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Saturday, March 31, 2007

Should Democrats Dump Wall Street?

The battle for the heart and soul of the Democratic Party. Here's the issue, in a nutshell:

[In 1992] Clinton famously exploded that his whole economic vision and political future were being held hostage by "a bunch of fucking bond traders." At another planning session ..., Clinton declared with sarcastic disgust: "Where are all the Democrats? We're all Eisenhower Republicans … . We stand for lower deficits and free trade and the bond market. Isn't that great?"

And here's part of a much longer essay by Robert Kuttner on the role of Robert Rubin and Wall Street in the Democratic Party:

Friendly Takeover, by Robert Kuttner, American Prospect: In April 2004, AFL-CIO president John Sweeney grew concerned that John Kerry was getting too much of his economic advice from the Wall Street wing of the Democratic Party. ... In the general election, he would need the unions. Sweeney proposed a private meeting to discuss living standards as a campaign issue, and the candidate invited the labor leader to his Beacon Hill home. Sweeney arrived ..., bringing his policy director, Chris Owens, and Jeff Faux of the Economic Policy Institute. There, seated in the elegant living room, were Robert Rubin and two longtime lieutenants: investment banker and former Rubin deputy Roger Altman, and fellow Clinton alum Gene Sperling -- Kerry's key economic advisers.

In a three-hour conversation, the group discussed the deficit, taxes, trade, health care, unions, and living standards. The labor people urged the candidate to go after Wal-Mart's low wages. Rubin countered that a lot of people like Wal-Mart's low prices. Kerry eventually announced that the meeting needed to wrap up... Sweeney and his colleagues were ushered out the door; Rubin, Altman, and Sperling remained. "Wall Street was in the room before we arrived," says Faux, "and they were there after we left."

Now, more than two years after Kerry lost a winnable election, the Democrats have taken back both chambers of Congress, running on an economic platform far more populist than Kerry's. With the strongest field in decades, they could win the presidency in 2008. Though Hillary Clinton is running as an economic centrist, a ticket led by John Edwards, Barack Obama, or Al Gore (if he gets in) would probably run a robust campaign on pocketbook issues. But if the Democrats do take back the White House, they are likely, once again, to find Bob Rubin in their living room. ...

Continue reading "Should Democrats Dump Wall Street?" »

    Posted by on Saturday, March 31, 2007 at 04:05 PM in Economics, Policy, Politics | Permalink  TrackBack (0)  Comments (53)


    Should We Use Science to Manipulate the Climate?

    Should we use science-based proposals for alleviating global warming such as putting particles in the upper atmosphere to deflect solar energy? Do we know enough about the risks of such wide-scale manipulation of the environment to be sure we know how this would turn out?

    Scientists weigh risks of climate 'techno-fixes', by Moises Velasquez-Manoff, The Christian Science Monitor: Faced with the specter of a warming planet and frustrated by the lack of progress..., some scientists ... seek a way to give humanity direct control over Earth's thermostat.

    Proposals run the gamut from space mirrors deflecting a portion of the sun's energy to promoting vast marine algal blooms to suck carbon out of the atmosphere. The schemes have sparked a debate over the ethics of climate manipulation, especially when the uncertainties are vast and the stakes so high. For many scientists, the technology is less an issue than the decision-making process that may lead to its implementation. [Graphic showing some of the proposals.]

    Environmental policy driven purely by cost-benefit analyses cannot, they say, effectively point the way on large issues like climate change. But even as many scientists caution against unintended, even catastrophic consequences of tinkering with climate, they concede that the more tools humankind has to confront a serious problem, the better.

    Others wonder if the mere hint of a quick-fix solution will only provide a false sense of security and hamper efforts to address the root problem: carbon emissions from a fossil fuel-based economy. And then there's the trillion-dollar question: In a politically fractured world, how will technologies that affect everyone be implemented by the few, the rich, and the tech-savvy? ...

    [G]eoengineering, ... subtracting a fraction of the sun's energy from the earth equal to that trapped by human-emitted greenhouse gases ..., is not a new idea, but only recently has it moved toward the scientific mainstream. In 2006, Nobel Laureate Paul Crutzen ... published a paper on injecting particles into the upper atmosphere to reflect incoming sunlight and cool the earth. Climate scientists have since run scenarios on climate models and first reports found that it might work. In November last year, NASA cohosted a conference on the topic. ...

    Continue reading "Should We Use Science to Manipulate the Climate?" »

      Posted by on Saturday, March 31, 2007 at 04:32 AM in Economics, Environment, Policy, Science | Permalink  TrackBack (0)  Comments (26)


      The Recent Decline in Productivity Growth

      Is the recent slowdown in productivity growth permanent? Maybe, but let's hope not:

      Productivity Lull Might Signal Growth Is Easing, by Greg Ip, WSJ: The U.S. productivity boom that began in the mid-1990s is showing signs of running out of steam. If it proves more than a temporary lull, slower growth in productivity -- that is, output per hour worked -- could lead to slower growth in living standards, more difficultly paying for the baby boomers' retirements and a greater risk of inflation. ...

      Official measures have slowed since the late 1990s, when an acceleration in productivity growth made possible faster growth, lower unemployment, lower inflation and lower interest rates. It fueled a boom in business investment and stock prices. Today, in contrast, productivity growth has slowed, business investment has turned down and inflation is proving stubborn.

      "All the elements of the good years of the '90s have now turned around," said Robert Gordon, an economist at Northwestern University...

      Continue reading "The Recent Decline in Productivity Growth" »

        Posted by on Saturday, March 31, 2007 at 12:57 AM in Economics, Technology | Permalink  TrackBack (0)  Comments (71)


        Doing the Impossible

        In rational expectations models, it is usually assumed that agents understand the nature of the equilibrium in the economy in which they operate. That is, they are able to solve the complex set of equations that describe the economy and calculate the equilibrium outcome. Many people object to rational expectations models because this information requirement seems too stringent - how can the average person solve such equations? And if they cannot, how can expectations be rational?

        One answer to this is to toss someone a ball and say "catch." Somehow, we don't know exactly how because as explained below it's "technically impossible," but somehow they are able to solve the differential equation problem and easily catch the ball. The discussion below is about baseball, but it describes a similar process - how players are able to solve what appear to be impossible problems using what economists call the "as if" principle - they behave as if they they are able to solve the underlying mathematical problem, e.g. firms behave as if they can set MC=MR and consumers behave as if they can solve the equations needed to maximize their utility. The discussion also covers topics such as findings from the psychology literature on whether "clutch hitters" really exist, and there are connections to the learning literature in economics through the descriptions of the simple algorithms used to solve the problems such as catching a fly-ball. Mostly though I just thought it was interesting and tried to connect it to economics to justify posting it:

        The psychology of baseball, EurakAlert: It’s the seventh game of the World Series — bottom of the ninth inning, your team is down 4-3 with runners on second and third — and you’re on deck. You watch as your teammate gets the second out. That means you’re up with a chance to win a championship for your team...or lose it.

        You’re known as a clutch hitter, and you’ve hit safely in 22 straight games — an impressive streak to be sure. But as you step into the batter’s box, your hands are sweating and your mind is racing. You think about the last time you faced this pitcher and the curveball he threw to strike you out. You look at him standing on the mound and he looks tired. You try to pick up clues from his body language. How fast is his fastball today? Will he tempt you with that curveball again?

        Psychologists are asking different questions: Does your recent hitting streak really matter? Is there even such a thing as a clutch hitter? Will the pitcher’s curveball fool you? And then there are the more basic questions: How is it possible to hit a 100 m.p.h. fastball without being able to see it for more than a split second? How is it that even sandlot players — mere children — can intuitively do the complex geometry needed to get to precisely the right spot to catch a fly ball?

        University of Missouri psychologist Mike Stadler uses research from dozens of behavioral scientists, plus some of his own, to try answering these complicated questions in his new book, The Psychology of Baseball. "Baseball turns out to be a good laboratory for studying psychological phenomena," Stadler says, "because you’re pushing the human system to its limits. And that’s a good way to see how the system works."

        Psychologists have been studying baseball players almost as long as the Red Sox had been disappointing fans in Boston, and much of the attention has naturally focused on the most heroic part of the game: hitting. Baseball’s great sluggers, such as Babe Ruth, Ted Williams, and Albert Pujols, make it seem so effortless, which makes it hard to accept the scientific consensus that hitting is basically impossible. That’s right, impossible. Why? A ball thrown by a major league pitcher reaches speeds of 100 m.p.h. and an angular velocity (the speed in degrees at which the ball travels through your field of vision) of more than 500 degrees per second. A typical human can only track moving objects up to about 70 degrees per second. Add to this the fact that it takes longer to swing a bat than it does for a pitch to go from the pitcher’s hand to the catcher’s mitt, which means a hitter must start his swing before the ball is released and has less than a half a second to change his mind. All that equals impossible.

        Continue reading "Doing the Impossible" »

          Posted by on Saturday, March 31, 2007 at 12:33 AM in Economics, Science | Permalink  TrackBack (0)  Comments (21)


          Friday, March 30, 2007

          Those Damn Immigrants Ruin Everything

          When I moved to Oregon from California in the late 1980s, it didn't take me long to realize it would be best if I put Oregon license plates on my car:

          Problems in your town? Blame it on Californians, by Angie Wagner, The Associated Press: It's dead inside Favorites bar this afternoon, where the propped-open door spills a bit of light onto the ancient Elvis pinball machine and the grumpy man puffing on a cigarette in front of the video poker machine.

          There's no food here, unless you count the vending machine against the green wall. Owner Ray Medrano had to make a choice: Close the kitchen or ban smoking in the joint altogether. His customers love their smokes more than their food, so the kitchen lost. For Medrano, there's only one despicable group of people to blame for Nevada passing a smoking ban that eliminates smoking in restaurants and bars that also serve food: Californians.

          ''California has a negative influence on our society,'' he says, glancing around as cigarette smoke fills the stuffy place. ... It's a popular refrain from many in the West. When Californians move in, it's always their fault when things change. They infect the rest of the region with their politics and questionable driving. They make housing prices soar.

          Sure, it's been 30 years since Oregonians first slapped ''Don't Californicate Oregon'' bumper stickers on their cars, but, like the song by the Red Hot Chili Peppers, ''Californication'' is still alive and well.

          ''I think it's just such a common desire to say things were really calm and great here and then these people came in,'' says Patty Limerick, history professor ... of the University of Colorado's Center of the American West.

          Since 1991, the number of Californians moving out topped the number of people moving into the state. And where do they go? The top five states Californians moved to between 2000 and 2005 were Arizona, Nevada, Texas, Washington and Oregon...

          For many Californians, they want what eludes them in their state - open space, clean air and not so much traffic. So they sell their houses for a chunk of change, move somewhere else in the West, buy a bigger house and start driving up the housing prices, much to the dismay of locals.

          Sherrie Watson has lived in Coeur d'Alene, Idaho, since she was 16 and is quite fed up with Californians. ''They complain how cold it is. And they just moved here because it is cheaper and to 'get away,' but then they keep saying things like, 'We did it in California this way, so why don't you change? They came here because they liked it the way it was when they visited, but then they want to change it...''

          Picking on Californians has almost become a sport, with people trying to come up with the catchiest slogans or blogging about how annoying Golden Staters are. Montanan Tom Heatherington runs a Web site called www.montana-sucks.com that sells T-shirts and bumper stickers that say: ''Montana sucks. Now go home and tell all your friends.''...

          Yep, lower wages, higher housing prices, ruined culture -- we need a wall.

            Posted by on Friday, March 30, 2007 at 06:45 PM in Economics | Permalink  TrackBack (0)  Comments (6)


            Jeffrey Lacker: Inflation and Unemployment

            Jeff Lacker has a nice discussion of the relationship between inflation, unemployment, and economic policy. If you want to learn more about the modern formulation of the Phillips curve and the policy issues surrounding it, this is a good source of information. Those who are familiar with the traditional Phillips curve story and inflation bias from the time-inconsistency literature may want to skip to the discussion in the section on "The Modern Phillips Curve." The "hybrid" Phillips curve is discussed here, and policy is discussed in this section. Here's the speech:

            Inflation and Unemployment, by Jeffrey M. Lacker President, Federal Reserve Bank of Richmond: I recently had the opportunity to guest-teach a couple of business school economics classes. It was great to be back in the classroom. ...

            I opened my discussions with a pair of questions, asking students to put themselves in the place of a monetary policymaker choosing a target for the federal funds rate. First I gave them a set of hypothetical facts about the state of the economy – a slowdown in housing in the wake of multi-year housing boom; rising mortgage default rates; preliminary indicators of a possible slowing in business investment. And then I asked them: “What are you going to do?” The students dutifully responded that this situation could call for a reduction in the funds rate. They’d obviously been doing their homework.

            Next, I gave them a set of hypothetical facts about inflation – core PCE inflation, on a year-over-year basis, has been above 2 percent for nearly three straight years; after some signs of moderation, recent months’ inflation numbers have moved higher; energy prices have been fluctuating around historically elevated levels and futures markets predict further increases to come; and labor compensation is rising after a relatively flat period. Same question: “What are you going to do?” Once again, their response came right out of the textbook – an increase in the funds rate is needed to counter rising inflation, other things equal.

            The trick of course is that both sets of hypothetical facts are drawn from the same period – basically right now. My objective was to underscore the fact that sometimes monetary policy decisions are not obvious, and that figuring out the appropriate policy action requires as complete a picture as possible of the state of the economy. Interpreting that picture can be a challenging task.

            The situation I presented to the students represents a policy-making dilemma. The actions needed to bring down inflation could work against our desire to see the real outlook solidify. The facts appear to present the policymaker with a tradeoff. You can address one – inflation or real growth – but that puts the other at risk.

            There is an element of truth to characterizing this situation as a tradeoff. But that characterization is also, I think, an extreme over-simplification and can be highly misleading. Monetary policy actions today are capable of affecting inflation and unemployment both now and in the future. Consequently, it is a mistake to view policy decision-making as a sequence of one-shot trade-offs. Some understanding of how inflation and unemployment interrelate over time is essential. I’d like to devote my remarks ... to the relationship between inflation and the real side of the economy and to what I think that relationship implies for policy-making.

            Continue reading "Jeffrey Lacker: Inflation and Unemployment" »

              Posted by on Friday, March 30, 2007 at 01:03 PM in Economics, Macroeconomics, Monetary Policy | Permalink  TrackBack (0)  Comments (9)


              Pro Growth Liberal: Tax “Cuts”: Fill My Mug and Pass the Popcorn

              PGL at Angry Bear reminds Greg Mankiw that tax cuts don't pay for themselves:

              Tax “Cuts”: Fill My Mug and Pass the Popcorn, by PGL: Greg Mankiw provides this parable about tax policy:

              Suppose that every day, ten men go out for beer and the bill for all ten comes to $100. If they paid their bill the way we pay our taxes, it would go something like this:

              The first four men (the poorest) would pay nothing. The fifth would pay $1. The sixth would pay $3. The seventh would pay $7. The eighth would pay $12. The ninth would pay $18. The tenth man (the richest) would pay $59. So, that's what they decided to do.

              The ten men drank in the bar every day and seemed quite happy with the arrangement, until one day, the owner threw them a curve. "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily beer by $20." Drinks for the ten now cost just $80.

              Let me interject something here from Greg's post. The story goes on and after the price cut:

              [T]he bar owner ... proceeded to work out the amounts each should pay [after the 20% reduction]. And so:

              The fifth man, like the first four, now paid nothing (100% savings).
              The sixth now paid $2 instead of $3 (33%savings).
              The seventh now pay $5 instead of $7 (28%savings).
              The eighth now paid $9 instead of $12 (25% savings).
              The ninth now paid $14 instead of $18 (22% savings).
              The tenth now paid $49 instead of $59 (16% savings).

              Each of the six was better off than before. And the first four continued to drink for free. But once outside the restaurant, the men began to compare their savings. "I only got a dollar out of the $20," declared the sixth man. He pointed to the tenth man," but he got $10!" "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got ten times more than I!"

              "That's true!" shouted the seventh man. "Why should he get $10 back when I got only two? The wealthy get all the breaks!" "Wait a minute," yelled the first four men in unison. "We didn't get anything at all. The system exploits the poor!"

              The nine men surrounded the tenth and beat him up. ... And that, boys and girls, journalists and college professors, is how our tax system works. ...

              Back to PGL:

              Greg continues with this parable, which can also be found here, commenting on the distribution of this alleged tax cut. I guess this is supposed to be a comment on the 2001 tax cut but there’s something missing here. In the real world, we did not get a tax cut – only a tax shift. Yes, government spending did not decline so somebody will have to pay more in taxes someday.

              So let’s finish his parable by assuming that the owner raised the price of the munchies such as popcorn and the beer nuts. One cannot talk about talk about the distribution of the change in tax policy without bringing in the total picture. Yet, we often see our conservative friends implicitly denying that either sales taxes or employment taxes (or both) will have to be increased. Of course, this is one of many myths that get created when one falls for the free lunch fallacy that permeates Republican discussions of fiscal policy.

              Hey bartender – pour me another pint and give me some more popcorn. It’s all free – right?

              I'll note too that the fact that the owner can cut 20% off the bill and still make a profit ought to raise some eyebrows among the patrons - that's no small amount of monopoly power. In a competitive market, the owner could not do this. In addition, this is not how we analyze the general equilibrium effects of change in the burden of taxes after a tax change. Even with partial equilibrium analysis, when taxes are increased the customers will not face 100% of the burden, the burden is shared between the owner and the customers. In the opposite direction, when taxes are cut, the reduced burden is shared as well. That's missing from this analysis.

              As to Greg's the main point, questions about the equity of tax cuts, the other thing missing is what taxes pay for. Making the good in the story beer (i.e. something we could do without) and then allowing the same quantity to be purchased at a lower price is not a parable that relates to government spending. Unlike this made-up story with it's made-up resentments, taxes fund government services - something must be given up when taxes are cut, or taxes must be raised in the future as PGL notes. In the case where programs must be cut, if it's essential social programs, then I hope that people do raise questions of basic equity. Cutting estate taxes when we cannot afford pre-school programs for disadvantaged children would be a much better parable for Greg to tell. We could point fingers at the disadvantaged and call them whiners for asking if paying for estate tax-cuts by not fully funding programs such as these is fair - but I suspect we won't hear that story.

                Posted by on Friday, March 30, 2007 at 11:03 AM in Economics, Income Distribution, Taxes | Permalink  TrackBack (0)  Comments (17)


                Outsourcing Government's Brain

                This Wall Street Journal article asks if the government is "outsourcing its brain," that is, assuming it has one:

                Is U.S. Government 'Outsourcing Its Brain'?, by Bernard Wysocki Jr., WSJ: ...Since the 2001 terrorist attacks and wars in Afghanistan and Iraq, the federal government's demand for complex technology has soared. But Washington often doesn't have the expertise to take on new high-tech projects, or the staff to oversee them. As a result, officials are increasingly turning to contractors ... that operate some of the government's most sensitive and important undertakings.

                The risk of this approach, in the words of Warren Suss, a ... consultant and expert on federal computer outsourcing, is that the government could wind up "outsourcing its brain." The number of private federal contractors has soared to 7.5 million, four times bigger than the federal civilian work force itself... Congress, meanwhile, is learning how hard it is to keep tabs on these activities. ...

                The government still buys pencils and office furniture, but now relies on others for sophisticated technology work, especially what's known as "systems integration" -- pulling together complex information networks for the military, homeland-security personnel and others.

                "Our ignorance is their gain," says Richard Skinner, inspector general at the Department of Homeland Security. Projects currently under way range from the design of next-generation military computer networks to the oversight of a $30 billion electronic "fence" being built along the Mexican border.

                Outsourcing originally sprang from concerns about overspending and mismanagement by the government itself. Starting in the 1980s, agencies realized it was cheaper to buy certain services directly from companies. In the 1990s, teaming up with the private sector became a popular idea, in part as a way to reduce the number of federal employees on the books.

                Today, the potential pitfalls are legion. Big contracts are notorious for cost overruns and designs that don't work, much of which takes place under loose or ineffective government scrutiny. ...

                Democratic Rep. Henry Waxman of California, new chairman of the House Oversight and Government Reform Committee, has castigated the Department of Homeland Security for lax oversight... Outsourcing details to private contractors "can be a prescription for enormous fraud, waste and abuse," Rep. Waxman said... One flashpoint ... is whether contractors hire other contractors without enough controls or competition. In March, Rep. Waxman introduced a bill that would put limits on contracts awarded without competitive bidding. ...

                Fueling the growth ... is a move toward giant, complex projects, awarded by Uncle Sam but pulled together by what's called a "lead systems integrator." Big contractors have become even more powerful in the post-9/11 era, some say, because the government has turned conservative, preferring to award contracts on critical national-security projects to proven players, especially as knowledgeable civil servants retire.

                The U.S. government "is losing their system engineering, program management, acquisition expertise," said Kenneth Dahlberg, CEO of Science Applications International Corp., of San Diego... He vowed that his company, one of the biggest federal contractors with 44,000 employees, would be there to fill the void. ...

                When there is lack of accountability and market-imposed discipline due to political connections, uninformed oversight (perhaps due to appointing non-experts into critical government positions, which may again relate to political connections), lack of competition in the contract award process, market failure, or for other reasons, there's no reason to believe that private companies will perform better than government. I'm not opposed to privatization when it's done properly, but large, politically connected, private sector firms lacking the proper incentives can be every bit as wasteful and inefficient as government. [There are several examples of this in the article].

                One minor quibble. The article says, "The government still buys pencils and office furniture, but now relies on others for sophisticated technology work." Pencils and office furniture aren't a counterexample, instead they are good examples of when the government should privatize. Buying pencils and furniture from the private sector means the government is relying on others for the work of producing these goods, as they should. It's unlikely that the government could produce either pencils or furniture cheaper itself. But it's a mistake to conclude from cases such as these that the private sector is better at producing all goods and services.

