growth recently look unusually large, but a longer view of the two series shows that changes of this magnitude are not unprecedented:

However, though subsequent data revisions may change this, the difference between the two series is unusually large:

I'm not sure what to make of the inceasing volatility in the difference between the two growth rates.

Wal-Mart Dons the Environmental Red Cape and Uses its Monopsony Powers to Promote Truth, Justice, and the American Way

Or is it really Wal-Mart's evil super-store twin up to its old profit maximizing tricks?

Wal-Mart fishes for eco-friendly profile, by Jonathan Birchall and Fiona Harvey, Financial Times: Wal-Mart has committed itself to taking most of the fish it sells in North America from environmentally sound sources, in its latest initiative to improve its much criticised record on environmental and social issues. The world’s largest retailer has pledged that all of its US fresh and frozen fish, excluding farmed fish, will eventually come from fisheries certified as being “sustainable” by the Marine Stewardship Council... Wal-Mart, which operates 900 fish counters, joins a small group of US retailers, including Whole Foods Market and Wild Oats, which source salmon, pollock, lobster and hoki fish from MSC-certified fisheries. ...

Wal-Mart has also established “sustainability networks” that bring its suppliers and its buyers together with concerned non-profit groups, covering products including agricultural products, seafood, and gold and jewellery. Rupert Howes, head of the Marine Stewardship Council, said: “It is hugely significant that Wal-Mart is doing this, and setting a real example to the rest of the industry.”

However, only a small number of fisheries have been certified as sustainable. This means it will take between three and five years for Wal-Mart to achieve its goal. The company has also been showing new interest in improving conditions in garment and footwear factories – another area highlighted by Mr Scott.

But it is still struggling to persuade many of its critics that it is serious about its conversion to the cause of corporate social responsibility. ... However, David Schilling, of the Interfaith Center on Corporate Responsibiity, which has co-ordinated numerous shareholder resolutions critical of Wal-Mart, said critics would watch for genuine changes that went beyond its current propaganda war. ...

Wal-Mart faces considerable challenges if it is to adapt its operations to the range of standards now embraced by some of its rivals. Unlike Nike or Gap, both of which have been active in developing supply chain monitoring, it sells a vast range of merchandise ranging from bananas to diamonds; its supply chain uses 60,000 factories worldwide for its own brand products alone, compared to around 700 at Nike.

Krugman's Money Talks: The V.H.A. ... Not Wealthy, but Sometimes Wise

Paul Krugman responds to comments on his recent column Health Care Confidential:

The V.H.A.: Not Wealthy, but Sometimes Wise, Paul Krugman, Money Talks: C.J. Stimson, Nashville, Tenn.: ...[We] often find ourselves debating the V.A. and its tremendous advances. The quality and cost figures reported over the last decade do seem to paint a very optimistic picture. But ... I often wonder whether it's actually replicable. The patient base for the V.A. makes it very unique and lends itself to improved outcomes and increased efficiency. The V.A. is a closed system where variables in the delivery of care, the most important of which is the patient, can be well controlled. If this degree of control could be exercised over a broader population, perhaps U.S. Health Care, Inc., would be feasible. I am afraid, however, that the American psyche is not ready to cede such control.  ...

Paul Krugman: As you say, the V.A. is a closed population, which is what makes it work. Big plans like Kaiser share some of the same advantages, and have partially matched the V.A.'s achievement. But to replicate the achievement nationwide, we'd need a nationwide health system - which is sort of a "well, duh" conclusion.

I am highly skeptical of claims that the obstacle to such a system lies in something deep about the American psyche. After all, people tell us that even the more limited goal of single-payer health care is deeply unacceptable to Americans, yet every American over 65 benefits from Medicare, which is single-payer pure and simple, and it's highly popular. So I think the problem is politics, not national character. ...

Jennifer C. Jaff, Farmington, Conn.: Your view of the Veterans Administration as a model of successful single-payer healthcare ignores the daily reality of patients -- especially those with chronic illness. Veterans Administration doctors routinely cut off all medication -- no tapering even where normal protocol is to taper, ... without reason, disregarding long-standing diagnoses ... of other Veterans Administration doctors. If you talk to patients with chronic conditions, you will find that the Veteran's Administration vastly under-treats, withholding medication and treatment that are used routinely in the private sector... In theory, you may be right. In practice, unless those engaging in this important debate about health care financing focus on the real experience of patients with chronic diseases -- those patients whose health care is the most expensive, and who have the most contact with the health care system -- these sorts of misimpressions of how things really work will lead to disastrous outcomes. ...

Health care policy that is made only for the healthy will jeopardize the care and financial stability of millions of Americans with chronic diseases. I, for one, am terrified when even the well-intentioned like you get this wrong. I see bankruptcy court in my future, and the future of fully half of Americans who suffer from at least one chronic disease, unless our needs and the cost of our care is addressed in any plan to reform the health care system in America.

Donna Whaley, Tennessee Colony, Tex.: I feel compelled to comment that this Op-Ed is obviously written by someone who is not dependent on the V.A. for health care. Someone who is not waiting for MONTHS for follow-up to a heart attack and a subsequent failed stress test, wondering if you will last until they can work you in. Or who discovered that her recent kidney stone procedure was done with outdated equipment and no anesthesia unnecessarily causing excruciating pain that could have been avoided. The V.A., I believe, does the best they can with what they have, but it is far from good enough. ... What I ask is that you please address the problems, too -- your article makes it sound utopian. ...

Paul Krugman: The V.A. does have some waiting time issues; as you say, they're due to lack of funds. The fact remains, however, that despite its shoestring budget the V.A. by all accounts does a better job in many dimensions than private health care.

Still, you've touched on my biggest worry about the V.A., which is that it will be starved for funds by politicians who prefer to use the money for, say, tax cuts. That's what happened to Britain's National Health Service, which is better than Americans think, but was nickel-and-dimed by successive British governments down to the point where it currently spends only about 40 percent as much per capita as the U.S. system.

Robert Feinberg, Chicago: Enjoyed your article on the V.A. My own experience as a retired naval officer differs. While I have had some positive experiences with V.A. care, on the whole, I have found the system still reflective of the old stereotypes. ... The fact is, among the retired officer community, most of us will do almost anything not to use the V.A. system .... But I am glad that it exists to provide care for those less fortunate ... By the way, did you know that the V.A. treats service-connected conditions only and that an entire generation of vets have no carte blanche access to the system? ...

Tom Lewis, Colebrook, Conn.: You missed one important point about the VHA. It emphatically does not serve all veterans. It means-tests them and serves generally the oldest, sickest and poorest. This makes its mission far harder because it does not cherry-pick the way the privatized, insured health care system does. With that in mind, it is an even more interesting model for a national health care system. On the other hand, all of its statistics are self-reported. I'm told that some V.H.A. institutions cook their statistics. There is no federal health care oversight agency for any of the federal health care agencies: D.O.D., prisons, V.H.A., etc. Bear in mind also, that the V.H.A. is very bureaucratic. Patients get bumped around a lot in the course of care. And access and quality of care vary considerably. The south and southwest are underbedded. The northeast and rust belt are wrongly bedded. Many vets do not have access to V.H.A. medical centers or clinics. Inpatient mental health care, for example, can be very uneven. (The writer is the former director of the New York State Division of Veterans Affairs.)

Ben Hadad, Houston: Please don't wax too poetic on V.A. health care unless you like most appointments three to four hours late and six months or more to make an appointment. Once they get you in they are great. Prescription drugs flow seamlessly by mail, certainly at an affordable cost. ...

Paul Krugman: The comments on the V.A. have been greatly informative ... Let me say something about how to interpret what you're reading.

First, experiences with the V.A. are by no means uniformly positive. That's what you'd expect. We're talking about a real-world system run by fallible human beings. So negative stories don't condemn the system, just as positive stories don't validate it. For that you need careful, systematic quality assessments - and these give the V.A. system very high marks.

Second, waiting times are a bit of an issue. This reflects the tightness of the V.A.'s budget. And there is, to be honest, some reason to think that this is always a risk with government-run health care: politicians see an opportunity to squeeze a bit, to make funds available for their pet projects, then to squeeze a bit more, and after a decade or two quality has really suffered. That's what happened to the British system, although that system remains much better than Americans have been told.

But - and this is my last point - consider the alternative. Out here in the non-veteran world, corporations are reacting to rising health care costs by dropping insurance; states are reacting by throwing people off Medicaid; and people without health insurance are leaving chronic problems untreated, then ending up in emergency rooms - or dead. Meanwhile, the V.A. is containing costs while providing excellent if not always perfect care.

Yellen Says the New Guy is Right

This Fed Letter from the FRBSF is based upon Janet Yellen's speech last week. She reviews the Greenspan years, looks ahead the the Fed under Bernanke, and talks about how Bernanke and Greenspan differ on explicit inflation targets:

2006: A Year of Transition at the Federal Reserve, Economic Letter, FRBSF: At the end of this month, Alan Greenspan will bring to a close his 18 years of distinguished service as Chairman of the Board of Governors of the Federal Reserve System. ... With such a significant transition for the Fed just days away, this seemed like a natural time to spend a few moments looking back at the Greenspan Fed and offering some of my own views on what may lie ahead under a "Bernanke Fed." ...

Alan Greenspan has won many plaudits for skillfully managing monetary policy—and deservedly so. During the Greenspan years, the U.S. economy has been extraordinarily stable, with just two mild and short recessions (Figure 1), and with low and stable inflation for over a decade ... Clearly, in the short time I have today, I cannot do justice to all the accomplishments.... So I'll focus on two aspects of policy that I believe have been especially important... a systematic, and therefore understandable and predictable approach to policy, and a growing emphasis on communication and transparency.

I will focus first on what I mean by a systematic approach to policy. While the Fed does not follow a policy rule, it has been consistent in its approach to achieving its dual mandate—keeping inflation low and stable and promoting maximum sustainable employment. ...

This systematic, consistent approach has enhanced the ability of financial markets to anticipate the Fed's response to economic developments and to respond themselves in advance of the Fed. Such market responses strengthen and speed the transmission of policy to the economy and conceivably enhance economic stability. Moreover, such an approach helps build the public's confidence in the Fed's commitment to low and stable inflation; this, in turn, may well make it easier for the Fed to respond to fluctuations in labor and product markets, because there is less risk that an easing of policy will unleash a wave of inflation fears. As successful as this systematic approach ... has by no means been a straitjacket for policy during the Greenspan years. Rather, policy also has been flexible when unusual circumstances called for it. ...

Now let me turn to the second aspect of policy, namely, the increased emphasis on communication and transparency. One of the first steps in this direction occurred in 1994, when the FOMC first started issuing press releases after its meetings that explicitly announced changes in the federal funds rate target. Over the decade or so since then, the press release has come to include a statement about the balance of risks to the attainment of its dual mandate, and at least some indication of where policy may go in the future. This enhanced transparency works in tandem with the systematic approach ... because it ... helps the markets anticipate the Fed's response to economic developments...

Of course, there have certainly been other developments in policy during the 18 years of Greenspan's chairmanship that have contributed to its success in achieving its dual mandate. But I believe these two—a systematic approach to policy and more communication and transparency—are particularly noteworthy. ...

Looking ahead to the "Bernanke years"

These achievements provide a great foundation for the new Chairman, Ben Bernanke. Having observed him when he was a member of the Board of Governors from 2002 to 2005, and being familiar with his remarkable body of research on macroeconomic policy, I feel pretty confident that he places an equally high value on a systematic approach as well as on transparency and communication. ... And any of you who have read the speeches he gave while he was a Governor will know that he is a consummate communicator and teacher.

