Economist's View

Reich: Democrats Need a Positive Agenda

Robert Reich has advice for Democrats should they take the House in this fall's elections:

Lawless in Guantanamo, by Robert Reich: The most important thing about today's Supreme Court's decision about Guantanamo prisoners is the Court's view that the Geneva Conventions apply to them. The Bushies have been ignoring the Geneva Conventions in every possible way... Bush doesn't believe in international law. His defiance of American law governing spying on Americans suggests he doesn't believe in U.S. law either. The question now is whether his administration will obey the Supreme Court. The White House continues to argue that the President, in his role as Commander-in-Chief, stands above and apart from the other branches of government.

I've been spending time helping candidates in close House races. I think it likely the Democrats will win back the House in November. If they do, House Dems will be sorely tempted to hold extensive hearings on the lawlessness of the Bush White House. They might even extend their investigative gaze to the Florida election of 2000 and the Ohio election of 2004; in both cases, there's mounting and convincing evidence of political tampering.

But I think it would be a grave mistake for House Dems to spend the next two years on such hearings. ... Democratic party hearings will not convince anyone ... who's not already convinced. They'll simply allow the White House to claim that all the fuss is nothing but partisan politics. I'd prefer House Dems spend two years putting forth a positive agenda for getting the nation back on track economically and in foreign policy. ...

Mishkin Nominated as Federal Reserve Governor

This is a very good choice:

Bush Picks Mishkin, Bernanke Ally, for Fed Governor, Bloomberg: Frederic S. Mishkin, a Columbia University scholar and an advocate of inflation targeting, was picked by President George W. Bush to serve as a Federal Reserve governor. ... Mishkin, a former head of research at the New York Fed, wrote a book on inflation targeting with Bernanke when the current Fed chairman was at Princeton University. ...

The board will have one more vacancy after the unrelated departure ... of Mark Olson, who last week was appointed head of the Public Company Accounting Oversight Board... Bush has yet to announce a nominee for the slot Olson is vacating. ...

Mishkin, whose appointment is subject to Senate approval, would have a term running through January 2014, and he would be eligible for re-appointment to a full 14-year term.

The nomination also provides Bernanke with a policy expert who has authored 150 papers on monetary economics. ...

His nomination is greeted with the following news on PCE inflation from the Dallas Fed:

May 2006: The trimmed-mean PCE inflation rate for May was an annualized 3.2 percent. According to the BEA, the overall PCE inflation rate for May was 4.5 percent, annualized, while the inflation rate for PCE excluding food and energy was 2.6 percent.

The tables below present data on the trimmed-mean PCE inflation rate and, for comparison, the overall PCE inflation and the inflation rate for PCE excluding food and energy. The tables give annualized one-month, six-month and 12-month inflation rates.

One-month PCE inflation, annual rate

Dec. 05 Jan. 06 Feb. 06 Mar. 06 Apr. 06 May 06 PCE -0.1 6.1 0.5 4.5 5.9 4.5 PCE excluding food & energy 1.6 2.2 1.4 4.0 3.0 2.6 Trimmed mean PCE 1.5 3.1 1.3 3.8 3.0 3.2

Six-month PCE inflation, annual rate

Dec. 05 Jan. 06 Feb. 06 Mar. 06 Apr. 06 May 06 PCE 2.9 3.3 2.6 1.4 1.9 3.5 PCE excluding food & energy 1.9 2.2 2.1 2.3 2.3 2.5 Trimmed mean PCE 2.3 2.5 2.2 2.4 2.4 2.7

12-month PCE inflation

Dec. 05 Jan. 06 Feb. 06 Mar. 06 Apr. 06 May 06 PCE 2.8 3.1 2.9 2.9 2.9 3.3 PCE excluding food & energy 2.0 1.9 1.8 2.0 2.1 2.1 Trimmed mean PCE 2.3 2.2 2.1 2.3 2.4 2.5

Note: These data are subject to revision

Manufacturing Optimism

This article from The Economist says to forget all the doom and gloom you hear about manufacturing, it's doing fine:

Lean and unseen, The Economist: ...General Motors (GM) ... announced this week that 35,000 employees—nearly a third of its hourly paid workforce—have accepted the company's incentives to retire early... They are part of an overhaul that GM says will lower its annual fixed costs by $5 billion... Delphi, a bankrupt car-parts maker that used to be part of GM, announced that 12,600 of its workers have also agreed to accept early retirement.

These huge cuts in ... the heart of American manufacturing have fed a popular belief that anyone who makes things in the United States is struggling against an onslaught of foreign competition. Whether American firms are building plants overseas ... to exploit cheap labour, or closing down factories because they cannot compete any more, the widespread assumption is that the country's entire industrial base is being “hollowed out”...

But someone forgot to tell American manufacturers the bad news. Most of them have enjoyed roaring success of late. Net profits have risen by nearly 9% a year since the recession in 2001 and productivity has been growing even more rapidly than is usual during economic expansions. ...

Capital equipment and durable goods-makers such as Caterpillar, General Electric, an industrial conglomerate, and Boeing, an aerospace giant, have always been the strongest bits of America's manufacturing base. Their position is the most secure ... because there is so much knowledge embedded in what they make. Even when a company such as Boeing stumbles over its efficiency, as it did a few years ago, its intellectual property gives it room to recover. These days, however, American manufacturers of all sorts—not just the big durable-goods makers—are quickly improving their efficiency. ...

Manufacturers were already outpacing their rivals in rich countries during 1995 to 2000, when their productivity was growing by 4.0% a year. After 2000, the country's metal-bashers somehow managed to raise their productivity growth by another notch, to 5.1% a year, according to the Bureau of Labour Statistics. No serious economist thinks that America can maintain such a torrid rate of productivity growth...; indeed, the pace has already eased in the past year or two. ...

Until recently, it was hard to judge whether America's manufacturers might eventually lose a step once the effects of the 1990s information-technology boom tailed off. Research by Dale Jorgenson of Harvard University and Kevin Stiroh of the New York Federal Reserve Bank showed that IT drove much of America's productivity burst between 1995 and 2000. In a new paper, Messrs Jorgenson and Stiroh, along with Mun Ho of Resources for the Future, a think-tank, have compared the late 1990s with the productivity growth of the past five years. Not only has productivity growth accelerated further—by another 0.7% a year, to 3.2%—but the forces behind it also appear to have become more broadly based.

The economists looked at the entire private sector, not just manufacturing, and suggested that there could be several explanations... Because American firms are finding myriad ways to raise productivity, and are not merely riding one wave of innovation from the IT boom, the economists think that productivity growth will settle at a rate above what America achieved in the two decades before 1995. Over the next decade, they expect private businesses as a whole to boost productivity by 2.6% a year. That would be good news. Manufacturers, which are boosting productivity even more rapidly than the rest of the economy, should do even better. ...

But all is not rosy. This is also from The Economist:

The rich, the poor and the growing gap between them: But after 2000 something changed. The pace of productivity growth has been rising again, but ... [a]fter you adjust for inflation, the wages of the typical American worker ... have risen less than 1% since 2000. In the previous five years, they rose over 6%. If you take into account the value of employee benefits, such as health care, the contrast is a little less stark. But, whatever the measure, it seems clear that only the most skilled workers have seen their pay packets swell much in the current economic expansion. The fruits of productivity gains have been skewed towards the highest earners, and towards companies, whose profits have reached record levels as a share of GDP.

Even in a country that tolerates inequality, ... most Americans are unhappy about the economy. According to the latest Gallup survey, fewer than four out of ten think it is in “excellent” or “good” shape, compared with almost seven out of ten when George Bush took office.

Paul Krugman: How To Be a Hack

This Paul Krugman column on how to spot a political hack is from April, 2000:

How to Be a Hack, by paul Krugman, Commentary, NY Times: ...[A]s a number of readers have informed me, everyone knows that I am a hired tool of global capitalism. This charge upset me greatly. In fact, I asked my masters for a raise, to 35 pieces of silver, to compensate for my hurt feelings.

But maybe this is a good occasion to talk about political bias in economic analysis. It is a real issue. But the corruption is more subtle -- and also more evenly spread across the political spectrum -- than my hate mailers seem to realize.

First of all, academic research in economics is by and large carried out without strong political bias. I'm not saying that what you read in the journals is always right (don't get me started), or that the researchers themselves are noble characters: successful economists, like successful academics in any field, are usually ambitious men and women with large egos. But the structure of rewards in a field in which top departments are constantly jostling for prestige favors cleverness and originality, not political correctness of any stripe.

While hired guns do not flourish at Harvard or the University of Chicago, however, in Washington they roam in packs.

Portrait of a hired gun: He or she is usually a mediocre economist -- someone whose work, if it didn't have an ideological edge, might have been published but wouldn't have had many readers. He has, however, found a receptive audience for work that does have an ideological edge. In particular, he has learned that pretty good jobs in think tanks, or on the staffs of magazines with a distinct political agenda, are available for people who know enough economics to produce plausible-sounding arguments on behalf of the party line. Ask him whether he is a political hack and he will deny it; he probably does not admit it to himself. But somehow everything he says or writes serves the interests of his backers.

Most of these hired guns work on behalf of right-wing causes: it's a funny thing, but organizations that promote the interests of rich people seem to be better financed than those that don't. Still, the left has enough resources to front a quorum of its own hacks. And anyway, love of money is only the root of some evil. Love of the limelight, love of the feeling of being part of a Movement, even love of the idea of oneself as a bold rebel against the Evil Empire can be equally corrupting of one's intellectual integrity.

How can you tell the hacks from the serious analysts? One answer is to do a little homework. Hack jobs often involve surprisingly raw, transparent misrepresentations of fact: in these days of search engines and online databases you don't need a staff of research assistants to catch 'em with their hands in the cookie jar. But there is another telltale clue: if a person, or especially an organization, always sings the same tune, watch out.

Real experts, you see, tend to have views that are not entirely one-sided. For example, Columbia's Jagdish Bhagwati, a staunch free-trader, is also very critical of unrestricted flows of short-term capital. Right or not, this mixed stance reflects an honest mind at work. You might think that hacks would at least try to simulate an open mind... But it almost never happens.

Of course, honest men can disagree, and they can also make mistakes. But it's still a good idea to tune out supposed experts whose minds are made up in advance. Or at least that's what they told me to say.

Taboo Research Topics

This discussion is about taboo research topics in biology, but such taboos exist in economics as well. Thus, these comments could just as easily be directed at our profession. Even with the protection of tenure, there are some topics that few, if any economists will dare address. As noted in the essay, just ask Larry Summers:

The Subject is Taboo, by Olivia Judson, Commentary, NY Times: ...I was 7 or 8, and ... had just spent the day walking around a golf course with a great friend of my mother’s ..., a man called Tim, and his opponent, a woman called Nora... Nora ... trounced him. Worse, she didn’t do it from ... the “ladies’ tees.” ... She did it from the hardest of all, the “tiger tees.”

I was chatting happily about this, ... not knowing that Nora’s tigerish defeat ... was, in Tim’s mind, an exasperating humiliation. I soon found out. As I relived Nora’s victory yet again, Tim leaned over to me and said, “Olivia. The subject is taboo. Do you know what that means?” And he explained.

Looking back, it seems somehow fitting that I learned this word in the context of male versus female performance. For certain subjects in science are taboo — and research into genetic differences in ability or behavior between different groups of people is one of the biggest of all.

The reasons for this are obvious. Some of the most ghastly atrocities of the 20th century were carried out under the banner of the “master race” and nasty pseudoscientific notions about genetic superiority. Sexual and racial discrimination still persist. ... Many geneticists I know are scared — really scared, and with reason — of having their careers ruined if they ask any other questions. Look no further than Lawrence Summers, former president of Harvard University, who was pilloried ... for wondering if mathematical ability in men and women might have some genetic underpinning. A sign has been hung on the door that says “Area Closed to Research.”...

Research into the genetics behind certain sorts of group differences — skin color, the ability to digest milk, the underpinnings of autism and the like — is now starting to be published. But other subjects remain ferociously contentious. Let me tell you a tale of three papers.

Last September, the journal Science published two papers that claimed natural selection had acted recently and strongly on two human genes involved in brain development. Let’s look at what this claim means. ...

The two [genes] featured in the Science papers are among those thought to affect brain growth. ... What do we know about these genes...? Not much. ... both appear to be involved in cell division, for example — but no one knows ... exactly. We also know ... these genes come in several subtly different forms. Whether these subtle differences matter is unknown. ...

Now, what does it mean to say that natural selection has acted on these genes? As I’ve been discussing ... Sometimes, natural selection promotes rapid change: a mutant form of a gene appears and spreads quickly — within a few hundred generations, say. Evidence of a rapid spread — within the last several thousand years — of a new version of each of the two genes is what the Science papers announced.

The papers caused a stir. For the papers also claimed that the new versions of the genes ... were more rare in sub-Saharan Africa than elsewhere. All this means is that, in populations outside Africa, the new forms of the genes may have conferred some sort of advantage — perhaps related to head size, perhaps not... But it didn’t take long for the whisperings to start that the new forms of the genes must be involved in intelligence.

The whispering has no basis: there is no evidence whatsoever that the variants have anything to do with intelligence. ... But brains, genes and race form an explosive mixture. So much so that ... the lead scientist on the papers, Bruce Lahn, will now be retiring from working on brain genes.

Meanwhile, another paper has appeared ... in ... the online journal Public Library of Science Biology. This paper failed to confirm the earlier result. However, the authors found that versions of other genes, also thought to be involved in brain function or structure, have been under recent natural selection ... and this time, the population is not outside Africa, but in it. ... Again, we have no idea what this means. But strangely, these results have received almost no attention: there has been no whispering this time.

I offer this story as ... an illustration of some of the grave difficulties in this field of research. ... As you can imagine, it is virtually impossible to work in an area as poisonously political as this one. On one side, you have neo-fascist groups twisting the most innocuous data out of shape; on the other, well-intentioned anti-racists who don’t even want the questions asked. Worse still, as ... the “intelligent design” movement shows, it is not always easy to make sure that science is discussed rationally. Result: most geneticists are totally unnerved — and who can blame them?

Perhaps, if open debate is impossible, declaring the area taboo is the best way to proceed. I don’t pretend to have a solution. But here are some thoughts. ...

If we declare brain genetics out of bounds, it will make it harder to understand how our brains are built ... and treat the diseases that affect people’s brains, especially in old age. ...[T]he study of human genetics has already illuminated a lot that is interesting and important about our evolutionary past, and how we have come to be. Handled well, this is a tremendously exciting area for research. Do we want to limit it? ...

[G]enetic information is pouring in. Questions about the genetics of human differences are not going to go away. ... Scientists have an essential role to play in mediating understanding. Do we really want to scare good scientists from this field? Then the only people left researching it could be those whose agendas genuinely are sinister.

Now that is a frightening thought.

Capitalism and Democracy

Has capitalism planted the seeds of inevitable democracy in China?:

Will China’s Capitalist Revolution Turn Democratic, by Minxin Pei, Project Syndicate: Communist China has experienced a monumental capitalist revolution in the last two decades, with an economy that is now six times bigger than it was 20 years ago. ... But if these stunning economic statistics make you think that so much capitalist development must also have brought more democracy to China, think again.

Most Westerners believe in a theory of liberal evolution, according to which sustained economic growth, by increasing wealth and the size of the middle class, gradually makes a country more democratic. While the long-run record of this theory is irrefutable, China’s authoritarian ruling elite ... has been smart enough to take adaptive measures aimed at countering the liberalizing effects of economic development.

Thus, for all its awe-inspiring economic achievement, ... democracy in China has stalled... Since the Tiananmen Square massacre of June 1989 ... not a single major democratic reform initiative has been implemented.

Instead of democratic transition, China has witnessed a consolidation of authoritarian rule... Since 1989, the Chinese Communist Party (CCP) has been pursuing a two-pronged strategy: selective repression that targets organized political opposition and co-optation of new social elites (the intelligentsia, professionals, and private entrepreneurs).

This strategy emphasizes the maintenance of an extensive law enforcement apparatus designed to eliminate any incipient organized opposition. Huge investments have strengthened the People’s Armed Police (PAP), a large anti-riot paramilitary force whose specialty is the quick suppression of anti-government protests...

To deal with new emerging political threats, such as the information revolution, the Chinese government has spent mightily on manpower and technology. A special 30,000-strong police unit ... screens Internet traffic, advanced technology is deployed to block access to overseas Web sites considered “hostile or harmful,” and Internet service and content providers ... must comply with onerous restrictions designed to suppress political dissent and track down offenders...

Having learned ... that a bureaucratic ruling party must co-opt new social elites to deprive potential opposition groups of leaders, the ... urban intelligentsia and professionals have been pampered with material perks and political recognition, while new private entrepreneurs have been allowed to join the Party.

This strategy of pre-emptive political decapitation has produced enormous dividends for the Party. In the 1980’s, its principal adversaries were the urban intelligentsia... Today, the mainstream of the Chinese intelligentsia is an integral part of the ruling elite. Many have joined the Party ..., and a large percentage enjoy various professional and financial privileges.

Predictably, the intelligentsia, usually the most liberal social group, is no longer a lethal threat to party rule. Worse, without support from this strategic group, other social groups, such as workers and peasants, have become politically marginalized and rudderless.

Although the Party’s ... approach has worked since 1989, it is doubtful that it will retain its efficacy for another 17 years. To the extent that China’s authoritarian regime is by nature exclusionary (it can only incorporate a limited number of elites), the co-optation strategy will soon run up against its limits, and the Party will no longer have the resources to buy off the intelligentsia or keep private entrepreneurs happy.

At the same time, selective repression can contain social frustrations ... only temporarily. As long as much of Chinese society views the current political system as unjust, unresponsive, and corrupt, there will always be a large reservoir of ill will toward the ruling elites.

When things go wrong – as is likely, given mounting social strains caused by rising inequality, environmental degradation, and deteriorating public services – China’s alienated masses could become politically radicalized. ...

So it may be premature for the Party to celebrate the success of its adaptive strategy. China’s rulers may have stalled democratic trends for now, but the current strategy has, perhaps, merely delayed the inevitable.