                  Posted by on Friday, March 30, 2007 at 01:49 AM in Economics | Permalink  TrackBack (0)  Comments (21)


                  A Monetary Fable

                  Paul Krugman from 1999. I like this one - it uses a simple, entertaining fable to illuminate important issues in international finance such as whether developing countries should stabilize their exchange rates:

                  A Monetary Fable, by Paul Krugman: Once upon a time, the world had a single currency, the globo. It was generally well managed: the Global Reserve Bank (popularly known as the Glob), under its chairman Alan Globespan, did a pretty good job of increasing the global money supply when the world threatened to slide into recession, trimming it when there were indications of inflation. Indeed, in later years some would remember the reign of the globo as a golden age. Businessmen in particular liked the system, because they could buy and sell anywhere with a minimum of hassle.

                  But there was trouble in Paradise. You see, although careful management of the globo could prevent a boom-bust cycle for the world as a whole, it could not do so for each piece of that whole. Indeed, it turned out that there were often conflicts of interest about monetary policy. Sometimes the Glob would be following an easy-money policy because Europe and Asia were on the edge of recession; but that easy money would fuel a wild speculative boom in North America. Other times the Glob would feel obliged to tighten money to head off inflation in North America, intensifying a developing recession in Latin America. And there was nothing regions could do about it.

                  Over time frustration over this impotence built up; and when the Glob failed, through policy misjudgements, to prevent a serious global recession the system broke up. Each region introduced its own currency: Europe adopted the euro, Latin America the latino, North America the gringo, and so on. But how should these local currencies be managed?

                  Continue reading "A Monetary Fable" »

                    Posted by on Friday, March 30, 2007 at 12:15 AM in Economics, International Finance | Permalink  TrackBack (0)  Comments (19)


                    Thursday, March 29, 2007

                    Killer Asteroids

                    Robert Reich notes a new report from NASA that "some 100,000 asteroids and comets routinely pass between the Sun and the Earth's orbit. About 20,000 of these orbit close enough to us that they could one day hit the Earth and destroy a major city." Here's more:

                    Deep Impact A new NASA report on killer asteroids ought to spook people into action, by Robert B. Reich, American Prospect: According to a new report from the National Aeronautics and Space Administration, ... over a thousand ...[asteroids] are large enough (almost a mile wide in diameter) and their orbits close enough to us as to pose a real potential hazard of crashing into the Earth with enough force to end most life on this planet. ...

                    Continue reading "Killer Asteroids" »

                      Posted by on Thursday, March 29, 2007 at 06:03 PM in Economics, Science | Permalink  TrackBack (0)  Comments (13)


                      Martin Wolf: The War on the Traditional Family

                      Martin Wolf says the welfare state is contributing to the demise of the traditional family:

                      The war on the traditional family, by Martin Wolf, Commentary, Financial Times: Incentives matter. If society rewards uneducated young women for becoming single parents, they will adopt that as their career. That is precisely what British politicians have done...

                      This is not how politicians put it. ...[They do not] admit that their aim is to eliminate the committed married couple from the poorer sections of British society. But that is the inevitable effect of trying to ensure that the choices of parents have no bearing on the economic welfare of their children.

                      It is not excessive to describe the resulting policies as a “war” on the traditional family. That is what it is, as Patricia Morgan, a well-known analyst in this area, argues...

                      Before the welfare state, both members of a couple needed one another – and, if possible, the extended family – because caring for children is incompatible with simultaneously earning an adequate income for a family. That has not changed. The difference is only that taxpayers now provide that income.

                      “By the end of the century,” Ms Morgan writes, “73 per cent of lone parents were receiving family credit [to bolster wages] or income support; 57 per cent were receiving housing benefit and 62 per cent council tax benefit. The figures for couples with children were 11 per cent, 8 per cent and 11 per cent respectively.” ...

                      The economic penalties for trying to create and sustain a stable and committed couple are, for those on moderate incomes, substantial. But the economic incentives for “faking it” are impressive.

                      Joint annual income now has to reach something like £50,000 gross before the couple suffers no loss from declaring a relationship. If a boyfriend who earns £380 a week pretends not to live with a non-working lone mother who has two children under 11, the couple will be £9,018 a year – no less than 60 per cent – better off than if the relationship is declared. Marriage has become economically damaging. So has honesty.

                      Why is the welfare system structured this way? One reason is the overriding aim of eliminating child poverty, regardless of the choices of parents; the other is the presumed desirability of liberating mothers from dependence on a man.

                      Yet it is assumed that incentives have no bearing on behaviour. The evidence is overwhelmingly against this absurd idea. Trying to eliminate child poverty by subsidising the form of family that is most likely to suffer from it is like trying to bale out a boat with a sieve.

                      The social consequences are severe. In a world in which the state replaces the father, uneducated young men are permanent adolescents, useful to father children but lacking any other valuable social role. We know that unmarried men are far less likely to work than married ones. This is partly because they are less marriageable. It is also because they have less incentive to work.

                      Continue reading "Martin Wolf: The War on the Traditional Family" »

                        Posted by on Thursday, March 29, 2007 at 01:57 PM in Economics, Social Insurance | Permalink  TrackBack (0)  Comments (46)


                        FRB Dallas: Good News and Bad News on the Economic Outlook

                        Evan Koenig of the Dallas Fed compares today's economy with the economy in 2000-01 and finds reasons to be both optimistic and pessimistic about the economic outlook:

                        Vive la Différence, National Economic Update, by Evan F. Koenig, FRB Dallas: There are several disturbing similarities between the U.S. economy's recent behavior and its behavior in 2000–01, but also some reassuring differences.

                        One similarity is the drag on growth coming from investment. Chart 1 shows the combined contribution to annualized GDP (gross domestic product) growth from residential and business equipment and software investment, measured in percentage points. Note that in 2005–06, just as in 2000–01, this contribution dropped from a positive 1 percentage point to a negative 1 percentage point.

                        Back in 2000–01, of course, most of the decline was due to a collapse of equipment and software investment. This time around, the housing sector has been feeling most of the pain.

                        Chart 1: 2005-06 investment collapse comparable to 2000-01, yet GDP growth holding up well

                        Despite nearly equal drags from investment, GDP growth slowed by 4 percentage points in 2000–01, versus only 2 percentage points in 2005–06.

                        Chart 2 shows the source of the difference: consumption growth. In 2000–01, consumption spending’s contribution to GDP growth fell by about 2 percentage points. Over the past couple of years, in contrast, consumption’s growth contribution has held comparatively steady.

                        Chart 2: Key is steady growth in consumer spending

                        Chart 3 slices the data differently: It compares monthly nonfarm payroll job gains in the goods-producing and service-providing sectors. It is striking that while goods-producing job growth has slowed by about as much as it did in 2000, service-providing job growth has held up much better than it did in the lead-up to the 2001 recession.

                        Chart 3: growth in sevice-producing jobs holds steady, unlike in 2001

                        Neither residential investment nor goods-producing job growth seems likely to improve anytime soon.

                        In the residential sector, the 30-percent plunge in building permits and decelerating new-home prices we’ve seen since the fall of 2005 are an ill omen for future investment and job growth (Chart 4). Consistent with this glum near-term outlook, new-home sales resumed their slide in January, after an upward spike in December. Sales are now down 31.5 percent from their July 2005 cyclical high. Residential construction and associated specialty-trade jobs account for about 15 percent of employment in the goods-producing sector.

                        Chart 4: Residential investment to remain a drag on GDP growth

                        Recent data on new orders for durable manufactured goods give a similarly discouraging view of near-term prospects for investment and factory job growth (Chart 5). Factories account for about 63 percent of employment in the goods-producing sector.

                        Chart 5: Falling durable-goods orders usuallyl portend factory job cuts

                        The big question is whether the drags from housing and manufacturing will let up before weakness there begins spilling over to the rest of the economy.

                        Update: See Calculated Risk for discussion of charts 4 and 5.
                        Update: David Altig at macroblog provides further analysis.

                          Posted by on Thursday, March 29, 2007 at 11:37 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (10)


                          The "Dramatic" Reduction in the Progressivity of Federal Taxes

                          The Center on Budget Policy and Priorities reports on changes in the progressivity of federal taxes over time:

                          New Study Finds "Dramatic" Reduction Since 1960 in the Progressivity of the Federal Tax System, by Aviva Aron-Dine, CBPP: In a new study, Thomas Piketty and Emmanuel Saez ... examine how the progressivity of the federal tax system has changed over time. Unlike previous analyses, theirs examines effective federal tax rates going back to 1960, including income, payroll, corporate, and estate taxes, and provides data for income groups reaching up to the top one-hundredth of one percent (.01 percent) of the population. Several crucial findings emerge from their study.

                          Regressive32907

                          “The progressivity of the U.S. federal tax system at the top of the income distribution has declined dramatically since the 1960s.” As Figure 1 shows, since 1960, average federal tax rates for middle-income households have increased and then declined modestly. Over the same period, high-income households saw sharp drops in their federal tax rates.

                          Moreover, the drops were largest for the very highest-income households. The average tax rate declined by a larger amount for households in the top one hundredth of 1 percent of the income scale (where incomes in 2004 averaged about $15 million) than for households in the top tenth of 1 percent (where incomes averaged above $3.7 million) or for households in the top 1 percent (where incomes averaged about $850,000). ...

                          “Large reductions in tax progressivity since the 1960s took place primarily during two periods: the Reagan presidency in the 1980s and the Bush administration in the early 2000s.” ...

                          As Piketty and Saez point out, economists generally assess whether a tax system is progressive based on whether the distribution of after-tax income is more equal than the distribution of pre-tax income. They assess whether a tax cut is progressive based on whether it makes the distribution of after-tax income more or less equal.

                          Like others who have examined the effects of the 2001 and 2003 tax cuts, Piketty and Saez find that the tax cuts made the distribution of after-tax income less equal. ... In short, the tax cuts were regressive.

                          Because it omits the effects of those tax cuts enacted in 2001 that were not fully phased in by 2004 (such as the repeal by 2010 of the estate tax and of the provisions of the tax code that reduce the value of itemized deductions and personal exemptions for households at high income levels), Piketty and Saez’s simulation substantially understates the regressivity of the tax cuts once they are fully in effect. Even so, it offers additional confirmation that the tax cuts were regressive.

                          In sum, Piketty and Saez’s new study shows that the federal tax system has become much less progressive over the past several decades, and the 2001 and 2003 tax cuts have continued this trend. Over much the same several decades, pre-tax income inequality has grown as well. Thus, during a period in which economic forces have been generating increased pre-tax inequality, changes in the tax system have exacerbated rather than mitigated the widening of the income gap.

                          The new results showing that income inequality continues to widen have been covered here before, the CBPP details the results here, and today's NY Times summarizes the results as well:

                          Income Gap Is Widening, Data Shows, by David Cay Johnston, NY Times: Income inequality grew significantly in 2005, with the top 1 percent of Americans — those with incomes that year of more than $348,000 — receiving their largest share of national income since 1928... The top 10 percent, roughly those earning more than $100,000, also reached a level of income share not seen since before the Depression.

                          Continue reading "The "Dramatic" Reduction in the Progressivity of Federal Taxes" »

                            Posted by on Thursday, March 29, 2007 at 02:43 AM in Economics, Income Distribution, Taxes | Permalink  TrackBack (0)  Comments (96)


                            Wednesday, March 28, 2007

                            Regulating Mortgage Markets

                            There are both costs and benefits to financial innovations such as subprime mortgages. Can regulation reduce the costs without affecting the benefits?:

                            'Irresponsible' Mortgages Have Opened Doors to Many of the Excluded, by Austan Goolsbee, Economic Scene, NY Times:  "We are sitting on a time bomb," the mortgage analyst said — a huge increase in unconventional home loans like balloon mortgages taken out by consumers who cannot qualify for regular mortgages. The high payments, he continued, "are just beginning to come due and a lot of people ... now risk losing their homes because they can’t pay the debt."

                            He would have given great testimony at the current Senate hearings on subprime mortgage lending. The only problem is, he said it in 1981 — when soon after several of the alternative mortgage products like those with adjustable rates and balloons first became popular.

                            When Senator Christopher J. Dodd, Democrat of Connecticut, gave his opening statement ... at the hearings lambasting the rise of "risky exotic and subprime mortgages," he was actually tapping into a very old vein of suspicion against innovations in the mortgage market.

                            Almost every new form of mortgage lending ... has tended to expand the pool of people who qualify but has also been greeted by a large number of people saying that it harms consumers and will fool people into thinking they can afford homes that they cannot.

                            Congress is contemplating a serious tightening of regulations to make the new forms of lending more difficult. New research from some of the leading housing economists in the country, however, ... suggests that regulators should be mindful of the potential downside in tightening too much.

                            A study conducted by Kristopher Gerardi and Paul S. Willen from the Federal Reserve Bank of Boston and Harvey S. Rosen of Princeton, Do Households Benefit from Financial Deregulation and Innovation? The Case of the Mortgage Market ..., shows that the three decades from 1970 to 2000 witnessed an incredible flowering of new types of home loans. These innovations mainly served to give people power to make their own decisions about housing, and they ended up being quite sensible with their newfound access to capital.

                            Continue reading "Regulating Mortgage Markets" »

                              Posted by on Wednesday, March 28, 2007 at 09:58 PM in Economics, Housing, Regulation | Permalink  TrackBack (0)  Comments (23)


                              Big Brother Bush

                              Free Exchange, the blog at the Economist, says:

                              Big Brother Bush?, Free Exchange: On the face of it, this study ... seems damning: the Bush justice department has investigated seven times as many Democratic politicians at the local level as it has Republicans. This is not true at the state and federal level. Liberal blogs have interpreted this as the Bush justice department going after the opposition wherever the sunlight of national media doesn't shine.

                              Possibly so. But it seems to me that there is another, at least equally parsimonious explanation: local officials in cities are, as far as I know, overwhelmingly disproportionately Democrats. Cities are also much more likely to be targeted by corruption investigations, for two reasons: they offer more opportunities for corruption, because they provide more services, and officials are much more removed from the local population; and they offer opportunities for bigger thefts. ... Also, small towns or counties have fewer officials, which means fewer people in on any corruption, which means fewer whistle-blowers to take down a conspiracy.

                              This thesis would also explain why there is no variation at the national and state levels; statewide offices offer sufficient scope for corruption in any state that any illicit activity is likely to bring Justice swooping down.

                              And indeed, when I look at the list of local investigations, they seem to be disproportionately concentrated in urban areas. To decide that this is a plot of some kind, I would have to compare the results from the Bush justice department to the Clinton justice department, an obvious check that the authors inexplicably decline to make. Instead, they calculate the chi-square as if Republican and Democratic politicians were randomly (i.e. basically evenly) distributed throughout the population. I'd declare this study not worth the paper it's written on, if only it weren't in electronic format.

                              Jane Galt follows with:

                              All politics is local, Asymmetrical Information: Gack. This terrible, terrible study on Justice department investigations is all over my favourite liberal blogs. Over at Free Exchange, we discuss why it's so awful...

                              At Matt Yglesias', commenter Brett Bellmore points out that it may even worse than that; according to him, the study didn't look at actual incidents, but only media accounts. Needless to say, the majority of media accounts of federal corruption investigations are going to come from major daily papers. And where do you find major daily papers? In big cities. And who dominates the political scene in big cities?

                              Is this really all you can expect from a communications professor? Someone needs to take their computers away until they promise to take Statistics 101 and actually listen this time, instead of just staring blankly at the pretty shapes on the board.

                              Update More here.

                              If you go to the update, by sure to read the response by the authors in the comments. I didn't find the arguments particularly compelling. The linked post in the update tries to raise lots of questions, but it doesn't actually refute the study as far as I could determine. For example, there aren't any statistical tests, though part 1 of the post does say things like:

                              This does make a noticeable difference in the percentages, though it does not by itself destroys the authors’ thesis.

                              In any case, here's another response. Paul Krugman discussed the study here, and this is his response to a comment appearing in Money Talks:

                              Jim C., Austin, Tex.: ...[T]here is a possible flaw in your logic that should not go unsaid. I do not know what the ratio of Republican to Democratic local and state officials is. Conventional wisdom is that there are many more Dems in local and state office than Reps. I don't know if this is true. But, say, for instance, there is a 2:1 ratio of Dems to Reps. This would make your data less horrific, but still highly biased. ... Raw numbers of this magnitude generally hold up under scrutiny, but it would be nice to confirm their validity in comparison with the pool of possible candidates for each group.

                              Moreover, we do not know the affiliation of the various U.S. Attorneys who chose to protect their jobs or their futures, to paraphrase your statements. One might argue that doesn't matter, but if that's the case, then the entire notion of partisanship is diminished. If it's simply a matter of pressure and bribery, then it doesn't matter much what the affiliation of the particular U.S. Attorney is.

                              Paul Krugman: Good point, but Shields and Cragan have already taken account of it. This is their analysis. There were slightly more Democrats than Republicans in public office, but only slightly, and they did statistical tests to show that the proportion of Democratic investigations was far more than could be explained by the proportion of Democrats in office. Look at the appendices and the chi-squared tests, he said wonkishly.

                                Posted by on Wednesday, March 28, 2007 at 04:32 PM in Economics, Politics | Permalink  TrackBack (0)  Comments (29)


                                Joseph Stiglitz: Europe Points the Way to a Better World

                                Joseph Stiglitz says the European model provides the foundation for building a better world:

                                Europe's success points the way to better world, by Joseph E. Stiglitz, Project Syndicate: In some quarters, pessimism dominated the recent celebrations marking the European Union's 50th birthday. Unease about the EU's future is ... understandable, especially given the uncertainty surrounding efforts to revive the Constitutional Treaty.

                                But the European project has been an enormous success... Europeans should not be dismayed by comparisons of GDP growth in Europe and, say, the United States. Of course, Europe faces great challenges in perfecting its economic union, including the need to reduce unemployment and boost the economy's dynamism.

                                But, while GDP per capita has been rising in the US, most Americans are worse off today than they were five years ago. An economy that, year after year, leaves most of its citizens worse off is not a success.

                                More important, the EU's success should not be measured only by particular pieces of legislation and regulation, or even in the prosperity that economic integration has brought. After all, the driving motivation of the EU's founders was long-lasting peace.

                                Economic integration, it was hoped, would lead to greater understanding... Increased interdependence would make conflict unthinkable. The EU has realized that dream. Nowhere in the world do neighbors live together more peacefully, and people move more freely and with greater security, than in Europe, owing in part to a new European identity... This stands as an example that the world should emulate...

                                A multi-polar world

                                Here, too, Europe has led the way, providing more assistance to developing countries than anyone else (and at a markedly higher fraction of its GDP than the US).

                                The world has faced a difficult period during the past six years. The commitment to democratic multilateralism has been challenged, and rights guaranteed under international conventions, such as the Convention Against Torture, have been abrogated.

                                Many lessons have emerged, including the dangers of hubris and the limits of military power, and the need for a multi-polar world. Europe, with more people than any nation except China and India, and the largest GDP in the world, must become one of the central pillars of such a world by projecting ... "soft power" - the power and influence of ideas and example.

                                Indeed, Europe's success is due in part to its promotion of a set of values that, while quintessentially European, are at the same time global. The most fundamental of these values is democracy... The second value is social justice. An economic and political system is to be judged by the extent to which individuals are able to flourish and realize their potential. ...

                                Europe has succeeded in part because it recognizes that the rights of individuals are inalienable and universal, and because it created institutions to protect those rights. America, by contrast, has witnessed a massive assault on those rights, including that of habeas corpus - the right to challenge one's detention before an independent judge.

                                Fine distinctions are made, for example, between the rights of citizens and non-citizens. Today, only Europe can speak with credibility on the subject of universal human rights. For the sake of all of us, Europe must continue to speak out - even more forcibly than it has in the past.

                                Likewise, ... with our environment - the scarcest of all of our resources. In this area, too, Europe has taken the lead, especially concerning global warming...

                                While economic integration helped achieve a broader set of goals in Europe, elsewhere, economic globalization has contributed to widening the divide between rich and poor within countries and between rich and poor countries.

                                Another world is possible. But it is up to Europe to take the lead in achieving it.

                                  Posted by on Wednesday, March 28, 2007 at 02:53 PM in Economics | Permalink  TrackBack (0)  Comments (62)


                                  Bernanke's Testimony before the Joint Economic Committee of Congress

                                  Federal Reserve Chairman Ben Bernanke testified today before the Joint Economic Committee of Congress. In his remarks, he clarified the Fed's position and indicated that there should be no expectation of a rate cut any time soon:

                                  Bernanke plays down need for rate cuts, by Krishna Guha, Financial Times: The Federal Reserve sees no need to cut interest rates in the light of adverse recent economic data, Ben Bernanke said on Wednesday. The Fed chairman said ”to date, the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing in core inflation”.

                                  The Federal Reserve chairman also emphasised that the US central bank remains concerned about the threat that inflation will not moderate as expected, arguing that high levels of resource utilisation could still fuel price rises. He added the US central bank was not as confident in its outlook as it had been a couple of months ago, when it was increasingly upbeat about the prospects for a soft landing.

                                  Mr Bernanke’s remarks ... offered no hint that the Fed yet believes that it will have to cut interest rates soon, as the market expects. But he recognised that “uncertainties around the outlook have increased” and said the Fed would respond in the light of incoming economic data.

                                  His comments came as the Department of Commerce released figures showing durable goods orders bounced back only weakly in February after a sharp plunge in January. ... Mr Bernanke told the Joint Economic Committee of Congress “the possibility that the recent weakness in business spending will persist is an additional downside risk.”

                                  The Federal Reserve chairman hinted the weakness in business spending had come as a surprise to the Fed ... However, Mr Bernanke added “despite the recent weak readings, we expect business investment in equipment and software to grow at a moderate pace this year”...

                                  Moreover, the Fed chairman signalled that he was less alarmed than many investors by the distress in the subprime mortgage market. “At this juncture…the impact on the broader economy and financial markets of the problems in the subprime market seem likely to be contained,” he said ... adding “we will continue to monitor this situation closely.”

                                  He reiterated the Fed’s view that the drag from cut-backs in residential investment should “wane” as builders work off the inventory of unsold new homes – though he recognised that the housing market correction “could turn out to be more severe than we currently expect...”

                                  Overall, Mr Bernanke indicated that the US central bank remains relatively upbeat on the prospects for US growth. ... Mr Bernanke reiterated a series of reasons why the Fed remains concerned about inflation. “The high level of resource utilisation remains an important upside risk to continued progress on reducing inflation,” he said. The Fed chairman refered to the “tightness in the labour market” and to difficulties firms face hiring qualified workers.