One area where he has differed with Chairman Greenspan is on how to define "price stability." Of course, both see price stability as a prime objective of policy. But for Chairman Greenspan, the definition has been behavioral—that is, he would say that we have achieved price stability when inflation is low enough that it does not materially affect people's economic decisions. In contrast, ... Bernanke ... said that he would like to see the establishment of a numerical objective for price stability... Since his nomination, he has said that he would not institute such an approach without a consensus among FOMC members.

For my part, I'm sympathetic to the idea of a quantitative objective for price stability, as I agree that it enhances both Fed transparency and accountability. ... I see an inflation rate between 1% and 2%, as measured by the core personal consumption expenditures price index, as an appropriate price stability objective for the Fed. However, I also think it is critically important that a numerical inflation objective not weaken our commitment to a dual mandate that includes full employment. ... I believe that a numerical long-run objective for inflation will enhance our ability to maintain that success even in the face of the significant challenges that may come up. ...

Revisions to Real and Nominal GDP

With today's disappointing advance GDP report which will be revised as new data arrive, I thought it might be worthwhile to look at typical revisions in recent years to see if there is any particular pattern.

Bush is Moving to Fill Two Slots at the Federal Reserve

News from Greg Ip and John McKinnon at the Wall Street Journal on Bush's choice to fill the two open seats on the Federal Reserve Board of Governors:

Bush Is Moving To Fill Two Slots At Federal Reserve, by Greg Ip and John D. McKinnon, WSJ: With leadership at the Federal Reserve about to change, the White House is moving to fill two vacancies on the central bank's seven-member board of governors. President Bush plans to soon nominate Kevin M. Warsh, a White House adviser on domestic finance and capital markets, to fill one of the two vacancies, two people familiar with the matter said. Mr. Bush aims to fill the other seat with an academic economist, and the likeliest candidate is Randall S. Kroszner, who teaches at the University of Chicago's Graduate School of Business, one of these people said...

The nominations would tilt the board's composition toward financial-industry expertise rather than macroeconomics. Mr. Warsh, a lawyer by training, was an investment banker at Morgan Stanley before joining the White House National Economic Council. He has been the White House's point person on financial-industry issues. Mr. Kroszner, who served on the Council of Economic Advisers during Mr. Bush's first term, specializes in banking, banking regulation, international-financial crises and monetary economics...

From Brad DeLong on Randall Kroszner [photo/web page, color photo]:

I know I'm proud to have played a (alas, very small) part in the education of Randy Kroszner and Robin Hanson, both far to my right.

From Institutional Economics:

Both Clarida and Kroszner would be excellent appointments.  Appointing non-specialists with financial market backgrounds would be a mistake in my view, increasing the risk of ... regulatory capture by Wall Street...

That doesn't sound like a strong endorsement of Warsh [photo, photo with Bush]. I know little about him. BusinessWeek Online has a bit more, but not much:

Warsh is the NEC's point man for contact with the financial-services industry. He has recently sought to raise his public profile by speaking to more industry groups and was mentioned as a candidate for chairman of the Securities & Exchange Commission before Bush tapped Rep. Christopher Cox (R-Calif.) for the job.

Update: Bloomberg reports that Al Hubbard, director of the White House's National Economic Council, says:

"They're going to fit very, very well'' at the Fed, said Al Hubbard ... in an interview. Warsh, who works for Hubbard, "has terrific business experience, having worked on Wall Street.'' Kroszner is "one of the great economists in our country,''...

The same report notes that a former Fed vice Chairman is not sold on Warsh:

Preston Martin, who was Fed vice chairman from 1982 to 1986. called Kroszner "a brilliant choice because he has served in many categories around and in the Federal Reserve system.'' "If I were on the Senate committee, I'd vote yes for Kroszner and no for Warsh,'' said Martin. "I have great reservations about Warsh because he just doesn't have the background.''

Brad DeLong has questions too.

The Economist Opposes Bush's Health Care Proposal

The Economist swallows hard, and then talks sensibly about health care reform:

America's headache, The Economist: Everyone , it seems, has a health problem. ... But nowhere has a bigger health problem than America. ... Pushed by polls that show health care is one of his main domestic problems ..., George Bush is expected to unveil a reform plan in next week's state-of-the-union address.

America's health system is unlike any other. The United States spends 16% of its GDP on health, around twice the rich-country average, equivalent to $6,280 for every American each year. Yet it is the only rich country that does not guarantee universal health coverage. ...[M]ost Americans receive health insurance through their employer, with the government picking up the bill for the poor (through Medicaid) and the elderly (Medicare).

This curious hybrid certainly has its strengths. Americans have more choice than anybody else, and their health-care system is much more innovative. Europeans' bills could be much higher if American medicine were not doing much of their R&D for them. But there are also huge weaknesses. The one most often cited ... is the army of uninsured. ... In many cases that is out of choice and, if they fall seriously ill, hospitals have to treat them. But it is still deeply unequal. And there are also appalling inefficiencies: by some measures, 30% of American health spending is wasted.

Then there is the question of state support. Many Americans decry the “socialised medicine” of Canada and Europe. In fact, ... around 60% of America's health-care bill ends up being met by the government (thanks in part to huge tax subsidies that prop up the employer-based system). Proportionately, the American state already spends as much on health as the OECD average, and that share is set to grow... America is, in effect, heading towards a version of socialised medicine by default.

Is there a better way? ...[T]here is no such thing as a perfect health-care system: every country treads an uneasy compromise between trying to harness market forces and using government cash to ensure some degree of equity. Health care is also ... where market forces have ... the most limited success: it is plagued by distorted incentives and information failures. To begin with, most health-care decisions are made by patients and doctors, but paid for by someone else. There is also the problem of selection: private-sector insurers may be tempted to weed out the chronically ill and the old, who account for most of the cost of health care.

In the longer term, America, like this adamantly pro-market newspaper, may have no choice other than to accept a more overtly European-style system. In such a scheme, the government would pay for a mandated insurance system, but leave the provision of care to a mix of public and private providers. Rather than copying Europe's distorting payroll taxes, the basic insurance package would be paid for directly by government...

Such a system would not be perfect but it could mitigate the worst inequities in America's health-care system, while retaining its strengths. In practice, however, it will not happen soon. American politicians are still scarred by the failure of Hillary Clinton's huge health-care plan .... Incremental change ... looks the only way forward...

[T]here is a flaw at the heart of his proposal. Mr Bush goes straight to one of the biggest distortions in American health care—the generous tax subsidies doled out to firms providing insurance. These help to promote a culture where costs do not matter. ...[T]he president wants to even things out by doling out yet more tax subsidies to others—for instance, letting individuals set more of their out-of-pocket medical expenses against taxes. Such hand-outs may have political appeal, but they will worsen the budget deficit and, most probably, drive up the pace of medical spending. America's health-care system could be improved in small steps. But those steps need to be in the right direction.

See The Economist's companion article "Desperate Measures" [free link] for more detail on these and other issues. It ends with:

Mr Bush's health-care philosophy has a certain political appeal. It suggests incremental change rather than a comprehensive solution. It reinforces existing industry trends. And it promises to be pain-free. Unfortunately, it will not work. The Bush agenda may speed the reform of American health care, but only by hastening the day the current system falls apart.

Paul Krugman: Health Care Confidential

Paul Krugman continues the health care theme from recent columns and in the post below this one with ideas on how to reform the health care system. He says there are lessons to be learned from a government run program that is not too far away:

Health Care Confidential, by Paul Krugman, On Health Care Commentary, NY Times: American health care is desperately in need of reform. But what form should change take? Are there any useful examples we can turn to for guidance? Well, I know about a health care system that has been highly successful in containing costs, yet provides excellent care. And the story of this system's success provides a helpful corrective to anti-government ideology. For the government doesn't just pay the bills ... it runs the hospitals and clinics.

No, I'm not talking about some faraway country. The system in question is our very own Veterans Health Administration, whose success story is one of the best-kept secrets in the American policy debate. In the 1980's and early 1990's, says ... The American Journal of Managed Care, the V.H.A. "had a tarnished reputation of bureaucracy, inefficiency and mediocre care." But reforms beginning in the mid-1990's transformed the system, and ... "have allowed it to emerge as an increasingly recognized leader in health care." Last year customer satisfaction with the veterans' health system ... exceeded that for private health care for the sixth year in a row. This high level of quality (which is also verified by objective measures ...) was achieved without big budget increases. ... How does the V.H.A. do it?

The secret of its success is the fact that it's a universal, integrated system. Because it covers all veterans, the system doesn't need to employ legions of administrative staff to check patients' coverage and demand payment from their insurance companies. Because it's integrated, ... it has been able to take the lead in electronic record-keeping and other innovations that reduce costs, ensure effective treatment and help prevent medical errors.

Moreover, the V.H.A., as Phillip Longman put it in The Washington Monthly, "has nearly a lifetime relationship with its patients." As a result, it "actually has an incentive to invest in prevention and more effective disease management. ..." Oh, and one more thing: the veterans health system bargains hard with medical suppliers, and pays far less for drugs than most private insurers.

I don't want to idealize the veterans' system. In fact, there's reason to be concerned about its future: will it be given the resources it needs to cope with the ... wounded and traumatized veterans from Iraq? But the ... V.H.A. is clearly the most encouraging health policy story of the past decade. So why haven't you heard about it?

The answer, I believe, is that pundits and policy makers ... can't handle the cognitive dissonance. (One prominent commentator started yelling at me when I tried to describe the system's successes in a private conversation.) For the lesson of the V.H.A.'s success story ... runs completely counter to the pro-privatization, anti-government conventional wisdom that dominates today's Washington.

The dissonance ... is one reason the Medicare drug legislation looks as if someone went down a checklist of things the veterans' system does right, and in each case did the opposite. For example, the V.H.A. avoids dealing with insurance companies; the drug bill shoehorns insurance companies into the program... The V.H.A. bargains effectively on drug prices; the drug bill forbids Medicare from doing the same.

Still, ideology can't hold out against reality forever. Cries of "socialized medicine" didn't, in the end, succeed in blocking the creation of Medicare. And farsighted thinkers are already suggesting that the Veterans Health Administration, not President Bush's unrealistic vision of a system in which people go "comparative shopping" for medical care the way they do when buying tile, represents the true future of American health care.

Previous (1/22) column: Paul Krugman:  Iraq's Power Vacuum
Next (1/29) column: Paul Krugman:  A False Balance

Gifts from Medical Companies and Health Care Costs

I am told by a cardiac nurse that she gets taken out to lunch once a week or so by medical and pharmaceutical device reps. She orders stents and a few other things so they treat her well. This spring, she is going to an all expenses paid conference in Las Vegas. There are a few classes you can attend if you want, she says they always make sure to have at least one, but attendance is not required and she doubts she will bother. There are plenty of places to cut costs for health care that don't involve cutting benefits to patients:

In Article, Doctors Back Ban on Gifts From Drug Makers By Gardiner Harris, NY Times: The gifts, drugs and classes that makers of pharmaceuticals and medical devices routinely give doctors undermine medical care, hurt patients and should be banned, a group of influential doctors say in ... The Journal of the American Medical Association. ... Broadly adopted, the recommendations would ... shut off the focus of drug makers' biggest expenditures. But Dr. David Blumenthal, an author of the article, said it was "not very likely" that many in medicine would listen to the group. ...

Federal law forbids companies from paying doctors to prescribe drugs or devices, but gifts and consulting arrangements are almost entirely unregulated. Voluntary professional guidelines suggest that doctors refuse gifts of greater than "modest" value. Sanctions against doctors who accept gifts of great value are extremely rare. The drug industry spends tens of billions of dollars a year to woo doctors, far more than it spends on research or consumer advertising. Some doctors receive a significant part of their income from consulting arrangements with drug and device makers. Others take regular vacations and golfing trips that are paid for by companies. ...