The FOMC Raises Target Rate to 5.25%

As expected, the Federal Open Market Committee voted today to raise the target federal funds rate to 5.25%. Of more interest are changes in the wording of the Press Release that signal the course of future policy. The key differences from the last statement are:

1. The Fed indicates that new data have validated their previous conjecture that economic growth would moderate. The wording has changed from saying growth is "likely to moderate" to "Recent indicators suggest that economic growth is moderating."

2. The statement upgrades the change in core inflation from modest to elevated. The statement "only a modest effect on core inflation" becomes "Readings on core inflation have been elevated in recent months."

More interesting is the change in the statement regarding underlying inflation pressure from input costs. Whereas before input costs and capacity constraints had the potential to "Add to inflation pressures," now they are seen as having the potential to "sustain inflation pressures." So they don't anticipate further increases in the pressure for prices to rise.

3. They indicate that inflation risks remain, but note that the moderation in aggregate demand should help. But the message is that the risk of inflation has not ended.

4. The San Francisco Fed joins the Kansas City Fed in not asking for an increase in the discount rate, a signal they may not favor a rate increase, though the vote itself was unanimous (with Olson not voting due to his recent resignation).

The statements about aggregate demand slowing and input costs sustaining rather than adding to inflation pressures indicate the Fed sees a fall in the inflation risk, but the statement also makes it clear the Committee is prepared to raise rates again if the forecasts from incoming data indicate inflation pressures are not abating.

Today's Statement	May 10 Statement
The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 5-1/4 percent.	[No substantive difference]
Recent indicators suggest that economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.	Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.
Readings on core inflation have been elevated in recent months. Ongoing productivity gains have held down the rise in unit labor costs, and inflation expectations remain contained. However, the high levels of resource utilization and of the prices of energy and other commodities have the potential to sustain inflation pressures.	As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.
Although the moderation in the growth of aggregate demand should help to limit inflation pressures over time, the Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.	The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Jack Guynn; Donald L. Kohn; Randall S. Kroszner; Jeffrey M. Lacker; Sandra Pianalto; Kevin M. Warsh; and Janet L. Yellen.	[Only difference is that Olson did not vote]
In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 6-1/4 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, Minneapolis, and Dallas.	In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 6 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, Minneapolis, Dallas, and San Francisco.

That Hissing Sound

Robert Reich, pointing to leaks in the housing bubble, gives the Fed some advice:

Market Meltdown: Say goodbye to the housing bubble, by Robert B. Reich, American Prospect: ...America’s housing bubble has not exactly burst. It’s just sprung a leak the size of your average mortgage banker. What’s clear is the boom is over. All across America, backlogs of unsold homes are long. Price increases are slowing. In some markets, home prices are actually dropping...

It’s better that bubbles leak than burst. Gradual declines are always easier to manage than explosions. But the housing boom has been so large and important to the American economy over the past five years that even this slow leak will cause severe headaches.

One will be experienced by millions of households that had turned their growing home values into piggy banks to finance their continued consumption. That easy route to cash is just about gone. The inevitable result will be less consumption, which will mean fewer jobs.

A more immediate problem will arise for all the people making, financing, and selling houses. Here we’re talking about a vast army of carpenters, plasterers, roofers, plumbers, electricians, mortgage bankers, home inspectors, real estate agents, architects, structural engineers and many more. According to Moddy’s Economy.com, housing-related employment has accounted for almost a quarter of the five million jobs that have appeared since 2003.

These jobs pay well even though most of them don’t require a college degree. That’s because they don’t have to compete in global commerce. Workers in Beijing or Calcutta can’t easily build houses in Phoenix or San Diego. ... But now with the housing boom over, many of these good jobs are over, too.

In other words, without the housing bubble, the American economy will lose a lot of its fizz. I don’t like bubbles, but from a jobs standpoint this recovery has needed all the fizz it can get. Median wages have gone nowhere. The ranks of the long-term unemployed have been unusually high. The percent of the labor force with jobs is lower than in 2000. Housing has been one of the few bright spots in the economy.

All of which brings us to Ben Bernanke and his gang at the Federal Reserve Board Open Market Committee. They’re determined to raise interest rates because they think the economy is too fizzy and still prone to inflation. I hope they listen carefully: The hissing sound they hear is air escaping the housing bubble. There’s less fizz in the economy than they think. Raise interest rates, and the Fed raises the likelihood the economy will deflate.

We'll know more soon when the Fed announces its rate hike decision from today's meeting.

Price Discrimination and Economic Welfare in the Market for Orthopedics

If firms have pricing power, if markets can be segmented so that there is no arbitrage between them, and if the elasticity of demand differs across the segmented markets, then a profit maximizing firm should charge a higher price where demand is more inelastic.

But if the barriers between markets break down, prices will begin to equalize. This article describes pricing in the market for orthopedics and explains how access to information about prices charged across hospitals is reducing the ability of orthopedic device suppliers to charge different prices to different customers for the identical product.

Does this type of pricing reduce economic welfare? First, we need to determine which type of price discrimination is operating. Following Varian:

Economists generally follow the taxonomy of Pigou, who used the term price discrimination to describe what we have been referring to as differential pricing. Pigou described three different forms of price differentiation:

• First-degree price discrimination means that the producer sells different units of output for different prices and these prices may differ from person to person. This is sometimes known as the case of perfect price discrimination.
• Second-degree price discrimination means that the producer sells different units of output for different prices, but every individual who buys the same amount of the good pays the same price. Thus prices depend on the amount of the good purchased, but not on who does the purchasing. A common example of this sort of pricing is volume discounts.
• Third-degree price discrimination occurs when the producer sells output to different people for different prices, but every unit of output sold to a given person sells for the same price. This is the most common form of price discrimination, and examples include senior citizens' discounts, student discounts, and so on.

The article says "hospitals that buy in the greatest volume do not typically receive the best prices" so we can rule out second degree. First degree is an idealized concept and has strict information requirements (e.g. you must know how much each hospital is willing to pay) and, as noted, third degree is more common. Interestingly, as explained after the article, it is not necessarily the case that third degree price discrimination reduces welfare. But first, here's the article:

Pricing Power at Risk for Orthopedics Makers, by Reed Abelson, NY Times: It is a market that does not appear to play by the usual rules of supply and demand. Depending on which hospital is buying an artificial knee or hip, the price charged by the manufacturer might vary by thousands of dollars. And hospitals that buy in the greatest volume do not typically receive the best prices.

For years, makers of artificial hips and other orthopedic devices have benefited from their pricing power. But the odd ways of that market may not last much longer, according to [analyst] Bruce M. Nudell... In a research report..., Mr. Nudell described the current pricing variation in artificial knees and hips as "unsustainable."

Mr. Nudell says that growing awareness among hospitals of the pricing disparities is a major threat to the orthopedic device industry. Already, pricing power is diminishing for the companies, which had been able to raise prices for artificial knees and hips an average of 8 percent annually in recent years. The increases are slowing, and he says he expects prices in coming years to be flat, or even decline. ...

Much of the market's unusual pricing dynamic is a result of the fact that the surgeon choosing the device typically does not have to pay for it — the hospital is responsible for the bill. ...

Mr. Nudell is predicting that the financial pressure on hospitals and the publicity over pricing will end the era in which device makers have felt free to raise prices every year because the hospitals had no idea what their peers were paying.

The market's unusual dynamics appear to have caught the attention of federal officials, too. Within the last week, four companies — Biomet, Zimmer Holdings, Stryker and the DePuy unit of Johnson & Johnson — said that they had received subpoenas from the Justice Department's antitrust division related to the manufacture and sale of orthopedic devices. The companies all say they are cooperating. ...

As the cost of implants devours an ever-higher share of hospitals' reimbursements, and as the pricing disparities receive greater publicity, hospital executives are growing increasingly concerned. Many of the purchasing managers surveyed mistakenly thought that they were getting better prices than their peers when, in fact, they were paying more.

"Transparency on these products is an inevitable reality and an inevitable requirement in order for the health care system to be increasingly competitive and efficient," said John A. Bardis...

I'm not sure why insurance companies wouldn't have information on prices across hospitals, but assuming the article is correct on the existence of information barriers, how does price discrimination affect economic welfare? Varian says:

Third-degree price discrimination increases welfare when it encourages a sufficiently large increase in output. If output doesn't increase, total welfare will fall. As in the case of second-degree price discrimination, third-degree price discrimination is a good thing for niche markets that would not otherwise be served under a uniform pricing policy.

The general impression that follows from this discussion is if price differentiation allows more consumers to be served it will generally increase welfare. Volume discounts, for example, can be expected to generally enhance welfare. Market segmentation that allows markets to be served that would otherwise be neglected is also a case where overall welfare can be expected to be enhanced.

On the other hand, price differentiation that merely shuffles prices paid by pre-existing customer groups and that does not result in an increase in the number of customers served, or the amount that they consume, will tend to reduce overall welfare. The key issue is whether the output of goods and services is increased or decreased by differential pricing.

And the key here is to recognize that the decision is in the hands of doctors, not patients, and doctors are not price sensitive according to this article and according to other evidence. Because of this, price discrimination would not be expected to bring about a large change in quantity in hospitals where prices are lower than they would be under uniform prices. Hence, the fall in barriers that allow price discrimination ought to enhance the economic welfare of those who need to use orthopedic products.

Echoes of the Alien and Sedition Acts of 1798

The resolution introduced into the House of Representatives for debate along with other condemnations of the press for reporting on bank spying brings this to mind. From the Wikipedia entry for Thomas Jefferson:

With a quasi-War with France underway (that is, an undeclared naval war), the Federalists under John Adams started a navy, built up the army, levied new taxes, readied for war and enacted the Alien and Sedition Acts in 1798.

The background for the act is:

With many Federalists advocating war against a major power, France, Federalists in Congress, in 1798, passed the laws which they asserted would protect national security in the United States and which sought to silence internal opposition. ... Jeffersonians, however, recognized that the laws were to be used as a tool of the ruling Federalist party to extend and retain their power, silencing any opposition. ... Under the Alien and Alien Enemies Acts, the president could deport any "dangerous" or "enemy" alien — a law that is still in effect in 2006.

Here's a shortened version of the act itself from an April entry in the Republican Study Committee blog:

THE SEDITION ACT OF JULY 14, 1798 ...

SEC. 2. And be it further enacted, That if any person shall write, print, utter or publish, or shall cause or procure to be written, printed, uttered or publishing, or shall knowingly and willingly assist or aid in writing, printing, uttering or publishing any false, scandalous and malicious writing or writings against the government of the United States, or either house of the Congress of the United States, or the President of the United States, with intent to defame the said government, or either house of the said Congress, or the said President, or to bring them, or either of them, into contempt or disrepute; or to excite against them, or either or any of them, the hatred of the good people of the United States, or ... for opposing or resisting ... any act of the President of the United States, ... or to resist, oppose, or defeat any such law or act, or to aid, encourage or abet any hostile designs of any foreign nation against the United States, their people or government, then such person, being thereof convicted before any court of the United States having jurisdiction thereof, shall be punished by a fine not exceeding two thousand dollars, and by imprisonment not exceeding two years. ...

SEC. 4. And be it further enacted, That this act shall continue and be in force until the third day of March, one thousand eight hundred and one, and no longer...

JONATHAN DAYTON, Speaker of the House of Representatives. THEODORE SEDGWICK, President of the Senate, pro tempore.

APPROVED, July 14, 1798: JOHN ADAMS, President of the United States.

The language and meaning of the Acts:

Under the Sedition Act, anyone "opposing ... any act of the President of the United States" could be imprisoned for up to two years. It was also illegal to "write, print, utter, or publish" anything critical of the president or Congress. It was notable that the Act did not prohibit criticism of the Vice-President. Jefferson held the office of Vice-President at the time the Act was passed so the law left him open to attack. ...

Jeffersonians denounced the Sedition Act as a violation of the First Amendment of the United States Bill of Rights, which protected the right of free speech. ... Subsequent mentions of the Sedition Act in particular in Supreme Court opinions have assumed that it would be unconstitutional today. For example ..., the Court declared, "Although the Sedition Act was never tested in this Court, the attack upon its validity has carried the day in the court of history." 376 U.S. 254, 276 (1964).

From the Wkipedia entry for Jefferson:

Jefferson interpreted the Alien and Sedition Acts as an attack on his party more than on dangerous enemy aliens. He and Madison rallied support by anonymously writing the Kentucky and Virginia Resolutions that declared that the Constitution only established an agreement between the central government and the states and that the federal government had no right to exercise powers not specifically delegated to it. Should the federal government assume such powers, its acts under them could be voided by a state. The Resolutions' importance lies in being the first statements of the states' rights theory that led to the later concepts of nullification and interposition.

And, back to the Wikipedia entry on the Alien and Sedition Acts:

At the time, the redress for unconstitutional legislation was unclear and the Supreme Court openly hostile to the anti-federalists. The Alien and Sedition Acts were not appealed to the Supreme Court for review...

In order to address the constitutionality of the measures, Thomas Jefferson and James Madison sought to unseat the Federalists, appealing to the people to remedy the constitutional violation, and drafted the Kentucky and Virginia Resolutions, calling on the states to nullify the federal legislation. The Kentucky and Virginia Resolutions reflect the Compact Theory, which states that ... States ... agree to cede some of their authority in order to join the union, but that the states do not, ultimately, surrender their sovereign rights. Therefore, states can determine if the federal government has violated its agreements, including the Constitution, and nullify such violations or even withdraw from the Union. ...

Although the Federalists hoped the Act would muffle the opposition, many Democratic-Republicans still "wrote, printed, uttered and published" their criticisms of the Federalists. Indeed, they strongly criticised the act itself, and used it as an election issue. The act expired when the term of President Adams ended in 1801.

Ultimately the Acts backfired against the Federalists; while the Federalists prepared lists of aliens for deportation, and many aliens fled the country during the debate over the Alien and Sedition Acts, Adams never signed a deportation order.

Twenty-five people, primarily prominent newspaper editors but also Congressman Matthew Lyon, were arrested, but it appears only eleven were tried (one died while awaiting trial) and ten were convicted of sedition, often in trials before openly partisan Federalist judges. Federalists at all levels, however, were turned out of power, and over the ensuing years Congress repeatedly apologized for or voted recompense to victims of the Alien and Sedition Acts.

It all sounds very familiar. Déjà Vu, Again and Again.

A Nickel Saved Through Opt-Out and Matching Grants is a Nickel the Government Won't Have to Give You

Having used Hal Varian's little blue book as one of my micro texts in graduate school, I have no doubt about his skills as a microeconomist. My complaint about this article examining policies to encourage low-income Americans to save more is that those skills are not used to identify the market failure the policies address.

To say, as in the opening line, that "Economists are in almost universal agreement that Americans save too little," and to follow with suggestions that the government intervene in the marketplace implies these markets do not produce the right incentives to save, that the market outcome is one of too little saving. The article does mention different savings rates as an explanation for differences in asset accumulation over time, but that is a behavioral statement, not a specific market failure. If we don't know what the problem is, how will we know what solution is best? My preference is to start by identifying the problem, then proceeding to find a solution. But whatever the problem is, the argument Varian makes is that these programs appear to work:

Looking for the Incentives That Will Prompt Americans to Save More, by Hal Varian, Economic Scene, NY Times: Economists are in almost universal agreement that Americans save too little, and several policies have been proposed with the goal of encouraging them to save more.

The Bush administration favors increasing contribution limits on tax-deferred savings accounts like I.R.A.'s. Critics argue that there would be little impact on total savings ... since wealthy households would simply transfer assets from taxable accounts to tax-sheltered accounts.

Leaving aside the behavior of high-income households, responsible members of both parties recognize that providing better incentives to low-income people is the most challenging problem. How can we get this group to save more?

It is possible for low- and middle-income groups to increase savings. After a detailed examination of the financial circumstances of people close to retirement, two economists, Stephen F. Venti ... and David A. Wise ..., concluded that the primary reason for differences in retirement assets was differences in propensities to save. ...

One promising proposal has been to set ... 401(k) plans so that employees are automatically enrolled in an appropriate plan unless they explicitly choose otherwise. ...[T]his simple policy increases participation rates dramatically.

Another suggestion is to provide matching grants to low-income individuals. ...("Saving Incentives for Low- and Middle-Income Families: Evidence From a Field Experiment With H&R Block"; ... nontechnical summary ...) In this experiment, ... low- and middle-income families ... were offered a 20 percent match on their contributions to an I.R.A., a 50 percent match or no match at all...

Only 3 percent of the individuals who had no match — the control group — contributed to an I.R.A. But 8 percent of those with a 20 percent match rate contributed, and 14 percent of those with a 50 percent match contributed. The amount contributed was four times as much as the control group for the 20 percent match rate and seven times as much for the 50 percent match rate. ... And most people stuck with their plans: four months after the initial contribution, over 90 percent of the individuals still kept the money in their I.R.A.'s.

These effects are far larger than those of the Saver's Credit, an existing program that provides a tax credit based on the amount of tax-deferred savings. The problem is that a tax credit is useful only if you pay taxes, and many low-income individuals have little or no tax liability after other deductions and credits are applied. Furthermore, the Saver's Credit is complicated and hard to understand. A matching contribution to a savings program is much easier to comprehend. ...

As the authors put it, "Taken together, our results suggest that the combination of a clear and understandable match for saving, easily accessible savings vehicles, the opportunity to use part of an income tax refund to save, and professional assistance could generate a significant increase in contributions to retirement accounts, including among middle- and low-income households."

Matching grants also have a long and venerable history as an American institution. They were invented by none other than Benjamin Franklin in conjunction with his fund-raising efforts for the Pennsylvania Hospital, the first public hospital in America, established in 1751.

Franklin persuaded the legislature to participate by indicating that it would receive "the credit of being charitable without the expense" and explained to the donors that "every man's contribution would be doubled." No doubt the sage of Philadelphia would heartily approve of his innovation being used to encourage the virtue of thrift.

This Day in History: Keynes Predicts Economic Chaos

On a whim, I went to This Day in History at the History Channel web site. This is what I found:

Keynes Predicts Economic Chaos, June 28, 1919: ...By the fall of 1918, it was apparent to the leaders of Germany that defeat was inevitable in World War I. After four years of terrible attrition, Germany no longer had the men or resources to resist the Allies, who had been given a tremendous boost by the infusion of American manpower and supplies. In order to avert an Allied invasion of Germany, the German government contacted U.S. President Woodrow Wilson in October 1918 and asked him to arrange a general armistice. Earlier that year, Wilson had proclaimed his "Fourteen Points," which proposed terms for a "just and stable peace" ... The Germans asked that the armistice be established along these terms... On November 11, 1918, the armistice was signed and went into effect, and fighting in World War I came to an end.