                                  Allan Meltzer, in a comment about Larry Summers' recent column calling on the Fed to ease policy in response to any signs of weakness in the economy, explains why the Fed is reluctant to ease too quickly:

                                  Allan Meltzer: We all have heard many times that those who forget their history are likely to repeat it. One of the main reasons that the Great Inflation continued from 1965 to 1979 was that the Federal Reserve (and the Bank of England) put great weight on unemployment and too little weight on inflation. In the 1970s the Federal Reserve waited for unemployment to get above 7 per cent before it abandoned any effort to lower inflation.

                                  The US saw both inflation and the unemployment rate rise to postwar peaks. Paul Volcker ended this policy by letting unemployment rise as required to bring down inflation. The public supported him.

                                  Larry Summers wants to repeat the earlier mistakes. Even before the unemployment has started to rise, he wants the Fed to anticipate the rise and react against it by lowering interest rates.

                                  An economy that cannot accept some temporary increase in the unemployment rate will live with increasing inflation followed by low investment, declining real wages, and higher unemployment. Fortunately, most of the members of the Open Market Committee understand that. And the public as in 1979-80 will demand an end to the policy.

                                  See also Kash Mansori, The Big Picture, Bloomberg, WSJ, NYT, and the Washington Post.

                                  Here is the text of Bernanke's prepared remarks:

                                  Testimony of Chairman Ben S. Bernanke, by Ben Bernanke, Federal Reserve Chair: Chairman Schumer, Vice Chairman Maloney, Representative Saxton, and other members of the Committee, thank you for inviting me here this morning to present an update on the outlook for the U.S. economy. I will begin with a discussion of real economic activity and then turn to inflation.

                                  Continue reading "Bernanke's Testimony before the Joint Economic Committee of Congress" »

                                    Posted by on Wednesday, March 28, 2007 at 12:02 PM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (11)


                                    Removing the Blinders on International Trade

                                    David Wessel and Bob Davis of the Wall Street Journal give an update on Alan Blinder's views on globalization and his estimate that trade will put tens of millions of jobs at risk [Update: free link to article plus related data on jobs at risk and offshoring]:

                                    Pain From Free Trade Spurs Second Thoughts, by David Wessel and Bob Davis, WSJ: For decades, Alan S. Blinder ... argued, along with most economists, that free trade enriches the U.S. and its trading partners, despite the harm it does to some workers. "Like 99% of economists since the days of Adam Smith, I am a free trader down to my toes," he wrote back in 2001. ...

                                    Yet today Mr. Blinder has changed his message... Mr. Blinder ... remains an implacable opponent of tariffs and trade barriers. But now he is saying loudly that a new industrial revolution -- communication technology that allows services to be delivered electronically from afar -- will put as many as 40 million American jobs at risk ... in the next decade or two. .... The job insecurity those workers face today is "only the tip of a very big iceberg," Mr. Blinder says.

                                    The critique comes as .... skepticism about allowing an unfettered flow of goods, services, people and money across borders is intensifying... Some critics are going public with reservations they've long harbored quietly. Nobel laureate Paul Samuelson ... damns "economists' over-simple complacencies about globalization" and says rich-country workers aren't always winners from trade. He made that point in a 2004 essay that stunned colleagues...

                                    Mr. Blinder's answer is not protectionism, a word he utters with ... contempt... Rather, Mr. Blinder still believes ... [n]ations prosper by focusing on things they do best -- their "comparative advantage" -- and trading with other nations with different strengths. He accepts the economic logic that U.S. trade with large low-wage countries like India and China will make all of them richer -- eventually. He acknowledges that trade can create jobs in the U.S. ... But he says the harm done when some lose jobs and others get them will be far more painful and disruptive than trade advocates acknowledge. ...

                                    His critique puts Mr. Blinder in a minority among economists, most of whom emphasize the enormous gains from trade. "He's dead wrong," says Columbia University economist Jagdish Bhagwati... Mr. Bhagwati says that in highly skilled fields such as medicine, law and accounting, "If we do a real balance sheet, I have no doubt we're creating far more jobs than we're losing."

                                    Mr. Blinder says that misses his point. The original Industrial Revolution, the move from farm to factory, unquestionably boosted living standards, but triggered an enormous change in "how and where people lived, how they educated their children, the organization of businesses, the form and practices of governments." He says today's trickle of jobs overseas, where they are tethered to the U.S. by fiber-optic cables, is the beginning of a change of similar dimensions, and American society needs similarly far-reaching changes to cope. "I'm trying to convince a bunch of economists who are deeply skeptical and hard to convince," he says. ...

                                    When he talked about trade in the past, Mr. Blinder emphasized its great benefits. ... As a Clinton aide, he helped sell the North American Free Trade Agreement... He was silent when his former Princeton student, N. Gregory Mankiw, then chairman of President Bush's Council of Economic Advisers, unleashed a political firestorm by ... appearing indifferent to pain caused to those whose jobs go overseas. "Does it matter from an economic standpoint whether items produced abroad come on planes and ships or over fiber optic cables?" Mr. Mankiw said at a February 2004 briefing. "Well, no, the economics is basically the same....More things are tradable than...in the past, and that's a good thing."

                                    Mr. Blinder says he agreed with Mr. Mankiw's point that the economics of trade are the same however imports are delivered. But he'd begun to wonder if the technology that allowed English-speaking workers in India to do the jobs of American workers at lower wages was "a good thing" for many Americans...

                                    Mr. Blinder began to muse about this in public. ... At the urging of former Clinton Treasury Secretary Robert Rubin, Mr. Blinder wrote an essay, "Offshoring: The Next Industrial Revolution?" published last year in Foreign Policy. ...

                                    Offshore32907In that paper, he made a "guesstimate" that between 42 million and 56 million jobs were "potentially offshorable." Since then he has been refining those estimates, by painstakingly ranking 817 occupations ... to identify how likely each is to go overseas. From that, he derives his latest estimate that between 30 million and 40 million jobs are vulnerable. 

                                    He says the most important divide is not, as commonly argued, between jobs that require a lot of education and those that don't. It's not simply that skilled jobs stay in the US and lesser-skilled jobs go to India or China. The important distinction is between services that must be done in the U.S. and those that can -- or will someday -- be delivered electronically with little degradation in quality. The more personal work of divorce lawyers isn't likely to go overseas, for instance, while some of the work of tax lawyers could be. Civil engineers, who have to be on site, could be in great demand in the U.S.; computer engineers might not be. ...

                                    Mr. Blinder says there's an urgent need to retool America's education system so it trains young people for jobs likely to remain in the U.S. Just telling them to go to college to compete in the global economy is insufficient. ... It isn't how many years one spends in school that will matter, he says, it's choosing to learn the skills for jobs that cannot easily be delivered electronically from afar.

                                    Similarly, he says any changes to the tax code should encourage employers to create jobs that are harder to perform overseas. ... Mr. Blinder says the focus should be on jobs with person-to-person contact, regardless of pay and skill levels -- from child day-care providers to physicians.

                                    Mostly he wants to shock politicians, policy makers and other economists into realizing how big a change is coming and what new sectors it will reach. "This is something factory workers have understood for a generation," he says. "It's now coming down on the heads of highly educated, politically vocal people, and they're not going to take it."

                                    Here's the Foreign Affairs article by Alan Blinder, "Offshoring: The Next Industrial Revolution?," (draft version in case link is blocked), and a summary of some of its contents is in "What Jobs are Safe from Offshoring?." Also, "The New Globalization" looks at the work of Blinder, Grossman, and others.

                                      Posted by on Wednesday, March 28, 2007 at 12:24 AM in Economics, International Trade, Unemployment | Permalink  TrackBack (1)  Comments (114)


                                      Tuesday, March 27, 2007

                                      Open University: Where are the Economic Historians?

                                      Eric Rauchway of Open University explains the disappearance of economic historians from history departments:

                                      Where are the Economic Historians?, by Eric Rauchway, Open University: Darrin McMahon asks "about the fortunes of economic history and of the understanding (or not) of economics by historians." As I believe the only economist on the Open U contributor list is Lawrence Summers, whose response to this query may not come quickly, I will offer my 2 cents.

                                      My university, UC Davis, hosts one of the best collections of economic historians in the country: Gregory Clark, Peter Lindert, Alan Olmstead, and Alan M. Taylor. I can say this without immodesty, because not one of them is in my department--the History Department--they're all economists. Nor is this atypical. Off the top of my head--this is not a comprehensive list--I can name sharp scholars of the economics of the Great Depression (Christina Romer, Brad DeLong; Ben Bernanke before he became Fed chair), nineteenth-century globalization (Jeffrey Williamson, Lance Edwin Davis), railroads (Robert Fogel), immigration and internal migration (Claudia Goldin, Joseph P. Ferrie), slavery, emancipation, and reconstruction (Fogel, Goldin, Stanley Engerman, Richard Sutch, Gavin Wright), who all work outside history departments, as indeed do most of the authors who publish in the Journal of Economic History. You can still find economic historians in history departments--Sutch's coauthor Roger L. Ransom; Robin L. Einhorn, William R. Summerhill, Niall Ferguson--but they're no longer so thick on the ground as once they were.

                                      What happened? Partly, technical innovations in economic methods made it difficult for the untrained to understand the new economic history. ...

                                      Economic history might have moved out of history departments for market reasons as well. If, to pursue economic history, you had to master technical skills that would make you eligible for an appointment in an economics department, you would probably prefer that to an appointment in a history department: economists get paid more because they're eligible for employment in government and business as well as universities.

                                      Is this split a Bad Thing? Well, if traditional historians continue to keep abreast of changes in economic history relevant to their work and vice versa, so they can incorporate it into their teaching and scholarship, then it's probably okay.

                                      I wish I could reassure Eric that economic history is alive and well within economics departments generally. I cannot, and that's a loss for our profession. I was fortunate enough to be forced to take both history of economic thought and U.S. economic history during graduate school, and face a core exam if I didn't learn them well enough, but that is no longer the case in most programs. In may cases, the courses are no longer offered at all.

                                        Posted by on Tuesday, March 27, 2007 at 06:06 PM in Economics, Universities | Permalink  TrackBack (0)  Comments (7)


                                        The Marginal Cost and Marginal Benefit of Cancer Drugs

                                        These are difficult choices:

                                        Setting a price for putting off death, by Daniel Costello, LA Times: What is the value of a few months of life? That question is at the center of one of the most controversial debates in medicine today involving a new generation of hyper-expensive cancer drugs.

                                        On Tuesday, the Food and Drug Administration approved GlaxoSmithKline's Tykerb, a once-a-day pill for late-stage breast cancer patients that costs nearly $35,000 a year. It's the latest of half a dozen new cancer therapies with names such as Avastin and Tarceva that can run as much as $100,000 for an annual supply.

                                        Although the medications work much longer in some patients, they help extend the lives of most for only a few months.

                                        The drugs' sky-high costs compared with their relatively small health benefits have sparked arguments among policymakers and medical professionals about what to do with the growing number of people who are depleting their life savings on the drugs or, worse, who can't get them at all.

                                        More broadly, they ask, is this the best way for society to spend its increasingly limited healthcare dollars? ...

                                        Drug companies and many patients insist even incremental gains are worthwhile. Small clinical advances are likely to turn into larger ones over time, and patients who can afford the treatments say they deserve them. ...

                                        But doctors, patient advocates and healthcare economists warn that the drugs are simply too expensive at a time when medical costs are rising rapidly...

                                        The costs aren't borne only by those who are sick. Because insurers pay for almost all federally approved drugs, the costs of covering them would eventually spill into the nation's overall medical bill and therefore would raise everyone's insurance premiums.

                                        This year, cancer drugs are expected to account for nearly 22% of the nation's drug bill, up from 13% in 2002...

                                        The debate also is raging among oncologists, who admit being torn about wanting to give patients marginally effective drugs that could cause serious financial harm. "These drugs are good, but it's important to remember they aren't a cure," said Peter Eisenberg, an oncologist at California Cancer Center in Greenbrae, Calif. "Drug companies are in another world if they think people can afford these things." ...

                                        The targeted cancer drugs and better detection are helping reshape cancer treatment, leading some to believe a corner has been turned in the fight against the disease.

                                        Last year, cancer deaths fell for a second straight year. ... But those gains have to be taken in context of what else the money spent on cancer treatment could have been used for, said Peter Neumann, director of the Center for the Evaluation of Value and Risk at Tufts-New England Medical Center. "In terms of the cost of a life saved, it's possible other areas of medicine, like better disease prevention or better cardiovascular care, may be more effective."

                                        Although it's a vague metric, one historical tool used to judge the value of a medical intervention is known as the Quality Adjusted Life Year, which is essentially a rule of thumb that a year of prolonged life is worth around $50,000 in today's dollars.

                                        By that standard, some of the new cancer drugs may not be worth their costs when measured against their benefit to society, Neumann said. ...

                                        My family faced this choice a couple of weeks ago. I wasn't part of the decision, but my observation from listening to those who were is that they fell ill-equipped to evaluate the benefits of treatment and there was considerable uncertainty over what choice was best. In the end, I think they were comfortable with the choice, but as others related their own stories and experiences, it seemed to me that families are rarely sure they have done the right thing. At the memorial gathering at my parent's house this topic came up somehow, and I heard tales on both sides - keeping people alive when it was very expensive and the quality of life was extremely poor, and cases where the choice to withhold treatment was second-guessed. I know there are lots of places to go for help and support, but it seems to me that families still need more guidance from the health professionals who are directly involved in treatment. But maybe it's just hard no matter what you do.

                                        More generally, to me life is not just another good to be allocated by the price system and it bothers me that how long you live may depend upon how much wealth you manage to inherit or accumulate. I don't know for sure how to fix this problem, but there is a part of me that believes that where life and death is concerned, everyone, rich and poor alike, should have access to the same care and treatment options.

                                          Posted by on Tuesday, March 27, 2007 at 01:04 PM in Economics, Health Care | Permalink  TrackBack (0)  Comments (45)


                                          Fed Watch: Back in the Game

                                          I think Tim is glad winter quarter is over:

                                          Back in the Game, by Tim Duy: My Christmas lights are still up. It is almost April, and my Christmas lights are still up. I used to tell myself, “I’ll never be that kind of guy.” You know, the type that thinks the lights go down on the Fourth of July, hell or high water. To be sure, my house is located off the road, secluded a bit from public view, so most people never notice the lights, keeping my little secret just that, a secret. That is, until my son notices the lights and insists they be plugged in, exposing my shame to the whole neighborhood – “He’s that kind of guy,” I can hear them all saying.

                                          Which is a long way to say that winter term became a hole that seemed to get deeper the more I worked. I can’t even really say how it happened, although the endless stream of students will pretty much decimate what would otherwise have been a decent workday. And with my wife returning to work after maternity leave, Tuesdays, the day I watch the kids, just became a little more hectic as we settled into a new routine. You would be amazed how many exciting things happen on Tuesdays! Not just at my house, either. Just a few weeks ago global markets got a little scary. You may have noticed; myself, it was a rare day that I did not catch a bit of news.

                                          As always, I have to put my attention toward the work that pays the bills first, somewhat unfortunate as Fed watching became a bit more interesting of late. Of course, the economy got more interesting first. The details have been covered far and wide, and can be summed up with one word: softer. A relief for the bears, especially after the initial, and, as it turned out, optimistic read on 4Q06 GDP growth. Expectations of stabilization in housing have yet to be realized. I can’t say that I am surprised; I have tended to believe that the downside in housing would progress longer than the bulls anticipated, but the damage would evolve more slowly than the bears anticipated. The tightening conditions in the mortgage market, particularly the subprime area, are knocking out another round of marginal buyers, promising to extend the housing weakness. The consumer is starting to look a bit anemic – a term that could also be applied to February’s employment report. More disconcerting to me has been the recent numbers on capital spending. Still, a bright spot was the stronger February ISM reading, belying concerns of a freefall in manufacturing and perhaps foretelling a more promising durable goods report this week. And initial jobless claims are not signaling impending doom either.

                                          At the same time, productivity growth looks to be slowing down, while inflation remains stubbornly high. Perhaps a couple of more quarters of weak GDP growth are all that is needed to bring inflation back down. I hope so, but nagging at me is the possibility that potential growth is off a bit more than anticipated; this is especially the case if the productivity slowdown is not simply a mid-cycle pause and labor force growth rates are slowing as well. Regarding the latter, I still believe the decreased labor force participation rates are a secular trend. Moreover, the story I hear every time I venture forth into the real world comports with David Altig’s take on the JOLTS report. Simply not enough skilled workers left to go around.

                                          All in all, the data suggested to me that the downside risks to growth were rising, but that inflation was still a concern, especially if potential output growth has pulled back. Lacking much guidance from Fedspeak (although, in retrospect, Chicago Fed President Michael Moskow had uttered some dovish remarks), the odds favored a steady policy from the Fed. Instead, the Fed managed a policy statement that pulled us about as close to neutral as possible while still keeping one eye on inflation. I don’t think the Fed was acting in response to recent market turbulence (a “Bernanke put”); I think it reflects policymaker’s honest assessment of the economy. I also find myself in agreement with Greg Ip today, who warns against expecting an imminent rate cut. To be sure, the Fed will eventually cut rates, but market participants have been consistently disappointed on this call since Hurricane Katrina. The Fed is usually not quick to cut rates.

                                          So that is a starting point to getting back into the game. I foresee better time management this term – not a big surprise, as I have the Spring off from teaching.

                                          Perhaps I will even get to those Christmas lights.

                                            Posted by on Tuesday, March 27, 2007 at 12:19 AM in Economics, Fed Watch, Monetary Policy | Permalink  TrackBack (0)  Comments (2)


                                            The Cost of the Tort System

                                            This estimates that "America's tort system imposes ... an annual "tort tax" of $9,827 on a family of four." That's approximately $2,457 per person:

                                            The Tort Tax, by Lawrence J. Mcquillan and Hovannes Abramyan, Commentary, WSJ: Economists have long understood that America's tort system acts as a serious drag on our nation's economy. Although many excellent studies have been conducted, no single work has fully captured the true total costs, both static and dynamic, of excessive litigation.

                                            The good news: We now have some reliable figures. The bad news: The costs are far higher than anyone imagined. Based on our estimates, and applying the best available scholarly research, we believe America's tort system imposes a total cost on the U.S. economy of $865 billion per year. This constitutes an annual "tort tax" of $9,827 on a family of four. ...

                                            How does the legal system extract such an astounding amount from our economy? We applied the rent-seeking theory of transfers from economic science to pick up where past studies -- including the highly regarded Tillinghast-Towers Perrin study -- leave off. We began by examining the static costs of litigation -- including annual damage awards, plaintiff attorneys' fees, defense costs, administrative costs and deadweight costs from torts such as product liability cases, medical malpractice litigation and class action lawsuits. The annual static costs, $328 billion per year, are well in excess of previous Tillinghast estimates.

                                            But $328 billion is only the beginning. After all, litigation doesn't just transfer wealth, it also changes behavior, and often in economically unproductive ways. Any true estimate of the costs of America's tort system must also include these dynamic costs of litigation -- the impact on research and development spending, the costs of defensive medicine and the related rise in health-care spending and reduced access to health care, and the loss of output from deaths due to excess liability.

                                            Consider the impact of medical liability concerns on the health-care sector. It is a well documented fact that the fear of litigation prompts doctors to engage in expensive defensive medicine..., which must be added to any comprehensive estimate of litigation costs.

                                            At the margin, higher health-care costs also reduce access to care for patients. We estimate that the additional $124 billion in liability-based health care costs adds 3.4 million Americans to the rolls of the uninsured. Uninsured people are more likely to suffer from a number of diseases and serious or even fatal conditions. Economically, the result is that more Americans are absent from the workforce and their productivity declines -- a total loss of output we estimate to be $39 billion per year.

                                            Excessive liability also hampers innovation. ... As liability costs increase, companies respond by shifting funds from research and development into fighting litigation and withholding or withdrawing products from the market. Less R&D spending means fewer new products and less innovation. ...

                                            An overly expensive liability system also increases the cost of many risk-reducing products and services, at the expense of human lives. ... Our analysis ... estimate[s] the human cost of a failure to enact reforms.

                                            Based on data from previous studies, we determined that more than 77,000 people would have been alive today and contributing to the workforce, but are not because of a failure to enact comprehensive tort reforms in the states...

                                            What we're left with, then, are annual dynamic costs of $537 billion resulting from our litigation system. Add that to the static costs of $328 billion and you arrive at the total of over $865 billion per year.

                                            In this study we do not venture to propose a specific litigation-reform agenda. But we do provide all who are concerned with this issue some hard numbers to work with. And if you're wondering who the victims are of a tort system out of control, the answer today: almost everyone.

                                            The tort law system and associated economics is not an area I know a lot about, but the opening sentence, "Economists have long understood that America's tort system acts as a serious drag on our nation's economy" brings up a question. What would the economy be like without a tort system at all? The tort system offers important protections and also offers the institutional structure needed to help capitalism function more efficiently (e.g. economic torts and competition law). I'm sure there are problems that could be fixed, i.e. eliminating the "excessive" part of litigation - as I said this is not a familiar area for me - but I find it hard to believe that the tort system itself imposes a serious drag on the economy or that most litigation can be classified as "excessive." If there was no system at all, I think we would be much worse off.

                                            The authors say they are estimating "the true total costs of "excessive litigation." But it looks to me like they estimate the cost of all litigation, not just the excessive part, however excessive might be determined. That is, they assume that all costs are excessive in their estimates. Here's how the Council of Economic Advisors handled this in a 2002 paper (the CEA uses a much better methodology for estimating the costs as compared to the methodology outlined above and arrives at lower figures):

                                            [R]ecognizing the controversy that exists about the incentive effects of tort liability in general, and punitive damages in particular, this paper will consider several scenarios. For our most cautious estimates of the size of the “litigation tax,” we make the very strong assumption that both economic (e.g., loss of wages, medical expenses) and non- economic (e.g., pain and suffering, loss of consortium, punitive) damages are currently set at an optimal level. We then consider an intermediate case that treats non- economic damages as essentially random and therefore part of the litigation tax. Finally, we consider the case in which all of the costs of the U.S. tort system are treated as economically excessive, which would result if both economic and non-economic damages were largely random and failed to provide proper incentives

                                            That brings up a second point. The article concludes by reminding us of the $865 billion dollar cost estimate. In a part I cut, there's an attempt to magnify this number by noting that "It is equivalent to the total annual output of all six New England states, or the yearly sales of the entire U.S. restaurant industry."