Surveys show that most doctors do not believe that these gifts influence their medical decisions, although most believe that they do affect their colleagues' medical judgment. But even small gifts can lead to profound changes in doctors' prescribing behavior, with "negative results on clinical care," the article states. As a result, all gifts should be banned...

Ken Johnson, a spokesman for the Pharmaceutical Research and Manufacturers of America, said the drug industry had a voluntary code of marketing conduct. "Only practices that do not compromise independent judgments of health providers - such as modest working meals, gifts of minimal value that support the medical practice, and distribution of free samples - are permitted," ... Dr. Duane M. Cady, board chairman of the American Medical Association, said in a statement that "drug and medical device makers can play a role in educating physicians about new products." He said the organization was "in the process of examining and updating its policy on gifts to physicians from industry." ...

Kaiser Permanente, the California-based managed-care group, is one of the few medical organizations in the United States that have enacted nearly all of the recommendations suggested by the journal article. Kaiser physicians prescribe heavily marketed medicines far less frequently than doctors nationally. ...

The article also argues that "no strings attached" consulting arrangements should be banned... Doctors should refuse free drug samples, the article states, because they are "a powerful inducement for physicians and patients to rely on medications that are expensive but not more effective." Such a refusal would also eliminate one of the principal reasons for which drug salespeople are routinely allowed to enter doctors' offices... While the article does not suggest that salespeople be refused entry into offices, it states that such visits have few useful functions. ...

Dr. Troy A. Brennan, former chairman of the American Board of Internal Medicine and the other principal author of the article, said he was looking forward to reading responses to it. "I don't think there are a lot of good answers as to why it's O.K. to accept these gifts and contracts," Dr. Brennan said.

Advertising and product differentiation can play a role in providing information, but this goes far beyond any socially useful function.

The Quiet Revolution that Transformed Women's Employment, Education, and Family

Another interesting looking paper I haven't had a chance to read:

The Quiet Revolution that Transformed Women's Employment, Education, and Family, by Claudia Goldin, NBER WP 11953, January 2006: Abstract The modern economic role of women emerged in four phases. The first three were evolutionary; the last was revolutionary. Phase I occurred from the late nineteenth century to the 1920s; Phase II was from 1930 to 1950; Phase III extended from 1950 to the late 1970s; and Phase IV, the "quiet revolution," began in the late 1970s and is still ongoing. ... The evolutionary phases are apparent in time-series data on labor force participation. The revolutionary phase is discernible using time-series evidence on women's more predictable attachment to the workplace, greater identity with career, and better ability to make joint decisions with their spouses. Each of these series has a sharp break or inflection point signifying social and economic change. ... The paper concludes by assessing whether the revolution has stalled or is being reversed... [Open AEA web link, Author web site link - both have sharper figures than the copies below]

Here are a few graphs from the paper:

 

 

 

Technology and Class Attendance

Guess what? If you lower the cost of missing class, less students show up. This article notes that when more material is posted for classes, attendance is lower. I've noticed the same thing. There is a very clear association between how much I post and class attendance and because of this, I have stopped posting as much review material. I thought it gave students a false sense of security. They would skip class thinking they could make up what was lost with web-based material later, then find out when the test time arrives that the posted material is not an effective substitute for coming to class, or that they have waited too long to get started making up missed material. That's when I start getting frantic email. It appears to me that it is the students on the margin who most easily fall victim to this temptation.

On the other side, though, are the students who make effective use of the posted material. They show up to class as always, and use what I post as a complement, not a substitute, to lectures. I am reluctant to allow class policy to be dictated by the students who are more interested in obtaining a piece of paper than learning, so I am rethinking my policy about posting material. I don't think my classes should be less effective for the best students just because other students cannot resist the temptation to sleep in on a cold and rainy morning knowing that lecture materials will be posted to make the sleep less costly. This isn't high school where it's the state's job to make sure every student is educated. In college, students must begin learning to take responsibility for their own education and I should not let some students to be held back in an attempt to force those at the other end of the spectrum to come to class, read, ask questions, and learn the material. Still, it's hard not to structure incentives so as to get the most out of every student rather than just the subset who are most interested in learning the course material:

Skip class? You've got online pal, Detroit Free News/LA Times, by Stuart Silverstein:  Skipping classes, particularly big lectures where an absence can go undetected, is a tradition among college undergraduates who party late or swap notes with friends. These days, professors are witnessing a spurt in absenteeism as an unintended consequence of adopting technologies originally envisioned as learning aids.

One of Azevedo's Classes

Last semester, Americ Azevedo's class on "Introduction to Computers" at the University of California, Berkeley, featured some of the hottest options in educational technology. By visiting the course's Web sites, the 200 students could download audio recordings or watch digital videos of the lectures, as well as read the instructor's lecture notes and participate in online discussions.

But there was one problem: So many of the undergraduates relied on the technology that, at times, only 20 or so actually showed up for class. "It was demoralizing," Azevedo said. "Getting students out of their media bubble to be here is getting progressively harder."

Even as many academics embrace electronic innovations, others are pushing back. To deter no-shows, professors are reverting to low-tech tactics such as giving more surprise quizzes or slashing online offerings.

"Too much online instruction is a bad thing," said Terre Allen, a communication studies scholar at California State University, Long Beach.

Last term, Allen posted extensive lecture notes online for her undergraduate course, "Language and Behavior." One goal was to relieve students of the burden of scribbling notes, freeing them to focus on the lectures' substance. Yet the result, Allen said, was that only about one-third of her 154 students showed up for most of the lectures. In the past, when Allen put less material online, 60 percent to 70 percent of students typically would attend. ...

Kelly A. Rocca, an assistant professor of communication at St. John's University in New York and one of the few scholars who has recently studied American college absenteeism, said she suspects that skipping class has reached an all-time high because of off-campus jobs and reliance on technology. To combat ditching in her own classes, Rocca refuses to post notes online. With undergraduates, she said, "the more reasons you give them not to come to class, the less likely they are to come." ...

Other research supports the common-sense belief that skipping class hurts a student's grades. Lee Ohanian, a UCLA economics professor, said he notices that frequent skippers often "are the ones who are doing just enough to get by. The ones who are getting the A's are in the front row at every lecture." Ohanian said "too much technology really leads to a passive learning environment" and spurs absenteeism. He has cut back on posting lecture materials online and now provides extensive notes only for the most complicated topics.

Despite concerns about absenteeism, schools increasingly are experimenting with ways to let students watch or listen to lectures on their computers or digital music players, ... Likewise, online, or "distance," education programs -- premised on students' not needing to be in class -- are growing.

Advocates of the new technologies say they give schools an effective, low-cost way to deliver instruction while freeing students to review material at their own pace. The online options also let students participate in discussions electronically and allow instructors the flexibility to make quick changes.

Update: Brief follow up at iLecture.

Smarter than the Average Bearish Investor?

"Even when it ... hurts you on average to take the gamble, the smart people ... actually like it more":

Would You Take the Bird in the Hand, or a 75% Chance at the Two in the Bush?, By Virginia Postrel, Economic Scene, NY Times: Would you rather have $1,000 for sure or a 90 percent chance of $5,000? A guaranteed $1,000 or a 75 percent chance of $4,000? In economic theory, questions like these have no right or wrong answers. Even if a gamble is mathematically more valuable ... someone may still prefer a sure thing. People have different tastes for risk, just as they have different tastes for ice cream... The same is true for waiting: Would you rather have ... $3,400 this month or $3,800 next month? Different people will answer differently. Economists generally accept those differences without further explanation... Shane Frederick, a management science professor at the Sloan School of Management at the Massachusetts Institute of Technology, ... discovered striking systematic patterns in how people answer questions about risk and patience, including those above. This short problem-solving test, he found, predicts a lot:

1) A bat and a ball cost $1.10 in total. The bat costs $1 more than the ball. How much does the ball cost?

2) If it takes five machines five minutes to make five widgets, how long would it take 100 machines to make 100 widgets?

3) In a lake, there is a patch of lily pads. Every day, the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half the lake?

The test measures not just the ability to solve math problems but the willingness to reflect on and check your answers. (Scores have a 0.44 correlation with math SAT scores, where 1.00 would be exact.) The questions all have intuitive answers — wrong ones. Professor Frederick gave his "cognitive reflection test" to ... students... Participants also answered a survey about how they would choose between various financial payoffs, as well as time-oriented questions like how much they would pay to get a book delivered overnight.

Getting the math problems right predicts nothing about most tastes, including whether someone prefers apples or oranges, Coke or Pepsi, rap music or ballet. But high scorers — those who get all the questions right — do prefer taking risks. "Even when it actually hurts you on average to take the gamble, the smart people, the high-scoring people, actually like it more," ... They are also more patient, particularly when the difference, and the implied interest rate, is large. Choosing $3,400 this month over $3,800 next month implies an annual discount rate of 280 percent. Yet only 35 percent of low scorers ... said they would wait, while 60 percent of high scorers preferred the later, bigger payoff. ...

The connection between cognition and risk preferences challenges some of the "prospect theory" developed [by] Daniel Kahneman and Amos Tversky. They observed that people would accept larger risks to avoid losses than to achieve gains, even when the two choices were mathematically equivalent. The same person might take a sure $100 instead of a 50 percent chance of $300, yet prefer a 50 percent chance of losing $300 rather than a sure $100 loss. This result, which has implications for investment and insurance, is one of the major findings of behavioral economics. Although prospect theory "is spectacularly true" for the low-scoring group, Professor Frederick writes, high scorers treat potential gains and potential losses about the same. ...

The correct answers, by the way, are 5 cents, 5 minutes, and 47 days.

Greenspan Opposes Wal-Mart's Banking Plans

There are limits to Greenspan's free-market tendencies after all:

Greenspan Opposes Bank Loophole, by Bernard Wysocki Jr., WSJ: Federal Reserve Chairman Alan Greenspan is opposing a regulatory loophole that allows corporations to own banks, thrusting himself into the middle of an effort by Wal-Mart Stores Inc. to establish a bank. Mr. Greenspan's salvo, outlined in a 12-page letter to Congress ..., is the latest in a controversy over the separation of commerce and banking. ...

Wal-Mart officials say the Utah bank would be a back-office processing center, handling debit-card, credit-card and electronic check-transfer payments ... A third party currently processes the transactions ... and bringing the work in-house would save Wal-Mart money. Company officials repeatedly have said they don't plan to establish bank branches. Under current law, these state-chartered banks, many incorporated in Utah, may open branches in more than 20 states...

In his letter, sent Jan. 20 in response to questions from Rep. Jim Leach, ... Mr. Greenspan doesn't single out Wal-Mart's application for criticism but mentions it along with the names of other big companies that have established industrial-loan corporations -- or industrial banks, as these state-chartered financial institutions are sometimes called. ...

"The ILC exemption is now the primary means by which commercial firms may control an FDIC-insured bank engaged in broad lending and deposit-taking activities and thereby breach the general separation of banking and commerce," Mr. Greenspan's letter said. He warned that the growing use of the loophole is "undermining the prudential framework that Congress has carefully crafted and developed" to oversee financial institutions. ...

In uncharacteristically blunt language, Mr. Greenspan urged Congress to close the loophole, which he said "provides the corporate owners of exempt ILCs a significant competitive advantage over other types of banking institutions, and creates an unlevel competitive playing field among banking organizations."

In an interview, Mr. Leach, the former chairman of the House banking committee, said he considered Mr. Greenspan's letter significant. "It's ... a stark warning to the Congress" about the need to separate commerce and banking, Mr. Leach said. "This is not primarily a Wal-Mart issue. It is a 'nature of the American economy' issue."...