In January 1919, John Maynard Keynes traveled to the Paris Peace Conference as the chief representative of the British Treasury. The brilliant 35-year-old economist had previously won acclaim for his work with the Indian currency and his management of British finances during the war. In Paris, he sat on an economic council and advised British Prime Minister David Lloyd George, but the important peacemaking decisions were out of his hands, and President Wilson, Prime Minister Lloyd George, and French Prime Minister Georges Clemenceau wielded the real authority. Germany had no role in the negotiations deciding its fate...

It soon became apparent that the treaty would bear only a faint resemblance to the Fourteen Points that had been proposed by Wilson and embraced by the Germans. Wilson, a great idealist, had few negotiating skills, and he soon buckled under the pressure of Clemenceau, who hoped to punish Germany as severely as it had punished France in the Treaty of Frankfurt that ended the Franco-Prussian War in 1871. ...

The treaty that began to emerge was a thinly veiled Carthaginian Peace, an agreement that accomplished Clemenceau's hope to crush France's old rival. According to its terms, Germany was to relinquish 10 percent of its territory. It was to be disarmed, and its overseas empire taken over by the Allies. Most detrimental to Germany's immediate future, however, was the confiscation of its foreign financial holdings and its merchant carrier fleet. The German economy, already devastated by the war, was thus further crippled, and the stiff war reparations demanded ensured that it would not soon return to its feet. ...

Keynes, horrified by the terms of the emerging treaty, presented a plan to the Allied leaders in which the German government be given a substantial loan, thus allowing it to buy food and materials while beginning reparations payments immediately. ... President Wilson turned it down because he feared it would not receive congressional approval. In a private letter to a friend, Keynes called the idealistic American president "the greatest fraud on earth." On June 5, 1919, Keynes wrote a note to Lloyd George informing the prime minister that he was resigning his post in protest of the impending "devastation of Europe."

The Germans initially refused to sign the Treaty of Versailles, and it took an ultimatum from the Allies to bring the German delegation to Paris on June 28. .... Clemenceau chose the location for the signing of the treaty: the Hall of Mirrors in Versailles Palace, site of the signing of the Treaty of Frankfurt that ended the Franco-Prussian War. At the ceremony, General Jan Christiaan Smuts, soon to be president of South Africa, was the only Allied leader to protest formally the Treaty of Versailles, saying it would do grave injury to the industrial revival of Europe.

At Smuts' urging, Keynes began work on The Economic Consequences of the Peace. It was published in December 1919 and was widely read. In the book, Keynes made a grim prophecy that would have particular relevance to the next generation of Europeans: "If we aim at the impoverishment of Central Europe, vengeance, I dare say, will not limp. Nothing can then delay for very long the forces of Reaction and the despairing convulsions of Revolution, before which the horrors of the later German war will fade into nothing, and which will destroy, whoever is victor, the civilisation and the progress of our generation."

Germany soon fell hopelessly behind in its reparations payments, and in 1923 France and Belgium occupied the industrial Ruhr region as a means of forcing payment. In protest, workers and employers closed down the factories in the region. Catastrophic inflation ensued, and Germany's fragile economy began quickly to collapse. By the time the crash came in November 1923, a lifetime of savings could not buy a loaf of bread. That month, the Nazi Party led by Adolf Hitler launched an abortive coup against Germany's government. The Nazis were crushed and Hitler was imprisoned, but many resentful Germans sympathized with the Nazis and their hatred of the Treaty of Versailles.

A decade later, Hitler would exploit this continuing bitterness among Germans to seize control of the German state. In the 1930s, the Treaty of Versailles was significantly revised and altered in Germany's favor, but this belated amendment could not stop the rise of German militarism and the subsequent outbreak of World War II....

Glenn Hubbard Defends Business Schools

Yesterday, I defended a liberal arts education. Today, Columbia Business School Dean and former Chair of the Council of Economic Advisers for the Bush administration Glenn Hubbard defends business schools and MBAs:

Do not undervalue the impact of business education, by Glenn Hubbard, Commentary, Financial Times: I expected many surprises as the new dean of a business school, but not an immediate challenge to defend the idea of business education. Until my appointment, I had seen no reason for such challenges...

A tough take on business schools came in a 2005 Harvard Business Review article by Warren Bennis and James O’Toole saying that “MBA programmes face intense criticism for failing to impart useful skills, failing to prepare leaders, failing to instill norms of ethical behaviour – and even failing to lead graduates to good corporate jobs”. In business circles, this is shocking – something like L’Osservatore Romano asking: do we still need a pope?

Such criticisms should be taken seriously. Pure theory pulls the academy apart from the worlds of commerce, industry and finance. And if the MBA does not at least cultivate leadership, what good is it? ... We are so enmeshed in a world shaped by business principles that only the big picture can remind us of its power.

For example, why did social conditions not change for the human race for thousands of years until England’s industrial revolution in 1750? Why did that revolution begin with the Spinning Jenny in the mid-18th century and not in the mid-first century AD when Hero of Alexandria developed a steam engine? Columbia Business School’s Bruce Greenwald says that human progress “appears to have arisen largely from the application of sustained management attention to everyday enterprise”. In a word, business. ...

Countries today prosper or fail to the extent that they embrace basic business principles. The task of the business school is, then, enormous – to apply knowledge to transform financial markets, to convince other societies of the benefits of transparency and to remind our own opinion leaders of the value of basic business principles. We have largely succeeded in the US, which is seeing sustained increases in growth of about 3.5 per cent a year with little inflation... This one percentage point addition to growth is happening ... because of improvements in productivity.

Why, then, is the US adding productivity growth when so many other big economies see negative growth in productivity? Those who say the answer is technology have spent too little time in Tokyo, Seoul and Berlin. The fact is, technology is better in many other countries. So US companies did not become more productive by simply buying faster computers. They became more productive by having managers and entrepreneurs who knew how to integrate these investments with new business models to raise productivity. These abilities to think strategically are teachable; and the central classroom for teaching leaders ... is the business school.

Many measure success by the salaries of business graduates after school. This is irrelevant. The real value of a business education is its impact years later, training future leaders how to unlock one set of problems after another. Business schools have pulled this off by integrating disciplines within the university and integrating academics with business leaders.

But the critics have a point. The present challenge for the top business school is to inspire researchers to be in even closer contact with business leaders, to answer real-world needs. By generating cutting-edge ideas that bridge theory and practice, a great business school’s research offers an education for a lifetime career, not just a toolkit for a first job. ...

Equal Pay at Wimbledon?

There is a controversy over the fact that the men's champion at Wimbledon will receive more prize money than the women's champion. However, the economic arguments behind the discussion of calls to equalize the prize money are based upon a labor theory of value, an economic argument that was discredited long ago:

Wimbledon, Women Test Equal Pay for Equal Play, by Scott Soshnick, Bloomberg: Odd as this might seem, it would be easier to cheer on female tennis players demanding equal prize money at Wimbledon if things were actually equal.

As things stand, however, I must disagree with Serena Williams, her sister, Venus, and Lindsay Davenport, who are among those demanding the same reward for the Gentlemen's and Ladies' champions... Equal pay should stem from equal work. Call me old- fashioned or worse, but fair is fair.

This year's men's champion will receive $1.2 million. The women's winner will get about $1.13 million, about $70,000 less... For some reason, those who support the idea of equal pay are quick to discount the fact that women play best-of-three-set matches while the men endure best-of-five sets.

It can make a difference. Hours of difference, hours of sweat equity, really. Though seven-time Grand Slam singles champion John McEnroe favors equal pay, he agrees with the assertion that men do more work. ''There are amazing men's matches that can be so long you say, 'How in the world can you say there should be equal pay,''' the NBC broadcaster says. ...

Here's the counter argument:

''We work just as hard as the men,'' says Kim Clijsters, the world's No. 2-ranked women's player and U.S. Open champion. ''There is a big strain on the body.'' ...

What's Fair?

''I don't think that it's fair the women get paid the same as the guys,'' says Andy Murray, Britain's No. 2 player. ''If you look at it, the guys have the potential to play a 5 1/2-hour match.''

Advocates of equal pay are fond of citing television ratings to buoy their argument.

Yes, it's true that last year's Venus Williams-Davenport Wimbledon final drew more viewers in the U.S. than the Roger Federer and Andy Roddick championship match. More British TV viewers also chose to watch the women.

Such an argument is shortsighted because, among other reasons, the game's popularity is cyclical. There was a time, and it will come again, when the male players are the bigger television draw.

One year Federer is all the rage and then it's tennis player-Sports Illustrated swimsuit model Maria Sharapova, some of whose audience is only marginally interested in her backhand.

Three Versus Five

Not only that, but female players can't discount the number of commercials a television network shows during a five-set match compared with three sets. More commercials mean more revenue...

So let's get this straight. ... The women are on par with the men. They're on par in every meaningful way. They pack stadiums. They draw a TV audience. They sell the game. The only difference is how long they play.

When that changes everyone should stand alongside the Williams sisters and clamor for equal pay.

The idea that equal hours justifies equal pay is wrong. I could spend months working on a painting, an actual artist could spend an hour, and when we were done my hours and hours of work would surely be less valuable than a few strokes from the artist unless someone had a curious taste for really bad art. Are grades based upon how much time you spend studying? Students sometimes make that argument (I worked really hard for the test) but the grade is based upon the output of the process, the score on the exam, not the amount of input (for fun, try answering the student with: you're an economics major, why should inefficiency in the form of long hours on the input side with little to show for it on the output side be rewarded? Similarly, why should McEnroe get paid more than women if he works harder like he says but has less viewers to show for it?). The value of inputs - laborers, plastic, wood, tennis players in tournaments - is determined by the demand for the product they produce. When demand for the product increases, the demand for inputs increases, and compensation rises. Compensation is not based upon how much time and effort goes into production - if nobody wants the product, then nobody will pay for the labor.

What is the product here? They are selling entertainment and compensation to inputs is based upon the added entertainment value provided by men and women players. It doesn't matter if people come to the stadium or tune in on TV to watch tennis or a swim suit model, all that matters is that they watch. The argument that tournament sponsors can sell less adds during women's matches stated above is relevant as that affects revenue, but if the ads are more valuable because of higher viewership, its not necessarily the case that compensation should fall. It's interesting that when confronted with higher viewership for women's matches, the writer argues that men should be paid more because "There was a time, and it will come again, when the male players are the bigger television draw."

In a competitive market, this wouldn't be an issue. The reason there is any dispute at all is because the players have monopsony power on the input side, and tournament organizers have monopoly power from their side of the prize money negotiation. When a monopsonist meets a monopolist (e.g. GM versus unions), there is no necessary outcome since both sides have negotiating power. The outcome will depend upon the relative power of each side in the negotiation and that, it seems, is really what is at issue here.

Unpleasant Estate Tax Tradeoffs

Today, the senate delayed the vote on the estate tax because "Senate Republicans are determined to pass the legislation this year, [but] they want to ensure they have the 60 votes needed to withstand a challenge by Democrats."

Most senators in favor of eliminating or reducing the estate tax also favor the Gregg bill changing the budget rules. The CBPP describes the Gregg bill as aiming a "budget knife at domestic programs while shielding tax cuts from fiscal discipline."

This analysis shows the likely outcome if those in favor of the bills prevail. If both bills are put into place at once, the estate tax cuts will trigger automatic across the board reductions in the entitlement programs:

Combined Effect of Bills Moving In The Senate Would be to Finance Near-Repeal of the Estate Tax with Cuts in Medicare, Veterans Benefits, School Lunches, and Other Programs, by by Robert Greenstein and Richard Kogan: At the urging of Senate Republican leader Bill Frist, the House of Representatives ... approved a measure designed by House Ways and Means Committee chairman Bill Thomas to repeal most but not all of the estate tax. The measure contains no “offsets”; its large cost would be financed through higher deficits. The Senate takes up the bill this week.

One day before Rep. Thomas unveiled his proposal, the Senate Budget Committee approved a far-reaching bill to make major changes in federal budget rules. Crafted by committee chairman Judd Gregg and co-sponsored by Senator Frist and 24 other Senate Republicans, the bill includes a provision that would establish binding deficit targets... In any year in which the deficit targets would otherwise be missed, automatic across-the-board cuts would be triggered in every entitlement program except Social Security.

Policymakers who have pushed for repeal of most or all of the estate tax (and for other tax cuts) often act as though tax cuts are a “free lunch,” ...[H]owever, this is not so. Sooner or later, someone has to pick up the bill.

The Gregg bill places a spotlight on how these tax cuts would be paid for. Taken together, the Thomas estate-tax bill and the Gregg budget-enforcement bill would result in multi-million dollar tax cuts for the estates of the wealthiest Americans who die, with these lavish tax cuts being financed by large reductions in health care, retirement, and other benefits on which millions of ordinary Americans rely....

Congressional Budget Office projections show that if the President’s tax cuts are extended ... and relief from the Alternative Minimum Tax is continued, the projected budget deficit in 2012 and every year thereafter will be close to or more than $200 billion above the level needed to hit the Gregg bill’s deficit targets...  Under ... the Gregg bill, every dollar that a tax-cut bill loses in revenue must eventually be made up by cutting a dollar out of entitlement or other mandatory programs (unless discretionary programs are cut more deeply, other tax cuts are terminated or scaled back, or other revenue-raising measures are adopted). ...:

Table 1: Cuts in Various Entitlement Programs
Triggered by Thomas Estate-Tax Plan
(in billions of dollars)

	Cuts 2007-2016
Medicare	121
Medicaid/SCHIP	64
Federal Civilian Retirement	17
EITC/Child Tax Credit	10
Military Retirement	10
Unemployment Insurance	10
SSI for elderly and disabled poor	10
Veterans disability compensation and pensions	8
Food stamps	8
School lunch/child nutrition	3
Farm Programs	3
Total entitlement cuts	283

...Enactment of the Thomas bill would trigger $283 billion in entitlement cuts over the 2007-2016 period, with $262 billion of these cuts coming in the second five years (2012-2016). ..

Table 1 displays the cuts that would have to be made in various entitlement programs to offset the increases in deficits the Thomas bill would cause. The Table is based on the official cost estimate that the Joint Committee on Taxation has issued of the Thomas bill...

A point could be made that few, if any, Members of Congress favor allowing the estate tax to return in 2011 to its parameters under the pre-2001 tax law. Many Senators ... support making permanent the estate-tax rules that will be in effect in 2009, when the first $3.5 million of an estate — $7 million per couple — will be exempt and the top rate will be 45 percent. Were that approach to be adopted, the entitlement cuts that would be triggered under the Gregg bill would be about half the size of the cuts shown in Table 1...

Wheels for Mini-Me

Here's the story: Daimler Hopes Americans Are Finally Ready for the Minicar:

The article says it will fit on a regulation pool table and that "Fortwo is the only car in the world less than 3 meters (roughly 10 feet) long."

This and a Hummer side by side at a stop light would make an interesting contrast.

State Universities, Competition, and Access for Low-Income Students

Here's a bit more on public universities and the effects of falling state support. As support has fallen, there has been an increased reliance on tuition, private sector funding of research, and donations as a means of funding, all of which subject state universities to market pressures that did not exist in the past.

How will universities respond? Of particular interest is whether the change will affect the ability of universities to provide access to low-income students. Do universities face competition and does that impact their ability to provide access? This is the enrollment manager at Oregon State University, which is about 40 or so miles north of us here at the University of Oregon, in an interview with The Atlantic magazine:

The Best Class Money Can Buy,  by Mathew Quirk,  The Atlantic:  I asked Bob Bontrager what he thought about eating other people's lunches.

"I personally prefer kicking their ass," he replied. "It's a zero-sum game. There's a finite number of prospective students out there. Are you going to get them, or is your competitor going to get them? You face the pressure and say, 'That feels burdensome to me; I don't want to deal with that.' Or you say, 'That's a pretty interesting challenge; I'm going to go out there and try to eat their lunch. I'm going to try to kick their ass.' That defines people who are more or less successful and those who stay in the position."

Bontrager, who works at Oregon State University, is the school's head of enrollment management—a relatively new but increasingly essential post in higher education. Three quarters of four-year colleges and universities employ an enrollment manager to oversee admissions and financial aid. The position is standard at private schools, and is spreading quickly across public institutions.

Over the past twenty years, often under cover of the euphemisms with which the industry abounds, enrollment management has transformed admissions and financial aid, and in some cases the entire mission of a college or a university. At its most advanced it has a hand in every interaction between a student and a school, from the crafting of a school's image all the way through to the student's successful graduation. Any aspect of university life that bears on a school's place in the collegiate pecking order is fair game: academic advising, student services, even the curriculum itself. Borrowing the most sophisticated techniques of business strategy, enrollment managers have installed market-driven competition at the heart of the university.

With their ever-expanding reach, enrollment managers are inevitably dogged by controversy. But it's the way they have changed financial aid—from a tool to help low-income students into a strategic weapon to entice wealthy and high-scoring students—that has placed them in the crosshairs of those who champion equal access to higher education. Adopting data-mining and pricing techniques from the airline and marketing industries, they have developed a practice called financial-aid leveraging that allows a school to buy, within certain limits, whatever class it wants. Often under orders from a president and trustees, enrollment managers direct financial aid to students who will increase a school's revenues and rankings. They have a host of ugly tactics to deter low-income students and to extract as much money as possible from each entering class.

All this, understandably, has given the enrollment-management industry a black eye. "It's a brilliantly analytical process of screwing the poor kids," says Gordon Winston, an economist at Williams, and an article last year in The Chronicle of Higher Education included a warning that "enrollment managers are ruining American higher education." But some in the industry use its techniques responsibly—to guarantee enough revenue to support the academic mission, or even to expand low-income access to higher education. Indeed, the sophisticated methods of enrollment management may be the only way for schools to hang on to their principles while surviving in a cutthroat marketplace. [... continue reading ...]