                                            But as noted above, that's only around $2,457 per person. And there is no estimate whatsoever of the benefits from the legal protections offered by the tort system. Certainly there are some benefits, and I can easily imagine that if there were no legal protection at all that we would each incur costs higher than (likely too large estimate of) $2,457 as people took advantage of the lack of legal protection.

                                            For these reasons, I don't think this tells us a whole lot about the net social value of the tort system. We don't know the cost of this system relative to an optimal system, e.g. if the optimal system costs $2,350 per person then the cost of the present system isn't so large, and we don't know the benefits of the present system relative to the optimal system or or relative to having no system at all (which would be optimal for some). It is also not as thorough as the CEA paper in covering the range of possible estimates due to variations in the assumptions about tax incidence, calculation of deadweight losses, the degree of excessive litigation, and so on. I don't mean to imply the CEA document is the final word, for example the EPI sees things quite differently ("[M]ost commonly alleged economic costs and impacts and ... have little or no basis in reality"), but it does appear to be on much firmer methodologically footing. But even it makes no attempt to estimate the benefits.

                                              Posted by on Tuesday, March 27, 2007 at 12:15 AM in Economics | Permalink  TrackBack (0)  Comments (42)


                                              Resale Price Maintenance and Consumer Welfare

                                              Here are sections from the transcript of a Supreme Court case about the economics of price maintenance agreements and whether they should remain illegal on a per se basis under antitrust law. The issue in this particular case is:

                                              Justices Hear Arguments About Pacts on Pricing, by Linda Greenhouse, NY Times: A 96-year-old rule that treats as an automatic antitrust violation any agreement between a manufacturer and its retailers to adhere to a minimum resale price is considered archaic and out of touch by the Bush administration and economists of the Chicago school.

                                              But it still has friends, and several of them sit on the Supreme Court. A Supreme Court argument on Monday laid to rest any expectation that the [per se] rule against “resale price maintenance” would go quietly...

                                              Continue reading "Resale Price Maintenance and Consumer Welfare" »

                                                Posted by on Tuesday, March 27, 2007 at 12:03 AM in Economics, Market Failure | Permalink  TrackBack (1)  Comments (4)


                                                Monday, March 26, 2007

                                                Daniel Gross: The Unknown Financial Superhero

                                                Daniel Gross recounts the actions of William McAdoo who "executed a series of maneuvers in the chaotic fall of 1914 that turned America into the global financial leader":

                                                The Unknown Financial Superhero, by Daniel Gross, Slate: The list of American government financial superheroes is relatively short. ... But a lively new book by New York University economist William Silber, When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America's Monetary Supremacy, makes a convincing plea for the inclusion of William McAdoo in the Dollar Pantheon. ...

                                                Silber argues, as Woodrow Wilson's Treasury secretary, McAdoo executed a series of maneuvers in the chaotic fall of 1914 that ... enabled the United States to seize the mantle of economic leadership from London. Almost a century later, the crown remains ours, if tenuously.

                                                When war broke out in Europe in the summer of 1914, the U.S. economy was still immature, a global debtor with an unloved currency that was subject to recurring panics. After a particularly nasty one in 1907, the United States decided to join the rest of the developed world and create a central bank. But by 1914, Congress and the president had yet to hammer out all the details.

                                                In the summer of 1914, panicked Europeans, who supplied much of the capital to the United States, were cashing in their U.S. stocks and bonds and dollars for gold, and repatriating the precious metal. That was bad news for U.S. securities, for the dollar, and for American banks, which didn't have enough gold to meet their commitment to redeem paper currency for hard metal. There was no Federal Reserve that could protect the dollar by raising interest rates. And J.P. Morgan, who had functioned as a sort of private Federal Reserve during his long career, had died the previous year.

                                                McAdoo, essentially devising monetary policy on the fly, sprung into action with a series of unprecedented measures. First, to stop foreigners from cashing in their U.S.-based assets for gold, he essentially ordered the New York Stock Exchange to close its doors on July 31, 1914. The NYSE would remain shut for nearly four months. Brokers were unhappy, but the draconian move halted capital flight.

                                                Next, to stop a run on the banks, he flooded the system with new currency. The Aldrich-Vreeland Act of 1908, which authorized the creation of the Federal Reserve, had established an emergency currency that banks could access in times of need. McAdoo made a big public show of chartering armored convoys to deliver gold, and then emergency currency, to the New York Subtreasury building across from the New York Stock Exchange. These actions, Silber argues, allowed banks to hold on to their supplies of gold while providing borrowers with access to capital.

                                                There was more. ...McAdoo helped orchestrate a bailout for New York City, which owed huge sums to foreign creditors. And he quickly developed the strategy that would help bring gold back into the country, thus allowing the banks to retire the emergency currency and the stock exchange to reopen. There was significant demand in Europe for U.S. agricultural commodities, especially cotton. But given the hazards of the Atlantic during wartime, shippers weren't eager to book cargoes. At McAdoo's urging, Congress in August 1914 created the Bureau of War Risk Insurance, which would allow shippers to obtain government-backed insurance for their cargoes.

                                                By the late fall of 1914, things were falling into place. The Federal Reserve Banks formally opened in November 1914. The dollar rallied against the British pound. Shipping traffic revived, and foreign buyers paid in gold, which allowed American banks to start phasing out the emergency currency. The New York Stock Exchange reopened on Dec. 12, 1914. And as the United States stuck to the gold standard and emerged as a peaceful hub of trade, the dollar gained greater, um, currency and respect. The United States, for so many years a global borrower, was well on the way to becoming a global lender. ...

                                                The final transfer of power from London to New York wouldn't come until after the war... It's also possible to make too much of the role played by any single person...

                                                Why did McAdoo triumph? Silber argues that it's because the former railroad executive, who had no formal economics education, thought like a businessman. He acted quickly and decisively, and focused on an exit strategy. Of course, McAdoo could not have succeeded without the support of President Woodrow Wilson, who happened to be his father-in-law. In March 1914, McAdoo had made one of the smartest career moves any executive can make: He got engaged to the boss's daughter.

                                                  Posted by on Monday, March 26, 2007 at 09:20 PM in Economics, Financial System | Permalink  TrackBack (0)  Comments (6)


                                                  Playing the Economics 101 Card

                                                  Let me see if I can help out in the dispute over using "Economics 101" in debates:

                                                  Economics 101, by Felix Salmon: I think we should implement a new corollary to Godwin's Law – call it McArdle's Law, after this blog entry at Free Exchange – saying that any time someone mentions "Economics 101" in a debate, they've automatically lost. The point of the Free Exchange blog is that people who criticize arguments as being "Economics 101" are generally on the wrong side of the argument. But then again, people who praise arguments as being "Economics 101" are generally equally wrongheaded...

                                                  This relates to the use of theoretical models, so think of a different kind of model, one we are all familiar with, a map.

                                                  A map showing only major arterials is like Economics 101 - it is a bare boned sketch showing only the major roads. A detailed map of a major city, say San Francisco for illustration, is like a more advanced course - it has all the major arterials and considerably more detail as well.

                                                  Which model should you use, the Economics 101 style bare-boned map showing only major roads, or the very detailed map showing each and every road and perhaps other details as well?

                                                  It depends upon the question being asked. If I want to know how to get from Los Angeles to San Francisco, if that is the question, the bare-boned map that highlights I5 and other major roads is much more useful than a map showing every road that exists between the two cities. And I probably don't need the map to show me where bus stops are, parks, underground pipes and electrical wires, population densities, or the many, many other things it would be possible to show on the map. Such detail gets in the way and obscures the path between the two cities, i.e. it makes the answer harder to find. A map showing only the major roads, or better yet just the detail I need to get from one city to the other, is best for this task.

                                                  But if I ask a different question, e.g. how to get from my house to a friend's house in the heart of the city, just showing the major roads won't do at all. I need sufficient detail to allow me to navigate smaller streets. I need a much more detailed model.

                                                  And if I ask yet a different question, e.g. how hard would it be to walk or ride a bike, then I may want to include elevations on the map, i.e. contour lines, to allow me to determine the difficulty of traversing the distance, maybe other things as well, e.g. foot and bike paths, not just roads for cars.

                                                  There is no one model to use to answer questions. A model should be detailed enough to capture all the major influences relative to the question one is trying to answer, but detail beyond that just gets in the way. A model is not an attempt to reflect every possible detail of the real world, that is far too complicated a task.

                                                  A model is an attempt to isolate and highlight the specific factors that relate to the question you are trying to answer so that we can understand why a particular phenomena exists, and how various actions might affect the outcome. Thus, for some questions, Economics 101 is all that is needed, but for other questions it won't be adequate at all.

                                                  But we shouldn't rule out the use of Economics 101 type models on a per se basis just because they are simple to use, for some questions such models are quite useful precisely because of their simplicity and transparency. Complication in and of itself is not a virtue.

                                                    Posted by on Monday, March 26, 2007 at 01:32 PM in Economics, Methodology | Permalink  TrackBack (0)  Comments (19)


                                                    Striking Health Care Fact?

                                                    Greg Mankiw says Tyler Cowen reports a striking health care fact:

                                                    Striking Health Care Fact, by Greg Mankiw: Tyler Cowen reports:

                                                    As of 2003, the average income of a French physician was estimated at $55,000; in the U.S. the comparable number was $194,000....Did I mention that health care is a labor-intensive industry? This is the major reason why French health care is cheaper than U.S. health care.

                                                    Let's take a closer look at this. According to the French Embassy:

                                                    Since the end of the 1960s, the number of doctors increased from 60,000 to more than 185,000 at the beginning of the 21st century. There are three doctors for every 1,000 habitants, which is an average ratio when compared to other Western countries.

                                                    So, there are 185,000 physicians, and, assuming the salary numbers given are correct, the difference in income between US and French physicians is $194,000 - $55,000 = $139,000. Thus, the total savings sounds like quite a bit, (185,000)($139,000) = $25,715,000,000. But, there are 62,752,136 people in France according to the CIA Factbook, so on a per capita basis the difference is only ($25,715,000,000/62,752,136), or around $410 per person.

                                                    Now, we know that

                                                    The United States spent an average of $6,102 a person on it in 2004, ... while Canada spent $3,165 a person, France $3,159, Australia $3,120 and Britain just $2,508.

                                                    So the difference in physician salaries only explains $410 of the $2,943 difference in costs (about 14% - I should acknowledge that some of these numbers are from different years, but all are during or close to 2003 so that shouldn't make much difference). Greg and Tyler may respond that they meant salaries generally, not just physicians, but that's not what is being claimed. For example, Tyler says "This is the major reason why French health care is cheaper than U.S. health care. France also spends less per unit on other inputs, such as prescription drugs," so it's clear he meant physicians alone in identifying the "major reason" for the difference in health care costs.

                                                    But why are lower physician costs a bad thing? Are Tyler and Greg saying that French physicians are not as good, i.e. that the lower salaries cause them to be of lower quality? If so, they should make that case directly and explain why health outcomes are better in France with lower quality physicians (Tyler covers this to some extent, though not the lower physician quality part, and he does note he'd like to see US physician salaries fall). If they are not making the claim that doctors in France are inferior due to the pay scale, then it seems to me they have presented yet another reason to support moving to a single-payer system - better or equal quality physicians at lower cost.

                                                    Tyler also says:

                                                    A visit to a GP's office (half of the doctors in France are GPs) had a reimbursement capped at 20 Euros, again circa 2003.  It is not hard to pay ten times that amount in the U.S.

                                                    But the French Embassy notes:

                                                    On the surface, it appears that health insurance reimburses medical care providers less in France than in other European countries. However, more than 80 percent of French people have supplemental insurance, often provided by their employers.

                                                    Finally, I found this part of the French Embassy's write-up of their system interesting:

                                                    The French government provides a number of diverse and comprehensive healthcare rights. For more than 96 percent of the population, medical care is either entirely free or is reimbursed 100 percent. The French also have the right to choose among healthcare providers, regardless of their income level. For example, they can consult a variety of doctors and specialists or choose a public, private, university or general hospital. Moreover, the waiting lists for surgeries found in other government supported healthcare systems do not exist in France. ...

                                                    The Medical care establishment is made up of three types of institutions: public hospitals, private clinics and not-for-profit healthcare. ...

                                                    Private clinics have quite a different history from public hospitals. They were started by surgeons and obstetricians and eventually evolved into private hospitals. A 1991 law requires all doctors in private clinics to share medical files with their colleagues and to create a Medical Care Commission to form evaluation procedures.

                                                    Another sector of the French healthcare system consists of not-for-profit private hospitals. These hospitals were originally denominational and currently make up 14% of the inpatient services among French Medical Care Institutions.

                                                    They are financed through endowments like public hospitals, but have the right to privacy like private clinics. The cooperation between the public and private sector in the French healthcare system is a positive feature that allows citizens to avoid waiting lists for surgeries, which are often associated with socialized medicine. Indeed, private medical care in France is particularly active in treating more than 50% of surgeries and more than 60% of cancer cases. This unique combination of government financed medical care and private medical services produces a health care system that is open to all and provides the latest in medical technology and treatment.

                                                    Update: In comments, Tyler says:

                                                    No, I didn't mean physicians' salaries alone, I meant unit prices alone.  The point is not that French doctors are worse, rather that we do not reap those cost savings simply by choosing more government intervention.

                                                    To avoid further confusion, here's more of Tyler's post:

                                                    Many people (Jon Chait also) argue that France has the best health care system in the world.

                                                    As of 2003, the average income of a French physician was estimated at $55,000; in the U.S. the comparable number was $194,000. A visit to a GP's office (half of the doctors in France are GPs) had a reimbursement capped at 20 Euros, again circa 2003. It is not hard to pay ten times that amount in the U.S.

                                                    Did I mention that health care is a labor-intensive industry? This is the major reason why French health care is cheaper than U.S. health care. France also spends less per unit on other inputs, such as prescription drugs.

                                                    Note that France still spends more than all or most other European systems, namely about 11 percent of gdp. When comparing health care outcomes, France only does slightly better than many Mediterranean countries with obviously non-enviable health care systems. It is not obvious that France does better on health care outcomes than Japan, again a country with non-enviable health care institutions. ...

                                                    It is easy to argue that the French system is better than that of the United States. But a defender of the French system must, in reality, fight "a war on two fronts"... The French system does not ... appear noticeably better than many other cheaper systems around the world. It does spend more money producing "customer satisfaction" and papering over some of the obvious inhumanities of the cheaper systems. That's why it is easy to hold up as a model. ...

                                                    If we are going to be umm...transitive here, let's have the debate where it belongs: expensive health care with marginal impact on measured health outcomes vs. saving lots of money and giving people much less in the way of health care services. I do think there is a good case for the latter, though looking toward the future I would myself prefer the former.

                                                    I might add I do favor taking action to lower doctors' wages in the United States. Letting in a greater number of qualified foreign doctors is step number one. But if we're going to criticize the U.S. system for its costliness, let's put the blame where it belongs.

                                                    I interpreted "This is the major reason" and "putting the blame where it belongs" and Greg's post as saying doctor's salaries explain the majority of the difference in costs, but Tyler apparently meant the blame should be placed more broadly.

                                                    Setting aside the debate about how different outcomes actually are, I understand the argument about comparing France to other European countries and to Japan. I haven't argued for France's system in particular myself, so in the parts of Tyler's post where he is arguing that France is not the best system in the world I think we are talking past each other to some degree - I was responding to Greg's post above which led with the point about doctor's salaries and was about France versus the U.S. alone. But I don't follow Tyler's contention in the comment that the large difference in costs between single-payer systems and the U.S. generally, or for France and the U.S. in particular, cannot be explained by differences in how the systems operate. That is likely affected to some degree by our different interpretations of what the data say about health care quality across the various systems.

                                                      Posted by on Monday, March 26, 2007 at 10:26 AM in Economics, Health Care, Policy | Permalink  TrackBack (0)  Comments (38)


                                                      Paul Krugman: Emerging Republican Minority

                                                      Paul Krugman on the declining support for the Republican Party:

                                                      Emerging Republican Minority, by Paul Krugman, Commentary, Turning Left, NY Times: Remember how the 2004 election was supposed to have demonstrated, once and for all, that conservatism was the future of American politics? I do: early in 2005, some colleagues in the news media urged me, in effect, to give up. “The election settled some things,” I was told.

                                                      But at this point 2004 looks like an aberration, an election won with fear-and-smear tactics that have passed their sell-by date. Republicans no longer have a perceived edge over Democrats on national security — and without that edge, they stand revealed as ideologues out of step with an increasingly liberal American public.

                                                      Right now the talk of the political chattering classes is a report from the Pew Research Center showing a precipitous decline in Republican support. In 2002 equal numbers of Americans identified themselves as Republicans and Democrats, but since then the Democrats have opened up a 15-point advantage.

                                                      Part of the Republican collapse surely reflects public disgust with the Bush administration. ... But polling data ... suggest that the G.O.P.’s problems lie as much with its ideology as with one man’s disastrous reign.

                                                      For the conservatives who run today’s Republican Party are devoted, above all, to the proposition that government is always the problem, never the solution. For a while the American people seemed to agree; but lately they’ve concluded that sometimes government is the solution, after all, and they’d like to see more of it.

                                                      Consider, for example ... in 1994, the year the Republicans began their 12-year control of Congress, those who favored smaller government had the edge, by 36 to 27. By 2004, however, those in favor of bigger government had a 43-to-20 lead.

                                                      And public opinion seems to have taken a particularly strong turn in favor of universal health care. Gallup reports that 69 percent of the public believes that “it is the responsibility of the federal government to make sure all Americans have health care coverage,” up from 59 percent in 2000.

                                                      The main force driving this shift to the left is probably rising income inequality. ... Interestingly, the big increase in disgruntlement over rising inequality has come among the relatively well off — those making more than $75,000 a year.

                                                      Indeed, ... the big income gains have been going to a tiny, super-rich minority. It’s not surprising, under those circumstances, that most people favor a stronger safety net — which they might need — even at the expense of higher taxes, much of which could be paid by the ever-richer elite. ...

                                                      So what does this say about the political outlook? It’s difficult to make predictions... But at this point it looks as if we’re seeing an emerging Republican minority.

                                                      After all, Democratic priorities — in particular, on health care, ... seem to be more or less in line with what the public wants.

                                                      Republicans, on the other hand, are still wallowing in nostalgia — nostalgia for the days when people thought they were heroic terrorism-fighters, nostalgia for the days when lots of Americans hated Big Government.

                                                      Many Republicans still imagine that what their party needs is a return to the conservative legacy of Ronald Reagan. It will probably take quite a while in the political wilderness before they take on board the message of Arnold Schwarzenegger’s comeback in California — which is that what they really need is a return to the moderate legacy of Dwight Eisenhower.

                                                      _________________________
                                                      Previous (3/19) column: Paul Krugman: Don’t Cry for Reagan
                                                      Next (4/2) column: Paul Krugman: Distract and Disenfranchise

                                                        Posted by on Monday, March 26, 2007 at 12:15 AM in Economics, Politics | Permalink  TrackBack (0)  Comments (62)


                                                        Rising Inequality: Does the President Feel Your Pain?

                                                        The administration admits "inequality is real," realizes the political need to appear concerned about it, but doesn't believe inequality is inherently a bad thing:

                                                        Bush Reorients Rhetoric, Acknowledges Income Gap, by Greg Ip and John D. McKinnon, WSJ (free): Until January, President Bush seldom acknowledged the widening gap between the rich and the middle class. Then, in a speech, he declared: "I know some of our citizens worry about the fact that our dynamic economy is leaving working people behind. ...Income inequality is real." He has raised the subject several times since.

                                                        This isn't a sudden change in Mr. Bush's economic philosophy, but rather a change in tactics forced by the changing political environment, say current and former administration officials and outsiders in touch with the White House.

                                                        Top White House economic officials still don't consider today's inequality -- the growing share of income going to those at the top -- an inherently bad thing; they believe it simply reflects the rising rewards accruing to society's most skilled and productive members. Nor do they see merit in various Democratic proposals to reduce inequality, such as ending Mr. Bush's tax cuts on the highest-earners, raising the minimum wage, making it easier to form unions and including labor standards in trade agreements.

                                                        But Democrats' takeover of Congress makes avoiding the issue difficult... Pushed by Treasury Secretary Henry Paulson, ... the administration is reorienting its rhetoric. ...

                                                        In his January speech, Mr. Bush cited several education initiatives he thinks are particularly important in addressing inequality -- making schools more accountable for their performance; improving math and science education; and making it easier for lower-income students to afford college.

                                                        To offset globalization's impact, the administration is pondering improvements in Trade Adjustment Assistance, a federal program to aid workers hurt by trade. That program is up for renewal this year.

                                                        But the administration hasn't yet offered any sweeping proposals to resist the market forces producing inequality -- and probably won't. Indeed, skeptics say the administration will address inequality only as much as needed to win votes in Congress, where the widespread public belief that globalization benefits only a small share of Americans has become an obstacle to Bush-backed efforts to liberalize trade and foreign investment. ...

                                                        Continue reading "Rising Inequality: Does the President Feel Your Pain?" »

                                                          Posted by on Monday, March 26, 2007 at 12:03 AM in Economics, Income Distribution, Politics | Permalink  TrackBack (0)  Comments (37)


                                                          Sunday, March 25, 2007

                                                          Summers: Policymakers Should Look Forward, Not Back

                                                          Larry Summers gives U.S. policymakers advice on how to respond to the possibility of an economic slowdown:

                                                          As America falters, policymakers must look ahead, by Lawrence Summers, Commentary, Financial Times (free): ...With clear evidence of a crisis in the subprime US housing sector, risks of its spread to other credit markets, sharp increases in market volatility, reminders of the fragility of global carry trades and signs of slowing economic growth, there is ... apprehension...

                                                          While it would be premature to predict a US recession, there are now strong grounds for predicting that the US economy will slow down very significantly in 2007. ...