In coming out against the ILC loophole, and by implication against Wal-Mart's bid for a bank, Mr. Greenspan has parted company with some free-market advocates who believe that a Wal-Mart bank, if it did turn into a retail-banking powerhouse, would encourage competition in the financial-services field, and would ultimately lower costs to consumers....

A spokesman for the Fed said it couldn't comment on whether incoming Fed Chairman Ben Bernanke would endorse every word of Mr. Greenspan's comments. However, the spokesman said other Fed officials have made similar comments, as official Fed positions, during the time Mr. Bernanke was a Fed official...

[The Full Letter: Read Greenspan's letter to Congress.]

The Evolution of Top Incomes

I haven't had a chance to read this yet, but I hope to:

The Evolution of Top Incomes: A Historical and International Perspective, by Thomas Piketty and Emmanuel Saez, NBER WP 11955, January 2006:  Abstract This paper summarizes the main findings of the recent studies that have constructed top income and wealth shares series over the century for a number of countries using tax statistics. Most countries experience a dramatic drop in top income shares in the first part of the century due to a precipitous drop in large wealth holdings during the wars and depression shocks. Top income shares do not recover in the immediate post war decades. However, over the last 30 years, top income shares have increased substantially in English speaking countries but not at all in continental Europe countries or Japan. This increase is due to an unprecedented surge in top wage incomes starting in the 1970s and accelerating in the 1990s. As a result, top wage earners have replaced capital income earners at the top of the income distribution in English speaking countries. We discuss the proposed explanations and the main questions that remain open. [Open link]

Here are some figures from the paper:

 

 

Best Science Available?

The administration has no comment regarding the use of Mickey Mouse science:

Mouse frustrates endangered species policy, by John Heilprin, AP: An acrobatic mouse is threatening Bush administration efforts to give Western developers an upper hand over endangered species. The Preble's meadow jumping mouse is in fact a distinct creature, according to a U.S. Geological Survey study presented ... to senior Interior Department officials.

That finding contradicts research touted by Interior Secretary Gale Norton last February when she proposed removing the mouse from the government's endangered species list. Critics say it also undercuts the administration's claim that it uses the best science available in promoting fewer protections for imperiled wildlife.

The previous study, which was done by a biologist since hired by Norton's department, concluded there was no genetic difference between the Preble's meadow jumping mouse and the much more common Bear Lodge meadow jumping mouse. Listed by the government as a threatened species since 1998, the Preble's meadow mouse stands in the way of any project that could damage its habitat, a broad swath of Colorado and Wyoming ...

The 3-inch mouse uses its 6-inch tail, and strong hind legs to launch itself a foot and a half into the air, where it can abruptly switch directions in mid-flight. It prefers to roam by night, scurrying and jumping along streams through undisturbed grasslands. There it dines on insects, spiders, fungus, moss, willow, sunflower, grasses and seeds, hibernating each winter from mid-October to early May.

A year ago, developers welcomed the findings of biologist Rob Roy Ramey ... and the Interior Department's conclusion, based on his findings, that the Preble's meadow mouse no longer needed federal protections. Ramey was later contracted as a science adviser to the Interior Department in its attempt to reclassify several species whose endangered status is blocking developers.

The new study was conducted by Tim King, a USGS conservation geneticist based in West Virginia, and peer-reviewed by academic experts outside government. One of the reviewers, Eric Hallerman, a professor of fisheries and wildlife science at Virginia Tech, said King's study debunks Ramey's work. "It contradicts it fairly strongly," Hallerman said. ... Hallerman said Ramey's work reflects the Bush administration's intrusion of politics in its scientific research. "It seemed to me from the get-go, he wanted to find that this was not a taxonomically valid subspecies," Hallerman said.

After others raised similar doubts, Interior officials agreed to revisit Ramey's work by commissioning King's study. They had no immediate comment Wednesday. ... King said it probably would be a few more months before officials decide whether his study justifies continued federal protections for the high-flying mouse. "I would think that would be one of the options," he said.

Though I would not want the present poltical environment to tackle such a task, I could be convinced that the Endangered Species Act needs reexamination. But there is no role for shoddy or comissioned science in such a process, and no role for anything that blurs the distinction between true science in search of the truth and work designed to reach or support a predetermined conclusion.

Privatization of Roads

Should the allocation of transportation services - driving on roads - be allocated by the price system? If we continue on the road to privatization, will we be satisfied that it is equitable for the haves to be able to drive on roads closed by resource constraints to the have nots?:

Indiana Sells Road for Billions; Prepare for Deluge, by Joe Mysak, Bloomberg: On Monday, Governor Mitch Daniels said a Spanish-Australian consortium had bid $3.85 billion to run the Indiana Toll Road, a 157-mile highway across northern Indiana that runs from the Illinois to Ohio, for 75 years. The legislature still has to approve the proposal...

A Merrill Lynch & Co. report published last July on the subject of U.S. toll road privatization asked whether sales like the Skyway were one-offs, "or do they represent the beginning of a sweeping trend that will spread to other tolled bridges, tunnels, expressways and long-distance toll roads?'' Let's bet on the sweeping trend. The money is just too big to resist...

Merrill Lynch estimates that at least 18 states from California to Massachusetts have state-, county-, or city-owned toll roads that might lend themselves to privatization. ... What you need is an established road, and the flexibility to increase tolls. ... We are going to see more of these transactions, and the numbers are going to get bigger and bigger. It was estimated last year that New Jersey might get $30 billion for the state's Turnpike and Parkway... That would cure a lot of Governor Jon Corzine's headaches. Merrill Lynch estimated that the New York State Thruway Authority might be worth something like $20 billion. ... So now the cry will go up: Sell the roads! ...

The sticky matter for Governor Daniels is selling the state's lawmakers, and everyone else in Indiana, for that matter, on the idea. But we've come a long way from the days where people felt bad about selling assets like landmark buildings and other property to foreign investors. ... The money is just too big.

Selling Yellowstone Park to private developers would raise a lot of money too, but that doesn't mean we should do it. There are arguments both ways here, and some of my concern is redued by recent research showing that toll lanes are used predominantly by people pressed for time, people late for daycare pickups, that sort of thing, not just higher income individuals. Still, equity considerations are a concern.

Hausman on Wal-Mart and Welfare

Interesting...

Econ professor illustrates benefits of Wal-Mart, PressZoom: Economics Professor Jerry Hausman placed the cooling hand of numbers on ... notions about Wal-Mart's economic impact in an IAP session titled, "The Consumer Benefits From Increased Competition in Shopping Outlets: Measuring the Effect of Wal-Mart," ... Hausman's ... hourlong talk ... focused on the direct and indirect effects for consumers when one of Wal-Mart's ... super centers comes to town. ... Hausman focused on ... grocery prices and shopping data for 10,000 families who buy food in Wal-Mart super centers.

The direct effect for consumers is easy to spot, he said: Wal-Mart brings in lower food prices. Cereal, for example, costs 17 percent less at Wal-Mart than at a traditional supermarket. The indirect effect of Wal-Mart occurs "even if you never enter a Wal-Mart," Hausman said, since supermarkets tend to drop their prices in competitive response to Wal-Mart's. In addition, Wal-Mart does not raise its prices after it has driven out the competition, he said. "The indirect price effect is 5 percent even if you never go into a Wal-Mart,"...

Hausman presented graphs to show that Wal-Mart's impact on consumers varies by income category: For families with incomes less than $10,000 annually, a super center makes a 30 percent difference in what they can buy. "The marginal utility on the poor is greater," he noted. The rate of overall improvement in consumer welfare [from] a Wal-Mart super center's direct and indirect effects on the cost of food in a community averages 3.75 percent, Hausman said.

"Getting a 3.75 percent improvement in consumer welfare is greater than any tax reform or other policies. And while Wal-Mart pays its employees less -- which does affect local wages -- you still can't beat that 3.75 percent. If economists could improve consumer welfare by that much, we'd all be heroes," Hausman said.

Hausman said the U.S. Bureau of Labor Statistics ( BLS ) is taking a puzzlingly inaccurate measure of Wal-Mart's economic role, especially for lower-income families: According to the BLS, consumers are no better off when a Wal-Mart enters their community. But that's not what the numbers show. According to Hausman's research, excluding Wal-Marts from local markets creates a "large loss" to consumer welfare, he said.

Hausman is co-author, with Ephraim Leibtag, of "Consumer Benefits From Increased Competition in Shopping Outlets: Measuring the Effect of Wal-Mart" ... and "CPI Bias From Supercenters: Does the BLS Know that Wal-Mart Exists?" .... Slides from Hausman's presentation are available on his web site.

The last part refers to bias in the way the CPI is calculated by the BLS. See the second paper below on how the BLS does not account for the fall in the price of the reference basket of goods when consumers purchase goods at lower price from Wal-Mart after a store enters a market. Here are the papers:

Consumer Benefits from Increased Competition in Shopping Outlets: Measuring the Effect of Wal-Mart, Jerry Hausman and Ephraim Leibtag, NBER WP 11809, December 2005: Abstract Consumers often benefit from increased competition in differentiated product settings. In this paper we consider consumer benefits from increased competition in a differentiated product setting: the spread of non-traditional retail outlets. In this paper we estimate consumer benefits from supercenter entry and expansion into markets for food. We estimate a discrete choice model for household shopping choice of supercenters and traditional outlets for food. We have panel data for households so we can follow their shopping patterns over time and allow for a fixed effect in their shopping behavior. We find the benefits to be substantial, both in terms of food expenditure and in terms of overall consumer expenditure. Low income households benefit the most. [AEA web link] [Link on Hausman's page]

CPI Bias from Supercenters: Does the BLS Know that Wal-Mart Exists?, Jerry Hausman and Ephraim Leibtag, NBER WP 10712, August 2004: Abstract Hausman (2003) discusses four sources of bias in the present calculation of the CPI. ... We discuss economic and econometric approaches to measuring the first order bias effects from outlet substitution bias. ... the current BLS procedure does not treat correctly outlet substitution bias and acts as if Wal-Mart does not exist. Yet, Wal-Mart offers identical food items at an average price about 15%-25% lower than traditional supermarkets. The BLS links out' Wal-Mart's lower prices. ... We find a significant difference between our approach and the BLS approach. Our estimates are that the BLS CPI-U food at home inflation is too high by about 0.32 to 0.42 percentage points, which leads to an upward bias in the estimated inflation rate of about 15% per year. [Link on Hausman's page - June 2005 revision]

For a different perspective, see Paul Krugman: Wal-Mart's Excuse.

Why is U.S. Productivity Strong Relative to Europe?

Hal Varian argues that a primary factor in explaining the U.S. productivity advantage in recent years is more effective use of information technology. Chris Giles of the Financial Times follows up with a discussion of this and other influences on the difference between the U.S. and European productivity rates. He says resistance to change and tougher management practices has forestalled the adoption of productivity enhancing technology:

How US productivity pulled away, by Chris Giles, Financial Times: You could call it the productivity myth. It goes like this. European economies trail behind the US because their citizens would rather people-gaze from a pavement cafe than labour loyally in the corporate salt mines. Americans, on the other hand, are a bunch of stakhanovites so preoccupied with boosting their nation’s gross domestic product they take just a week’s vacation a year.

The conveniently simple notion that Europeans are poorer because they prefer leisure to work can no longer be supported by the data, however. ... One fact is indisputable. Over the past decade the US has stolen a march on its competitors so marked that it can no longer be dismissed as a statistical blip. ... The trend had been obvious for some time before that. ... The US has not always held so unassailable a lead. In the 1950s and 1960s, European per capita incomes steadily rose towards US levels, spurred on by the rapid recovery from the devastation of the second world war and the successful integration of European economies. ...