I'm told Bontrager was asked to use different language when descibing his competitive spirit to the media. We have an enrollment manager, and she relies on the results of an econometric model that has been developed over many years by colleagues to help uncover the responsiveness of enrollment to changes in enrollment policy and the implementation of programs designed to affect recruitment and retention. It's been a helpful tool.

The effect on access for low-income students is a big concern, though I know both the Admissions/Enrollment Manger and Financial Aid Directors here and they certainly fall into those trying to preserve the core mission of equal access and are among the most devoted advocates of these principles.

But the tension is there -- our funding and ability to provide quality education depends critically on these revenue sources -- and we have also instituted scholarship programs designed to attract quality students irrespective of need. These programs are based, in part, upon knowledge about elasticities gleaned from the econometric estimation of enrollment decision models and other statistical work and they do pay attention to the revenue that is generated.

My view from the inside, for what it's worth, is that people are worried about these issues and doing their best to preserve access, but the pressure is there and the argument that always carries the day is that we must survive to serve any low-income students at all even if that means serving fewer low-income students than we might desire to fulfill our commitment to equal opportunity. Over time, in a competitive marketplace, that leads to incentives and outcomes that bear watching as a matter of public policy.

If you are interested in these issues, the article does a good job or presenting the tensions universities feel to maximize revenue at the expense of other values such as equal access, though it may be a bit strident on the access issue.

Not Quite As Dead As a Doornail, But Dead Nonetheless?

Calculated Risk emails remarks from the president on Social Security reform:

President Discusses Line-Item Veto, White House News Release: "Now, I'm going to talk about discretionary spending in a minute, but I just want you to understand that a significant problem we face is in our mandatory programs. And I know you know that. Those would be programs called Medicare and Social Security and Medicaid.

As you might recall, I addressed that issue last year, focusing on Social Security reform. I'm not through talking about the issue. I spent some time today in the Oval Office with the United States senators, and they're not through talking about the issue either. It's important for this country -- (applause) -- I know it's hard politically to address these issues. Sometimes it just seems easier for people to say, we'll deal with it later on. Now is the time for the Congress and the President to work together to reform Medicare and reform Social Security so we can leave behind a solvent balance sheet for our next generation of Americans. (Applause.)

If we can't get it done this year, I'm going to try next year. And if we can't get it done next year, I'm going to try the year after that, because it is the right thing to do. It's just so easy to say, let somebody else deal with it. Now is the time to solve the problems of Medicare and Social Security, and I want your help."

 Talking Points Memo also discusses Bush's comments and begins "tracking some positions here on Social Security, now that the president has announced he's going to take another stab at phasing out Social Security next year." PGL at Angry Bear adds:

 Reuters reports:

Treasury Secretary nominee Henry Paulson said Tuesday that letting tax rates rise would be a mistake ...

So how would he reduce the deficit?

Treasury Secretary nominee Henry Paulson said ...America faces a "formidable challenge" funding government health and retirement plans and must tackle it soon. An aging population that will increasingly strain the resources of Social Security and Medicare means the problems cannot be simply set aside, he said. "I really do believe that we need to begin very seriously the process of addressing them because the earlier we step up to these issues, the less costly will be the ultimate solution,"

There does seem to be a bit of a renewed push, so we shall see if it goes anywhere, but for now I think this is posturing for the elections in the fall. While the administration would like to privatize Social Security, no doubt about that, I think this is meant to energize the base and and appear faithful to core conservative ideas rather than a serious attempt to revive reform. But it's worth watching.

Update: Comments so far are skeptical about the "charge up the base for the fall elections" explanation, though I'll note that, unlike last election, there is no mystery about what the Republican's would like to do so those who want to charge up the opposition can use the issue in any case. But if that's not it, and as I noted I'm not even sure a push is coming, what is the reason for the sudden attention to this issue?

Calculated Risks are Rising

Calculated Risk, who knows these data as well as anyone, says housing is entering a danger zone:

Existing Home Sales, by Calculated Risk: The National Association of Realtors (NAR) reports: Existing-Home Sales Ease In May

Sales of existing homes experienced a minor decline in May with home prices rising near normal rates, according to the National Association of Realtors®....

Total housing inventory levels rose 5.5 percent at the end of May to 3.60 million existing homes available for sale, which represents a 6.5-month supply at the current sales pace. ...

Click on graphs for larger image

Existing Home Sales are a trailing indicator. The sales are reported at close of escrow, so May sales reflects agreements reached in March and April.

Usually 6 to 8 months of inventory starts causing pricing problem - and over 8 months a significant problem. Current inventory levels are now in the danger zone.

Update: David Altig at macroblog has more.

The Decline of Liberal Arts Education

Reading this piece in Project Syndicate about the future of European universities reminded me of discussions about the decline of classic liberal arts education in the U.S. Let's start with this essay by Warren Goldstein, chair of the History Department at the University of Hartford, appearing in the Yale Alumni Magazine.

This echoes my own experience. When I was Department Head, I began bringing back former students who had found success in the business world to talk to our undergraduate majors about how best to prepare for the working ("real") world. Time and again I heard the view expressed in this article, that businesses want people who can think, write, analyze, develop persuasive arguments, they want the type of skills a liberal arts education is intended to promote. With that foundation, they would tell me, they can teach the people the skills needed to do the job effectively. Some were adamant in their refusal to hire business school graduates, preferring instead to hire people with the broad set of skills acquired with a broader education. Economics generally received praise, not so much for specific theoretical tools we teach, but rather for the way it taught students to think about the world and approach problems:

What would Plato do? A (semi-)careerist defense of the liberal arts, by Warren Goldstein, Yale Alumni Magazine:

Nahh, don't tell me -- I bet I can guess your major: art history, right? -- Tom or Ray Magliozzi

If you're an NPR listener, you've probably heard some version of this line on Car Talk. Usually the hapless college student on the phone is female, and Tom and Ray (aka Click and Clack...) are showing their avuncular concern for her employment prospects. ...[L]iberal arts-bashing is one of their favorite sports. As far as I can tell, from my turret in the besieged educational outpost of the liberal arts, nearly all parents of college-age students agree with them. ...

The Wal-Mart Question

Wal-Mart once again. This match pits Wal-Mart supporter Jason Furman against former Wal-Mart employee and detractor, Barbara Ehrenreich:

Is Wal-Mart Good for the American Working Class? I wish it was better, by Barbara Ehrenreich and Jason Furman:

From: Jason Furman
To: Barbara Ehrenreich
Subject: The Low Prices Are Good News
Posted Monday, June 26, 2006, at 3:18 PM ET

Barbara,

...I myself have never worked at Wal-Mart, and I can only remember shopping there once. In fact, I instinctively recoil at the big-box shopping centers spreading their uniformity across the American landscape. But I try hard not to let my personal and somewhat elitist shopping inclinations get in the way of an appraisal of Wal-Mart's positive role in America's economy and society. (For my full appraisal, see this paper ...)

Are you as surprised as I am by how quickly Wal-Mart's critics move past the issue of low prices? You will hear comments like, "Yes, Wal-Mart may have somewhat low prices, but let's talk about its impact on workers, the environment, trade with China, etc." But given just how important these low prices are to the hundreds of millions of Americans that shop there, I hope I can beg your indulgence to linger on them for a few moments.

Repeat After Ben

John Berry explains the Fed's struggle to find an effective communication strategy:

Fed Officials Confront a Failure to Comprehend, by John M. Berry, Bloomberg: Five months into the term of Chairman Ben S. Bernanke term he and his colleagues haven't figured out how to get financial markets to understand what they are trying to do with monetary policy in today's volatile economic setting.

It's now a foregone conclusion that the Federal Open Market Committee will raise its target for the overnight lending rate by a quarter-percentage point, to 5.25 percent, on Thursday.

The issue is how to draft a statement that explains the committee's thinking that leaves it free to respond to new economic data without giving some stubborn traders the impression that the Fed is soft on inflation. ...

Some officials, convinced that economic growth is slowing and that inflation will settle down again soon, would really rather not raise the target this week for the 17th time in a row.  Even those officials feel they have no choice because investors, shaken by recent inflation reports, fully expect them to do so. ...

The major concern among officials at this point is the small rise in inflation expectations shown by a variety of measures the Fed follows. Officials want to keep expectations capped....

Nevertheless, unless inflation momentum is much stronger than most Fed officials think it is, at some point soon, they are going to want to leave the lending rate target unchanged. What some traders can't seem to comprehend is that if the FOMC were to do that, it wouldn't mean that the committee might not raise the target at a subsequent meeting. A pause wouldn't mean the Fed was done. ...

Obviously, no one knows exactly what the policy path will be for the rest of the year, including Bernanke and his colleagues. What the officials fervently hope is that they can find the right words to persuade the markets to leave them free to analyze incoming economic data and make their policy decisions accordingly. ...

The minutes matter and they'll set a baseline for expectations regarding future policy, but communication between meetings, particularly around key data releases, has been more problematic than the minutes.

Is Jon Stewart Bad for America?

I received an email saying if I wanted to keep younger readers, I should post Jon Stewart videos. But I would never pander like that:

Jon Stewart 'Hurts the Country,' Science Finds, by Andrew Ferguson, Bloomberg: ...[A] pair of political scientists from East Carolina University released the results last week of their 18- month study of the influence that Jon Stewart, the TV comedian, has on U.S. democracy. The report's conclusions about the effect of Stewart and his Comedy Central ''Daily Show'': not good. ...

Baumgartner and Morris cite data from the Pew Research Center that show almost half of Americans between the ages of 18 and 24 watch the ''Daily Show'' at least occasionally. This is also the age group that is most averse to consuming ''hard news'' from newspapers, magazines or TV. Only one in four of Stewart's regular viewers report following hard news closely, while, in 2004, more than half said they got some information about the campaign from Stewart. ... Now Baumgartner and Morris come to confirm what should be obvious... This isn't good news at all.

''Jon Stewart,'' they write, ''may have a unique effect on young viewers.'' With a barrage of jokes that require almost no contextual knowledge to understand, he flatters his viewers' sense of superiority even as he makes them more cynical -- and cynical not just about individual politicians but about the processes and possibilities of self-government.

Newspaper readers, who are much better informed, also show a slight increase in cynicism, the researchers found, but they ''do not display cynicism toward the system in the same manner as watchers of the 'Daily Show.'''

Meanwhile, despite their lack of knowledge, ''Daily Show'' viewers ''reported increased confidence in their ability to understand the complicated world of politics.'' Stewart is raising their self-esteem at the same time he makes them dumber.

Now, this is a familiar phenomenon in the contemporary U.S. -- rising ignorance accompanied by rising self-regard. We can't blame Stewart for it all by himself... But the study does raise the question: Who's hurting the country now? ...

Just because the truth hurts is no reason to stop telling it. Here's a recent example of Stewart in action:

[Video -WMP Video -QT]

TDS: The Miami Seven: Jon Stewart takes a look at the case known to many as "The Miami Seven." He examines the careful and decisive evidence told to us by Alberto Gonzales:

Gonzales: These individuals wish to wage a quote: "full ground war against the United States."

Stewart: Seven guys? I’m not a general. I am not anyway affiliated with the military academy, but I believe if you were going to wage a full ground war against the United States, you need to field at least as many people as say a softball team.

Please Alberto, don’t take any questions-you were doing just fine up until then. That was followed up by some careful analysis of the men involved in the plot.

A: One of the individuals was familiar with the Sears Tower- had worked in Chicago and had been there-so was familiar with the tower, but in terms of the plans it was more aspirational rather than operational.

Stewart: No weapons, no actual contact with al-Qaeda, but one of them had been to Chicago…

Cynical in the sense of "skeptical of the motives of others?" Let's hope so.

How Would You Spend 50 Billion?

Your goal: Reduce human suffering. Your budget: Fifty billion dollars. Where do you start?:

Who Should Be Helped First?, by Bjørn Lomborg, Project Syndicate: The list of urgent challenges facing humanity is depressingly long. AIDS, hunger, armed conflict, and global warming compete for attention alongside government failure, malaria, and the latest natural disaster. While our compassion is great, our resources are limited. So who should be helped first?

To some, making such priorities seems obscene. But the United Nations and national governments spend billions of dollars each year trying to help those in need without explicitly considering whether they are achieving the most that they can.

The western media focuses on a tsunami in Asia; donations flow freely. An earthquake that devastates Pakistan garners fewer headlines, so the developed world gives a lot less. There is a better way. We could prioritize our spending to achieve the greatest benefit for our money.

This month, I will ask UN ambassadors how they would spend $50 billion to reduce suffering. They will repeat the same exercise that some of the world’s best economists tackled in a 2004 project called the “Copenhagen Consensus”... But the question shouldn’t be left to politicians or Nobel laureates alone. We must all engage in the debate. ..

Here’s one fact to consider: the entire death toll from the Southeast Asian tsunami is matched each month by the number of worldwide casualties of HIV/AIDS. A comprehensive prevention program providing free or cheap condoms and information about safe sex to the regions worst affected by HIV/AIDS would cost $27 billion and save more than 28 million lives. This, say the economists who took part ..., makes it the single best investment that the world could possibly make. The social benefits would outweigh the costs by 40 to one.

Other options that the economists favored spending some of their $50 billion include providing micro-nutrients to the world’s hungry, establishing free trade, and battling malaria with mosquito nets and medication. At the other end of the scale, responses to climate change like the Kyoto Protocol would cost more than they would achieve, so the economists crossed them off the list of things to do right now.

Regardless of whether we agree with the economists, everybody must admit that we cannot do everything at once. ... Often, politicians avoid prioritization. Why? The glib answer is because it is hard. ...

The UN conference won’t be easy. But it shows that there is a will to put prioritization squarely at the center of attention. It will produce a “to do” list that will demonstrate how to achieve the most that we can for humanity...

The principles of economics provide a sound basis on which to make rational choices. Now, the discussion needs to shift from the academic sphere to political life. It’s time for all of us to consider and compare our own priority lists. ...

Everything Old is Still Old

This National Review Online commentary urges Republican leaders to reconsider their opposition to tax increases as part of the solution to growing entitlements. The idea is to trade concessions on taxes for the creation of personal Social Security accounts with the hope that, once the door has been opened slightly, salesmanship can open it further and allow conservatives to reach their goal of privatizing Social Security. Beware of compromise in sheep's clothing:

Entitlement-Reform Realities A little conservative compromise will go a long way as we attempt to revamp today’s safety-net system, by Jagadeesh Gokhale, NRO: Some conservatives are apoplectic about the prospect of abandoning the “no-tax-hike” pledge as part of entitlement reforms. ... Unfortunately, the political and economic arithmetic of entitlement shortfalls does not permit them much hope; remaining wedded to high principles and shunning compromise will only worsen their choices. They should learn from past experience and adopt a more strategic approach. ...

As the aphorism goes, “possession is nine-tenths of the law.” Liberals’ programs have been in operation for decades and are now supported by a large bloc of voters, making it especially difficult for conservatives to challenge or modify them. It’s quite telling that liberals are viewed as having no new ideas. But that could be because most of their ideas are already in operation.

Liberals are in a peculiar bind. Entitlement shortfalls are growing larger and threatening to undo their legacy. ... That presents an opportunity for conservatives to revamp today’s safety-net system by introducing their own market-oriented framework, with personal Social Security accounts as the crown jewel. Unfortunately, worsening entitlement shortfalls also make adopting personal accounts more difficult each year. The closer baby boomers come to retirement age, the less likely they are to acquiesce to smaller entitlement benefits than they are currently promised in exchange for adopting personal accounts — as last year’s debate showed. ...

Now the cake of higher future taxes is in the oven, with the temperature rising rapidly. Could conservatives remove the cake and replace future tax hikes with personal accounts? As last year’s stalled Social Security debate showed, that’s unlikely. But conservatism’s high priests continue to answer this question with a “yes.” Perhaps they have a closely guarded strategy for guaranteeing overwhelming electoral success.

Could conservatives do better by agreeing to accept some of the taxes in exchange for removing the cake earlier and replacing a part of future tax increases with personal accounts? The answer of the high priests is “no,” which is puzzling given that their choices would only worsen over time.

What are the strategic tradeoffs? Three items seem relevant: First, resolving the entitlement shortfall by paring scheduled benefit growth is becoming less feasible as time passes. The large baby-boomer voting bloc would increasingly view those benefits as inviolable and would likely possess the political muscle to enforce those claims. Thus, intransigence on compromise will make higher taxes more, not less, likely. ...

Second, the fact that personal Social Security accounts do not yet exist and thus cannot compete with the existing system to demonstrate their superiority is a huge disadvantage. Their absence allows liberal opponents to compare personal accounts with placing one’s retirement on a Las Vegas roulette table.

Third, if personal accounts were introduced and proved successful, they would incorporate property rights much more compelling than existing claims on Social Security benefits. Those rights on income-earning assets would also be bequeathable.... Such rights would not only be irreversible, they would carry strong momentum for expansion as more groups clamored for access to personal accounts.

So any arguments that the advantages of introducing personal accounts are not worthy of a few early concessions on taxes appear far from credible.

First, there is nothing that necessitates linking tax changes to personal accounts - no such linkage was made when taxes were cut. This is nothing more than a strategy for attaining personal accounts, it is not a solution to the entitlement problem. Medicare is the problem, not Social Security. Here's Robert Reich on this point who, while bemoaning turning 60, is compelled by his 60th birthday to think hard about Social Security:

On Turning 60 (Postscript), by Robert Reich: Commentator Rodger doesn't believe we can grow our way out of the pending Social Security crisis, but I think he's (almost) wrong. Look, I was a trustee of the Social Security trust fund. I saw up close how the actuaries made their projections for when the fund will run out of gas. They plugged in (and continue to plug in) very low estimates of average annual economic growth over the next seven decades. But if the U.S. economy grows anywhere close to its average growth over the LAST seven decades -- which is over 3 percent a year -- the trust fund will do just fine. How can we grow that fast when we won't have enough new entries into the labor force to support the vast baby-boom generation? Two ways: First, productivity gains will be substantial, as new technologies work their way through the economy (consider the astounding productivity gains what's over the last five years). Second, America will continue to have lots of legal and illegal immigration, despite whatever Washington does in the meantime. So don't worry too much about Social Security. Fix your worried gaze at Medicare instead. There's the real problem.