                                                          Continue reading "Summers: Policymakers Should Look Forward, Not Back" »

                                                            Posted by on Sunday, March 25, 2007 at 02:06 PM in Economics, Policy | Permalink  TrackBack (0)  Comments (17)


                                                            Why Republicans are Skeptical about Global Warming

                                                            Jonathan Chait analyzes Republican opposition to the idea that global warming exists, that it is caused by humans if it does exist, and to doing anything about it:

                                                            Why the right goes nuclear over global warming, by Jonathan Chait, Commentary, LA Times: Last year, the National Journal asked a group of Republican senators and House members: "Do you think it's been proven beyond a reasonable doubt that the Earth is warming because of man-made problems?" Of the respondents, 23% said yes, 77% said no. In the year since that poll, ...[t]he U.N.'s Intergovernmental Panel on Climate Change released a study, with input from 2,000 scientists worldwide, finding that the certainty on man-made global warming had risen to 90%.

                                                            So, the magazine asked the question again last month. The results? Only 13% of Republicans agreed that global warming has been proved. As the evidence for global warming gets stronger, Republicans are actually getting more skeptical. Al Gore's recent congressional testimony on the subject, and the chilly reception he received from GOP members, suggest the discouraging conclusion that skepticism on global warming is hardening into party dogma. Like the notion that tax cuts are always good or that President Bush is a brave war leader, it's something you almost have to believe if you're an elected Republican.

                                                            How did it get this way? The easy answer is that Republicans are just tools of the energy industry. It's certainly true that many of them are. Leading global warming skeptic Rep. Joe L. Barton (R-Texas), for instance... The bottom line is that his relationship to the energy industry is as puppet relates to hand.

                                                            But the financial relationship doesn't quite explain the entirety of GOP skepticism on global warming. For one thing, the energy industry has dramatically softened its opposition to global warming over the last year, even as Republicans have stiffened theirs.

                                                            The truth is more complicated — and more depressing: A small number of hard-core ideologues (some, but not all, industry shills) have led the thinking for the whole conservative movement.

                                                            Your typical conservative has little interest in the issue. Of course, neither does the average nonconservative. But we nonconservatives tend to defer to mainstream scientific wisdom. Conservatives defer to a tiny handful of renegade scientists who reject the overwhelming professional consensus.

                                                            National Review magazine, with its popular website, is a perfect example. It has a blog dedicated to casting doubt on global warming, or solutions to global warming, or anybody who advocates a solution. Its title is "Planet Gore." The psychology at work here is pretty clear: Your average conservative may not know anything about climate science, but conservatives do know they hate Al Gore. So, hold up Gore as a hate figure and conservatives will let that dictate their thinking on the issue.

                                                            Meanwhile, Republicans who do believe in global warming get shunted aside. ...Gannett News Service recently reported that Rep. Wayne Gilchrest asked to be on the Select Committee on Energy Independence and Global Warming. House Republican leader John Boehner of Ohio refused to allow it unless Gilchrest would say that humans have not contributed to global warming. The Maryland Republican refused and was denied a seat.

                                                            Reps. Roscoe Bartlett (R-Md.) and Vernon Ehlers (R-Mich.), both research scientists, also were denied seats on the committee. Normally, relevant expertise would be considered an advantage. In this case, it was a disqualification; if the GOP allowed Republican researchers who accept the scientific consensus to sit on a global warming panel, it would kill the party's strategy of making global warming seem to be the pet obsession of Democrats and Hollywood lefties.

                                                            The phenomenon here is that a tiny number of influential conservative figures set the party line; dissenters are marginalized, and the rank and file go along with it. No doubt something like this happens on the Democratic side pretty often too. It's just rare to find the phenomenon occurring in such a blatant way.

                                                            You can tell that some conservatives who want to fight global warming understand how the psychology works and are trying to turn it in their favor. Their response is to emphasize nuclear power as an integral element of the solution. Sen. John McCain, who supports action on global warming, did this in a recent National Review interview. The technique seems to be surprisingly effective. When framed as a case for more nuclear plants, conservatives seem to let down their guard.

                                                            In reality, nuclear plants may be a small part of the answer, but you couldn't build enough to make a major dent. But the psychology is perfect. Conservatives know that lefties hate nuclear power. So, yeah, Rush Limbaugh listeners, let's fight global warming and stick it to those hippies!

                                                            The thinking may have been led by a few, but they found many willing followers. I think the influence of business in the GOP, not just the energy industry, is a factor. The fear is that any policy to address global warming will require business to implement costly changes, or, in the case of unilateral action by the U.S., reduce competitiveness causing profit to fall. Thus the policies, and even the idea the global warming exists are resisted. With Libertarians joining them based on their general opposition to any government interference, opposition has become, as Jonathan notes, part of the party's core principles.

                                                            Update: Brad DeLong says Jonathan Chait should ask a deeper question:

                                                            Why have the industry shills and the hard-core ideologues led the thinking for the whole conservative movement? They have led the thinking because the energy industry has funded them.

                                                              Posted by on Sunday, March 25, 2007 at 08:46 AM in Economics, Environment, Policy, Politics | Permalink  TrackBack (0)  Comments (75)


                                                              Coordinated Capitalism and Beyond

                                                              A review of Barry Eichengreen's The European Economy Since 1945: Coordinated Capitalism and Beyond:

                                                              Boom and Bust, by Sheri Berman, Book Review, NY Times: Postwar European history falls neatly into two periods. From 1945 to 1973, the countries of Western Europe recovered rapidly from the almost unimaginable devastation caused by World War II and then took off, growing faster than the United States and more than twice as fast as their own historical trends. From 1973 to the present, however, their economies have struggled with low growth and high unemployment...

                                                              As a result of this divided history, the so-called European model has both cheerleaders and naysayers. Social democrats and others on the left focus on the first period, applauding the continent’s ability to generate high living standards while cushioning individuals and societies from the ravages of unfettered markets. Right-wing critics and free marketeers focus on Europe’s contemporary problems, arguing that the continent’s generous welfare benefits and heavy regulation condemn it to continuing decline.

                                                              Both views contain some truth. But since the same conditions that led to success in one era have produced problems in the next, neither interpretation fully explains the story. In “The European Economy Since 1945,” Barry Eichengreen ... of Berkeley presents not only a comprehensive account of Europe’s postwar economic experience but also an important analysis of capitalist development more generally.

                                                              Drawing on his credentials as both an economist and a political scientist, Eichengreen argues that the key ... lies in recognizing that the recipe for growth varies, depending on one’s position in the economic race. In the years after 1945, Europe needed to recover from the war and catch up with the United States. This involved what economists call “extensive growth”... After the war, Europe developed a variety of institutions well suited to these tasks.

                                                              Large trade unions, employer organizations and corporatist arrangements, Eichengreen shows, helped labor-market partners reach and sustain long-term agreements to limit wage demands, ensure high levels of investment and plan for routine industrial restructuring. Unions agreed to hold down labor costs and in return were given either representation on corporate boards (Germany), influence over government planning and policy making (Sweden and France) or the ability to dole out government jobs and funds (Austria). Strong welfare states helped cement this bargain, providing workers with generous benefits to offset their wage restraint and the unemployment generated by industrial restructuring. ... And the government bureaucracies of nationalized industries helped mobilize and coordinate the resources necessary for the relatively clear-cut tasks associated with catch-up growth.

                                                              All this worked just as it was supposed to, generating prosperity across the continent. By the early 1970s, however, the potential for extensive growth had been largely exhausted. Europe’s businesses and infrastructure had been rebuilt, its labor force transferred from agriculture to manufacturing, the latest technology imported and adopted. At this point, Eichengreen says, “the continent had to ... switch from growth based on brute-force capital accumulation and the acquisition of known technologies to growth based on increases in efficiency and internally generated innovation” — that is, to “intensive growth.”

                                                              The problem, of course, was that Europe was now saddled with institutions ill suited to the creativity and flexibility that intensive growth demands. As Eichengreen puts it, “the continent’s very success at exploiting the opportunities for catch-up and convergence after World War II doomed it to difficulties thereafter.” The new situation called for flexible and mobile work relationships, technological novelty and the financing of risky ventures — none of which Europe’s postwar institutions were good at. ... (Eichengreen adds that a similar dynamic has played out in Eastern Europe, since Soviet institutions were not bad at extensive growth but awful at intensive growth.)

                                                              Eichengreen backs up his argument with reams of data and detailed examples... He reminds us that economic development calls for much more than simply the unleashing of market forces; it demands institutions capable of generating the resources, skills and relationships necessary to handle the particular economic challenges a country has to face at a particular time. And by demonstrating how institutions helpful in one era can become counterproductive in another, Eichengreen has important lessons about the future to teach both policy makers and publics.

                                                              “The European Economy Since 1945” should make readers wary of universal prescriptions for economic policy, since it shows how the fit between policies and circumstances is clearly ... important...

                                                              So what should the nations of Europe do now that the advantages of their “economic backwardness” have been fully exploited? Without settling the debate between the European model’s supporters and detractors, Eichengreen suggests that international competition is compelling Europe to abandon its distinctive model and become more flexible.

                                                              This will not be easy. Eichengreen himself stresses the difficulty of institutional change... Yet thanks to political will and creative policymaking, as Eichengreen points out, some countries on the continent, particularly the Nordic ones, have managed to adapt successfully. They are keeping themselves internationally competitive even while continuing to provide social benefits in health, education and social insurance far above American standards. Others, like France and Germany, will have to follow their lead. Otherwise, they will probably face the decline the pessimists have long been predicting.

                                                              Here's the Economist's review of the book. In the debate between the Sachs and Easterly camps over economic development, this is worth remembering:

                                                              [Eichengreen] reminds us that economic development calls for much more than simply the unleashing of market forces; it demands institutions capable of generating the resources, skills and relationships necessary to handle the particular economic challenges a country has to face at a particular time.

                                                              Update: Here is the first chapter.

                                                                Posted by on Sunday, March 25, 2007 at 12:07 AM in Economics, Social Insurance | Permalink  TrackBack (0)  Comments (74)


                                                                Saturday, March 24, 2007

                                                                Frederic Mishkin: Inflation Dynamics

                                                                If you are interested in inflation dynamics and recent research suggesting that inflation dynamics have changed, this speech by Federal Reserve governor Frederic Mishkin looks at three important questions:

                                                                1. What is the available evidence on changes in inflation persistence in recent years?
                                                                2. What is the available evidence on changes in the slope of the Phillips curve?
                                                                3. What role do other variables play in the inflation process?

                                                                The speech summarizes and interprets research on these questions, and discusses the impact of the research on the conduct of monetary policy. As I've explained before, I am in agreement with his conclusions about the role of policy in anchoring expectations and how this has changed estimated inflation dynamics, and what this implies for monetary policy and inflation targeting. Too bad my monetary theory and policy class ended last week - I can't make them read this [Update: Brad DeLong provides a nice summary of the sections discussing the role of policy in anchoring expectations]:

                                                                Inflation Dynamics, by Frederic S. Mishkin, Federal Reserve Governor: Under its dual mandate, the Federal Reserve seeks to promote both price stability and maximum sustainable employment.[1] For this reason, we at the Federal Reserve are acutely interested in the inflation process, both to better understand the past and--given the inherent lags with which monetary policy affects the economy--to try to forecast the future. We economists have made some important strides in our understanding of inflation dynamics in recent years. To be sure, substantial gaps in our knowledge remain, and forecasting is still a famously imprecise task, but our increased understanding offers the hope that central banks will be able to continue and perhaps even improve upon their successful performance of recent years.

                                                                Today, I will outline what I see as the key stylized facts that research has in recent years uncovered about changes in the dynamics of inflation and will present my view of how to interpret these findings. The interpretation has important implications for how we should think about the conduct of monetary policy and what we think might happen to inflation over the next couple of years. I will address these two issues in the final part of the talk.

                                                                Continue reading "Frederic Mishkin: Inflation Dynamics" »

                                                                  Posted by on Saturday, March 24, 2007 at 01:41 PM in Economics, Fed Speeches, Monetary Policy | Permalink  TrackBack (0)  Comments (9)


                                                                  What Conundrum?

                                                                  Mohamed A. El-Erian of the Harvard Business School and Nobel laureate in economics Michael Spence say there's nothing puzzling or hard to understand about global imbalances, declining risk spreads, flattened yield curves, and declining market volatility. However, their analysis of these changes leads them to conclude that global imbalances raise "considerable challenges, as does the ability to maintain an orderly global reconciliation process over time":

                                                                  Capital Currents, by Mohamed A. El-Erian and Michael Spence, Commentary, WSJ: For the past few years, the U.S. has generated insufficient domestic savings to cover its investment needs. The difference has been covered by large capital inflows from abroad, the counterpart of which is the much-discussed current account deficit, which has been running at unprecedented rates of 6%-7% of GDP. ...

                                                                  This has raised concerns about its sustainability, including whether it will end in a sudden and disorganized manner that sharply reduces growth in the global economy and causes problems in global capital markets. And underlying the concern is a kind of puzzlement about the configuration of global savings -- one that runs counter to virtually every text book description: The world's richest country appears to be saving at a low rate and has to borrow from poorer, developing countries to maintain its consumption and investment.

                                                                  Let's analyze this puzzle, beginning with the U.S. The financial assets of U.S. households have risen rapidly in the past 10 years, at rates well above inflation. The most dramatic increase occurred in household real estate, principally housing. At least some of these increases in asset values were not anticipated, relative to ... long-term ... savings and consumption plans... [I]t ... seems reasonable that U.S. households would consume a portion of their windfall ... over time.

                                                                  The recent shakiness in the subprime mortgage market has created uncertainty as to whether this dynamic will be sustained. ... More generally, the potential pressure on house prices could also reduce household's propensity to consume out of their accumulated equity windfall. And ... there is concern in ... capital markets that global growth could be negatively impacted.

                                                                  These concerns are worth monitoring carefully -- and they highlight a more general issue...: While individual consumption and savings decisions may have been largely rational, that does not mean that the decisions of individual households "add up" properly in the aggregate... In fact they easily might not have. ...

                                                                  [W]e can consume and invest more than output by importing more than we export -- and we did. Hence the trade deficit. However, this ability is dependent on the ability and willingness of the rest of the global economy to accommodate the US desire for higher consumption by investing in the US. That accommodation has been forthcoming from emerging economies generally, including OPEC and China, as well as from Japan.

                                                                  Their initial reaction to their improved external trade balances has been primarily to recycle the funds to the "risk free assets," U.S. Treasuries and Agencies. By financing U.S. consumption, many surplus countries are also meeting their domestic objectives, to promote exports, increase employment and build up significant reserve cushions to deal with the possibility of sudden disruptions in global capital markets.

                                                                  This constellation of conditions was largely unanticipated by both markets and policy makers, and as a result it has been reflected in a host of unusual economic and market outcomes -- referred to as conundrums, aberrations, puzzles, etc. The most visible is ... global "imbalances"; also of note is the excessive compression in risk spreads, the unusual collapse in market volatility, the inverted shape of the U.S. yield curve...

                                                                  Now to the future. Over time, emerging markets will inevitably divert more of their assets to more sophisticated investments abroad. ... One effect will surely be to put upward pressure ... on the cost of capital in the U.S., as the incremental demand for treasuries declines.

                                                                  While the shift is inevitable, it would be unlikely that the emerging economies as a group would deliberately ... undermine global economic markets. There will also be domestic pressure on policy makers in emerging countries to gradually shift their emphasis away from the producer and towards the consumer. That will mean lowering the savings rate relative to investment, increasing consumption and letting it assume a more important role (relative to exports...) in driving growth.

                                                                  Under this state of the world, domestic consumption in the rest of the world picks up over time, facilitating the needed adjustment in the U.S. The result is a gradual journey to a more normal relationship between assets and income returns, with savings moving to a more normal long-run pattern.

                                                                  But this process is not automatic and faces significant disruption risks; and it is particularly sensitive to "policy mistakes." Among these policy mistakes, protectionism measures in the U.S. would derail the global adjustment So, too, would the inability of emerging economies to navigate their complex policy challenges.

                                                                  Geopolitical shocks would also be a problem... Finally, significant "market accidents" ... associated with excessive leverage and ... sudden and large portfolio changes and credit rationing, would add to the policy complexity.

                                                                  So where does all this leave us? The current configuration of global imbalances, while highly unusual is not a real puzzle. It is the result of a series of individual decisions in both advanced and emerging economies that were largely rational when considered at the micro level. ...

                                                                  The aggregation of these decisions at the national and international levels raises considerable challenges, as does the ability to maintain an orderly global reconciliation process over time. The fundamental question, therefore, is whether these global considerations will be sufficient to minimize the risk of "policy mistakes" in a world that is subject to geo-political risk and bouts of excessive leverage.

                                                                  One thing that bothers me about this story is that it begins with a run-up in asset prices as the source of global imbalances:

                                                                  Let's analyze this puzzle, beginning with the U.S. The financial assets of U.S. households have risen rapidly in the past 10 years, at rates well above inflation. The most dramatic increase occurred in household real estate, principally housing.

                                                                  However, prices are endogenous variables, and therefore this explanation leaves the primary driving force behind the run-up in asset prices unexplained. Jim Hamilton looks at the housing market in "Bubble, bubble, toil, and trouble." His analysis is concerned with whether or not housing prices have departed from underlying fundamentals, and he doesn't believe that they have. He concludes:

                                                                  Low interest rates and rapid population and employment growth relative to the supply of available housing were the main factors driving house prices up...

                                                                  To that, Jim adds:

                                                                  The one thing to which I think I was not paying enough attention two years ago was the role of lax credit standards and even fraud ([1], [2]) in addition to low interest rates as factors fueling the boom. I have been coming around to the view that there may have been some significant market failures behind that. My first worry here is about Fannie Mae and Freddie Mac, and the second concerns whether some of our institutions have the right incentives for fund managers to properly value lower-tail risks. This ready availability of credit, over and above the low interest rates themselves, I now believe was an important factor contributing to the real estate boom.

                                                                  I would also mention regulatory restrictions as an important factor, e.g. see Edward Glaeser's on zoning regulations or Krugman on Flatlands and Zoned Zones. But many people blame (or thank) the Fed for driving interest rates so low.

                                                                  Which opens the door to "Did the Fed Do It?" from David Altig. David isn't so sure that the Fed is to blame for the escalation in housing prices:

                                                                  Did The Fed Do It?, macroblog: The ISI Group's Andy Laperriere, writing on the opinion page of yesterday's Wall Street Journal, says the answer is yes (at least in part):

                                                                  Federal Reserve officials and most economists believe the problems in the subprime mortgage market will remain relatively contained, but there is compelling evidence that the failure of subprime loans may be the start of a painful unwinding of a housing bubble that was fueled by easy money and loose lending practices...

                                                                  The ... fallout from the second major asset price bubble in the last decade should prompt some broader questions. For example, what role did the Fed's loose monetary policy from 2002-2004 play in fueling the housing bubble? Should the Federal Reserve reexamine its policy of ignoring asset bubbles?

                                                                  I know that the easy money claim has become something of a meme, but I often find myself pondering this picture:

                                                                  Interest_rates

                                                                  What's the story here?  That the long string of federal funds rate cuts beginning in January 2001 caused the decline in long-term interest rates -- including mortgage rates -- that commenced a full half-year (at least) before the first move by the FOMC?  That low levels of short-term interest rates have kept long-term rates well below their pre-recession peaks?  Then what to make of the fact that rates at the longer end of the yield curve have barely budged in the face of a 425 basis point rise in the funds rate target?  Maybe it's "long and variable lags"? Should we then be expecting that big jump in long-term rates any day now?  I guess it's still a conundrum. But maybe, then, we should be a little circumspect about the finger pointing?

                                                                  OK, here's part of the Laperriere article I can get behind:

                                                                  It's not the size of foreclosure losses as a share of the economy that matters, it is the effect those losses have on the availability of credit.

                                                                  Like I said.

                                                                  In a recent speech, Fed Chair Ben Bernanke says the Fed still has the ability to affect long-term rates:

                                                                  The empirical literature supports the view that U.S. monetary policy retains its ability to influence longer-term rates and other asset prices. Indeed, research on U.S. bond yields across the whole spectrum of maturities finds that all yields respond significantly to unanticipated changes in the Fed’s short-term interest-rate target and that the size and pattern of these responses has not changed much over time (Kuttner, 2001; Andersen and others, 2005; and Faust and others, 2006). ...

                                                                  [G]lobalization of financial markets has not materially reduced the ability of the Federal Reserve to influence financial conditions in the United States. But, ... globalization has added a dimension of complexity to the analysis of financial conditions and their determinants, which monetary policy makers must take into account.

                                                                  I'm also intrigued by David's suggestion, and hopefully more evidence can settle whether previous research has this wrong. But for now, my policy recommendations will still account for the possibility that the Fed can affect long-term rates.

                                                                    Posted by on Saturday, March 24, 2007 at 04:17 AM in Economics, Financial System, Housing, Market Failure, Monetary Policy | Permalink  TrackBack (0)  Comments (39)


                                                                    Friday, March 23, 2007

                                                                    Milton Friedman in China

                                                                    Here's another response to Paul Krugman's "Who Was Milton Friedman?" [previous response from Anna Schwartz and Edward Nelson along with and Paul Krugman's reply]:

                                                                    Milton Friedman in China, by Bertrand Horwitz, Reply by Paul Krugman, In response to Who Was Milton Friedman?: To the Editors:

                                                                    Paul Krugman's "Who Was Milton Friedman?" [NYR, February 15] is the best brief popular summary I have thus far read of the contributions of Professor Friedman, "the economist's economist" and the greatest exponent of free markets since Adam Smith as Krugman rightly contends. ...

                                                                    Friedman's contributions ... were clearly described..., but a few other important results of his influence were missed. Much has been written about his and his students' ("the Chicago Boys") impact on the significant improvement of the economy during the Chilean dictatorship, but neither Krugman nor others even in memoriam have noted Friedman's effect on Chinese economic policy at crucial periods in its development. When he first visited China in 1980 the only policy guidelines the authorities set down following the breakdown of Mao's crumbling disorder were so-called pragmatic rules: "cross the river and feel the rocks" and then "seek the truth from facts." The "river" was not named and the place to "look" was not specified. In the meetings he had with the Chinese leaders, Friedman strongly emphasized the importance of unfettered markets, pointing to China's neighbor, Hong Kong, as a model to be followed.