But the good times in Europe and Japan are long gone. In the past decade, the gap between US living standards and those in other leading countries widened again. ... the relative position of Europe’s economy has declined since 2000.

For much of that period, economists have grasped at sociological and cultural straws as they sought to explain the continued disparity in living standards. They have argued it had much to do with Europeans’ determination not to work themselves into the ground like their unfortunate US counterparts. Part of this is true. Europeans do work fewer hours than US employees... Most of this difference is indeed a conscious choice. The decline in European weekly working hours has been a consistent feature since 1950. In the US, in contrast, hours worked stopped falling in the early 1980s and since then, while US citizens have become richer, they have not chosen to “buy” additional leisure time.

Europeans accept that lower incomes are the price of spending more time at home. If they worked US hours, ... European GDP per capita would increase from 73 per cent of US levels to 86 per cent. ... A second drag on European living standards is the share of its population that is working. Unemployment dogs Germany, France and Italy ... because European economies are worse at getting the young into employment and keeping older people at work. For the 30 to 50 age group, there is almost no difference between the participation rates of the US and Europe...

The Conference Board, the global business organisation, has found that the differences between the two can be found in just three industries: retail, wholesale and finance. Take retail, where research ... indicated that the US’s advantage is almost entirely due to the building of new shops and the closure of existing stores that had become uncompetitive. The Wal-Mart effect, in other words, transformed the US economy as much as it transformed the US landscape.

By contrast, in Europe planning laws and a reluctance to allow old establishments to fail have prevented productivity growth from taking off. Prof Robert Gordon of Northwestern University thinks the outcome reflects the power of existing producers in Europe at the expense of poorer consumers. This, he believes, is a high price for Europeans to pay for the preservation of small and unproductive shops. The idea that European economies are bad at exploiting new technology is supported by detailed research ... Management differences and the use of technology explains Europe’s poor performance... US companies use technology better and their hire-and-fire culture keeps workers on their toes.

If Europe wants to improve its productivity levels, it seems, it must accept tougher management, the emergence of new and much more productive shopping centres and the death of many companies. The same lessons apply to Japan. For the US, the lesson of the past decade is that it should avoid complacency ... If Europe were to rediscover its competitive spirit and close the gap, it could disappear as quickly as it came...

Spying on Professors

This is a post from my daughter, Amy, at Flash Report on the recent story about students spying on their professors at UCLA:

Weighing in on the UCLA Story, Flash Report, by Amy Thoma

What Explains the Decline in the Volatility of Real GDP Growth?

This is a graph of quarter to quarter growth rates for real GDP in the U.S. since 1947:

Does anything catch your eye? In the mid-1980s (some narrow it down to first quarter of 1984), the variance of GDP growth declines substantially, by 50%. The source of the decline is not completely clear. This NBER paper uses cross-country evidence to help to settle whether it was from better technology, better policy, a run of good luck where no big shocks hit the economy, financial innovation, or some other explanation:

Assessing the Sources of Changes in the Volatility of Real Growth, Stephen G. Cecchetti, Alfonso Flores-Lagunes, and Stefan Krause, NBER WP 11946, January 2006: Abstract In much of the world, growth is more stable than it once was. Looking at a sample of twenty five countries, we find that in sixteen, real GDP growth is less volatile today than it was twenty years ago. And these declines are large, averaging more than fifty per cent. What accounts for the fact that real growth has been more stable in recent years? We survey the evidence and competing explanations and find support for the view that improved inventory management policies, coupled with financial innovation, adopting an inflation targeting scheme and increased central bank independence have all been associated with more stable real growth. Furthermore, we find weak evidence suggesting that increased commercial openness has coincided with increased output volatility. [Open link to paper]

'We Must Change Policy Direction'

Former Treasury Secretary Robert E. Rubin says it's time for politicians to stop playing games and deal with our mounting economic challenges. He urges both sides to set aside differences and hammer out effective bi-partisan solutions. I will just note that one party is in power, the other isn't, and the party in power has shown few signs of a willingness to seek political solutions that will allow these problems to be addressed through negotiatied, compromise solutions:

'We Must Change Policy Direction', by Robert E. Rubin, Commentary, WSJ Online: ...[T]he leaders of Asia's emerging market economies... are making tough decisions ... The result is large numbers of well-educated workers in low-wage and increasingly market-based environments (especially in China and India)... This has created a competitive challenge of historic proportions which encompasses manufacturing and virtually all services electronically communicable. We can meet this challenge and enjoy a bright future. Our economy has great strengths ... However ... to avoid the real possibility of great economic difficulty, we must re-establish our own seriousness of purpose about economic policy, and we must change policy direction on many fronts.

Some would argue that our reasonably healthy GDP growth ... indicates that we can stick with the economic policy status quo. I believe this would be a serious mistake. Median real wages ... have been roughly stagnant for the past five years -- and many Americans have had falling real incomes. Private sector job growth has been the lowest of any recovery since the '30s. ...

Re-establishing seriousness of purpose regarding economic policy ... will require ... making choices that are very difficult politically, compromising among divergent views ..., and putting aside ideology in favor of facts and analysis. There is ... widespread agreement that our future economic well-being is threatened by large ... fiscal deficits, huge increases in entitlement costs ..., personal savings rates of approximately zero, public school system inadequacies, and high health care costs. But our political system is failing to mediate differing views on how to address these issues, and failing to make the difficult decisions required. ...

To move forward, serious policy advocates from all perspectives should start by agreeing on two basic bedrock principles: that there is no free lunch; and that a strong future requires incurring costs now for benefits later. We should then put everything on the table. Our strategy should have four components:

(1) We should re-establish sound fiscal conditions for the intermediate term ... and put in place a real plan to get entitlements on a sound footing ... (2) We need a strong public investment program -- paid for, not funded by increased public borrowing -- to promote productivity growth, to help those dislocated by technology and trade, and to equip all citizens to share in our economic well-being and growth. (3) We must pursue an international economic policy that continues global integration, ... (4) We should work toward a regulatory regime that meets our needs and sensibly weigh risks and rewards.

Our strategy should reaffirm market-based economics as the most effective organizing principle for economic activity, while recognizing the critical role of government in providing the many requisites for economic success that markets, by their very nature, will not provide.

Broad participation in economic well-being and growth is critical ... to realize our economic potential. ... Broad-based participation is also the best antidote to protectionism, and to pressures for undue restrictions on our economic flexibility and immigration. For these same reasons, measures to increase security for the growing number of people dislocated in our rapidly changing economy may well be wise economically. This can be done without creating the rigidities and excessive social benefits that have led to chronically slow growth and high unemployment in Continental Europe. ... Our economy is not working for too many of our people, and that is a problem for all of us...

The proponents of supply-side theory who assert that tax cuts will wholly -- or even significantly -- pay for themselves (through increased growth and federal tax revenues), appear to be no more accurate now than they were in the '90s. ... Virtually all mainstream economists take the view that sustained long-term deficits will crowd out private investment, increase interest rates, reduce productivity and reduce growth. ... The adverse impact on interest and currency rates has not yet occurred, partly because business has had relatively low levels of demand for capital -- but most importantly because of vast capital inflows from abroad ... This is not indefinitely sustainable; at some point, which could be near in time or still some years out, continued imbalances, increasing fiscal debt levels and ever-greater overweighting of dollar holdings abroad are highly likely to lead to loss of confidence, and trouble.

The fiscal and entitlement holes are now so deep that measures adequate to address them would be exceedingly difficult politically... And, even more importantly, the proposals themselves would likely be so sharply attacked as to become politically toxic. Thus, I believe that the most realistic way forward is for the president to bring together the leaders of both parties and both houses to make these decisions with joint political responsibility. Everything should be on the table... Finding the balance that best promotes economic growth in this context could well call for revenue increases as well as spending discipline... None of this is easy, but our economy could well be at a critical juncture... To realize our bright future and to minimize the risk of serious difficulty, we urgently need our own sense of mission to meet the challenges facing our economy.

What China Can Learn from India

Yasheng Huang from the MIT Sloan School of Management says China could learn a thing or two from India about economic development. He believes India will outperform China in the next few decades unless "China embarks on bold institutional reforms":

China could learn from India’s slow and quiet rise, by Yasheng Huang, Financial Times: In an article published in 2003 called “Can India overtake China?” Tarun Khanna of Harvard Business School and I argued that India’s domestic corporate sector – strengthened by the country’s rule of law, its democratic processes and relatively healthy financial system – was a source of substantial competitive advantage over China. At that time, the notion that India might be more competitive than China was greeted with wide derision.

Two years later, India appears to have permanently broken out of its leisurely “Hindu rate of growth” ... and its performance is beginning to approach the east Asian level. ... More impressively, India is achieving this result with just half of China’s level of domestic investment in new factories and equipment, and only 10 per cent of China’s foreign direct investment. ...

Why, then, is India gaining strength? Economists and analysts have habitually derided India’s inability to attract FDI. This single-minded obsession with FDI is as strange as it is harmful. Academic studies have not produced convincing evidence that FDI is the best path to economic development compared with responsible economic policies, investment in education and sound legal and financial institutions.

An economic litmus test is not whether a country can attract a lot of FDI but whether it has a business environment that nurtures entrepreneurship, supports healthy competition and is relatively free of heavy handed political intervention. In this regard, India has done a better job than China. From India emerged a group of world-class companies... This did not happen by accident.

Although it has many flaws, India’s financial system did not discriminate against small private companies the way the Chinese financial system did. Infosys benefited from this system. ... It is unimaginable that a Chinese bank would lend to a Chinese equivalent of an Infosys. With few exceptions, the world-class manufacturing facilities for which China is famous are products of FDI, not of indigenous Chinese companies. ...

Pessimism about India has often been proved wrong. Take, for example, the view that India lacks Chinese-level infrastructure and therefore cannot compete with China. This is another “China myth” – that the country grew thanks largely to its heavy investment in infrastructure. ... China built its infrastructure after – rather than before – many years of economic growth and accumulation of financial resources. The “China miracle” happened not because it had glittering skyscrapers and modern highways but because bold economic liberalisation and institutional reforms – especially agricultural reforms in the early 1980s – created competition and nurtured private entrepreneurship.

For both China and India, there is a hidden downside in the obsession with building world-class infrastructure. As developing countries, if they invest more in infrastructure, they invest less in other things. Typically, basic education, especially in rural areas, falls victim to massive investment projects... China made a costly mistake in the 1990s: it created many world-class facilities, but badly under-invested in education. Chinese researchers reveal that a staggering percentage of rural children could not finish secondary education. India, meanwhile, has quietly but persistently improved its ­educational provisions, especially in the rural areas. For sustainable ­economic development, the quality and quantity of human capital will matter far more than those of physical capital. ...

Unless China embarks on bold institutional reforms, India may very well outperform it in the next 20 years. But, hopefully, the biggest beneficiary of the rise of India will be China itself. It will be forced to examine the imperfections of its own economic model ... China was light years ahead of India in economic liberalisation in the 1980s. Today it lags behind in critical aspects, such as reform that would permit more foreign investment and domestic private entry in the financial sector. The time to act is now.

Update - New Economist adds:

MIT's Yasheng Huang writes ... that China could learn from India's slow and quiet rise ... Huang's claims are, I think, exaggerated - India's poor infrastructure is a problem, and its education system has major shortcomings. Nonetheless, it is refreshing to read a piece these days that doesn't extoll the virtues of China, and which demonstrates that "pessimism about India has often been proved wrong"

Global Imbalances and Monetary Policy

NY Fed president Tim Geithner gave a speech today on the implications of global imbalances for the conduct of monetary policy. Here's the speech. Brad Setser comments here. I'll update this post later today.