And I'm tired of the "we're the party of ideas" claim. The recent Republican agenda includes:

Flag Burning
Line Item Veto
Tax Cuts
Gay Marriage

This is the party of new ideas? Where?

Update: MaxSpeak has more to say about the NRO commentary.

Update: Brad DeLong has even more. And in response, I like pomegranates, always have, and as an add-on to the main course or as a snack they're great (though watch out for the stains). But, like Brad, I wouldn't feature them as the main course.

Ahmadinejad is a Destabilizing Influence; Bernanke is Not

What is the explanation for the recent large stock market losses in the U.S. and around the world generally? Was it U.S. monetary policy as many claim, or something else?

What News Is Moving the Markets?, by Robert J. Shiller, Commentary, Project Syndicate:  Stock markets in much of the world have shown sharp cumulative declines since around May 10, with most of the drop occurring in the two-week period to around May 23, but with prices continuing to fall on average since then. Does trouble in the world’s stock markets mean trouble for the world economy? ...

Forecasts of Output Growth and Inflation under Hawkish, Intermediate, and Dovish Monetary Policies

To give you some idea how economists might investigate alternative monetary policies, I estimated a simple econometric model and then simulated three different possible monetary policies to see how inflation and output growth would react.

More specifically, I estimate a two lag vector autoregressive (VAR) model with the variables output growth, inflation, and the federal funds rate. Rates of change are measured as year over year. You can think of these models as very general reduced form equations where all of the endogenous variables are functions of exogenous or predetermined variables. For example, the output growth equation is:

y_t = b₀ + b₁y_t-1 + b₂y_{t-2 +} b₃inf_t-1 + b₄inf_t-2 + b₅ff_t-1 + b₆ff_t-2 + e_t

The other two equations would be the same except the left-hand side variable would be either inf_t or ff_t instead of output growth, y_t, and the coefficients would differ. Because every variable in the system depends upon lags of every other variable, these models are fairly general (contemporaneous values on the right-hand side can be substituted for to get the lagged specification).

I estimated this model using data from 1960Q1 through 2006Q1, then simulated three monetary policies over the next two years:

Dove: Increase to 5.0 in 2006Q2 (as was done), and stay at 5.0 thereafter.

Intermediate: Increase to 5.0 in 2006Q2, then to 5.5 in 2006Q3, then hold at 5.5.

Hawk: Increase to 5.0 in 2006Q2, then to 5.5 in 2006Q3, then to 6.0 in 2006Q4, then hold at 6.0.

Graphically, here are the three policies since 2000Q1. The graph shows actual policy through 2006Q1, and the simulated policies through 2008:1. Note that these policies continue to increase the federal funds rate at the smae measured pace as in recent quarters (the changes are in increments of .5 rather than .25 in both the historical data and in the simulations because there are approximately two meetings per quarter):

Click on figure to enlarge

Here are the outcomes of the simulations. In these two graphs, actual values are shown through 2006Q1 along with the forecasts for the three different policy scenarios:

Click on figures to enlarge

Focusing first on output in the top graph, initially the path of output growth is very similar for the three policies, so much so that only the red line is visible on the graph. However, after peaking at around 4.1% in either 2006Q3 or Q4 depending on the policy, output growth then falls until the end of the forecast period at 2008Q1. The differences in output growth at 2008Q1 are 3.41% for the hawkish policy, 3.58% for the intermediate, and 3.76% for the dovish policy. So, there is approximately a one third of a percentage point difference in output growth between the hawkish and dovish scenarios.

The second graph brings up a problem with this class of models. In these simple VAR models, changes in policy have very little effect on inflation and, to the extent that policy does have an effect, it is perverse. Inflation is higher, though not by much, when policy is tighter and this is one reason the results should be interpreted with caution. For example, after two years, inflation is forecast to be 3.47% under the hawkish policy, 3.44% under the intermediate policy, and 3.41% for the dovish policy, values that are perverse but unlikely to be statistically distinct. The solution to the "price puzzle" is to add more variables, commodity price indexes are one way to reverse the sign, but explaining the movement in inflation through time (and hence inflation expectations) remains problematic generally and some recent work has moved toward solutions based upon imposing structural restrictions, or explanations that use theoretical results involving indeterminacy (multiple equilibria).

Finally, I should add that the results do not change much if a measure of the output gap (the deviation of output from a quadratic trend) is used instead of output growth, or if PCE less food and energy is used instead of PCE. Not perfect, but enough for now...

Sweet Spots and Doughnut Holes

Paul Krugman is on vacation, so here's a column from October, 2003. The column explains how the 2001 and 2003 tax cuts contain provisions designed to make it politically difficult to call for a rollback of the tax cuts to their original levels:

The Sweet Spot, by Paul Krugman, Commentary, NY Times, October 17, 2003: "What we have here is a form of looting." So says George Akerlof, a Nobel laureate in economics, of the Bush administration's budget policies — and he's right. With startling speed, we've blown right through the usual concerns about budget deficits — about their effects on interest rates and economic growth — and into a range where the very solvency of the federal government is at stake. Almost every expert not on the administration's payroll now sees budget deficits equal to about a quarter of government spending for the next decade, and getting worse after that.

Yet the administration insists that there's no problem, that economic growth will solve everything painlessly. And that puts those who want to stop the looting — which should include anyone who wants this country to avoid a Latin-American-style fiscal crisis, somewhere down the road — in a difficult position. Faced with a what-me-worry president, how do you avoid sounding like a dour party pooper?

One answer is to explain that the administration's tax cuts are, in a fundamental sense, phony, because the government is simply borrowing to make up for the loss of revenue. In 2004, the typical family will pay about $700 less in taxes than it would have without the Bush tax cuts — but meanwhile, the government will run up about $1,500 in debt on that family's behalf.

George W. Bush is like a man who tells you that he's bought you a fancy new TV set for Christmas, but neglects to tell you that he charged it to your credit card, and that while he was at it he also used the card to buy some stuff for himself. Eventually, the bill will come due — and it will be your problem, not his.

Still, those who want to restore fiscal sanity probably need to frame their proposals in a way that neutralizes some of the administration's demagoguery. In particular, they probably shouldn't propose a rollback of all of the Bush tax cuts.

Here's why: while the central thrust of both the 2001 and the 2003 tax cuts was to cut taxes on the wealthy, the bills also included provisions that provided fairly large tax cuts to some — but only some — middle-income families. Chief among these were child tax credits and a "cutout" that reduced the tax rate on some income to 10 percent from 15 percent.

These middle-class tax cuts were designed to create a "sweet spot" that would allow the administration to point to "typical" families that received big tax cuts. If a middle-income family had two or more children 17 or younger, and an income just high enough to take full advantage of the provisions, it did get a significant tax cut. And such families played a big role in selling the overall package.

So if a Democratic candidate proposes a total rollback of the Bush tax cuts, he'll be offering an easy target: administration spokespeople will be able to provide reporters with carefully chosen examples of middle-income families who would lose $1,500 or $2,000 a year from tax-cut repeal. By leaving the child tax credits and the cutout in place while proposing to repeal the rest, contenders will recapture most of the revenue lost because of the tax cuts, while making the job of the administration propagandists that much harder.

Purists will raise two objections. The first is that an incomplete rollback of the Bush tax cuts won't be enough to restore long-run solvency. In fact, even a full rollback wouldn't be enough. According to my rough calculations, keeping the child credits and the cutout while rolling back the rest would close only about half the fiscal gap. But it would be a lot better than current policy.

The other objection is that the tricks used to sell the Bush tax cuts have made an already messy tax system, full of special breaks for particular classes of taxpayers, even messier. Shouldn't we favor a reform that cleans it up?

In principle, the answer is yes. But an ambitious reform plan would be demagogued and portrayed as a tax increase for the middle class. My guess is that we should propose a selective rollback as the first step, with broader reform to follow.

Will someone be able to find the political sweet spot, the combination of fiscal responsibility and electoral smarts that brings the looting to an end? The future of the nation depends on the answer.

Sweet spots seem to have a lot in common with doughnut holes. But on the broader question, two and a half years after the column was written, is it smart politics to call for "selective rollback as the first step, with broader reform to follow" as the elections approach in the fall?  I haven't heard anyone hit the political sweet spot yet.

Econoblog: The Costs and Benefits of Immigration

A Wall Street Journal Online Econoblog on the costs and benefits of immigration:

Immigration's Costs -- And Benefits, Econonblog, WSJ: ...The Wall Street Journal Online asked economists Gordon Hanson of the University of California, San Diego, and Philip Martin, of the University of California, Davis, to discuss the underlying causes of immigration (both legal and illegal), its historical roots and the nature of the current political uproar over the issue.

Gordon Hanson writes: For all the heat that the debate about immigration has generated, the net economic impact of immigration on the U.S. economy appears to be remarkably small. First, some thoughts on legal immigration, before we address illegal immigrants.

And Justice for All

Following up on the previous post, here are Greg Mankiw's views on the existence of, the source of, and solutions to growing income inequality in the U.S.:

On Inequality, by Greg Mankiw: A student asks a broad question:

I was wondering if you could offer your views on income inequality.

Let me offer a few observations as broad as the question:

1. There is little doubt that U.S. income inequality has been increasing for the past three decades. (The trend in world inequality is very different.) Most economists who study the topic attribute the trend primarily to changes in technology that reward skilled workers relative to unskilled workers. Education and other skills are more valuable now than they were in the past.

2. Reasonable people can disagree about how much the government should redistribute income. Part of the disagreement is economic: for example, how large are the elasticities that determine tax distortions? Part of the disagreement is philosophical: for example, is taking money from high-wage individuals to give it to low-wage individuals a way to ameliorate the injustices inherent in a market economy or a form of government-sanctioned theft? Economists can help with the economic part of the disagreement, but we have no comparative advantage to help with the philosophical part.

3. However much redistribution we choose, the best way to accomplish it is by a progressive system of taxes and transfers. Economists sometimes call this a negative income tax, because low-income individuals pay a "negative" tax. The current progressive income tax together with the Earned Income Tax Credit is close to being an example (although the EITC has a variety of conditions that a pure negative income tax would not have). Wikipedia reports the following... "...the EITC is one of the largest anti-poverty tools in the United States, and enjoys broad bipartisan support."

4. Ideally, I would use consumption, rather than income, as the tax base for purposes of raising revenue and redistribution. The benefit of consumption taxes over income taxes is that they do not distort the intertemporal allocation of consumption. A variety of economists have proposed ways to implement a progressive consumption tax. For example, the Hall and Rabushka flat tax is progressive in average tax rates; the Bradford X-tax is similar but even more progressive.

5. Having achieved the desired degree of redistribution with a system of taxes and transfers, policymakers should focus on economic efficiency when setting most other policies. That is, policy regarding international trade, rent control, minimum wages, health care, housing and so on should, in my view, aim to make the economic pie as large as possible. Although these other policies affect the size of different slices, they are inefficient and poorly targeted instruments for purposes of redistribution. To the extent that we choose to redistribute income, we should use the best tools we have for that purpose (see points 3 and 4).

Greg and I aren't that far apart on the economic issues, e.g. when I talk about market failures that is the same as his point about efficiency. I've also noted previously that consumption taxes are generally more efficient than income taxes, but the politics that come with them are more difficult since consumption taxes generally require ex-post income redistribution policies to make them progressive.

On the economics, I suspect where we would differ is on how pervasive market failures are and how effective government can be when it intervenes to overcome them. For example, I would claim that market failures make the private provision of health and social insurance less efficient than government regulated provision, but I suspect he would not, at least not to the same degree.

On the philosophical issue, he doesn' say how much income redistribution he favors, but as I said my view, broadly stated, is that it ought to be sufficient to overcome injustices and equalize opportunity, but there are those on the left who would go further than this in terms of equalizing outcomes.

Finally, I should note that Krugman would disagree strongly with the claim in point 1 that the main cause of growing inequality is an increase in the skill-based wage premium. See Graduates versus Oligarchs. This is important because the solution to income inequality depends upon whether it is a reward to education, or a consequence of government policy. Quoting Krugman:

The notion that it's all about returns to education suggests that nobody is to blame for rising inequality, that it's just a case of supply and demand at work. And it also suggests that the way to mitigate inequality is to improve our educational system — and better education is a value to which just about every politician in America pays at least lip service.

The idea that we have a rising oligarchy is much more disturbing. It suggests that the growth of inequality may have as much to do with power relations as it does with market forces. Unfortunately, that's the real story.

I suspect the need to intervene to overcome injustices associated with government policy and changing power relations is another area where Greg and I would disagree.

In a Coconut Shell

Can you summarize Democratic ideology succinctly, Republican-like even?:

Democrats, don't put it in writing It's the party of case-by-case, not sweeping dogmas, by Jonathan Chait , Commentary, LA Times: After the 2004 presidential election, some of us liberals came away with the conclusion that it's awfully hard to defeat an incumbent president during wartime. And some of us came away with the conclusion that John Kerry is a really awful politician.

Other liberals, though, decided that what this country needs are some good policy journals. It is because of liberals like these that so many Americans think we're all a bunch of weenies. One of those weenies is my friend Kenneth Baer, who, along with Andrei Cherney, has founded a center-left journal called Democracy. The premise of Democracy is that conservatives have taken power in large part because of their intellectual journals — and that liberals can reclaim that power by fighting back likewise.

"Conservative policy journals," writes Baer, "helped take a marginal movement in American life that was thumped at the polls (Goldwater in 1964) and, over four decades, turn it into a dominant force." ... Democracy's editors believe that the central purpose of this journal-led restoration is to Think Big. No policy papers, please. ... Their role is to formulate sweeping principles.

Alas, this is inherently a losing game for liberals. Here is the problem: Conservatism and liberalism are not really mirror images of each other. Conservatives venerate the free market and see smaller government as an end in itself. Liberals do not venerate government in the same way, and we do not see larger government as an end in and of itself. For us, everything works on a case-by-case basis. Should government provide everybody's education? Yes. Should government manufacture everybody's blue jeans? No. And so on. ...

Everybody knows what [Republicans] stand for. They're for lower taxes, strong defense and less spending — even if they habitually fail at the spending part and have royally screwed up the defense portion of late.

But nobody knows what Democrats stand for because you cannot, and should not, formulate sweeping dogmas when you're operating on a case-by-case basis.

Consider the Clinton administration. What did it stand for on, say, economic policy? Well, progressive taxation, reducing the deficit (but not at the expense of Medicare, Medicaid, education and the environment), expanding health coverage, investing in technology, and … you see? We're long past the point where it can be described by a single overarching theory...

Some liberals see this problem and conclude that Democrats got too wishy-washy under President Clinton. If we'd just held firm to strong liberal, pro-government principles, they say, the public would know where we're coming from.

Well, that's probably true. But it wouldn't win any elections. Why not? Because, as social psychologists Lloyd A. Free and Hadley Cantril concluded in 1964, Americans are ideological conservatives and operational liberals. Everybody's for less spending and regulation in the abstract. When you try to translate that into specifics — say, lower Medicare benefits or looser standards on pollution — voters run screaming in the other direction.

Any debate that takes place at the level of ideological generality, then, inherently favors the right. Liberals can try to come up with slogans of their own. ... But that brings you back to the problem of nobody understanding what you believe in. ...

The editors of Democracy scorn this pragmatic interpretation. "Progressives too often have come to eschew bold ambition," they write, "preferring to take shelter in the safe harbor of 'realism' and 'competence.' "

Realism and competence may not make for a stirring theme, but when you've had eight years of the alternative, they look pretty good.

"For us, everything works on a case-by-case basis." That makes it sound ad hoc, random, without any underlying principles. For me it's not, or I hope it isn't. I try to use two main principles to decide if the government should intervene, but make no claim this is a mainstream Democratic position. First, will the private market provide adequate quantities of the good, or are there significant market failures? Since no market is perfect, are the market failures substantial enough so that government, even with it's own inherent inefficiencies, still does a better job of providing the goods? If so, the government should intervene by providing the appropriate incentives to the marketplace (which can be as simple as full disclosure requirements on sales, or as complex as pricing rules for telecommunications), or providing the good itself when market incentives are insufficient. Second, does the policy overcome social or economic problems and equalize opportunity? Of course people shouldn't starve or go without housing, healthcare, schooling, legal defense, etc., but I'm not much for equalizing outcomes. However, I do believe in equalizing opportunity and that can involve redistributive policies as it does in the provision of universal education. In any case, it's not hard to boil things down to simple slogans:

Making markets work for all of America,
Equalizing  opportunity, and
Protecting our future.

Something along those lines would work for me. What would you add/subtract, or do you agree that "[Y]ou cannot ... formulate sweeping dogmas... We're long past the point where it can be described by a single overarching theory"?

"The Fiscal House is in Severe Disorder"

I've had a lot of problems with the things Ben Stein has written in the past (understatement alert), and I cut the parts I didn't like from this commentary, but I suppose I should give credit when it's due: 

Note to the New Treasury Secretary: It's Time to Raise Taxes, by Ben Stein, Commentary, NY Times:

Henry M. Paulson Jr.
The Goldman Sachs Group
New York, N.Y.

Dear Mr. Paulson:

You almost certainly don't remember little me, but I met you many years ago... To become chairman of an empire like Goldman Sachs is a spectacular achievement by any measure. But now you have your work cut out for you as Treasury secretary. You are facing what is, in many ways, the most dangerous economic future since the Depression. Danger is coming on many fronts, only dimly seen by the powers that be in Washington, and your insights ... will be urgently necessary. ...

Right now, inflation is moving out of the Federal Reserve's comfort zone. The Fed chairman, Ben S. Bernanke, is doing the right thing by raising rates and trying to slow the overheated economy, but in a way that does not bring us a recession. To give us a soft landing without recession or stagflation — rising inflation and slow growth, as we had in a good part of the 1970's — is not an easy or assured task. ...

May I respectfully suggest that in this environment, ending the estate tax is not a major sensible priority? May I suggest that having the lowest taxes in 65 years on high-income taxpayers is not really as prudent as it might be if we were not running stupendous deficits, with far worse in the future?

I know you are a Republican, and so am I. Now and then, scornful fellow Republicans ask me what kind of Republican I am, since I'm for higher taxes on the rich. I tell them that I am an Eisenhower Republican, the kind who wants to leave a healthier America to posterity. That includes an economy not headed for the status of a banana republic's economy.