                                                                    This indeed, up to a point, is the road that has been taken. Again in 1988, the Chinese authorities, deeply worried by double-digit inflation which they knew undercut the Nationalists before 1949, sought his advice. Rumors had been spreading then that in Shanghai there was a run on the banks and even ordinary people were approaching foreigners with shouts of "wai hui, wai hui" (foreign exchange). The greatest spokesman for monetarism and his students had analyzed the causes of inflation in more than a dozen countries and had persuasively shown that the quantity theory of money works, that inflation indeed is a phenomenon of "too much money chasing too few goods," and that the application of price controls and rationing was a "cure" which would only worsen the situation. Friedman's advice was taken and since then China's inflation has been within a small, acceptable range.

                                                                    Further missing from Krugman's summary is Friedman's theoretical contribution to the adoption of flexible foreign exchange rates. Until his analysis, flexibility was rejected on the grounds that such rates would be unacceptably unstable because of speculation. And it was Friedman whose faith in free markets led to his promulgating the negative income tax. When families' incomes fall below a certain level, they should be sent checks, using the money as they see fit. Missing also is Friedman's contribution to statistics—a nonparametric test is named after him. Whether his contributions will stand up to the test of time remains to be seen, but as he was so fond of saying: "the proof of the pudding is in the eating." Or as Einstein similarly said about theoretical physics: "the test of truth is experience." -- Bertrand Horwitz Asheville, North Carolina

                                                                    Paul Krugman replies: I wasn't aware of the China story, and am glad to have it out there.

                                                                    I didn't bring up exchange rate policy because I don't think Friedman can be said to have made a deep intellectual contribution on the subject. Nonetheless, his advocacy of flexible rates does illustrate two of his great virtues.

                                                                    First, on this as on other issues he showed himself much less doctrinaire and much more realistic than many of his acolytes: many conservative economists are drawn to visions of a restored gold standard or a world currency, dismissing the problems such a system would create; Friedman knew better.

                                                                    Second, his famous paper on flexible rates is a masterpiece of writing, with a brilliant analogy: achieving international adjustment by changing the exchange rate, rather than by depending on thousands of firms to change their prices, is like shifting to daylight savings time, rather than depending on thousands of firms to change their working hours.

                                                                    More on the reference to "cross the river and feel the rocks" is in "Mo zhe shi tou guo he," or, "Cross the River by Groping the Stone Under Foot." A comparison of the "Beijing Consensus" with the "Washington Consensus [that] emerged from the neoliberal revolution that swept the globe with the arrival of the Thatcherite and Reaganite schools of thought and power" is part of the discussion.

                                                                      Posted by on Friday, March 23, 2007 at 05:40 PM in Economics | Permalink  TrackBack (1)  Comments (6)


                                                                      Geithner: Credit Markets Innovations and Their Implications

                                                                      New York Fed president Tim Geithner, who hasn't been shy about warning about financial risks from financial market innovation, doesn't seem too concerned that problems in the subprime mortgage market will spread and cause wider disruptions. Here's part of a longer speech:

                                                                      Credit Markets Innovations and Their Implications, by Timothy Geithner, NY Fed President: ...The latest wave of credit market innovations has elicited some concerns about their implications for the stability of the financial system, concerns similar to those associated with earlier periods of rapid change in financial markets. Will the most recent credit market innovations amplify credit cycles, contributing to "excessive" lending in times of relative stability, and then magnify the contraction in credit that follows? Will they introduce greater volatility in financial markets? Will they create greater risk of systemic financial crisis?

                                                                      These concerns have been heightened in some quarters by the problems currently being experienced in the subprime mortgage sector. It will take some time before the full implications are understood and the full impact can be assessed. As of now, though, there are few signs that the disruptions in this one sector of the credit markets will have a lasting impact on credit markets as a whole.

                                                                      Indeed, economic theory and recent practical experience offer some reassurance against both these specific concerns and more general worries about the implications of credit market innovations for the performance of the financial system. ...

                                                                      There are ... compelling arguments in favor of a generally positive assessment of the consequences of innovation. Does experience provide support for these arguments, or are these changes too new for us to know? ...

                                                                      We are now well into the third decade of experience with the consequences of these earlier innovations, and this history offers some useful lessons for evaluating the probable impact of the latest changes in credit markets.

                                                                      The ease with which the U.S. financial system absorbed the substantial scale of corporate defaults that peaked in recent years in 2002 provides some support for the argument that broader and deeper capital markets make the system more resilient. In general, there does not seem to be strong empirical support for the proposition that derivatives increase volatility in financial markets. ...

                                                                      Credit market innovation does not appear to have resulted in a large increase in leverage in the corporate sector, as some had feared. ...

                                                                      Default rates do not appear to have risen, nor recovery rates fallen as these credit innovations have spread, despite concerns they might lead to excess lending, the mis-pricing of credit risk and more messy and more complicated workouts, resulting from the greater diffusion of the investor base.

                                                                      And although the sources of the broad moderation in GDP volatility observed in the United States over the past two decades are still the subject of debate, the fact that this moderation occurred during a period of extensive innovation in credit and other financial markets should provide some comfort for those who expected the opposite.

                                                                      Innovations in credit markets are inevitably accompanied by challenges. Indeed, the history of innovation in financial markets provides many examples of periods of rapid change accompanied by fraud and abuse, by challenges in assessing value and risk, by concerns about the adequacy of investor and consumer protection, and by unexpected behavior of prices, defaults and correlations. To some degree, these types of problems are the inevitable consequence of change and innovation.

                                                                      Although recent experience as well as theory provide some reassurance..., these judgments require qualification. Some aspects of this latest wave of innovation are different in substance ... from their predecessors. ... [B]road changes in financial markets may have contributed to a system where the probability of a major crisis seems likely to be lower, but the losses associated with such a crisis may be greater or harder to mitigate.

                                                                      What should policymakers to do mitigate these risks?

                                                                      We cannot turn back the clock on innovation or reverse the increase in complexity around risk management. We do not have the capacity to monitor or control concentrations of leverage or risk outside the banking system. We cannot identify the likely sources of future stress to the system, and act preemptively to diffuse them.

                                                                      The most productive focus of policy attention has to be on improving the shock absorbers in the core of the financial system, in terms of capital and liquidity relative to risk and the robustness of the infrastructure. ...

                                                                      The Federal Reserve is actively involved in a range of efforts... The stronger these shock absorbers, the more resilient markets will be in the face of future shocks, and the more confident we can be that banks will be a source of strength and of liquidity to markets in periods of stress and that the financial system will contribute to improved economic performance over time.

                                                                      Here's more from the Fed from the last few days:

                                                                      Update: See also "Toothless Fed, Part 2 (Risk Management Shortcomings)" from Yves Smith at naked capitalism.

                                                                        Posted by on Friday, March 23, 2007 at 04:08 PM in Economics, Fed Speeches, Financial System, Monetary Policy | Permalink  TrackBack (0)  Comments (26)


                                                                        The U.S. vs. Other Systems of Health Care

                                                                        Jane Galt says:

                                                                        I have a new bloggingheads up with Jonathan Chait, during which I complained about the general tendency for health care books to engage in "argument through anecdote", where the data plays a distant second fiddle to the heartrending stories about x person who didn't get good treatment. So single-payer advocates drag out some American woman who didn't get a breast exam until it was too late, and opponents counter with the Canadian guy who died on the waiting list to see an oncologist.

                                                                        I'm sympathetic to the data-based versus anecdote point she is making, but in this case I wondered if her impression wasn't partly due to what she chooses to read. Ezra Klein comments along these lines, and he also gives some useful comparisons between the U.S. and single-payer systems - the main reason for the post:

                                                                        Arguing Health Care, by Ezra Klein: Is Megan's problem with health care writing really that the literature is too narrative-driven? Yikes. She should read some issues of Health Affairs, or the Annals of Internal Medicine, or the New England Journal of Medicine. This is not a debate that lacks for data.

                                                                        Meanwhile, Megan actually gets a few things wrong in her argument with Chait. She suggests that waiting lines are longer in Europe. That's, uh, untrue. France and Germany don't have waiting lists. Americans do, by the way, with around 40% of patients waiting one month or more for elective surgery. She then suggests that moving to a French or Canadian system would require walking back the medicine we actually provide, telling people they can't have MRIs anymore. That's similarly incorrect. Care utilization in France and Germany is as high -- and in France, higher -- than it is in America. But they pay less per unit of care. And the technology isn't radically different. Germany actually has more CT scanners per million than we do, while the French have three less. The French and the Germans both have more physicians per capita and more acute care beds. Oh, and the French and Germans pay less, and don't have 47 million uninsured.

                                                                        All this information -- and more! -- can be found in various data-heavy books on the subject, like Thomas Bodenheimer and Kevin Grumbach's wonderful Understanding Health Policy. The thing is, they tend to point towards the same conclusions Jon Cohn's book does, albeit with fewer anecdotes. One reason I spend less time arguing health care with libertarians these days is that it doesn't seem productive. If you really don't want to believe that other system's in the world are better, you won't. If the costs, outcomes, access, and equity advantages offered by the French, German, Japanese, Scandinavian, or Veteran's Affairs systems don't convince you, you simply don't want to be convinced. There are issues, like card check, where I see how the counterargument could be convincing and understand it is, to some degree, a values judgment. Health care isn't one of those issues.

                                                                        There's a bit more here.

                                                                          Posted by on Friday, March 23, 2007 at 03:39 PM in Economics, Health Care | Permalink  TrackBack (1)  Comments (27)


                                                                          William Easterly: Africa's Poverty Trap

                                                                          William Easterly has spent much of his career applying economic analysis to very poor countries:

                                                                          Africa's Poverty Trap, by William R. Easterly, Commentary, WSJ: There is a sad law I have noticed in my economics career: the poorer the country, the poorer the economic analysis applied to it. Sub-Saharan Africa, which this month marks the 50th anniversary of its first nation to gain independence, Ghana, bears this out.

                                                                          There has been progress in many areas over the last 50 years -- ... yet the same poor economics on sale to Ghana in 1957 are still there today. Economists involved in Africa then and now undervalued free markets, instead coming up with one of the worst ideas ever: state direction by the states least able to direct.

                                                                          African governments are not the only ones that are bad, but they have ranked low for decades on most international comparisons of corruption, state failure, red tape, lawlessness and dictatorship. Nor is recognizing such bad government "racist"... Instead, corrupt and mismanaged governments ... reflect the unhappy way in which colonizers artificially created most nations, often combining antagonistic ethnicities. Anyway, the results of statist economics by bad states was a near-zero rise in GDP per capita for Ghana, and the same for the average African nation, over the last 50 years.

                                                                          Why was state intervention considered crucial in 1957? Africa was thought to be in a "poverty trap," since the poor could not save enough to finance investment necessary to growth. Free markets could not get you out of poverty. The response was state-led, aid-financed investment. Alas, these ideas had already failed the laugh test... The U.S. in 1776 was at the same level as Africa today, yet it escaped the poverty trap. The same was also true for the history of Western Europe, Australia, Japan, New Zealand and Latin America. All of these escapes from poverty happened without a state-led, aid-financed "Big Push."

                                                                          In the ensuing 50 years, there have been plenty more examples of poor countries which grew rapidly without much aid -- China and India (who each receive around half a percent of income in foreign aid) being the most famous recent examples. Meanwhile, aid amounted to 14% of total income year in and year out in the average African country since independence.

                                                                          Despite these reality checks, blockbuster reports over the last two years by the U.N. Millennium Project (led by Jeffrey Sachs), Mr. Sachs again in his book "The End of Poverty," the U.N. Development Program (UNDP), the Tony Blair Commission for Africa, and the U.N. Conference on Trade and Development (Unctad) have all reached what the UNDP called "a consensus on development": Today Africa needs another Big Push. Do they really think nobody is paying attention?

                                                                          Africa's poverty trap is well covered in the media, since it features such economists as Angelina Jolie, Madonna, Bono and Brad Pitt. But even Bill Gates ... expressed indifference to Africa's stagnant GDP, since "you can't eat GDP." Mr. Gates apparently missed the economics class that listed the components of GDP, such as food.

                                                                          The World Bank and the International Monetary Fund have good economists who have criticized state intervention. Under the pressure of anti-market activists, alas, they have soft-pedaled these views lately in favor of ... U.N.-led Millennium Development Goals...

                                                                          The cowed IMF and the World Bank never mention the words "free market" in thousands of pages devoted to ending poverty. ... World Bank economists are so scared of offending anyone on Africa that they recite tautologies. The press release describing the findings of the 2006 World Bank report "Challenges of African Growth" announces: the "single most important reason" for Africa's "lagging position in eradicating poverty" ... is "Africa's slow and erratic growth." The next World Bank report may reveal that half a dozen beers has been identified as the single most important reason for a six-pack.

                                                                          Today Unctad (in its 2006 "Big Push" report) still offers to make possible government "infant-industry policies" for "small, fragmented economies" by setting up a regional market, presumably so Burkina Faso and Niger can help absorb the potential output of the Togolese automobile industry.

                                                                          Unctad lacks everything but chutzpah: All aid to Africa, it said, should be moved into a new U.N. Development Fund for Africa, to which Unctad helpfully offered its "in-house experience"... Unctad will thus permit the economics of Africa to at last "escape from ideological biases," so we can finally understand "why economic activity should not be left entirely to market forces."

                                                                          The free market is no overnight panacea; it is just the gradual engine that ends poverty. African entrepreneurs have shown what they are capable of. They have, for example, launched the world's fastest growing cell phone industry to replace the moribund state landlines. What a tragedy, therefore, that aid agencies have foisted the poorest economics in the world on the poorest people in the world for 50 years. The hopeful sign is that many independent Africans themselves are increasingly learning the economics of how to get rich, rather than of how to stay poor.

                                                                          With that attitude you almost want him to be wrong. There seems to be little love lost between Sachs and Easterly. Right or not, Sachs is clearly well-intentioned.

                                                                          A couple of comments, or questions rather about his examples in support of the free market approach to development. He says "In the ensuing 50 years, there have been plenty more examples of poor countries which grew rapidly without much aid -- China and India ... being the most famous recent examples." Are these examples of free markets at work once government stepped aside, or are they cases where the state has provided substantial direction as the big push to get the ball rolling? Should we wonder why he doesn't mention countries where the strict free-market approach has failed and paved the way for populist alternatives?

                                                                          Nobody knows for sure what the secret is to escaping poverty, and the answer may lie somewhere between the strict free-market and the heavy-handed state intervention approaches. But whatever the answer, given what we know presently, the case for a strict free-market approach is not as clear as Easterly implies.

                                                                            Posted by on Friday, March 23, 2007 at 01:15 AM in Economics | Permalink  TrackBack (1)  Comments (65)


                                                                            Jeffrey Sachs: Absent-Minded Killers

                                                                            Jeffrey Sachs wants us to stop "chasing other species off the planet":

                                                                            Absent-minded killers, by Jeffrey Sachs, Project Syndicate: ...We humans are now so aggressively fishing, hunting, logging, and growing crops in all parts of the world that we are literally chasing other species off the planet. Our intense desire to take all that we can from nature leaves precious little for other forms of life.

                                                                            In 1992, when the world's governments first promised to address man-made global warming, they also vowed to head off the human-induced extinction of other species. The Convention on Biological Diversity, agreed ... to conserve biological diversity...

                                                                            Unfortunately, like so many other international agreements, the Convention on Biological Diversity remains essentially unknown, un-championed, and unfulfilled. That neglect is a human tragedy. For a very low cash outlay - and perhaps none at all on balance - we could conserve nature and thus protect the basis of our own lives and livelihoods. We kill other species not because we must, but because we are too negligent to do otherwise.

                                                                            Consider a couple of notorious examples. Some rich countries, such as Spain, Portugal, Australia, and New Zealand, ... engage in so-called "bottom trawling". Bottom trawlers drag heavy nets over the ocean bottom, destroying ... marine species in the process. Complex and unique ecologies, most notably underground volcanoes known as seamounts, are ripped to shreds, because bottom trawling is the "low cost" way to catch a few deep sea fish species. One of these species, orange roughy, ... already is being fished to the point of collapse.

                                                                            Likewise, in many parts of the world, tropical rainforest is being cleared for pastureland and food crops. The result is massive loss of habitat and destruction of species, yielding a tiny economic benefit at a huge social cost. After cutting down a swath of rainforest, soils are often quickly leached of their nutrients... As a result, the new pastureland or farmland is soon abandoned, with no prospect for regeneration of the original forest and its unique ecosystems.

                                                                            Because these activities' costs are so high and their benefits so low, stopping them would be easy. Bottom trawling should simply be outlawed; it would be simple and inexpensive to compensate the fishing industry during a transition to other activities. Forest clearing, on the other hand, is probably best stopped by economic incentives, perhaps combined with regulatory limits. Simply restricting ... land clearing probably would not work, since farm families and communities would face a strong temptation to evade legal limits. On the other hand, financial incentives would probably succeed, because cutting down forest ... is not profitable enough to induce farmers to forego payments for protecting the land.

                                                                            Many rainforest countries ... suggest the establishment of a rainforest conservation fund by the rich countries, to pay impoverished small farmers a small amount ... to preserve the forest. A well-designed fund would slow or stop deforestation, preserve biodiversity, and reduce emissions of carbon dioxide [from] the burning of cleared forests. At the same time, small farmers would receive a steady flow of income, which they could use for micro-investments...

                                                                            [W]e should designate a global network of protected marine areas, in which fishing, boating, polluting, dredging, drilling, and other damaging activities would be prohibited. Such areas not only permit the regeneration of species, but also provide ecological benefits that spill over to neighbouring unprotected areas.

                                                                            We also need a regular scientific process to present the world with the evidence on species abundance and extinction, just as we now have such a process for climate change. Politicians don't listen very well to individual scientists, but they are forced to listen when hundreds of scientists speak with a united voice.

                                                                            Finally, the world should negotiate a new framework ... to slow human-induced climate change. There can be little doubt that climate change poses one of the greatest risks to species' viability. ...

                                                                            These measures are achievable... They are affordable, and in each case would ultimately deliver large net benefits. Most importantly, they would allow us to follow through on a global promise. It is too painful to believe that humanity would destroy millions of other species - and jeopardise our own future - in a fit of absent-mindedness.

                                                                              Posted by on Friday, March 23, 2007 at 12:15 AM in Economics, Environment, Regulation | Permalink  TrackBack (0)  Comments (27)


                                                                              Reagan: The Great Taxer (Updated)

                                                                              Continuing with "Don’t Cry for Reagan," for those still battling this one out, here's more Reagan versus Bush:

                                                                              The Great Taxer, by Paul Krugman, Commentary, NY Times, June 2004: Over the course of this week we'll be hearing a lot about Ronald Reagan, much of it false. A number of news sources have already proclaimed Mr. Reagan the most popular president of modern times. In fact, though Mr. Reagan was very popular in 1984 and 1985, he spent the latter part of his presidency under the shadow of the Iran-Contra scandal. Bill Clinton had a slightly higher average Gallup approval rating, and a much higher rating during his last two years in office.

                                                                              We're also sure to hear that Mr. Reagan presided over an unmatched economic boom. Again, not true: the economy grew slightly faster under President Clinton, and, according to Congressional Budget Office estimates, the after-tax income of a typical family, adjusted for inflation, rose more than twice as much from 1992 to 2000 as it did from 1980 to 1988.

                                                                              But Ronald Reagan does hold a special place in the annals of tax policy, and not just as the patron saint of tax cuts. To his credit, he was more pragmatic and responsible than that; he followed his huge 1981 tax cut with two large tax increases. In fact, no peacetime president has raised taxes so much on so many people. This is not a criticism: the tale of those increases tells you a lot about what was right with President Reagan's leadership, and what's wrong with the leadership of George W. Bush.

                                                                              The first Reagan tax increase came in 1982. By then it was clear that the budget projections used to justify the 1981 tax cut were wildly optimistic. In response, Mr. Reagan agreed to a sharp rollback of corporate tax cuts, and a smaller rollback of individual income tax cuts. Over all, the 1982 tax increase undid about a third of the 1981 cut; as a share of G.D.P., the increase was substantially larger than Mr. Clinton's 1993 tax increase.

                                                                              The contrast with President Bush is obvious. President Reagan, confronted with evidence that his tax cuts were fiscally irresponsible, changed course. President Bush, confronted with similar evidence, has pushed for even more tax cuts.

                                                                              Mr. Reagan's second tax increase was also motivated by a sense of responsibility — or at least that's the way it seemed at the time. I'm referring to the Social Security Reform Act of 1983, which followed the recommendations of a commission led by Alan Greenspan. Its key provision was an increase in the payroll tax that pays for Social Security and Medicare hospital insurance.

                                                                              For many middle- and low-income families, this tax increase more than undid any gains from Mr. Reagan's income tax cuts. In 1980, according to Congressional Budget Office estimates, middle-income families with children paid 8.2 percent of their income in income taxes, and 9.5 percent in payroll taxes. By 1988 the income tax share was down to 6.6 percent — but the payroll tax share was up to 11.8 percent, and the combined burden was up, not down.

                                                                              Nonetheless, there was broad bipartisan support for the payroll tax increase because it was part of a deal. The public was told that the extra revenue would be used to build up a trust fund dedicated to the preservation of Social Security benefits, securing the system's future. Thanks to the 1983 act, current projections show that under current rules, Social Security is good for at least 38 more years.

                                                                              But George W. Bush has made it clear that he intends to renege on the deal. His officials insist that the trust fund is meaningless — which means that they don't feel bound to honor the implied contract that dedicated the revenue generated by President Reagan's payroll tax increase to paying for future Social Security benefits. Indeed, it's clear from the arithmetic that the only way to sustain President Bush's tax cuts in the long run will be with sharp cuts in both Social Security and Medicare benefits.

                                                                              I did not and do not approve of President Reagan's economic policies, which saddled the nation with trillions of dollars in debt. And as others will surely point out, some of the foreign policy shenanigans that took place on his watch, notably the Iran-contra scandal, foreshadowed the current debacle in Iraq (which, not coincidentally, involves some of the same actors).

                                                                              Still, on both foreign and domestic policy Mr. Reagan showed both some pragmatism and some sense of responsibility. These are attributes sorely lacking in the man who claims to be his political successor.