Update: Here's a follow up from the Financial Times. President Geithner believes the trajectory for the current account deficit is unsustainable, and it's not necessarily self-correcting in a smooth, non-disruptive fashion, but we just don't know for sure how rocky the road might be. In his view, the longer the trade gap builds, the larger the risks. Because of this, policies such as reductions in the federal budget deficit are needed to mitigate the risk:

US current account deficit ‘unsustainable’ – NY Fed chief, by Christopher Swann, Financial Times: Timothy Geithner, president of the New York Federal Reserve, on Monday dismissed the view that the US current account deficit was sustainable, suggesting the risk of a sudden fall in the dollar would grow the longer the trade gap widened. ... Mr Geithner said the problem could not necessarily be expected to solve itself. “Time does not necessarily help. The longer these gaps continue to build, the greater the ultimate adjustment required, and the greater the risks that accompany that process,” he said.

“The plausible outcomes range from the gradual and benign to the more precipitous and damaging,” he said. “The size and duration of these [global] imbalances, perhaps the most visible of which is the US current account deficit, present challenges – and risks – for the world economy.” His warning came as Raghuram Rajan, chief economist at the International Monetary Fund, repeated his concern over the risk of a run on the dollar. “You cannot discount a run on the dollar. But you cannot fully quantify that risk at the moment,” he said ...

Mr Geithner ... does not see a role for monetary policy in responding to the current account by raising interest rates to slow domestic demand growth and so the demand for imports. Rather, he believes the risks on the external side make it more important for the Fed to keep inflation under control, to avoid adding to the problems and to preserve the Fed’s flexibility in a crisis.

Many economists have argued that the risks to the dollar from the bloated current account deficit are mitigated by support for the currency from Asian central banks... However, Mr Geithner said this should provide little comfort over the long term. “A prolonged continuation of the exchange rate arrangements that have given rise to the large increase in foreign official investments in US financial assets is unlikely to be consistent with the domestic requirements of those economies and for this reason many are already in the process of change,” he said.

“Even if we could be confident that the world would be comfortable financing the US on these terms for some time, that fact alone does not mean that it is prudent for the US to continue borrowing on this scale.” Mr Geithner repeated his call for US politicians to reduce the budget deficit. The fact that the US is using much of the money borrowed from abroad to finance public spending, he said, increased the dangers. If it was being invested in the productive capacity of the US tradeable goods industries, this would at least help the US to pay back its foreign obligations.

"Bitter Conflict" at the World Bank

It's hard to argue with the goal of reducing corruption, but this hardly seems like the best way to go about it. It's so surprising to hear that Paul Wolfowitz is creating controversy as president of the World Bank:

Wolfowitz triggers graft storm at World Bank, by Andrew Balls and Edward Alden, Financial Times:  Paul Wolfowitz, president of the World Bank, has triggered a bitter conflict with the bank’s senior career staff by empowering a group of close political advisers to pursue aggressively what he sees as widespread corruption surrounding bank projects. The dispute has come to a head with the appointment ... of Suzanne Rich Folsom, a counsellor to Mr Wolfowitz with close ties to the Republican party, as the new director of the Department of Institutional Integrity, the internal bank watchdog that investigates suspected fraud and staff misconduct.

Her appointment has raised objections that a person close to Mr Wolfowitz, and with a political background, has been put into a senior position at a unit that was seen as independent of the president’s office since it was set up in 2001. Robert Hindle, previously the senior manager of the unit and a long-time World Bank employee, resigned ... largely as a result of ... concern at the targeting of employees who had worked on projects that developed corruption problems... A number of senior bank staff and executive directors representing member countries ... complain of a lack of consultation by Mr Wolfowitz’s advisers, and an atmosphere of suspicion. Roberto Dañino, the bank’s general counsel and a former prime minister of Peru, this month also announced his resignation because, friends said, he was unhappy at the way the bank was being run by Mr Wolfowitz... Mr Wolfowitz’s appointment last year was greeted with apprehension by some long-time staff. Many Republicans believe the bank is plagued by corruption. Ms Rich Folsom was hired ... with the task of improving the bank’s relations with Congressional Republicans.

Brad DeLong has more.

Paul Krugman: Iraq's Power Vacuum

Infrastructure is essential in allowing an economy to reach its potential, a fact Paul Krugman illustrates with Iraq. He explains how the failure to develop Iraq's infrastructure through effective reconstruction efforts has undermined the chance of a successful outcome:

Iraq's Power Vacuum, by Paul Krugman, Commentary, NY Times: In the State of the Union address, President Bush will assert ... that he has a strategy for victory in Iraq. I don't believe him. ... To explain myself, let me tell you some stories about electricity.

Power shortages are a crucial issue for ordinary Iraqis, and for the credibility of their government. As Muhsin Shlash, Iraq's electricity minister, said ..., "When you lose electricity the country is destroyed, nothing works, all industry is down and terrorist activity is increased." ... In today's Iraq, blackouts are the rule rather than the exception. ... Baghdad and "much of the central regions" - in other words, the areas where the insurgency is most active and dangerous - currently get only between two and six hours of power a day.

Lack of electricity ... prevents businesses from operating, destroys jobs and generates a sense of demoralization and rage that feeds the insurgency. So why is power scarcer than ever...? Sabotage by insurgents is one factor. But as ... The Los Angeles Times ... showed, the blackouts are also the result of some incredible missteps by U.S. officials. Most notably, ... U.S. officials ... decided to base their electricity plan on natural gas: ...American companies were hired to install gas-fired generators in power plants across Iraq. But ... "pipelines needed to transport the gas" - ... to the new generators - "weren't built because Iraq's Oil Ministry, with U.S. encouragement, concentrated instead on boosting oil production." Whoops.

Meanwhile, ... U.S. officials chose not to raise the prices of electricity and fuel, which had been kept artificially cheap under Saddam, for fear of creating unrest. But as a first step toward their dream of turning Iraq into a free-market utopia, they removed tariffs and other restrictions on ... imported consumer goods. The result was that wealthy and middle-class Iraqis rushed to buy imported refrigerators, heaters and other power-hungry products, and the demand for electricity surged ... This caused even more blackouts.

In short, U.S. officials thoroughly botched their handling of Iraq's electricity sector. They did much the same in the oil sector. But the Bush administration is determined to achieve victory in Iraq, so it must have a plan to rectify its errors, right? Um, no. ... all indications are that the Bush administration ... doesn't plan to ask for any more money for Iraqi reconstruction.

Another Los Angeles Times report ... contains some jaw-dropping quotes from U.S. officials, who now seem to be lecturing the Iraqis on self-reliance. "The world is a competitive place," declared the economics counselor at the U.S. embassy. "No pain, no gain," said another official. "We were never intending to rebuild Iraq," said a third. We came, we saw, we conquered, we messed up your infrastructure, we're outta here.

Mr. Shlash certainly sounds as if he's given up expecting more American help. ... Yet he also emphasized the obvious: partly because of the similar failure of reconstruction in the oil sector, Iraq's government doesn't have the funds to do much power plant construction. In fact, it will be hard pressed to maintain the capacity it has, and protect that capacity from insurgent attacks.

And if reconstruction stalls, as seems inevitable, it's hard to see how anything else in Iraq can go right. ...[T]he Bush administration... doesn't have a plan; it's entirely focused on short-term political gain. Mr. Bush is just getting by from sound bite to sound bite, while Iraq and America sink ever deeper into the quagmire.

Previous (1/19) column: Paul Krugman:  The K Street Prescription
Next (1/26) column: Paul Krugman:  Health Care Confidential

Update: From the Washington Post:

Professionals Fleeing Iraq As Violence, Threats Persist: Exodus of Educated Elite Puts Rebuilding at Risk: ... Iraq's top professionals -- doctors, lawyers, professors -- and businessmen have been targeted by shadowy political groups for kidnapping and ransom, as well as murder, some of them say. So many have fled the country that Iraq is in danger of losing the core of skilled people it needs most ... "It's creating a brain drain," said Amer Hassan Fayed, assistant dean of political science at Baghdad University. "We could end up with a society without knowledge. How can such a society make progress?" Professionals and businessmen with the means to escape are going to Jordan, Syria, Egypt or, if they have visas, to Western countries...

Fed Watch: Ready to Invert

Tim Duy with his latest Fed Watch:

I had previously believed that the Fed would not purposefully invert the yield curve (in this case, the spread between the 10 year and the Fed Funds rates). I had thought that whatever economic environment would drive tighter Fed policy would drive long rates higher. But it looks like inversion day is coming, barring some near term changes in the bond market. Moreover, the Fed looks to be sending a very specific signal: Even if we do pause at the March meeting, our bias remains tilted toward inflation. A solid economy and rising energy prices means it is too early to call off the dogs. In my opinion, policymakers do not want investors to get the idea that a pause in rates signals an imminent rate cut. Instead, they are signaling that without a more dramatic change in the economic environment, the odds remain tilted toward more tightening in the post-Greenspan era.

As this post kept getting longer and longer, a quick outline of my take on the Fed’s position is in order:

1. Overall, economic activity is quite healthy.
2. Consumer spending cooled at the end of last year, but Fed officials don’t seem particularly worried.
3. Housing is cooling as well, but not uniformly, and not in such a way as to suggest a crash is coming.
4. The expectation continues to be that firms will step up capex spending.
5. Resource utilization continues to be a concern.
6. A cessation in rates hikes should not be interpreted as the first step toward cutting rates.

The Beige Book was, in my opinion, somewhat hard to get a handle on. Mixed messages were common, leaving open the possibility of cherry picking little bits and pieces to support whatever story you want to tell. With that in mind, I concluded that the anecdotal message was that despite some cooling in housing and consumer spending, economic activity continued its solid expansion. And while prices pressures remain contained, there are enough signals of potential inflationary pressures to keep policymakers on their toes.

I was somewhat surprised by the benign impressions of consumer spending given wide expectations that Q4 GDP will look soft due to a weak household spending component. Moreover, the slowdown in the housing market appears to be evolving as planned, with pockets of cooling somewhat offset by pockets of heating up – including an acceleration in Oregon (Oregon is relatively inexpensive compared to other West Coast states). This pattern will support the underlying contention at the Fed that the housing “bubble” is not likely to pop with the same consequences as the burst of the technology bubble. The auto industries woes are still evident – no surprise here. But outside of that, not much of concern to policymakers and reflective of the quiescence we see in FedSpeak.

Consistent with the December employment and industrial production reports, manufacturing activity looked solid:

Increases in manufacturing activity were widely reported across the country. Only the St. Louis District characterized industrial activity as mixed. Elsewhere, robust expansion was reported in the San Francisco, Dallas, Kansas City, Minnesota, Chicago, New York, and Boston Districts. More moderate expansion was indicated in the Cleveland, Richmond, Philadelphia, and Atlanta Districts.

So it looks like, via both anecdotal and data evidence, that resource utilization from the physical capital side of the equation is on the rise – this is evidently important to at least one governor, as we will see a bit later. What about the labor side of the equation? Here it is worth repeating the relevant section from the Beige Book overview:

Most Districts reported signs of continued, if generally moderate, increases in employment. Cleveland, Minneapolis, and Richmond all cited moderate employment gains, with Richmond noting that its rate represented a slowdown. New York, Atlanta, Kansas City, and Dallas reported evidence of stronger employment growth. However, Boston noted that output growth had generally not translated into higher employment, while St. Louis reported a widely mixed pattern of layoffs and hiring. Hiring at financial and legal services firms is boosting the New York District's employment growth, although New York also reported some hiring in manufacturing. Atlanta reported strong demand for both skilled and unskilled labor, in part boosted by storm-recovery efforts.