Now, I know that ... Ronald Wilson Reagan, when asked if he were not worried that his tax cuts would burden posterity with a heavy weight, supposedly asked, "What has posterity ever done for me?" Those of us with teenage children certainly know what he meant. But the problem is no longer quite as funny.

The fiscal house is in severe disorder. ... Mr. Bernanke knows what's right and wrong. You will have allies. But someone needs to take a stand, and that person might as well be you. The time is always right to do right... This one will make running Goldman Sachs look easy.

Respectfully submitted,
Ben Stein

The Costs of Inequality and the Opportunity Cost of Policy Choices

From the NY Times Economic View, the economic and human costs of income inequality followed by Gene Sperling on the opportunity cost of tax cuts and spending on the war:

Income Inequality, and Its Cost by Anna Bernasek, Economic View, NY Times: Inequality has always been part of the American economy, but the gap between the rich and the poor has recently been widening at an alarming rate. ... The social and political repercussions of this disparity have been widely debated, but what about the effects on the economy?

Oddly, despite its position in the political debate, the question has received little attention from economists. Mostly, they have focused on measuring income inequality and establishing its causes. Some research has been done, however, and the results, including insights from related disciplines like psychology and political science, are disturbing.

What's in a Job?

Years ago, my dissertation adviser used to tell me that people don't have marginal products, jobs have marginal products. There is certainly individual variation in performance on jobs, more so in some than others, but for the majority of jobs it is true that it is the job itself, not the person doing it, that determines its productivity. A person can be the best 7-11 clerk ever, but the job puts a limit on the productivity that can be achieved and hence the wage that can be earned.

Suppose we take all jobs and break them down into a finite set of k skills or tasks, S₁, S₂, ..., S_k. Then an hours worth of labor at a particular job can be viewed, on average, as some combination of these skills or tasks, L = a₁S₁ + a₂S₂ + ... a_kS_k.

When I think of changes in the labor market, it is sometimes helpful to think about how this skill set is evolving through time -- some coefficients (the a_j terms) get larger, some get smaller, and so on. Some may be zero until certain points in time when they are invented by new technology, and some may be zero after particular points in time.

Notice also that from a labor supply point of view these individual tasks or skills are what determines how unpleasant a job is. Each individual will have preferences (disutility) over these skills and hence have a different willingness to work at a job depending upon their aversion to the tasks involved. A change in productivity, for example, could shift the tasks toward a more undesirable set causing workers to demand higher wages not only because they are more productive, but also because the characteristics of the job have changed. Of course, this could go the other way as well if the job shifts to tasks that are more desirable. In extreme cases you might be willing to pay to do the job (suppose the job were to stand on the sideline and make sure an end zone cone stays in place at the super bowl).

Interestingly, under such a formulation, it is not necessarily the case that an increase in productivity increases wages. Suppose there is an increase in productivity that also causes a marked shift towards tasks that workers find more tolerable. In labor market terms, the labor demand curve and the labor supply curves would both shift outward leaving an uncertain effect on wages. [On a technical level it also calls into question identification schemes that use productivity to map out the labor supply curve.] But I don’t think this explains flat wages in recent years, i.e. that productivity changes have made jobs so much better for laborers that there was no reason to raise compensation even though productivity increased, but there may be cases where the changes in job characteristics are important to consider.

So why do I bring this up? No particular reason, just some thoughts on a lazy Saturday -- labor economists will probably tell me they know all about this through work on compensating differentials, etc. anyway. But I am curious how technological change and advances in information technology have altered the typical job in recent decades. Is a typical hour of work more tolerable, less tolerable, or just as miserable day-in and day-out as it ever was? Any ideas?

You Don’t Have a Clue, Do You?

This is Ed Leamer writing at Cato Unbound as part of the series on the future of the American worker in the global economy:

It’s Like Hurricanes, by Edward E. Leamer, Conversation, Cato Unbound: Rather than in the abstract, try tackling the following problem.

I grew up in the small town of Vestal near Binghamton, New York. The major industry of the area in 1900 was cigars, which left when tobacco fashion shifted to cigarettes and cigarette production was mechanized. No matter, by 1950 the Endicott Johnson shoe company had replaced cigars. But shoes, which had left artisan shops in Boston to come to upstate New York, continued their footloose behavior and left the US altogether in the 1960s. Not to worry. By 1980 IBM was the major employer of the area. ... IBM produced ... mainframe computers built by high school graduates at high wages.

Now IBM is gone and there is not much of anything in the way of jobs except hospitals and Wal-Mart. Young people are fleeing for better lives elsewhere. It isn’t just Binghamton. On Tuesday, June 13, Sam Roberts wrote about this in the New York Times in an article titled “Flight of Young Adults Is Causing Alarm Upstate” ...

We have a real problem here, don’t we? What is causing this radical change in the physical geography of wealth formation? What should Binghamton do? Is there any way to save upstate New York? What say ye, o wise men of Cato Unbound?

First, Mr. Thomas Friedman: What did you mean by the item quoted in Richard’s original essay: “you no longer have to emigrate in order to innovate”? Should we plaster the Binghamton area with posters that say that, and keep all the bright kids in the area?

Frank: Is this the failure of education? Did my high school in Vestal take the wrong path after I graduated? Do State officials need to swoop down on these schools to prepare kids to do the problem-solving tasks of the 21st Century? Or is it the institutions? Do we need some new laws that make membership in a labor union mandatory?

Richard: How does the word “creative” help find a solution? This region contributed more than its share to the innovations of the 20th Century—Corning glass, Xerox, Ansco, and thousands of small manufacturing firms. IBM was one of the most innovative companies that has ever existed. ... IBM was the opposite of diversity, with straight white men wearing starched white shirts and creased dark trousers. Do you think now the region could be helped by some remedial general training in tolerance as a way of attracting creative people?

Robin: What do you say about this? You have a sharp critical scalpel, but what solutions do you propose for a real problem? It sounds like your advice is: Don’t worry. Be happy.

Last, to Ed: For all the wisdom your words try to convey, you don’t have a clue, do you? It’s like hurricanes. You can study and understand, but there isn’t much you can do about it, except offer some disaster relief after the storm has hit.

Inflated Worries?

Several recent posts have said there's no need for the Fed to be so concerned with inflation. The Dallas Fed says yes there is, and here's why:

Parsing Recent Inflation Data, by Jim Dolmas, Dallas Fed: Measured core consumer price inflation has picked up noticeably over the past few months. The following table compares inflation over the 12 months of 2005 with annualized year-to-date inflation in several core consumer price indexes.

	2005	2006	Diff
CPI ex. food & energy	2.2	3.1	0.9
Median CPI	2.5	3.7	1.2
PCE ex. food & energy	2.0	2.7	0.7
Trimmed mean PCE	2.2	2.9	0.7
Market-based PCE ex. food & energy	1.7	2.2	0.5
Note: 2006 is YTD annualized

What’s going on here? Some analysts have suggested that the primary culprit behind the recent surge in core rates is a sharp increase in the price index for owner-occupied housing. For the PCE, at least, this is not the case. While the price index for owner-occupied housing has contributed somewhat to the recent surge, the pattern of increase in the core PCE remains even if owner-occupied housing is excluded from the index.

The following four charts show 1-, 3-, 6- and 12-month inflation rates for the PCE ex. food and energy and for the PCE ex. food, energy and owner-occupied housing (OOH).

Note in particular that the 3- and 6-month rates—which Chairman Bernanke described on June 5 as “having reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth”—are lower when OOH is excluded from the index, but still above 2 percent. For the 12-month rate, excluding OOH makes only a negligible impact over the past few months.

If OOH is not the culprit, which component is? Unfortunately in this case, there seems to be no single perpetrator. Looking at the distribution of component price changes over the past several months, it appears that the distribution’s center of gravity, so to speak, has shifted rightward. The fraction of components (weighted by expenditure) increasing at annualized rates of 0–3 percent has been squeezed, and the fraction of components increasing at annualized rates of better than 3 percent has grown.

Chart 5 plots the evolution of the distribution of price increases over the past year:

Compared with December 2005, the fraction of components experiencing annualized price increases above 3 percent has grown from about 33 percent to 57 percent, and the fraction with increases running at better than 2 percent has risen from 47percent to 68 percent. Rather than identifying a single component to blame for the recent pickup in core inflation, Chart 5 suggests an explanation more akin to the resolution of Agatha Christie’s Murder on the Orient Express: They all did it.

Isolation

For those with a taste for variety, here's a bit of sociology from Crooked Timber:

Social Isolation in America, by Kieran Healy: Here’s an important new paper... The paper compares the social network module of the 2004 General Social Survey (GSS) to the 1985 GSS, the last to include network questions. The key question of interest is this:

From time to time, most people discuss important matters with other people. Looking back over the last six months—who are the people with whom you discussed matters important to you? Just tell me their first names or initials.

...The new findings are striking: since 1985, the number of people saying there is no-one with whom they discuss important matters nearly tripled. As McPherson et al say,

The modal respondent now reports having no confidant; the modal respondent in 1985 had three confidants. Both kin and non-kin confidants were lost in the past two decades, but the greater decrease of non-kin ties leads to more confidant networks centered on spouses and parents, with fewer contacts through voluntary associations and neighborhoods. … Educational heterogeneity of social ties has decreased, racial heterogeneity has increased.

The predicted probability of social isolation is much higher the fewer years of education one has. Also, “Young (ages 18—39), white, educated (high school degree or more) men seem to have lost more discussion partners than other groups.”

The observed differences are pretty big, as these things go. Are they real? It may be that the 2004 respondents differed from the 1985 respondents in their interpretation the words “discuss” and “important.” (People might interpret “discuss” as face-to-face discussion, when they may also be pouring out their hearts on a blog somewhere, for instance.) Because of these issues, the authors spend a lot of time investigating the validity of the measure. More interestingly, it may be that we really are observing a shift in patterns of network affiliation. Feel free to speculate in the comments... [T]he paper ...discusses several of the most plausible interpretations of the shift...

Update: The Washington Post has a story on this research: Social Isolation Growing in U.S.

Does Corruption Improve Economic Efficiency?

Does corruption create economic incentives that improve efficiency? Sometimes it can. For example, bribing your professor to grade exams and homeworks quickly rather than waiting two or three weeks might improve efficiency, but bribing them to give you a higher grade you don't deserve would not. In this article examining corruption in the equivalent of the DMV in India, the negative effect - bribing for a higher score on the driving test - outweighs the positive effect of reducing processing time:

Driving in New Delhi: Don't complain about standing in line at the DMV., by Joel Waldfogel, Slate: At least in principle, some kinds of government corruption are not so bad because they promote efficiency in how regulations are administered. ... But a new study of driver's license examinations in New Delhi, India, confirms what most international policy wonks have long said: The benefits of corruption are not worth the costs.

The Department of Motor Vehicles, here and in many foreign countries, is a place of long lines, sour bureaucrats (think Patty and Selma Bouvier, Marge Simpson's chain-smoking spinster sisters), and bleak interior decorating. ... Since access to government clerks is normally allocated on a first-come, first-served basis, people pay with their time rather than their money. This is inefficient: Suppose you're in a big hurry and would be willing to pay a lot to avoid waiting, while I don't mind waiting. Then you could go ahead of me, making you a lot better off and me only a little worse off, which reduces our collective frustration. One way to achieve this efficiency would be to charge a higher price for expedited service. Yet, an expedited government service option typically does not exist. So, in some countries, the offer of a bribe in exchange for quicker processing is a common form of corruption—reducing the social cost of waiting in line.

But DMVs exist for a purpose... They're supposed to reduce unsafe driving. ... Do the clerks in fact do so? To study the process of getting a driver's license in New Delhi, the authors ... recruited 822 Indians who wanted a driver's license, randomly assigning them to three groups. ...

One of the groups in the Indian study was offered a cash bonus for getting a license within 30 days. These subjects had an incentive do whatever was necessary (offer bribes) to get a license quickly. ... A second group was given driving lessons. If the licensing process accurately screens out unprepared ... drivers, then these applicants should be more likely to succeed in getting a license. Both of these applicant groups were compared to a third control group who received neither lessons nor a speedy completion bonus. ... Eventually, they gave their subjects a follow-up written exam to gauge their driving skills.

So, what happened? More than a third (37 percent) of the control group got a license, compared to 45 percent of the subjects who took driving lessons and 65 percent of the people who got paid for getting a license quickly. Subjects in the cash bonus group were most likely to hire "agents" to help them navigate the bureaucracy, spending an average of 1,280 rupees to get a license, compared with 560 rupees for those without an agent. And applicants using agents got their licenses 15 percent faster, making an average of a quarter fewer trips to the Indian DMV... They spent about three hours of their own time, as opposed to five hours for those who did not hire an agent.

The agents saved applicants time by, for example, standing in line for them. But the extra cost of using an agent dwarfs the benefit of saving two hours for a typical Indian, who makes 40 rupees per hour, raising the suspicion that the agent's fee purchased something other than time. And indeed, 88 percent of the applicants who hired an agent did not have to take the driver's exam before getting a license, while almost all of the other applicants did.

Perhaps the aspiring drivers who hired agents were better-qualified...? Dream on. The drivers who used an agent had much lower scores on the follow-up drivers exam given by the researchers.

This study confirms the view of the World Bank, which "has identified corruption as among the greatest obstacles to economic and social development." Payoffs at the Indian DMV may save some qualified drivers some time. But it has the bad direct effect of allowing unsafe drivers on the road. ... The lesson applies beyond the DMV. If bribing a procurement officer works better than building a solid airplane or bridge, why bother with safety checks? Dealing with by-the-book Pattys and Selmas is pretty unpleasant. But a world without them is much worse.

See Is Corruption in Iraq Economically Beneficial? for more on the economics of corruption. Also see When is Corruption Good from the Private Sector Development blog which includes links to topics such as how to measure the costs of corruption. For even more, see Becker and Posner: Economics of Corruption-Posner, Becker's comments, Posner's response, and Becker's response. This quote from The New Yorker article highlighted in the first link is worth repeating:

[E]ven if corruption can be a useful means of bypassing inefficiencies in the short term, in the long term it tends to create inefficiencies of its own. Bribing, it turns out, doesn’t always speed things up ... a vast study of twenty-four hundred companies in fifty-eight countries ... found that the more a company had to bribe, the more time it spent tied up in negotiations with bureaucrats. Graft also encourages government officials to keep complicated procedures in place... So corruption isn’t just a product of bad institutions and policies; it also helps cause them. Almost every study done in the past ten years has found that, on the whole, corrupt countries grow more slowly and have a much harder time attracting foreign investment.

Update: Truck and Barter has more.

Save the Wails?

This probably isn't the mainstream position on pandas:

Do not panda to misty-eyed sentiment, by Alan Beattie, Commentary, Financial Times: ...Every week, the worldwide panda industry strikes another blow for soft-headed sentiment over rational cost-benefit analysis. This week’s feel good tale was new research suggesting there were 3,000 giant pandas left in the wild, twice earlier estimates. So what? If pandas can stand on their own four feet, good. If they cannot, tough. We should stop subsidising them. Pandas are endangered because they are hopelessly incompetent.

Take their diet. As we all know ..., pandas eat almost exclusively bamboo shoots. What panda apologists ignore is that ... bamboo has so few nutrients that the piebald buffoons have to spend 16 hours a day stuffing themselves with it. It is like trying to subsist on sugar-coated cardboard.

To shovel twigs into their mouths they use what Big Panda tries to pass off as an opposable thumb but is basically a deformed bone. And ridiculously, given their diet, giant pandas have a short digestive tract suitable for carnivores, not vegetarians, so most of the bamboo they eat goes through undigested.

They are also famously bad at sex. Even in the wild pandas do not mate much... Little wonder no respectable family of animals wants them. ... Yet thanks to soft-headed anthropomorphism – their big eyes and round faces remind us of babies, apparently – they are fêted everywhere, notably as the logo of the charity WWF. ...

Pandas are badly designed, undersexed, overpaid and overprotected. They went up an evolutionary cul-de-sac and it is too late to reverse. By cosseting them we are simply rewarding failure. Pandas are doomed. Let them go.

The author is the FT’s world trade editor. He sports a proper opposable thumb, eats most things and has a digestive system perfectly suited to his omnivorous diet

Whatever makes you happy, in a utilitarian kind of way.

This is a bit outside my area, but I thought I'd try to add something. This is an assessment of the Noah's Ark model of species preservation from a textbook I just received in the mail, Environmental Economics by David A. Anderson.

The Noah's Ark model asks how to best preserve biodiversity and other benefits from protecting endangered species under the constraint of a limited budget. It takes account of four specific factors in the decision of whether a species should be preserved (invited on the Ark), the species distinctiveness, the direct benefits from preservation (e.g. recreational and emotional), the likelihood the species will survive, and the economic cost of preservation efforts. The problem is, as usual, to match the marginal benefits (measured as direct benefits plus diversity benefits times the probability of survival) and the marginal costs:

Are We Loading the Right Species Onto the Ark? Andrew Metrick and Martin Weitzman (1998) collected data on four criteria of the Noah's Ark Model -- direct benefits, distinctiveness, survivability, and cost -- and examined whether actual rankings correspond with the logic of the model. For measures of society's rankings of species, they looked to the nomination process for protection under the Endangered Species Act. This included counts of positive comments made about the species, the decision whether or not to include species on the protected lists, and the amounts of public expenditures on the recovery of the species.

Direct benefits were measured in terms of species' size and taxonomic class. As a measure of distinctiveness, they determined whether a species was the sole representative of its genus and whether it was a subspecies. For survivability they used a 1 to 5 ranking of endangerment created by the Nature Conservancy. For cost they used a variable indicating whether or not recovery of the species conflicts with public or private development plans.

The findings indicate that we place a high priority on the large, cuddly "charismatic megafauna" like bears and cats. More surprisingly, they suggest that society spends more money on less endangered species than on more endangered species, and expenditures do not increase significantly for more unique species. Further, society is more likely to spend money on an animal whose preservation conflicts with development plans than on those that could be saved at a lower cost. In other words, according to this study, our current strategies for environmental protection do not coincide with what most economists would recommend in terms of maximizing social welfare.