                                                                              Update: Email brings approval ratings for Bush, Nixon, Clinton, and Reagan (click on figure for larger version):

                                                                              Presapprov

                                                                                Posted by on Friday, March 23, 2007 at 12:09 AM in Budget Deficit, Economics, Politics, Taxes | Permalink  TrackBack (0)  Comments (21)


                                                                                Thursday, March 22, 2007

                                                                                Want Tax Cuts? Then Pay for Them

                                                                                Jared Bernstein looks at the differences between the president's budget proposal and the House Budget Committee's proposal for spending and revenue:

                                                                                Show us the money, by Jared Bernstein, Comment is Free: Well, with both the Democratic House and Senate having weighed in on President Bush's 2008 federal budget, the battle lines are taking clear shape.

                                                                                Today, the House Budget Committee released its mark-up of the budget resolution, a document that sets broad budgetary outlines and preferences - on spending and revenue targets... In this case, there are some clear lines of demarcation from the president's budget that are worth noticing.

                                                                                First, on the so-called sunset clause under which the president's tax cuts are due to expire in 2011: they say, if you want to cut taxes, you've got to find the money. (This idea is called pay-as-you-go, or paygo). And second, in some key areas of domestic programmes, most notably healthcare for poor kids, where Bush cuts, the House and Senate Democrats spend.

                                                                                The part of all this that is sure to get the most attention is the expiration of the Bush tax cuts enacted in 2001 and 2003. Though it's fair to say conservatives never intended for the sun to set, to sell the cuts they had to build in their demise by the end of the decade. Now they go around saying that allowing the cuts to expire would amount to a massive tax increase.

                                                                                But since it would take new legislation to extend the cuts, Democrats legitimately make the case that to do so would be to enact yet another round of tax cuts. Which brings us to the second point: paygo. ... [P]ay-as-you-go ... mean[s] that any tax cut must be offset with either a tax increase or a cut in entitlement spending. ... But beyond that, it means the tax-cut zombies have a new, big problem.

                                                                                For years, they have been able to ignore the fiscal implications of their massive tax cuts. They could wave hands and argue that the cuts would pay for themselves ... (even when their own agencies were submitting reports saying that wouldn't happen). Or they could simply ignore the fact that both current (the wars in Iraq and Afghanistan) and looming (healthcare) expenses were going to lead to large and damaging deficits.

                                                                                In other words, as long as the grown-ups are away, you can have all the guns and butter you want. Well, paygo means the grown-ups are back in the room.

                                                                                Bush and the Republican minority are starting to get really fired up about all this and are accusing the Democrats of massive tax increases. But ..., if Bush and the Republicans want to extend the cuts, they are going to need to find the money.

                                                                                Which bring us to a final point. The president does go after entitlements, cutting them by $52bn over five years, and the Democrats are already taking flak for not joining him there. But here's why that is not fair: before this budget discussion even started, the White House ruled out any tax increases to pay for spending priorities.

                                                                                Under these conditions, the Democrats have to fight their way out of a tight box. Even with the sunsets, vital public healthcare spending will ultimately have to fall. In fact, the president's budget threatens health coverage to more than 1 million children by 2012.

                                                                                With this resolution, they are essentially saying they are going to take the revenue from the expiring cuts and spend it on their priorities, which include expanding the very child healthcare programme the president is cutting... You want to cut more taxes? Show us the money...

                                                                                And, from the Center on Budget and Policy Priorities today, "Key Argument Against Applying Pay-As-You-Go To Tax Cuts Does Not Withstand Scrutiny" which will make it even harder for Republicans to argue against the need to pay for any further tax cuts.

                                                                                I worry that deficit hawkishness will cause the deficit numbers themselves will take precedence over the programs they represent, i.e. that the desire to show progress on the budget deficit will lead to unwise cuts in necessary programs. The current deficit isn't a problem, it's the long-term outlook that we need to worry about, and focus on current deficit numbers is more for show than for real budgetary dough.

                                                                                There are political gains to be made from deficit reduction in the short-run, and certainly a return of discipline is needed after the excesses of the last few years, but we need to be careful how we go about resolving projected budgetary imbalances and keep in mind that the long-run is the focus. I have much more confidence that Democrats will exercise sound judgment than I do for Republicans, e.g. not cutting taxes on the wealthy if it means giving up health care for children. On this point, Jared Bernstein notes:

                                                                                True, [Democrats] are keeping mum on big forthcoming budgetary constraints. But when the powers that be are ready to entertain the possibility that there are other ways to deal with the challenge of entitlements - specifically healthcare - than cutting them, the Democrats will come back to the table.

                                                                                  Posted by on Thursday, March 22, 2007 at 02:30 PM in Budget Deficit, Economics, Taxes | Permalink  TrackBack (0)  Comments (12)


                                                                                  The Fed's View of the Sub-Prime Mortgage Market

                                                                                  Robert Reich comments on the problems in the sub-prime mortgage market:

                                                                                  The Fed and the Sub-Prime Lending Debacle, by Robert Reich: What the Fed does or fails to do has more effect on the nation’s poor than any other policy making body. When the Fed decides to fight inflation by raising interest rates and cooling the economy, it’s the poor who are the first to be drafted into the inflation fight because their jobs are the most tenuous, and they’re the first to lose them. When the Fed decides to ease up and reduce rates, it’s the poor who are among the first to get the new jobs because employers who are most likely to hire at the start are small service businesses offering jobs at the bottom rungs of the wage scale. The best example of this occurred in the late 90s, when Alan Greenspan bucked conventional economic wisdom and decided that the economy could safely grow fast enough that unemployment dropped to around 4 percent. The result was to create more jobs for people in the bottom fifth of the income ladder – whose total income therefore began to rise for the first time in decades.

                                                                                  But the Fed affects the poor in another way, too. It determines their access to credit. And here as well, the Fed's decisions can either be a great boon to poorer Americans or a huge curse, depending on how responsibly the Fed manages the credit markets. In this respect, it’s done a lousy job in recent years. In the early 2000s, rates were so low that banks didn’t know what to do with all the extra money they had on hand. But instead of keeping an eye on bank lending standards, the Fed looked the other way. The result: Credit standards were disregarded in a tidal wave of sub-prime lending to the poor home buyers – often without down payments, often with mortgage interest rates that would rise if and when the prime rate went upward. Then what happened? The Fed raised short-term rates seventeen consecutive times, catching poor borrowers in the very trap the Fed allowed banks to set for them. So now millions of poorer Americans face foreclosures on their homes, and sub-prime lenders are in trouble.

                                                                                  Will anyone hold the Fed responsible? Answer: No. Does anyone know how to hold the Fed responsible? Answer: No.

                                                                                  See also "Does Debt Get Enough Credit?" for my views on this, and "Regulation of Mortgage Markets" for a summary and analysis of the regulatory structure. [Update: Tanta at Calculated Risk also comments in Cole Testimony: Cui Bono?, "I want to point out ... the one place in this document where I think the Fed has really drunk a little of the Kool Aid."]

                                                                                  We've all been critical of regulators to one degree or another, so I should let the Fed defend itself. This is testimony from Roger Cole, the Federal Reserve's Director of Banking Supervision and Regulation given today before the Senate Committee on Banking, Housing, and Urban Affairs:

                                                                                  Mortgage markets, by Roger T. Cole, Federal Reserve: Introduction Chairman Dodd, Ranking Member Shelby, members of the Committee, I appreciate the opportunity to discuss mortgage lending, the recent rise in mortgage delinquency and foreclosure rates, particularly in the subprime sector, and the Federal Reserve’s supervisory response.

                                                                                  The Federal Reserve is concerned about recent developments in mortgage markets and has been closely monitoring the effects of these developments on the financial health of mortgage borrowers and lending institutions. Regarding safety and soundness of the banking system, less than half of subprime loans have been originated by federally regulated banking institutions. To date, the deterioration in housing credit has been focused on the relatively narrow market for subprime, adjustable-rate mortgages, which represent fewer than one out of ten outstanding mortgages. Borrower performance deterioration in the subprime market has been concentrated in loans made very recently, especially those originated in late 2005 and 2006, and problems in those loans started to become apparent in the data during the latter half of 2006.

                                                                                  As in past credit cycles, market investors and lenders have begun to implement more appropriate underwriting standards and to change their risk profiles. Some borrowers are clearly experiencing significant financial and personal challenges, and more subprime borrowers may join these ranks in the coming months. We are mindful that any action we take should not have the unintended consequence of limiting the availability of credit to borrowers who have the capacity to repay. I will shortly offer some suggestions to address these challenges, including the potential for lenders to work with troubled borrowers.

                                                                                  We know from past cycles that credit problems in one segment of the economy can disturb the flow of credit to other segments, including to sound borrowers, creating the potential for spillover effects in the broader economy. Nevertheless, at this time, we are not observing spillover effects from the problems in the subprime market to traditional mortgage portfolios or, more generally, to the safety and soundness of the banking system.

                                                                                  Subprime lending has grown rapidly in recent years and has expanded homeownership opportunities for many individuals. It is important to ensure that these gains are not eroded by the recent increase in delinquencies and foreclosures in the subprime market. It is especially important to preserve homeownership for the many low- and moderate-income borrowers who have only recently been able to achieve the goal of owning a home.

                                                                                  Later in my testimony, I will discuss the recent activity in mortgage markets and the possible causes for the increases in delinquencies and foreclosures in the subprime market. I will discuss the Federal Reserve’s ongoing efforts as a banking supervisor to ensure that the institutions we supervise are managing their mortgage lending activities in a safe and sound manner, including assessing the repayment capacity of borrowers.  ...

                                                                                  I will also discuss our efforts in the area of consumer protection, including guidance to ensure that lenders provide consumers with clear and balanced information about the risks and features of loan products at a time when the information is most useful, before a consumer has applied for a loan. The Federal Reserve Board has significant responsibilities as a rule writer for several consumer protection laws, and I will discuss our efforts to date to improve the effectiveness of our regulations in this area as well as our plans to continue this work in the near and longer term.

                                                                                  Continue reading "The Fed's View of the Sub-Prime Mortgage Market" »

                                                                                    Posted by on Thursday, March 22, 2007 at 12:34 PM in Economics, Financial System, Housing, Regulation | Permalink  TrackBack (0)  Comments (23)


                                                                                    The Wasted Lunch

                                                                                    Tyler Cowen argues against single-payer health insurance:

                                                                                    Abolishing the Middlemen Won't Make Health Care a Free Lunch, by Tyler Cowen, Economic Scene, NY Times: Proponents of single-payer national health insurance note that private health insurance has overhead costs of 10 to 25 percent of expenditures. Medicare, by contrast, has overhead costs of about 2 to 3 percent, and socialized European health care systems generally have low overhead costs as well. That is why single-payer supporters claim that we can save money by substituting government for private insurance. But this would shift overhead costs, not reduce them.

                                                                                    The monitoring, marketing and overhead costs of private insurance are what allow more expensive medical treatments through the door. It is precisely because competing insurance companies spend money evaluating the appropriateness of claims that they are willing to pay for so many heart bypasses, extra tests, private hospital rooms and CT scans. ...

                                                                                    European systems are relatively good at providing prenatal care or mending someone hit by a car. Few people would try to get these services unless they were really needed. No one but an expectant mother, for instance, will show up for a prenatal checkup; nor would excess prenatal checkups cost a great deal. The unwillingness of European systems to spend on overhead means they will do best specializing in these kinds of services.

                                                                                    Health insurers cannot just offer expensive tests, technologies, hospital rooms and surgeries for older patients for the taking. Doctors will too often recommend these services and receive reimbursement, even to the point of financial abuse. Medicare has this problem to some extent.

                                                                                    When it comes to these discretionary benefits, European systems are more likely to make people wait for them, more likely to make the service inconvenient or uncomfortable, or simply not make the services available in the first place. All of these features discourage those who don’t really need care, and, of course, some people simply go elsewhere and pay out of their own pockets. Either way, the overhead costs have been shifted onto patients and their families.

                                                                                    On average, European systems are relatively good for the young, who are generally healthy and need treatment for obvious accidents and emergencies, with transparent remedies. European systems are less effective for the elderly, the primary demanders of discretionary medical benefits. ...

                                                                                    American citizens could, if they wanted, replicate many features of Canadian and European systems, but in the private sector. They, or their employers, could join stringent but cheap managed care plans. Health maintenance organizations were popular 15 years ago, but Americans didn’t like being told that they couldn’t have a treatment, or that they would have to wait. That experience showed that Americans are willing to pay for insurance company overhead costs, if it means they sometimes get more in return.

                                                                                    Private insurance also provided earlier access to prescription drugs ... for 20 years or more before Medicare did. The competition among private insurers may appear wasteful, but over time it stimulates better and more complete coverage.

                                                                                    Nor are Canadian and European health care systems as cheap as they look. Measuring health care expenditures as a share of national income does not count waiting costs or the lack of availability of many advanced technologies and treatments. ...

                                                                                    As ... populations age and the value of medical technology grows, the overhead costs of private insurance will prove an increasingly wise investment. ... In the long run, the hidden and indirect costs of single-payer systems are harder to measure and thus are ultimately harder to control.

                                                                                    Middlemen and marketing costs have long been viewed with suspicion by critics of commerce. But these practices are usually signs of market sophistication, not waste. The gains from abolishing private insurance and its overhead costs are an illusion. TANSTAAFL, or "There Ain’t No Such Thing as a Free Lunch."

                                                                                    But TISATAAWL, or "There is such a thing as a wasted lunch," a lunch someone else could have eaten had it not been tossed in the trash.

                                                                                    Here are a few quotes in rebuttal from Paul Krugman who has written quite a bit about this. Quite a few resources are wasted simply fighting over who pays the bills, and in marketing and underwriting policies (while some of the overhead costs would be shifted to the private sector as noted above, there are still substantial savings from eliminating waste). Here's one estimate of what could be saved by switching to a single-payer system:

                                                                                    McKinsey & Company ... recently released an important report dissecting the reasons America spends so much more on health care than other wealthy nations. One major factor is that we spend $98 billion a year in excess administrative costs, with more than half ... accounted for by marketing and underwriting - costs that don't exist in single-payer systems. ... To put these numbers in perspective: McKinsey estimates the cost of providing full medical care to all of America's uninsured at $77 billion a year.

                                                                                    Another consideration is the savings that come from preventive care, something single-payer insurers have an incentive to provide, but private insures do not:

                                                                                    Americans spend more on health care per person than anyone else... Yet we have the highest infant mortality and close to the lowest life expectancy of any wealthy nation. How do we do it?

                                                                                    Part of the answer is that our fragmented system has much higher administrative costs than ... the rest of the advanced world. ... In addition, insurers often refuse to pay for preventive care ... because [the] long-run savings won’t necessarily redound to their benefit.

                                                                                    What about cost control from spending money on overhead, one of the benefits cited above from the up to 25% spent on overhead costs?:

                                                                                    [T]o get health reform right, we'll have to overcome wrongheaded ideas as well as powerful special interests. For decades we've been lectured on the evils of big government and the glories of the private sector. Yet health reform is a job for the public sector, which already pays most of the bills directly or indirectly and sooner or later will have to make key decisions about medical treatment. ...

                                                                                    Consider what happens when a new drug or other therapy becomes available. Let's assume that the new therapy is more effective ... than existing therapies ..., but that the advantage isn't overwhelming. On the other hand, it's a lot more expensive... Who decides whether patients receive the new therapy? We've traditionally relied on doctors to make such decisions. But ..., the high-technology nature of modern medical spending has given rise to a powerful medical-industrial complex that seeks to influence doctors' decisions. ...[D]rug companies in particular spend more marketing their products to doctors than they do developing those products ... They wouldn't do that if doctors were immune to persuasion.

                                                                                    So if costs are to be controlled, someone has to act as a referee on doctors' medical decisions. During the 1990's it seemed, briefly, as if private H.M.O.'s could play that role. But then there was a public backlash. It turns out that even in America, with its faith in the free market, people don't trust for-profit corporations to make decisions about their health.

                                                                                    Despite the failure ... to control costs with H.M.O.'s, conservatives continue to believe that the magic of the private sector will provide the answer. ... [I]s giving individuals responsibility for their own health spending really the answer to rising costs? No.

                                                                                    For one thing, insurance will always cover the really big expenses. We're not going to have a system in which people pay for heart surgery out of their health savings accounts and save money by choosing cheaper procedures. And that's not an unfair example. The Brookings study puts it this way: "Most health costs are incurred by a small proportion of the population whose expenses greatly exceed plausible limits on out-of-pocket spending."

                                                                                    Moreover, it's neither fair nor realistic to expect ordinary citizens to have enough medical expertise to make life-or-death decisions about their own treatment. A well-known experiment ... carried out by the RAND Corporation... found that when individuals pay a higher share of medical costs out of pocket, they cut back on necessary as well as unnecessary health spending. ... Eventually, we'll have to accept the fact that there's no magic in the private sector, and that health care - including the decision about what treatment is provided - is a public responsibility.

                                                                                    Next, what about the comparison to to other countries, are waiting times, etc. as bad as implied?

                                                                                    ...Employment-based health insurance is the only serious source of coverage for Americans too young to receive Medicare and insufficiently destitute to receive Medicaid, but it's an institution in decline. ... The funny thing is that the solution - national health insurance ... - is obvious. But to see the obvious we'll have to overcome pride - the unwarranted belief that America has nothing to learn from other countries - and prejudice - the equally unwarranted belief, driven by ideology, that private insurance is more efficient than public insurance. Let's start with the fact that America's health care system spends more, for worse results, than that of any other advanced country. In 2002 the United States spent $5,267 per person on health care. Canada spent $2,931; Germany spent $2,817; Britain spent only $2,160. Yet the United States has lower life expectancy and higher infant mortality than any of these countries.

                                                                                    But don't people in other countries sometimes find it hard to get medical treatment? Yes ..., but so do Americans. ... The journal Health Affairs recently published ... a survey of the medical experience of "sicker adults" in six countries, including Canada, Britain, Germany and the United States. ... It's true that Americans generally have shorter waits for elective surgery ... although German waits are even shorter. But Americans ... find it harder ... to see a doctor when we need one, and our system is more, not less, rife with medical errors. Above all, Americans are far more likely than others to forgo treatment because they can't afford it. ...

                                                                                    And also:

                                                                                    The authors of the study compared the prevalence of such diseases as diabetes and hypertension in Americans 55 to 64 years old with ... a comparable group in England. Comparing us with the English isn't a choice designed to highlight American problems: Britain spends only about 40 percent as much per person on health care..., ... Moreover, England isn't noted either for healthy eating or for a healthy lifestyle.

                                                                                    Nonetheless, the study concludes that "Americans are much sicker than the English."... What's ... striking is that being American seems to damage your health regardless of your race and social class. That's not to say that class is irrelevant. ... In fact, there's a strong correlation within each country between wealth and health. But Americans are so much sicker that the richest third of Americans is in worse health than the poorest third of the English. ...

                                                                                    Finally:

                                                                                    [I]nsurance companies ... devote a lot of effort and money to screening applicants... This screening process is the main reason private health insurers spend a much higher share of their revenue on administrative costs than do government insurance programs like Medicare, which doesn't try to screen anyone out. ... [P]rivate insurance companies spend large sums not on providing medical care, but on denying insurance to those who need it most. What happens to those denied coverage? Citizens of advanced countries ... don't believe that their fellow citizens should be denied essential health care because they can't afford it. And this belief in social justice gets translated into action... Some ... are covered by Medicaid. Others receive "uncompensated" treatment, ... paid for either by the government or by higher medical bills for the insured. ...

                                                                                    At this point some readers may object that I'm painting too dark a picture. After all, most Americans ... have private health insurance. So does the free market work better than I've suggested? No: to the extent that we do have a working system of private health insurance, it's the result of huge though hidden subsidies. ...

                                                                                    I'm not an opponent of markets. ... I've spent a lot of my career defending their virtues. But the fact is that the free market doesn't work for health insurance, and never did. All we ever had was a patchwork, semi-private system supported by large government subsidies. That system is now failing. And a rigid belief that markets are always superior to government programs - a belief that ignores basic economics as well as experience - stands in the way of rational thinking about what should replace it.

                                                                                    For more, see the links here. Single-payer isn't perfect, but all things considered it's the better solution.

                                                                                      Posted by on Thursday, March 22, 2007 at 12:41 AM in Economics, Health Care | Permalink  TrackBack (3)  Comments (102)


                                                                                      Regulation of Mortgage Markets

                                                                                      Has regulatory oversight of mortgage markets been too lenient?:

                                                                                      Regulators Scrutinized In Mortgage Meltdown, by Greg Ip and Damian Paletta, WSJ: The well-publicized woes in the business of subprime mortgages ... are raising a big question: Are regulators partly to blame?

                                                                                      Federal regulators over the past decade issued rules to tighten standards for making loans to borrowers with blemished credit or low incomes. Yet standards still declined and the volume of loans surged in the past two years.

                                                                                      One reason: Changes ... have moved large swaths of subprime lending from traditional banks to companies outside the jurisdiction of federal banking regulators. In 2005, 52% of subprime mortgages were originated by companies with no federal supervision... Another 25% were ...[only] indirectly supervised by the Federal Reserve...

                                                                                      "What is really frustrating about this is [federal regulators] don't have enforcement authority to do anything with these state-licensed, stand-alone mortgage lenders," says Fed Reserve Governor Susan Bies.

                                                                                      Yet even where federal regulators have jurisdiction, they sometimes have been slow to grapple with the explosive growth in especially risky practices and quick to shield federally regulated banks... The underlying belief, shared by the Bush Administration, is that too much regulation would stifle credit for low-income families, and that capital markets and well-educated consumers are the best way to curb unscrupulous lending.

                                                                                      The industry argues the system is working. "Market discipline in this industry is swift, can be severe, and is more effective in changing lending practices than any potential changes in regulation," says Doug Duncan, chief economist at the Mortgage Bankers Association. ... Consumer advocates counter that families have been losing their homes and savings to excessively burdensome loans for years. ...

                                                                                      "Perhaps we all should have done something earlier and faster," says Sheila Bair, ... chairman of the Federal Deposit Insurance Corp. ... "Early on, regulators didn't see extensive consumer complaints and credit distress," she adds, noting that rising home prices masked some of the problems. ...

                                                                                      There is widespread agreement that the biggest shortcoming in the regulation of mortgages is the patchwork of state and federal oversight. Amid rapid evolution in industry practice, the system leaves many market segments barely supervised, and some supervised by multiple regulators.