Atlanta reported several locations with tight labor market conditions, while Boston, New York, Philadelphia, Chicago, Kansas City, Dallas, and San Francisco all reported specific occupations in which jobs have been difficult to fill. Several of these Districts cited trucking jobs. Skilled construction workers are relatively sought after in Dallas and San Francisco, and skilled manufacturing jobs were mentioned by Boston, Chicago, and Dallas. Atlanta listed a variety of specialties in "extreme shortage." New York and San Francisco noted that finance-industry labor markets were relatively tight. Despite reports of labor market tightness, Boston, Philadelphia, Minneapolis, Kansas City, and San Francisco all noted that wage increases have been generally moderate. However, New York, Chicago, and Dallas all reported some acceleration in compensation.

Mixed messages here – St. Louis and Atlanta appear to be on opposite ends of the spectrum – but the story seems to point to a strengthening labor market with accelerating wage gains in some locals. Will this acceleration spread? In the current environment, I would say this is a good bet. Note that jobless claims, a leading indicator, have fallen to a six year low. Will the Fed be unhappy, from an inflation perspective? Maybe. As always, the answer to this question depends on pass through. The Fed will be most concerned if they sense that pricing power is emerging that will allow firms to raise prices to offset higher wages. If not, then rising wages would reflect productivity gains. Nothing bad about that – it would simply indicate that the short run data is catching up to the long run theory.

On, then, to the inflation story. Note that the report on trucking and shipping has the feel of emerging transportation bottlenecks:

Burning Bridges To and From the World Bank

Following up on the topic of economic and political ties between Africa and China in the post below this one, the World Bank and Chad are having troubles over oil revenues from a World Bank sponsored project intended to ease poverty, and there are indications this may result in Chad abandoning the World Bank agreement and forging deals with China instead:

Why a World Bank oil project has run into the sand, by David White, Financial Times: It was touted as the formula all future projects of its kind would follow. The conditions put in place for an oil development and pipeline project in central Africa were hailed by the World Bank as a pioneering breakthrough, a way of tracking where the money went and making sure it helped the people who needed it most. Yet two and a half years since oil for export started pumping ... the triumph rings hollow.

The deal, which obliged Chad to account for most of its direct revenues from the $4.2bn (£2.4bn, €3.5bn) project, was meant to overcome the sorry history of mineral exploitation in developing countries – the “resource curse” that, instead of bringing development, gets in the way of it, favouring corruption, self-serving elites, waste, poverty and unrest.

But the World Bank took a gamble setting its test case in a fragile country held back by war, with no record of good governance and little experience of budget management. Always questionable, the experiment is now at an impasse, a victim of mutual misunderstanding and the desperation of a shaky regime needing to shore up its rotting power base.

The breakdown is a significant early test for Paul Wolfowitz, who took over as World Bank president last June... Chad had defied the bank by changing its law on managing petroleum revenues, to gain more freedom in spending its money. ...[T]he outcome will have important implications. It could demonstrate how any country can bypass international attempts to impose standards on it. It could also leave one of the world’s poorest countries ... even worse off than before.

The government seems not to have reckoned with the full consequences. For the moment it has no access to further funds either from its main creditor or from its oil. A cornerstone international institution is sticking to its principles but at a potential cost, both to the people the scheme was supposed to benefit and to its reputation.

“It’s a paradox, when the World Bank is an organisation that presents itself as the high priest of the fight against poverty, and its first reflex is to close down projects of social benefit,” says Mahamat Ali Hassan, Chad’s economy minister. Chadian officials’ charge of “blackmail” has a resonance in other developing countries. ...

The differences between Chad’s new legislation and the 1999 original would seem to leave room for negotiation but both sides have dug in. ... In an exercise in brinkmanship, Idriss Déby, Chad’s president, had the law approved by parliament in late December. A week later ... he had a two-hour telephone conversation with Mr Wolfowitz. Next morning, the World Bank chief called in board members. The bank’s loans to Chad, destined mostly for non-oil projects, were suspended...

Chad’s government received the notification only five days later. Mr Déby, who still had the possibility of sending the law back to parliament, immediately signed it. The bridges were now burnt. Each side appears to have underestimated the other’s determination.

The freezing of funds has created bewilderment in Chad’s government, which by its spokesman’s admission “has its back to the wall”. ... “If it’s crunch time, Chad could turn its back on the international community,” warns Chris Melville of Global Insight... Officials hint at alternative oil deals with China, already the dominant client for oil from neighbouring Sudan. Chad may seek bridging finance from other African oil producers – possibly Gabon or Equatorial Guinea – or elsewhere. That could sustain the regime for a year until taxes from the oil venture begin flowing in. Chad may be able to cancel its World Bank debt on the oil project and go its own way. ...

Chad was supposed to establish a model of good practice. But, as a western observer in the country puts it: “The risk is that it will become an example for the worst pupils.” ...

Africa and China

As the economic ties between China and Africa grow stronger, there are questions about the nature of the evolving relationship:

A match made in Beijing, by Lyal Whi, Mail & Guardian Online, South Africa: Africa needs China. ...China’s insatiable appetite for natural resources is creating unprecedented demand for commodities, pushing prices to new highs and fuelling economic growth across the continent. But China’s relations with Africa have stirred a polarised debate from Cape to Cairo. China is either the next big thing, usually in the view of business and some governments. Or it is the red peril, the new coloniser...

In terms of political ideology and approaches to socio-economic development, China is closely aligned to countries of the south. This has ... shaped China’s relations with countries in Africa and elsewhere and created a somewhat idealistic impression of the distant partner or big brother in the East ... Many Africans still believe that relations with China are of an altruistic nature. They tend to forget the hardnosed commercial reality that now determines international relations -- and relations with China in particular.

They are seemingly unaware of the fact that China’s relations with Africa are merely part of a broader strategy of engagement with the developing world, focused on the search for natural resources. Reliable access to resources is essential for ongoing growth and development and is at the core of China’s national interests. In this respect, China and Africa are ideal partners. Africa is a treasure trove of metals and minerals and has huge agricultural potential. ...

But China’s relations with Africa have faced criticism. Firstly, trade imbalances are increasingly in China’s favour and large-scale dumping of cheap manufactured products are undercutting local industries. ... The South African clothing and textile sector has lost more than 100 000 jobs since 1995 due largely to the influx of cheaper products from China. Trade with China has, if anything, worsened unemployment and poverty in South Africa, which are two of the most pressing problems facing the country today.

Secondly, the slow trickle of long-term fixed investments from China indicates a lack of commitment in Africa. ... Finally, the nature of Chinese activities on the continent ... are often accused of undermining the principles of good governance and human rights, is a source of controversy both on the continent and abroad. The use of Chinese labour on many of the African based contracts is also a point of contention. ... China’s so-called “respect for sovereignty” carries little resonance among human rights groups ...

China needs Africa. Apart from Latin America, Africa is probably the richest diversified source of metals, minerals, fuel and agricultural produce in the world. ... China is also seeking greater international recognition and leverage in multilateral organisations. Africa is able to provide such support and assist China in improving its “soft power” of influence and acceptance worldwide.

China-Africa relations are first and foremost commercial in nature. But China’s pursuit of business interests in Africa should not disregard the principles associated with political good governance. ... Finally, Africa can learn from China’s process of economic development and liberalisation, which has turned it into an investment magnet and one of the most competitive markets in the world. An improved investment climate in Africa will guarantee a reliable supply of resources and unlock vast potential in the labour market.

Health Savings Accounts: Krugman vs. Feldstein

Last year, the administration promoted Social Security privatization. This year, the push is for Health Savings Accounts. Here's president Bush in his radio address today:

President's Radio Address: ...For the sake of America's small businesses, workers, and families, we must also make health care more affordable and accessible. A new product known as Health Savings Accounts helps control costs by allowing businesses or workers to buy low-cost insurance policies for catastrophic events and then save, tax-free, for routine medical expenses. This year, I will ask Congress to take steps to make these accounts more available, more affordable, and more portable...

I thought it would be useful to review the debate over these accounts. Here's Martin Feldstein's arguments in support of Health Savings Accounts:

Health and Taxes, by Martin Feldstein, WSJ, 1/19/04: ...Health Savings Accounts ... may well be the most important piece of legislation of 2003. These new tax and medical insurance rules have the potential to transform health-care finances, bringing costs under control and making health care reflect what patients and their doctors really want. It is remarkable that this legislation has received so little public attention.

Today's high cost of health care reflects the way that the tax law has subsidized the use of insurance to pay for health care. ... Because out-of-pocket payments at the time of care are only a small fraction of the total cost of producing that care, individuals naturally want "the best care" that medical science can provide. And the demand for that high-tech care drives medical innovation toward new and more expensive modes of treatment.

The demand for the typical health-insurance policy reflects the tax provision that allows employees to exclude payments for health insurance from their taxable income. ...[T]he resulting tax saving is a very large subsidy for the purchase of the kind of comprehensive, low-deductible insurance policy that drives up health-care costs ... essentially a $120 billion subsidy for purchasing the wrong kind of insurance. ...

The new HSA law (a part of the recent Medicare reform bill) eliminates the preferential subsidy... Anyone under the age of 65 can establish a Health Savings Account if they have a "qualified" health-insurance plan. A "qualified" plan is an insurance policy that has a minimum deductible of $2,000 for a family and a $10,000 limit on the family's annual out-of-pocket expenses. The deductible is designed to make individuals more cost-conscious in their consumption of health care, and the annual limit on out-of-pocket expenses is there to prevent financial hardship... An individual can withdraw funds from his HSA without paying tax if the money is used for any kind of health bills...

High-deductible policies give individuals and their doctors an incentive to avoid wasteful health spending. When spending comes from the individuals' own Health Savings Accounts, individuals and their doctors have a strong reason to balance the costs of medical procedures against the potential favorable impact on health. ...

Here's Paul Krugman with a different view:

Medical Class Warfare, by Paul Krugman, NY Times, 7/16/04: The ... main component of the Bush plan involves "health savings accounts." ...[H]ealth savings accounts don't seem to have much to do with the needs of the families likely to find themselves without health insurance. For one thing, such families need more protection than a plan with a $2,000 deductible provides. Furthermore, the tax advantages of health savings accounts would be small for those families most at risk of losing health insurance, who are overwhelmingly in low tax brackets.

But for people whose income puts them in high tax brackets, these accounts are a very good deal; making the premiums deductible turns them into a great deal. In other words, health savings accounts will offer the already affluent, who don't have problems getting health insurance, yet another tax shelter. Meanwhile, health savings accounts, in the view of many experts, will actually increase the number of uninsured.

This perverse effect shouldn't be too surprising: unless they are carefully designed, medical policies often have side consequences that worsen the problems they supposedly address. ... In the case of health savings accounts, the key side consequence is a reduced incentive for companies to insure their workers. When companies provide group health insurance, healthier employees implicitly subsidize their sicker colleagues. They're willing to do this largely because the employer's contributions to health insurance are a tax-free form of compensation, but only if the same plan is offered to all employees.

Tax-free health savings accounts and premiums would provide healthier and wealthier employees an incentive to opt out, accepting higher paychecks instead, and would lead to higher insurance premiums for those who remain in traditional plans. This would cause some companies to stop providing health insurance, or raise employee contributions to a level some workers can't afford. ...