Fighting Yesterday's Economic War

Robert Reich says policymakers tend to overreact to the potential for a rerun of the worst economic event in their lifetimes. Because of this tendency, the current Fed is overly sensitive to inflation and to a repeat of the 1970s. In fact, he says, the Fed should be worried about deflation, not inflation:

The Real “Flation” Threat, by Robert Reich, American Prospect: Each generation responds to its own traumatic memory. Ben Bernanke and his Federal Reserve remember the double-digit inflation of the 1970s and are determined to mount a preemptive strike. That’s why they’re poised on raising interest rates yet again Bernanke and company have no direct memory of the trauma that haunted the previous generation, the depression of the 1930s.

Each generation, in its determination to avoid the nightmare it does remember, runs the danger of over-reacting, and thereby bringing on the opposite trauma. A generation ago, economic policy makers paid too little attention to inflationary forces then building in the American economy. Eventually, Paul Volcker had to break the back of inflation by raising interest rates sky high. That put the economy into a severe recession. Now Bernanke and company are paying too little attention to deflationary forces building in America and the global economy.

Bernanke fears that today’s economy resembles the one that began to overheat the 1970s. But he’s wrong. ... Bernanke and company worry the U.S. labor market is heating up. They’re wrong here, too. ...

If anything, there’s too much capacity relative to demand. This is a recipe for deflation. Prices can begin to drop because buyers hold off, expecting further price decreases. It happened in Japan in the 1990s. It’s already starting to happen in certain housing markets in the United States...

The Fed and other central bankers around the world are raising interest rates because they’re fighting the last war. But they already won that war. Inflation is no longer our biggest threat. They ought to be worried about the war before the last one, and the specter of deflation. They’re in danger of losing that war even before they know they're in it.

I think I'll put Reich in the "sees the potential for a hard-landing" group.

Update: It occurred to me after I posted this that I should have mentioned Ben Bernanke's Views Affected by Depression.

Paul Krugman: The Minimum Wage

Paul Krugman is on vacation this week so, for those who visit regularly for the condensed versions of his columns, here's something from the past to fill the void. With the large amount of discussion concerning raising the minimum wage recently, this book review Krugman did for the September 1998 edition of Washington Monthly about the minimum wage and a closely related topic, the living wage, might be of interest. It might also surprise you:

The Living Wage, by Paul Krugman, 1998: Review of Living Wage: What It Is and Why We Need It, by Robert Pollin and Stephanie Luce

Economics textbooks enthuse about the virtues of a price system. In a market economy, nobody needs to order people to economize on a scarce commodity or make extra efforts to produce it: Scarcity leads to a high price, and sheer self-interest does the rest. Conversely, nobody needs special persuasion to take advantage of an underemployed resource: Abundance will make it cheap, and again self-interest will take it from there.

And yet there is a problem with markets: They are absolutely and relentlessly amoral. Labor, in a market system, is just another commodity; the wage a man or woman can command has nothing to do with how much he or she needs to make to support a family or to feel part of the broader society. Some conservatives have managed to convince themselves that this poses no moral dilemma, that whatever is, is just. And one supposes that there are still unrepentant socialists who believe that one can do away with market determination of incomes altogether. But after a century marked by both the Great Depression--which basically ended unalloyed faith in markets--and the fall of communism, most people support some version of the welfare state: a system that is based on markets, but in which the government tries to prevent too unequal a distribution of income.

But how is that to be accomplished? The standard economist's solution, which is also the main way the U.S. welfare state operates, involves "after-market" intervention: Let the markets rip, but then use progressive taxes and redistributive transfers to make the end result fairer. However, many liberals have always felt that this solution is unsatisfactory. Instead, they want to increase "market" wages, notably through support of collective bargaining, and through the imposition of minimum wage standards.

The "living wage" movement, which has attracted considerable support in several major U.S. cities, is a variant on this tradition. As described in Robert Pollin and Stephanie Luce's new book Living Wage, it essentially involves putting a floor on wages not through a conventional minimum wage law, but by requiring minimum wage standards of firms that do business with a local government. Aside from novel enforcement issues (I know this lawyer who will explain to you about creating dummy companies for the contract work, leaving the rest of the business unregulated), this is basically a distinction without a difference: The living wage movement is simply a move to raise minimum wages through local action.

So what are the effects of increasing minimum wages? Any Econ 101 student can tell you the answer: The higher wage reduces the quantity of labor demanded, and hence leads to unemployment. This theoretical prediction has, however, been hard to confirm with actual data. Indeed, much-cited studies by two well-regarded labor economists, David Card and Alan Krueger, find that where there have been more or less controlled experiments, for example when New Jersey raised minimum wages but Pennsylvania did not, the effects of the increase on employment have been negligible or even positive. Exactly what to make of this result is a source of great dispute. Card and Krueger offered some complex theoretical rationales, but most of their colleagues are unconvinced; the centrist view is probably that minimum wages "do," in fact, reduce employment, but that the effects are small and swamped by other forces.

What is remarkable, however, is how this rather iffy result has been seized upon by some liberals as a rationale for making large minimum wage increases a core component of the liberal agenda--for arguing that living wages "can play an important role in reversing the 25-year decline in wages experienced by most working people in America" (as this book's back cover has it). Clearly these advocates very much want to believe that the price of labor--unlike that of gasoline, or Manhattan apartments--can be set based on considerations of justice, not supply and demand, without unpleasant side effects. This will to believe is obvious in this book: The authors not only take the Card-Krueger results as gospel, but advance a number of other arguments that just do not hold up under examination.

For example, the authors argue at length that because only a fraction of the work force in the firms affected by living wage proposals will be affected, total costs will be increased by only 1 or 2 percent--and that as a result, not only will there be no significant reduction in employment, but the extra cost will be absorbed out of profits rather than passed on in higher prices. This latter claim is wishful thinking of the first order: Since when do we think that cost increases are not passed on to customers if they are small enough? And the idea that employment "of the affected workers" will not suffer because the affected wages are only a small part of costs is a non sequitur at best. Imagine that a new local law required supermarkets to sell milk at, say, 25 cents a gallon. The loss in revenue would be only a small fraction of each supermarket's total sales--but do you really think that milk would be just as available as before?

They also argue that because there are cases in which companies paying above-market wages reap offsetting gains in the form of lower turnover and greater worker loyalty, raising minimum wages will lead to similar gains. The obvious economist's reply is, if paying higher wages is such a good idea, why aren't companies doing it voluntarily? But in any case there is a fundamental flaw in the argument: Surely the benefits of low turnover and high morale in your work force come not from paying a high wage, but from paying a high wage "compared with other companies" -- and that is precisely what mandating an increase in the minimum wage for all companies cannot accomplish. What makes this an odd oversight is that the book contains a lengthy and rather well-done critique of attempts by local governments to create jobs through investment incentives, arguing that they mainly end up in a zero-sum poaching war; how could the authors have failed to notice the parallel?

But while there is much that is silly in their book, Pollin and Luce are diligent and honest--and as a result the book carries lessons and implications they may not have intended. The most interesting section is their estimates of the impact of living-wage proposals on the budgets of hypothetical families--estimates that perhaps give us the clue to what all this is really about.

Consider, for example, the effects of "Plan Y" (never mind) on the hypothetical head of a household, currently making $5.43 an hour. According to their estimates, as long as he or she remained fully employed, the living-wage law would raise earned income from $10,860 to $14,500--and also mandate $2,500 in health coverage. (This is, incidentally, a 57 percent increase in the cost to employers; you have to have a lot of faith in Card-Krueger not to worry that some jobs might be lost.) According to their numbers, that family would currently pay less than $900 in taxes while receiving some $9,700 in benefits such as food stamps, Earned Income Tax Credit, and health care. Their calculations also show that most of the gains from the living wage proposal would be offset by reductions in these other redistributive programs. Indeed, only about one-fifth of the mandated increase in wages and benefits actually gets manifested in disposable income; the rest is taken away as benefits decline.

Now to me, at least, the obvious question is, why take this route? Why increase the cost of labor to employers so sharply, which--Card/Krueger notwithstanding--must pose a significant risk of pricing some workers out of the market, in order to give those workers so little extra income? Why not give them the money directly, say, via an increase in the tax credit?

One answer is political: What a shift from income supports to living wage legislation does is to move the costs of income redistribution off-budget. And this may be a smart move if you believe that America should do more for its working poor, but that if it comes down to spending money on-budget it won't. Indeed, this is a popular view among economists who favor national minimum-wage increases: They will admit to their colleagues that such increases are not the best way to help the poor, but argue that it is the only politically feasible option.

But I suspect there is another, deeper issue here--namely, that even without political constraints, advocates of a living wage would not be satisfied with any plan that relies on after-market redistribution. They don't want people to "have" a decent income, they want them to "earn" it, not be dependent on demeaning handouts. Indeed, Pollin and Luce proudly display their estimates of the increase in the share of disposable income that is earned, not granted.

In short, what the living wage is really about is not living standards, or even economics, but morality. Its advocates are basically opposed to the idea that wages are a market price--determined by supply and demand, the same as the price of apples or coal. And it is for that reason, rather than the practical details, that the broader political movement of which the demand for a living wage is the leading edge is ultimately doomed to failure: For the amorality of the market economy is part of its essence, and cannot be legislated away.

Martin Wolf is Smokin'

Martin Wolf takes on the powerful anti-tobacco lobby:

The absurdities of a ban on smoking, by Martin Wolf, Commentary, Financial Times: Smokers are the new lepers. One already sees them huddled in doorways. Soon the health bill now before the UK parliament will ban smoking in all workplaces in England, including pubs, restaurants and private clubs. But the government revealed ... that the ban might eventually apply to doorways and entrances of offices and public buildings, as well as to bus shelters and sports stadiums. Smokers are to be driven out into the wilderness...

As a life-long non-smoker, I wonder what is driving these assaults. Is it an attempt to improve public health, as campaigners suggest? Or do smokers serve a need every society seems to have - for a group of pariahs that all right-thinking people can condemn? I strongly suspect the latter. ...

The discovery of passive smoking has, for this reason, given the anti-tobacco lobby its success. It has overwhelmed the protests of libertarians. Riding a tide of moral indignation, the government has enacted a draconian law banning smoking even in private clubs. Now it plans to extend that ban outdoors.

So how many lives might this extension "save" (or, more precisely, prolong)? Indeed, how many lives might the ban itself save?

According to a survey published in 2003 by the Parliamentary Office of Science and Technology, ... passive smoking increases the risk of death from lung cancer by 25 per cent. This sounds dramatic. But these studies probably contain biased or inaccurate samples: some smokers may, for example, be classified as non-smokers. Moreover, the risk for non-smokers of death from lung cancer is itself only 10 per 100,000. So the increase generated by passive smoking comes to just 2.5 per 100,000.

If every non-smoker were exposed to sufficient quantities of second-hand smoke this would amount to a maximum of 1,000 deaths a year in England, ... less than 0.2 per cent of all deaths in the country. In practice, however, the ...deaths from lung cancer caused by passive smoking ... must be very much smaller than this. Many people already live in an overwhelmingly tobacco-free environment. ...

Moreover, the government's ban does not even go near to eliminating passive smoking. As for the proposed extension to open spaces, it can add nothing. The notion that people would be exposed to dangerous quantities of passive smoke in open bus shelters or the doorways of buildings seems ludicrous. It also seems next to impossible to police fairly: where do doorways stop and who decides?

These difficulties do not, as it happens, apply to the places where the most damaging forms of passive smoking occur, in homes. That is where vulnerable children are likely to be most exposed... If the UK government were engaged in a serious health endeavour, as opposed to gesture politics, it would outlaw smoking in the home. This would be perfectly feasible... Children could be encouraged to "shop" their parents. Random visits could be arranged. ...

There is a precedent, although not a happy one: Montgomery County, in Maryland, US, did ban smoking in the home a few years ago, but then retracted the ban under global ridicule. Yet why the ridicule should have won out is far from obvious. All those people who think that the risks from passive smoking justify comprehensive legislation on public places must see the still stronger case for protecting children at home. Indeed, I wonder why the UK government does not ban the noxious weed altogether... That would be in accord with policy on a range of prohibited drugs.

Note: I am opposed to any such policy. I am merely pointing out the absurdities of current plans. Harm to others is a necessary justification for government interference. But it is not sufficient. Intervention should also be both effective and carry costs proportionate to the likely gains...

One of the usual counterargument is to note that for some groups, food servers in restaurants, bartenders, my officemate in graduate school, and so on, the risks might be a lot higher than average and people shouldn't have to sacrifice their health for the opportunity to take these jobs. Since the private marketplace will not internalize these costs properly, a legislative solution is needed.

Also, it does seem that those who suffer the most harm with the least ability to avoid it, the children of smokers, are the least protected. And while I agree there is no way to effectively legislate a solution, there is still a role for government in providing education about the harmful effects of secondary smoke through public service announcements. Compared to when I was young, education has made great inroads already.

The "China Bashing" Trap

Ronald McKinnon of Stanford University explains why "China bashing" is a bad idea through a comparison of the pressure being applied on China today to revalue the yuan with a period 30 years ago when similar pressure was applied to Japan to revalue the yen with less than desirable results. Some highlights:

The Problem with “China Bashing”, by Ronald McKinnon, Commentary, Project Syndicate: Pressure on China today to push up the value of the yuan against the dollar is eerily similar to the pressure on Japan 30 years ago to make the yen appreciate. Back then, “Japan bashing” came to mean the threat of US trade sanctions unless Japan softened competitive pressure on American industries. By 1995, the Japanese economy had become so depressed by the overvalued yen ( endaka fukyo ) that the Americans relented and announced a new “strong dollar” policy. Now “China bashing” has taken over, and the result could be just as bad, if not worse. ...

The financial press and many influential economists argue that a major depreciation of the dollar is needed to correct America’s external deficit. But the US current-account deficit – about 6% of GDP in 2004 and 2005 – mainly reflects a new round of deficit spending by the US federal government and surprisingly low personal savings by American households (perhaps because of the bubble in US residential real estate).

Moreover, the cure can be worse than the disease. Sustained appreciation of a creditor country’s currency against the world’s dominant money is a recipe for a slowdown in economic growth, followed by eventual deflation, as Japan found in the 1990’s – with no obvious decline in its large relative trade surplus. In a rapidly growing developing country whose financial system is still immature, introducing exchange-rate flexibility..., as the IMF advocates, is an even more questionable strategy.

If a discrete exchange-rate appreciation is to be sustained, it must reflect expected monetary policies: tight money and deflation in the appreciated country, and easy money with inflation in the depreciated country. But domestic money growth in China’s immature bank-based capital market is high and unpredictable, while many interest rates remain officially pegged. Thus, the People’s Bank of China (PBC) cannot rely on observed domestic money growth or interest rates to indicate whether monetary policy is too tight or too loose. ...

If China is to avoid falling into a Japanese-style liquidity trap, the best solution is to fix its exchange rate in a completely credible way so that there is no fear of currency appreciation. Then financial liberalization could proceed with market interest rates remaining at normal levels. But China’s abandonment of the yuan’s “traditional parity” in July 2005 rules out a new, credibly fixed exchange-rate strategy for some time.

Failing this, China must postpone full liberalization of its financial markets. This means retaining, and possibly strengthening, capital controls on inflows of highly liquid “hot” money from dollars into yuan, and continuing to peg certain interest rates, such as basic deposit and loan rates, to help preserve the profitability of banks.

Such measures are, of course, an unfortunate detour. True, China’s economy is now growing robustly and is not likely to face actual deflation anytime soon, but if China does fall into a zero-interest rate trap, the PBC, like the BOJ, would be unable to offset deflationary pressure in the event of a large exchange-rate appreciation. With short-term interest rates locked at zero, pressure for further appreciation would leave the PBC helpless to re-expand the economy.

China’s monetary and foreign exchange policies are now in a state of limbo. Instead of stable guidelines with a well-defined monetary (exchange rate) anchor and a firm mandate to complete financial liberalization, China’s macroeconomic and financial decision making will be ad hoc and anybody’s guess – as was true, and still is, for Japan.

With so many different analyses of global imbalances, with so many different policy recommendations about how to resolve them and who is at fault, and with dire warnings about every policy choice from some credible analyst, this must be pretty confusing to people with little training in the area. Quite honestly, it's pretty confusing even if you have had training and the main message seems to be that the future holds a great deal of uncertainty even for those who have studied these problems extensively.

So, since I have nothing in particular to add to the confusion on this issue that someone hasn't already said, I'll go, with appropriate apologies, to a corny, worn out analagy type ending. Should you buy an umbrella to ward off the coming economic storm? Changes in the economic weather, like changes in the weather more generally, are hard to predict until signs of change are evident. So far the clouds that are visible aren't gathering into a storm, but I wonder, is your economist uncle's arthritic knee, the one he swears predicts big storms, aching yet?

What Ended Serfdom?

While surfing for material related to another post, I came across this piece by Paul Krugman written in 2003 on the end of serfdom. It's interesting to think about the analysis in terms of the global labor market developing today, China, India, the decline of unions, the loss health and retirement benefits as the social contract changes, sweatshops, etc., but the main reason for passing it along is for its general historical interest and its analysis of the economics underlying the end of the feudal era:

Serf's Up!, by Paul Krugman: James Surowiecki writes fine columns, and this one is no exception. But he's got the story of the effects of the Black Death on serfdom backwards. He - and anyone else curious about history - should read  Evsey Domar's  classic 1970 paper "The causes of slavery or serfdom: a hypothesis." (Sorry, doesn't seem to be available online. Update: Domar's paper is available here. Thanks smk - Brad DeLong too for posting it.)

Here's what Surowiecki says: "The Black Death helped undermine feudalism. The population decline was so severe that the individual’s labor grew more valuable, which enabled serfs to abandon their lords and become tenant farmers or urban workers." That sounds plausible, but it's not the way it happened. According to Domar, serfdom actually withered away before the Black Death, as European population grew close to its Malthusian limit. The puzzle is why serfdom wasn't reinstituted after the Black Death.

Domar was motivated by his knowledge of Russian history. Serfdom in Russia, he knew, wasn't an institution that dated back to the Dark Ages. Instead, it was mainly a 16th-century creation, contemporaneous with the beginning of the great Russian expansion into the steppes. Why?