                                                                                      Lenders that aren't federally regulated are generally state-licensed. But many state regulators lack the resources and mandates of their federal counterparts. Some of the biggest subprime blowups have happened in California. The home-state regulator, the California Department of Corporations, has 25 examiners to oversee more than 4,800 state-licensed lenders, including many of the country's largest subprime companies. By comparison, San Francisco-based Wells Fargo & Co. alone has 34 examiners from the federal Office of the Comptroller of the Currency [OCC] and the equivalent of 12 Fed examiners assigned to it.

                                                                                      Federal regulators, meanwhile, have tended to focus more on the solvency of the institutions they oversee and less on individual consumer complaints. ...

                                                                                      Public disciplinary actions by federal bank regulators are rare. ... Federal regulators say they spot and correct problems quietly during the examination process before they reach the point where public enforcement action is needed.

                                                                                      Regulators appointed by President Bush often have been more sympathetic to industry concerns about red tape than their Clinton administration predecessors. When James Gilleran, a former California banker and bank supervisor, took over the OTS in December 2001, he became known for his deregulatory zeal. At one press event in 2003, several bank regulators held gardening shears to represent their commitment to cut red tape for the industry. Mr. Gilleran brought a chain saw.

                                                                                      He also early on announced plans to slash expenses to resolve the agency's deficit; 20% of its work force eventually left. ...[H]is successor, Mr. Reich, a former community banker, has reversed many of Mr. Gilleran's cuts. Citing "understaffing," he hired 80 examiners last year and plans to add 40 more this year. ...

                                                                                      Last fall federal bank regulators, at the urging of consumer groups and after extensive debate, proposed standards on "nontraditional mortgages" that they thought would compel banks to make "teaser" loans only to consumers who could pay the highest interest. ... However, with the subprime market already imploding, some bankers and regulators worry the new guidance could boost defaults by making it harder for strapped borrowers to refinance.

                                                                                      Recent events have prompted regulators to join the industry in calling for national laws to oversee the mortgage market. "Congress needs to seriously consider a national anti-predatory lending law that would apply to all mortgage lenders," said Ms. Bair. Ms. Bies shares that view, but also warns enforcement powers are needed. ...

                                                                                        Posted by on Thursday, March 22, 2007 at 12:33 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (15)


                                                                                        Wednesday, March 21, 2007

                                                                                        The FOMC Holds Target Rate at 5.25%

                                                                                        No surprise, the Fed left the target rate at 5.25%. The statement says:

                                                                                        Continue reading "The FOMC Holds Target Rate at 5.25%" »

                                                                                          Posted by on Wednesday, March 21, 2007 at 11:45 AM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (5)


                                                                                          Does Debt Get Enough Credit?

                                                                                          David Leonhardt on our love-hate relationship with debt:

                                                                                          Once Again, Debt Is Miscast as the Villain, by David Leonhardt, NY Times: Later this year, the National Film Preservation Foundation is going to re-release a silent movie from 1912 called “The Usurer’s Grip.” It’s a cautionary tale about borrowed money that revolves around the Jenkses, a fictional middle-class family who need a $25 loan so their young daughter can be treated for consumption. After a loan shark tricks Mr. Jenks into borrowing at an interest rate of 180 percent, the family is brought to the brink of ruin. ...

                                                                                          Just like the Jenkses, thousands of families have recently fallen sway to the sweet promises of moneylenders. Today’s version of the story typically involves a house that a buyer couldn’t actually afford or a refinanced mortgage that had a devil lurking in the fine print. As everyone knows by now, delinquencies and foreclosures have started rising, and they will certainly rise further. ...

                                                                                          Now, a lot of people are saying that the economy is finally going to pay the price for its spendthrift ways. Which, when you stop and think about it, is roughly the same warning we have been hearing since at least 1912.

                                                                                          Americans have a very strange relationship with debt. We seem to take on more of it than any other society ever has, but, boy, do we like to beat ourselves up about it. Benjamin Franklin implored his fellow citizens, for the sake of their own independence, not to become “a slave to the lender.” ...

                                                                                          [I]t’s important to remember that the mortgage market is following a classic cycle that nearly every other form of consumer credit has also followed. When somebody comes up with an innovation, be it consumer loans, credit cards or creative mortgages, it inevitably leads to an explosion of borrowing that includes a good amount of excess and downright abuse. After the abuse is cleaned up, though, most families end up better off.

                                                                                          That’s what I find so appealing about “The Usurer’s Grip.” It came out at a time very much like today, when the excesses were becoming so obvious that they obscured almost everything else. The producer of the movie was ... Arthur Ham, ... arguably the Progressive movement’s leading crusader against the consumer-loan business, according to Lendol Calder, ... an expert on debt. To Mr. Ham, moneylenders were “sharks, leeches and remorseless extortioners” with “an arrogant disregard of human rights.”

                                                                                          And some clearly were. But Mr. Ham didn’t really distinguish between the true sharks and the lenders who were in fact selling a useful new product, namely loans for ordinary families. To him, anyone charging a higher interest rate than banks then charged businesses (6 percent) was a crook.

                                                                                          This, Mr. Calder argues, made the message of the movie “more wrong than right.” Mr. Ham himself came to realize as much in the years that followed. By 1916, he had teamed up with the better elements of the lending business to pass laws that set a standard rate of 42 percent — an eye-popping rate by today’s standard but, at the time, still progress. “It was the birth of the modern personal finance business,” Mr. Calder says.

                                                                                          It’s easy to see everything since then as a step in the wrong direction... But think about what life was like before easy money. Think about how hard it would be to buy a house or pay for college if a 42 percent interest rate still seemed normal.

                                                                                          Some of the changes are surprisingly recent. Just a generation ago, a temporary setback, like illness, divorce or job loss, was much more likely to force a family to take drastic measures than it is today. That’s in large measure because of debt, which allows families to smooth out the rough edges of their financial lives. ...

                                                                                          Mortgages are a big part of this story. ... If you take out a mortgage today, you’ll pay thousands of dollars less in upfront fees than you would have in the mid-80s. ... Home buyers who know they’re going to live in their house for only a few years now also have the ability to get an interest rate that reflects their situation. The 30-year fixed-rate mortgage isn’t the only game in town.

                                                                                          Of course, people in the mortgage business ... like to argue that the current problems are mere footnotes compared with all the progress. They are wrong about that. The excesses were real, and they were big. We’re still figuring out just how big.

                                                                                          The solution will have to involve new guidelines, voluntary or government-imposed, that force lenders to be clearer about the terms they’re offering borrowers. But as long as we take tough measures to clean up the mess, we’ll end up with a healthier mortgage market than we had beforehand. And then we can go looking for the next form of debt to captivate and torment us.

                                                                                          If we decide to go the regulatory route, I'm not sure that forcing "lenders to be clearer about the terms they’re offering borrowers" is the solution. The story that borrowers did not understand the terms of their loans doesn't ring true to me, though I have no real evidence one way or the other and may have to change my mind about that. It seems more likely to me that buyers were overly optimistic about prices continuing to rise, the ability to rent condos and other investment properties to tenants, to believe whatever they needed to believe to justify the purchase.

                                                                                          I think there is a market failure here, an asymmetry in the information that buyers have relative to the information possessed by real estate agents and lenders. When the lender tells the buyer that the rental rate on condos is 86%, or whatever, buyers cannot easily verify these claims and the claims are likely to be believed, especially when the buyer wants to believe. These numbers and others like them that are overly optimistic end up on the loan papers and are ultimately used to justify the loan's approval. Perhaps an examination of the quality of the data being used to justify some of these loans and more stringent guidelines as to what is and what isn't acceptable would be a place to start. A situation where, for example, it's common knowledge that the amount listed as income on many high-risk loans is inflated isn't optimal. The shake-out in the industry going on right now will cure some of the excesses, but the even so the regulation of these markets needs to be reexamined.

                                                                                          But I think we have to be careful not to be overly restrictive and inadvertently prevent worthy buyers from purchasing a home, and therefore I'd err on the side of too many rather than too few loans when thinking about regulating these markets. However, with reality-based, verifiable, and reasonable guidelines in place, having lenders deny loans when borrowers cannot meet the conditions is better than expecting buyers to turn down their dream house when it's dangled in front of them.

                                                                                          Update: Caroline Baum's view is different. She is pushing Congress to take a hands-off approach saying people took the risks and this is what happens, or, in her words, "Early indications from Congress are that fingers will be pointed at everyone except constituents." See "Government Is 'Here to Help' Subprime Borrowers."

                                                                                            Posted by on Wednesday, March 21, 2007 at 03:33 AM in Economics, Financial System, Regulation | Permalink  TrackBack (1)  Comments (57)


                                                                                            Robert Samuelson: Global Warming Has Gone Hollywood

                                                                                            I don't have time to say much about this, but here it is anyway:

                                                                                            Global Warming Has Gone Hollywood by Robert Samuelson, Washington Post: "[W]e need to solve the climate crisis. ... We have everything we need to get started, with the possible exception of the will to act. ...' -- Al Gore, accepting an Oscar for "An Inconvenient Truth''

                                                                                            Global warming has gone Hollywood, literally and figuratively. The script is plain. As Gore says, solutions are at hand. We can switch to renewable fuels and embrace energy-saving technologies, once the dark forces of doubt are defeated. It's smart and caring people against the stupid and selfish. Sooner or later, Americans will discover that this Hollywood version of global warming (largely mirrored in the media) is mostly make-believe.

                                                                                            Most of the many reports on global warming have a different plot. Despite variations, these studies reach similar conclusions. Regardless of how serious the threat, the available technologies promise at best a holding action against greenhouse gas emissions. Even massive gains in renewables (solar, wind, biomass) and more efficient vehicles and appliances would merely stabilize annual emissions near present levels by 2050. The reason: Economic growth, especially in poor countries, will sharply increase energy use and emissions.

                                                                                            The latest report came last week from 12 scientists, engineers and social scientists at the Massachusetts Institute of Technology. Called "The Future of Coal,'' the report was mostly ignored by the media. The report makes some admittedly optimistic assumptions: "carbon capture and storage'' technologies prove commercially feasible; governments around the world adopt a sizable charge (aka, tax) on carbon fuel emissions. Still, annual greenhouse gas emissions in 2050 are roughly at today's levels. Without action, they'd be more than twice as high.

                                                                                            Coal, as the report notes, is essential. It provides about 40 percent of global electricity. It's cheap ... and abundant. It poses no security threats. Especially in poor countries, coal use is expanding dramatically. ... By 2030, coal use in poor countries is projected to double and would be about twice that of rich countries (mainly the United States, Europe and Japan). Unfortunately, coal also generates almost 40 percent of man-made carbon dioxide (CO2), a prime greenhouse gas.

                                                                                            Unless we can replace coal or neutralize its CO2 emissions, curbing greenhouse gases is probably impossible. Substitution seems unlikely simply because coal use is so massive. ...

                                                                                            Carbon capture and storage (CCS) is a bright spot: catch the CO2 and put it underground. On this, the MIT study is mildly optimistic. The technologies exist, it says. ... But two problems loom: First, CCS adds to power costs; and second, its practicality remains suspect until it's demonstrated on a large scale.

                                                                                            No amount of political will can erase these problems. If we want poorer countries to adopt CCS, then the economics will have to be attractive. Right now, they're not. Capturing CO2 and transporting it to storage spaces uses energy and requires costlier plants. Based on present studies, ... the most attractive plants with CCS would produce almost 20 percent less electricity than conventional plants and could cost almost 40 percent more. Pay more, get less -- that's not a compelling argument. ...

                                                                                            [T]here are no instant solutions, and a political dilemma dogs most possibilities. What's most popular and acceptable (say, more solar) may be the least consequential in its effects; and what's most consequential in its effects (a hefty energy tax) may be the least popular and acceptable.

                                                                                            The actual politics of global warming defy Hollywood's stereotypes. It's not saints versus sinners. The lifestyles that produce greenhouse gases are deeply ingrained in modern economies and societies. Without major changes in technology, the consequences may be unalterable. Those who believe that addressing global warming is a moral imperative face an equivalent moral imperative to be candid about the costs, difficulties and uncertainties.

                                                                                              Posted by on Wednesday, March 21, 2007 at 03:24 AM in Economics, Environment | Permalink  TrackBack (0)  Comments (25)


                                                                                              Tuesday, March 20, 2007

                                                                                              The 1601 Elizabethan Poor Law

                                                                                              After the post on poorhouses, this description of the 1601 Elizabethan Poor Law was suggested by email:

                                                                                              The 1601 Elizabethan Poor Law, by Marjie Bloy: ...After the Reformation ..., it became necessary to regulate the relief of poverty by law. During the reign of Elizabeth I, a spate of legislation was passed to deal with the increasing problem of raising and administering poor relief. [Here are some key historical dates in the years prior to the 1601 law followed by discussion of the law:]

                                                                                              Continue reading "The 1601 Elizabethan Poor Law" »

                                                                                                Posted by on Tuesday, March 20, 2007 at 09:04 PM in Economics, Social Insurance | Permalink  TrackBack (0)  Comments (4)


                                                                                                Thomas Palley: Memo to Fed: Cut Rates, then Reform Policy

                                                                                                Thomas Palley sends an email saying:

                                                                                                Hi Mark,

                                                                                                Given that the FOMC kiicked off its two day March meeting today, I thought your readers might be interested in this take on monetary policy.

                                                                                                And here it is. I hold different opinions on some of these issues - I would guess we would disagree on both implicit and explicit inflation targeting - but that shouldn't prevent other opinions from appearing here:

                                                                                                Memo to Fed: Cut Rates, then Reform Policy, by Thomas I. Palley: The US economy is showing signs of a potentially rapid deceleration. In particular, there is accumulating evidence that the housing sector slowdown may be becoming a meltdown. In many areas house prices are falling, house sales are down nationally, and mortgage delinquencies and foreclosures are rising - especially in the sub-prime market. This has caused tremors in broader financial markets. The only good news is employment and wages continue growing, but labor markets conditions are also widely viewed as a lagging indicator.

                                                                                                This sobering picture argues for the Federal Reserve to immediately start lowering interest rates. Additionally, the Fed must come to grips with the problem of debt-financed asset inflation, which lies behind the current housing bust. That calls for deeper policy reform.

                                                                                                An important element of the case for lower interest rates is the fact that the tightening effects of earlier rate increases continue building because of the long lags with which monetary policy works. Consequently, conditions are still tightening despite the fact the Fed has been on hold since June 2006.

                                                                                                One lag concerns adjustable rate mortgages whose interest rates are adjusted annually. That means rates on these mortgages have been rising throughout the year despite the Fed’s rate pause, and they will continue rising for borrowers whose rates are scheduled to be reset in the next three months. A similar mechanism holds for mortgages with initial low teaser rates and mortgages with one-time reset clauses that trigger after a fixed period.

                                                                                                Meantime, the spillover effects from the housing sector’s problems are growing. Increased delinquencies and defaults have caused belated tightening of credit standards, which promises to make mortgages more expensive and difficult to obtain. That will reduce the number of homebuyers and also make re-financing more difficult.

                                                                                                Increased defaults also mean more foreclosures, which will further lower home prices. Currently, this impact is concentrated in lower priced homes served by the sub-prime market. However, price reductions can be expected to ripple into contiguous parts of the market, making re-financing more difficult for those owners and even causing additional defaults.

                                                                                                Lastly, declining home prices and tightening credit standards will diminish mortgage equity extraction, as is already happening. Since such cash outs have been an important factor supporting robust consumer spending, this augurs weaker future spending.

                                                                                                In addition to lowering interest rates, the Fed must also address two problems calling for deeper policy change. First, Chairman Bernanke’s close identification with inflation targeting has created something of a bind. Though the Fed has no official inflation target, it has allowed market opinion to settle on the idea of an implicit two percent target. With inflation stubbornly stuck above two percent, this means a rate reduction could dent the Fed’s credibility.

                                                                                                This confirms former Chairman Greenspan’s view that inflation targeting would adversely limit the Fed’s flexibility and discretion. The clear implication is that inflation targeting is a bad idea, and the Bernanke Fed should now distance itself from that idea by abandoning chatter about inflation targeting.

                                                                                                A second problem is that a rate reduction could trigger renewed debt-financed asset inflation, which highlights a major dilemma. If the Fed pushes rates too high in its attempt to choke off wider inflationary effects of asset inflation, it risks triggering a credit crunch and defaults as is now happening. Conversely, if it does not push rates high enough it risks triggering accelerated inflation as agents borrow more in anticipation of rising prices. This implies a knife-edge situation, with the economy being held hostage by asset speculation.

                                                                                                One solution is quantitative regulation extending the system of margin requirements to asset classes such as mortgages. This would enable the Fed to vary the cost of those assets without changing interest rates, thereby damping speculation without imposing collateral damage on the rest of economy.

                                                                                                As a graduate student, Chairman Bernanke wrote about how the Great Depression was fostered by a cascade of bank failures that rippled through the financial system. It would be ironic if he were now to preside over his own financial crisis. Moving promptly to lower rates and enacting policy reform that gives the Fed new tools for controlling asset inflation seems a good way to lessen that likelihood.

                                                                                                  Posted by on Tuesday, March 20, 2007 at 01:34 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (16)


                                                                                                  Greenspan Eggs and Ham

                                                                                                  I do not like Greenspan eggs and ham! I do not like them, Bernanke-I-am. But the organizers of this charity auction are hoping somebody might:

                                                                                                  Going, going, gone: one expensive breakfast with Greenspan, AFP: Deep-pocketed bidders battled Tuesday to win a coveted meeting with former Federal Reserve chairman Alan Greenspan, one of a constellation of stars on offer in a charity auction. ... Breakfast or tea for up to four people with Greenspan and his wife, NBC correspondent Andrea Mitchell, carried an estimated value of 5,000 dollars.

                                                                                                  But that would be small change to any Wall Street type keen to get an insight into the thinking of a man who ... still has the power to move markets. ... Bidding ... ends on April 6.

                                                                                                    Posted by on Tuesday, March 20, 2007 at 01:31 PM in Economics, Monetary Policy | Permalink  TrackBack (0)  Comments (0)


                                                                                                    IRS Agents Say There's Pressure to Close Corporate Tax Cases

                                                                                                    David Cay Johnston reports on pressure IRS agents are feeling to end corporate cases prematurely so that managers can meet case load goals and receive bonuses:

                                                                                                    I.R.S. Agents Feel Pressed to End Cases By, David Cay Johnston, NY Times: The head of the Internal Revenue Service faces questions in Congress today about auditors’ complaints that they are being forced to close corporate cases prematurely, allowing billions in tax dollars to go unpaid. ...

                                                                                                    The agency countered that it had increased the number of companies whose tax returns it examined by a fourth since 2001, even though the number of auditors was virtually the same. ... [T]he officials say they have shortened the average time to complete an audit from almost two years in 2001 to less than 18 months last year.

                                                                                                    I.R.S. officials say the auditors who are complaining are mostly older agents unwilling to adopt new approaches. ... Deborah M. Nolan, the I.R.S. official in charge of auditing businesses with more than $10 million of assets, said that her auditors recommended payment of almost $27 billion in additional taxes last year, more than double the amount in 2001, but down 15 percent from 2005 when added taxes totaled almost $32 billion...

                                                                                                    Asked about data showing that additional taxes recommended for each audit are up, the agents who were interviewed all said that this showed only how pervasive tax cheating had become. ...

                                                                                                    One veteran agent of the largest corporate audits compared the I.R.S. to a crew that walks through an orchard instead of working from ladders. “You can grab all the low-hanging fruit in a few highly productive hours, while leaving most of the harvest untouched,” he said.

                                                                                                    In an interview last week, Ms. Nolan ... reiterated her position that the agency would “do the right thing” by keeping cases open past preset deadlines when evidence points to large amounts of tax due.

                                                                                                    All 21 agents interviewed over the last two months said that the I.R.S. paid lip service to its “do the right thing” policy. They provided e-mail messages and memos in which managers and executives made little or no mention of anything but closing files quickly.

                                                                                                    In one widely circulated directive, Cheryl P. Claybough, who oversees half the audits of communications, technology and media companies, alternately encouraged and chastised subordinates for not closing cases quickly enough, while making only passing references to the “right thing” policy. ...

                                                                                                    A Feb. 1 e-mail message from Kenneth L. Kates of the audit quality assurance operation orders nine subordinates to complete their reviews of audits without mentioning quality.

                                                                                                    “We must have ten case apiece closed by 3-7-2007,” Mr. Kates wrote. “You must keep me informed and make me aware immediately if you will have any problems meeting this goal. The goal translates into two cases per week.”

                                                                                                    All of the agents interviewed said they believed that the controlling factor in determining whether their superiors qualified for cash bonuses and promotions was their success at closing cases. “How the managers get paid; that’s the real policy,” one auditor in Texas said.

                                                                                                    Only in cases of blatant fraud, agents said, are deadlines ignored. A few agents supplied e-mail messages and memos to support their statements.

                                                                                                    Two auditors described separate training sessions that began with a few words about the “right thing” policy, then focused entirely on closing cases by the preset deadlines.

                                                                                                    “What message do you think employees get when almost an hour is spent on cycle time and overage, and doing the right thing gets a brief mention?” one auditor said.

                                                                                                    One agent, who said he had worked on some of the largest I.R.S. cases, said he was admonished for resisting management pressure to close a case in which his team believed that vast sums were due.

                                                                                                    The agent said his team was forced to sign off on a closing agreement allowing the company to permanently underpay its taxes by hundreds of millions of dollars a year. When a taxpayer receives a formal closing agreement from the I.R.S. .., the taxpayer may forever follow that practice, even if it violates the tax law. ...

                                                                                                    [O]ne of the agents ... said, “in most cases management is making these decisions in order to drive case closure goals.”

                                                                                                    Over and above whatever politics might be behind this policy, this is an example of an agency problem, i.e. the problem of having the incentives of those making the decisions (cases processed) differ from the incentives needed to produce optimal public policy (tax equity and efficiency). Performance goals can work, but they have to be constructed carefully so that the incentives of decision makers are consistent with overall policy goals. Basing bonuses of managers on closed cases within a particular time frame does not appear to produce optimal corporate tax compliance policy.

                                                                                                      Posted by on Tuesday, March 20, 2007 at 02:43 AM in Economics, Taxes | Permalink  TrackBack (0)  Comments (11)