And, from another column:

America's Failing Health, by Paul Krugman, NY Times, 8/27/04: ...Clearly, health care reform is an urgent social and economic issue. But who has the right answer? ... George Bush's economists think ... health costs are too high because people have too much insurance and purchase too much medical care. What we need, then, are policies, like tax-advantaged health savings accounts tied to plans with high deductibles, that induce people to pay more of their medical expenses out of pocket. (Cynics would say that this is just a rationale for yet another tax shelter for the wealthy, but the economists who wrote the report are probably sincere.) ...

[Others] believe that health costs are too high because private insurance companies have excessive overhead, mainly because they are trying to avoid covering high-risk patients. What we need, according to this view, is for the government to assume more of the risk, for example by picking up catastrophic health costs, thereby reducing the incentive for socially wasteful spending, and making employment-based insurance easier to get. A smart economist can come up with theoretical justifications for either argument. The evidence suggests, however, that the [second] position is much closer to the truth. ...

Does this mean that the American way is wrong, and that we should switch to a Canadian-style single-payer system? Well, yes. ... My health-economist friends say that it's unrealistic to call for a single-payer system here: the interest groups are too powerful, and the antigovernment propaganda of the right has become too well established in public opinion. All that we can hope for right now is a modest step in the right direction... I bow to their political wisdom. ...

I'm with Krugman on this one.

Global Competition and Changes in the Structure of the U.S. Economy

Daniel Altman talks about the decline in manufacturing and other changes in the U.S. economy driven by technological change and globalization:

Exporting Expertise, If Not Much Else By Daniel Altman, Economic View, NY Times: Want to understand what's really happening in the American economy? ...[T]he sea of numbers that pour out of ... statistical agencies... describe some disturbing changes. You can look at the economy in two ways: by production, or by people. The two aren't always the same... This is clear when you look carefully at the biggest long-term trend in the economy: the decline of manufacturing.

Both of manufacturing's two big categories, durable goods (like cars and cable TV boxes) and nondurable goods (like pastrami and pantyhose), have plunged, but the exact trends have differed. From 1965 to 2005, the percentage of payroll employees devoted to durable goods dropped to 8 percent, from 19 percent; over the same period, the share of the economy they represent shrank by just four percentage points. In other words, workers in these industries became a lot more productive as their numbers dwindled.

 

The picture was different for nondurable goods. In that category, the employees' share of the nation's labor force also declined steeply, by nine percentage points, to just 5 percent of the total. But nondurables' share of the economy dropped by even more, by 10 percentage points. ... Most of the losses in nondurable production had already occurred by the early 1990's. That's not too surprising, when you think about it: the nation's agriculture had become about as efficient as it could be, and clothing imports from developing countries like China, Bangladesh and Mauritius were in full swing.

The story for durable goods is more troubling. Half of the decline in production has been a legacy of the last recession: sales went down, and they have stayed down. The situation is a first, and it has been reflected in the labor market, too. ...[A]fter the 2001 recession, [employment] sank below nine million and hasn't picked up. ... The explanation may lie ... in the world's emerging economies. They saturated the American market with nondurables in the 1980's and early 90's, using the profits to move onto higher-value, durable items.

The change in the trend for durable goods was not the only worrisome legacy of the last recession. In the information sector, which had been among the most steadily growing areas of the labor market, growth has completely stalled ... The relatively small industries of broadcasting and Internet publishing have started upward ... But in print publishing, telecommunications and Internet services, the trend has been absolutely flat, despite the economy's return to regular growth.

Of course, there have been winners, too. The share of the economy devoted to medical care services has grown by eight percentage points in the past four decades, with commensurate changes in employment. But this isn't necessarily great news for the economy. ...

The leisure and recreational industries have also expanded, with the share of employment up by four percentage points. Here, too, exporting is difficult: after all, gambling, artistic performances and restaurant dinners usually take place on site. More promising, management and professional services like law and finance resumed their strong growth after taking a hit in the recession. These areas are the ripest for exporting. Need some business advice? No problem. Want some derivatives structured? Great. ...

We are becoming a nation of advisers, fixers, entertainers and high-tech engineers, with a lucrative sideline in treating our own illnesses. ... The change is being forced on us by global competition and our own aptitudes. The first step in dealing with it is to realize what's happening. The second, most likely, is to prepare for more of the same.

Whale of a Job

It's too bad that the whale they were trying to rescue from the Thames did not survive the ordeal. It reminded me of this story of "A whale that ... will always have the last laugh":

Bob Welch: Tale of flying blubber keeps bubbling up, by Bob Welch Columnist, The Register-Guard, November 10, 2005: Saturday marks the 35th anniversary of the funniest thing that ever happened in Oregon: the exploding whale. Like you needed reminding, right? ... [E]ach year at this time, [we] pay tribute to the ... Oregon Department of Transportation ... for bringing us the laugh heard 'round the world.

Who can we thank for helping keep the spirit alive? An otherwise unassuming Eugene man, Steve Hackstadt, mastermind of the ever-popular "TheExplodingWhale.com" Web site. It receives about 10,000 hits a day ... "There are still people who don't believe," says Hackstadt, a 35-year-old software engineer who works for NASDAQ. "Some think it's an urban legend." No, it's too perfect for legend.

In 1970, an 8-ton sperm whale washed ashore dead - this is an important fact, this "dead" part - just south of Florence. After considering ways to get rid of the stinking, rotting remains, the Highway Division gathered its finest minds to noodle a solution.

Being guys, they naturally figured a half-ton of dynamite would do the job. Most of the ex-whale, they figured, would blow out to sea as mist and any small pieces would be cleaned up by the gulls. ... As KATU's Paul Linnman says while narrating film footage: "The humor of the situation gave way to a run for survival as huge chunks of whale blubber fell everywhere." A woman can be heard saying, "Here come pieces of ... ." The hood of a car is crunched like a pop can.

Nobody was hurt. "However," reported Linnman, "everyone on the scene was covered with small particles of dead whale." Oregon rain - with a ... twist.

For most people, the story faded. But .... In 1990, columnist Dave Barry saw the video and called the explosion "the most wonderful event in the history of the universe." Then, in the mid-'90s, along came Hackstadt, a graduate student in the University of Oregon's computer information science department. He saw the video and slapped it on his personal Web page. "It's a classic," he says. ... Eight tons of whale blubber, splattered up to a quarter-mile from the ex-whale, attest to that.

If engineers thought the idea of burying the whale to be impractical, the story itself refuses to be buried. It has a cult following, ... "I've received death threats. Some people don't understand that the whale was dead when this happened. A lot of people are confused. It's like: 'You killed Keiko.' "

No, no, no. This story isn't about death. It's about a whale that refuses to die. A whale that lives on. A whale that, thanks to man's stupidity, will always have the last laugh.

For Whom the Benefit Tolls

According to this geriatric medicine specialist, it's not for thee:

It's a benefit, but for whom?, by Daniel J. Stone, Commentary, Los Angeles Times: As a geriatric medicine specialist, I am confronted daily by the chaos and confusion of Medicare's Part D drug benefit. The program should reflect President Bush's ideals of "compassionate conservatism." Compassion would mean user-friendliness and easy access to affordable drugs. And a conservative plan would maximize "bang for the buck." Instead, the priorities of the insurance and pharmaceutical companies have trumped these objectives.

Economics 101 tells us that the largest purchasers have bargaining power to get the best prices... Similar national bargaining entities in Canada and Europe allow foreign consumers to pay a third to one-half of U.S. drug prices. A single Medicare bargaining entity, however, threatened to place unprecedented price pressures on drug companies and might have reduced or eliminated the role of private insurers.

So Congress sacrificed Medicare's bargaining power in favor of a system in which multiple private insurers offer competing plans. This decision will ultimately transfer billions of dollars from seniors and the government to insurers and drug companies. Some claim the industry needs these resources to finance tomorrow's drug breakthroughs. Although the need for research dollars is real, it seems unfair for Medicare seniors to shoulder costs that also subsidize Canadian and European consumers.

One of my patients, Betty L., is already feeling the pinch. A low-income senior on Medi-Cal, Betty was automatically enrolled in a Medicare Part D program on Jan. 1. ...[H]er new Healthnet plan requires small co-payments. ... [and] it omits coverage for ...[drugs] Medi-Cal covered. To get those medicines, and cover her new co-pays, Betty will be charged ... extra ... We all have a right to question a prescription drug program that will cost $700 billion over 10 years and yet increases drug payments for some of the poorest.

George A. and Mary S., two other patients in my practice, have "Medi-Gap" drug coverage policies, and they are less financially vulnerable... In order to find the right Part D coverage, they must sort though ... about 80 different plans ... George A., an 85-year-old bachelor with multiple medical problems, knows that Medicare Part D might save him money... he just hasn't had the motivation to make an informed choice. Given his advanced age and relative financial security, George would rather pay more and worry less about the prospect of change.

Mary S., a relatively healthy 80-year-old, has Internet access, and she's sophisticated about medication issues. I've explained that it would be relatively easy to use Medicare's interactive website to input her medications and find plans that would cover her current prescriptions. "When you get old," she countered, "nothing is that easy." As Mary's comments suggest, Part D's congressional architects seemed to think that seniors would be utterly at ease when it comes to using the Internet and reading the fine print in insurance plans. Unfortunately, that description doesn't fit most Americans in any age range, much less seniors.

The Department of Health and Human Services is proclaiming that 21 million seniors have enrolled in the program. Conveniently, this statistic ignores the fact that the vast majority ..., like Betty L., were ... automatically enrolled them in Part D. About 22 million more seniors still need to make a choice, and many of them, like George A. and Mary S., remain too uninformed, confused or wary to make up their minds.

How did American seniors and AARP, their powerful watchdog, permit Congress to approve a complex and confusing drug benefit program that squanders its bargaining power? The answer is that it was better than nothing. That abysmal standard appeared sufficient... But seniors have a right to expect those in power to adhere to principles rather than corporate interests when their health and financial welfare are at stake. Saddling seniors with a flawed program that prioritizes special interests rather than seniors' interests can be considered neither compassionate nor conservative.

The Decline in Workplace Provided Health Coverage

This is from Table 132 of this report from the CDC web site. It's a graph of the percentage of people with workplace provided private health coverage from 1984-2003. There's quite a bit of detail in the table including breakdowns of coverage by age, sex, race, and income level. For example, here's coverage by age:

The numerical overall changes by age are:

Age

	1984	2003	Change
Under 18 years	66.5	58.6	-7.9
18-44 years	69.6	62.2	-7.4
45-64 years	71.8	70.0	-1.8

Thus, the largest decline is for those under 45.

Here are the numerical endpoint data by sex along with the overall changes. Given the standard errors in the table (not shown here), there is little difference between males and females:

Sex

	1984	2003	Change
Male	69.8	63.3	-6.5
Female	68.4	63.3	-5.1

There are, however, big differences by income level, and the changes are larger for those under 18. As the following table shows, the decline in workplace provided health care coverage has been largest among those earning between 100% and 200% of the poverty level, a change of over 20%, while the change for those outside this range is less than 10%:

Age and Percent of Poverty Level

All ages	1984	2003	Change
Below 100 %	24.1	19.9	-4.2
100-149 %	52.4	31.8	-20.6
150-199 %	69.5	46.8	-22.7
200 % or more	85.0	78.6	-6.4
Under 18 years
Below 100 %	23.0	14.0	-9.0
100-149 %	58.3	30.1	-28.2
150-199 %	75.8	47.0	-28.8
200 % or more	86.9	79.9	-7.0

These data show that middle income families have been affected most by the decline in employer provided private health care coverage.

Update: A colleague writes to tell me:

The explanation for the decline in coverage (at least through the late 90s) is also quite interesting.  David Cutler has a paper (NBER WP #9036), arguing that the reason for the decline was not a decrease in employers offering HI, but a decrease in employees choosing to purchase insurance from their employers, primarily due to rising premiums.