He came up with a simple yet powerful insight: there's no point in enslaving or enserfing a man unless the wage you would have to pay him if he was free is substantially above the cost of feeding, housing, and clothing him.

Imagine a pre-industrial society where population is pressing on limited land supplies, and the marginal product of labor - and hence the real wage rate under competitive conditions - is barely at subsistence. In that case, why bother establishing property rights in human beings? It costs no more to hire a free worker than to feed an indentured laborer. Indeed, by 1300 - with Europe very much a Malthusian society - serfdom had withered away from lack of interest.

But now suppose that for some reason land becomes abundant, and labor scarce. Then competition among landowners will tend to push up wages of free workers, and the ruling class will try, if it can, to pin peasants down and prevent them from bargaining for a higher standard of living. In Russia, it was all about gunpowder: suddenly steppe nomads were no longer so formidable, and the rich lands of the Ukraine were open for settlement. Serfdom was an effort to keep peasants from taking advantage of this situation. (And if I've got it right, those who were venturesome enough to run away and set up outside the system became Cossacks.)

Meanwhile, the New World opened in the west. Sure enough, the colonizing powers tried various forms of indentured servitude - making serfs of the Indians in Spanish territories, bringing over indentured servants in Virginia. But eventually they hit on a better solution, from their point of view: importing slaves from Africa.

Here's the puzzle. In Europe circa 1100, with population scarce, serfdom was useful to the ruling class. By 1300 it wasn't, and had been allowed to drift away. But after 1348 it should have been worthwhile again. Yet it wasn't effectively reimposed. There were attempts to restrain wages and limit labor mobility, as well as attempts to tax the peasants (Wat Tyler's rebellion fits into all this.) But all-out feudalism didn't return. Why?

And an even bigger question: why hasn't indentured servitude made a comeback in the modern era? Yes, I know, human rights and all that - but if it was profitable to have indentured servants in the modern world, I'm sure that Richard Scaife's think tanks would have no trouble finding justifications, and assorted Christian groups would explain why it's God's will.

Anyway, have to get back to real work. But try to find a copy of Domar's paper and read it.

Can't You Speak English?

Should we deny citizenship to people who find it very difficult to become fluent in English because they weren't exposed to English before a critical age?:

Economic Scene Legislate Learning English? If Only It Were So Easy, by Austan Goolsbee, Economic Scene, NY Times: President Bush's plan to give longstanding illegal immigrants a path to citizenship would require them to learn English as a sign that they accept American culture. The conservative base of the Republican Party considers any policy that would open that path as little more than amnesty, and they consider the English requirement trivial...

[E]vidence from economics suggests that ... this path would not be nearly as easy as either side might think. Immigrants already have a strong incentive to learn English: better English means a better job and a higher income. Not speaking English largely means being trapped in a low-paying job... Yet millions still do not know English. Why not?

As Hoyt Bleakley, an economist at the University of Chicago Graduate School of Business, puts it: "For someone not to speak English after being in the country for many years and in the face of the clear job market reward for learning English, is likely a sign that learning the language is very tough for them. I'm not so sure that having Congress tell them it's required will actually do anything."

The difficulties adults have with learning English are at the center of the research that Professor Bleakley has done with a fellow economist, Aimee Chin, of the University of Houston, in their forthcoming ... study "Language Skills and Earnings: Evidence from Childhood Immigrants."

The study's approach begins with ... the ... idea ... that a child can learn a new language as fluently as a native speaker as long as the child starts before a critical age (usually thought to be around 11 or 12). Past the critical period, it is difficult to become fluent in a new language and virtually impossible to speak without an accent.

It is a theory that can help explain why Henry A. Kissinger, who immigrated to the United States at about age 14, speaks English with a German accent while his younger brother, Walter, does not. ... Professor Bleakley and Professor Chin show rather stark evidence for this theory in the data on immigrants' job prospects. ...[T]hey document that poor English skills meant less schooling and substantially lower wages for immigrants and that these disadvantages often extended to their children, even if those children were born in the United States. ...

Professor Bleakley and Professor Chin extend this initial study ... by asking how immigrant parents' language skills affect their children in "What Holds Back the Second Generation? The Intergenerational Transmission of Language Human Capital Among Immigrants." As a starting point, the study notes that half the students now classified as having low English proficiency were, in fact, born in the United States. They are overwhelmingly the children of non-English-speaking immigrants. So, it is natural to ask what impact parents have.

In turns out that children whose immigrant parents came to the United States when young do just about the same in school regardless of [where] the parents came from... But the situation is different for children whose parents were older when they arrived. The children from non-English-speaking households do much worse than English-speaking ones...

When Professor Bleakley and Professor Chin compare the overall distribution of test scores of English- and non-English-speaking families, they find that the ... top half of students from non-English-speaking households do just about as well as the top half from English-speaking households. It seems that a child with talent can succeed no matter what the parents' skills are... But parents whose English is poor have a big negative impact on the below-average children.

Based on his research, Professor Bleakley sees some serious problems with the more extreme immigration proposals like the old Proposition 187 in California, which sought to deny a public education to the children of illegal immigrants. "For many children of immigrants," Professor Bleakley said, "the school system is one of the only exposures to English they will get." Kicking them out of school when they are young means they will most likely never be fluent in English.

The current dispute over immigration reform has been characterized as a battle between two messages: "Welcome to America" and "Please Go Home." Whichever message prevails in the political battle this summer, unless directed mainly at 10-year-olds, had best come with a translation.

In the Bad Old Summer's Time?

Larry Summers says the economists who worried about growing global imbalances and predicted tough times ahead that have since rescinded their predictions in favor of milder scenarios may have thrown in the towel too early:

Summers Sees Account Deficit as Global Threat, by John M. Berry, Commentary, Bloomberg: Former Treasury Secretary Lawrence H. Summers said last week that the $800 billion U.S. current account deficit represents a risk to the global economy and that if its decline isn't carefully managed, it could lead to a world recession. ... In contrast, several of the other conference speakers, including ... Richard N. Cooper and ... Peter Garber..., portrayed the deficits as relatively benign.

And a large majority of the roughly 75 economists and academics present indicated by a show of hands that they expect the current account deficit eventually to shrink smoothly to a sustainable level. ... [T]here was also broad agreement that the big short-fall in transactions with the rest of the world may continue unabated for years to come.

Summers was skeptical... In recent years, numerous economists have predicted the foreign investors and central banks whose purchases of U.S. stocks and bonds, direct investments in companies and bank loans have financed the current account deficits would become reluctant to continue doing so. That could have forced up interest rates and caused the deficits to decline.

That hasn't occurred, of course, and now some of those economists are wondering if it ever will. Summers labeled that thinking the ''throw in the towel theory.'' ''Since the conventional view hasn't been right, that's evidence that view is wrong,'' or so that argument goes, Summers said. To the contrary, there's ''more risk now'' than previously that a crisis could erupt...

On June 15, the Boston Federal Reserve Bank's president, Cathy E. Minehan, asked how many of the participants expected a smooth correction of the deficits at some point. So many hands went up that she didn't ask who disagreed. ...

Either way, smooth or rough, American households are going to feel a lot of pain when the adjustment does occur. ... For the current account deficit to shrink, U.S. savings have to rise and consumption will have to fall. Summers derided as an ''enduring fallacy'' the notion that a country can decide to save more, have its current account deficit improve and maintain good economic growth while nothing else happens.

''If the current account deficit falls, something else has to change,'' Summers said. Exports have to rise, or imports will have to fall, and if U.S. savings were increasing, ''there would be a decline in global aggregate demand'' unless growth increased elsewhere in the world, he said. ...

Several papers presented at the conference provided convincing evidence that the U.S. current account deficit isn't just the product of over-consumption by Americans. Economic circumstances and government policies in many other parts of the world have played a major role as well.

The extraordinarily high savings rate in China and a number of other countries has provided a huge amount of capital to be invested elsewhere. By keeping its currency peg at a relatively low value to the U.S. dollar, the People's Bank of China, its central bank, has accumulated an enormous amount of dollars, much of which it has used to purchase U.S. Treasury securities.

Several other East Asian countries also maintain currency pegs that have required them to accumulate dollars. And with oil priced in dollars, so have many of the oil exporting nations. ...

Were the U.S. current account deficit to begin to shrink, the surpluses in other countries ... would have to shrink as well. As Summers put it, ''What happens in the rest of the world is probably more important in the resolution of this than what happens in the U.S.''

No one at the conference had a clue as to what might happen to cause the deficit to begin to shrink, which is another reason to wonder whether it may be a financial crisis. In the meantime, the deficit is still headed higher.

I'll add that this could be reducing economic activity to some extent already due to uncertainty about future economic conditions. Whether a hard landing actually occurs or not, the chance that it will has to be taken seriously by consumers, financial markets, and policy makers as they formulate plans for the future.

Is a Wile E. Coyote moment coming?

At a Minimum

Gene Sperling tries to convince president Bush that increasing the minimum wage would help worker's and improve his political standing:

Bush Should Call Kennedy on the Minimum Wage, by Gene Sperling, Commentary, Bloomberg: Memo to President Bush:

I know you don't often take advice from former Clinton administration economic officials... Nonetheless, Mr. President, you would help both working Americans and your own political interests if you picked up the phone and told Senator Edward Kennedy that he should take another shot at trying to raise the minimum wage to $7.25 an hour.

Yes, his amendment to do that failed yesterday... Nonetheless, I believe that with your support he could get the seven votes that would provide him with the 60 needed to pass Senate procedural hurdles.

Before anyone on your team starts raising red flags, let me make clear that I get your concerns. ... a minimum wage is a form of price control... And yes, when raised too high, it can come at the expense of jobs for minority youths. So why should a conservative Republican president seek a Bush-Kennedy bill? Let me give you three reasons.

Dignity for American Workers: First, on the issue of price controls, we have to acknowledge that ignoring the lopsided bargaining power that can exist in labor markets and the workplace risks offending core American values. We don't allow an employer to condition a job on sex from a single mother of three, even if she would take the deal to keep food on her table.

While offering a low wage may not be as despicable as sexual harassment, most Americans would agree that economic dignity should also limit how little that employer can pay that same woman -- even if she was desperate enough to accept $3 an hour...

A Raise for 15 Million Americans: Second, raising the minimum wage isn't only about helping teenagers in their summer jobs. Of Americans who now make the federal minimum wage of $5.15 an hour, 35 percent are sole breadwinners and the typical minimum-wage worker brings in half of total family income.

And while 7.3 million would directly get a raise, the Economic Policy Institute estimates that an additional 8 million would likely get an indirect bump up -- meaning a raise for 15 million Americans. ...

A Reasonable Bill: Finally, as to the fear that higher minimum wage would crimp labor markets... The claims by opponents that minimum wage increases cost jobs look weaker and weaker over time. No one has yet rebutted convincingly David Card and Alan Krueger's study that compared fast-food jobs on the border of New Jersey and Pennsylvania, and found no decrease in lower-wage jobs after New Jersey raised its state minimum wage.

Rather, the Economic Policy Institute, Fiscal Policy Institute, and Center for American Progress have all found that states that raised minimum wages above the federal level have had just as good, if not better, employment and small business performance than states that haven't.

Heading Off Democrats: The truth is Mr. President, I'd be surprised if your political advisers wouldn't support this advice. After all, there is real hope in Democratic circles that ... minimum-wage referendums in November will increase turnout among Democrats and progressive independents. ...

Update: Greg Mankiw complains that Gene Sperling only looks at "a single controversial study that finds no adverse side effects," then presents only one side himself in rebuttal. Brad DeLong adds evidence that counters Mankiw's.

Shrinking Middle-Class Neighborhoods

More evidence of increasing polarization in the U.S.:

U.S. Losing Its Middle-Class Neighborhoods, by Blaine Harden, Washington Post: Middle-class neighborhoods, long regarded as incubators for the American dream, are losing ground in cities across the country, shrinking at more than twice the rate of the middle class itself.

In their place, poor and rich neighborhoods are both on the rise, as cities and suburbs have become increasingly segregated by income, according to a Brookings Institution study... It found that as a share of all urban and suburban neighborhoods, middle-income neighborhoods in the nation's 100 largest metro areas have declined from 58 percent in 1970 to 41 percent in 2000. ... It far outpaced the decline of seven percentage points ... in the proportion of middle-income families living in and around cities. ...

"No city in America has gotten more integrated by income in the last 30 years," said Alan Berube, an urban demographer at Brookings who worked on the report. "It means that if you are not living in one of the well-off areas, you are not going to have access to the same amenities -- good schools and safe environment -- that you could find 30 years ago," he said. ...

The Brookings study says that much more research is needed to better understand why middle-income neighborhoods are vanishing faster than middle-income families. But it speculates that a sorting-out process is underway in the nation's suburbs and inner cities...

The Brookings study says that increased residential segregation by income can remove a fundamental rung from the nation's ladder for social mobility: moderate-income neighborhoods with decent schools, nearby jobs, low crime and reliable services. ...

Recapture the Flag

Here's some fun for those boring summer days yet to come. If you follow this link, you will find the rules to the game 'Capture the Flag' from the 1947 Scoutmaster’s Handbook. Here’s a shortened version:

Capture the Flag - This is one of the most popular outdoor games for scouts.

Traditional Rules: From the 1947 Scoutmaster's Handbook, pp 447-8:

• Space – Large;
• Type – Strenuous;
• Teams - Half Troop;
• Formation - Informal ;
• Equipment - Two Signal Flags

Each team has its own territory in which its Scouts are free to move as they please … The object … is to enter the enemy's territory, capture the flag, and carry it across the line into home territory without being caught. … If the flag is successfully captured, it must be carried across the line into home territory...

Here's a version adults can play:

Capture the U.S. Flag - This is one of the most popular political games.

Political Rules - From the 2000 Republican Handbook by Carl Rove:

• Space – United States;
• Type – Political and Patriotic;
• Teams – Republican and Democrat;
• Formation – By Party;
• Equipment - Two United States Flags

Each party has its own blue and red territory in which its members are free to display the U.S. flag as they please … The object … is to enter the other party’s territory, capture the U.S. flag, and carry it across the line into home territory without being Swift Boated. … If the flag is successfully captured, it must be displayed prominently on cars, houses, clothing, etc. in the home territory...

The Republicans have captured the Democrat’s U.S. flag and, for now, the flag is theirs alone. But the game is far from over. It’s time for the Democrats, who are no less patriotic, to go on the offensive and recapture the flag.

Mirror, Mirror, On the Wall...

Was there ever any question? Apparently there was:

Are Economists Smarter?, Laurence J. Kotlikoff, Economist's Voice: The final straw that forced my friend Larry Summers to resign as President of Harvard may have been his alleged suggestion that "economists are smarter than sociologists." I must say that I too was taken aback. I had always thought economists were better looking than sociologists, but smarter?

I tried this proposition out on my brother, who’s a veterinarian at Cornell. "Mike," I asked, "Are we economists smarter than sociologists?" "Sorry," he said. "You’re better looking and more personable, but not smarter than sociologists or, for that matter, vets."

"Actually, this is good news," I said. "For years I’d been told that economists are people who are good with numbers, but don’t have the personality to be actuaries, let alone sociologists."

"Now that I’ve got you on the phone," Mike said, "do you really think that Larry Summers thinks that economists are smarter?" "Not really," I said. "I’ve know Larry since grad school. He loves to provoke, debate, shake things up, but I can’t believe he thinks we’re smarter. Better looking, yes, but not smarter. And after what he’s gone through at Harvard, I don’t think he’s feeling very smart."

"Mike," I said, "you’re a scientist as well as a vet. What’s smarter mean, anyway? Have you scientists located the smart gene yet?"

"We have," Mike said. "And there’s an easy test for it. Anyone who thinks he’s smarter doesn’t have it. And, if you don’t mind, pretty boy, I’ve got work to do."

"Gee," I thought, as I hung up the phone. "I wish I had that smart gene. My brother must have it. He’s writing papers I can’t begin to read, and he isn’t asking the smarter question. If only we’d been identical, not fraternal twins."

Funny thing is that at one time, I was sure I was smarter than my brother. I was in grad school at Harvard and my brother was a stable boy, mucking out stalls at Penn’s large animal hospital. We’d both gone to Penn, but I majored in a hard subject, economics, and Mike took it easy studying English. He wouldn’t and couldn’t be caught dead in a math or science course. When we graduated, Mike headed to one dead end job after another, finally ending up at age 26 literally knee deep in horse manure.

"Larry, I’m going to be a vet," he told me one day. "No way," I said. "You’re knocking your head against the stall. You’re not smart enough to be a vet. You did so-so in math and science in high school, and you haven’t looked at those subjects in a decade. You’ll have to go to night school for years to even apply."

"Larry, I’m going to be a vet."

And sure enough, five years later, after night school, being rejected at Penn’s vet school and finally being accepted there, Mike graduated number one in his class! I remember when they gave him the award for being the top student. I couldn’t believe it. I still can’t believe it. I, after all, had all the smarts. I did better in math and science and scored higher in the SATs. Mike had no aptitude for these subjects. Who would know this better than his twin brother? But there he was getting this award.

This shook my faith in smarts. But then I thought, "Gee, a lot of what vets do is very hands on, practical. Maybe this is why he succeeded. Maybe I’m still the smartest." I checked with my sister Barbara, who had gone from being a paralegal to running a major U.S. corporation. "Don’t worry," she assured me, "you’re the smartest."

But then Mike messed me up again. Not content with being a vet, he proceeded to get a PhD in physiology. Then he joined Penn’s vet school faculty and turned into a hard core scientist with a huge lab, NIH grants, you name it. He’s now doing genetic research with no time to talk to his "smarter" half. Penn’s Vet school recently asked if he would consider being its dean.

I’m very proud of Mike. I tell his story to every kid I know who’s been told he can’t make it, has lousy test scores, "has low aptitude," and didn’t go to Harvard. I also tell them that "measures" of smarts—IQ, SATs, GPAs, the ranking of your college—have a laughably small ability to predict success as measured by labor earnings let alone making brilliant discoveries or just enjoying life. Finally, I tell them that human potential is neither quantifiable nor bounded and that anyone who’s really smart knows this for a fact.